Ethical obligations in a financial advice practice

On 1 January 2020, FASEA’s code of ethics became enforceable by law, requiring advisers to comply with its 12 detailed standards. Each standard is explored in detail in FASEA’s guidance.

This article, sponsored by GSFM, examines the implications of this in practice and explores ways to ensure your practice and all who work within it meet those ethical obligations.

It’s just one year since the final report from The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) was released, detailing 76 recommendations. Of those, the government has implemented 16 recommendations and, according to a statement from Treasurer Josh Frydenberg^[1], will have introduced to parliament all recommendations requiring legislative change by the end of 2020.

One of the latest pieces of draft legislation released by the treasurer is the requirement for licensees to inform clients of any suspected misconduct within 30 days, and to investigate the nature and full extent of any misconduct, or unethical behaviour, within a reasonable amount of time. There was a significant volume of evidences presented to the Royal Commission showing this had not been standard across the industry.

As a result of the Royal Commission’s final report and recommendations, there’s been a significant amount of change across the financial advice industry. A large number of high profile executives left financial services businesses, while some large licensees sold off or closed their dealer groups. Large institutions have set aside not insignificant sums for remediation following revelation of poor behaviour and lax compliance standards.

As all this was playing out, ASIC received nearly 2,5000 applications from financial advisers for Australian Financial Services Licences (AFSLs); word on the street suggested the volume meant it took upwards of six months to work through the process. A large number of advisers found themselves ‘homeless’, having to undertake the onerous task of either applying for their own AFSL or finding a new licensee for their practice.

At the same time, licensees, advisers and advisory practices were grappling with the introduction of a new code of ethics. It’s now just over one month since the Financial Adviser Standards and Ethics Authority’s (FASEA) Code of Ethics, released in 2019, became enforceable by law.

Financial advisers are expected to meet the code’s high standards and licensees are required to ensure their authorised representatives comply with the code. Where advisers or licensees fail to meet the code’s standards, ASIC can and will take enforcement action. While FASEA’s Code of Ethics is designed to raise standards of professional and ethical behaviour, it does not replace or override the laws governing the provision of financial advice.

According to FASEA’s Guidance^[2] to its Code of Ethics, responsibility for applying the tenets of the Code falls on individual advisers and each must be able to explain their interpretation and application of the Code in every single individual situation.

Ethics and professionalism

“It is inherent in the definition of a profession that a code of ethics governs the activities of each profession. Such codes require behaviour and practice beyond the personal moral obligations of an individual.”^[3]

There’s been a lot of debate about financial advice being a profession. Under the most basic definition, a ‘professional’ is described as someone who follows an occupation as a means of earning a livelihood, generally based on specific knowledge and experience. Professionals have generally undergone some tertiary study – think about medical professionals, lawyers or journalists. However, the term professional typically has a broader meaning focused around some moral or ethical foundation within the practice of a specific and usually established expertise^[4].

Consumers expect the best of their professional service providers. Whether an architect or accountant, a teacher or technician, we expect services to be provided in an honest and transparent manner, with integrity, and importantly, to keep our best interests central to all that they do.

Professionals are usually required to abide by a set of professional standards for their industry; these standards are often managed by a governing body that represents the interests of that group of professionals. It usually comprises a set of ethics, behaviours and practices the members of that body must adhere to.

For financial advice to be viewed as a profession by the broader community, ethical standards and practices must form the cornerstone. The Financial Planning Association has a Code of Professional Practice for members which brings together a comprehensive set of ethical principles, practice standards and conduct rules. The introduction of FASEA’s code of reinforces the importance of ethics in the financial planning industry and will help to make financial advice a profession that Australians can trust.

The ethics led practice

Recent headlines about a large financial institution that turned a blind eye to the practice of churning among some of its advisers provide an interesting illustration. References to ‘best interests breaches’ and ‘morally indefensible’ behaviour are definitely not the sort of headlines most businesses court and demonstrate the relationship between behaviour (failure to act in a client’s best interest) and ethics (the morals of the behaviour coming under fire). While smaller businesses may not always come to the notice of the media, this type of behaviour is most definitely on ASIC’s radar.

It’s important to note that the approach to running an ethical financial planning practice shouldn’t start and stop with the adviser. From the receptionist who may speak to clients on the phone and handle their paperwork, through to the adviser, paraplanner and practice manager…all staff need to understand and abide by the Code of Ethics. The licensee and adviser will carry the responsibility of a breach. By implementing the following strategies in your practice, you can help mitigate the risk of a breach of FASEA’s standards.

1. Establish a practice-wide code of conduct, one which encapsulates your business’s values and FASEA’s Code of Ethics. Your code of conduct should set clear expectations about your employees’ behaviour when carrying out their duties. You need to be sure they understand each of the twelve standards in the Code of Ethics and how each standard may specifically intersect their role.
2. Lead by example, because employees will look to the key individuals in the practice to understand what behaviour is and isn’t acceptable. Senior advisers and personnel will set the tone for ethics in the practice; as such, they need to demonstrate the code of conduct in all they say and do.
3. Workplace training is a positive way to ensure all staff understand both the practice’s values and the obligations of the FASEA Code. The use of workshops to promote ethics in your workplace can reinforce the practice’s standards of conduct and clarify behaviours and practices that do and don’t work within your code of conduct.

Importantly, ethics training should not be a once off and does not solve a problem. Ideally, training should teach team members to make good decisions that are compliant with the law and consistent with your practice’s values.

It could be incorporated as part of regular team meeting; for example, by using a variety of case studies which could address common ethical dilemmas across the financial planning industry. The AFCA website is a good source of cases and decisions made by AFCA and its predecessor organisations to form the basis of discussion.

4. Ethics should be a key performance indicator (KPI). By reinforcing and potentially rewarding all staff for embodying your values, adhering to your practice’s code of conduct and behaving in a way that makes ethical behaviour central to their work will create an ethical practice. Although a values-driven KPI can be harder to quantify than one with specific and measurable outcomes, it will highlight the importance of values and ethics to your practice.
5. Create a feedback loop within your practice. Encourage staff to provide honest feedback about the processes, conversations and client interactions to ensure no issues may arise that you are not aware of, but which could potentially compromise your business.

FASEA’s Code of Ethics

The Code of Ethics is a set of principles and core values that, according to FASEA, lays the foundations for a ‘true profession’ to emerge. It believes that those financial advisers who formerly provided a commercial service, are now committed to offering a professional service, informed by a Code of Ethics intended to shape every aspect of their professional conduct.

According to FASEA:

“The Code of Ethics imposes ethical duties that go above the requirements in the law. It is designed to encourage higher standards of behaviour and professionalism in the financial services industry.”

The Code of Ethics addresses five core values:

1. Trustworthiness
2. Competence
3. Honesty
4. Fairness
5. Diligence

The Code of Ethics requires that financial advisers must act at all times and in all cases, in a manner demonstrably consistent with FASEA’s twelve ethical standards. These are summarised in figure one. These will be monitored by ASIC’s approved compliance schemes.

 

 

FASEA’s code of conduct comes with guidance. So many scenarios and situations won’t necessarily fit neatly into a standard, nor is the standard a ‘tick and flick’ approach to scenario. A degree of analysis and professional judgement needs to occur. The guidance states:

“As with every profession, there is allowance for differences of professional opinion on how the ethical rules of the profession should apply in a particular case.”

It’s also important to note that each of the standards shouldn’t be considered in isolation; FASEA intended the standards to operate in combination to strengthen your practice. Importantly, it’s important to note the same conduct may breach multiple standards of the Code – this is illustrated in the following case studies.

ASIC, compliance and complaints

Advisers have a “fundamental, personal, professional obligation to understand and to adhere^[5]” to their ethical obligations under the Code of Ethics. It’s a responsibility that can’t be outsourced to any other party, including the adviser’s employer or licensee.

The role of the financial services licensee is to monitor and enforce compliance with the Code, and is expected to structure their business operations in a way that facilitates all advisers operating under that licensee being able to operate ethically and meet their obligations under the Code.

According to ASIC, Australian Financial Services Licensees are required to take reasonable steps to ensure that their financial advisers comply with FASEA’s Code of Ethics from 1 January 2020, and advisers are obliged to comply with the code from that date onwards. ASIC may take enforcement action against both Licensees and advisers where it receives breach reports.

In its first 12 months of operation, AFCA experienced a 40 percent increase in complaints above that received by its predecessor organisations. Complainants were awarded $185 million in compensation over that period, with 70 percent of cases found in favour of the complainant.

While credit products dominated the complaints, AFCA received a high number of complaints about financial advice (figure two).

 

 

Case studies

The following case studies are based on real events; however the names of people and organisations have been changed, and some details altered. The case studies have been drawn from the Australian Financial Complaints Authority (AFCA). For each, potential breaches of FASEA’s Code of Ethics are identified.

Case study one

Jenny and her husband David had been clients of Countrywide Financial Planning for a number of years. Last year their adviser, Max, invited them to purchase membership in his timeshare managed investment scheme.

Jenny and David attended an information session for the investment, during which Max provided them with information and advice about the investment. During the information session, Jenny asked Max if it was possible to cancel membership in the scheme. Max informed Jenny she could cancel the investment for an exit fee of $350; she and David relied on that statement when deciding to take up the investment.

It transpired this was a misleading statement, one which Max later denied making.

Instead, the clients were required to pay out a loan, find a buyer for their portion of the timeshare and pay an additional fee. This was outlined on page 44 of the scheme’s Product Disclosure Statement (PDS).

Other issues included:

• Max’s file notes were incomplete and did not record all the matters referred to Jenny and David in their statements. The absence of this record in the adviser’s file notes was considered important
• The statement of advice (SOA) provided to Jenny and David was generic in nature and was not tailored specifically to them; it did not identify their objectives, nor did it provide advice reasonably likely to satisfy those objectives. The SOA also failed to discuss the specified risks associated with accepting the advice in this case – investment in a non-liquid managed investment scheme on a long term basis.

Breaches of FASEA’s code of ethics

Jenny and David stated they would not have invested had they known they could not easily exit the investment. From the details provided in the case study, Max potentially would have breached the following standards in the Code of Ethics.

 

 

Case study two

Louise was in her early 30s when she received an inheritance of $87,000 from her grandparents. She wanted to invest it to provide for her three children’s education. She sought financial advice from Margaret at MMM Financial Services, who suggested she invested it in shares, and then use those shares as security for a margin loan with a $400,000 credit limit to fund further share trading. Louise was not an experienced or knowledgeable investor.

The Corporations Act 2001 (the Act) requires advisers to have a reasonable basis for personal advice provided to the clients. This means Margaret should have taken Louise’s objectives, financial situation and needs into account, as would reasonably be considered to be relevant to the advice.

The advice provided to Louise was complex and, if inappropriate, had a serious potential to negatively impact her financial situation because it exposed her to potential losses from margin calls.

Approximately eighteen months after the margin loan was established, there was a market downturn and the first of a series of margin calls. Louise had to sell shares, at a loss, to meet the calls, and ended up substantially in debt. Louise paid off the margin loan using a line of credit and transferred her investment portfolio to another financial adviser. She then lodged a complaint with the relevant authority.

The investigation found Margaret’s records were inadequate considering the complexity of the advice and she had gathered little quantitative client information. She had not recorded Louise’s objectives, nor investigated her financial situation. This lack of information meant that Margaret was unable to demonstrate the advice was appropriate with respect to Louise’s risk tolerance. The complaints body found that inappropriate advice was a cause of financial loss.

Breaches of FASEA’s code of ethics

Louise did not understand the risks of the margin loan and would not have taken it up if she’d known she could be exposed to margin calls. From the details provided in the case study, Margaret potentially would have breached the following standards in the Code of Ethics.

 

 

Case study three

Cheryl and John were a married couple with three young children. They were both 35 years of age and on a single income of $75,520 per annum. Cheryl was on extended maternity leave and in receipt of $8,550 Centrelink benefits per annum. Cheryl and John sought financial advice from Brian, a senior adviser at Acme Advisers. They wanted to appropriately structure their superannuation to maximise their retirement savings.

Advice can only be provided if it would be reasonable to conclude the advice is appropriate for the client, and the adviser has acted in the best interests of the client. This means the Brian would not be able to demonstrate the disputed advice was appropriate unless the best interests duty has been complied with.

Financial advice is appropriate if it would be reasonable to conclude, at the time the advice was provided, that it is fit for purpose and is likely to leave the client in a better position if they follow the advice.

Brian recommended a ‘double geared’ investment strategy for Cheryl and John. It had a particularly high fee load and was unlikely to leave them in a better financial position.

The investigation found against Brian for three key reasons:

Firstly, the advice was not in the applicants’ best interests because the costs of the plan outweighed the benefits to the applicants and was unaffordable.

Secondly, the double geared advice was not appropriate because Brian had failed to assess Cheryl and John’s risk profile until after he provided the advice. The client fact find and risk profile were not provided to and signed by the clients until after the advice had been prepared and on the same day it was implemented.

Finally, Brian had not prioritised the applicants’ interests over his own interests and those of his practice. The applicants could not afford the strategy because it did not provide for realistic living expenses. In addition, the fees charged for the initial and ongoing advice had a negative impact on the overall strategy and the growth of John’s superannuation that it could not be in the applicants’ best interests.

The complaints body investigating the case found the advice was inappropriate.

Breaches of FASEA’s code of ethics

From the details provided in the case study, Brian potentially would have breached the following standards in the Code of Ethics.

 

 

Case study four

After selling a small business, Ellen and Geoff had $275,000 to invest. Friends had recommended a local adviser Len from L&L Financial Planning. Because the clients thought they may use the money within a couple of years to seed a new business, they specified a short term investment horizon with no risk to their capital.

Len suggested they invest in ‘Term Deposits’ offered by his licensee; these were not term deposits but rather loan agreements in which the licensee borrowed amounts from clients to loan to other clients. It was in fact an unregistered managed investment scheme.

The Statement of Advice provided by Len contained misleading or deceptive statements as to the nature and risks associated with the investments. The investment was positioned as available only to a select number of clients who have been using the services of L&L Financial Planning for minimum of 10 years; Ellen and Geoff were given access because they’d been recommended by a long-term client. L&L Financial Planning claimed it had an objective to provide clients with a guaranteed return for their cash investments as well as guaranteed security.

The SOA also claimed it paid a competitive fixed term interest rate and used the strength of the government guarantee on the deposits as a selling point.

In fact, the funds were packaged up and loaned to other clients; the practice earned the difference in the rate at which the money was loaned, less the rate paid to clients. The funds were in no way government guaranteed and could not be guaranteed by the practice if a borrower defaulted. It did not disclose that the client’s money was packaged up and loaned to other clients and although technically a managed investment scheme, there was no PDS or other form of documentation.

It was found the adviser had engaged in misleading or deceptive conduct, had issued a defective SOA and had been running an unregistered managed investment scheme.

Breaches of FASEA’s code of ethics

Len had exposed his clients to risk while presenting the investment opportunity as risk free or guaranteed. From the details provided in the case study, he potentially would have breached the following standards in the Code of Ethics.

 

 

For the financial advice industry to thrive, it needs to regain the trust of the Australian people. Acting ethically and being trustworthy will build trust among consumers and increase their confidence in using financial services. FASEA’s Code of Ethics is an important first step on this journey to rebuild the industry’s positive reputation and re-establish the industry’s importance to the financial security of all Australians.

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[1] https://ministers.treasury.gov.au/ministers/josh-frydenberg-2018/media-releases/taking-action-banking-superannuation-financial-4
[2] https://www.fasea.gov.au/wp-content/uploads/2019/10/FASEA-Financial-Planners-and-Advisers-Code-of-Ethics-2019-Guidance-1.pdf
[3] Australian Council of Professions, 2003 – https://www.professions.org.au/what-is-a-professional/
[4] https://www.professions.org.au
[5] https://www.fasea.gov.au/wp-content/uploads/2019/10/FASEA-Financial-Planners-and-Advisers-Code-of-Ethics-2019-Guidance-1.pdf