The cost of playing by FOFA's rules

The second tranche of the Government's Future of Financial Advice legislation has laid out the remuneration and best interests ground rules for financial planners but, as Mike Taylor reports, much will depend on the attitude of those administering the new rules.

When Assistant Treasurer Bill Shorten introduced the second tranche of his Future of Financial Advice (FOFA) legislation to the House of Representatives, much attention was focused on its approach to fee disclosure and the best interests test.

That attention was entirely justified in circumstances where the Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 laid out the remuneration game rules to which the industry will have to adhere for the foreseeable future.

The bill gives financial advisers very little choice other than to adopt a fee-for-service approach. The only wriggle room it provides is the vague suggestion that there may be scope for them to prove that some forms of volume rebates are not conflicted.

It is assumed that proof that a volume-rebate arrangement is not conflicted will need to be provided to the Australian Securities and Investments Commission.

The Government has explained its position in the explanatory memorandum attaching to the bill, which dealing with the issue of volume rebates states:

"Where a volume-based payment of this kind is made, section 963L requires the party alleged to have paid or accepted conflicted remuneration to prove that the payment is not conflicted remuneration.

That is, if that party has paid or received a volume-based benefit of the type described, it will have to demonstrate that, in the circumstances, the benefit was not in fact conflicted remuneration.

In an industry as complex and fast-evolving as the financial services industry, there are and will always be a wide range of remuneration arrangements.

However, volume-based payments of the kind described in section 963L appear on the face of it to be inherently conflicted, since the financial adviser will have a financial incentive to maximise the value of the payments irrespective of the suitability of the products or investments for the client.

It would be legislatively impractical to define and categorise all remuneration arrangements precisely, and to prescribe in advance which are conflicted and which are not. Where there are volume-based benefit structures that are not inherently conflicted, this will be peculiarly within the knowledge of those paying and receiving the benefits.

It is therefore appropriate that those parties be required to demonstrate that the benefits are not conflicted."

It says something about the intent of the legislation that Division 4 of the bill is headed “Conflicted Remuneration” and describes “conflicted remuneration” to mean “any benefit, whether monetary or non-monetary, given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients that, because of the nature of the benefit or circumstances in which it is given:

• could reasonably be expected to influence the choice of financial product recommended by the licensee or representative to retail clients; or, 
• could reasonably be expected to influence the financial product advice given to retail clients by the licensee or representative.

The bill then goes on to detail forms of monetary and non-monetary remuneration which are not regarded as conflicted, including general insurance and basic banking products.

The bill’s explanatory memorandum said the ban on conflicted remuneration included a ban on both monetary and non-monetary (soft-dollar) benefits. However, it said in relation to monetary benefits that there are areas the ban on conflicted remuneration does not apply to:

• general insurance;
• life insurance which is not bundled with a superannuation product;
• individual life policies which are not connected with a default superannuation fund; and
• execution-only (non-advice) services.

However it digs deep into the commercial structures which have underpinned dealer groups when, at section 963L, the heading states “Volume-based benefits presumed to be conflicted remuneration”.

The legislation states: “It is presumed for the purposes of this Division that a benefit of one of the following kinds is conflicted remuneration, unless the contrary is proved:

• a benefit access to which, or the value of which, is wholly or partly dependent on the total value of financial products of a particular class, or classes:
  • recommended by a financial services licensee, or a representative of a financial services licensee, to retail clients, or a class or retail clients; or
  • acquired by retail clients, or a class of retail clients, to whom a financial services licensee, or a representative of a financial services licensee, provides financial product advice.
• a benefit access to which, or the value of which, is wholly or partly dependent on the number of financial products of a particular class, or particular classes:
  • recommended by a financial services licensee, or a representative of a financial services licensee, to retail clients, or a class of retail clients; or
  • acquired by retail clients, or a class of retail clients to whom a financial services licensee, or a representative of a financial services licensee, provides financial product advice.

While those analysing the second tranche believe the Government has provided some wriggle room by allowing scope to prove some volume rebate arrangements are not conflicted, the logistics of pursuing such an argument would seem likely to be both costly and time-consuming for those involved.

Where client best interests are concerned, the second tranche introduced by Shorten last week fulfilled many of the arguments which had been presented by the Financial Planning Association (FPA) amongst others by not requiring financial planners to go beyond what is currently regarded as reasonable professional conduct in the sense of knowing their client.

The problem for the FPA and other stakeholders in dealing with the introduction of the second tranche of the legislation is that, initially at least, they did not have the opportunity to peruse the usual explanatory memorandum attaching to the bill.

However when it was finally released, it described the legislation’s approach to the best interests test in the following terms: There is a general obligation on providers of financial advice to act in the best interests of the client.

This general obligation is supplemented by a provision setting out steps that, if the provider can prove they have taken, will be taken to satisfy the general obligation. These steps have been set out based on the specific conditions under which financial advisers currently operate.

This approach is needed given the broad nature of a best interests obligation; it may allow a provider to demonstrate that it has complied with the obligation by proving it took certain steps.