CPD: Ethics – the ‘grey’ zone

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The grey zone is that area that can’t be readily categorised as ‘right’ or ‘wrong’.

FASEA’s Code of Ethics seeks to impose ethical duties that go above the requirements of the law. It’s designed to encourage and embed higher standards of behaviour and professionalism in the financial advice industry[1]. However, while laws may be clear, anything open to subjective interpretation can be prone to ‘grey areas’ – not everything is black and white. In this article, proudly sponsored by GSFM, those grey areas are explored in the context of ethics and financial advice.

Defined by dictionary.com as ‘an ill-defined situation or area of activity not readily conforming to a category or set of rules’, the grey zone is that area that can’t be so readily categorised as ‘right’ or ‘wrong’. The grey zone sits between the border between black and white, or, from an ethics perspective, is where right and wrong become blurred. It generally requires the application of some form of moral judgement.

Even in the law, which seeks to eradicate grey areas, there are situations that don’t exactly fall into a specific category; similarly, when examining ethics in a financial practice, it’s important to be aware that the grey zone exists. Academic research suggests that all organisations have grey areas where the border between right and wrong behaviour is blurred, but where a major part of organisational decision-making takes place. While grey areas can be a source of problems for organisations, they can also have benefits[2].

Most people are confronted with a wide range of ethical dilemmas on a regular basis. While what’s right is clear, the magnitude of the circumstances can impact how comfortable each individual is making decisions about their behaviour and choices. The small white lie, ignoring the restaurant bill error in your favour, or having a loved one take responsibility for a driving offence as a further loss of points might lose you your driver’s licence.

In business, pressures to be successful and profitable may lead people to confront issues and decisions that are in the grey zone, one in which conflicts of interest can arise and good decision making may become impaired. Good people can end up acting in a questionable manner.

Ethics problems in particular are not always clear cut. Detailed codes of conduct, such as FASEA’s Code of Ethics, target what is and isn’t acceptable in providing financial advice. It aims to bring clarity to decision making, and is used to examine actions when it comes to enforcement. Despite the existence of the Code of Ethics, you are likely to encounter ethics problems that aren’t definitively black or white, right or wrong, but fall into the grey zone and require professional and moral judgement to resolve.

Codes of Ethics

A study[3] that investigated effects of codes of ethics on perceptions of ethical behaviour found the presence of an ethics code in businesses improved the organisational climate, and provided support for ethical behaviour, the freedom to act ethically, and greater satisfaction with the outcome of ethical problems. Further, the presence of a code of ethics was found to have a positive impact on perceptions of ethical behaviour in organisations.

FASEA’s Code of Ethics (Code) became law from 1 January 2020. It requires financial advisers to not only abide by the law, but aims to raise standards for financial advisers to improve consumer outcomes and increase public confidence in the advice they receive.

It is FASEA’s intent that the Code introduces ethical duties on advisers that go above the requirements in existing law and are designed to encourage and embed higher standards of behaviour and professionalism in the financial advice sector.

The Code appropriately places personal responsibility on advisers to understand and apply their professional judgement to their ethical obligations in client engagements so that their professional conduct is focussed on providing advice that is in the best interests of the client[4].

FASEA’s Code is a set of principles and core values that lay 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.

The Code addresses five core values, each of which would be reasonably expected from any professional providing a service:

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

FASEA’s Code requires financial advisers to act in a manner demonstrably consistent with the twelve ethical standards summarised in figure one.

 

 

However, FASEA notes the standards that comprise the Code are not intended to provide definitive guidance. It acknowledges that individual circumstances will differ in practice and there is allowance for differences of professional opinion on how the ethical rules of the profession should apply in a particular case. This is where you may encounter the grey zone.

Doing what is right will depend on the particular circumstances and requires you to exercise your professional judgement in the best interests of each of your clients.

The grey zone in your practice

Previous articles have discussed the importance of ethics in your financial practice – it’s not simply how you behave, but how you, your colleagues and referral partners behave. It’s important not to assume these parties possess a highly developed sense of ethics. That’s why it’s important to educate and reaffirm, on a regular basis, the importance of ethical practices in your business.

While the grey zone can provide challenges for your business, it can also provide benefits. Being aware of the grey zone and using examples and case studies that aren’t black and white provide an excellent opportunity for training and discussion. List the situations that your team may encounter in their day-to-day work that might not be black and white. Once such situations are identified, you can take a proactive approach with training.

Importantly, the grey zone is why it’s important all employees of a financial planning business are aligned with its values and practices. If you are transparent about how to deal with ethical issues that aren’t clearly black or white, there a lower chance of breaching FASEA’s Code and, therefore, less likelihood of facing enforcement action.

So, where are some of the potential grey areas in financial planning?

Inside information

While everyone knows that insider trading is against the law, there’s a broad range of inside information that can come across an adviser’s path. Examples include:

  • An acquaintance working at the local council who happens to mention the reclassification of an area of commercial property to residential zoning
  • A client who discusses a significant new contract won or issued by their business
  • A friend who bemoans a substantial revenue hit for the listed company they work for and the potential ramifications
  • Dinner party conversation in which you learn of a major merger between two listed companies
  • An event at which a fellow attendee excitedly tells you how close his biotech firm is to a game-changing vaccine.

Having this information isn’t breaking the law. Acting on it for personal gain is. That’s black and white; section 1043A of the Corporations Act 2001 prohibits a person from trading in listed securities while in possession of non-public, price-sensitive information. The ASX regulatory guide explicitly states that Key Management Personnel, employees and family members are not permitted to trade when there is sensitive information not yet publicly disclosed.

Tipping off a property developer client about the pending reclassification of land is in the grey zone. It might not breach the law, but is it ethical?

In most instances, share trading activities based on information you’ve received will breach – or at least skirt very close to – insider trading. While there’s no shortage of people willing to share their stock tips, you need to examine the rationale underpinning the tip. When it arises from information not publicly available, it’s risky to recommend clients buy or sell based on that information.

Case study one: Protecting clients’ interests

Brad was the director of a stockbroking business and personally advised a number of high net worth clients through managed discretionary accounts (MDAs). One of the stocks held by most clients was a listed agribusiness company. Brad had connections with the company’s management team and had good insights into its prospects; he genuinely believed it was a solid investment for his clients and for a number of years it performed very well. He also invested personally.

One morning, Brad received a call from his friend, the managing director of that agribusiness company. It was a heads up that the business was making an announcement to the ASX at 2:00pm that afternoon. The plantation had been badly impacted by a fungus and advice was that the trees needed to be felled, the land rehabilitated and the business start over; news that was to adversely impact its share price.

Brad did not sell his own shares as he knew that constituted a breach of insider trading laws. However, he did sell his clients’ shares; in his mind, he was acting in his clients’ best interests. This action was taken without notifying the clients.

Once the announcement was made, the share price fell by 75 percent, a loss his clients had avoided. Brad believed he had not breached the law as he did not gain personally from the transactions; he wore the loss on his own portfolio.

ASIC did not take the same view. Whereby Brad knew his actions weren’t entirely proper, he believed he was operating within the bounds of the law. He was found guilty of insider trading; he was fined, had his licence revoked and was banned from holding a directorship for ten years.

Brad’s actions potentially breached a number of FASEA’s standards, including:

 

 

Offshore investments

For most Australians, offshore investments mean investing in a global fund, an ETF based on a global index or holding shares in Amazon or Apple. For some however, somewhat different strategies are employed. Often touted as ‘tax minimisation strategies’, the intent of parking investments and money offshore can easily stray into the realm of tax avoidance, something the Australian Tax Office (ATO) is taking a greater interest in.

According to OPEC, nearly 100 countries carried out automatic exchange of information in 2019, enabling their tax authorities, including the ATO, to obtain data on 84 million financial accounts held offshore by their residents. This includes information on account holders, balances, interest and dividend payments, proceeds from the sale of assets, and other income.

Not all of these Australians are multi-millionaires hiding their wealth from a voracious tax office – many have worked overseas and upon their return to Australia, opt to leave investments parked in a more favourable jurisdiction. In fact, individual Australians hold more than $100 billion offshore, spread across more than 1.6 million accounts[5], according to ATO data collected under the above-mentioned international cooperation agreement. Some 370,000 taxpayers have so far been identified as holding offshore accounts, with an expectation that many more will be identified.

According to the ATO, an individual who is an Australian resident for tax purposes will be taxed on their worldwide income. As such, if you have a client who has investments held overseas, their foreign income must be declared, irrespective of its size. This may include income from offshore investments, employment, pensions, business and consulting, or capital gains on overseas assets.

Advisers also need to be aware of the risks that go with understanding cross-border tax arrangements. Australian financial planners can only advise on products and services in Australia, and not those in the offshore location.

While there are legitimate ways for clients to minimise tax obligations, usually the purview of their accountant, advisers should be wary of clients with complex offshore investment structures, or those wanting to implement such structures, particularly if tax avoidance is the clear goal. Although ‘tax minimisation’ might appear legitimate, it’s important to ensure there’s no breach of Australia’s tax laws. Afterall, the minimum ethical obligation of FASEA’s Code is for advisers to comply with legal obligations.

In such a scenario, advisers also risk breaching standard six, in which advisers must take into account the broad effects of the client acting on their advice. These effects are not limited to the effects on the client, but may include implications for your client’s other family members.

Life insurance

In 2013, the Future of Financial Advice Reforms (FOFA) enshrined the best interest duty into law. The reforms introduced significant change to the regulation of personal financial advice, including a ban on conflicted remuneration. This ban did not extend to risk products and commission payments continue to be the predominant remuneration structure in risk advice.

As noted in the article Ethics and insurance in financial advice ASIC’s 2014 and 2016 reviews of the risk advice sector uncovered a range of practices that would not comply with FASEA’s new ethical framework. Common breaches, also uncovered by the 2018 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, included advice that:

  • recommended customers cancel one life insurance policy issued by the company and replacing it with another also issued by that same company, so the adviser could collect the maximum upfront commission payable
  • mis-sold insurance cover, including customers being provided with false or misleading information in relation to the purchase
  • coerced customers into taking out a policy they did not need
  • sold policies to customers that they did not understand.

Conflicts of interest, particularly in terms of remuneration, are regarded as a key risk factor in the delivery of ethical financial advice. Some of the key warning signs of poor advice ASIC identified included:

  • high clawback rates
  • high volumes of replacement product advice
  • product bundling
  • upsellling.

While some of this may be justified and not breach relevant laws, some of it lands clearly in the ‘grey zone’ where the ethics underpinning the advice must be examined.

For example, does the client understand the risk advice provided? Has it been clearly explained, do they understand the ongoing cost structure and what they are covered for? If not, it could be in breach of standard five: advisers must ensure their client understand the recommendations made, the benefits of any financial products recommended, the costs and risks involved in acquiring, holding and disposing of the recommended products.

Does the advice consider the financial wellbeing of the clients’ family? Is a bundled product appropriate, or would separate policies be more effective for the client’s situation? If not, it could be in breach of standard six: advisers must take into account the broad effects of the client acting on their advice…these effects are not limited to effects on the client but may include implications for other family members of the client.

Does the client understand the fees and charges and do they know how you will be remunerated for the advice? If they are being moved from one risk provider to another, do they understand how the remuneration structure works? If not, that could breach standard seven: the client must be provided with a clear and simple explanation of the fees and charges, including any benefits you or your principal will receive.

Case study two: Stepped premium policy strategy

A common policy type across the risk insurance industry is a stepped premium policy. It has a premium that increases – or ‘steps up’ – each year according to a range of risk factors, such as age. An ASIC review found that stepped insurance policies lapse at particularly high rates after the first year.

Charlie and Isobel went to see Julia at Excellent Advice Pty Ltd. The couple had recently had their first child and wanted to be sure they had enough cover should either of them get seriously ill or die. There was a mortgage to cover and they wanted to ensure their child would be well provided for.

After agreeing on the policies, Charlie and Isobel signed up and felt comfortable that they were suitably covered for unforeseen circumstances. When renewal time came, they noted their premiums had increased significantly. Charlie called Julia and asked about the premium increases. Julia suggested they could switch to another policy, one which would provide the same cover but with a lower premium. Remuneration for this was not discussed. Charlie and Isobel agreed and the paperwork was duly finalised. The following year, Charlie and Isobel were faced with the same issue – a significant premium increase. When Julia was contacted, she again suggested a policy switch.

Despite the fact Julia ensured the coverage of new policies met the couple’s needs, did not charge a fee for making changes, and sourced cheaper policies each year, she potentially breached several FASEA standards, including the following:

 

 

Self-managed super funds

The number of self-managed superannuation funds (SMSFs) continues to grow in Australia; assets under management are second only to industry funds[6]. At 30 June 2020, there were nearly 600,000 SMSFs with assets totalling $678 billion. While SMSFs are an appropriate investment vehicle for some, for other less sophisticated investors they don’t always result in optimal client outcomes.

The decision to establish an SMSF may be driven by your client, or result from advice received from an accountant or other third party. It’s essential to understand the driver, particularly if you are concerned about the appropriateness of an SMSF structure for the client.

Even if a third party has established an SMSF on their behalf and they come to you for investment advice, it’s important to ensure your clients understand their responsibilities as trustees of the SMSF, that they are personally liable for all decisions made by the fund. This includes following any advice you or other service providers give them.

It is, therefore, imperative to ensure that your clients understand both their responsibilities and all advice they are given. Importantly, you should make your client aware that SMSF trustees can be penalised for non-compliance in several ways:

  1. Their fund losing its concessional tax treatment
  2. Being disqualified from their role as trustee – this means they can no longer be members of the SMSF and they are unable to start a new one
  3. Fines or imprisonment, depending on the seriousness of the breach.

If you don’t believe your clients have the requisite knowledge and time required, or sufficient assets to make an SMSF viable, it’s important to guide them appropriately. Whether or not the initial advice came from you, a failure to ensure your clients understand their responsibilities is firmly in the grey zone and could be called to question, particularly if you proceed to offer investment advice. Potentially, you could be in breach of standard two, the requirement to act in your client’s best interest if, in fact, an SMSF is not.

Similarly, there’s the potential to breach standard six – what are the implications for not only your client, but the other members of the SMSF?

Exotics

The growth of online trading platforms has been a pandora’s box of ‘exotic’ financial instruments. From more vanilla futures and options strategies, there are contracts for difference (CFDs) available across shares, foreign exchange (forex), indices, commodities and even cryptocurrency. Forex trading online has grown exponentially.

Not many advisers are licensed to trade options and futures and of those who are, it’s generally limited to Accredited Derivatives Adviser Level 1, which allows them to advise on and implement basic option positions. This includes the ability to:

  • Sell options to close out a position
  • Buy and sell warrants
  • Exercise warrants and options
  • Write covered call options.

When correctly managed, option strategies can be very useful for clients with share portfolios, particularly those managing retirement funds through an SMSF and wanting to increase dividend income or provide some protection against capital loss.

However, what do you do if a client wants an option strategy you’re not licensed to provide? Perhaps it’s something you do for yourself and are comfortable with. Perhaps the client has been dabbling themselves and wants some advice.

Undertaking transactions you’re not licenced for is a breach of the law and therefore a breach of standard one: advisers are required to comply with their legal obligations.

On the other hand, a client is dabbling with exotic instruments, an interest you have in common. You share a couple of your strategies with the client, strategies that you’ve had some success with. It’s not formally part of your advice, you’re not trading on behalf of the client. It’s a scenario in the grey zone; while it may not trigger standard one and breach the law, is it strictly ethical? Even if the client does well from the trades, are you really acting in their best interest given the potential for significant loss – in some cases, unlimited loss –  using some of these instruments?

It’s likely this scenario would result in a breach of standard two: acting in the client’s best interest is fundamental. It could also breach standard six: Advisers must consider the broad effects of the client acting on their advice, including implications for other family members of the client.

It could also constitute a breach of standard 10: Advice should not be provided in any area unless you have the necessary skills and competencies to do so in a professional way. A personal interest in a trading strategy is vastly different to formal qualification and ongoing training to maintain it.

Case study three: The investment group

Darren is a young financial adviser building a client base of young professionals. He’s always been interested in online trading and options strategies, and is an Accredited Derivatives Adviser Level 1. Darren’s licensee does not permit options trading for clients, so he dabbles on his own account, in his own time.

He’s chatted to some of his clients about his interest in options trading and a number of them expressed interest in learning more. Darren put together a small investment group, which met outside of business hours. They discussed option strategies and he explained how to implement those strategies. They also discussed trading CFDs. He did not trade on behalf of any client.

Although Darren did not act for any client, by providing detailed information about strategies and implementation, he strayed into the grey zone and potentially breached the following FASEA standards:

 

 

Financial advisers are required to act ethically and in the best interests of their clients at all times. While that might seem an obvious requirement to many, regular media announcements of adviser’s wrong doings demonstrate these requirements are overlooked by some practitioners and businesses.

The best interest duty underpins both the operations and provision of advice by financial planning practices and enshrines it in law. Similarly, FASEA’s code of ethics now makes ethical practice a binding requirement for financial advisers.

An ethical and professional partnership between adviser and client occurs when a client understands the adviser’s recommendations and trusts that the advice is in their best interest. If unsure about any element of advice you provide, if it’s not clearly black or white, consider the client outcome. Will you client be better off if that advice is implemented? Does the advice breach any FASEA standard? Does it breach your moral code? If it’s still unclear, discuss with your colleagues and licensee.

It’s important to remember that at its simplest, ethics can be viewed as knowing what the right thing to do is, and then doing it.

 

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[1] FASEA, Financial Planners and Advisers Code of Ethics 2019 Guidance
[2] The Functionality of Gray Area Ethics in Organizations, John G. Bruhn, November 2008
[3] Codes of Ethics as Signals for Ethical Behavior; Adams, Tashchian & Shore, February 2001
[4] House of Representatives, Standing Committee on Economics – FASEA Opening Statement, 30 June 2020
[5] https://www.theguardian.com/australia-news/2019/aug/15/new-tax-data-reveals-australians-hold-100bn-in-offshore-accounts
[6] ASFA, Superannuation Statistics, June 2020

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