Interim Report – financial advice
Written by Partner Michelle Levy and Senior Regulatory Counsel Michael Mathieson
Although the Commissioner says that the Royal Commission is part of the executive and not the judiciary and that he is therefore not able to make any findings of law, he comes pretty close in his views in response to Round 2. And in some important respects, those views do not correspond with conventional views.
The Commissioner looks at the financial services licensee's obligation to manage conflicts of interest and then at the best interest duty and duty of priority that apply to the adviser under FoFA. Rather unexpectedly, he says that the duty of priority is no more than a restatement of the duty to act in the best interests of the client. When taken together, the two provisions (the licensee's obligation to manage conflicts and the adviser's duty to give priority) presuppose that conflicts of interest are 'managed' by giving priority to the client's interests. It is clear that the Commissioner thinks that this just doesn't work in practice.
As to what the client's interests are – Commissioner Hayne is very clear: 'the interests of the client are to obtain the best financial advice reasonably available … if the advice is to acquire a financial product, it is in the client's interests to obtain the best product: best in the sense that it is fit for purpose but best in the sense also that it is the cheapest and (as far as can reasonably be determined) the best performing product available.' The emboldening is ours because we think it is fair to say that not only does this interpretation not correspond with the interpretation adopted by most advisers and licensees, but it also departs from the conventional legal view that the best interests duty is concerned with process, and not outcome or the merits of the advice. Although later in the Report, the Commissioner does acknowledge that the formulation of the adviser's duties in FoFA – 'as amplified in the legislation' – appear to require no more than that the adviser 'do no harm' to the client rather than to 'do what is best'. But ultimately he does not appear to accept this formulation, or if he does, he says it is not sufficient.
In either case, the Commissioner's views will present a very real challenge for advisers with limited (or single product issuer) approved product lists, which is a point that has not been lost on the Commissioner.
The Commissioner describes the adviser's interests as being: 'to further his or her own career and to maximise financial reward and that the licensee's interest is to maximise profit. Where an adviser is employed by, or aligned with and acts on behalf of, a principal who manufactures or sells financial products, the adviser's interests (and the principal's) will be advanced by persuading a client to acquire one of the principal's products.'
And it is this irreconcilable conflict, Commissioner Hayne suggests, that is at the heart of the misconduct and failures to meet community standards explored in Round 2 of the hearings. Commissioner Hayne says that a regime (FoFA) that permits the management of conflicts by requiring an adviser to prefer the client's interests to their own, in circumstances where advisers and licensees continue to 'stand to benefit financially from clients acting on the advice that is given', is never going to work. Since regulating conflicts has not worked in practice, he asks whether the law should be amended to require conflicts to be eliminated.
Commissioner Hayne points to the survival of grandfathered commissions, the continued payment of commissions for life insurance and the phenomenon of vertical integration as the chief culprits. Our money is on the Commissioner recommending that both grandfathered commissions and commissions on life insurance be banned. (The adage that life insurance is not bought but sold does not seem to resonate with him.) There is also a suggestion that he may recommend against the use of balanced scorecards where they include any revenue component. As to vertical integration – we are not prepared to call it – but the Report does note that the structure of financial services industries in other jurisdictions has been and is the subject of legislative intervention.
Fees that were paid to advisers for services that were not provided was, even the most casual observer will have noticed, a significant aspect of the Round 2 hearings. Leaving aside the largely admitted misconduct, Commissioner Hayne appears to have been puzzled and surprised by the industry-wide practice of product issuers paying advice licensees ongoing fees for services at all. Focusing it appears on (non-super) investment platforms, he asked whether the client (investor) should be required to expressly authorise those payments (by implication a tick on an application form is not in the Commissioner's view sufficient) and whether express authorisation of ongoing fees should be required more frequently than every two years and should also apply to 'grandfathered' clients (investors).
He also queries the value of ongoing advice at all and, while the Report does not say anything directly about the superannuation round, there is a hint here that he may query whether superannuation trustees should ever pay ongoing advice fees from a superannuation fund.
The Commissioner ends this part of his Report with a series of questions, with the most difficult (in our view) being: how can licensees improve the quality of their advisers' advice, can conflicts of interest and duty be managed, should product manufacturers be permitted to provide financial advice, should advisers be permitted to recommend or sell a product issued by their related party, should any part of an adviser's remuneration be asset-based or dependent on sales, and should platform operators be permitted to deduct fees on behalf of licensees without the express authority of the client (investor)?