Edition 50 > November 2018

Allens Unravelled

Welcome

Dear clients and colleagues

We are celebrating something of a special occasion at Unravelled, with this being our 50th edition (and that is without counting our special editions). When we first picked up the pen, our goal was, and remains, to unravel some of the complexity in financial services regulation and promote discussion. In our first edition, back in 2014, we asked whether existing financial services regulation not only adds cost, complexity and uncertainty to financial services providers but also whether it serves the interests of those it is intended to protect. The Royal Commission seems to have provided a pretty compelling answer to our second question.

In looking over our previous Unravelleds, I noticed that we have been particularly insistent about two things: language and complexity. We think that words should mean something and that we should all say what we mean, plainly. Jargon and complexity don't help when it comes to clear thinking. And it turns out that they also have their part to play in how conflicting interests are, again according to the Royal Commission, often resolved in favour of the financial services provider.

Last week, the Royal Commission published a paper, by a US academic, Professor Sunita Sah, about conflicts of interest. In a sign of the times (behavioural economics is the discipline of the day) Professor Sah has a PhD in psychology, not law. The professor says that advisers (across a range of industries and professions) give significantly more self-serving, biased advice when they have a conflict of interest. And they do this even when they believe they are being objective and impartial. The paper describes the reasons and tactics advisers use to rationalise, excuse or deny the influence of their personal interest in giving advice. It refers to accountants who believe their expertise and professional standards are such that they can put aside their personal interest, and surgeons who think they deserve the gift from the pharmaceutical company because they have sacrificed so much for their work.

Professor Sah's paper also, somewhat alarmingly, points out that telling the client or patient about the adviser's conflict not only may not help but can make matters worse. Apparently, it can lead to increased trust (my adviser is so trustworthy that they warn me about their advice). It can also lead to a desire in the client or patient to demonstrate that they trust the adviser, despite their personal and conflicting interest (I don't want my doctor to think that I don't trust them, so I will follow their advice).

But, to return to my theme, Professor Sah's paper introduced me to a new term that explains rather nicely what turns out to be, less nicely, an experience many of us will recognise – 'ethical fading'. It describes a decision-making process in which moral issues are pushed to the background, or 'fade'. I can't help but think about how many hessian bags I have carefully collected only to bring home a rather large collection of plastic bags each time I visit the supermarket. I then went on to read a bit more about ethical fading and learned that the language we use has a big part to play with jargon and euphemisms being pressed into service so that 'the moral implications of a decision are obscured'. I was reminded of board papers I had read that referred to improved functionalities and increased optionalities for customers in support of a decision that, at best, represented a happy coincidence between the company's interests and the customer's. And then there is complexity the longer and more complicated the process, the less likely it is that anyone will remember the customer more ethical fading.

Professor Sah concludes in the paper that a person with a conflict of interest cannot be trusted – not only or even because they may act corruptly (knowingly in their own interests) but, rather, because they will do so unwittingly. It is why Lord Herschell had the following to say in Bray v Ford back in 1896, presumably without the benefit of a psychologist:

It is an inflexible rule of a Court of Equity that a person in a fiduciary position, such as the respondent's, is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule.

Lord Herschell is very likely to have concluded that, human nature being what it is, a duty to give priority when one has a conflicting interest, or to manage a conflict of interest, is no answer to protecting consumers who rely on their advisers to act in their interests when they have their own conflicting interest. It is probable that Commissioner Hayne will not think so either, and that he will recommend removing exceptions from conflicted remuneration, and banning percentage-based commissions on loans and asset-based advice fees paid from superannuation products. None of ASIC, APRA or Treasury supports legislation to undo vertical integration, but there is a chance that Commissioner Hayne might say they are also suffering from a case of ethical fading, and recommend some structural separation between financial advisers and product manufacturers. That would be a big change not only for the banks, but also for the industry superannuation funds that are building their personal advice arms.

Now, while we reckon that 50 editions is a pretty good effort, one thing we think you may have learned about the Financial Services Regulation team at Allens is that we persevere, and so we will be back with our 51st edition next month (not that we are counting). Until December.

Yours sincerely

Michelle Levy

In this edition Relevant sectors

AFCA's powers and obligations – 'systemic issues'

Written by Senior Regulatory Counsel Michael Mathieson

In his Interim Report, Commissioner Hayne rejected claims that misconduct in the financial services sector was the fault of 'a few bad apples' and did not raise 'broader or systemic concerns'. Commissioner Hayne's comments made me think about AFCA and what it can do (and must do) about 'systemic issues' identified in the course of handling complaints. Read more...

   

Relevant sectors  Relevant sectors  Relevant sectors  Relevant sectors  Relevant sectors
Relevant sectors  Relevant sectors  Relevant sectors  Relevant sectors  Relevant sectors

The ins and out (goings) of responsible lending

Written by Overseas Practitioner Craig Dewar

Very broadly speaking, current legislation relating to responsible lending says that a person must not recommend or make an 'unsuitable' loan to a consumer an unsuitable loan being one that either does not meet the consumer's requirements and objectives, or imposes repayment obligations that they are unable to meet without substantial hardship. Read more...

   

Relevant sectors
Relevant sectors

 
 

 

Meet the team
Geoff Sanders

Geoff Sanders
Melbourne

Marc Kemp

Marc Kemp
Sydney

Penny Nikoloudis

Penny Nikoloudis
Melbourne

Christopher Kerrigan

Christopher Kerrigan
Sydney

Jo Ottaway

Jo Ottaway
Melbourne

Belinda Thompson

Belinda Thompson
Melbourne

Simun Soljo

Simun Soljo
Sydney

 

Meet the team
Michelle Levy

Michelle Levy
Super and Wealth
Sydney

Geoff Sanders

Geoff Sanders
Super and Wealth
Melbourne

Michael Mathieson

Michael Mathieson
Super and Wealth
Sydney

Marc Kemp

Marc Kemp
Funds
Sydney

Penny Nikoloudis

Penny Nikoloudis
Funds
Sydney

Karla Fraser

Karla Fraser
Banking
Brisbane

James Darcy

James Darcy
Banking
Melbourne

Belinda Thompson

Belinda Thompson
Regulatory investigations
Melbourne

Malcolm Stephens

Malcolm Stephens
Funds
Sydney