AIOFP paper: FOFA – a chance to get it right

Peter Johnston, on behalf of Association of Independently Owned Financial Planners, released a discussion paper entitled “FOFA – a chance to get it right” with recommendations for changes to proposed FOFA legislation.

The objective of this paper is to demonstrate that politicians of all persuasions over the past 30 years have failed to make critical structural changes to protect consumers from investment product failure. Most have preferred to make cosmetic changes that have suited political objectives at the time without materially adjusting the industry’s fundamentals. The adage of ‘The future is the past returning through another door’ will continually haunt consumers and the industry well after the politician’s have moved on. As history has continually demonstrated, this outcome we can be guaranteed of.

A footnote to this paper is the AIOFP is not being critical of the regulator. ASIC are merely an organ of Government and totally reliant upon the parameters set by politicians. In fact, the recent budgetary cuts and resultant departure of 150 mostly investigatory staff is a major blow to consumer and adviser security.

Ironically, ASIC and advisers interests are aligned, we both rely upon third parties to perform their duties diligently to avoid product failure and the resultant carnage. A significant portion of the blame for the $29 billion of either frozen or failed products since 2006 can be attributed to the performance of  Research Houses, Auditors, Trustees and Directors of the entities. But, at the end of the day it has been the poor decisions by politicians who have the ultimate responsibility of framing market supervision and structure that needs to change.

We are recommending two fundamental changes that will significantly enhance protection for consumers and advisers when making product decisions.

ASIC’s role with Product Disclosure Statements [PDS] – ASIC have been telling consumers and the industry for many years that they do not scrutinise new product PDS’s entering the market. Arguably the message should have been clearer but consumers and the industry have not been listening. Everyone has assumed that a PDS is checked for commercial viability including the role and character of Directors/Promoters by ASIC before market release. Most have treated it as a first ‘filter’ in the due diligence process. Wrong, all PDS’s are released to the market with minimal if no ASIC scrutiny with an accompanying ‘buyer beware’ tag. This will come as a major shock to most in the industry and all consumers.
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ASIC only have the resources and ‘politician driven’ power to be reactive to product failure not proactive. In analogous terms, they are ‘policemen/women’ enforcing the laws and ‘ambulances’ attending accidents trying to look after the injured but they do not act as Protectors. Thanks to the politicians, ASIC do not have the power or resources to be proactively looking to stop the accidents happening. We are absolutely positive that all consumers and the industry would want ASIC to be proactively protecting consumers from dodgy operators and fundamentally flawed products by being more active in the front end of the industry. This can only be achieved by politicians giving the resources to stop the accidents happening and being more creative with legislative strategy.
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Suggestion 1 – Politicians legislate to give ASIC more resources to become not only the Policeman and Ambulance of the industry but the front end consumer Protector.
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The role of Research Houses in the advice process – Research Houses play an absolutely critical role in the industry for consumers, ASIC and advisers. They are unofficially empowered with the decision making role on which manufacturer’s products are good, bad or exceptional and whether they commercially survive. They have unfortunately become the unofficial ‘gate keepers’ of the industry with far too much power in our view.
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Advisers need positive research ratings to satisfy their Insurers and due diligence process, hence they rely heavily upon research houses. Product manufacturers need a positive research report to get inflows from advisers; hence they rely heavily upon a positive research rating. You can see where this is heading. The massive problem facing this intertwined relationship is that research houses are getting paid by the product manufacturers to rate their products. This profoundly conflicted relationship has proven to be extremely costly for consumers, advisers, ASIC and society generally. Of the $29 billion of failed or frozen products they all had a positive research rating. This culture has fostered complacency, sloppiness, ‘special favours’ and down right incompetent decisions that leaves consumers, advisers and ASIC wounded while the research houses run for cover behind their disclaimers. This all care and no responsibility attitude has to be stopped by the politicians.
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ASIC should be the ‘gate keeper’ to the industry, it is a far too potentially conflicted role to allow commercial operators to have this much power. Remember Joh B’s classic comment? ‘if there is no conflict there is no interest’. Advisers should be the only source of income for research houses. US Congress recently addressed the ‘shop around for a rating’ scandal that ignited the GFC, our politicians need to be brave enough do the same. There needs to be a levy placed on all advisers to fund an ASIC supervised panel of research houses. They should be generously paid to ensure that high quality staff is employed and their business model is commercially viable. All PDS’s must then be scrutinised by this panel before the ASIC process and adviser/client consumption commences. Yes a back log on PDS approval would probably happen but it is better than the alternative.
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Suggestion 2 – Politicians follow their US counterparts by legislating to give ASIC control of the research process to protect consumers and advisers.
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FOFA has been largely driven by the spate of product failures and bad advice events like Storm. With the exception of Storm [which incidentally was influenced by a large Institution] bad advice issues are on the lower scale and normally resolved by FOS or COSL anyway. The big ticket items are products failing, hence the $29 billion figure already mentioned. The reason why these products failed are varied but it is commercially inconceivable to link it to product commissions. Commissions are a fraction of the capital involved, the cold hard facts are many of these products should not have been on the market in the first place and directly linked to politicians not making hard decisions and preferring to gorge on low lying political fruit.
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Some brief views on the current FOFA proposal to demonstrate it is a superficial cosmetic approach.

1. Banning of product commissions – totally agree, it is an inducement that leads to conflicts of interests. Will make a huge difference but most have already done it anyway.
2. Opt in – totally unnecessary, with a no commission environment advisers will be charging clients directly. Each and every year advisers will be judged on their performance and clients will be making a ‘cheque book’ judgement on whether to pay or not. Considered to be a political concession to the Industry Fund lobby.
3. Bests Interests – nice cosmetic touch but we are subject to a fiduciary duty in the courts anyway. Quickly changed from the original proposal of Fiduciary Duty when the full ramifications were considered.
4. Platform rebates/profit share – Industry Funds subsidise their advice practices with their internal platform profits, why can’t independents negotiate a share of a platform profit to subsidise advice? Platforms are administration services not investment products. A clear case of favouritism for Industry Funds.
5. Banning risk commissions in Super – Australia has a $1.3 billion underinsurance problem already in a commission environment, it will only exacerbate the problem. Widely considered to be a poorly thought through ‘red herring’ to leverage publicity.

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We trust you can now see that these 5 FOFA items, when put into context with our two suggestions, will make little difference to whether products will fail or not. As previously stated, these failed products should not have been on the market in the first place. Until the supply and scrutiny process is addressed the adage of ‘the worst thing about history is that every time it repeats itself the price goes up’ will continue to haunt us.
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Finally, It should also be noted that an advisers entire commercial and family life depends upon clients avoiding product failure, it can and does destroy every aspect of their life. It is inconceivable to even suggest an adviser would select a product purely based on receiving a very short term benefit knowing that it would fail.
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FOFA has received unprecedented publicity and has conditioned every one for change. The AIOFP hopes politicians will embrace the occasion with sound, commercially driven decisions that will make a real difference to the industry going forward.
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We welcome your comments and feedback.