CPD: A deep dive into FASEA’s Code of Ethics – Part one

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FASEA’s Code of Ethics contains twelve standards that are grouped under four ethical competencies

Consumers expect the best of their professional service providers, however it’s not always the case. FASEAS’s Code of Ethics, and its twelve standards, became law on 1 January 2020 to ensure best practice across Australia’s financial advice providers. In this article, proudly sponsored by GSFM Pty Ltd, we take a close look at standards one to six. A follow up article will examine standards seven to twelve.

So much has happened in 2020 that the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry seems but a distant memory. The Royal Commission highlighted numerous situations in which best practice – and an ethical approach to the provision of financial advice – was absent.

A media release from federal treasurer Josh Frydenberg on 31 January 2020 reaffirmed the government’s commitment to taking action on all 76 Royal Commission recommendations. Because of the global pandemic and managing its impact on the health and wealth of both Australians and the country’s economy, the federal government has yet to implement all of the recommendations.

At the same time the Royal Commission was grilling banks, insurers and financial advisers – and hearing firsthand from distressed consumers – the Financial Adviser Standards and Ethics Authority (FASEA) was consulting with industry on its new code of ethics for financial advice.

The Code of Ethics imposes ethical duties on financial advisers and has been designed to encourage higher standards of behaviour and professionalism in the financial services industry.

The establishment of FASEA

The Corporations Amendment (Professional Standards of Financial Advisers) Act 2017 established the Financial Adviser Standards and Ethics Authority (FASEA) in April 2017, to set the education, training and ethical standards of licensed financial advisers in Australia.

At the same time, the Commonwealth Parliament amended the Corporations Act (2001) (the Act) to provide for improved standards of education, training, ethical behaviour and professionalism for relevant providers (financial planners and financial advisers) providing advice to retail clients in relation to relevant financial products.

Among those changes, section 921E of the Act requires all relevant providers (as defined in Section 910A of the Act) to comply with a Code of Ethics made by FASEA under paragraph 921U(2)(b) of the Act.

On 8 February 2019, by legislative instrument, FASEA made the Financial Planners and Advisers Code of Ethics 2019 (the “Code”). Compliance with the Code became mandatory for relevant providers providing advice to retail clients in relation to relevant financial products on 1 January 2020.

FASEA’s Code of Ethics addresses five core values and its standards reflect these in practice.

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

The code requires that financial advisers must act at all times, in all cases, in a manner that is demonstrably consistent with FASEA’s twelve ethical standards; this will be monitored by ASIC’s approved compliance schemes.

Financial advisers are obliged to regulate their own behaviour to comply with the Code of Ethics. Further, advisers have a ‘fundamental, personal, professional obligation to understand and to adhere to their ethical obligations under the Code’

Importantly, responsibility cannot be outsourced to an employer, licensee, or any other party. Licensee have a role under the Act; they must monitor and enforce compliance with the Code with respect to all advisers operating under their remit.

Licensee are expected to structure their business operations in a manner that facilitates advisers being able to operate ethically and meet each of the twelve standards in the Code of Ethics.

Code of Ethics

FASEA’s Code of Ethics contains twelve standards that are grouped under four ethical competencies:

  • Ethical Behaviour (standards one to three)
  • Client Care (standards four to six)
  • Quality Process (standards seven to nine)
  • Professional Commitment (standards ten to twelve)

Each of the standards contain ethical principles and it’s expected that advisers will need to exercise professional judgement against those principles in each particular circumstance. It’s important to recognise that the standards are not a compliance checklist.

Ethics can be defined as ‘moral principles that govern a person’s behaviour or the conducting of an activity’. In financial planning, it can be distilled into acting in the client’s best interests at all times, acting with competence, honesty, integrity and fairness.

In short, the way any one of us would like ourselves and our family members and friends to be treated by any professional service provider.

Ethical behaviour

Ethical Behaviour encompasses standards one to three and encapsulates the spirit of the values that underpin each of the twelve standards.

The first of those values, trustworthiness, is particularly important to highlight when discussing ethical behaviour. It’s through ethical behaviour and good conduct that a service provider builds trust and maintains with clients; breaching that trust is often the result of unethical conduct.

According to FASEA: Trust requires you to act with integrity and honesty in all your professional dealings, and these values are interrelated[1].

Figure one highlights each of the standards that fall under the competency ‘Ethical Behaviour’.

Standard one

Financial advisers have always had to abide by those laws that guide their profession. While the majority operate within prescribed legal boundaries and within the spirit of the law, there’s been a consistent small number of those trying to avoid or circumvent the intent of the laws – the laws that exist to protect your clients.

Standard one – acting in accordance with applicable laws and the Code of Ethics, is highlighted by FASEA as the minimum ethical obligation for financial advisers to meet.

This standard requires that:

  • Advisers will take steps to understand their legal obligations, under both the law and FASEA’s Code of Ethics
  • Advisers must ensure the advice they provide is not intended to circumvent the intent of financial services laws or the Code of Ethics
  • Advisers must not establish business structures to circumvent ethical obligations
  • Advisers must act in the best interests of clients.

Importantly, standard one encourages advisers to consider both the legalities and ethics of each course of action they take.

Case study – breaching the Corporations Act 2001

ABC Financial Planning* was taken to court by ASIC and had its licence cancelled because it breached s912B of the Corporations Act 2001.

This section of the Corporations Act 2001 requires AFS licensees to have arrangements to compensate retail clients for losses they suffer as a result of the licensee or its representatives breaching their obligations under the law, including FASEA’s Code of Ethics.

Despite being unable to obtain professional indemnity insurance to comply with the obligation to have adequate compensation arrangements in place, ABC Financial Planning continued to operate a financial services business. Its authorised representatives continued to provide advice, make product recommendations and meet with new and existing clients.

Breaching the Corporations Act 2001 in this way is in clear contravention of standard one:

  • ABC Financial Planning either did not take steps to understand, or ignored, their legal obligations to have current professional indemnity insurance
  • While the advice provided by ABC Financial Planning is not in contention, failing to implement appropriate business practices breached both financial services laws or the Code of Ethics
  • By failing to have appropriate arrangements to compensate retail clients for losses from advice or recommendations, ABC Financial Planning did not act in its clients’ best interests.

*Names and details changed to protect privacy

Standard two

Standard two requires that financial advisers act with integrity and in the best interests of their clients. Although encapsulated in a range of earlier laws, the Code of Ethics makes clients – and their best interests – front and centre.

Integrity is important – it’s an essential component of trust, the first of FASEA’s values. A person who fails to act with integrity will not build trust with clients. Integrity is also inextricably linked with FASEA’s third value of honesty; for without integrity, acting with honesty may be marginalised.

Acting in the best interests of clients demonstrates each of FASEA’s five values and is the pivotal requirement that underpins each of the twelve standards.

This standard requires that:

  • Advisers consider each client, and their needs, individually
  • Advisers are honest, open and frank in all dealings with clients
  • Advisers prioritise their clients’ interests over their own or their licensees’ interests
  • Advisers must honour commitments made to their clients.

Front and centre of standard two is putting each and every client’s interests first. This requires that advisers ensure that the advice, products and services recommended are appropriate to meet the client’s objectives, financial situation and needs. This needs to include consideration of the client’s longer-term interests and expected future circumstances.

Case study – what’s right for one isn’t necessarily right for another

In 2007, a particular superannuation fund – ABC Super* – was performing exceptionally well, delivering returns far in excess of its retail and industry super peers.

Financial adviser Jenny had her own licence and was very thorough in her research of financial products. During a regular client meeting, the client, Louise, informed her that she wasn’t happy with her superannuation; that, in fact, her son’s superannuation fund was far better and Louise wanted to transfer her super into that fund.

Jenny didn’t know much about the fund Louise was determined to move her super to, so she requested time to undertake some research. There was little detail available online, and calls to the fund elicited limited information. Because she was located in the same city, Jenny decided to call into the offices of the fund to see what she could learn.

After visiting the super fund, Jenny was concerned. It was a high risk enterprise and the returns had been generated by the heavy use of derivatives and instruments such as collateralised debt obligation (CDOs). Jenny wasn’t comfortable for any of her clients to invest super in such a high risk venture, particularly clients like Louise who were close to retirement and couldn’t afford a significant drawdown in their retirement funds.

Jenny had a meeting with Louise and explained her findings and why, despite the high returns currently achieved by the fund, she did not believe it was an appropriate investment for Louise. She clearly explained the types of investments in the fund’s portfolio, and what might happen to Louise’s retirement funds in the event of a market correction.

Despite this, Louise decided to ignore Jenny’s advice and switched her superannuation to the high performing fund. Before long, the global financial crisis came along and wiped out more than 50 percent of her superannuation savings.

Louise tried to mount a case against Jenny for not having talked her out of switching her super, even though she had a signed a document acknowledging that Jenny advised against the move. Jenny had maintained detailed notes; from her research into the super fund, case notes from her meetings and calls with Louise and details of her rationale for advising against the move.

Jenny was cleared of any wrong doing and found to have acted in the best interests of her client. Although the Code of Ethics was not yet in play, it’s clear that Jenny met the requirements of standard two:

  • Jenny considered Louise and her needs when making the advice
  • Jenny was honest, open and frank in all dealings with Louise, even when providing information and advice that Louise did not want to hear
  • Jenny prioritised Louise’s interests over her own; while she recognised she’d likely lose Louise as a client, Jenny was determined to do the right thing by her client.

*Names and details changed to protect privacy

Standard three

Standard three requires that advisers must not advise, refer or act in any other manner where they have a conflict of interest or duty that is contrary to the client’s best interests. This has been the most contentious of FASEA’s standards and has created the most debate.

This standard focuses on an actual conflict that might arise between the duty an adviser owes to a client and any personal interest they have or duties they owe another individual or organisation, such as their practice or licensee.

Avoiding conflicts by putting client interests first demonstrates each of FASEA’s five values;  it also harks back to the pivotal requirement of always acting in the clients’ best interests.

This standard requires that:

  • Advisers make an assessment as to whether their personal interests are compatible with the best interests of their client
  • Advisers must ensure the advice they provide is not in conflict with personal interest
  • Advisers must remain aware of changing circumstances and whether than can result in conflicts of interest with some or all clients.

Standard three “…does not seek to ban particular forms of remuneration, nor does it determine that particular forms of remuneration will always give rise to an actual conflict of interest or duty. That said, you should remain open to the possibility that certain forms of remuneration will always fail to meet the requirements of the Code of Ethics.” [1]

Case study – referral fees

Mike and John went to uni together and once finished their respective degrees, decided to set up business together. Mike has done a Financial Planning degree and became an authorised representative of ACME Financial Planning. John had studied business and decided to move into insurance broking.

The two worked from the same premises, but operated separate businesses. Mike’s business was fee for service, John was compensated by upfront and ongoing commissions from the insurance companies with which he wrote business. Both operated within the bounds of the respective laws governing their professions.

Both Mike and John were believers in the value of advice and the importance of adequate insurance cover and as such, had an arrangement whereby they would refer clients to one another. After some time they decided they should pay one another a fee for a client referral. This fee would be scaled, based on the estimated worth of that client over a forward ten year period. Low value clients would be referred at a basic fee of $100, scaling up to $1,000 for a higher value client.

Mike and John each saw an increase in clients – and revenue – as a result of this arrangement. Mike spent more time talking to his clients about the importance of a range of insurance policies, making John’s job much easier; it tended to result in clients being more open to a broader range of insurance policies which, in turn, meant more commission for John and a higher referral fee for Mike.

Referral paperwork was not updated to include the fee and clients were not informed verbally. In fact, clients were not aware either party would receive a fee for the referral.

Mike was in breach of standard three, which requires that advisers must not advise, refer or act in any other manner where they have a conflict of interest. By receiving an undisclosed fee for the referral, particularly one that would scale up based on complexity and client value, is a clear conflict of interest. Mike’s failure to assess and recognise (or act on the fact) that his personal interests were not compatible with the best interests of his clients is in clear contravention of standard three.

*Names and details changed to protect privacy

Client care

Client Care is the second area of ethical competence and encompasses standards four to six. As with Ethical Behaviour, this area of ethical competence encapsulates the spirit of the values that underpin each of the twelve standards.

While honesty and trustworthiness continue to be crucial, the values of competence, diligence and fairness are particularly pertinent when it comes to client care; for without these, the standard of care for your clients may not comply with the best interests duty.

Figure two highlights each of the standards that fall under the competency ‘Client Care.

Standard four

Standard four requires that financial advisers may act for a client only with that client’s free, prior and informed consent. When it comes to existing clients, the consent should have been obtained as soon as practicable after the commencement of the Code.

The idea behind standard four is to ensure clients are well informed and freely consent to personal financial advice before they act, or after the fact in the case of existing clients. With respect to existing clients, if informed consent has not already been met, advisers are required to plan a practicable timeframe for doing so.

This standard requires that:

  • Advisers ensure each client freely consents to the ongoing services, fees payable and payments for any additional services offered
  • Advisers use professional judgement to be satisfied each client has provided free, prior and informed consent; where uncertainty prevails, the adviser should take appropriate action
  • Advisers must obtain informed consent as part of the initial engagement with each client and not proceed to deliver services until that consent is received
  • Advisers obtain consent from any retail client to whom they have provided financial advice and implemented a recommendation
  • Advisers may need to use a range of techniques to be satisfied each client has provided informed consent, depending on the client’s financial literacy and understanding.

It’s important to note that ‘free consent’ comprises an agreement between adviser and client that’s free any form of coercion or pressure, from the adviser or another party.

Case study – informed consent

Bob and Patricia had been clients of their local regional financial planning practice for some years. Their initial financial adviser had retired some years back, and for many years they consulted Graham. He looked after their retirement funding and, between the income generated by super and investments, as well as a part Age Pension, they lived comfortably.

Despite his good health, Bob died unexpectedly. Graham attended his funeral and told Patricia she could call him at any time. A few months later she called in to see him. She was flustered and looked upset. She advised him that her son had found a new financial adviser who would look after her affairs. She was very apologetic and gave Graham a letter from the new adviser.

Graham was aware of the new advisory practice on the other side of town. He’d head a few comments about their high risk approach to investing and their involvement in some speculative property developments on the outskirts of their regional town. He was concerned they were not a good fit for an elderly widow.

Graham contacted Patricia’s son Josh, but he refused to take or return his calls.

A few months later Graham noticed Patricia’s house was for sale. It was her pride and joy, so he was particularly surprised. He decided to visit and check in on her. He knocked on the door and was surprised at her appearance when she answered. She’d lost weight, had clearly been crying and looked unkempt.

Over a cup of tea he gently teased the story from her. Josh had taken her to see the new adviser, Marc. Between them, they convinced her to withdraw her superannuation and cash in her investments, placing the proceeds in the property development. They had also convinced her to sell her home of 32 years. Josh was to use some of the proceeds to build her a granny flat at the back of his home, pay off his mortgage and put the rest into the property development.

Patricia explained she didn’t want to sell her home. She didn’t want to move, but she felt she needed to for Josh’s sake. He and Marc had made her feel that if she didn’t support the property development, it might not go ahead and that would be bad for both of them. Patricia had paid a substantial fee to Marc for the advice but could not say what it was for, nor did she understand what ongoing services would be provided.

Graham believed Patricia had been coerced by both Marc and Josh, a victim of elder abuse; he helped her lodge a complaint against Marc with the Australian Financial Complaints Authority (AFCA).

Marc breached standard four because:

  • He did not ensure Patricia freely consented to the services or fees payable
  • He did not speak to Patricia at any time without Josh present, and did not take steps to make sure she wasn’t coerced into going along with their plans
  • He delivered services – including redeeming investments – without being sure of Patricia’s free consent.

*Names and details changed to protect privacy

Standard five

Standard five again circles back to acting in each client’s best interests, an essential element when it comes to providing ‘Client Care’. The standard requires that all advice and financial product recommendations given to a client must be in the best interests of the client and appropriate to their individual circumstances.

Further, advisers must be satisfied – and have reasonable grounds to be satisfied – that the client understands the advice and the benefits, the costs and risks of the financial products recommended.

Acting in the best interests of clients demonstrates each of FASEA’s five values. In addition, ensuring the appropriateness of financial and product advice reinforces the value of competence.

This standard requires that:

  • Advisers ensure that financial advice and product recommendations are appropriate to each client’s individual circumstances
  • Advisers are aware of, and knowledgeable about, available financial products that would meet each client’s needs
  • Advisers focus on each client’s individual circumstances and do not apply a ‘one size fits all’ approach to advice and recommendations
  • Advisers provide the advice and information in a way that ensure client understanding; this may mean a different approach for different clients, depending on their sophistication and understanding
  • Advisers must be satisfied that each client understands the advice received and the products recommended – this includes benefits, risks and costs associated with each product or service.

Case study

Seventy-seven year old Colin is a widower. His financial situation is simple. He receives the Age Pension, which is topped up by a small annuity. This income is enough to meet his needs and sees him meeting AFSA’s ‘basic’ retirement living standard. He has two adult children, both of whom own their own homes and help him out occasionally with lumpy bills such as his annual council rates.

Colin received a $205,000 bequest from an uncle. It was the first time he had received a large sum of money and he wasn’t sure what to do with it. His son recommended he see a financial adviser to invest it in such a way that didn’t affect his pension entitlement. Colin hadn’t previously received financial advice and was inexperienced in financial matters.

He asked at his local bank branch who he should speak to; an appointment was made with a visiting financial adviser who looked after clients at a number of the bank’s branches. When he met with Frank, the adviser, Colin explained he wanted to gift $50,000 each to his two children and top up his annuity with $100,000 so he had a little more disposable income. The $5,000 he was keeping ‘in the bank’ as a contingency fund.

Frank recommended that Colin invest the $100,000 in a growth fund as that would have a better longer term return than topping up his annuity. The SOA prepared by Frank stated that investment in the growth fund carried a risk of capital loss, that the daily unit price would fluctuate and that the investment was not capital guaranteed.

Colin accepted the advice and made the recommended investment. The investment performed badly and suffered significant losses over several years.

He later lodged a formal complaint, claiming he had not understood the advice Frank had provided; he did not fully understand the investment profile of a growth fund, nor the risks associated investing in equity markets. It was found the investment in a growth fund was not an appropriate investment for Colin given his age and circumstances.

Frank breached standard five because:

  • He did not ensure that the financial advice and product recommendation he made was appropriate for Colin’s individual circumstances
  • He failed to provide the advice and information in such a way that ensured Colin understood it. He should have recognised Colin’s lack of sophistication and provided a simple explanation
  • He should have made sure he was satisfied Colin understood the advice and products recommendation.

*Names and details changed to protect privacy

Standard six

Standard six requires advisers to consider the broad effects arising from the client acting on their advice. It’s expected that advisers actively consider the client’s broader, long-term interests and likely circumstances.

Integrity is important – it’s an essential component of trust, the first of FASEA’s values. A person who fails to act with integrity will not build trust with clients. Integrity is also inextricably linked with FASEA’s third value of honesty; for without integrity, acting with honesty may be marginalised.

Acting in the best interests of clients demonstrates each of FASEA’s five values and is the pivotal requirement that underpins each of the twelve standards.

This standard requires that:

  • Advisers consider the long-term interests of each client
  • Advisers consider the ‘likely circumstances’ of each client – while one cannot foretell the future, likely circumstances include reasonably foreseeable events given the client’s current and likely circumstances

In terms of limited advice, FASEA acknowledges it can be highly effective in meeting a client’s immediate needs. Limited advice scenarios might include SMSF advice, insurance, stockbroking, investment and intra-fund advice. The Code does not prohibit this type of advice but aims to make sure it’s only provided in appropriate circumstances.

Case study – inappropriate advice

Peter and Helen were in their early 50s. Looking ahead, they decided it would be a good idea to get some financial advice to make sure they were well set up for retirement. Both hoped to retire by at least age 65 and spend at least ten years working through their travel bucket list.

They sought recommendations from their friends and decided to see Jon, a financial adviser licenced through a large accountancy and financial advice practice.

Peter and Helen were uncertain about their financial position and wanted a financial plan to make sure their mortgage was paid out before they retired and a have a strategy to build up their retirement savings.

Peter worked full time and Helen part time; their combined income was around $90,000 per annum, with a small variance when Helen worked overtime. Between them, they had a combined superannuation balance of $215,000 and an outstanding mortgage of $286,000 on a home worth $645,000.

Jon recommended that Peter and Helen set up an SMSF and roll their existing superannuation funds into it. He recommended a mix of direct equities and managed funds. He also established a margin lending account and encouraged them to borrow against their home equity to purchase a portfolio of shares to be held outside of the SMSF. The rationale was that the value of the shares would grow over the medium to long term and enable the couple to pay out their mortgage.

Jon did not take steps to ensure Peter and Helen had the knowledge and skills to manage a margin account or an SMSF for which they were personally liable. The couple did not understand how margin lending worked, nor that they would be hit with margin calls in the event of a market downturn. This transpired and Peter and Helen found themselves in a worse financial position that they had previously been in.

ASIC found the advice provided was inappropriate for Peter and Helen and did not meet their needs or objectives.

Jon breached standard six because:

  • He failed to consider the long-term interests of his clients
  • He failed to consider the ‘likely circumstances’ of each client – given market cycles, he should have made sure they understood the potential for margin calls and how this could impact their financial position
  • He did not consider the broader impact on Peter and Helen of them acting on his advice and the ramifications it could have on their retirement plans.

*Names and details changed to protect privacy

Standards one to through to six, spanning Ethical Behaviour and Client Care encapsulate reasonable expectations that Australian consumers would expect from financial advice (and other) professionals.

Financial advisers are required to act ethically and in the best interests of their clients at all times. For many, that may seem an obvious requirement; however, since the Royal Commission and the many examples of unethical behaviour documented through that process, the media continues to publish examples where financial advice has fallen short. This demonstrates that acting in the best interests of all clients is a requirement overlooked by some practitioners and businesses.

FASEA’s Code of Ethics now makes ethical practice a binding requirement for financial advisers. This is a positive step towards establishing financial advice as a respected profession.

The pandemic and resulting health and financial crises have highlighted the importance of advice in Australia. The Code of Ethics plays a critical important role in re-establishing the industry’s importance to the financial security of all Australians.

 

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[1] FASEA Financial Planners & Advisers Code of Ethics Guide, October 2020

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