Marriage of convenience?

If your strategy involves:

~ the creation of a new mortgage broking division within your existing financial planning practice;

~ a merger into your practice of an existing mortgage broking business; or

~ the creation of a new joint venture enterprise partly owned by financial planners and partly owned by mortgage brokers... then you must consider the manner in which the requirement of both licensees (in the case of financial planning) and aggregators (in the case of mortgage broking) to maintain a degree of control over the operating and compliance systems of the business can be accommodated without any conflict.

The control issues will be very difficult to manage if a financial planning practice and a mortgage broking practice are operated through one company.

Each of the financial planning licensees and the mortgage broking aggregator will seek to exercise a significant degree of control over the commercial operations of the company and its compliance procedures, as well as have veto powers in respect to ownership issues and exit strategies.

Obviously, the interests of a financial planning licensee will not necessarily dovetail with the interests of a financial planning aggregator.

There is great potential for conflict and tension between these two entities — with the company owners being, in effect, the ‘ham in the sandwich’.

One hypothetical possibility is that somewhere down the track the owners of a combined enterprise might wish to sell their shareholding to another party who is perfectly acceptable to either the financial planning licensee or mortgage aggregator, but not to both of them.

The criteria adopted by a financial planning licensee for approving new shareholders will be quite different to the criteria adopted by a mortgage aggregator.

A financial planning licensee will want to be certain that the incoming shareholders have the necessary qualifications and training to make them acceptable authorised representatives.

The financial planning licensee will not be concerned about the capacity of the new owners to carry on a mortgage broking business.

However, a mortgage broking aggregator will want to be certain that the incoming shareholders are accredited as loan writers with each of the major banks and have the qualifications and expertise to conduct a mortgage broking business.

The mortgage aggregator will not be concerned about the capacity of the new shareholders to carry on a financial planning business.

Some financial planning licensees have sought to resolve this conflict by establishing their own mortgage broking aggregator.

The mortgage broking aggregator is then a related company to the financial planning licensee and directors of one company are also directors of the other company. While this solution goes a long way to resolving the conflict issues, it is still not perfect.

Firstly, the mortgage broking aggregator will only obtain accreditation with the major banks if the banks are satisfied that the management of the aggregator has sufficient expertise in loan writing, possesses a strong banking background and will generate sufficient volume of new business to justify accreditation.

Secondly, there is still a real potential for conflicts of interest at board level between the financial planning licensee and the mortgage broking aggregator — notwithstanding commonality of ultimate ownership.

The directors of each company have a duty to advance the interests of their company and not to compromise its interests to those of another company.

It is difficult to see how issues will not arise in the future where the interests of the financial planning licensee conflict with the interests of the mortgage broking aggregator.

An issue of ‘management expertise’ will arise whenever financial planning and mortgage broking are combined into the one company and whenever a financial planning licensee establishes its own ‘captive’ mortgage broking aggregator for the purpose of accrediting authorised representatives to conduct mortgage broking.

It would be easy (but wrong) to assume that experienced financial planners or experienced executives of a financial planning licensee have the competence and expertise to properly manage a mortgage broking business.

The management of a mortgage broking practice and the management of a mortgage broking aggregator can only be safely entrusted to persons who have appropriate tertiary qualifications, mortgage broking industry training and accreditation and extensive ‘hands on’ experience in mortgage broking.

While it may be theoretically possible for a company to carry on both financial planning and mortgage broking and for that company to include among its directors both experienced financial planners and experienced mortgage brokers, it is possible that the seeds for disagreement and tension at management level will have been sown.

One of the major sources of potential disagreement that could arise whenever there is a jointly owned company is the exit strategies that will be available to shareholders who wish to leave.

If, for example, a shareholder and director who supervises the company’s mortgage broking practice wishes to leave and to dispose of their shares, then some serious issues arise:

(a) will the shares be purchased by the remaining shareholders? (This is the normal procedure required by the shareholder agreements in privately owned companies). And if so, at what price? If the remaining shareholders are financial planners, then they may be reluctant to acquire the departing shareholders’ shares because they recognise that they do not have the expertise to continue to manage and supervise the mortgage broking division of the company. Without proper management and supervision, the mortgage broking division of the company would diminish in value and thereby reduce the value of the shares in the company; and

(b) will a transfer of the shares from a departing shareholder be approved by both the financial planning licensee and the mortgage broking aggregator? For the reasons set out above, it is most unlikely that the consent of both parties would be obtained.

Another possible approach to a single company carrying on business as both a financial planner and a mortgage broker would be to focus mainly on one of those businesses only and to treat the other as an ‘ancillary’ to the main business.

This situation is more likely to arise whenever a financial planning group elects to conduct mortgage broking as part of its ‘holistic’ practice.

The downside with this approach is that the financial planner will not be getting anything like the potential income and value available from the mortgage broking division of its practice.

Indeed, it is likely that the failure to operate the mortgage broking practice to its maximum potential will damage the reputation and goodwill of the financial planner.

Another potential solution would be for the financial planning licensee to accept a mortgage broking agreement from a mortgage aggregator and for the licensee, in its capacity as a mortgage broker, to grant mortgage sub-broking agreements to each of his authorised representatives. However, this solution does not effectively deal with the ‘conflict’ issues and the ‘management expertise issues’.

A fundamental issue whenever mortgage broking is conducted as part of a financial planning practice is the extent to which the ‘appropriateness of advice’ standards, which apply in the financial planning profession, will apply to the mortgage broking operations of the company. It is likely that both clients and the law will require the same stringent advice standards to be met in conducting the mortgage broking operations of a company that are met in conducting financial planning. Most mortgage brokers would find this to be a radical departure from their usual practice and would be very reluctant to assume this obligation.

Mortgage brokers generally have no training in the methodology employed by financial planners in formulating advice.

Mortgage brokers generally assume (in my view, incorrectly) that they provide a ‘no advice’ service. Their management systems and fee structures do not provide for the level of research and advice required of financial planners.

In some cases it would be possible for a general release to be obtained from a client relieving the company from providing any advice in relation to a mortgage transaction. However, this may not be possible if the client has received related financial planning advice from the company (for example, if advice has been given that it would be appropriate for the client to utilise unused equity in his or her home to acquire financial investments).

In any event, a client may think it decidedly strange if a financial planner gave advice in relation to one aspect of his or her affairs but refused to give advice in respect to another aspect of those same affairs.

Many of these issues will arise whenever a financial planning authorised representative enters into a formal partnership with a mortgage broker in order to conduct a mortgage broking business.

The critical business issue to be resolved with a partnership is who gets what, if and when the partnership is dissolved?

This issue may be resolved by buyback arrangements being included in the formal partnership agreement between the parties.

Great care must be taken whenever there is any link formed between a financial planning practice and a mortgage broking practice that there is no unintentional breach of the provisions of the Privacy Act and the Spam Act.

This could inadvertently occur if personal information (such as e-mail addresses, fax numbers and telephone numbers) were released by one party to the other for the purpose of enabling the other party to promote the activities of the new linked business.

Two other ways of effectively linking a financial planning practice and a mortgage broking practice are:

(a) a simple referral arrangement; or

(b) a joint-venture arrangement.

A referral arrangement avoids most, if not all, of the difficult management issues previously identified.

However, it does not result in the financial planning practice having any equity or control over the mortgage broking practice.

It does, however, leave the principals of each practice free to focus on the business in which they each have recognised expertise.

Ultimately, it is a business decision as to whether it is in the long-term interests of each principal to ‘stick to their knitting’ or to take a more holistic and adventurous approach to their practice.

A joint venture may, provided it is correctly structured so it is not deemed to be a partnership, provide a solution for many of the critical commercial and management issues.

Under a joint venture, each of the parties contributes defined resources (physical assets as well as personnel) to further a joint venture, with each of the joint venturers retaining their own separate authorities and accreditations and the mortgage broking business being conducted through the accreditation of the mortgage broker joint venturer. Income is divided in agreed proportions. The joint venture can be structured so that each party is able to effect exit arrangements without compromising the integrity of the other party’s business or the joint venture.

The management of each of the businesses that contribute to the joint venture remains in the hands of those who are qualified and trained to operate those businesses.

While a joint venture will be a satisfactory solution for many parties, it should not be thought that it is the solution for every case.

Experience has shown that each party’s individual circumstances are so different from other parties’ circumstances that it is impossible to make a single strategy that will have universal application.

Every situation must be evaluated on its merits and careful thought and planning must precede any move to create a link between a financial planning practice and a mortgage broking practice.

Malcolm Wright is partner at Wright Pavuk Lawyers, Sydney. He will be speaking on this subject at the Linking Mortgage Broking and Financial Services seminar to be held at the University of Technology Sydney on May 1, 2007.