Pearls and Irritations

 The long-suffering consumer of financial services has plenty to be pleased about thanks to sweeping industry reforms. The initiatives mark the end of a gravy train culture and a renaissance in genuinely independent financial advice. They are reforms, however, of which the majority of financial planners and their clients are largely unaware.

Commissioner Kenneth Hayne examined some 10,000 submissions and conducted seven (very) public hearings to arrive at 76 recommendations addressing this problem of trust in financial services. Some of those recommendations have already been implemented by the government, and almost all of the rest will be underway before the end of June 2020, although most people do not realise it.

Warning: adviser not independent

On 20 August 2019 the Federal Treasurer, Josh Frydenberg, announced that legislation will be introduced so that all financial advisers are not permitted to provide advice to a new client without first declaring whether they are classified ‘independent’ under the law – and, if not, explaining the reasons why not.

The Commissioner said conflicts of interest are “deep-seated issues” at the heart of the many instances of poor advice aired in his hearings. The Future of Financial Advice (FoFA) reforms that started in July 2013 failed to deal with conflicts of interest properly, he said, and the new FASEA standards would likewise fail. He explained that neither increased education nor better disclosure would be sufficient because the “flawed premise” that conflicts can be managed is, in fact, the real problem.

Under existing laws, an adviser is required to ‘manage’ conflicts of interest and disclose, in general terms, certain information about the advice provider. However, there is no requirement for an adviser to bring to the client’s attention the conflicts that prevent the adviser from being independent under the law.

Hayne’s Recommendation 2.2 introduces this obligation by referring to the Financial Services laws relating to independent financial advice, something that few financial advisers satisfy. For an adviser to describe his or her services as ‘independent’, ‘impartial’, or ‘unbiased’ (or even similar words such as ‘independently owned’ or ‘non-aligned’) certain conditions must be met, described in section 923A of Corporations Act. This ‘independence law’ reads like a list of the obstacles to independence:

• receiving commissions
• conflicted remuneration (such as fees calculated on the volume of business placed, also known as ‘asset fees’) and
• associations with product issuers.

Furthermore, in circumstances where an adviser might satisfy these conditions as an individual, yet the adviser’s Financial Services Licensee permits any of its other advisers to have these conflicts, the adviser still fails the independence test.

As yet unseen legislation to be introduced to Parliament by 30 June 2020 will ensure any adviser who does not meet the requirements set out above will – before providing advice – be required to bring that fact to the client’s attention and to explain, prominently, clearly and concisely, why that is so.

The end of money for nothing

The FoFA reforms were intended to improve trust in the financial services industry. Unfortunately, extensive lobbying by deep-pocketed stakeholders watered down the effect of many of its key initiatives. FoFA more accurately stands for the ‘Failure of Financial Advice’, described one writer recently.

A good example was the notion to ban ‘conflicted remuneration’. The government conceded a raft of exceptions so that eventually the definition of conflicted remuneration had more holes than a sieve. Trailing commissions in place before FoFA commenced were one of those holes. Advisers were allowed to continue receiving unearned income that ASIC says accounted for nearly one-third of their total income, an exception known as ‘grandfathered commissions’.

Hayne’s recommendation 2.4 proposed to end the grandfathered commissions and legislation introduced in August 2019 to ban grandfathered commissions passed through the House of Representatives. Next stop is the Senate where no significant opposition is expected.

Annual, In Advance Opt-In

One of the pieces of evidence tabled during the Royal Commission came to be known at the ‘Fees for No Service’ scandal, where clients were found to be paying fees, in some cases for many years, without receiving any service. The Commissioner said this had been allowed to happen because FoFA’s ‘Opt-In’ laws were ‘backward-looking’.

Under existing laws, where a client has entered into an ongoing fee arrangement with a financial adviser, the adviser must give the client an annual Fee Disclosure Statement setting out:

• the amount of each ongoing fee paid in the previous year
• information about the services that the client was entitled to receive during the previous year, and
• information about the services that the client actually received under the arrangement.

Recommendation 2.1 from the Royal Commission reverses this to an annual, ‘forward-looking’ arrangement which …

• must tell the client clearly what fees he or she will pay, and what services he or she will receive in exchange for those fees, and
• must not permit or require the deduction of fees from any account held by the client except with the client’s express written authority, which must also be renewed annually.

Frydenberg’s legislation will effectively make illegal the ongoing fee arrangements most advisers operate under. It will no longer be possible for ongoing fee arrangements to exist where the client is not engaged with his or her adviser.

Superannuation no longer a honey pot

Australians’ retirement nest egg is nearly worth three trillion dollars. Three trillion is a lot of money – that’s a 3 followed by 12 zeros. As you might expect with such a vast sum of money there are many clawing fingers keen to dip into the honey pot to extract their share of fees.

The potential for conflicts of interest is obvious. The Royal Commission heard evidence, for instance, that superannuation funds often permit members to pay for financial advice out of their super accounts. The member might, however, be seeking advice much broader than the subject of his or her superannuation assets alone.

Commissioner Hayne noted that the sole purpose of superannuation is to provide for retirement income; he put superannuation trustees on notice that where advice fees are deducted from member accounts that advice had better be limited to the superannuation itself.

However he went further in the case of the MySuper default accounts. “It’s difficult to imagine circumstances in which a member would require financial advice about their MySuper account,” he said, and with recommendation 3.2 banned any advice fees being deducted from MySuper accounts. The Commissioner further clarified with recommendation 3.3 that any advice fees deducted from any superannuation account will need to conform with the new rules about ongoing fees, captured under recommendation 2.1.

Good news for both consumers and advisers

For years now, ASIC has conducted surveillance activities consistently concluding there is an unshakeable connection between poor advice and conflicts of interest.

The good news for consumers is that genuinely independent advice will become a lot more common than it is today. For advisers, there is a real opportunity to shrug off the shackles of a gravy train culture and enjoy the respect and trust that comes with being a member of a profession.

 Daniel Brammall is President of the Profession of Independent Financial Advisers.

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