The Royal Commission and financial planners - what's going on?

Jul 2018

Round 2 of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has examined the financial planning industry. The hearings finished in April, and concluded with some damning recommendations made by counsel assisting.

While we don’t yet have any findings from Round 2, one thing is for certain: the Commission has already had an impact. Numerous officeholders have departed from leading Australian companies, financial planning and wealth management businesses are being sold off, and class actions foreshadowed. 

Context 

The Royal Commission comes five years after the introduction of the initial measures of the Future of Financial Advice (FOFA) reforms which amended the Corporations Act 2001 (Cth). These reforms introduced from 1 July 2013:

  1. A prospective ban on conflicted remuneration structures such as commissions and volume based payments. Despite the ban being prospective, some entities have chosen to implement it on existing clients’ accounts. Some banks were criticised during the Commission for not doing the same;
  2. A statutory duty for financial advisers to act in the best interests of their clients. This involves taking ‘reasonable steps’ to place a client’s interests ahead of their own;
  3. An opt-in obligation that requires advice-providers to obtain their clients’ agreement to ongoing fees every two years. 

The Commission investigated four broad areas, and recommendations were made which may result in findings that could impact the provision of financial advice for years to come. 

1.  Fees for service

During the Round 2 hearings, members of the financial services industry acknowledged that between 2007 and 2015 some clients were charged fees for services that were not provided in whole or in part. The reasons for charging fees in such circumstances included:

  1. Businesses choosing to do so despite not providing the full services; 
  2. Administrative errors; or
  3. Misconduct on the part of advisers. 

Some banks have refunded over $100 million to clients that had been incorrectly charged as fees. Financial institutions’ reputations and share prices have suffered following revelations of fees being charged for services not provided.  

The Commissioner is expected to make findings on:

  1. Whether ongoing service arrangements are beneficial to clients; and 
  2. Whether grandfathered commissions should cease. 

 

The industry keenly awaits the outcome. In the meantime, members of the industry would be advised to:

  1. Ensure that the fees they are charging concern services actually provided. Already some institutions are going beyond their legal obligations and ending existing grandfathering arrangements. This means that large numbers of clients no longer have to pay fees such as trailing commissions that were implemented before the FOFA reforms came into effect;
  2. Consider their internal audit processes so that clients paying fees for little or no service can be identified; and
  3. Difficult as it would be, consider a review of the governance and remuneration structure of the whole organisation, to ascertain whether the organisation has a culture which tolerates (or even encourages) conduct that is to the financial advantage of the organisation but to the detriment of clients.  

2. Investment platform fees

The Commission also scrutinised the use of platforms, which hold various investments in one place and provide a centralised reporting system that is administratively attractive to advisers. ‘Vertical integration’ occurs when the investment products are created, sold and promoted on the one platform. 

Problems can arise when these platforms are vertically integrated because:

  1. They can result in layers of fees being charged at each level; and
  2. In-house advisers can be given volume incentives to promote the platform’s products which may not be in their clients’ best interests. 

The Commission investigated the vertical integration of platforms with banks and wealth managers and found that:

  1. Platform fees are sometimes deducted from clients’ accounts without the client opting in to pay ongoing advice fees as required by law. If the accounts have insufficient funds, some entities can liquidate the non-cash investments to meet the fees; and
  2. The charging of ‘uncompetitive’ fees and the use of volume rebates does not encourage investment in the clients’ best interests. 

The vertical integration model has historically proven to be profitable, but this profitability has waned and is likely to be further reduced subject to the outcome of the Commission.

3. Inappropriate financial advice and improper conduct by financial advisers

The Commission’s investigations into inappropriate advice and improper conduct could prompt large numbers of dissatisfied clients to make complaints about the advice they have received. 

The Commission examined two case studies in which bank-affiliated advisers were said to have given advice which was in breach of the Corporations Act, inappropriate and not in their clients’ interests, and which was conceded by the banks to arguably amount to misconduct. 

In one instance counsel assisting the Commission argued that the bank’s remuneration scheme encouraged the generation of revenue for the entity, rather than the provision of appropriate advice, and the bank did not have a system in place to identify advisers who presented a high risk to clients. 

Industry members may need to prepare themselves for findings from the Commissioner which recommend legislative changes regarding the remuneration of advisers. Internal compliance issues, such as identification of potential risks to clients, are also the subject of submissions by industry members, and likely to be the subject of findings or recommendations by the Commissioner. 

4. The disciplinary regime 

The Commission also examined the adequacy of the prevailing disciplinary processes in the financial advice industry.  The Commission considered case studies which demonstrated potential failings in the current systems.   

Of particular interest were case studies involving Dover Financial Advisers, which acquired authorised representatives despite failing to:

  1. Conduct reference checks of new authorised representatives in a timely fashion; and 
  2. Properly investigate where matters had been disclosed to Dover that arguably ought to have caused it to take further steps before authorising the person.  

The Commission also heard evidence about the role of ASIC and industry associations (the Financial Planning Association (FPA) and the Association of Financial Advisers (AFA)) in disciplinary processes and the adequacy of the current disciplinary systems.  

The Commission heard that while the FPA and the AFA have the capacity to expel members, there is no requirement for financial planners to be members of those associations, meaning planners are able to leave associations to avoid their sanctions, but continue operating as financial planners. This renders the FPA and the AFA relatively ineffective when it comes to preventing repeated breaches by financial planners.   

We expect the Commission to make findings on the present disciplinary system and whether changes are required to reduce the incidence of misconduct. 

What’s next 

The fourth and final round of hearings concluded on 6 July 2018 and the Commissioner is authorised to submit an interim report no later than 30 September 2018, and will provide a final report by 1 February 2019. In the meantime, the financial advice industry has some time to consider how to best meet its clients’ needs and demonstrate to the public that it is deserving of its trust. 

Various banks are already selling their advice businesses, which may resolve some of the issues examined by the Commission. This may, however, also result in increased fees for advice to compensate for the loss of commissions. In any event, the increasing costs and highlighted risks of obtaining financial advice could be enough to discourage investors from remaining in the advice market for some time to come.

This article may provide CPD/CLE/CIP points through your relevant industry organisation.