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Royal Commission 1: How the tone was set

Commissioner Kenneth Hayne and the Counsels Assisting, Rowena Orr QC and Michael Hodge QC, are doing a fine job at the Financial Services Royal Commission. Their ability to interrogate witnesses under oath, forcing the truth, the whole truth and nothing but the truth, has focussed the minds of financial executives in a much sharper way than a chat with ASIC. It delivers ‘gotcha’ moments every day.

The headlines feature fees imposed on dead people, fees-for-no-advice and a cost of 25% of a super balance to transfer to an in-house fund. But more important, Kenneth Hayne has already decided the “chief challenge” is removing sales as a factor in remunerating financial advisers. The key is the link between advice and products. His team is also asking a lot of questions about percentage-based fees and promoting in-house products, and the entire vertical integration model is under fire.

The whole truth?

I have listened to at least a dozen hours of evidence and read many transcripts. While there’s a level of "truth" coming out, is it really “the whole truth”? The Commission has accused witnesses of obfuscation, misleading statements and dissembling. For example, no witness is saying the reason the majors fought for retention of commissions under FOFA was to make more money.

It shouldn’t have taken a Royal Commission to reach the truth. Under section 1308(2) of the Corporations Act, it is a criminal offence for any person to give "false or misleading" statements to ASIC. AMP’s admission that it made 20 “false and misleading” statements to ASIC has become one of the Commission’s flash points.

When the two weeks of evidence into financial advice started on 16 April 2018, most of the first morning was consumed by the impressive Rowena Orr outlining what she intended to show over the coming days. Anyone due to give evidence would have experienced sleepless nights. Before any witness hit the stand, she outlined some of the issues:

“The adviser misconduct covered by these notifications included improper use of customer funds, misleading conduct concerning advisers’ qualifications or authorisations, falsifying customer or compliance documentation, deliberate overcharging of fees, provision of poor quality advice, and failures to comply with disclosure obligations.” 

That was for just for starters. The major banks and AMP were each highlighted for wrongdoing, dispelling the argument that advice problems were due to ‘a few bad apples’.

False and misleading statements

On the second morning, 17 April 2018, Michael Hodge (MH) spent hours taking Anthony 'Jack' Regan (JR), Group Executive for financial advice, through a quagmire of AMP transgressions, counting them off until he reached 20. It became so ridiculous that Jack Regan himself actually added an extra one with an embarrassed laugh:

MH: Well, the suggestion is, first, that a letter went to the client telling them that they needed to contact the external provider?

JR: We know that didn’t occur in all cases.

MH: And that didn’t occur. And second, that the reason then that the fees kept being paid was because the client hadn’t contacted the external provider and AMP hadn’t checked?

JR: That’s correct.

MH: And I think that takes us to 17 false or misleading statements, by my count, Mr Regan?

JR: Well, are you counting that as one or two?

MH: I only counted that as one. Do you think I should count that as two?

JR: I think in fairness, Mr Hodge, you should.

MH: Okay. The 18th false or misleading statement by AMP to ASIC.

Putting shareholders ahead of complying with the law

Clearly, the Commission wanted AMP to admit it had placed profits and shareholders ahead of complying with regulations and its fiduciary duty to clients, and Michael Hodge nailed it.

MH: What we seem to be seeing is that a conscious decision is made to protect the profitability of AMP at the expense of complying with AMPs licence. Do you agree?

JR: Yes, that’s – I believe that’s what that shows, yes.

MH: You say it’s preferencing the interests of shareholders, by that, I take it, you mean at least in the short-term of maintaining the profitability of the company at the expense of complying with the law?

JR: Yes, that’s correct.

MH: Is it in the long-term interests of AMP shareholders for AMP to be maintaining its profitability at the expense of complying with the law?

JR: It is not.

A brief FOFA recap and buying Count Financial at the top of the market

The history of the Future of Financial Advice (FOFA) legislation is essential background and reveals the messy politics that now burdens the Government. Cuffelinks has previously published summaries of FOFA, including this excellent piece by Harry Chemay in 2014.

I worked at Colonial First State (CFS) for a decade until 2012, first as a Consultant then as a General Manager. Although I had no responsibility for financial advice (thank you! thank you!), it dominated conversations at General Manager weekly meetings for many years. Millions of dollars of executive and consultant time were spent on FOFA, starting with a response to the Ripoll Inquiry in 2009. FOFA proposals on conflicted advice and best interests duty were released by the Labor Party in April 2010, the Bill was passed in June 2012 and the law became effective from 1 July 2013. That date receives regular references at the Royal Commission, because it coincides with the ‘grandfathering’ or retaining of commissions paid to advisers (Grandfathering is explained in the next article in Cuffelinks).

Throughout these years, executives with responsibility for financial advice sat on external committees and visited lobbyists and politicians hoping to retain the ability to pay commissions to advisers to sell CFS wealth products. It was the rationale for the vertically-integrated structure: advice, platform and funds management under one owner. The peak of CBA's commitment to driving all parts of the value chain was the purchase of the advice business, Count Financial, in August 2011 for $373 million. According to those close to the deal, the financials depended on Count advisers selling CFS products, but the dream was killed by FOFA.

Inability to defend the vertical integration model

When the Coalition was elected in 2013, it set out to repeal Labor’s FOFA laws. However, the Government led by Mathias Cormann could not get the numbers in the Senate, and the ban on conflicted remuneration and best interest duty remained. Over the next few years, problems at Commonwealth Financial Planning and Storm Financial surfaced, and CBA started to incur massive reputational damage from its advice channels. Other banks exited parts of their wealth management businesses as the dreams of vertical integration started to fall apart.

Combined with other scandals in financial services, these events laid the foundations for the Royal Commission. The Commission has run day after day exposing the weaknesses of the vertical integration model, and not one bank executive has been able to defend it. ASIC’s Peter Kell argued the model is fundamentally conflicted, saying ASIC’s evidence was that most of the bank-owned advice businesses did not operate in the best interests of the customer. It is now widely expected that the Commission's findings will lead to new regulations further compromising the profitability of the model that was once the future of banking and advice.


Graham Hand is Managing Editor of Cuffelinks.

April 27, 2018

Advisers are always in a difficult position. With the exception of cases of outright fraud or deception, advice is only "bad" in retrospect.
Perfectly good advice can still have bad outcomes as all advice is based on assumptions that may not hold.
A severe long-term market downturn market will make all previous advice to hold or buy share-related investments look "bad" when, in most cases, it was simply good advice de-railed (possibly only temporarily) by unexpected external events.

Most of the problems we're hearing about are attributable to executives and remuneration schemes rather than advisers and their ethics. But if the end result is more intense regulation for what is already an over-regulated industry, the good independent advisers will find it harder to survive as compliance costs soar and advice becomes even more expensive for clients.

Garry Mackrell
April 26, 2018

The discussion around fees is also always contentious.
Just as with Loans and deposits, if you try to charge on a marginal/fully absorbed cost plus basis, and apply this to the size of each transaction sum, the effective margin or % fee will vary enormously. The small punter will scream and accuse the service provider of offering low margins for bigger customers.

Alternatively, if it is a flat $ fee for the same service the small punter will still scream!

If you only charge for the upfront service, then I can guarantee there will be no service on an ongoing basis, as there is no incentive to do so.

I am glad I am retired!

Garry Mackrell
April 26, 2018

Graham, I thought the following article by Stephen Bartholomeusz was a thoughtful insight into some of the possible pros and cons of advice models going forward.
I am not sure so-called “independent” advice will be as guileless or as inexpensive or as riskless as people may think will occur.
One example - Scale v non-scale business models are always a major economic challenge, as is regulatory oversight.
I think John Leske’s idea of aligned and non-aligned has solid economic logic but I suspect the need for bloodletting will work against that.

To me, there is always going to be a misalignment of expectation between what people hope to achieve with their investment decisions and what they actually achieve.
Unlike the purchase of products and services which are consumed immediately and hence provides immediate feedback,the value of financial advice can only be gauged after the elapse of considerable time.
As nobody can predict the future, the advice may have been sound but not achieve the objective, or could have been faulty but successful.
Everybody is wise after the event and the weaknesses self evident.
Regulators then build systems to prevent the last disaster, but which probably help create the next one.

Regards Garry.

April 26, 2018

I'm not sure FOFA was entirely to blame for the problems with CBA's acquisition of Count. Even without FOFA, the idea of Count advisers switching from, say, BT Wrap to a CBA equivalent was overly optimistic. Count advisers operate essentially independently, making it a tough ask to coerce them into changing product/platform provider. It was always unlikely, regardless of FOFA. Unfortunately, the business case assumed outcomes that few people thought were realistic.

Removing "sales" incentives from the planning process is certainly the "chief challenge", as identified in the article. But this is not a problem unique to financial planning. It's an example of the more general problem of obsession with (supposedly) measurable KPIs which almost inevitably leads to perverse outcomes. This happens to varying degrees across all industries, sectors, and professions, private and public.


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