A guide to the Ripoll Inquiry recommendations and their likely impact

Bryan Ashenden takes a look at the far-reaching impact the recommendations of the Ripoll inquiry could have on the financial planning industry.

Monday November 23, 2009, marked the start of a wave of change to the financial services industry. That day, the Parliamentary Joint Committee on Corporations and Financial Services (PJC), chaired by Bernie Ripoll, handed down its report on its Inquiry into Financial Products and Services in Australia (the Ripoll Report).

In this update, we take a look at the major findings of the Ripoll Report, the recommendations made and the potential implications. Additionally, we look at the question of ‘where to from here?’.

The PJC Inquiry

On February 25, 2009, the committee resolved to inquire into and report on the issues associated with recent financial product and services provider collapses, such as Storm Financial and Opes Prime, with particular reference to the:

• role of financial advisers;
• general regulatory environment for financial products and services;
• role played by commission arrangements relating to product sales and advice, including the potential for conflicts of interest, the need for appropriate disclosure, and remuneration models for financial advisers;
• role played by marketing and advertising campaigns;
• adequacy of licensing arrangements for those who sold financial products and services;
• appropriateness of information and advice provided to consumers considering investing in financial products and services, and how the interests of consumers can best be served;
• consumer education and understanding of financial products and services;
• adequacy of professional indemnity insurance arrangements for those who sold the products and services, and the impact on consumers; and
• need for any legislative or regulatory change.

These terms of reference were subsequently expanded on March 16, 2009, to include the role of the banking and finance industry in providing finance to investors in Storm Financial and so on and their practices around margin lending activities.

The PJC received 398 formal submissions, 37 supplementary submissions and held nine public hearings.

The findings

While noting that its role was not that of a judicial inquiry, the PJC formed a broad conclusion that many of the issues surrounding the collapse of Storm Financial and Opes Prime were the result of investors receiving poor quality advice.

There were a number of contributing factors to this poor quality, from the systems and processes used to marketing methods, the roles of lenders and the role of the regulator.

Regarding the collapse of Storm Financial, the Ripoll Report noted the following issues were of concern:

• a one-size-fits-all approach was adopted, which doesn’t reconcile with the requirement that advice be appropriate to each individual client’s personal circumstances;
• insufficient client understanding of the products they were entering into and their associated risks;
• a focus on sales targets leading to finance being made available inappropriately to some clients;
• the poor management of margin call processes; and
• the role of the Australian Securities and Investments Commission (ASIC) in investigating matters surrounding Storm Financial.

Similarly regarding Opes Prime, the Ripoll report noted the following concerns:

• the lack of clients’ understanding of the securities lending arrangements they had entered into;
• inappropriate provision of sophisticated products to retail investors;
• ineffective disclosure in product marketing material regarding the risks of the products; and
• a need for federal regulation of margin lending.

It’s important to note that the Government did not wait until the delivery of the Ripoll Report before taking action.

Legislation has already passed (with full effect from November 10, 2010) to have margin lending activities regulated as a financial product under Corporations Law, which then introduces licensing, education and other requirements for margin loan providers as well as people looking to provide advice in this area.

Similarly, changes are currently underway to have all other forms of consumer credit regulated under Federal legislation, with changes starting to take effect from July 1, 2010.

The recommendations

The Ripoll Report has made 11 recommendations for reform. A more detailed analysis of these reforms is below, but there are three major recommendations that could, if implemented, have a significant impact on the manner in which advice is provided to clients.

These three major recommendations concern:

• the introduction of a statutory fiduciary duty for financial advisers, requiring them to put the interests of their clients ahead of their own (Recommendation 1);
• the development of an appropriate mechanism by which to cease payments from product manufacturers to financial advisers (Recommendation 4); and
• the establishment of an independent, industry-based professional standards board to oversee nomenclature, competency and conduct standards for financial advisers (Recommendation 9).

There is also a recommendation (Recommendation 5) that the Government consider the implications of making the cost of financial advice tax deductible, although such a change is unlikely to occur unless and until significant movement occurs on the three recommendations mentioned above.

Where to from here?

The Ripoll Report only contains recommendations for reform. It does not effect an immediate change in legislation. The Government is not required to implement all or any of the recommendations made.

Following the release of the Ripoll Report, the Government stated it would respond to the recommendations in conjunction with the Cooper Review into superannuation, which will also be looking at commissions and fee structures in superannuation.

Phase 2 of the Cooper Review is due to look at commission and fee structures, but this has since been deferred to Phase 3 (for which submissions will close on February 19, 2010).

The Cooper Review is not due to present its final findings to Treasury until June 30, 2010.

The Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, has also stated that the Government will be "working through the recommendations of the Ripoll Report and will judge its recommendations against those two policy principles to help ensure that financial advice is in the best interests of the client, while keeping this advice within the reach of those who may need it most".

The scope of the PJC is also important to remember when considering the recommendations made. The PJC is only empowered to have regard to and make recommendations on those matters that fall within its terms of reference.

This did not stop many of those who made submissions to the PJC commenting on matters outside this scope, and while the Ripoll Report did not comment on them, it doesn’t mean the Government won’t take them into account in determining its next steps.

Of course, it’s important to remember there are two other important events in 2010 that may well have an impact on when proposed government reforms are to be released.

Federal Budget

History has shown that if a Government wants to introduce a new measure to change established practice from a particular date, this will often occur on Budget night. In relation to the Ripoll Report specifically, it is unlikely a particular measure will be introduced that night as the recommendations don’t have a specific revenue impact for the Government.

However, additional funding for the regulator (i.e, ASIC) may be announced.

However, findings from the Henry Tax Review or possible initiatives from the Cooper Superannuation Review (such as curbing commissions on super guarantee payments) could be announced at this time.

Federal election

A Federal election is due to be called in the second half of 2010 but could occur sooner.

Depending on what changes the Government wants to make in light of the Ripoll Report, the Henry Tax Review and Cooper Super Review, some of these changes may be announced before the election, as part of the election campaign or reserved until after the election.

One thing is certain, change will occur. It is just the what, how and when that remains unclear at this stage.

The Ripoll Report recommendations

Recommendation 1

The committee recommends that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an Australian Financial Services Licence (AFSL) requiring them to place their clients’ interests ahead of their own.

The imposition of a fiduciary duty for financial advisers was an expected outcome of the Ripoll Report. However, the issue with fiduciary duties is that there is no single clear understanding of what it encompasses, so any legislative codification of this duty needs to be clear in its meaning.

There has been previous talk of a fiduciary duty requiring an adviser to provide the ‘best advice’ or advice that is in the ‘best interests’ of a client.

The introduction of the concept of ‘best’, however, creates issues as it will be difficult to defend an action to show that there was nothing else available or no better product in the investible universe that would have delivered a better result for the client.

The PJC recommendation of placing the client’s interest ahead of those of the adviser is similar to the approach adopted by the Financial Planning Association (FPA) that needs to be adhered to by FPA members — being a duty of putting the client first.

That is, the choice of strategies and products should be made based on meeting the needs of the client first.

Any issues around remuneration (direct or otherwise) should not influence the recommendations.

Recommendation 2

The committee recommends that the Government ensure ASIC is appropriately resourced to perform effective risk-based surveillance of the advice provided by licensees and their authorised representatives. ASIC should also conduct financial advice shadow shopping exercises annually.

The PJC is of the view that ASIC should be more targeted in its surveillance activities based on information that becomes available about licensees.

For example, if ASIC becomes aware of a licensee that has disproportionately recommended one type of product or has a higher level of inherently risky product investments, it should be more targeted in its surveillance of the licensee.

Whilst this initial component of the recommendation has generally been supported, there is less support for ASIC undertaking annual shadow shopping exercises.

This is not surprising.

A more targeted and effective surveillance program should assist in identifying potential areas of risk or concern. Shadow shopping exercises in the past have resulted in a focus in the media on poor areas of advice to the detriment of the majority of good advice that is being provided to investors.

An annual shadow shopping exercise has the potential to do more damage to the public perception of financial advisers than actually rectifying any shortcomings.

Recommendation 3

The committee recommends that the Corporations Act be amended to require advisers to disclose more prominently in marketing material restrictions on the advice they are able to provide consumers and any potential conflicts of interest.

This recommendation is intended to ensure clients are more aware of the potential limitations on the type of advice that can be provided or products that can be recommended by an adviser.

The PJC notes this is more important or relevant in vertically integrated financial institutions.

If implemented, this could involve additional work on documents such as Financial Services Guides.

The issue to be grappled with is how a requirement to make such disclosures more prominent can be balanced against a desire to shorten the length of disclosure documents generally in order that clients actually read and understand them.

Historically, more disclosure has led to longer and more complicated documentation.

Recommendation 4

The committee recommends that the Government consult with and support the industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers.

In making this recommendation, the PJC acknowledges the steps that the financial services industry has already taken in looking to remove and/or more clearly disclose payments that can be regarded as possibly giving rise to conflicts of interest.

This includes initiatives from the FPA and the Investment and Financial Services Association to unbundle advice fees from product/platform fees from July 1, 2012.

Additionally, there is a view that the introduction of a fiduciary standard (as per Recommendation 1) could act to remove some of these payments in any event.

This recommendation has raised the largest debate since the report was released. What is most interesting is what the Ripoll Report doesn’t say. In making this recommendation, the PJC in the Ripoll Report itself doesn’t specifically mention which type of payments it is referring to.

However, the chairman of the parliamentary inquiry into the financial services industry, Bernie Ripoll, is on record as saying this refers to all types of payments, including shelf fees, volume bonuses, soft dollar incentives and commissions.

In addition, if ‘all’ means everything, it’s not restricted to investment products but can also include insurance.

It is also interesting to think about what sort of payments fall within the actual verbatim recommendation (i.e, payments from product manufacturers to financial advisers):

• shelf fees are generally paid from product manufacturers to platforms, so potentially aren’t covered;
• volume bonuses are generally paid from platforms to the AFSL holder (rather than to advisers), so potentially aren’t caught;
• shares in any volume bonuses may be paid to advisers in full, part or not at all, but are payments from AFSL holders, rather than product manufacturers, so potentially aren’t caught; and
• is a payment from a product/platform to an adviser as an asset based fee for service charge caught? In this case, it could be taken to mean that advisers will only ever be able to charge clients on a fee for service basis directly.

The Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, stated at the recent FPA national conference that any change must be guided by two key principles:

• firstly, that the financial advice that people get must be in their best interests — distortions to remuneration, which misalign the best interests of the client and the adviser, should be minimised; and
• secondly, in minimising these distortions, we need to ensure that we do not put financial advice out of the reach of those who would benefit from it.

Any movements in relation to fee arrangements need to be managed carefully as they have the potential to drive many participants out of the industry as it becomes more complicated and/or it turns the risk of actually increasing the cost of advice onto investors as benefits of scale and cross-subsidisation are lost.

These comments seem to indicate that there is scope to keep some forms of payments to advisers.

Recommendation 5

The committee recommends that the Government consider the implications of making the cost of financial advice tax deductible for consumers as part of its response to the Treasury review into the tax system.

Not surprisingly, this recommendation has received widespread support from the industry, many viewing it as long overdue. However, as mentioned previously, any movement in this regard is unlikely in the absence of reform on other recommendations.

Recommendation 6

The committee recommends that section 920A of the Corporations Act be amended to provide extended powers for ASIC to ban individuals from the financial services industry.

Currently, ASIC only has the power to ban an individual from the financial services industry where they are able to form the view that the individual "will not comply" with prescribed requirements under the Corporations Law.

This is a very high standard to be satisfied and the PJC agrees as per ASIC submissions that the standard should be one of a slightly lower level where ASIC can form the view that an individual "may not comply" or "is unlikely to comply".

This would allow ASIC to take into account other conduct of the individual when forming an opinion.

Additionally, this would remove a potential issue where an individual could demonstrate that they are meeting the actual legislative requirements (e.g, a tick-a-box approach) and ASIC had no choice but to continue to allow the individual to participate in the financial services industry.

Recommendation 7

The committee recommends that, as part of their licence conditions, ASIC require agribusiness managed investment scheme licensees to demonstrate they have sufficient working capital to meet current obligations.

The PJC expressed their concern that some agribusiness schemes have relied too heavily on new investments to support existing schemes and therefore made this recommendation. It has received general support within the industry.

Recommendation 8

The committee recommends that sections 913B and 915C of the Corporations Act be amended to allow ASIC to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee "may not comply" with their obligations under the licence.

This recommendation is in line with Recommendation 6 and allows ASIC to take an approach to issuing, suspending and cancelling licences on more than just a tick-a-box approach.

Recommendation 9

The committee recommends that ASIC immediately begin consultation with the financial services industry on the establishment of an independent, industry-based professional standards board to oversee nomenclature (classification), competency and conduct standards for financial advisers.

Within the financial services industry, there has been a desire over many years to have the term ‘financial planner’ or ‘financial adviser’ enshrined in legislation, such that you can only hold yourself out to be one of these if you meet certain requirements.

This recommendation is in support of such a move, but not through legislative intervention.

Rather, this recommendation seeks to align financial planning with, for example, the accounting profession.

For example, to hold oneself out as a Chartered Accountant, an individual needs to be a member of the Institute of Chartered Accountants in Australia (ICAA), must meet initial education and qualification requirements set by the ICAA (i.e, the professional year program) and meet ongoing educational requirements to retain their status as a Chartered Accountant.

The ICAA also has the power to ban or suspend membership for misconduct or for not meeting requirements, in which case the individual can no longer hold him or herself out as a Chartered Accountant.

The PJC also notes that many submissions stated that initial entry education requirements (RG 146) and ongoing requirements are too low.

The PJC has agreed that these requirements should be lifted, but that ASIC should consult with the industry about the best way to do this to ensure that it doesn’t result in an unintended increase in the cost of advice.

Finally, while a recommendation has been made for an independent industry based professional standards board, there must be some degree of doubt about how independent such a board would ultimately be.

Financial services is a highly regulated industry and true self regulation is perhaps an impossibility. It would not be surprising to see such a board be comprised of a mix of government, regulatory and industry participants.

Recommendation 10

The committee recommends that the Government investigate the costs and benefits of different models of a statutory last resort compensation fund for investors.

This recommendation recognises the current deficiencies of professional indemnity (PI) insurance arrangements, including what may be covered under such policies, when an insurer will accept that a valid claim is made and the reduction of PI providers in the marketplace.

More importantly, it recognises that investors may be left with no means of recourse or rectification if a particular event is not insured and the product or advice provider is subsequently unable to make good on any valid claim.

While there is agreement within the industry that clients should not be left uncompensated for valid claims, there are significant concerns on how this recommendation will operate.

In particular, there is real concern that it could increase costs to advisers/providers, driving many out of the market and/or resulting in a significant increase in cost to investors such that advice becomes less affordable.

Recommendation 11

The committee recommends that ASIC develop and deliver more effective education activities targeted to groups in the community who are likely to be seeking financial advice for the first time.

While education is not the only solution, this recommendation is broadly supported.

What has not been recommended?

There are a couple of important issues that were raised in the PJC process that the Ripoll report either did not comment on or were specifically mentioned in the report as areas that the PJC did not believe change was required — because it was unnecessary or because it would add more cost or complexity to the system. These include the following:

• no differing standards or fiduciary duties depending on the type of role or function of an individual (e.g, in-house product sales advice vs independent advice offerings);
• no restrictions on what type of products can be offered to particular types of investors;
• no separate licensing regimes for different types of advice;
• no differing capital adequacy requirements for different types of advice; and
• no risk rating system for financial products.

Of course, it is still open to the Government to decide to introduce reforms on any of these points.

Bryan Ashenden is senior manager, technical and advocacy, at BT Financial Group.