ASIC set to to increase auditing and monitoring of financial advisers

Mark Halsey takes a look at recommendation two of the PJC inquiry into financial products and services and its potential implications for the industry.

On November 23, 2009, the Parliamentary Joint Committee (PJC) on Corporations and Financial Services issued a report from an inquiry into financial products and services in Australia. Eleven recommendations were made.

This article focuses on Recommendation Two: that the government should ensure that ASIC is adequately resourced to perform effective risk-based surveillance of licensees and their authorised representatives, and that ASIC should conduct annual shadow shopping exercises.

Here we consider the practical implications likely to arise if the recommendations are actually put into place by the Federal government and its agencies.

There is no certainty that any of the recommendations will be put into place, and the government has already indicated that it will consider the recommendations alongside the Cooper Review into superannuation.

The Cooper Review is meant to make its recommendations to the government by June 30, 2010, but it may comment on some issues before the final report is released.

In its report, the PJC expressed 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" (paragraph 5.122 on page 98).

The report states that the PJC is firmly of the opinion that ASIC needs to undertake the enforcement of legislative standards of advice with a more rigorous and targeted approach.

ASIC should perform effective risk-based surveillance on the advice provided by licensees and their authorised representatives, focusing particularly on licensees that:

• have come to the attention of the regulator previously;
• recommend a high proportion of high-risk products;
• have a limited approved products list (APL);
• disproportionately recommend one type of product; or
• have limited experience or qualifications.

The PJC went on to say that it considered it important that ASIC establish robust audit processes (to be undertaken by suitably qualified field staff).

In their submission to the PJC, ASIC submitted that it is going to increase shadow shopping and also perform targeted surveillance of advisers.

ASIC has suggested this course of action in order to assess the quality of advice and to highlight other matters, such as the adequacy of the current training requirements.

Following the recommendation, it is very likely that ASIC will increase the auditing and monitoring of licensees and their authorised representatives.

Practical consequences

There are a number of obvious consequences of the recommendation.

It seems clear that audits by ASIC will be more frequent and targeted, and the emphasis will probably move away from matters of form towards matters related to the quality of advice.

ASIC will shift its focus to analysis of the type of advice that has been given and how appropriate it is for a particular client.

As noted above, the recommendation is that there be particular focus on licensees who satisfy certain criteria. While one would expect it to be straightforward for ASIC to determine the licensees who have previously been investigated, it will be more difficult to determine which licensees:

• recommend a high proportion of high risk products;
• have a limited APL; and
• disproportionately recommend one type of product.

Such information can probably only be determined by ASIC after considering data provided by licensees. So, how will ASIC know if licensees are recommending a high proportion of high-risk products? It would seem that there are only two possible ways that this could be known.

Firstly, ASIC could send surveillance teams to work through client files at all of the licensee offices around the country.

Given that the report noted that ASIC did not have the resources to investigate the qualifications and experience of individual authorised representatives (a comparatively small task), it would seem highly unlikely that ASIC would have the resources to undertake such a detailed consideration of the individual client files of every licensee.

But there is a recommendation for an increase in field staff, so it is a possibility — albeit a remote one.

Alternatively, ASIC could require that licensees provide a great deal of information to targeted questionnaires provided by ASIC to licensees.

These could include a requirement for detailed information about recommendations, across various asset classes and across all clients, of a licensee.

It would seem that kind of information collection would be necessary for ASIC to know whether there was a disproportionate recommendation of one product type by any particular licensee.

Any licensee who has been unfortunate enough to recently receive a notice in relation to forestry products would be familiar with this kind of questionnaire.

For licensees who have not received such a notice, it might be helpful to be informed about the kind of information that was requested, and the process by which this information was requested.

Licensees who have received such a notice will be all too familiar with the requirements.

In relation to the forestry products (and other types of schemes), certain targeted licensees were provided with largely blank spreadsheets formatted by, and bearing headings created by, ASIC.

One of the difficulties was that in relation to these notices, information was requested which was not current. So, for example, ASIC required information such as the investor’s age, taxable income, and salary income as of the date of the investment.

While a number of licensees have computer systems that are capable of providing details of a client’s current income, the general practice is that when these details change, they are automatically updated in the computer system.

For example, a client’s financial circumstances may have significantly changed since the time the investments were made (for sake of convenience, let us assume three years ago), and there may have been at least two or more updates to the client’s fact find data during the two or more reviews that have occurred.

Perhaps at the time of investing, the client was an employed manager earning $120,000 per annum.

Now, the client has retired. Their financial details now show a much lower income.

However, ASIC wants the income at the time of investing, and that detail can only be obtained from paper-archived fact finds in many cases.

Many licensees ensure that such updated information is inserted into the computer system, and the old outdated information is no longer available.

The logical extension of this is that for every client it has been necessary to retrieve outdated documents and to physically look at the paper records for client income (both salary and total taxable income) at the time that the investment was made. In some cases there have been hundreds or thousands of clients, and for each one a paper investigation has been requested of the licensee.

We are aware of licensees who were unfortunate enough to receive these notices, and have had their compliance teams tied up for weeks or months working on providing information in response to these notices by completing spreadsheets for ASIC.

Determining if a licensee disproportionately recommends one type of product will require that the same kind of data is provided. All this work will probably require very targeted software.

It would certainly be hoped that ASIC will provide details of exactly what information it will require at the beginning of any information collection period, so that information collection mechanisms can be put in place at the beginning of that period.

While this will inevitably mean an increased compliance burden, it should be a manageable burden — and resourcing should be allocated in a sensible and predictable way.

It seems likely that licensees may have to provide a copy of their APL, as well as records of business written, to ASIC.

A further obvious outcome is that if the recommendation is enacted, it will mean that there is the potential for a significant increase in more comprehensive audits from ASIC.

Those audits will presumably involve much more subjective consideration in relation to the quality of advice given, instead of focusing upon procedural issues.

I have been concerned for some time regarding the level of investigation provided by the internal and external compliance personnel of licensees in relation to authorised representative audits, as there has seemed to be an over emphasis on procedural issues — and comparatively little focus on the actual technical quality of advice.

This may seem logical, because many compliance personnel may not be sufficiently RG146 trained and competent and may not be equipped to make judgment calls about the quality of advice or its appropriateness.

It seems likely that prudent and conscientious licensees will find it necessary to undertake a thorough qualitative audit across a range of clients for each authorised representative.

In its report, the PJC noted that it was not of the opinion that the benefits of receiving annual returns from licensees outlining advice practices would justify the administrative burden created for ASIC.

The PJC stated that there were more efficient ways of taking a risk-weighted approach to surveillance than receiving information from every licensee in Australia.

This comment is interesting for a number of reasons.

Firstly, while stating that the task may be an excessive burden upon ASIC’s resources, there is no reference to the compliance burden to be placed upon licensees (which does seem to be a comment generally lacking throughout the report).

Secondly, the earlier comment in relation to field auditors suggests that perhaps licensees will have more regular physical visits from ASIC.

Interestingly, it is our understanding that Storm Financial did receive visits from ASIC before the announcement of its problems, and this does not appear to have assisted in preventing the problems that have arisen.

Conclusion

If the recommendations are adopted by the government and ASIC, expect more onsite audits undertaken by ASIC. These audits will pay greater attention to the actual quality of advice and appropriateness issues.

It also seems likely that ASIC will be much more demanding in terms of information to be provided by all licensees, since there will inevitably be data analysis carried out from the information which is provided.

This process has already commenced with the service of section 912C Notices on several leading AFS licensees.

The notices, which require responses by the relevant licensees in early March 2010, contain questionnaires with over 800 detailed questions about the licensees’ business models, processes and policies, training and supervision procedures relating to representatives, product research and APL processes etc.

Most AFS licensees can expect there will be greater demands upon licensees’ compliance resources during 2010, since the effect of the recommendations and issues identified by the PJC translates into action by the regulator and other key financial services industry stakeholders.

Mark Halsey is a solicitor with Halsey Legal Services, a West Australian based law firm that specialises in the financial services area.