A question of ethics

caw-trust

Two masters too many – it’s a question of ethics. Conflicts of interest in the financial advice industry. By Lee White FCA

Trust is in short supply in the financial advice industry. The ABA’s wholesale review of commissions paid to sales staff is the tip of the iceberg.

Twenty four years after the Keating Government introduced compulsory superannuation, which started a gradual process of making individuals more responsible for their long-term savings, institutions still show an inability to honour the trust that investors and retirees have placed in them.

At the heart of this problem is conflict of interest. In the context of providing financial advice, it is when an adviser has two masters. And usually one of those masters – bank, insurance company, fund manager – has colossal resources that make those of an individual investor insignificant.

These bodies either pay advisers for selling products using commissions and other conflicted product sales incentives; or encourage advisers to charge percentage-based asset fees which are often misleadingly called fees for service. However, in a growing number of cases, advisers are using a genuine fee for service remuneration model. Commissions and percentage-based asset fees are paid by relatively painless extraction from the clients’ investments (which is why these are preferred); whereas genuine fees for service demonstrate that the adviser has no bias toward a particular product because the client is paying for advice (not for products). This is similar to traditional professionals. Put simply, if the financial adviser receives any remuneration from a financial institution or product, there is a flaw which creates tension.

Put simply, the crux of the issue is many financial advisers are more influenced by the money they receive out of the products they sell, rather than to ensure their clients are put into the right financial product, or none at all, if that is in the clients’ best interests. For example, should I pay off my mortgage with a recent inheritance on which my adviser will earn nothing; or should I gear into investments on which my adviser will earn a %-based asset fee?

The number of victims who suffer at the hands of unscrupulous and conflicted advisers grows each year as does the list of financial institutions who support these questionable practices. 

In lockstep with these scandals are the inevitable enquiries and investigations. ASIC is looking into life insurance claims practices. Meanwhile the Senate granted a further extension to August 31, 2016 to the inquiry into the Scrutiny of Financial Advice by the Senate Economics Reference Committee. That extension will also enable it to review the life insurance industry.

None of these developments surprise consumer groups who must surely shake their heads in an “I told you so” response when their earlier efforts revealed the shaky foundations on which the advisory industry rests. In 2012, an ASIC investigation showed that only 58 per cent of investment advice was of an acceptable standard. ASIC announced that about one third of life insurance advice was between “poor” and “terrible”. In both cases, commissions were blamed for the poor results.

Now is the time to call a halt to the discussion that has taken place since the early 1990s and require planners and advisers to operate under stronger standards if they want to be viewed as putting the interest of their clients first. Progress needs to move from disclosure to removal of conflicts of interest.

The industry already has a template for that goal in the independent Accounting Professional and Ethical Standards (APES) Board’s ethical standard APES 230. When first proposed, the Board saw commissions and percentage-based asset fees as creating “threats of self interest for which no safeguards exist that can reduce the threats to an acceptable level.”

Given the recent scandals, progress needs to pick up speed and remove the various forms of remuneration that lead to conflicts and replace them with hourly rates or fixed fees. Such a fiduciary rule could apply to all providers of financial advice, save investors millions of dollars and improve the nation’s overall prosperity, as financial advisers would no longer be tempted to steer them to inappropriate products with higher fees and lower returns.

Who knows, it might even restore investor trust in the nation’s financial institutions.

This article was first published by Chartered Accountants Australia New Zealand. You can visit the original page here