How financial planners can avoid conflicts of interest

Samantha Hills provides tips for financial planners on how to manage and avoid conflicts of interest when dealing with clients, ahead of the proposed FOFA changes.

The Future of Financial Advice Reforms (FOFA) will change, to some extent, the way you manage conflicts of interest in your business.

But this is not that revolutionary.

Licensees are already subject to requirements which govern the way they manage conflicts of interest.

If you are up to speed on your existing obligations, it will be an easier step across to the new regime, if and when it comes into play.

Conflicts of interests – AFSLs and ACLs

If you have both an Australian Financial Services Licence (AFSL) and an Australian credit licence (ACL), you may have noticed that a number of your general obligations under each licence are identical but that your conflicts of interest obligations vary slightly from licence to licence.

Under your AFSL, you must:

Have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by the licensee or a representative of the licensee in the provision of financial services as part of the financial services business of the licensee or the representative.

This is from section 912(1)(aa) of the Corporations Act 2001.

Under your ACL, you must:

Have in place adequate arrangements to ensure that clients of the licensee are not disadvantaged by a conflict of interest that may arise wholly or partly in relation to credit activities engaged in by the licensee or its representatives.

This is from section 47(1)(b) of the National Consumer Credit Protection Act 2009.

The critical differences are those in bold type above.

In Regulatory Guide (RG) 181 Licensing: Managing conflicts of interest, the Australian Securities and Investments Commission (ASIC) defines conflicts of interest as “circumstances where some or all of the interests of people (clients) to whom a licensee (or its representative) provides financial services are inconsistent with, or diverge from, some or all of the interests of the licensee or its representatives.

This includes actual, apparent and potential conflicts of interest.”

In RG 205 Credit Licensing: General conduct obligations’ ASIC states that the obligation regarding conflicts of interest arises “where an interest of the licensee…conflicts with a legal obligation that the licensee…owes to the client, including one that arises under the credit legislation, National Credit Regulations, or at law (whether through statute, common law or contractual arrangements between the licensee and the client".

This description, which is the closest thing to a definition of “conflicts of interest” offered in RG 205, seems narrower than the definition offered in RG 181.

However, in RG 205, ASIC states that, in relation to conflicts management obligations under the AFSL and ACL regimes, “the conflicts obligation for credit licensees is more explicit about the required outcomes for the consumer”.

It appears that the current AFSL regime tolerates conflicts of interest that disadvantage the client as long as these are in some way “managed”. In RG 181, ASIC states that conflicts of interest are managed by controlling, disclosing or avoiding them.

This suggests that the current AFSL regime might tolerate a conflict of interest which disadvantages the client – provided the conflict has been disclosed to the client.

The danger is that ASIC might take the view that this does not amount to “adequate” arrangements for managing conflicts of interest. In the advice context, if the FOFA reforms come into play, this issue will at least become clearer.

In the meantime, we believe that the most prudent and efficient course of action if you hold both an AFSL and an ACL is to apply both standards across both licenses – using the methods of controlling, disclosing or avoiding conflicts of interests so that they are managed in such a way that no conflict of interest occurs which disadvantages a client.

Conflicts of interest requirements in action

No matter what the fate of the FOFA reforms, conflicts of interest will remain an issue dear to ASIC’s heart.

Recently, the regulator conducted a surveillance exercise into a financial planning business and, as a result, imposed additional conditions on its AFSL. This is one form of action ASIC can take if it identifies issues or concerns with the way a licensee is operating.

It was concerned that the licensee had entered into an agreement with an investment platform which gave rise to a conflict of interest. ASIC said that, in providing advice to clients to move from existing products to the platform, the licensee made insufficient disclosures regarding its conflict of interest.

ASIC’s comment suggests that, in this case, disclosing the conflict would have been an appropriate way of managing it. RG 181 suggests that there will be times when a conflict is so great that the only appropriate way of managing it in accordance with section 912A(1)(aa) is to avoid it altogether.

ASIC had other concerns about the licensee on this occasion as well. Where ASIC raises concerns about AFSL holder’s arrangements for managing conflicts of interest in the advice process, it will often have other concerns about the advice process as well.

This is because many of the requirements applicable to the advice process themselves act to manage conflicts of interest – for example, the disclosure of commissions or demonstrating a reasonable basis for the advice.

Your AFSL and ACL are not the end of the story, even putting FOFA to one side for the moment.

Fiduciary duty and conflicts of interest

It is possible that, at times, you have a fiduciary duty to your client. Fiduciary duty is a concept which derives not from the law made by the Parliament but from that which has developed through the courts – initially in England and then later in our own courts here in Australia.

A fiduciary duty imposes particular obligations on one party towards another party – for example, an obligation not to put your own interests ahead of those of the other party.

Particular categories of relationship automatically give rise to a fiduciary duty – for example, the relationship between solicitor and client, or the relationship between agent and principal.

By contrast, we recently considered, in the context of advising a client, whether the relationship between broker and client automatically entails a fiduciary duty and found that it does not.

Where the particular relationship does not automatically give rise to a fiduciary duty, other characteristics of a relationship might make it (or parts of it) fiduciary in nature.

One characteristic is one party placing its trust in the other party – as a client might do in their adviser. There is ongoing debate as to whether financial planners generally owe fiduciary duties to their clients.

Such debate takes into consideration the kinds of characteristics present in the relationship typically in place between adviser and client.

The reality is that whether or not a particular relationship is fiduciary will vary depending on the adviser and the particular client involved.

In our view, if you carefully abide by the requirements imposed on you by legislation relating to your ACL and/or AFSL, you have a good chance of avoiding being accused of breaching a fiduciary duty, should one exist.

In comes FOFA

FOFA introduces a number of requirements, such as the “best interests” duty, which, if they come into play and you meet them, will help you steer clear of conflicts of interest.

FOFA also proposes to introduce two new specific obligations relating to conflicts of interest in the advice process.

These are:

• 961K — Conflict between the client’s interests and those of provider.
• If there is a conflict between the interests of the client and the provider’s interests, the provider must give priority to the client’s interests when giving the advice; and
• 961L — Conflict between the client’s interests and those of licensee or authorised representative:

If the provider knows, or reasonably ought to know, that there is a conflict between the interests of the client and the interests of:

• A financial services licensee of whom the provider is a representative, or
• An authorised representative of whom the provider is an employee, then the provider must give priority to the client’s interests when giving the advice.

According to the proposed section 961, the “provider” will be the individual who provides the advice. “Conflict” is not defined in the proposed amending legislation. It is hard to predict precisely how ASIC will interpret these provisions if they come into play.

Nevertheless, it is clear that these proposed sections would make the adviser responsible for prioritising the client’s interests, in the course of giving the advice, over those of the adviser, the adviser’s employer (if they are employed by an authorised representative) and the adviser’s licensee.

In our view, these sections will make it very difficult, for example, for an adviser to recommend that a client changes from an existing to a new life insurance policy if the existing one does not offer a commission to the adviser but the new one does – unless it is clearly in the client’s interests to move to the new policy.

This is the same outcome as we would expect under the existing section 945A of the Corporations Act 2001, which requires you to have a reasonable basis for your advice. Under the proposed legislation, section 945A would be repealed.

The Government explains these proposed new sections in its explanatory memorandum as follows:

Consistent with the best interest obligations, a provider does not breach the obligation to give priority merely by accepting remuneration from a source other than the client (for example, a commission paid by an insurance provider).

However, if the provider gives priority to maximising a non-client source of remuneration over the interests of the client, the provider will be held in breach of their obligations.

The bottom line

Conflicts of interest should be carefully managed by both holders of AFSLs and holders of ACLs.

Where one entity holds both an ACL and an AFSL, the same measures can be employed across conflicts that appear in both the financial services and the credit spheres – provided that the measures meet the requirements under both regimes.

Be mindful of the possibility that, at times, with some of your clients, a fiduciary duty may exist. This will also require you to carefully manage, or steer clear of, conflicts between your interests and those of the client.

In due course, new legislative requirements will tighten up the way you manage (and sometimes avoid) conflicts of interest. But if you are on top of your current obligations, it shouldn’t be too big a step across to the brave new world of FOFA.

Samantha Hills is a lawyer at Holley Nethercote.