Financial advice: State of play post Royal Commission
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) handed down its recommendations to the public on 4 February 2019. Since then, the Government and regulatory bodies have moved to acknowledge and address the issues raised in the Royal Commission report.
This blog looks at some of the main recommendations relating to financial advice, all of which have been supported by the Government. Before considering those recommendations, it is important to understand the framework through which the Commissioner viewed the industry. The Commissioner contended that the financial advice industry was in a state of ‘incomplete transformation’ into a profession – but was missing a number of key features and required significant change before it could be deemed a profession.
The guiding principles followed when making Commissioner Hayne’s determinations included:
1. Obey the law.
2. Do not mislead or deceive.
3. Act fairly.
4. Provide fit for purpose services.
5. Deliver services with reasonable skill and care.
Overall the Commissioner identified three areas of concern:
1. Fees for no service - the Commissioner highlighted what he believed was a fundamental misunderstanding that financial advisers had in relation to the difference between a commission and a fee, which has led to the creation of the ‘fee for no service’ issue. The Commissioner did not accept the charging of fees for no service was accidental, a processing error or oversight.
2. Poor financial advice - the primary concern of the Commissioner related to conflicts of interest resulting in poor financial advice.
3. Lack of a consistent disciplinary system - the report also advocated the need for a stronger, more coherent disciplinary scheme which removes the challenges ASIC faces, namely that the existing disciplinary arrangements for financial advisers are fragmented and hampered by inadequate sharing of information.
The following 8 recommendations sought to address these areas of concern and we explore below their potential impacts on the industry.
RECOMMENDATION 2.1 – ANNUAL RENEWAL AND PAYMENT
“Ongoing fee arrangements (whenever made):
• must be renewed annually by the client;
• must record in writing each year the services that the client will be entitled to receive and the total of the fees that are to be charged; and
• may neither permit nor require payment of fees from any account held for or on behalf of the client, except on the client’s express written authority to the entity that conducts that account given at, or immediately after, the latest renewal of the ongoing fee arrangement. “
The Commissioner took issue with current ongoing service arrangements, as services to be provided under those arrangements were so loosely defined that they had little or no substantive content beyond a promise to speak to the client once each year. The mere offer of a review was deemed insufficient to justify a service fee. References are drawn to section 1041G of the Corporations Act 2001 (in relation to dishonest conduct) as fees were charged without any proper basis. Also, there was concern over the ‘invisible’ nature of fee payments made directly from investments.
1. The Government agreed with the recommendation noting that these changes will help ensure that clients actively consider whether they are benefiting from ongoing fee arrangements.
2. APRA and ASIC issued a joint letter in April 2019 requiring RSE Licensees to review their governance arrangements in respect of the oversight fees and other charges being deducted from members' superannuation accounts for payment to third parties such as financial advisers.
What it Means
Advice firms should review their fee disclosure statements and consider providing annual opt-in arrangements, as no grandfathering is expected to apply under the pending legislation. Ongoing service agreements will need to be clear and measurable, and systems will be required to track what was actually delivered relative to what was promised, with a view to periodically processing refunds as appropriate. System changes will also be needed to automatically turn off advice fees within product structures if they are not expressly re-authorised, as specified in legislation.
AFS Licensees should review their business models and fee structures more broadly in light of the findings of the Royal Commission, and seek advice where necessary.
RECOMMENDATION 2.3 - QUALITY OF ADVICE REVIEW
“In three years’ time, there should be a review by Government, in consultation with ASIC, of the effectiveness of measures that have been implemented by the Government, regulators and financial services entities to improve the quality of financial advice. The review should preferably be completed by 30 June 2022, but no later than 31 December 2022. The review should consider whether it is necessary to retain the ‘safe harbour’ provision in section 961B(2) of the Corporations Act. Unless there is a clear justification for retaining that provision, it should be repealed. “
1. The Government agreed with the review. It further agreed that it is appropriate to undertake the review following the implementation of the recently legislated Financial Adviser Standards and Ethics Authority (FASEA) requirements.
What It Means
There is a need for greater focus by AFS Licensees on the quality of advice being provided in advance of the Government review and consideration should be given to expanding the scope of independent reviews of statements of advice. The outcomes of these reviews can be used to tailor internal adviser training programs and uplift adviser capabilities, in addition to the professional development, examination and education activities required under the FASEA regime.
AFS Licensees should also complete their assessments of the education requirements for individual advisers relative to the FASEA pathways and oversight the completion of outstanding activities by advisers.
RECOMMENDATION 2.4 – GRANDFATHERED COMMISSIONS
”Grandfathering provisions for conflicted remuneration should be repealed as soon as it’s reasonably practicable”.
1. The Government agreed to end grandfathered commissions by 1 January 2021. Any conflicted remuneration received after that date will have to be rebated back to clients. Volume-based rebates are expected to be reflected in lower fees for all impacted clients. The Ending Grandfathered Conflicted Remuneration Bill 2019 was passed in the House of Representatives on 10 September 2019.
2. ASIC will monitor and report on implementation of change from 1 July 2019 to 1 January 2021, and this has already commenced.
What It Means
Advice firms will need to consider the impact on their business including remuneration structures and valuations, with a view to determining their future business arrangements. Consideration also needs to be given to implementing processes to cease or rebate commission payments in preparation for the deadline prohibiting receipt.
RECOMMENDATION 2.5 – LIFE RISK INSURANCE COMMISSIONS
When ASIC conducts its review of conflicted remuneration relating to life risk insurance products and the operation of the ASIC Corporations (Life Insurance Commissions) Instrument 2017/510, ASIC should consider further reducing the cap on commissions in respect of life risk insurance products. Unless there is a clear justification for retaining those commissions, the cap should ultimately be reduced to zero.
1. The Government supported this recommendation.
What It Means
Advice firms need to review their business model for providing insurance advice and consider the impact on business valuations.
Noting the current underinsurance issues in Australia, adjusting the system to a user pay model may mean that the people who can least afford to pay will not get the benefit of advice and will either opt for inferior products or elect no cover at all.
RECOMMENDATION 2.7 – REFERENCE CHECKING AND INFORMATION SHARING
“All AFSL holders should be required, as a condition of their licence, to give effect to reference checking and information‑sharing protocols for financial advisers, to the same effect as now provided by the ABA in its ‘Financial Advice - Recruitment and Termination Reference Checking and Information Sharing Protocol’.”
1. The Government agreed with mandating reference-checking protocol.
What It Means
Advice firms need to review the ‘Financial Advice – Recruitment and Termination Reference Checking and Information Sharing Protocol’ available on the Australian Banking Association (ABA) website and consider changes to their HR practices to comply with the protocol.
RECOMMENDATION 2.8 – REPORTING COMPLIANCE CONCERNS
“All AFSL holders should be required, as a condition of their licence, to report ‘serious compliance concerns’ about individual financial advisers to ASIC on a quarterly basis.”
Commissioner Hayne suggested the following definition: “Serious compliance concerns are where the licensee believes, and has some credible information in support of the concerns identified, that a financial adviser may have engaged in dishonest, illegal, deceptive and/ or fraudulent misconduct or any misconduct that, if proven, would be likely to result in an instant dismissal or immediate termination; or deliberate non-compliance with financial services laws or gross incompetence or gross negligence.”
1. The Government agreed to mandate reporting of ‘serious compliance concerns’.
What it Means
Advice firms will need to implement additional monitoring and reporting processes to fulfil their obligations to ASIC, with a greater focus on the activities of individual advisers.
RECOMMENDATION 2.9 – MISCONDUCT BY FINANCIAL ADVISERS
‘All AFSL holders should be required, as a condition of their licence, to take the following steps when they detect that a financial adviser has engaged in misconduct in respect of financial advice given to a retail client (whether by giving inappropriate advice or otherwise):
• make whatever enquiries are reasonably necessary to determine the nature and full extent of the adviser’s misconduct; and
• where there is sufficient information to suggest that an adviser has engaged in misconduct, tell affected clients and remediate those clients promptly.”
1. The Government agreed with the AFSL condition. The recommendation is in line with increased ASIC powers as part of the ASIC Enforcement Review.
2. The Government created the Australian Financial Complaints Authority (AFCA), a consolidated body to respond to complaints across the financial service sector.
3. The Government introduced the Treasury Law Amendment (AFCA Co-operation) Regulations requiring all compulsory AFCA members to take reasonable steps to co-operate with AFCA.
4. The Government extended AFCA's remit to consider financial complaints dating back to 1 January 2008.
What It Means
Advice firms will need to build out their oversight frameworks to better monitor advisers, identify and fully investigate issues, and remediate clients as required.
AFS Licensees should review their practices against RG 256 Client review and remediation conducted by advice licensees and ensure that review and remediation is taken as efficiently as possible where misconduct is identified.
RECOMMENDATION 2.10 – A NEW DISCIPLINARY SYSTEM
“The law should be amended to establish a new disciplinary system for financial advisers that:
• requires all financial advisers who provide personal financial advice to retail clients to be registered;
• provides for a single, central, disciplinary body;
• requires AFSL holders to report ‘serious compliance concerns’ to the disciplinary body; and
• allows clients and other stakeholders to report information about the conduct of financial advisers to the disciplinary body.“
1. The Government agreed to introduce a new system.
2. FASEA recently released a Code of Ethics, which all financial advisers will need to comply with from 1 January 2020. Any new disciplinary body would need to operate consistently with the arrangements for applying and monitoring the Code.
3. ASIC is in the process of approving code monitoring bodies which all financial planners will need to sign up to in late 2019.
What it Means
This measure will place more individual responsibility on advisers, but will also require AFS Licensees to implement additional monitoring and reporting processes to fulfil their obligations to the new disciplinary body. This has the potential to increase regulatory levies depending on the funding model.
In respect of the FASEA Code of Ethics, AFS Licensees should review and update their conflict of interest procedures and other policy frameworks to ensure alignment and incorporate relevant tests into their ongoing processes for advice file reviews.
The Government released its Implementation Roadmap on 19 August 2019 which summarises the actions taken to date across all 54 of the 76 recommendations arising from the Royal Commission that were directed to the Government, and the legislative changes planned to be implemented by end 2020. The vast majority are intended to be implemented by mid 2020.
While the recommendations relating to financial advice present substantial work for the industry, and there is a long way to go to rebuild consumer trust, the changes underway appear to be a step in the right direction.