Gao, Melody --- "Shaping the future: financial advice reforms" [2016] PrecedentAULA 29; (2016) 134 Precedent 9

SHAPING THE FUTURE

FINANCIAL ADVICE REFORMS

By Melody Gao

The Future of Financial Advice (FOFA) reforms introduced a series of changes to the financial services industry in Australia. After being heavily contested and discussed between politicians, major banks, industry regulators and superannuation funds, the current provisions look to be here to stay for the foreseeable future. Now, as the FOFA requirements settle, it is time to assess the success of their implementation and impact on targeting the issues they set out to address.

In response to the report produced by the Parliamentary Joint Committee on Corporations and Financial Services in 2009 (Report),^[1] the Australian government introduced two pieces of legislation on 1 July 2012: the Corporations Amendment (Future of Financial Advice) Act 2012^[2] and the Corporations Amendment (Further Future of Financial Advice Measures) Act 2012.^[3] Together, they are known as the Future of Financial Advice (FOFA) reforms, and have brought significant changes to the face of the financial services industry.

The Report was triggered by the collapse of several high-profile financial product and service providers. The legislative intent behind the FOFA reforms was to restore consumer confidence and trust in the financial services industry by improving transparency, accountability and professional standards. These improvements would be achieved by, among other things, addressing the best interests duty, conflicted remuneration and imposing stricter disclosure and licensing requirements.

Given the extent and complexity of the FOFA reforms, this article seeks to explore the four key aspects of the reform – the statutory best interest duty, the ban on conflicted remuneration, the establishment of a public register for financial advisers, and the new licensing regime for accountants.

BEST INTERESTS DUTY

One key change introduced by the FOFA reforms is the imposition of a statutory duty requiring financial advisers to take reasonable steps to act in the best interests of their retail clients, and to place the clients’ interests ahead of their own when providing advice to retail clients (the best interest duty). Although these obligations seem obvious to professionals such as lawyers and doctors, and despite the fact that they are managing the life savings and financial security of many Australians, financial planners have not hitherto been bound by such high standards on their conduct.

The new best interest duty provisions are contained in Division 2 of Part 7.7 of the Corporations Act 2001 (Cth)^[4] (Corporations Act) and practical guidance for financial advisers on how to comply with this duty when providing personal advice to retail clients is set out in the Australian Securities and Investment Commission (ASIC) Regulatory Guide 175 (RG175), released on 13 December 2012.^[5]

The practical guidance requires financial advisers to:

• act in the best interests of their clients in relation to the advice provided;^[6]

• only provide advice to the client if the advice would reasonably be considered as appropriate to the client;^[7]

• warn the client at the same time as providing the advice if the advice is based on incomplete or inaccurate information relating to the client’s personal circumstances;^[8] and

• prioritise the client’s interests where there is a conflict between the interests of the client and the adviser’s own interests, or those of one of the adviser’s related parties or their associates.^[9] However, advisers are not required to make inquiries to determine whether a conflict of interest exists.

The FOFA reforms apply the best interests duty directly to the individual who provides the advice. Prior to the FOFA reforms, only Australian Financial Service (AFS) licensees and their authorised representatives were required to fulfil the duty. ASIC now expects individual advice providers to proactively apply measures and processes to fulfil the best interest duty.

Before discussing what measures and processes are necessary, it is important first to ask what the ‘best interests’ of a client means.

What is the best interests duty?

Neither the Corporations Act nor RG175 provide a definition for what the ‘best interests’ of the client is. However, ASIC has adopted the test of whether the client would be in a ‘better position’ according to the standard of a ‘reasonable advice provider’ and outlines the factors that should be considered in making the assessment. These factors include:

• the client’s position had they not followed the advice;

• the facts at the time the advice was provided that the advice provider had, or should have had, if they followed their obligations;

• the subject matter of the advice sought by the client;

• the client’s objectives, financial situations and needs;

• where relevant, product features that the client particularly values, provided that the client understands the cost of, and is prepared to pay for, those features; and

• if the client follows the advice, they receive a benefit that is more than trivial.

ASIC has emphasised in RG175 that the ‘better position’ standard is an objective standard for assessing the processes implemented by the advice provider in fulfilling the best interest duty. Past investment performance will not be considered in making the assessment. Therefore, advice providers are expected to exercise judgement in their dealings with clients, and must realise that a ‘one-size-fits-all’ advice model is no longer sufficient.

How do you act in someone’s best interests?

To demonstrate compliance with the best interest duty requirement, advice providers must take the following reasonable steps, as prescribed in s961B(2) of the Corporations Act:

(a) identify the objective, financial situation and needs of the client through client instructions;^[10]

(b) identify the subject matter of the advice being sought by the client, and the objectives, financial situation and needs of the client that would reasonably be considered as relevant to the advice sought on that subject matter;^[11]

(c) where it is reasonably apparent that information relating to the client’s relevant circumstances is incomplete or inaccurate, make reasonable inquiries to obtain complete and accurate information;^[12]

(d) assess whether the provider has the expertise required to provide the client with advice on the subject matter sought and, if not, decline to provide the advice;^[13]

(e) recommend a financial product after conducting a reasonable investigation into the financial products with the client’s objectives and personal circumstances and assessing all information gathered in the investigation;^[14]

(f) base all judgements in advising the client on the client’s relevant circumstances;^[15] and

(g) take any other steps that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances.^[16]

The legislative intent behind these steps is to set up minimum standards for providing advice, and hope good processes will lead to improvements in the quality of advice provided. Some of the above steps may be simpler or more demanding, depending on individual circumstances. Clearly, with s961B(2)(g) the scope of s961B(2) is further expanded to require any reasonable additional steps to act in the client’s best interests at the time of the advice.

The Corporations Amendment (Revising Future of Financial Advice) Regulation 2015^[17] (2015 Regulation) commenced on 1 July 2015 and alleviates some of the burden of s961B(2) of the Corporations Act for certain financial products. Under the 2015 Regulation, a provider is not required to undertake the steps in s961B(2)(d)^[18] to s961B(2)(g)^[19] if the subject matter of the advice sought by the client relates only to a basic banking product, a general insurance product, consumer credit insurance or a combination of those products. In order for the modified reasonable steps provisions to apply, the provider, in providing such advice, must be an agent or employee of an Australian Authorised Deposit-taking Institution (ADI), or a provider acting in arrangement with an Australian ADI under the name of the Australian ADI.

BAN ON CONFLICTED REMUNERATION

The provisions on conflicted remuneration and other banned remuneration are contained in Division 4 and 5 of Part 7.7 of the Corporations Act and ASIC Regulatory Guide 246 (RG 246)^[20] (together referred to as the ‘FOFA conflicted remuneration provisions’).

Generally, under the FOFA conflicted remuneration provisions the following parties are banned from conflicted remunerations when dealing with retail clients:

• AFS licensees and their representatives (including authorised representatives) are prohibited from accepting conflicted remunerations;^[21]

• Product issuers and sellers are prohibited from giving conflicted remuneration to AFS licensees and their representatives;^[22] and

• Employers of an AFS licensee or representative are prohibited from giving their AFS licensees or representative employees conflicted remuneration for work they carry out as an employee.^[23]

The above duties apply to both personal and general financial product advice, regardless of the channel used to communicate the advice.

What is conflicted remuneration?

Conflicted remuneration is defined in the Corporations Act as any benefit, whether monetary or non-monetary, given to an AFS licensee (or its representatives) who provides financial product advice to retail clients that, because of the nature of the benefit or the circumstances in which it is given, could reasonably be expected to influence the choice of financial product recommended or the financial product advice given, to a retail client.^[24] Examples of conflicted monetary benefits may include commissions and volume-based payments, and examples of non-monetary benefits may include hospitality-related benefits and marketing assistance, depending on the circumstances under which such benefits are given.

Section 963B and s963C of the Corporations Act set out the circumstances under which a benefit is not considered to be conflicted remuneration. One example of such circumstances is when a benefit is given to a licensee or representative in relation to the issue or sale of a financial product to a person. Certain financial products are also exempt from the conflicted remuneration provisions, such as basic banking products^[25] and general insurance products.^[26]

Benefits authorised by the client may in certain circumstances be an exception to the ban on conflicted remuneration where the retail client has given clear consent to a benefit being given. According to ASIC’s view, consent will be ‘clear’ consent if it is genuine, express and specific. In putting this principle into practice, affected parties should consider establishing processes and procedures to obtain retail clients’ clear consent regarding such benefits. The 2015 Regulation further clarifies ASIC’s position in administering this exception and indicates that it is not sufficient for a clear consent to be sought if it is sought as a part of a broad range of terms and conditions agreed by the client in aggregate. A clear consent may expressly be sought, however, in a separate and distinct section of the terms and conditions agreed by the client.

A breach of the FOFA conflicted remuneration provisions will occur if ASIC makes a determination that a benefit is conflicted remuneration. In making its determination, ASIC will assess the substance of the benefit over its form and consider the overall circumstances in which the benefit is given or accepted. This includes, but is not limited to, the business structure of the AFS licensee or representative, the type of financial advice provided and the types of products to which the advice relates.^[27] A list of factors that ASIC will consider in making the determination is set out in RG 246.53.

Breaches of the FOFA conflicted remuneration provisions will result in civil and/or administrative sanctions. ASIC has indicated that disclaimers, renaming conflicted remuneration, or contracting out of complying with these provisions, will not limit the scope and applicability of the FOFA conflicted remuneration provisions. ASIC expects affected entities to undertake a wholesale review of payment structures, delivery channels, and performance-based benefits for employees who provide advice to retail clients. For most affected entities, establishing a new regulatory procedure for obtaining retail clients’ authorisation, and preparing relevant disclosure documents, will become crucial in being FOFA-compliant.

FINANCIAL ADVISERS REGISTER

On 31 March 2015, ASIC launched the new Financial Advisers Register – a public register for all advisers providing personal financial advice to retail clients on investments, superannuation and life insurance as a measure to improve transparency and accountability in the financial sector.

The Financial Advisers Register contains detailed information that allows clients to verify the credentials, licensing status, work history, any previous sanctions or bans, and qualifications and professional memberships of their financial planner or adviser. Employers will also be better able to assess the suitability of new financial advisers by using the Financial Service Register to check the work history of new planners. They will also be able to conduct reference checks with previous employers, addressing the ‘bad apple’ issue that is regularly raised when financial planners are exposed for misconduct and poor advice. As the administrator of the register, ASIC now enjoys greater ability to identify and monitor financial advisers through the Financial Advisers Register and aims to use this tool to improve overall professionalism in the industry.

Excluded from the current scope of the register are financial advisers who provide general advice only, to retail clients and wholesale clients, or who provide personal advice to wholesale clients. Nor are financial advisers who provide personal advice on basic banking products, general insurance products, consumer credit products or a combination of any of the above to retail clients or wholesale clients included in the register. The legislative intent behind the above exclusion is that the register is intended to be a tool for retail consumers, not for professional or institutional investors.

THE NEW LICENSING REGIME FOR ACCOUNTANTS

Two recent inquiries – the Financial System Inquiry, and an Inquiry by the Parliamentary Joint Committee on Corporations and Financial Services – have revealed the inadequacy of the current regulatory arrangements with regard to professional standards. To restore public confidence in the industry, the FOFA reforms has introduced stricter requirements for financial advisers to raise the professional, ethical and educational standards in the industry. One of these measures is the removal of the accountant’s exemption from holding an AFS licence in providing advice regarding self-managed superannuation fund (SMSFs) by 1 July 2016.

Under the current regime, accountants are allowed to provide financial advice regarding SMSFs without an AFS licence. The FOFA reforms remove this exemption for accountants from operating under an AFS licence, meaning that accountants will be unable to provide advice on SMSFs without holding an AFS licence in their own right or being an authorised representative of another AFS licence-holder. This change will take place on 1 July 2016, and any accountants who continue providing SMSF advice without appropriate licensing after this date will be in breach of the Corporations Act.

Recognised accountants who apply before 30 June 2016 will be able to take advantage of the transitional arrangements where less onerous requirements apply. The transitional arrangements have been developed by the federal government to ease the requirements for recognised accountants applying for limited AFS licences by imposing lower competency requirements. Applicants who apply after 1 July 2016 must be mindful of the stricter requirements for the experience and knowledge of the nominated responsible manager, as set out in ASIC Regulatory Guide 105 (RG105).

Holders and applicants of a limited AFS licence must also be aware of the requirements to hold appropriate professional indemnity insurance and be members of an approved external dispute resolution scheme.

CONCLUSION

The FOFA reforms are complicated and have changed various aspects of the financial service sector. Understanding the four key aspects of the reforms is a good start in becoming FOFA-compliant or helping your client to become FOFA-compliant. Independent reviews are important in the post-commencement period to identify practical challenges and problems in implementing FOFA-compliant policies and procedures. Further reforms (and updated ASIC regulatory guidance) are to be anticipated in the medium term, so it is important to ensure that your clients are meeting current requirements so that they are well-placed to adapt to any future legislative changes.

Melody Gao is a lawyer with Sophie Grace Pty Ltd in Sydney, specialising in financial services law. PHONE [phone] EMAIL [e-mail].

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^[1] Parliamentary Joint Committee, Inquiry into Financial Products and Services in Australia (2009).

^[2] Corporations Amendment (Future of Financial Advice ) Act 2012 (Cth).

^[3] Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 (Cth).

^[4] Corporations Act 2001 (Cth).

^[5] ASIC Regulatory Guide 175, Licensing: Financial Product Advisers – Conduct and Disclosure.

^[6] Corporations Act, s961B.

^[7] Ibid, s961G.

^[8] Ibid, s961H.

^[9] Ibid, s961L.

^[10] Ibid, s961B(2)(a).

^[11] Ibid, s961B(2)(b).

^[12] Ibid, s961B(2)(c).

^[13] Ibid, s961B(2)(d).

^[14] Ibid, s961B(2)(e).

^[15] Ibid, s961B(2)(f).

^[16] Ibid, s961B(2)(g).

^[17] Corporations Amendment (Revising Future of Financial Advice) Regulation 2014 (Cth).

^[18] Corporations Act, s961B(2)(d).

^[19] Ibid, s961B(2)(g).

^[20] ASIC Regulatory Guide 246, Conflicted Remuneration.

^[21] Corporations Act ss963E, 963G and 963H.

^[22] Ibid, s963K.

^[23] Ibid, s963J.

^[24] Ibid, s963A.

^[25] Ibid, s963D.

^[26] Ibid, s963B(1)(a).

^[27] ASIC Regulatory Guide 246, RG 246.51.

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