Unless the obvious 'elephant in the room', the product/advice conflict, is addressed head on, any attempt to respond to the Royal Commission’s exposure of poor behaviour and inappropriate advice with more legislation is likely to continue to prove costly and ineffective.
The 'best interests' protections in the current legislation skirt around the issue and have already failed to prevent the selling of inappropriate products by advisers linked to product manufacturers. A fatal flaw is the reliance on 'reasonableness' to test various aspects of 'acting in the best interests of the client'.
'Reasonableness' is simply too low a standard when account is taken of the diverse range of skills and knowledge possessed by financial planners. There is no industry consensus on what body of knowledge all planners should subscribe to or what is regarded as best practice on the many aspects of personal finance.
Doctors provide a model for financial advisers
Medicine has had a long history of grappling with issues of professionalism and the separation of product from advice. The AMA’s 'Position Statement on Doctors’ Relationship with Industry 2010' potentially provides a model for the personal finance industry. Replacing 'doctor' with 'financial planner' (and other appropriate substitutions) in Section 3 of their Position Statement sets a standard for financial advice:
3.1 The major principles guiding [financial planners’] relationships with industry include the following:
- The [financial planner’s] primary obligation is to the [client]. Considerations involving industry are appropriate only insofar as they do not intrude or distort that primary obligation;
- The primary objective of relationships between [financial planners] and industry should be the advancement of the [financial] health of [clients];
- [Financial planners] must maintain their professional autonomy (bold added), [advice] independence and integrity. Relationships between [financial planners] and industry must not compromise [financial planners’] professional judgement or ability to act in their [clients’] best interests
- The [client’s] [financial] health needs should be the primary consideration when utilising products and services;
- [Financial planners] should manage potential conflicts of interest appropriately so as to maintain the public’s trust and confidence in the [financial planning] profession. Appropriate management may include, but is not limited to, timely and honest disclosure of relevant relationships with industry to [clients], peers, ethics committees, and others in a transparent and accountable manner as well as eliminating the potential for conflicts of interest to develop.
Adoption of Section 9.2 would require:
[Financial planners] in practice should not ask for or accept a fee, loans, or equivalent consideration from industry in exchange for seeing them in a promotional or similar capacity.
The notion that a doctor could be employed or authorised to practice by a pharmaceutical company, for example, would be regarded as outrageous by both the medical profession and the public (although we know dubious practices still occur, showing it is impossible to remove all rogues from any industry).
Until advice is effectively separated from product, either by legislation or self-regulation, consumers cannot be confident that the requirements of the product manufacturer are not unduly influencing the advice.
Future directions and practical next steps
I am not naive enough to believe that separation along the lines that exists between doctors and industry will occur immediately. Although desirable in the long term, in the short term it would be very disruptive for product manufacturers to disband their large distribution networks.
A better alternative is to make a legislative distinction between aligned (to a product manufacturer) and non-aligned advisers. Key aspects of this distinction could include the following:
- Aligned advisers would be required to clearly state and have acknowledged by clients the nature of their alignment and that their advice may conflict with the best interests of the client i.e. no 'best interests' duty. They should also be required to inform potential clients of the existence of non-aligned advisers and their 'best interests' obligation.
- Aligned advisers would not be able to call themselves 'financial planners' or 'financial advisers', but something along the lines of 'financial product sales consultants' or 'financial services agents'. The titles 'financial planner' and 'financial adviser' would be strictly defined.
- Non-aligned advisers would have a general 'best interests' duty to clients, that need not be as prescriptive as currently.
- Much of the current compliance, disclosure and reporting requirements would be removed for non-aligned advisers, enabling them to reduce the cost of advice and service a much wider market.
- 'Assets under management' fees would be abolished for both aligned and non-aligned advisers. Fees would be charged on an hourly basis or on an agreed retainer basis. These fees should be tax deductible.
- Both aligned and non-aligned advisers would be required to disclose the annual costs in dollar and percentage terms of all charges paid by clients for financial services provided, arranged and managed by the adviser, including advice, administration, fund manager, loan and personal risk insurance costs. Also, standard illustrations of those charges should be provided to potential new clients so valid cost comparisons can be made at the time of choosing an adviser. This requirement would serve to nullify any under-pricing or subsidising of advice by product manufacturers to position themselves to win product-related business.
Non-aligned advisers would meet ASIC’s current definition of independence. Under the existing regime there is little to be gained from complying with this definition. There is no regulatory relief and the potential marketing advantage is drowned out by the noise of the large product manufacturers and their aligned advisers. Our experience is that without education most consumers, to their detriment, are not aware of the difference between an independent and non-independent adviser.
If the distinction is enhanced, along the lines proposed above, it is likely that more Australians will see non-aligned advisers as value for money sources of quality objective financial advice and acting only in clients’ best interests when recommending third party product solutions. Also, it may help to drive change within the advice industry, with more aligned advisers being attracted to the non-aligned space.
Given the proposed level of legislative support, it is possible to see how the fledgling non-aligned advisers could over time potentially evolve into a true profession, developing a relationship with industry not unlike that of doctors. The role of advisers could be restricted to advice with referrals to trusted brokers for product placement, enabling an adviser to look after many more clients at significantly lower cost than currently is the case.
In summary
My views are driven by a belief that financial product manufacturers should have a very limited role (if any) to play in the provision of financial advice to consumers. Their overriding reason for providing financial advice is to facilitate the sale of product, rather than seeing advice as the core business.
The resulting conflict of interest, together with confused consumers, will almost inevitably lead to future misselling disasters. Legislating 'best interest' and a focus on financial literacy are band-aid solutions that do not reach the heart of the problem.
As in the provision of medical services, financial advice needs to be separated from product to increase the chances that providers of advice are intrinsically driven by their clients’ welfare.
John Leske is a Principal of Wealth Foundations. This article is general advice only as it does not take into account the objectives, financial situation or needs of any particular person.