Law and order in financial services

Advisers could face hefty lawsuits if they are unable to keep pace with regulatory change and capability development. Jassmyn Goh finds out how advisers can avoid legal traps.

In the past year, conversations around the financial services industry have jumped from the life insurance framework (LIF) to robo-advice, and accountant licensing changes, and many more hotly debated topics.

The plague of regulatory changes and proposals left, right, and centre, mean advisers need to stay vigilant on what could cost them a lawsuit. Money Management looked to financial services law firms to find out what top 10 legal traps they see for the coming year.

1. Fintech/robo-advice

The industry has been inundated with talk about robo-advice and new fintech capabilities entering the market over the past year.

While some advisers are embracing the change, The Fold Legal managing director, Claire Wivell Platter, said those who were alarmed or afraid were going to be left behind.

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"My general view is that robo-advice is coming and advisers need to get with the plot and use it to their advantage to service the clients they can't afford to service well themselves, and focus on relationship management," Wivell Platter said.

"Robo-advice is still in its infancy and there are lots of types, and advisers need to be aware of who's doing what and how they're doing it, and what's working."

Holley Nethercote partner, Grant Holley, said the legal requirement for robo-advice is for the advice to be in the client's best interest.

"If you try to give advice all through the computer, then you'll need very intelligent algorithms to get the relevant information and apply the information with advice," he said.

"The scope needs to be really, really clear on the website and what exactly the tool is going to do for you and won't do for a client. And things they're not going to be so good at should be triaged to a normal adviser where they can have a normal discussion.

"But if you think you're getting a more holistic service, you're not. It's horses for courses," Holley said.

2. Fraud

The rise of fintech has also opened advisers up to the trap of fraud, DBA Lawyers director, Daniel Butler said.

"It is easy for people to access passwords and internet devices and for fraudsters to sell financial products. It is the world of the internet, and lots of people do trade over the internet so it's a matter of having proper precautions in place to minimise risk," Butler said.

"We've got the technology platforms driving ahead but we haven't got the legal system that has kept up with the technology."

3. Accountants' licence

Despite knowing that the accountants' licencing regime will change on 1 July, less than 500 accountants had lined up to be licensed by the Australian Securities and Investments Commission (ASIC) by the beginning of April.

Cowell Clarke partner, Catherine Evans, said accountants needed to get their limited Australian Financial Services Licence (AFSL) lodged as soon as possible as changes may need to be made if they are rejected.

From 1 July, accountants who do not have a limited AFSL or the right RG 146 training could be giving unauthorised advice, including self-managed superannuation fund (SMSF) advice.

"Have processes in place and deliver training to ensure everyone understands what their role will be post 1 July. Have a clear process for when an authorised adviser needs to be brought in and think through how that will happen so that client experience is not adversely affected," Evans said.

"Ensure you and your representatives fully understand what you can and can't do under your AFSL and at what point referrals must be made. Before embarking on a new opportunity or area of business, get advice about whether you are authorised to do so or whether you need a variation."

4. Fees

While the life insurance framework (LIF) still sits as a proposal, advisers need to be aware of how fee structure changes will affect their business.

"Advisers need to ask themselves how do they charge for advice and demonstrate value to clients so they want to pay for your advice," Evans said.

"Think strategically about your revenue model and how you charge clients. Think about how you are delivering value and how you communicate that to clients."

Maurice Blackburn principal, Josh Mennen, said if commission payments remained, it would not adequately address the risk of advisers engaging in churn where they replace an old with a new policy in order to receive higher commissions.

"It's also important for advisers to ensure they're working on a fee-for-service model because a commission based remuneration structure has been proven to cause conflicts of interest," he said.

"Commissions also don't do anything about the sale of in-house product over more appropriate non-affiliated products," he said.

5. Best interest duty

The lack of incentive to give advice on non-affiliated products, thanks to commission based remuneration, may or may not be in the client's best interest.

Mennen said this was especially the case in large financial institutions like the big banks, AMP, and Macquarie as they were more geared towards recommending their own in-house products.

"It is important for advisers to be confident that the approved product list (APL) is a balance of affiliated and non-affiliated products. It is also not enough to just have something on an APL, they have to actually use it.

Holley said best interest duty was all about prioritising client's interest in any conflict of interest, and if an adviser relied on safe harbour they needed a document trail to prove they had taken necessary steps if there were competing versions of events.

"Keep a paper trail to illustrate that you've prioritised the clients' interest in the event of a conflict. Advisers need to consider whether there is a conflict and have some sort of written note of that consideration and I doubt many are doing that," he said.

6. Poor advice

Holley said possibly the biggest risk to an adviser was providing poor advice.

Under the old-fashioned common law negligence course of action, if an adviser breaches their duty of care and the client suffers loss or damage as a result, then they can be sued.

"The number one thing for advisers to do is to make sure that they and the client are on the same page about what the adviser is going to do for the client," Holley said.

"Around 80 per cent of disputes would not have occurred if the scope of the task or the subject matter was clearly defined."

Holley noted that there was also a risk of advisers giving advice in social situations offhandedly, like at a barbeque for example. He said this did not follow normal procedures and made advisers vulnerable to risk.

7. Risk tolerance

Financial advisers also need to be aware of the client's risk tolerance and matching that tolerance to investments, Wivell Platter said.

The firm had seen instances where advisers were not informing clients that they could choose either a higher risk investment option compared to their tolerance level in order to reach their investment objectives, or a more consistent investment option that did not quite meet their objectices.

If advisers chose to do the former it could "come back to bite advisers if there is a downturn in the market and the client is in a volatile portfolio," Wivell Platter said.

Mennen noted that advisers needed to be very cautious in engaging clients in margin lending or options trading.

"Advisers need to be very confident and have got their customer's risk profiling correct," he said.

8. DIY documents

The drive for do-it-yourself documents have increased with the incentive of cutting costs but huge legal battles arise as a result of cutting corners, Butler said.

"When advisers set up their clients with crappy documents like binding death benefit nominations that just don't work, they're skating on thin ice. The wall is pulled from underneath them when the client dies and then there's a huge legal battle regarding hundreds and hundreds of thousands of dollars on fighting the uncertainty of those documents," he said.

"There are quite a lot of advisers that make crappy documents because the web is really popular. It's not a problem ordering over the web but if you are the adviser doing the documents by yourself, making the legal judgements, and doing the changes, you're only as good as your own knowledge base.

"I don't think people intentionally go out there to do a disservice but what we find is not a lot of the advisers read their documents and don't know what is in the documents."

9. Marketing

Many people have been fined for misleading marketing in the past two years and ASIC has the ability to impose a $10,200 infringement, according to Wivell Platter.

She said the infringements were mainly advisers marketing their services and overstating the benefit of their services, or their independence, or the merit of the things they recommend like SMSFs.

"There is bit of a lack of understanding of the requirements. If you recommended an SMSF and since they're not suitable for everyone, the message needs to be balanced to say that it may or may not be suitable, and that there are advantages and disadvantages," she said.

Wivell Platter noted that it might not even be the adviser delivering the marketing material, but rather other people who do not necessarily know the restrictions, or that advisers have an obligation to adhere to the messages.

10. Education requirements

As the Government proposed the requirement for a degree-equivalent status and the need to pass an exam for advisers last month, Evans said this was a potential legal trap.

"Advisers should start early to ensure the additional education requirements can be completed quickly," she said.

According to the Government's announcement, the education and exam requirements are proposed to commence on 1 January 2019. Existing advisers have until 1 January 2024 to reach degree equivalent status and until 1 January 2021 to pass the exam.