Countering conflicts of interest

So much has been written and said of late in regard to conflicts of interest, but what have we achieved in the practical understanding of what to do?

The Corporations Act disclosure requirements for each of the Financial Services Guide and Statements of Advice (SOA) require that a client is made aware of the remuneration and inducements that will be received, the sources of those, and any association that might influence the services given.

The provisions themselves are framed so broadly that one might wonder why there was any need for the Financial Planning Association (FPA) to enunciate it any further in its principles.

The answer is quite simple. These rules are being applied in an industry where a complexity in product remuneration arrangements and associations has developed throughout the evolution of the industry itself.

Drivers of competition

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The life insurance industry was itself the great precursor.

Originally, many life insurance companies attracted tied advisers and multi agents with benefits such as volume incentives and practice support.

Since the 1970s, there has been a considerable decline in the sale of insurance products through tied advisers, accelerated since the introduction of the Financial Services Reform Act.

Distribution had to become more broadly based, reliant upon commissions and volume-based arrangements. Over the same period, the growth in managed funds has also influenced the drivers of competition.

For financial planners it has meant that all product providers will offer some form of benefit in order to attract and retain their product preference or loyalty. It is a competition for shelf space to attract greater sales for your particular product. Nothing wrong with that. Per se, competition is healthy.

The difference in the financial services industry, and what makes it look unhealthy to an outward observer, is that the product competition does not occur at the point of sale, at the consumer level.

Product providers don’t compete there, for they recognise that the choice is actually made before that, at the planner level.

So what the industry is now being asked to do is to identify the threads of incentives running throughout the distribution process, and decide how these should be addressed.

If only it were that simple.

Identifying conflicts

The questions to be asked are easy, dealing with the results is not, and disclosure as a remedy is fraught with its own dangers.

Your first step is the process of identification, where any arrangements or inducements that objectively could be regarded as influencing or limiting the service provided need to be recognised.

Impact assessment

The next step, impact assessment, becomes a little harder. You have to decide how significant each one is, or the significance as it might be perceived by the client, and rate them accordingly.

Ask yourself in each case, what is the result on the breadth and depth of the service that I give to clients? Would your service be delivered differently if that arrangement did not exist?

It is at this point that the application of the conflict of interest principles becomes somewhat unstable, given how the industry is currently structured.

For example, for many practices, the predetermined approach is that clients should hold their investments on an investment platform, for example a wrap.

The conflict here is that, as ASIC has said, a platform can often cost more to the client.

However, most planners will argue that it does in fact benefit the client because, in reducing the internal administration costs required, the planner is able to keep his or her own costs to the client down.

Another example exists by virtue of the fact that planners employed by a bank or similar financial institution are able to provide advice.

Realistically they only provide advice upon the products issued by the employer, or a related financial institution. The conflict here is that the planner is obviously not able to give that client the broadest possible advice on a range of comparable products.

We can even turn our attention to the conflict that theoretically exists as a consequence of the volume incentives based upon the amount of funds under advice with a particular product. It is the financial services’ version of a loyalty program.

There are all kinds of rebates passed back from platform providers, from broking firms for volume of trades and commission earned, and from fund managers of individual products, such as cash management trusts.

These examples are illustrations of some of the most common situations for which it is unrealistic to believe they will disappear in the short term.

Disclosure as remedy

So our only current remedy is to deal with them at the third step of the process, namely by effecting a disclosure to the consumer.

Disclosure is expected to be the remedy if (and only if) the conflict does not require complete removal.

Once again, the purported solution is not that simple.

Firstly, deciding what conflicts can’t be addressed merely by disclosure requires an ethical discipline that is almost unrealistic within the current industry structure.

Secondly, we have to appreciate that disclosure itself is not the complete cure in all cases. Just because I tell you that I am going to hit you doesn’t mean that what I then do is not an assault.

Working out what can and can’t be cured by disclosure therefore still requires a great deal of industry attention, so we concentrate firstly on addressing those practices that cannot, and will never be able to be, cured by disclosure.

The next problem, for those incentives or associations that can be dealt with by disclosure, is how to make that disclosure effective.

The ultimate standard if you are looking to apply the shield of disclosure is that what you have disclosed has to inform the client, so that he or she has a context in which to place and consider what you have disclosed.

There is no point telling a client you will receive 10 per cent commission if most clients don’t know that it is above the usual rate. It is the very fact that you have failed to tell the client that it is significantly higher that will colour any assessment as to whether this is sufficient disclosure.

The whole objective is to ensure the client is in a position of making an informed decision about whether they should follow your advice.

The decision a client makes should be based on not just an assessment of the soundness of the strategy you have suggested, but an assessment of the breadth and depth of the research you have undertaken on their behalf.

Informed decision making

Recently, I saw a Statement of Advice issued by a financial planner of a bank.

Nowhere did it explain to the client that the bank’s product, the ones actually recommended, were the only ones considered.

Even if it had, would the client have fully appreciated the actual ramifications of this? Many clients might think this is the norm.

What a client needs in order to make an informed assessment is a benchmark understanding of the industry — what are common arrangements, and what are not.

But therein lies the problem, for that kind of disclosure needs to be made simple and effective.

Our experience of grappling with simple and clear communication over the past two years has not been at all easy. If we are to avoid a repetition of that, a preliminary task will be to resolve once and for all an industry position on the fee-for-service versus commission remuneration debate.

Lucille Bennetto is head of compliance at Lonsdale Financial Group .