Compliance mistakes advisers can avoid from Dixon Advisory

A takeaway for financial advisers from the Dixon Advisory scandal based on its determinations from the Australian Financial Complaints Authority (AFCA) would be to avoid deviating from clients’ asset allocations. 

In reviewing three AFCA determinations regarding Dixon, a common denominator is a failure by Dixon to describe the risk of the asset allocation properly. 

Failures across the three cases include:

• The financial firm recommended an asset allocation based on risk profile.
• The financial firm incorrectly described the risk of asset categories.
• The recommended portfolios did not align with the complainant’s risk profile.
• The financial firm recommended a high proportion of related-entity investments.
• The financial firm had incorrectly described the risk of residential property.
• The asset allocation was outside of the recommended parameters. 
• The financial firm failed to diversify the growth portfolio of the portfolio. 
• The financial firm failed to adequately explain the investments. 
• The asset allocation was outside of the complainant’s desired target asset allocation.
• The advice was not appropriate nor in the complainant’s best interest. 

In all three cases, Dixon classified its US Masters Residential Property Fund as “mixed assets” with both defensive and growth characteristics and that AFCA determined was an inappropriate label.

“Industry generally recognises some investments can have both income (defensive) and growth characteristics. Examples include bank issued hybrid note securities, such as convertible notes, or infrastructure investments that generate strong income linked to CPI (which increases its capital valuation). Some less risky property investments may be based on strong rent yields and income distributions together with projected capital appreciation. These types of investments are quite different to, for example, riskier property investments that are geared or with mezzanine finance for proposed property developments, or Australian equities that pay dividends,” AFCA wrote.

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“While consumers may understand most investments involve some risk, some consumers may not know those riskier property investments, that may only produce a slightly higher return than a traditional defensive asset, can have considerably higher investment risk that could lead to capital losses.”

As a result, the recommended asset allocation was not aligned with the risk profile of the complainants’ self-managed superannuation fund (SMSF), and they were worse off by $561,277.

Writing on LinkedIn, advice compliance specialist Greg Dawes wrote: “Ensure you have a sound basis for your risk profiling process and ensure clients are aware of the risks of the chosen asset allocations. The more you move away from conventional and widely accepted ideas, the more you will need to justify your position.

“If you are materially deviating from your neutral allocations (both for individual asset allocations and growth/defensive splits), you need to have a solid explanation about why this is appropriate and demonstrate that you have explained these risks to your clients. Stating that ‘it is within acceptable ranges’ in the statement of advice is unlikely to be sufficient if your portfolio underperforms.”

Regarding the use of non-traditional products, such as the residential property fund, Dawes said clients need to be informed of any additional risks involved and keep sufficient records to demonstrate you have done so. They should also record that they have considered similar alternative products and why those were dismissed.

“The more you stray from traditional investment products, the more you need to show that the client has been informed of the additional risks that may be involved. For example, if you are including more complex income investments like hybrids and notes in the clients’ defensive allocation, you need to explain the risk of capital loss compared to simpler products like term deposits.

“The hardest part isn’t explaining it, but having records to indicate how you were satisfied the client has understood your explanation.”

He also explained to Money Management that advisers could not rely on an SMSF trustees’ duties around investment decisions as a way of avoiding responsibility. In two of the three cases, Dixon cited the fact that the complainant had obligations as an SMSF trustee and was ultimately responsible for every investment decision. 

However, AFCA disagreed and this fact does not absolve the adviser from providing appropriate investment advice and adhering to the conflict priority rule as the trustee had placed their trust in the adviser to manage the portfolio.

These failures were described as:

• The complainants were not responsible for the loss.
• The breach [by the adviser] was the cause of the loss.

Dawes said: “You cannot rely on your client’s status as an SMSF trustee (and their responsibility for making investment decisions). AFCA recognises a trustee’s right to engage a professional adviser and rely on the adviser’s judgement about specific investments and asset allocation.

“If faced with a complaint where you think the client has contributed to the loss, you might be better to try negotiating a settlement rather than going to an AFCA determination.”