Blessed is the code maker

There are few professions in which remuneration methods draw as much attention as financial advice.

With the majority of financial planners still paid through commission, the Australian Securities and Investments Commission’s (ASIC) recent criticism of wealth management professionals’ ethics and remuneration methods has added fuel to a fiery debate on conflicts of interest in the industry.

Financial planners may appear to be fighting a losing battle in trying to calm the regulator, but according to Financial Planning Association (FPA) board member Sarah Brennan, the association’s codes of practice are more demanding of FPA members than the rules ASIC has put in place to control adviser remuneration.

When the FPA decided in late 2003 that it would respond to growing consumer and regulatory scrutiny of the remuneration of financial advisers by drawing up a series of new codes of practice, it was Brennan, an industry consultant, who they largely turned to.

“The FPA rules of professional conduct are all about higher standards, and one of the components of that incorporates a higher standard of practice than the fee disclosures required by ASIC,” she says.

ASIC requires full disclosure to clients of all forms of remuneration, fees, commissions, and other benefits the planner receives for providing financial advice, whether direct or indirect, perceived or perceivable.

“That’s already in the professional code of conduct for the FPA,” Brennan says.

Code, guide and principles

With Brennan leading the charge, the FPA embarked on a program — the third and final component of which is due for completion in October this year — to give guidance to its members on avoiding and managing conflicts of interest.

Brennan says the first two phases were jointly developed by FPA members and representatives from the Investment and Financial Services Association to ensure both sides of the industry had a harmonised code.

The result of the first phase was what Brennan describes as a “very specific code”, the Code of Practice on Alternative Remuneration, otherwise known as soft dollar payments.

The code bans advisers from accepting or offering remuneration in the form of soft dollar options such as free computers, office accommodation, free business tools such as commercially available software, and cash or gifts of any sort over the value of $300, which is volume sales related. It was adopted by the FPA in August 2004, and came into force on January 1, this year.

Brennan says an independent arbitration committee, which refers its decisions back to the FPA for enforcement, polices the code.

“Flowing on from that was the guide on rebates, looking to address volume bonuses, marketing allowances etcetera, which came up when we were looking at the [soft dollar] code,” Brennan says.

The Industry Guide on Rebates and Related Payments was also adopted in January, 2005.

“There was nothing wrong with those kinds of payments, but it was confusing for consumers. That phase was about transparency and commonality of definitions.”

Brennan says the third stage was motivated by ASIC’s release of CLERP 9, and its related Policy Statement 181 (PS 181).

In these, ASIC acknowledged conflicts of interest could not be completely prevented. Brennan summarises ASIC’s message: “If the practice is such that it wouldn’t be seen as consistent with providing fair and honest advice, don’t do it. But if it is consistent with providing fair and honest advice, then manage it.”

But how should potential conflicts of interest be managed?

Dealing with conflicts

Brennan says while the first two phases of the FPA’s program on conflicts of interest dealt with specific situations, members of the 20-strong task force assigned to look into CLERP 9 and PS 181 opted for a more general and all-encompassing approach for the third phase.

“In looking at conflict of interest … this phase aimed to generate principles instead, so the task force didn’t have to get back together and reassess each time someone came up with something new.”

Brennan says task force members asked themselves: “What do we want FPA regulation to look like in five or 10 years time?”

The group agreed that the overriding principle should affirm advisers’ fiduciary obligation to act in the interests of their clients.

“That’s law today, but the task force thought it was important to restate that and have it as the overarching principle, because everything else sits below that,” she says.

The other key point the task force wanted to embody in the principles, Brennan says, was the value of advice.

“What planners do is phenomenally valuable, and that should be valued, and consumers should know that’s what they pay for.”

The group released its seven principles for consultation in April 2005, inviting comment from its members until October 28, 2005. The draft document spells out the principles themselves, and also gives examples of outcomes for consumers and changes in practices that may arise as a result of each principle’s application.

Brennan, along with other task force members, has spent time presenting and explaining the principles to FPA members, and soliciting feedback.

She says most of the concerns raised by members indicated a misunderstanding of the principles’ implications.

“There was a misconception that what the principles were saying, particularly principles one and two, was that the FPA was banning trail commissions.”

Principle one states that: “A financial planner will provide a client with clear, concise and comprehensive information so that the client will understand the advice and service being offered and its cost.”

Principle two says: “Financial planning advice should be independent from, and not tied to, product recommendations.”

Examples supplied on how the principles might be interpreted make it clear that remuneration structures that encourage advisers to sell in-house products will not be tolerated under the rules.

The examples also state clearly that adviser commissions should be separate from the price of products and disclosed separately, a move that may have given advisers the impression that trail commissions were being banned completely.

Brennan says rather than banning trail commissions, these principles aim to separate the cost of advice from the cost of a product that might result from the advice.

“That’s not just at the time when the client is getting advice, it’s on an ongoing basis,” she says.

Brennan explains the intention of the principles is getting advisers and clients to agree on the cost of advice, separate from product costs, and then work out a method of payment.

“You [as the client] might decide that you want to pay me [the adviser] for advice by writing a cheque. You might decide you want to pay me for it by setting up a direct debit from a bank, like you might do a gym membership, which is deducted on a monthly basis, or you might decide that you’d like me to deduct that fee from the investment pool, and again that’s fine.”

In the past, fees deducted from the investment pool either upfront or ongoing have been called commissions.

“What we’re really saying is commission as a concept, you can still deduct it from the investment pool, which is how you pay for the ongoing advice, but it’s an ongoing advice fee. It’s not a commission.”

Some of the principles may be introduced through a transition period. Brennan suggests the creation of fee disclosure templates, and the separation of product and advice fees as two areas that may be phased in due to technical implementation requirements.

“Having said that, I would point out that in the case of platforms, master trusts and wrap accounts, they already do show that breakdown, so therefore that separation of advice and products already occurs,” she says.

Another area Brennan says may be subject to phasing in relates to principle six, which states: “There should be a separation of corporate governance in place between an Australian Financial Services licensee and related fund managers, and product/platform manufacturers within the same group.”

Brennan acknowledges FPA members may incur additional compliance costs as a result of the introduction of the principles, but she says it is not the association’s intention to impose another layer of complexity on the industry.

“Have a think about how this is going to apply to your business and come and talk to us during the consultation process, because if it is going to put on another layer of cost that at the end of the day is going to be worn by the adviser and the consumer, let’s look at how we work through that, because that’s not the aim at all,” she says.