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Chapter 5
Issues raised during the inquiry
5.1
Before outlining specific regulatory concerns the committee examines two
broad issues behind the debate on the regulation of financial products and
services. The first relates to the industry's historical beginnings,
particularly the emergence of financial advisers as a sales force for product
manufacturers, which is a legacy potentially inconsistent with contemporary
expectations that financial advisers provide a professional service that meets
their clients' best interests. The sales-advice conflict frames the committee's
later examination of the effect of sales imperatives on the quality of financial
advice, and whether the current regulatory framework needs to better reflect the
expectation for professional, unbiased conduct in the industry.
5.2
The second broad issue concerns the question of whether advice about
financial products, or the financial products themselves, are responsible for poor
investment outcomes. This question is important because the answer dictates
whether the focus of regulation needs to be on improving the quality of
financial advice, or identifying and restricting the sale of poor financial
products.
5.3
The committee then canvasses various claims about deficiencies in the
current regulation of financial product advice, principally with the conduct
and disclosure-based approach to managing conflicts of interest. There were
also contributions critical of the minimal competency requirements of the
licensing regime; a lack of regulation over margin lending; and deficiencies
with professional indemnity (PI) insurance as a consumer compensation
mechanism. Suggestions for reform stemming from these concerns are contained in
Chapter 6.
5.4
The alternative view that the content of the regulatory regime requires
little or no change is also discussed in this chapter. Those advocating this
position called for recent problems in the financial services industry to be
put in perspective, claiming that inadequate regulatory enforcement has been
responsible for failing to protect investors from rogue elements giving poor
financial advice, rather than the entire regulatory system failing consumers.
5.5
Finally, the committee notes concerns about poor financial literacy amongst
consumers and discusses the extent to which the regulation of financial product
advice should intervene on this basis.
A sales or advice industry?
5.6
The financial advice industry has significant structural tensions that
are central to the debate about conflicts of interest and their effect on the
advice consumers receive. On one hand, clients seek out financial advisers to
obtain professional guidance on the investment decisions that will serve their
interests, particularly with a view to maximising retirement income. On the
other hand, financial advisers act as a critical distribution channel for
financial product manufacturers, often through vertically integrated business
models or the payment of commissions and other remuneration-based incentives.
5.7
Australian Securities and Investments Commission (ASIC) noted the
historical basis for the links between manufacturers and advisers:
Remuneration of distributors of financial products was
historically set by the product manufacturer. It was based on the value of
products sold and deducted from the amount paid by the consumer for the
product. These remuneration settings encouraged product distributors to sell
certain products.
As the market for financial advice services has grown, the
historic connection with product manufacturers and this remuneration structure
has conflicted with investors’ needs for quality unbiased advice and their
perception that this is what financial advisers provide.[1]
5.8
ASIC described the industry as still being characterised by its
distributive function:
Today financial advisers usually play a dual role of
providing advice services to clients and acting as the sales force for
financial product manufacturers. Approximately 85% of financial advisers are
associated with a product manufacturer, so that many advisers effectively act
as a product pipeline. Of the remainder, the vast majority receive commissions
from product manufacturers and so have incentives to sell products ... This
structure creates potential conflicts of interest that may be inconsistent with
providing quality advice and these conflicts may not be evident to consumers.[2]
5.9
The conflicts of interest inherent in these arrangements are currently
subject to disclosure and conduct regulation that seeks to manage these conflicts
and protect investors from poor advice, while maintaining market efficiency
(see paragraph 2.2). The regulatory framework has not compelled the industry to
shift from acting as a distribution network to providing a professional,
unbiased service. Instead, the transition from product sales to professional advice
seems to be occurring gradually as a consequence of some sections of the industry's
desire to improve consumer confidence in their services. In evidence to the
committee, MLC commented that the FSR regime does not reflect the industry's
increasing focus on advice:
It is a product-based regime. We are really moving into the
advice world and trying to rearrange the way we focus on the customer away from
the product in the conversations that are going on out there between advisers
and clients.
...
...for the last many decades the industry has been based on
product, distribution and sales of manufactured services. In the last seven or
eight years it has quite significantly changed. Now advisers are concentrating
on giving quality advice to the client; that is separate to the product
outcomes in many cases and we just need to continue that journey.[3]
5.10
Australasian Compliance Institute (ACI) noted: 'Quality financial advice
is intended to be about financial strategy and not just individual products'.[4]
The Institute of Chartered Accountants in Australia (ICAA) expressed a similar
view:
The Institute’s view is that the primary role of financial
advisers is to provide financial advisory services, the emphasis is on
providing financial advice and that the “sale” of a product is a potential end
by-product of the process. The service to the client is advice. The investing in
a investment product or setting up an insurance policy while a legitimate
outcome of the advice it is not the principal objective. Specifically the role
of the financial adviser is to provide strategic advice and this advice
revolves around personal goals and objectives, structuring, taxation, wealth
creation, wealth protection, estate planning, risk management and not the sale
of products.[5]
5.11
These comments support the view that the need for greater
professionalism and a focus on clients' interests should be reflected in a
regulatory regime that matches these objectives. That is, the tension between
the industry's dual sales and advice functions should be clearly resolved in
favour of regulations that mandate a higher level of professionalism and better
protect consumers from the negative consequences of conflicted advice. Others
argued that the present system has generally worked well for consumers and that
the entire industry should not be overhauled in response to the actions of
fringe elements. This debate is explored later in the context of the adequacy
of the regulations managing conflicts of interest (beginning at paragraph 5.24),
and the deficiencies with enforcement of the existing regime (beginning at
paragraph 5.104).
5.12
The committee notes that poor advice can have varying consequences, from
catastrophic losses to sub-optimal returns from poor investment performance or
excessive fees. Industry Super Network's submission described the varying effects
of conflicted financial advice:
The examples of Storm Financial and other collapses present
the committee and the broader community with the most egregious examples of the
effects of conflicted financial advice on the savings of Australians. However,
ISN submits that the ‘slow burn’ effect of commissions and conflicted advice on
the superannuation savings of millions of working Australians, demonstrates
that these scandals are not isolated examples of poor practice but evidence of
the “structural corruption” caused by conflicted remuneration practices.[6]
5.13
This report will consider the extent to which the sales and distribution
function of the industry is harmful to Australian investors seeking
professional advice, and the most appropriate regulatory measures to address
poor financial advice.
Poor advice or faulty product?
5.14
The other central issue relates to the question of whether poor or
catastrophic investment outcomes are due to a failure of financial advice, or the
products in which clients invest.
5.15
Financial Planning Association of Australia (FPA) suggested that
advisers and their clients can be the victims of misinformation from product
providers:
...a financial planner is there to provide advice and to
necessarily recommend a product based on what they know and what they understand
around that product at that time. Mostly those products fulfil their
obligations. They fulfil what it is they said they were going to do, but there
are instances ... where the product promised has not been delivered, and the
managed investment scheme examples are two good points. They were robust
investments where the corporate entity made certain decisions which were not
fully disclosed and were not fully understood. The financial planner was not
privy to what was going on and the company itself ended up collapsing and
taking everything with it.[7]
5.16
Boutique Financial Planning Principals Group (BFPPG) also claimed that
planners can be victims of poor products:
...a product provider can misrepresent a poorly designed
investment product, a research house can rate the product well, and a financial
planner can recommend the product to a client based on the manufacturer’s
misrepresentation and the research houses’ ratings.[8]
5.17
ASIC emphasised that it has no power to intervene to prevent people from
investing in risky or flawed products:
Consistent with the economic philosophy underlying the FSR
regime, ASIC does not take action on the basis of commercially flawed business
models. A significant feature of the recent collapses leading to investor
losses, is flawed business models, that is, models that could only prosper if
asset prices continually rose and debt markets remained open and liquid.
Responsibility for flawed business models lies with management and the board.[9]
5.18
Preventing such investment losses is the role of the financial adviser,
rather than the regulator. Indeed, most agreed that the crux of the problem is
the advice that accompanies a decision to invest in certain products. The
consequences of product failure will be greatly mitigated if the investment is
only one part of a diversified portfolio that matches the client's tolerance
for risk.
5.19
For instance, MLC argued that products are generally safe as long as
clients are advised to invest in them appropriately.[10]
CPA Australia told the committee that the regulatory focus needs to be on the
advice attached to investment products:
...products range from a simple bank account term deposit
through to some very sophisticated structured products. Those sophisticated
structured products may be appropriate for particular sophisticated investors
who have advice. Whilst there are questionable products and structures out
there, it is really about whether or not people are being put into those or
recommended those products appropriately or not. It is a question of appropriate
advice.[11]
5.20
Mr Peter Worcester of Worcester Consulting Group agreed with this view:
...the whole thing needs to be client focused. For that
client is that total mix of product appropriate? If you think about it, who
cares whether you buy share fund A, share fund B or share fund C? It is not
going to make an actual material amount of difference. But if you are geared
200 per cent in share fund A versus having 50 per cent in share fund A and 50
per cent in cash, then your starting focus is on the client issue.[12]
5.21
The committee has focussed mainly on the regulation of advice given
about investment products, rather than the products themselves. Some discussion
is given to the possibility of restricting certain kinds of products to
sophisticated investors (see paragraphs 6.166 to 6.169).
Regulatory issues
5.22
The committee received evidence suggesting that the current regulatory
arrangements are failing to protect consumers from poor financial advice and
its consequences. The following issues were of particular concern:
-
Current disclosure and conduct standards are inadequate
mechanisms for managing financial advisers' conflicts of interest.
-
The licensing system is deficient, in that competency
requirements for licensees and/or their authorised representatives are too low,
oversight of individual advisers is too diffuse, and consumers are unable to readily
identify varying capabilities.
-
Lending practices by institutions lending for investment purposes
have been below community expectations and not subject to appropriate
regulatory control.
-
Professional indemnity insurance is designed to indemnify
advisers, and is unsuitable for compensating investors that have suffered
losses as a consequence of poor advice that does not comply with the adviser's
legislative obligations.
5.23
These issues are examined below. The perspective of those who believe
the problem is one of proper enforcement, rather than the regulatory settings
themselves, is considered further on beginning at paragraph 5.104.
Managing conflicts of interest
5.24
Conflict of interest was a consistent policy concern raised during the
inquiry. Many were of the view that the existing legislative requirement to
disclose conflicts of interest and provide advice to a standard that is
appropriate to the client has not been effective. That is, the efficient
markets approach has not prevented advice conflicted by remunerative or
ownership arrangements from manifesting itself as poor quality or inappropriate
advice to consumers.
5.25
ASIC commented that the Wallis inquiry approach may no longer be
appropriate given the breadth of retail investors today:
[ASIC is] querying whether it has gone far enough in
protecting retail investors, given the important role, which was not foreseen
by the Wallis inquiry, that retail investors would play in the market. They had
not foreseen and could not have foreseen the impact that the superannuation
levy has had on investment in our markets. In that situation, you have a much
broader range of retail investors and retirees. You have groups of people who
lose money at the wrong time in their life and it is no answer to them to say:
‘Well, it was a risk, you know. There was disclosure. You should have read the
disclosure statement.’ The fact is that they cannot easily come back into the
workforce.[13]
5.26
ASIC's submission added:
While increased intervention could impact on market
efficiency, the benefits it will deliver, in terms of increased investor
protection from loss and increased investor confidence causing retail investors
to re-enter the market, may outweigh the costs...[14]
5.27
Australasian Compliance Institute told the committee that efforts to
ensure affordable advice should be balanced against the need for investor
protection:
The remuneration model for financial advisers is acknowledged
as problematic and potential conflicts of interest that may be present in the
model are often justified on the basis of making the advice affordable for
consumers, who would not be able to or perhaps not want to pay upfront the
‘real’ cost of the advice.
However, many of the investors currently receiving advice may
be considered some of the most vulnerable in the market (i.e. they have a low
understanding of the market and its various products and are heavily reliant on
the advice they receive) and so considerations for their protection are
important.[15]
5.28
The debate about the effect of remuneration and ownership-based conflicts
was extensive, and is included in the following section of the report. The
committee then outlines evidence to the inquiry on the effectiveness of
disclosure and conduct regulations in managing these conflicts.
Remuneration-based conflicts
5.29
A significant conflict of interest for financial advisers occurs when
they are remunerated by product manufacturers for a client acting on a
recommendation to invest in their financial product. There are a number of ways
in which advisers can be remunerated directly or indirectly by product
manufacturers for their clients' financial decisions. They include:
-
trail commissions charged at ongoing intervals (usually annually)
as a percentage of assets;
-
up-front commissions charged as a percentage of the initial
investment;
-
volume bonuses and sales target rewards; and
-
'soft dollar' incentives.[16]
5.30
These payments place financial advisers in the role of both broker and
expert adviser, with the potentially competing objectives of maximising
remuneration via product sales and providing professional, strategic financial
advice that serves clients' interests. The committee received considerable
evidence on the nature and effect of these conflicts, including on the quality
and cost of advice, and whether it is possible for them to be managed
appropriately.
5.31
In their submission, ASIC described the conflicts associated with
commission-based remuneration. They noted that it can lead to advice that is
not in the best interests of the client:
Commission payments can create real and potential conflicts
of interest for advisers. They could encourage advisers to sell products rather
than give strategic advice (e.g. advice to the client that they should pay off
their mortgage), even if this advice is in the best interests of the client and
low risk. Commissions also provide an incentive to recommend products that may
be inappropriate but are linked to higher commissions. Higher commissions might
be provided for selling higher-risk products, perhaps because other advisers
are unwilling to sell these products due to the high risk (e.g. Westpoint).
Products that might be in the interests of the client but do
not generate a high commission return (such as industry superannuation funds)
might not be recommended to clients.[17]
5.32
Industry Super Network wrote:
The dominant remuneration structure in the financial advice
industry remains based on a commission or asset based fee payment made by a
product provider to the financial adviser.
While notionally a payment for advice, asset based fees are a
de facto sales commission. Currently, the way that most financial advisers are
remunerated means that their interests are more closely aligned with the sales
and distribution function of large financial institutions than with their
clients.[18]
5.33
They provided the committee with a comprehensive list of the problems
associated with commissions:
ISN submits that commission based fees are problematic
because they:
-
Cause a conflict of interest because the adviser is paid by the
product provider not the client, and so will only be paid for recommending a
certain product and receives payment only after a recommendation is implemented
-
Are often combined with other conflicted remuneration structures
such as shelf fees and volume rebates
-
Are anti-competitive in the sense that products with higher
commissions are favoured; good products which do not pay a commission will
seldom be recommended even if they are superior.
-
Are economically inefficient in the sense that they are not tied
to the provision of a quantity of advice – commissions are paid irrespective of
ongoing provision of advice services.
-
In some cases commissions lead to bad advice because they
encourage the planner to steer consumers into strategies which inflate their
investments or exposure, to increase up front commissions (for example, the
gearing strategies used in the Storm cases)
-
Are difficult for consumers to understand; this reduces the
capacity for consumers to compare prices or to digest the financial impact that
commissions have on their investments
-
Are more erosive on retirement savings and other investments than
one off advice fees (the longer term the investment, the more erosive
commissions are)
-
Are designed to suit the business models of financial advisers,
rather than serve the needs of the client.[19]
5.34
Q Invest commented that remuneration-based conflicts have been
practically difficult to manage:
It is indeed a truism that “No man can serve two masters” –
and this is more so in the financial planning industry. As an industry,
financial advisers are at a crossroad and each of us needs to honestly decide:
Who is our master – the client or the product issuer? Experience has shown us
that attempting to serve both places the financial planner in an untenable
position.[20]
5.35
CHOICE claimed that commission-based remuneration encouraged advisers to
churn clients through investment products to generate the maximum amount in
fees.[21]
5.36
Not all evidence to the committee regarding commissions was negative,
though. Some argued that the conflicts commissions create can be managed and
that consumers should be able to make an informed choice about the remuneration
model that suits them, particularly when seeking affordable payment structures.[22]
Commonwealth Bank of Australia (CBA) stated that commissions subsidise the cost
of advice:
Research commissioned by Colonial First State suggests that
it costs advisers an average of $3,570 to produce a full service financial
plan. However, few investors, in fact around just 3% of superannuation members
who had recently switched super funds, were prepared to pay this amount.
This reality results in subsidies being employed to ensure
that consumers have sufficient access to advice. These subsidies take many
forms and may include commissions and other payments by product manufacturers
to either independent or aligned advisers; salaries paid to advisers employed
by product manufacturers, including superannuation fund providers, or
associates of product manufacturers and ownership of dealer groups by product
manufacturers, superannuation funds or associates. These subsidies are present
in most types of product/adviser relationships, including the retail investment
and superannuation markets and the industry and public sector superannuation
fund markets.
The presence of subsidies provides net benefits to consumers
by enabling the provision of cost effective advice.[23]
5.37
Other contributions also sought to emphasise that alternative
remunerative structures are also capable of creating perverse incentives. Professional
Investment Services claimed that:
...conflicts are inherent both directly and indirectly across
the different remuneration methodologies, including instances like salaried
advisers. There are conflicts associated with all the different types of
remuneration methods, even to the extent that on an hourly fee base, if you
have not dealt with lawyers or accountants over time where you think they have
pushed the hours out to get greater fees, then I am sure you have not lived.[24]
5.38
AXA's submission included a similar view:
...fee for service charged on the basis of time has in some
sectors resulted in unnecessary servicing. On the other hand, fixed fees can
lead to under servicing and performance based fees can lead to unnecessary
risks being taken.
Ultimately, what is important is that customers understand
and direct the costs they pay for advice, administration and products, both
upfront and ongoing. Effective disclosure is essential to this.[25]
5.39
This debate is explored further in the following chapter, starting at
paragraph 6.54, in the context of proposals to ban commission-based
remuneration.
Ownership conflicts
5.40
The other conflict of interest for advisers stems from the relationship
between product manufacturers and the adviser's licensee. Specifically, advisers
who are authorised representatives of licensed advisory groups owned by product
manufacturers in a vertically integrated business model are conflicted.
5.41
Industry Super Network noted the dominance of large vertically
integrated financial institutions in the financial planning industry:
These large conglomerate institutions typically own all
aspects of the financial services value chain from banking, wholesale funds
management, product manufacture, administration and retail distribution
including financial planning. The bulk of the financial planning industry is
concentrated in the hands of relatively few institutions. Rainmaker Information
reports that 73% of adviser groups are institutionally owned, if taken by
adviser numbers, or 78% if taken from funds under advice. Many financial
institutions operate a number of different sub-brands within their groups...
5.42
They added:
The institutional ownership of the bulk of financial planning
dealerships is significant because it reinforces the concern that financial
advisers are compromised by the commercial imperative of selling and
distributing the products manufactured by their parent or related party
organisations.[26]
5.43
ASIC commented on the practice of re-branding aligned financial advisers
and noted that 'consumers might not appreciate that they are getting advice
from an adviser that is owned by a product manufacturer'.[27]
On the disclosure requirements regarding ownership they said:
In 2008, ASIC conducted a review of branding disclosure of 35
bank or institutionally-owned advisers and found that while advisers disclosed
the relationship in the FSG as required by the Corporations Act, the information
was often not prominently disclosed.[28]
5.44
BFPPG noted:
Institutionally owned (or partly owned firms) such as Garvan,
owned by National Australia Bank; Hillross, owned by AMP; BT, owned by Westpac;
Ipac, owned by AXA etc, form the major portion of the industry. These firms
serve as the distribution arm for their owners’ products. Where the firm is not
wholly owned by an institution there are usually financial arrangements in
place that favour the distribution of the institution(s)’ products. A key objective
for the relevant institutions is to generate funds under management.[29]
5.45
They suggested that a client being unable to recognise ownership bias is
a 'bigger, and more subtle problem' than that created by commissions.[30]
5.46
ACI stated:
Our members would ... question whether a company that issues
a product should be licensed to provide personal financial advice to existing
and prospective clients for just its own product and if in this instance this
could genuinely be considered “advice”.[31]
5.47
Others claimed that the conflicts of interest associated with vertically
integrated product/advisory models are outweighed by the benefits to consumers.
For example, Investment and Financial Services Association (IFSA) commented
that:
...while vertical integration in the financial services
industry is common, and undoubtedly gives rise to potential conflicts of
interest, it is important to also consider the significant benefits that
consumers receive from this integration, namely:
-
Strong risk management – through imposing standards
consistent with those across the group;
-
Security – through more substantial capital backing;
-
Economies of scale – through a larger organisation with
more capital and purchasing power;
-
Accessibility – through more efficient processes supported
by other parts of the group; and
-
Affordability – often vertically integrated businesses are
able to cross-subsidise other parts of their business, reducing costs for
consumers that access those subsidised services.[32]
5.48
ING Australia commented:
While we understand that institutional ownership of advice
groups brings with it an obvious conflict of interest, we believe the benefits
of this structure outweigh an appropriately managed conflict...
ING Australia believes that institutional ownership of
financial advisory firms can assist in ensuring quality advice by providing the
operational framework, expertise and support (both financial and professional).
Large institutions are less likely to put at risk their reputation and brand
and they have the scale and resources to ensure that their products and
services meet a very high standard and comply with their legal obligations.[33]
5.49
AMP also emphasised the consumer protection associated with this model:
As an integrated organisation AMP is better able to ensure
consumer protection through higher standards of training, monitoring and
supervision than the minimum standards prescribe. AMP is also vigilant in
protecting its brand and reputation in the event of a failure in process.[34]
5.50
Guardian Financial Planning also suggested that the backing of large
financial institutions offered clients protection:
Financial institutions have the structures in place to ensure
compliance with regulations, legislation and other internal checks, including
business values. The outcome is that institutions tend to look after their
brand and their customers. That sees advisers aligned to institutions protected
and governed by explicit policies around hiring practices, supervision and
compliance, education and professional development.
The other critical element is capital backing. In those
instances where the checks and balances fail institutions stand behind their
mistakes. Having deep capital reserves adds another layer of protection for
consumers.[35]
5.51
BFPPG responded as follows:
It has been argued that there is an inherent weakness in
small independent AFSLs because of a lower level of capital adequacy. In fact
the most often quoted reason for using a small independent AFSL is the
advantage of advisor independence, and typically the experience and personal
service that goes with being small. Consumers see these important factors as
being greater than the disadvantage that these businesses are less highly
resourced and less capitalized.[36]
5.52
Highlighting recent poor practices from large licensees with a reputation
to protect, they noted:
The small AFSL often has family assets supporting the
business, works longer hours, takes a lower level of income to build the
business and has a closer and more personal relationship with clients.
Reputation is even more important for the small AFSL because of the positive
impact of referrals to the business from client advocates and the negative
impact of one mistake that can put them out of business.[37]
Disclosure
5.53
Evidence to the committee strongly suggested that the current disclosure
requirements had not been an effective tool for managing conflicts of interest.
5.54
One problem is that the present arrangements enable or encourage
licensees to take a risk-averse approach to compliance, rather than providing
disclosure material that is focussed on informing consumers. In their
submission ASIC noted that disclosure documents are often lengthy and complex,
reflecting the nature of the products and providers' all-encompassing approach
to legislative compliance. Such material is unlikely to serve informed
decision-making where consumers are disengaged or unable to comprehend it.[38]
5.55
FPA suggested that excessive disclosure and the expense that accompanies
it was a consequence of the industry's risk-averse approach to complying with
FSR:
...financial services reform scared the pants off the whole
financial planning industry and has led everyone to over-comply, to over-advise
and to over-disclose in order to protect the most critical thing a financial
planner and their licensee have—that is, their reputation. As I was going to
mention earlier, this has created a real fear factor. We are continuously
debating rigorously with ASIC on the interaction between principles based
regulation, which we all support, and the black and white letter of the law,
which is sometimes needed to try and understand what the principles are. So in
an effort to deliver principles based regulation, which we continue to support,
there have been grey areas: what is the difference between general and personal
advice? What is limited personal advice? What is scalability of advice? What is
the difference between a statement of advice, a record of advice and a
statement of additional advice? These poor people sit there trying to
deliberate while they service their clients. What they end up with is a one
size fits all, highly costly, overregulated but very complying system.[39]
5.56
Argyle Lawyers also told the committee that disclosure had become too
compliance-focussed:
...compliance documents that currently exist have become a
mechanism for the licensee ensuring that it has met the act and will not breach
the law rather than providing consumers with the ability to make an informed
decision and make choices. The classic example of that is the statement of
advice, which is 125 pages long and that nobody is going to read.[40]
5.57
BFPPG also described the risk-averse approach to disclosure:
The requirements relating to SOAs have skewed advice so that
emphasis is now on the protection of the financial planner against all possible
future problems and then the production of those long, complicated SOAs in the
most efficient manner. In other words, if in doubt, put it in the SOA – the
result has been over complicated and extremely long SOAs that are of little
value to the client. In addition, the cost of producing them in an efficient
manner has put an unnecessary financial strain on financial planners and made
the provision of simple one–off advice more costly.[41]
5.58
They argued that the motivations of advisers are not necessarily
apparent to their clients:
Currently, it is very difficult for consumers to identify
whether they are dealing with a financial product salesperson or an independent
financial planner committed to putting their interests first. There is ample
evidence that financial product salespeople hold themselves out to be
independent in a misleading manner so as to make it easier to make a sale...
...the sale of financial product is not, of itself, a
problem. It is the sale of the product under the guise of independent advice by
a salesperson with a vested interest in the sale itself that is the problem.
Consumers should be able to ask the question ‘Why am I being sold these
products – Is it because the financial planner is putting me first or is he
putting himself first?” and the answers should be clear and obvious.[42]
5.59
Argyle Lawyers criticised the emphasis on form over substance encouraged
by the current framework:
...the regulatory system currently encourages a tick-the-box
approach to compliance, without promoting an ethical or integrity foundation
within financial services for the provision of advice. The evidence associated
with the recent financial product and advisory collapses suggest to us the
existing legal compliance frameworks alone are insufficient to pick up and identify
systemic instances of unethical conduct within financial advisory firms.[43]
5.60
Other evidence suggested that there are inherent limitations on what
disclosure can do to protect consumers, no matter what the disclosure
regulations provide for in terms of brevity and clarity. ASIC's submission
suggested that 'disclosure can be an inadequate regulatory tool to manage the
conflicts of interest created by commissions'. They indicated that this is due
to 'the strength of the conflict and consumers’ difficulty in understanding
their impact'.[44]
In evidence ASIC commented on the difficulty of ensuring that complex
remuneration structures are clearly disclosed:
...when you have multiple types of remuneration that are
predominantly paid by the product manufacturer to the adviser and to the
licensee for the sale of that product, on top of volume bonuses and potential
conferences that you can go to, that complexity leads to the consumer’s lack of
understanding of how much it is costing them at the end of the day. So you do
come across people who believe to a large degree that, because they have not
written a cheque, they have not had to pay for the advice that they have
received.[45]
5.61
They also noted that disclosure, even if clear, is limited in its
capacity to convey conflicts:
Yes, I have disclosed it, but is it an informed consent? Or
is it really that, as the investor, when I have seen these fees, I have turned
my mind to the fact and said, ‘Could this guy have distorted his advice because
of these fees?’ And that is extremely difficult for an investor to do unless
they are really experienced, because the person you are with is a trusted
adviser.[46]
5.62
In their submission ASIC also described the problem of consumers not
understanding the restricted nature of the advice they may be receiving,
notwithstanding the legitimate reasons these restrictions serve. ASIC stated:
The scope of advice provided by an adviser may be restricted.
For many reasons licensees restrict the range of products financial advisers
can advise on e.g. through an approved product list. This restriction may be to
ensure the products recommended meet minimum standards, to ensure the advisers
are adequately trained on the products they advise on and to give the
professional indemnity insurer comfort about the risks of negligent advice
being given. The range of products that an adviser is permitted to advise on
can also be influenced by which products are more profitable to the licensee
(e.g. where there is a commission from a product manufacturer or a relationship
with a product manufacturer). The restricted nature of the advice is often not
evident to consumers.[47]
5.63
CHOICE told the committee that disclosure had in fact been
counter-productive:
The requirement to disclose conflicts is often more of a
hindrance than a help. People are poorly equipped to identify, accept and
account for the impact of conflicts on advice, mainly because consumers simply
do not expect conflicts in the first instance. Disclosures are not sufficient
to counteract a client’s own understanding of the role of an adviser. There is
also evidence to suggest that disclosing conflicts can perversely increase
consumer confidence in the advice rather than act as a stark warning on the
quality of advice.[48]
5.64
The Accounting Professional and Ethical Standards Board outlined the
different adviser/client relationships:
The first one is what I would call the broker agent salesman.
This is where the adviser is authorised to act on behalf of another. The
adviser clearly has a conflict of interest and he must fully disclose that. The
second role is the steward, which is probably what many of the investment
advisers are. In this case the adviser has agreed to act on another’s behalf.
There is a basis of trust and confidence, and the interests of the adviser
should be aligned with those of the other party. You then have a third higher
level, which is a fiduciary relationship. In that case the adviser has accepted
a legal responsibility to act on another party’s behalf. The adviser can have
no conflict of interest whatsoever, which is typically seen in a trustee
relationship, a director or a power of attorney.
5.65
They added that these relationships are not made clear to consumers:
The current legislative framework misleads the public by not
clearly differentiating these three roles. It enables the salesman in a
profession effectively to pass themselves off as a licensed investment adviser,
which enables them to gain the trust of their client.[49]
5.66
ACI recognised the difficulty of disclosing complex remuneration
arrangements:
...some of these remuneration models are so complex in
themselves that disclosure does not ensure that a client understands and can
make a judgment about the effect of the fees on the advice they are being
provided; the total of the fees; or how it affects their return on the
investment.[50]
5.67
MLC agreed:
...there is a significant number of payments moving between
parties in the industry that the client has no chance of being able to
understand so they think that they might be getting an independent outcome when,
in fact, they are not.[51]
5.68
MLC suggested that clients understood the proprietary, vertically
integrated model, where advisers work for the manufacturer. They also
understand independent advisers, but the confusion 'lies in the middle'.[52]
Conduct standards
5.69
The committee also heard that the legislative standard of advice
provided under section 945A is insufficient to ensure advice is given in the
clients' interests (outlined at paragraph 2.20). ASIC told the committee that
the standard does not meet consumers' expectations:
It appears that there is a mismatch between the client’s
expectation that the adviser is providing a ‘professional’ service (e.g. advice
that is in their best interests) and the obligations of the adviser under the
Corporations Act (that the adviser provides advice that is appropriate to the
client and manages conflicts). Investors may see advisers as similar to lawyers
and accountants in terms of duties and professionalism.[53]
5.70
ASIC told the committee that:
...the law at the moment is uncertain as to whether the
fiduciary duty exists or not. We take the view that it may well exist, but it
is unclear.[54]
5.71
Industry Super Network stated that the current standard allowed advisers
to make recommendations knowing that there are better alternatives:
To give a concrete example of the flaws in the reasonable
basis test, a financial planning dealership might only have their own managed
investment product on their approved product list. However, this product might
be more expensive or offer a higher commission than most other managed
investment products on the market. It would be possible in most cases for a
planner to recommend their own product and demonstrate that it is appropriate
for the client who needs a managed investment product, although the planner is
aware that there are many other similar products which would be cheaper for the
client or have less beneficial remuneration for themselves.[55]
5.72
Concerns have also been raised about the compatibility of the
'appropriateness' test with advice given under licensing arrangements where
only one type of product may be recommended. The problem was highlighted during
the committee's inquiry into agribusiness managed investment schemes (MIS),
where the schemes were sold to investors through AFSL holders licensed to
advise only on agribusiness MIS.[56]
5.73
During that inquiry, a number of people queried whether it was possible
to provide appropriate advice to clients when a single product may be
recommended, also raising concerns about the transparency of these limitations.
ASIC informed the committee that it is technically possible to provide
compliant advice in those circumstances, without commenting about specific
examples.[57]
In evidence to this inquiry, ICAA repeated their concerns:
It is not possible to provide holistic advice if your only
product solution is one particular product.[58]
Committee view
5.74
The committee is of the opinion that disclosure documents are too long
and confusing for conflicts of interest caused by commission-based remuneration
and vertical ownership structures to be properly understood by consumers. The
documents are so inaccessible that they are probably not read at all by most
people. There are also limits as to the usefulness of disclosure, however clear
and concise, in an environment where clients have already committed in their
mind to their trusted adviser's chosen strategy. Present conduct standards are
useful in that they prohibit clearly inappropriate advice being given to
consumers, but the threshold is low enough to allow advice that favours the
adviser's interests above those of the client. Therefore, consumers are not
necessarily getting advice that is in their best interests but, because of the
limitations of disclosure, often do not realise this. Recommendations for
improving the regulation of financial advisers to better protect investors are included
in Chapter 6.
5.75
It should be recognised that the limitations of the current regulatory
approach enable poor advice that is mainly incremental in its effect, rather
than being catastrophic for investors. Conflicted advice that meets the current
legislative requirements is more likely to lead to sub-optimal investment
strategies or excessive fee arrangements, than to cause the sort of
catastrophic outcomes described earlier in this report. Without making any
particular judgement about specific cases, the committee is of the general view
that situations where investors lose their entire savings because of poor
financial advice are more often a problem of enforcing existing regulations,
rather than being due to regulatory inadequacy. Where financial advisers are
operating outside regulatory parameters, the consequences of those actions should
not necessarily be attributed to the content of the regulations. Potential
shortcomings of regulatory enforcement are discussed later in this chapter,
starting at paragraph 5.104.
Competency under the present
licensing system
5.76
Another area of regulatory concern was the competency of licensees and individual
financial advisers under the present licensing arrangements. The major
criticism of the current system is that licensees' minimum training standards
for advisers are too low, particularly given the complexity of many financial
products. ASIC's guidance on how licensees can meet the obligation to
ensure authorised representatives are adequately trained and competent was
outlined at paragraph 2.27.
5.77
ICAA commented on the increasing complexity of the financial services
industry and suggested that deficiencies exist in the education framework for
financial planners. They suggested that the current requirements are
inconsistent:
Currently the education requirements introduced through FSR
are at a minimum level and the training courses available range from a few days
to completion of a post graduate diploma or under graduate degree. All of these
course options meet the regulatory requirement of a financial planner becoming
compliant with ASIC Regulatory Guide 146. Australians cannot have a
professional relationship with an adviser when there is such disparity in the
education levels of the advisers in the industry.[59]
5.78
Association of Financial Advisers (AFA) agreed that 'the education bar
needs to rise' to deal with an evolving profession.[60]
ING Australia also stated that 'the current adviser training requirements are
too low'.[61]
Financial Ombudsman Service (FOS) told the committee that some complaints they
receive indicate that the advisers in question do not understand the products
they are selling.[62]
AMP agreed:
...the minimum entry levels for financial advisers are too
low and this is a significant contributing factor to advisers providing advice
on products that they do not fully understand.[63]
5.79
They also noted industry inconsistencies:
Each Licensee is left to set its own benchmark (at or above
the prescribed minimum standard) for assessing adviser capability. Whilst some
Licensees prescribe rigorous training standards, supplemented with 'on-the-job'
supervision, there is inconsistency across the industry.[64]
5.80
Argyle Lawyers claimed that low competency levels correlate with
unethical conduct:
...the minimum competency levels that exist within ASIC
Regulatory Guide 146 at the moment are completely inadequate to allow advisers,
for example, to position themselves to deal with the complex ethical issues
they face when giving advice, and the younger and more inexperienced they are
the more likely they are to make the wrong decision and the more likely they
are to be influenced by peers and superiors to take the wrong action.[65]
5.81
Others suggested that the competency requirements for licensees are also
too relaxed. For instance, AXA claimed that it was too easy for prospective
licensees to demonstrate that they can meet their obligations, without having
the skills or resources to actually do so.[66]
5.82
ASIC made the following comment about their responsibility when granting
a licence:
...we are required to grant a licence if the conditions in
the legislation are met. The two substantive conditions are that the key people
are of good fame and character and the other one is that we have no reason to
believe that they will not comply with their licence conditions. The test of
having a state of mind that somebody will not comply before they have even
started business is extremely difficult...[67]
5.83
In their submission ASIC stressed that granting a licence in no way
provides an endorsement of the applicant's business model. ASIC also noted that
a high threshold must be reached for them to suspend or cancel a licence, and
that it is difficult to remove licensees in anticipation of a breach of their
conditions.[68]
5.84
The committee also received complaints suggesting that the licensing
system enabled too many people with minimum competency to use the term
'financial planner' in a way that is misleading to consumers. FPA stated that
'there are too many people out there holding themselves out to be financial
planners when in fact they are not; they are doing a whole range of other
things'.[69]
BFPPG also complained that the term is able to be used too broadly:
The public can readily identify other professions: doctors,
lawyers etc by their title. There are, however, thousands of individuals
holding themselves out to be financial planners who meet the barest minimum
training or ethical requirements. In most cases these people are associated
with single product areas of advice or advice that is focussed strongly into
one type of asset class or investment type. There are real estate agents who
call themselves financial planners so that they can offer advice on the
investment of excess funds after the purchase or sale of a property. There are property
developers who call themselves financial planners so that they can package the
sale of their property development into superannuation funds. There are many
other examples.[70]
Committee view
5.85
The committee acknowledges concerns that the minimum qualification
threshold for advisers is low. However, these concerns need to be considered in
light of the requirement for licensees to demonstrate that their authorised
representatives have the capabilities to provide the financial services covered
by the conditions of their licence. Accordingly, licensees are required to
ensure higher competency standards as the complexity of the advisers' role
increases. Consideration also needs to be given to the affordability of advice
should educational standards for advisers be increased, as well as the
transition arrangements that would need to be implemented. These matters are
discussed in Chapter 6, starting at paragraph 6.110.
5.86
The committee recognises that it is very difficult for ASIC to deny an
application or cancel a licence if they think the licensee will be unable to
meet their obligations, which somewhat undermines the safety provided by a licensees'
requirement to ensure its authorised representatives have sufficient
competence. The committee makes a recommendation with respect to this at
paragraph 6.157.
5.87
There are also very legitimate concerns about the varying competence of
a broad range of people able to operate under the same 'financial adviser' or
'financial planner' banner. The licensing system does not currently provide a
distinction between advisers on the basis of their qualifications, which is
unhelpful for consumers when choosing a financial adviser. These concerns are
addressed by the committee's recommendation at paragraph 6.160.
Lending practices
5.88
The practices of some lending institutions that lent money for
investment purposes were discussed during Chapter 3. This section addresses
the problems with the regulation of margin lending more generally. ASIC's
submission identified two main issues associated with lending institutions
lending to fund retail investment. They are:
-
a
lack of regulatory control over the provisions of credit for investing; and
-
corporate
governance and risk management failures by lenders that encouraged high risk
lending and meant that loans were poorly managed.[71]
5.89
On the first issue ASIC noted:
...lenders of investment credit such as margin lenders do not
have the same obligations in relation to conduct and disclosure under the
Corporations Act as AFS licensees, and borrowers do not have the same
protections as investors in financial products.[72]
5.90
ASIC also commented on relaxed lending practices when markets were
rising:
While Australian lending institutions have not engaged in
some high risk lending practices that occurred overseas, recent retail investor
losses have shown that in some cases Australian lending institutions may have
failed to apply their usual standards in the bull market. This was particularly
so where the retail investor dealt with the financial institution indirectly
through an intermediary. In some cases this has resulted in higher risk lending
to retail investors and inadequate management of existing loans.[73]
5.91
The submission also expressed concern about the risks inherent in
lending institutions outsourcing suitability, risk management and monitoring
responsibilities to intermediaries such as financial advisers.[74]
Committee view
5.92
The committee notes that these problems are reflected in the extensive
evidence it received concerning the supply of margin loans to Storm Financial
clients. Margin lending practices in this instance were below the sort of responsible
conduct the community expects from lending institutions and beyond the scope of
ASIC to regulate as a financial product under the Corporations Act 2001
(Corporations Act). The gap in regulation to protect margin loan customers has
been addressed in margin lending reforms that were passed by the parliament on
26 October 2009. These reforms are discussed further in the next chapter,
starting at paragraph 6.161.
Investor compensation
5.93
In the event that consumers suffer catastrophic losses as a consequence of
negligent advice, attention turns to the avenues available for investor compensation
in these circumstances. Presently, there is no statutory compensation scheme
for this purpose. The compulsory professional indemnity (PI) insurance regime
provides only limited protection, and evidence to the inquiry suggested that it
is not suitable, or indeed intended, for such a role.
5.94
ASIC confirmed that 'there are significant limitations on the
effectiveness of PI insurance as a compensation mechanism for retail
investors'. The consumer is not directly involved in the insurance contract,
which provides licensees with insurance against losses owing to 'poor quality services
and misconduct'. Insurance policies may exclude certain circumstances,
depending on the extent of cover the insurer is willing to provide. Fraud is
generally not covered and contracts do not apply where the licensee has ceased
business.[75]
5.95
Insurance Council of Australia also stressed that PI insurance has
limitations as a guarantee mechanism:
...you cannot make a commercial product into a compensation
mechanism. If there is the policy decision that a compensation mechanism is
necessary to maximise the chances of a wronged consumer being paid compensation
then you need to look at the pros and cons of a compensation fund.[76]
5.96
This suggestion is examined in the following chapter, starting at
paragraph 6.171.
5.97
ACI also questioned the usefulness of PI insurance for consumers:
ACI regards this benefit of PI insurance as being
questionable for consumers. If the adviser is properly supervised then they
should have limited scope to amass huge indemnity requirements. However, if
there is a need to call on the PI cover then the PI cover must meet its
purpose. It seems that frequently it is very difficult to claim against,
suggesting that it simply adds costs for no consumer benefit. If this is the
case there may be little point continuing with it in its current form.[77]
5.98
AMP agreed:
In some of the recent collapses, PI cover has shown to be
inadequate in providing sufficient levels of compensation for affected clients.
Unscrupulous licensees can avoid their responsibilities and the existing
compensation model tends to punish those that comply with the regulations while
also failing the consumer.[78]
5.99
Maurice Blackburn Lawyers were particularly critical of PI insurance as
a compensation mechanism:
Some of the reasons for the inadequacy of PI insurance are as
follows:
-
The effect of exclusion clauses forming part of PI
insurance policies which limit the application of the policy, particularly
where the exclusion pertains to one of the key financial services that the
insured provides to consumers. Exclusions also often limit the application of
the policy to financial products on an approved products list;
-
Monetary limits on liability which significantly limit the
amount that can be recovered under PI insurance policies and, in particular,
where such limits include the legal costs of defending claims brought against
the insured; and
-
The requirements of a “claims made” insurance policy
whereby notice of a claim needs to be made within the period stated in the
insurance policy giving rise to the impediment that the notification period may
already have expired before the client is aware that they have suffered a loss.[79]
5.100
Maurice Blackburn also complained of the difficulties clients face in
obtaining information about relevant PI policies:
As the law currently stands, there are very limited avenues
available to plaintiffs to obtain information in relation to the insurance
status of defendants or proposed defendants prior to the commencement of
proceedings or throughout its conduct. This significantly hampers our ability
to advise our clients on such aspects as recoverability and to properly assess
the prospects of recoverability. Often it is not until considerable funds have
been spent in pursuing an action that it is revealed that there is no
responding insurance policy or there is a limit on the liability in a
responding insurance policy.[80]
5.101
Compounding these limitations is a greater reluctance from insurers to
provide PI on the terms it was previously available, due in part to the
financial crisis and recent product/adviser failures. Association of Financial
Advisers submitted that 'The increase in claim limits for external dispute
resolution schemes such as the Financial Ombudsman Service (FOS) has resulted
in higher claims being paid, resulting in a less profitable industry.'[81]
Insurance Council of Australia told the committee that insurers had limited the
amount of cover they are willing to provide and the conditions under which
cover will be available.[82]
ASIC confirmed that the market for PI insurance for financial advisers had
'hardened'. They indicated that premiums were to increase; new policies are
excluding margin loans; automatic run-off cover will be limited; insurers are
reviewing product lists and excluding certain products; and some insurers are
not writing new cover or are withdrawing from the financial adviser market.[83]
5.102
Q Invest argued that the current requirements are too prescriptive:
The current requirements, whilst innocuous at first glance,
overlook certain commercial side effects which have a deleterious effect on
competition, affordability and, ultimately, the cost of advice borne by
consumers.[84]
Committee view
5.103
The committee notes that PI insurance is not intended to be a catch-all
scheme designed to compensate investors whenever they have a successful claim
against an adviser. It merely ensures that advisers can meet their obligations
if a finding is made against them, if occurring in circumstances covered by the
relevant insurance policy. Investors are not protected in a number of important
situations, notably where the licensee has become insolvent, disappeared or
behaved fraudulently. Alternative compensation mechanisms warrant consideration
to address these shortcomings. The committee looks at these proposals in the
next chapter, starting at paragraph 6.171.
Enforcement issues
5.104
In contrast to the perspective that regulatory deficiencies are causing
a failure to protect investors from poor advice, there is a strong view that
the present regulatory system is adequate and the failure is one of
enforcement. The committee was told that some perspective is required when
assessing problems within the sector, which are limited to the actions of a
small number of rogue operators. Current conduct and disclosure regulations,
properly enforced, are sufficient to address these issues.
5.105
FPA indicated that the current regulatory system had withstood a very
challenging period:
...as a result of the global financial crisis financial
services reform has been stress tested like you would never believe and it has
withstood the tests of a very significant set of events. We believe therefore
that financial services reform and its application to financial planning is
robust.[85]
5.106
AFA also suggested that the problems exposed by Storm needed to be kept
in proportion:
...if they operated outside the law and did not overlay their
ethical and moral position, do we then want the other roughly 16,000 advisers
who are doing the right thing to take a far more onerous path—those who have
not had parliamentary inquiries created because of their conduct? I think there
is a need to separate that out.[86]
5.107
CPA Australia also indicated that the problem needed to be kept in
perspective:
Overall the vast majority of advisers and licence holders are
doing the right thing. The level of abuse or people breaking the rules is
relatively small. Admittedly, we have had some pretty high, public incidences
where advisers, business models or products have fallen over, with Storm and so
on, but ... we are seeing serious issues with [only] a handful. The vast
majority of our members are doing the right thing.[87]
5.108
AXA stated:
AXA believes that the failures which are the subject of your
inquiry have resulted primarily from a combination of the excessive promotion
of credit in conjunction with investing, poor and unethical business practices
and in some cases poor advice. It appears that in many cases the investment
strategies presented to clients included excessive levels of risk in the
context of the client’s personal circumstances and a level of risk that they
did not fully understand as a consequence of gearing.
AXA also believes that these practices are not typical in
Australian financial services, and do not point to a wholesale failure of the
Australian financial system or the regulation thereof.[88]
5.109
Professional Investment Services expressed the same view:
Almost every industry has its bad eggs. In my time in the
industry, the majority of advisers put their clients’ interests first at all
times ... Whilst it is important for the committee to focus on the terrible
issues at hand, I would encourage them not to use a sledgehammer to crack a
pea...[89]
5.110
They added:
...without quality advice to consumers, they would be left to
their own accord and make many, many more costly mistakes.[90]
5.111
Similarly, Guardian Financial Planning noted that advisers tied to large
dealer groups were not responsible for the sort of catastrophic advice that
affected Storm investors:
The industry is made up of around 17,000 practitioners who
fall into two broad camps—noninstitutional operators, known as independent
financial advisers, and those that are backed by a financial institution, often
referred to as aligned or tied advisers. The majority of advisers are said to
be aligned to institutions such as AMP, AXA, the banks or businesses such as
ours. Historically, they seem to have been the focus on media, professional
bodies and regulators. However, it is a small number of non-institutional
operators who have been at the forefront of the highest profile collapses. Those
operators represent a small minority of advisers. For example, as best we
understand the details, Storm Financial had around 13 advisers. The industry
has some 17,000 advisers.[91]
5.112
They argued that the focus should be on identifying and weeding out
fringe elements in the industry.[92]
5.113
IFSA warned the committee against 'overcompensating for the last
mistake', stressing that section 945A of the Corporations Act 'is not an
insignificant weapon to defend and advocate on behalf of consumers'.[93]
CPA Australia also suggested that the problem has been one of adequate
regulations not being enforced:
Storm was giving the same advice, irrespective of the client
circumstances. It was often margin loans which possibly exceeded their capacity
to pay or even their need for the underlying investment. It would appear Storm
were doing a one-size-fits-all approach to advice. Everyone was doing the same,
getting the same advice and clearly, whilst they might have been doing the
right thing around disclosure and so on, that is not in line with section 945A
of the Corporations Act where there has to be a sound basis for the advice. I
guess we fail to see if someone was looking at a licence holder, I would have
thought serious questions would have been asked earlier as to how a one-size-fits-all
advice model works for all their clients.[94]
5.114
They suggested that ASIC's approach of acting on complaints had been too
reactive, possibly due to resource constraints:
They really need to toughen up on the proactive, doing things
earlier, and if that means more resources, and it would seem as though it
would, then that is where the energies should be, because at the moment ...
they seem to come in either after the fact or when they go in early we do not
see anything actually happen that changes the course of events that
subsequently follows.[95]
5.115
ICAA noted that the annual audit for AFS licensees does not include a
proper examination of the advice being provided by their authorised
representatives:
Currently there are extensive requirements as to how a business
applies for an AFSL and there are ongoing requirements and obligations. However
it could be argued that there seems to be a gap in the on-going compliance
requirements and what is included as part of the compliance audit. An AFSL is
required to be audited that involves conducting both a financial and compliance
audit to check whether the licensee is complying with its licence conditions
and the requirements of the Act. Currently the audit and monitoring does not
examine in depth the advice being provided by the representatives of the AFSL.[96]
5.116
Q Invest wrote:
In our view, most participants in the financial services
sector willingly comply and apply their best endeavours to meeting their
obligations.
We question whether additional disclosure obligations would
have saved investors from the collapses we have witnessed.
In our opinion, enforcement and appropriate action in terms
of the spirit of those obligations is what was missing.[97]
5.117
They suggested:
ASIC should strive for a primarily preventive function, through
greater monitoring, supervision and enforcement of obligations imposed on AFS
licensees and other entities falling within its jurisdiction. The reality is
that there are enough laws in existence to cover every conceivable instance of
misconduct within the financial services industry today. It needs to be
recognised, therefore, that what we need now is a regulatory body who will be
ready, willing and able to take the necessary steps to ensure that all the
participants in the industry are complying with those laws.[98]
5.118
IFSA also told the committee that higher standards would not prevent
non-compliance, with ASIC needing to be able to 'respond pre-emptively'.[99]
However, ASIC told the committee that they have limited scope to intervene
before breaches occur:
The FSR regime is largely self-executing: AFS licensees and
other participants are expected to comply with the conduct and disclosure
obligations in the law. ASIC oversees compliance with these obligations and
then takes appropriate enforcement action when there is non-compliance. ASIC’s
power to take action ahead of non-compliance is limited.[100]
5.119
ASIC reported that it will undertake targeted surveillance of randomly
selected licensees to assess the quality of advice being provided, in addition
to shadow shopping exercises.[101]
Suggestions for a more targeted risk-based approach are examined in the
following chapter, starting at paragraph 6.18.
5.120
The enforcement of disclosure requirements was also referred to in
evidence. SDIA suggested that compliance documents of 70 pages and more cannot
be considered clear and concise, as they are required to be.[102]
BFPPG expressed the view that ASIC was not properly enforcing the requirement
to disclose ownership conflicts:
ASIC has not been rigorously enforcing the regulations in the
key area of ownership. The regulations are clear: all financial planners must
disclose their ultimate licensee ownership. It follows that the disclosure must
be made in a manner that is meaningful for the client. The reality, however, is
quite different. The majority of clients have no idea who the ultimate licensee
is. In many cases they believe they are dealing with independently owned firms
when in fact they are dealing with institutionally owned firms.[103]
5.121
ASIC noted that it cannot review all disclosure documents and that it
'adopts a risk based methodology to assist with which disclosure documents it
should review'.[104]
Committee view
5.122
As the committee alluded to above, improved enforcement of existing
regulations is essential in minimising catastrophic investment losses that
occur as a consequence of financial advice that is manifestly poor and
inappropriate. Current regulations already prohibit advisers from recommending
an investment strategy that is inappropriate for their clients' circumstances
and places them at risk of financial ruin. The committee is of the view that ASIC
has been too slow in its enforcement of section 945A of the Corporations Act, which
requires advisers to provide advice that is appropriate to clients' needs.
Proposals for more effective, proactive enforcement and the committee's view on
these are included in the following chapter, commencing at paragraph 6.18.
5.123
In making these comments, the committee does not preclude recommending
legislative changes in the next chapter that will improve the overall quality
of advice clients receive from financial advisers. Regulatory amendments will
potentially complement improved enforcement measures designed to protect
investors from advice that may have catastrophic consequences. They will also
address the incremental yet pervasive detriment to consumers caused by poor,
conflicted advice as described above at paragraph 5.75.
Financial literacy
5.124
Recent catastrophic investor losses demonstrate that many investors do
not have the expertise to filter poor financial advice using their own
knowledge about sensible investing. Many retail investors do not understand the
nature of investment risk and the importance of spreading risk across
diversified asset classes, instead relying on third parties to steer them in
the right direction. As was made apparent during evidence to this inquiry, many
investors seek financial advice for the very reason that they have minimal
financial literacy, and therefore place complete faith in the investment advice
they receive.
5.125
ASIC agreed that many consumers do not have the levels of financial
literacy needed under the current system:
The FSR regime places the onus on investors to take
responsibility for their own investment decisions. The onus is on the retail
investor to recognise when they need to seek financial advice and to have a
sufficient education, understanding and motivation to read and comprehend the
disclosure documents they will receive when they receive advice and/or invest
in products (e.g. SOAs, FSGs, and PDSs). This presumes that most Australians
will have a reasonable level of financial literacy and understanding.[105]
5.126
Their submission stated that the requisite financial literacy to cope
with investor information is often not present:
...the 2006 ABS Adult Literacy and Life Skills Survey found
that 46% of Australians aged 15-74 do not have the level of literacy needed to
understand narrative text, such as in newspapers or magazines, to the minimum
level required to meet the complex demands of everyday life and work in the
emerging knowledge-based economy. This suggests that many people would have
difficulty understanding the disclosure documents they would receive when they
invest or make other financial decisions.[106]
5.127
ASIC further noted that the infrequent nature of investment decisions
mitigates the opportunity for people to develop financial literacy.[107]
5.128
IFSA also stated that 'we have had a whole generation of people forced
to be investors' and many do not have any understanding of the complexities of
their second largest investment, superannuation.[108]
Their submission acknowledged that the literacy problem represents a 'complex
and generational challenge', but emphasised its importance as a consumer
protection mechanism:
We believe that it is important to recognise that while
improving financial literacy will almost certainly assist with consumer
protection, initiatives focused on consumer protection are unlikely to address
the complex and generational challenges associated with improving financial
literacy.[109]
5.129
MLC noted that poor financial literacy is the reason why financial
planners are increasingly important:
The big issue and gap that I see that needs to be addressed
is the Australian superannuants’ understanding of risk and the risk that they
are taking with their retirement moneys. What we have seen through the crisis
is a lot of people that are approaching retirement or are older and in
retirement were probably more exposed to markets than they understood, or at
least the impact of the market changes was much greater than they thought. That
is a big challenge and it has led to our conclusion that the best way to do it
is to get Australians to talk to a financial planner.[110]
5.130
FPA suggested that:
We have a long way to go in helping consumers become more
capable in terms of their financial obligations, responsibilities, preparation,
planning and all those sorts of issues. There is a whole body of work in there.
I think if you have a professional financial planner with a
robust regulatory environment and an informed client, you are going to get the
best outcome.[111]
5.131
ICAA warned against believing that consumers should be expected to
protect themselves in the immediate term:
Many people ... talk about consumer responsibility, saying
that consumers should take more responsibility. The reality is that it is not
going to happen in the current environment where you have got limited consumer
literacy. So you cannot pass it off and say consumers need to take more
responsibility. Yes, consumers need to increase their education and
understanding themselves, but that is a generational issue. That will happen
probably 10 or 20 years down the track when my kids are coming out of high
school and so on.[112]
5.132
AFA commented that financial advisers are educators and need to be
responsible in that role:
There is a need, obviously, for consumers to take
responsibility for the financial decisions that they make but equally there is
for advisers, who are in a sense the client’s first educator when they get into
that relationship.[113]
Committee view
5.133
The committee notes that ASIC is presently delivering a number of
financial literacy programs via initiatives such as school curriculum-based
programs and their own consumer information website, FIDO. While these are
certainly useful approaches, the committee is of the view that ASIC could be
doing more to target key, higher risk, older demographic groups by promoting
sensible investment messages, including through the mainstream media. The
committee makes a recommendation about investor education in Chapter 6.
5.134
Notwithstanding this, the reality is that better investor education is
not the only answer to protecting investors from poor financial advice. It is a
solution often proposed by those in the industry wishing to maintain the regulatory
status quo, but is not in the committee's view effective at protecting the most
vulnerable investors. The complexity of investment strategies leaves the
prospect of clients determining the quality of financial advice they receive,
through the filter of personal knowledge, beyond the capacity of many. Most
clients quite legitimately trust in the knowledge and professionalism of their
financial adviser to provide them with good advice, and do not have the
confidence in their own understanding of the subject to challenge the advice
they are given. Therefore the regulatory system should, to a reasonable extent,
protect consumers from poor advice, rather than relying on consumer's being
sufficiently financially literate to determine for themselves whether their
adviser's recommendations are in their interests.
5.135
The next chapter examines proposals for the more effective regulation of
financial services.
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