09/12/2010

The Federal Government has assured institutional financial planners that they will still have a role to play under FOFA.  But the more you look at how the various proposed changes will operate, the harder it is to see how that role can work.

The Future of Financial Advice (“FOFA”) reform is designed to raise the bar in advisory standards and foster advisor independence.  One of its missions is to ensure that financial services licensees and their authorised representatives act not only in the best interest of their clients, but always place the clients’ interests ahead of their own.  A new statutory duty will be introduced and the remuneration structure of advisors will be drastically changed.  FOFA will significantly alter the landscape of financial planning.

The Government anticipates a future financial planning industry that will be product neutral in terms of fees and free from bias.  But we need a reality check on the reasonable step test in the application of the new statutory duty and what it entails.  That check throws up some difficulties, especially for institutional planners.

Currently, under section 945A of the Corporations Act, authorised representatives are required to have a reasonable basis for advice (having made reasonable inquiries in relation to the personal circumstances of the client) and to have established that the advice is appropriate to the client’s personal circumstances.

The “know your client” and “know your product” rules have always been the cornerstone of financial planning.  The issue of conflict of interest has largely been addressed through a system of disclosures, warnings and corporate governance. 

Under FOFA, additional standards will apply.  The system of warnings and disclosures will not be sufficient to meet the new statutory duty requirement in the management of conflict of interest, as the advisor will be required to place the interest of the clients above their own.

Under FOFA, three main proposals work hand in hand to deliver the Government’s missions to achieve the stated objectives:

• a prospective ban on conflicted remuneration structures, including commissions and any form of volume based payment;
• the requirement for retail clients to agree to the fees and to annually renew (by opting in) to an adviser’s continued services;
• the introduction of a statutory duty akin to what is called a ‘fiduciary duty’ and an obligation on advisers to take “reasonable steps” to discharge this duty.

The remuneration structure of financial planners will be completely revamped. Advisors will be banned from receiving commission or other incentive payments from product providers.  Fee for services will be adopted and payment for financial advice will only come from the clients.

Financial services licensees will also have to meet the new reasonable steps test in the discharge of the statutory duty.  The issue of advisor independence will need to be re-visited. 

Advisors who are aligned with product issuers will have a higher duty to discharge.  This is an import aspect given a recent survey which found that the big six financial planning conglomerates are placing an average of 73% of clients’ superannuation into home brands (funds run by the broader company that owns the distribution network.)

From the information released by Treasury so far, the following practical guidelines are available.

• Advisors are not expected to base their recommendations on an assessment of every product available. But the duty may require them to search beyond the approved product list or recommend that the client should see another advisor if the advisor cannot recommend a product that is in the best interest of the client.
• While the remuneration for advice will be paid for by the client and commission based remuneration will not be allowed, it is possible for institutions to pay salary to employees for advisory services. Where will bonuses sit in the scheme particularly if those bonuses are linked to in-house product sales?
• Banks and other institutions can still distribute their products.

Currently, the Government is consulting extensively with industry regarding FOFA.  The implementation of the proposals will need to be thought through carefully to avoid uncertainty.  It is also important that the “reasonable steps” requirement of the duty should be clarified so that the industry will be able to meet the new expectations and put in place procedures, governance or re-training to meet the new requirements.

The new model may represent some departure from the traditional concept of “fiduciary duty” as we understand it under the general law, given the information that has already been provided by Treasury.

A fiduciary duty is a very high duty which involves many characteristics.  In his book “Fiduciary Obligations”, the ANU legal academic PD Finn pointed out that different relationships described as “fiduciary” give rise to different rules and behaviour standards.  It is therefore not possible to define one single set of rules that apply to all fiduciaries. 

However, there are a number of characteristics of a fiduciary duty that apply across the board.  These include:

• a duty not to act for your own benefit or for the benefit of any third party but only in the interests of the beneficiaries for whom you act;
• the duty not to act capriciously or unreasonably although the fiduciary is not the final arbiter of what the best interests of the beneficiaries are; and
• the duty of good faith which includes the duty not to exert undue influence, the duty not to misuse property and confidential information and the duty to avoid conflict of interest.

Exactly which of these characteristics we will see in the new statutory duty is yet to be revealed. But if these requirements were to be strictly applied, many affiliated advisors will find it difficult to meet the high standards required including the duty to avoid conflict of interest and to act only in the best interest of the clients.  Treasury, however, has confirmed that banks and institutions will still be able to distribute their products.

The big question is how the legislation will deal with these two potentially contradictory positions: the preservation of the role of institutional planners on the one hand and the imposition of a strict statutory fiduciary duty on the other.  

If you have any questions in regard to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.