For most people, the concept of acting in a client’s best interests, the requirement to behave fairly and ethically in the provision of financial advice, is indisputable. OpenMarkets examines the ethics that underpin the provision of advice and execution in listed securities.
Ethics can be defined as a system of moral principles, the rules of conduct recognised in a particular class of human actions. As individuals, we expect that our service providers will always act in our best interests, whether they be accountants, doctors, dentists, lawyers, financial advisers or stockbrokers.
In financial services, ethical principles are enshrined in law. The Future of Financial Advice (FOFA) reforms, implemented in July 2013, were conceived to improve the transparency and access to financial advice for all Australians. FOFA introduced the concept of ‘best interests duty’ to ensure all parties providing financial advice act in the best interests of clients, provide appropriate advice, warn the client if the advice is based on incomplete or inaccurate information, and prioritise the client’s interests.
Despite this, the trade press – and often the mainstream media – regularly publish stories about financial advisers who have engaged in unethical behaviour, which results in financial loss and distress for clients. In many cases this is poor behaviour perpetuated by lone wolves, although there have been several situations where it is systemic throughout an organisation – most recently, the big four banks have received scrutiny for some of their advice practices.
Ethics and listed securities
Listed securities are being recommended by a growing number of advice professionals – brokers, financial advisers and accountants. The huge growth in the number of, and demand for, exchange traded products – including exchange traded funds (ETFs), exchange traded managed funds (ETMFs) and listed investment companies (LICs) – has largely driven this increase.
Although bound by the provisions of the best interests duty, there are several ethical requirements particular to listed securities. These are encapsulated in the Code of Ethics that provides guidance on ethical conduct for members of the Stockbrokers and Financial Advisers Association. The objective of this code is to:
“maintain and improve ethical behaviour in the securities and derivatives profession and the conduct of members of the profession with the consumers of their services.”
Personal responsibility
The Stockbrokers and Financial Advisers Association’s code of ethics requires members to:
- act in the interests of their clients, employers and the public
- be honest
- not engage in conduct that would bring the profession into disrepute
- be unbiased in the services they provide and in their conduct with clients
- comply with the standards of the profession notwithstanding pressure from clients, employers, peers or others to compromise those standards.
Importantly, the code of ethics states that members are personally responsible and accountable for their conduct. This is also the view of the law; those providing financial advice are personally responsible for that advice. While up line management may also be found liable in some cases, each individual must take responsibility for their own behaviour – even if directed by another.
Obey the law
Although this directive may seem obvious to most, the fact that it needs to be enshrined in a code of conduct suggests this is not always the case. Laws are frequently updated and it is incumbent on advisers to remain up-to-date. There are laws governing the provision of financial advice in general, those focused on advice given about listed securities and derivatives, as well others regulating tax, superannuation and anti-money laundering.
Competency
The increased popularity of ETFs has led many more financial advice professionals to recommend listed securities; this requires a different knowledge set from unlisted investments. Advisers must ensure they have relevant knowledge of securities and derivatives in relation to the products being recommended, and importantly, understand market rules.
Insider trading
It is an offence under the Corporations Act to trade using inside information. It is also an offence to communicate inside information to others who are likely to trade based on the inside information. Inside information might include advanced knowledge of profit warnings, takeovers or legal action that might impact a security’s price. Even if the transaction is for the benefit of clients, if it is based on insider knowledge, it is illegal.
Best execution
According to ASIC’s regulatory guide 223:
“Market operators and market participants must comply with their obligations under the competition market integrity rules.
These rules address issues raised by competition between exchange markets and the operation of crossing systems by market participants. The competition market integrity rules apply to all trading in equity market products and Commonwealth Government Securities (CGS) depository interests.”
This applies to trades executed via ASX or Chi-X, and additional rules apply to trading derivatives.
Most importantly for investors, the rules focus on achieving the best execution for clients; for retail investors, best execution is defined as ‘best total consideration’ – for buy orders, paying as little as possible, for sell orders, receiving the best price possible. Best execution applied to all listed securities, whether a share, an ETF or a listed investment company.
Conflicts of interest
A conflict of interest may arise where the advice provided to a client results in a benefit to the adviser or a related party. Related party has a broad definition an includes colleagues, the licensee, a family member or friend. Meeting the best interests duty – acting in the best interests of clients always – should remove conflicts of interest.
Unfortunately, there are innumerable case studies both pre-and post-FOFA detailing those advisers who put their own interests before those of their clients. Whether it was recommending stocks a firm was trying to offload or a financial product based on the size of a commission, there’s a real-life case study for just about any scenario.
Ethics in financial advice is about providing sound advice that is in a client’s best interests and will help them achieve their financial objectives. It is also about making sure the client understands the advice and relevant investment recommendations. If an Australian equity ETF is recommended, does the client understand the market and other potential investments that are available? If an LIC is recommended, does the client understand that it might trade at a premium or discount at different times?
Over time, the provision of sound advice, good communication and an ethical approach to business will pay dividends in the form of positive client relationships and business growth through referrals from satisfied clients.
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