Professionalising the financial planning industry

Financial Services is fraught with conflicts of interest, says Robert Keavney. But the regulatory focus on these problems means that financial planning has a bright future.

Financial services is more heavily regulated than most other industries and is about to become more so. There are those who feel we are unfairly picked on and complain that we are subjected to such scrutiny.

Yet, it is both appropriate and inevitable for us to be the focus of attention due to the unusual nature of our relationship with clients.

In most industries a simple transaction takes place between the business and its customers. The customer hands over money in order to possess goods or services.

In a car dealership, buyers leave the premises driving the new automobile they own, and the dealer deposits the money into its accounts. The ownership of the vehicle and the cash have changed hands in a clean transaction.

For large parts of financial services, this is not the case. The investors own their money throughout the whole process, it is simply lent to, advised upon, managed by or invested in some financial institution.

The institution holds, manages or advises on the funds on behalf of, and for the benefit of, the investor. During this process, one party has control of the other party’s money.

Naturally, how we deal with other people’s money will be subject to scrutiny.

My interest has always been the financial advice sector because it is close to the clients for whose benefit, purportedly, we are all here.

I have been observing and have participated in planning since 1982. It is clear to me that various participants have different primary objectives. Some aim, first and foremost, to serve their clients needs. Others’ main driver is to make as much money as possible from clients.

It is legitimate to charge clients for one’s services as we are operating commercial enterprises. I’m not arguing that financial advice should be a charitable activity. Further, the higher the level of service provided, the higher the level of fee will be justified. Those who provide outstanding service are entitled to earn good incomes.

A certain portion of advisers or dealers have no interest in receiving additional revenue in relation to their clients, over and above their clients’ fees.

They believe that the receipt of fees brings an obligation to uncompromisingly serve their clients’ interests. Of course, this assumes their fees are at a level sufficient to support the profitable provision of service.

Others always look for additional ways to clip to ticket, as if they feel it is reasonable to milk the funds entrusted to their care as much as possible. Inevitably, at times, this will influence the advice some give.

Another factor that can influence advice is the practice of dealers providing sales targets or incentives for recommending related products or referring to related services.

Conflicts of interest

Ripoll focused on bank sales targets as a cause for many people being given finance which was not appropriate for them. It goes without saying that sales targets for a given product emphasise sales of that product over ensuring its appropriateness to clients.

In my experience, if a product or service is in a client’s interest, quality advisers will always recommend it. They don’t need an incentive to do so.

Hence sales targets or bonuses for recommending particular products/ services don’t reconcile readily with unbiased advice, as they provide an inducement to sell more of a product than they would do automatically (ie, more than is appropriate).

Yet to much of the industry, product sales incentives or cross-referral incentives are a matter of course. It is so obviously in the business’ interests to offer them that the question of whether it is consistent with being client-centred seems to never arise.

Dealers who do this may believe they are client centred, but they are introducing a conflict of interest.

Ripoll’s focus on payments from product manufacturers is a step towards eliminating remuneration that could compromise recommendations to clients.

Remuneration should never be able to influence advice given to clients. This is screamingly obvious. It is very difficult to be indifferent to your level of income. Few are able to attain such indifference.

If remuneration can influence advice it often will, leading to other recommendations than would have been made impartially. No one can defend this.

If an adviser whose revenue considerations influence the products they recommend was to be frank with clients about this, clients may have reservations about accepting the advice. Thus some advisers are forced to not be forthright with clients.

Few people want to make a living misleading people. Yet many otherwise well-intentioned individuals are put in this position to some degree due to industry remuneration practices.

We have the opportunity to put all this behind us. Whether we like it or not, we may be forced to.

Ripoll recommended that conflicts of interest be disclosed more prominently. Everyone in the industry knows how often these disclosures are carefully worded to soften the impression of conflict. Why is this done? Not to benefit the client.

Our industry is heavily laced with conflicts. If there is another industry that is more heavily conflicted, I’m glad I don’t work in it.

There are outstanding individuals who have a conflict but are not influenced by it.

However, many people and organisations are influenced. If clients’ trust in us is to be justified, we owe it to them to make sure they unambiguously understand any conflict and how it can alter our behaviour.

One of the furphies about this disclosure is that it greatly adds length to documents. Generally, it will only add length if it involves obfuscation.

I have seen Statements of Advice which include wording like: 'You need to understand that I have a conflict of interest in xxx as my income will be higher as a result of recommending it. Nonetheless, I recommend it as I believe it is appropriate in your situation. Please see Appendix xxx to understand the details of my remuneration.'

This gives the client the essential information about a conflict and the remuneration disclosure can set out details in an equally plain English format.

This does not add a lot of length. On a few occasions the arrangements to be disclosed are complex, but where they are hard to understand, there is all the more reason to set it out clearly.

Fiduciary duty

Ripoll proposes a cessation of payments from product manufacturers to advisers. The reality is that almost all revenue passes from manufacturers to dealers to advisers. Eliminating direct payments from manufacturers to advisers will make little difference. Any regulations will need to reflect this reality.

It will also need to be mindful of the potential for circumvention in dealerships that are part of diversified institutions.

The dealer may reward the sale of related products by paying bonuses to its planners without the need to transfer funds from the product manufacturing division.

This cross subsidisation may avoid any ban on manufacturer/ advisers payments but leave the conflict of interest intact.

The authorities are well aware of the ability of the industry to mould practises to accommodate new regulations without substantive changes to fundamentals issues.

The imposition of a fiduciary duty offers the prospect of going to the heart of the relationship, rather than black letter law prescription of practices. While there will be great interest in how the fiduciary duty is defined, it is a sound and appropriate step.

As advisers, we hold out to clients that we are on their side and act for their benefit. This claim is either true or it's not. This ensures we mean it.

It must be acknowledged that it is quite acceptable for a product manufacturer to employ a sales force to promote their products, but this should not masquerade as being advice.

To my mind, legislation should recognise the difference between advice and sales.

This may involve a limiting of the fiduciary duty of sales people to recognise they can only serve their clients’ interests within this framework of their employer’s products.

At the moment, we have the absurd situation whereby the representatives of many financial institutions claim that they genuinely and impartially believe their employer’s products are best of breed. Employing a sales force can’t be banned as any business is entitled to sell its products, but the pretence that it is advice should be eliminated.

Methods of payment

Regulation will need to allow advisers’ fees to be paid from clients’ accounts in financial institutions, especially wrap accounts.

Even if product providers are not allowed to pay advisees with their money, they must be allowed to perform the administrative function of deducting agreed adviser fees from clients’ accounts and directing it to advisers.

To not allow this forces us back to the time where fees were paid by cheque. This is less efficient for both parties for no benefit.

This article has contained harsh criticisms of certain industry practices. To ensure balance, I readily acknowledge there are many first class professionals among the ranks of advisers, and more every year.

There is a wonderful future for the financial planning industry.

Advisers who can eliminate conflicts of interest, provide quality service and charge adequate fees to operate profitably are in an impregnable position. It is clear that the tide of public and political attitudes is flowing this way. It is much easier to swim with this tide than to try to oppose it.

However, I must note my concerns about the insurance industry. Certainly the practice of churning commissions has driven up costs for the whole industry.

However, there is a large body of planners who already operate on fees, gaining public acceptance of paying and providing precedents for those who are moving this way. Moving away from commission is a well-trodden path for planners.

This is not the case for insurance, and a cessation of commission could wipe out the insurance advice profession. This area calls for careful thought.

I would like to conclude by thanking Jo-Anne Bloch for her wonderful leadership of the Financial Planning Association (FPA) in the areas dealt with by this article. I am very sorry to see her go. The FPA will be very fortunate to find another leader of such character.

Over the last few years the association has correctly identified the direction of regulation and kept the ahead of the game. As a result, planners have been invited to the table where our fate is being determined.

Jo-Anne has been vilified for this far-sightedness by some planners who would have preferred a leader modelled on King Canute, commanding the tide not to roll in. She can look back on her role with great satisfaction.

Robert Keavney is an industry commentator.