CPD: Ethics and inadequate financial advice

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The provision of inadequate financial advice can lead to breaches of the Code of Ethics.

On 1 January 2020, FASEA’s Code of Ethics became enforceable by law, requiring advisers to comply with its 12 detailed standards. By the end of 2020, it was announced that FASEA (but not its Code of Ethics) would be disbanded. This article, proudly sponsored by GSFM, examines the importance of upholding these standards and how the provision of inadequate financial advice can lead to breaches.

While FASEA and the standards that comprise its Code of Ethics had been viewed in some quarters as contentious, and have been subject to much discussion, the government’s announcement that FASEA would be disbanded came as a surprise to many.

In a joint statement released in December 2020, Treasurer Josh Frydenberg and Minister for Superannuation, Financial Services and the Digital Economy Jane Hume announced some changes to the financial services landscape in response to recommendations from the 2018 Hayne Royal Commission.

FASEA’s role is to be absorbed by two entities. ASIC’s existing Financial Services and Credit Panel (FSCP) will be expanded to consolidate FASEA’s code monitoring with ASIC’s other monitoring functions, a move designed to help reduce the regulatory burden for financial advisers. Some other elements of FASEA’s role, including administration of the adviser examination, will also be incorporated into FSCP’s expanded mandate.

In terms of the Code of Ethics and its standards, the government will move FASEA’s standard-making functions to Treasury, with the standards to be set by legislative instrument. There has been no indication that the current twelve standards that comprise FASEA’s Code of Ethics will change once this transition is complete.

While no exact date has been provided for these changes, FASEA is funded until 1 July 2021; accordingly, many across the industry expect the transition to be complete on or around this date.

This time last year, when COVID-19 was a virus afflicting China and not yet seen as a significant threat to the world, Australia’s financial services industry was watching the announcements roll out of Treasury as recommendations from the Hayne Royal Commission were issued on a regular basis. These announcements ground to a halt once the government moved into crisis mitigation mode to shield, as far as possible, Australia’s economy from the havoc being wrought by the global pandemic.

Despite this, and the changes businesses had to make to continue operating in remotely during (and after) periods of lockdown, licensees, advisers and advisory practices were grappling with the introduction of FASEA’s Code of Ethics, which became enforceable by law on 1 January 2020. Whether operating from a home office or high rise, advisers (and staff) had to continue meeting the code’s high standards and licensees had to continue to ensure authorised representatives complied with the code. The big change in the future will be that monitoring and enforcement activities will transition to ASIC’s FSCP, rather than falling on the licensee’s shoulders.

Where advisers (or licensees) fail to meet the Code’s standards, ASIC will take enforcement action. It’s important to remember that while FASEA’s Code of Ethics is designed to raise standards of professional and ethical behaviour, it does not replace the laws that govern the provision of financial advice.

Responsibility for applying the tenets of the Code falls on individual advisers continues in 2021; each adviser must be able to explain their interpretation and application of the Code in all dealings with clients.

Underpinned by values

FASEA’s 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. This is not likely to change when responsibility for the Code of Ethics transitions to Treasury.

FASEA describes the purpose of its Code as follows:

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 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, summarised in figure one.

FASEA’s code of conduct comes with guidance. Not all scenarios and client situations will necessarily fit neatly into a standard, nor is the standard a ‘tick and flick’ approach to compliance. Professional judgement and analysis are required and, where an adviser isn’t sure about the right course of action, they need to discuss this with their licensee or their advisory board. After all, as stated in the guidance:

“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.”

The Australian Financial Complaints Authority (AFCA)

In its first two years of operation, AFCA received more than 153,000 complaints and resolved approximately 135,000 disputes; from this, more than $474.5 million was awarded in compensation and refunds to Australian consumers and small businesses.

Investments and advice saw an increase of 22% in the average number of complaints received each month during the 2019–20 financial year, a total of 4,615 complaints. During this period, complaints about investment and advice comprised 6% of the total complaints received by AFCA. Complaints about superannuation were slightly higher at 9% and life insurance represented just over 2% of total complaints. Once again, banking and credit products and services dominated complaints[1].

Of those 4,615 investments and advice complaints, 1,042 complaints related to financial planners or advisers, which represents 23% of all investments and advice complaints. In total, more than $53.4 million in compensation and refunds was awarded with respect to complaints about inadequate or inappropriate financial advice.

Each of the issues raised in figure two are a breach of one or more of FASEA’s ethical standards. While the specifics of each complaint may result in the breach of different standards, in general terms, it’s likely that those advisers who have been the subject of these complaint areas will have breached common standards as follows.

Misleading product/service information

Complaints in this category have increased year on year. Advisers subject to complaint about providing misleading product or service information are likely to have breached the following standards:

Inappropriate advice

Advisers subject to complaints about providing inappropriate advice will have likely breached the following standards:

 

Failure to follow instructions/agreement

Where advisers have failed to follow instructions or acted in contravention to agreements, they will have likely breached the following standards:

Failure to act in a client’s best interests

Acting in a client’s best interests is a tenet that underpins FASEA’s Code of Ethics. Where advisers are found to have failed to act in a client’s best interests, they will have likely breached a number of ethical standards, including:

Service quality

Service quality is a somewhat subjective form of complaint and could arise from so many different facets of advice. It could potentially breach each standard, depending on the nature of the complaint.

For example, it may have been a failure to disclose a conflict of interest (standard three) or to provide clear and simple advice (standard five). Maybe the adviser didn’t clearly explain fees and charges (standard 7) or maintain complete and accurate records of advice (standard 8).

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) or its predecessor organisation. For each, potential breaches of FASEA’s Code of Ethics are identified.

Case study one: Misleading conduct and non-disclosure

Michael was a long-term client and personal friend of a director of ABC Financial Services, which was the responsible entity of a mortgage fund. Michael was a long-term investor in the fund.

The fund allowed investors to invest in mortgages secured over real property and earn a fixed rate of return over a fixed investment term. It was intended that the fund would apply maximum loan-to-value ratios to the borrowers, and that those maximums would not exceed a fixed percentage of the secured property’s independent valuation. Michael invested $162,500 through his self-managed superannuation fund (SMSF).

The corporate borrower defaulted on the mortgage and the property was subsequently sold at a loss, resulting in only a partial return to the first mortgagee and no return to the second mortgagees, including Michael and his SMSF.

In his complaint, Michael told AFCA the adviser misled him about the creditworthiness of the borrower and the existence of a third mortgage over the property. He said that if he had known about these factors he would not have invested and would not have suffered a loss.

In its response to the complainant, ABC Financial Services said it only provided general advice and disclosed all required information. It also said Michael’s investment history implied he would have invested anyway.

AFCA investigated the information that should have been disclosed and examined whether the adviser misled Michael by omission, whether there was conflict of interest, and what loss was caused by the misrepresentation and non-disclosure.

During the dispute resolution process, AFCA found there had been issues with late payments and the existence of a third mortgage should have been disclosed to Michael in the relevant Product Disclosure Statement. By not disclosing the required information, the adviser had misled the complainant by omission.

However, there was insufficient evidence of any mismanaged conflict of interest for the adviser or ABC Financial Services. Further, AFCA found that Michael would have continued to invest in similar sub-schemes, so therefore decided the complainant had contributed to his losses to such an extent that a 40% reduction in the compensation award was appropriate. As a result, ABC Financial Services was required to:

  1. Pay Michael’s SMSF an amount of $97,500.00, plus interest at the rate of 15.95% calculated daily for the period of the investment.
  2. Pay additional compound interest at the rate of 1.25% on the total amount from the termination date of the investment to the date of payment.

Breaches of FASEA’s code of ethics

By not disclosing required information and misleading the client by omission, the adviser potentially breached the following standards in the Code of Ethics:

Case study two

Husband and wife Rob and Lisa sought investment advice in their capacity as corporate trustees of their SMSF. This advice was provided by Julia at JJ Financial Planning.

One of the recommended investments was an agribusiness investment, which was subsequently wound up. This resulted in a substantial loss to the SMSF. Rob and Lisa claim they were not advised of the risks associated with this investment.

Julia disputed this claim and said she was supported by the fact that the Statement of Advice she provided – and the client signed – disclosed the attributes of the Project and stated that it was considered “speculative” and provided no guarantee of returns.

However, AFCA’s case manager was not satisfied that Rob and Lisa had sufficient opportunity to read the SOA, because it was signed by them at the same meeting where it was provided to them.

The licensee provided a copy of the adviser’s file notes of the meeting at which this investment was discussed. Those notes do not record that there was any discussion about the risks of investment. As such, AFCA did not believe the file note supported Julia’s statement that she verbally disclosed the risks and told the complainants that the agribusiness project was speculative.

AFCA found in favour of the complainants and determined that:

  1. The licensee makes good the losses plus interest calculated at the rate of 5% pa compounded annually from date of the determination to the date of payment, and
  2. The Applicants assign to the licensee all their rights and interests in respect of the Project within 14 days of receiving a written request and payment of any transfer or assignment fee from the licensee. Such written request may only be sent by the licensee within 14 days of payment of the amount detailed in the first point.

Breaches of FASEA’s code of ethics

By not disclosing information about the significant risks associated with the investment, particularly as it was regarded as ‘speculative’, the adviser potentially breached the following standards in the Code of Ethics:

Case study three

The complainants, Susan and Colin, were 69 and 72 at the time of seeing adviser Edward, an authorised representative of the financial firm ACME Financial Planning.

Edward recommended that Susan and Colin invest in a Capital Protected Fund (the G Fund). At the time Colin had $337,237 and Susan had $490,820 to invest.

Susan and Colin were classified as Assertive – Balanced investors, which resulted in a recommended asset allocation of 30% defensive assets and 70% growth assets. The complainants say they understood from Edward that the G Fund was capital protected, but that they would get the highest return for the year locked in.

They later found out that they would only get the return available at the anniversary of the product. They claimed had they known this, they would not have invested. Susan and Colin also claimed that Edward did not advise them of the CGT payable when they rolled their money out of the G Fund and overcharged them fees.

AFCA determined that the adviser failed to adequately explain how the product worked. Had the complainants known the level of uncertainty with the fund they would not have invested. The determination also noted that Edward failed the best interest duty by not providing appropriate risk profiling and advice to his clients. Finally, AFCA accepted that the complainants would have been conservatively invested if appropriately advised; this resulted in a total loss of $91,958.34.

This determination was found in favour of the complainants. Total compensation equating to the couple’s loss, plus 1.5% interest per annum compounding annually from determination to the date of payment, was paid.

Breaches of FASEA’s code of ethics

By inadequately describing how the product worked and failing to provide appropriate risk profiling and advice to his clients, Edward potentially breached the following standards in the Code of Ethics:

For the financial advice industry to grow and thrive in the post COVID world, it needs to reclaim trust and build professionalism. Acting ethically will, over time, build trust among Australia’s consumers and increase their confidence in seeking financial advice.

FASEA’s Code of Ethics, in whatever form it takes in the future, will continue to be an important element of journey to restore the industry’s positive reputation and re-establish the industry’s importance to the financial security of all Australians.

 

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[1] AFCA, Annual Review 2019-2020

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