Fiduciary duty - best interests or best advice?

What does ‘best interests’ advice mean for financial advisers? Pam Roberts reports.

When the Ripoll enquiry findings were released, a key recommendation was the introduction of statutory fiduciary duty for financial planners to act in the best interests of clients. This means an obligation to place a client’s interests ahead of their own. The fiduciary (or best interests) duty would be on the licensee (dealer group) and apply to authorised representatives.

What is the ‘best interests’ duty?

A fiduciary duty is not solely about the quality of the advice. Instead, for financial planners it is about putting the client’s interests ahead of their own.

Effectively, this means avoiding conflicts of interest and not taking payments without the client’s active consent. If payments are made that breach the duty, the fiduciary must ‘account for profits’ to the client, which means the client actually owns the payments unless they agree to the fiduciary receiving it.

In a number of cases the courts have found a fiduciary duty does apply to financial advisers in the particular circumstances under examination.

However, inserting the duty into the Corporations Act will mean it will become an express obligation and ASIC will have greater powers to become directly involved to prohibit conduct it regards as breaching the duty.

The Government has advised in the Future of Financial Advice (FOFA) Information Pack released on 28 April 2011 that the best interest duty will be subject to a reasonableness test and an adviser will not be obliged to trawl through the entire gamut of financial products on the market. However, the Government also directs:

“If the adviser cannot recommend a product that is in the best interest of the client from their own ‘approved product’… then the fiduciary duty may require them to search beyond the ‘approved product list’ or recommend that the client should see another adviser… If a person considers that they cannot provide advice that is in the best interests of the client in accordance with the duty, they must refuse to provide the advice.”

Best interests or best advice? That is the question

Acting in the best interests of a client is not the same as providing the best advice to a client, although each action impacts on the other. In providing advice a professional financial adviser already has an obligation to provide appropriate advice and to exercise reasonable care and skill.

The quality of advice is also covered under the advice contract, with these obligations remaining unchanged.

The Government has made clear that the best interest duty is about the process of providing the advice, not the quality of the advice itself. Advisers who get the process right, but whose actual advice is not appropriate, reasonable or is negligent, will remain accountable for the cost of client loss.

Who is responsible?

As outlined in the FOFA Information Pack, the ultimate responsibility for complying with the duty to act in the client’s best interests falls to the licensee, who will be financially responsible for any breaches.

Individual authorised representatives may be subject to administrative penalties, such as banning orders.

Making the licensee ultimately responsible is consistent with other requirements in Corporations law and also ensures that licensees put into place systems and procedures to ensure representatives comply with the new duty.

Stakeholders and the fiduciary duty

Licensee/dealer Group

Licensees will need to streamline the services they provide to authorised representatives. Licensees may need to review where there may be gaps in products on their approved product lists and where training and administration procedures need to be updated and enhanced.

Licensees will find this difficult when there is no draft legislation to work from and a start date of 1 July 2012.

The administration cost of operating a financial advice business is likely to increase. At the same time, financial planning group revenue streams are under threat (with items such as rebates from fund managers). Increased costs will fall to authorised representatives and then, inevitably, clients will pick up the tab.

Licensees may also feel the impact of increased insurance costs as professional indemnity (PI) premiums may rise to reflect the greater statutory obligations envisaged by FOFA. Consequently, from 1 July 2012 PI insurance will need to cover the best interest duty as well as other statutory changes.

Authorised representatives/advisers

From 1 July 2012 financial advisers will need to put their client’s interests ahead of the interest of themselves and their licensee.

Although the Government has said financial advisers will not need to trawl the length of the market to find the best possible product for a client, practical problems will still arise.

If a product is not on the advisers approved product list, advisers will have to seek individual approval. In some instances, that approval may not be forthcoming. In addition, advisers who are authorised representatives may not be aware of the principal’s interest in a particular product.

Clients

Will clients notice their adviser is under a statutory duty to act in their best interest? Probably not, but if and when the cost of advice increases, they will definitely notice that. They will also notice some of the structural problems with the new FOFA regime, including:

• The lack of tax concessions for advice;
• The inefficiencies of having to opt into advice every two years; and
• The inevitable problems clients will encounter if they forget to opt in.

Conclusion

As with all FOFA reforms, the devil may well be in the detail. How this new statutory fiduciary duty will work and the details advisers and licensees need won’t be available until draft legislation is released after June 2011.

Many advisers have already factored in a ‘best interests duty’ into their advice remuneration structures from 1 July 2012. However, increasing the key concern for advisers over this and other FOFA reforms is the increasing cost of advice, a cost which will inevitably be borne by clients.

Pam Roberts is technical services manager at IOOF.