CPD: The ethics-centric financial advice practice

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There are a number of strategies that can be implemented to create an ethics-centric practice.

Professional standards reforms for financial advisers were introduced to the Corporations Act 2001 in March 2017 to raise the education, training and ethical standards of people providing personal advice to retail clients. In this second article of 2021’s Ethics Series, proudly sponsored by GSFM, the parallels between FASEA’s Code of Ethics and the Corporations Act will be explored and the benefits of an ethics-centric practice explored.

It’s not news to anyone reading this article that advisers have been subject to a plethora of regulatory change over the past two decades. The Corporations Act 2001 (the Act) has been amended regularly over this time.

Professional standards reforms for financial advisers were introduced to the Corporations Act 2001 in March 2017 to raise the education, training and ethical standards of those providing personal advice to retail clients on more complex financial products[1]. These reforms required FASEA to develop the Code of Ethics, which came into effect just over a year ago. Like all change, it has strong ties with the overarching legislation that regulates the provision of financial advice.

With the introduction of the Code of Ethics, ASIC expects Australian Financial Services licensees to take a number of reasonable steps to ensure that their authorised representatives comply with the Code of Ethics. For example, licensees must:

  • Ensure their authorised representatives were aware of the need for compliance with the Code from 1 January 2020 onwards and that this compliance is ongoing
  • Provide training and/or guidance to their authorised representatives about the types of conduct that is consistent/inconsistent with the code
  • Facilitate individual advisers’ ability to raise concerns with the AFS licensee about how the licensee’s systems and controls may be hindering their ability to comply with the code, and acting on those concerns where appropriate
  • Consider whether advisers are complying with the code as part of their regular, ongoing monitoring of adviser conduct
  • Make any necessary changes to systems and processes to ensure compliance with the Code of Ethics (and, of course, the Act).

ASIC may suspend or cancel an AFS licence if it is no longer satisfied that the licensee or the licensee’s representatives are of good fame or character. While it is intended that this monitoring role will be transferred to ASIC in due course, it remains the licensees’ responsibility in the near term.

The legislative environment

The legislative authority under which the Financial Planners and Advisers Code of Ethics 2019 is made is paragraph 921U(2)(b) of the Corporations Act 2001. It states that all relevant providers must comply with the Code under section 921E of the Corporations Act 2001.

Standard one of the Code explicitly requires advisers to ‘act in accordance with all applicable laws, including this Code, and not try to avoid or circumvent their intent.’ This Standard requires, as an ethical duty, that advisers comply with legal obligations and not seek to avoid them, and is considered to be the minimum ethical obligation the Code confers upon advisers.

Importantly, the Code of Ethics requires financial advisers meet their obligations in the law in respect of the advice provided to each client, including:

  • The best interests’ duty
  • The appropriateness of advice
  • Prioritisation of client’s interests
  • Additional requirements for product replacement recommendations
  • Australian Taxation laws.

Figure one draws parallels between the Code of Ethics and applicable sections of the Act. As is evident, most of the standards that comprise the Code of Ethics are inextricably linked to a number of sections of the Act.

Source: https://www.tpb.gov.au/code-comparison-corporations-act-fasea-standards

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.

An ethics centric practice

It’s important to note that the approach to an ethics centred advice practice should not start and stop with the adviser. In fact, it extends from the receptionist who may greet clients and handle their paperwork, through to the adviser who meets with clients and develops and appropriate financial planning strategy.

It also includes others, such as paraplanners who implement investment decisions, or practice managers who develop staff training. All staff members need to understand how the Code of Ethics impacts their role in the practice and how they can perform their roles in such a way to meet their obligations and support the advisers and licensees to meet theirs. After all, it’s the licensee and adviser who carry the responsibility (and potential enforcement action) of a breach.

There are a number of strategies that can be implemented to create an ethics-centric practice that can help mitigate the risk of breaching FASEA’s Code of Ethics.

  1. Code of conduct: by establishing a practice-wide code of conduct, one which encapsulates your business’s values as well as the Code of Ethics, your team should have a clear understanding of their role and the expectations that go with it. Any code of conduct should set clear expectations about employee behaviour when performing their role and, an ethics-centric practice, how each of the twelve standards may specifically intersect their role.
  2. Checklist: a checklist can be used to safeguard compliance with the Code. The questions in the checklist should be tailored to each role in the practice and include those relevant to dealing with prospective clients, as well as new and existing clients.
  3. Communication: It’s really important to communicate clearly, openly and honestly with your clients. In the initial meetings, don’t simply tell them what you will do for them, but detail how you will work with them to achieve their objectives. Establish ongoing channels of communication and explain how you will communicate with them. It’s important to detail the method and frequency.
    Remember that it’s important not to make promises you know you cannot (or may not be able to) keep. As well as potentially being a breach of the Code of Ethics, it will reflect badly on the practice.
  4. Set key performance indicators (KPI): by reinforcing your company’s 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 may sometimes be more challenging to quantify than one with specific and measurable outcomes, it will highlight the importance of values and ethics to your practice.
  5. Workplace training: it is essential to make sure all staff understand both the practice’s values and the obligations of the FASEA Code. Using workshops to promote ethics in your workplace will reinforce the practice’s standards of conduct and clarify behaviours and practices that do and don’t work within your own code of conduct – and within the Code of Ethics.
    Importantly, ethics training should not be a once off. Ideally, training should be practical as far as possible, and teach team members to make good decisions that are compliant with the law and consistent with your practice’s values.
    Ethics training could be incorporated as part of a regular team meeting; for example, by using a variety of case studies that address common ethical dilemmas across the financial planning industry.
  6. Feedback loop: by encouraging staff to provide honest feedback about the processes, conversations and client interactions, you are better placed to make sure you’re aware of issues that may arise that could potentially compromise your business. A feedback loop can help you identify gaps in relation to processes and procedures, and where a checklist or workplace training may
  7. Lead by example: regardless of your position in a practice, it’s important to set a good example. For those who are senior in the practice, it’s more important to demonstrate those behaviours that are acceptable and point out those which are not. Senior advisers and personnel will set the tone for ethics in the practice; as such, they need to demonstrate the Code of Ethics in all they say and do.
  8. Regular audit: These or similar strategies may have already been implemented in your practice. If so, it’s important to review the effectiveness of each. What’s working well and what’s not? If you can identify gaps in processes that may lead to a breach of the Code, it’s better to identify them ahead of time than when ASIC comes knocking on your door.

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

Jim and Mary obtained advice from John, an authorised representative of the financial firm ABC Financial Planning. This advice recommended an investment of $105,000 into a single managed investment scheme, which several years later entered into liquidation. It was wound up with no return to investors.

Jim and Mary made a complaint that the advice to make this investment was inappropriate as it did not match their risk profile and there was no diversification in the overall strategy.

ABC Financial Planning claimed the advice was appropriate given the information available to the adviser at the time.

Key findings:

  • The overall strategy was heavily overweight towards a single managed investment scheme and lacked critical diversification
  • The managed investment scheme was not an appropriate investment to recommend to the complainants
  • Risk profiling found the complainants to be ‘balanced’ investors.
  • While it may have been appropriate for a balanced, growth or high growth investor to have some exposure to the managed investment scheme, the complainants were heavily overweight to this one financial product with minimal basis for this being appropriate for their needs and objectives
  • There were no discussions about other options for diversification.

The determination was made in favour of the complainants and, within 28 days of Jim and Mary accepting this determination, ABC Financial Planning was to pay the complainants $114,515.91 plus interest.

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

Pamela is a trustee of a family trust; her complaint was in relation to an investment she made for the family trust. The investment was in a capital property fund for which the financial firm, ACME Financial Advice, was the trustee. The recommendation was made by her adviser Paul, an authorised representative of ACME.

Investment in the capital property fund was via an Information Memorandum for wholesale investors only. Under the heading ‘About the Information Memorandum’, the disclosed criteria for investing in the property fund was as follows:

“The offer made in this Information Memorandum is available to Australian Wholesale clients by invitation only.”

In her complaint, Pamela claimed she should not have been invited to invest in the fund because the family trust did not meet the necessary ‘wholesale investor’ criteria. She contested the appropriateness of the family trust being allowed to invest in a wholesale fund as a retail investor and sought the return of the family trust’s $300,000 investment.

Further, Pamela claimed at the time of making the initial investment, she was not aware the fund was only intended for wholesale investors. If she had been aware, she would not have invested.

Key findings:

  • Because the complainant was not a wholesale investor at the time of investing in the fund, the investment should not have been accepted.
  • ACME Financial Advice failed to provide information about how it classified Pamela and the family trust as a wholesale investor, including failure to request an accountant’s certificate.
  • The complainant was entitled to a refund of its total investment of $300,000 (plus interest).

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 three

Max made a complaint about a $100,000 investment he made in a managed investment fund. The financial firm for which his adviser Jeff worked, Boss Financial, was identified as the Responsible Entity and the issuer of the units in this fund.

Max claims that:

  • He was approached by his adviser Jeff, a director of Boss Financial, to invest in the fund
  • Jeff promised Max a guaranteed rate of return at 9% per annum and stated it was a low-risk product
  • Jeff failed to assess the suitability of this product for Max before he invested in the fund
  • He requested a withdrawal of his entire investment and despite repeated withdrawal requests, none were processed, and no funds were paid to him.

Key findings:

  • Jeff’s encouragement to invest in the fund was found to be misleading.
  • The promise of guaranteed returns and security of the investment involved misleading and deceptive conduct.
  • It was reasonable to expect that the complainant would not have invested, had he known about the risks associated with the fund.

In addition, Max’s circumstances and financial literacy were found to be limited. The financial firm’s breach of its obligations resulted in Max suffering a loss, so the determination was in his favour. Within 30 days of the complainant’s acceptance of this determination, Boss Financial had to repay the $100,000 investment plus interest.

Breaches of FASEA’s code of ethics

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

Case study four

Kasey had worked her way through high school and university, and by the time she landed her first graduate position at age 23, had accumulated $11,395 in superannuation. Her father suggested she should see a financial adviser to make sure it was all set up to maximise her future retirement benefit.

She went to see Errol, an authorised representative of Flynn Financial Advice. He advised Kasey to rollover her superannuation into a new fund. He also recommended she cancel her existing TPD/ Life insurance with a sum insured of $200,000 and take out new TPD/ Life cover for $500,000, as well as income protection insurance.

Kasey claimed the advice was not in her best interests. The premiums and advice fees amounted to 46% of her balance in the first year. She lost her entire balance within three years.

Key findings:

  • The advice to rollover the complainant’s funds and obtain new insurance was not in the complainant’s best interests as it resulted in her entire balance being eroded in less than three years.
  • There was no adequate explanation for why the switch was appropriate for her, why she needed to cancel her previous insurance, or why increased cover was required.
  • The best interests duty requires the adviser to ensure they “know the client”, “know the product”, and provide advice that is appropriate in the client’s circumstances; these requirements were not met.
  • The Flynn Financial Advice also breached its obligations by providing an SOA after implementation of the advice.

AFCA considered this latter point to be a serious breach of the financial firm’s obligations. An SOA is the key document explaining the advice, the reason for it and associated costs. Without it the complainant would have been unable to make an informed decision whether to accept the recommendations or not.

The case was found in Kasey’s favour; the firm had to compensate her $14,028.67 plus interest.

Breaches of FASEA’s code of ethics

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

Financial advisers are required to act ethically and in the best interests of their clients at all times; only then will the advice industry be viewed as a profession. While that may seem obvious to many readers, the ongoing public examples of unethical behaviour from a small number of practitioners demonstrates this requirement is overlooked by some financial advisers and businesses.

The best interest duty underpins the operational aspects of, and provision of advice by, financial planning practices. It is enshrined in the Corporations Law 2001 and in the Code of Ethics. A binding Code of Ethics is a positive step towards true professionalism for the industry.

 

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[1] https://www.legislation.gov.au/Details/F2019L00117
[2] https://www.fasea.gov.au/wp-content/uploads/2019/10/FASEA-Financial-Planners-and-Advisers-Code-of-Ethics-2019-Guidance-1.pdf

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