Why FOFA alone cannot change the culture of financial planning

The Government's Future of Financial Advice proposals may serve to alter the legislative environment but, as Mike Taylor writes, new research suggests much more is required to alter underlying financial planning firm cultures.

If there is one thing the Government cannot specifically guarantee to deliver via its Future of Financial Advice (FOFA) reforms it is ethical behaviour.

Yet an analysis of factors contributing to the recent business failures and collapses that have scarred the financial planning industry suggests that a failure to fully understand ethical considerations and responsibilities represented a major contributing factor.

According to the research, undertaken as part of a PhD thesis process at Victoria University by Argyle Lawyers principal Dr June Smith, the failings around ethics are owed not only to some of the more minimal educational requirements involved in providing financial advice but in the underlying culture of the companies within which planners are working.

Discussing the question with Money Management last week, Smith suggested that not even good training could be guaranteed to overcome a bad company culture where ethical standards were concerned.

She said that it was in these circumstances that while the types of legislative and regulatory changes likely to flow from the Government’s FOFA reforms might provide useful changes to the underlying rules, they would not necessarily serve to effectively alter cultures.

Indeed, organisations such as the Financial Planning Association (FPA) would be disappointed by any close examination of Smith’s research because it suggests that many members and member organisations are falling at the first hurdle.

Smith’s research defines the 10 most common forms of unethical conduct in financial advice as:

1. Misleading statements as to performance, product features or security and business reputations;
2. Use of client funds for own purposes;
3. Advice did not meet client objectives or circumstances and had no reasonable basis;
4. Lack of financial product research/inadequate understanding or financial product recommended;
5. Failure to disclose remuneration benefits and conflicts of interest;
6. Failure to disclose information relevant to client decision;
7. Inadequate written advice or failure to tailor advice to client;
8. Inadequate explanation and examination of risks associated with investment;
9. Inadequate explanation of the risks associated with a financial product; and
10. Failure to follow internal procedures and policies of the Australian Financial Services (AFS) licensee.

In other words, the top 10 failings identified by Smith’s research do not involve the intricacies of providing financial advice — they involve the basics.

What is more, the research suggested that all too often these failings were slipping through the cracks with respect to risk management and compliance systems.

What is most disturbing about Smith’s findings is that they suggest that many of the issues the industry thought it had successfully addressed remain a part of the day-to-day practices of some advisers.

According to Smith, this fact tends to explain why the Westpoint and Storm collapses appeared to run against the reformist efforts of organisations like the FPA, the Association of Financial Advisers and the Financial Services Council.

In short, the reformist objectives and associated noble rhetoric were not matched by any significant change to the underlying culture of some advisory firms and their advisers.

Smith suggests that a part of the problem confronting the financial planning industry is its evolutionary history with respect to the influence of major insurance and banking companies — specifically, the selling of products rather than provision of advice.

“Perhaps there really does need to be a split within the industry — a division between those providing advice and those selling products,” she said.

Smith’s research analysis said the findings had raised questions about “the commoditised approach to financial advice used by some financial advisers and the ongoing failure to accurately match financial products to the needs, circumstances and objectives of clients”.

It said the data suggested financial advisers still struggled with even basic legal concepts such as having a “reasonable basis” for advice and “suitability” of advice to the client.

“The complaint analysis highlighted a pattern of over-reliance on template Statements of Advice not tailored to the client’s specific circumstances,” it said.

“The widespread use of substantial templating of advice poses ethical risks of its own and can at times lead to greater risk for consumers. It also hinders the adviser’s ability to fully disclose all matters relevant to an informed decision-making process.”

Smith’s analysis said that many of the forms of unethical conduct should have been identified by the Australian Financial Services Licence (AFSL) holder’s risk management and compliance systems but were not.

“This suggests that AFS licensees are inadequately identifying some of the key ethical risks associated with the provision of financial advisory services or that those risks are not being appropriately managed and supervised,” it said.

The analysis said some of the unethical conduct identified might also have arisen as a result of failures in the ethical frameworks of financial advisory firms, and that while lessons might be learned from such experiences, they appeared to be too quickly forgotten.

At least a part of the answer, according to Smith, is to place a greater emphasis on ethical issues both at an adviser and compliance manager level, because the research findings suggest that “ethical reasoning levels amongst financial advisers and compliance managers are currently lower than is required to effectively resolve the complex ethical dilemmas often associated with the provision of advice to consumers”.

A key finding of Smith’s research is that age and experience can represent key factors in terms of ethical standards and how they are applied in a planning environment, and that the higher your educational qualification the higher the level of your ethical behaviour is likely to be.

It found that younger and less experienced advisers and compliance officers were more likely to engage in unethical decision-making and were therefore at a higher risk of engaging in unethical conduct than their older and more experienced counterparts.

However, the research also found that the size of an organisation could be a factor with respect to unethical behaviour, suggesting that larger financial services organisations were more exposed to risks associated with a poor ethical climate and culture within their advisory divisions, as well as a lack of ethical leadership.

Hardly surprising among the issues said to influence the underlying culture of organisations were remuneration structures, with the research suggesting that those who adopted a fee-for-service culture were likely to be more ethically aware than those who took commissions.

It found that while there was no evidence that financial advisers who received commission payments had lower levels of ethical reasoning ability, “the research indicates that remuneration structure and the inherent conflicts of interest associated with some commission and volume-based payments led to unethical outcomes in the provision of financial advice and the failure of advisers to place their client’s interests before their own”.

In short, Smith said her research had supported the FOFA and industry association reforms to introduce a fiduciary conduct standard, implement fee-for-service models, ban some forms of commission and volume-based payments and introduce an opt-in mechanism for consumers.

However, she warned that, notwithstanding these changes, significant and complex ethical issues related to conflicts of interest would remain — albeit in a reduced or different form — and would require a more substantial solution.

Smith encapsulated the results of the research by suggesting that while the imposition of regulatory solutions such as the FOFA reforms were aimed at raising conduct and professional standards, they represented only a first step and might not of themselves be capable of achieving their stated objective.

“Regulatory responses such as FOFA may not always resolve ethical conduct and behaviour issues and a more comprehensive solution may be required, including a reinvigorated approach to the use and application of ethics frameworks,” she said.