We covered these issues in lecture 8.

The level of enquiry required for a financial planner to have a reasonable basis for advice and to comply with their duty to act with reasonable professional care and skill was recently discussed in Newman v Financial Wisdom Limited. In that case the Victorian Supreme Court accepted (at paragraphs 168 -175) the testimony of an expert financial planner that:

"... investment advisers [can] either carry out research and analyse investment products themselves or use research and analysis generated from external sources. The extent of the research and the analysis which it would be reasonable to expect the adviser to do [depends] on the nature of the product which [forms] the basis of the particular recommendation and the needs of the client being advised. [Advisers] often [rely] on information being supplied by external research organisations, in which case, the adviser should evaluate the overall quality and effectiveness of the analyses so provided so as to ensure that reliance placed on any such information [is] reasonable in all the circumstances. For the purpose of advising a client, the adviser should take into account general economic and other information in relation to markets, industries and securities so as to be in a position to make judgments about future income and growth expectations and risk factors associated with particular securities. An adviser should provide written reports to the client about recommended securities so that the client can understand the basis on which those securities are recommended. The reports should cover such matters as risks associated with the issuer of the security, risks associated with the product, market and economic risks, capital and income prospects and so on.

[A] financial adviser should [conduct] a detailed interview in which data [is] collected on the client's present financial position and their objectives [are] identified and agreed. The financial adviser should [prepare] a written financial plan so as to position the client to achieve an efficient use of their resources [which] also [advises] on immediate and future strategies to achieve the client's objectives, [records] the advice given and the reasons for the advice, [discloses] any interest of the adviser and [also refers] to the research undertaken on any recommended investment. Before recommending an investment, the adviser should either carry out research and analyse the investment or use research and analysis generated from external sources. The extent of the research and analysis [depends] on the nature of the investment product and the needs of the client. The adviser should be able to provide and should normally provide to the client sufficient written information about the investments recommended so that the basis on which they [are] considered appropriate for the client [can] be understood. Both risk factors and return expectations should be addressed, including risks associated with the issuer, risks associated with the product, market and economic risks and capital and income prospects.

[For conservative investors], ... a prudent financial planner would [advise] a mix of investments to provide some capital growth, low volatility, low risk and some income - varied according to the needs of the particular client. ...

[A] reasonable and prudent financial adviser would advise a client of the degree of risk involved in a particular investment, irrespective of the client's risk profile or the client's wish to obtain an immediate tax deduction and if, because of the nature of the investment, the financial adviser was not prepared to recommend it but the client insisted on going ahead, the adviser would have the client sign a written indemnity.

We looked at this issue in lecture 9.

In order to ensure that consumers receive personal financial advice that is in their best interests, the Government proposes to amend the Corporations Act to introduce a statutory fiduciary duty on Australian Financial Services Licensees and their authorised representatives which will require them to act in the best interests of their clients (see the Government's Future of Financial Advice information pack). The duty will clarify that in no circumstances is it permissible for advisers to place their own interests ahead of their clients' interests, even with disclosure of the conflict.

Some of the remuneration arrangements that use to be prevalent in the financial planning industry certainly would have tested the resolve of financial planners to put the honest and impartial giving of advice ahead of their self-interest!

In June 2004, ASIC released a research report on Disclosure of Soft Dollar Benefits in the financial planning industry. It defined soft dollar benefits as benefits other than standard commission payments. The report revealed that a wide range of soft dollar benefits were being offered. Benefits to individual advisers included overseas trips, share options and cash bonuses for selling particular financial products. Benefits to financial planning firms included 'fee rebates', potentially worth millions of dollars each year to the larger firms. The report contained examples of both good and poor practice and provided guidance about effective disclosure.

IFSA and the FPA subsequently released their Industry Code of Practice on Alternative Forms of Remuneration in the Wealth Management Industry in July 2004 and Industry Guide on Rebates & Related Payments in the Wealth Management Industry in November 2004 as part of a broader initiative by the two bodies to improve payment and remuneration practices in the industry.

The FPA also adopted Principles for Managing Conflicts of Interest in June 2006. Principle 1 requires the cost of financial planning advice to be separately identified as a financial planning advice fee in the Statements of Advice provided by FPA members to clients, and the total fees paid for ongoing advice to be disclosed to clients on a regular basis. Principle 3 seeks to remove any bias in payment methods to advisers from licensees and places responsibility with the licensee to determine that remuneration arrangements are not biased against the client. Principle 4 seeks to ensure that those FPA Principal members which are part of a group that also provides financial services products or platform services have in place arrangements which enable the interests of clients to be considered independently of wider group interests.

Notwithstanding these improvements in industry standards, ASIC was sufficiently concerned by the conflicts caused by commission arrangements that, in its submission to the Parliamentary Joint Committee on Corporations and Financial Services Inquiry in 2009 into the Storm Financial, Opes Prime and other similar collapses, it recommended that financial planners should be banned from being remunerated in any way that might distort the quality of their advice. ASIC said that this should include banning up-front commissions, trail commissions, soft-dollar incentives, volume bonuses, rewards for achieving sales targets and fees based on a percentage of funds under advice - effectively limiting planners to charging on a fee for service basis. It said (at 168-72):

"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. Moreover, because many advice businesses are remunerated through product sales, the businesses need to continue to bring in new clients to invest in products. Further, because commissions are paid irrespective of whether or not services are provided there is little incentive to service existing clients.

Remuneration based on the amount of funds under advice can also create conflicts of interest. Advisers who are remunerated by reference to funds under advice have an interest in selling investment products to their clients and encouraging their clients to borrow to invest.

There is evidence that these conflicts of interest can affect the quality of advice. ASIC’s 2006 Shadow Shopping exercise suggested that unreasonable advice was more common where the adviser stood to get higher remuneration if the recommendation was followed.

Storm may be an example of the potential impact on clients of failure to manage conflicts of interest created by commissions and remuneration based on funds under advice. While our investigations are continuing, we understand that Storm advisers may have counted loans as funds under advice and took a percentage of funds under advice as remuneration, creating a possible incentive to recommend clients take out loans or increase the size of existing loans."