CPD: Ethics and the client’s best interests

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Employ ethical practices help stay on the right side of AFCA in the event of a client complaint.

Acting in a client’s best interests is something we all want – and expect – from our service providers. It underpins good service, professionalism and ethical behaviour. The interplay between those factors is explored in this article, part of the Ethics Series proudly sponsored by GSFM.

According to ASIC, the best interests duty and related obligations are:

“…designed to ensure that retail clients receive advice that meets their objectives, financial situation and needs, and that you act in the best interests of your clients when providing advice.”

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 summary, the way any one of us would expect to be treated by a professional service provider, whether they be medical, legal or financial.

The Future of Financial Advice Reforms (FOFA) introduced an amendment to the Corporations Act 2001, one which enshrined the best interest duty into law. It was an extension of the existing fiduciary duty owed to clients by financial advisers, the one which covered the need to ‘know your client’, know the products you recommend and always act with the interests of those clients front and centre. This amendment came with an addition – penalties, including banning and disqualification orders.

Section 961B of the Corporations Act 2001 (as amended) lists the steps an adviser must take to satisfy the ‘best interests’ standard. In summary, these are[1]:

  1. To identify the client’s financial situation, objectives and needs; these should be provided to the adviser by the client.
  2. To identify the subject matter of the advice sought by the client (whether explicitly or implicitly).
  3. To identify the client’s relevant circumstances – the objectives, financial situation and needs that would reasonably be considered as relevant to the advice sought on the identified subject matter (i.e. the client’s relevant circumstances).
  4. To ensure this information is complete and correct and make reasonable enquiries should be made if gaps or inconsistencies are apparent.
  5. To assess whether you have the expertise required to provide the client advice on the subject matter sought and, if not, declined to provide the advice.
  6. When considering the advice sought, whether it would be reasonable to consider recommending a financial product. If a financial product is deemed relevant, a recommendation should only be made after thoroughly investigating the most appropriate products relevant to the client’s circumstances.
  7. When advising the client, the financial adviser must base all judgements on the client’s relevant circumstances.
  8. Take any other step that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances.

This last catch all statement encapsulates the spirit of the legislation; regardless of the client’s requirements, the advice must be underpinned by knowledge of the client and their circumstances. While the best interest duty applies to retail clients, a similar fiduciary duty is required for dealings with wholesale clients. To meet obligations under section 961B of the Corporations Act 2001, is indisputably to act ethically in all dealings with clients.

A failure to act in a client’s best interests would not only breach section 961B of the Corporations Act 2001, it would also breach several of FASEA’s ethical standards, notably:

RG175, published on 15 June 2021, contains a section that sets out what ASIC considers advice providers must do to meet their best interests obligations to:

  • act in the best interests of their clients
  • provide appropriate advice
  • warn the client if advice is based on incomplete or inaccurate information
  • prioritise the client’s interests.

Importantly, RG 175.236 specifies that AFS licensees also have an obligation to take reasonable steps to ensure that their authorised representatives comply with:

  • the best interests duty
  • the appropriate advice requirement
  • the obligation to warn the client if advice is based on incomplete or inaccurate information
  • the obligation to prioritise the client’s interests.

ASIC is more likely to take the view that processes for complying with the best interests duty are not effective, and that the best interests duty is not being complied with, if an advice model typically leads to a one-size-fits-all outcome; in other words, the processes do not allow each client’s relevant circumstances to be considered or result in advice that does not reflect the client’s relevant circumstances.

Keeping on the right side of regulators

Acting in the client’s best interests is central to acting ethically and doing the right thing by clients. However, for various reasons, disgruntled clients may still choose to complain about advice they have received. The Australian Financial Complaints Authority (AFCA) has compiled a checklist of tips to getting financial advice right. As well as standing yourself in good stead in the event of a complaint, this list will also help you meet your ethical obligations.

1. Take detailed file notes

AFCA relies on evidence provided by the parties to a dispute. Documents created at the same time as the activity or advice in question are usually given more weight than later recollections of what was said or done. This means contemporaneous file notes of conversations and actions are invaluable when a dispute comes before AFCA.

Whenever possible, confirm verbal instructions from a client in writing (e.g. send them an email after a telephone conversation confirming what was said). Statement of Advice and file notes should detail how any conflicts between goals, available resources and willingness to take risk are resolved.

This approach will also help you meet your obligations under standard eight, to keep and maintain complete and accurate records of advice and services provided.

2. Clear goals and strategy – you must have a conversation with the client about their goals

AFCA does not consider client objectives and instructions written in industry terms that few clients would understand to be a reliable record. Rather, AFCA recommends you write down a client’s objectives in the words the client has used in answering your questions about their objectives and how to quantify those objectives.

This demonstrates that you have heard and understood the client’s goals in seeking advice – e.g. ‘to retire at age 65 with an income of $50,000 per year’. You should detail how the strategy you are recommending will achieve the client’s goals.

This will also demonstrate that you have met the following FASEA standards. In the first instance, that you have complied with your legal obligations and acted with integrity and in the client’s best interests.

It will also help to prove ‘informed consent’; if the advice is provided in ‘layman’s terms’, in such a way that it’s accessible to the client, it is more likely to have met the requirements of standard four. It also increases the likelihood of clients understanding the advice received, thereby meeting the requirements of standard five.

3. Turn clients away or refer when appropriate

If your services are not suited to a particular client, you must tell them so. It’s important that you don’t try to shape the client to your offering. An attempt to offer advice that you’re not qualified or authorised to provide could see you in breach of standard ten; it’s important to only provide advice and recommendations in areas you have competency.

If a client is seeking a return that does not match their risk profile and you can’t convince them to change their expectations, either send them away (or see point four).

If providing advice that does not suit the client, or advice that does not meet their risk profile (even if it does match their return expectations), there is a risk of breaching standard six. This standard requires you to consider the broad effects of the client taking your advice, the long term impacts on the client and other family members. It also risks breaching those standards that deal with acting in the client’s best interests (two and nine).

4. Explain the risks to clients who choose to act against your advice

If a client chooses to act against your advice, you must be very clear in explaining the risks and documenting that the course of action is against your advice. Explain the risks in language the client understands, make a contemporaneous file note, and have the client sign it.

This action can prevent you from potentially breaching a number of FASEA standards, including those dealing with acting in a client’s best interests (standards two and nine), informed consent (standard four) and taking into account the broad effects of the advice (standard six).

5. Explain what types of service you are providing

Clients don’t know the difference between information, general advice, personal advice, limited advice, and execution-only services.

If you don’t give the appropriate explanations and warnings, or you are unclear about your service offering, then you could be found liable for advice or services that you had not intended to provide.

Standard four requires ‘informed consent’ and a clear explanation of the services and advice you are providing. A failure to do this adequately may see you in breach of standard four as well as liable for advice you hadn’t intended to provide.

6. Use template forms and documents carefully

It’s important to ensure template forms and documents about strategies, products and risks are appropriate to the client you are advising.

According to AFCA, it will be difficult to convince them that you have selected the right strategies and financial products for a client if the documents contain errors, are missing information, or contain copious amounts of irrelevant material. You will also have some trouble convincing AFCA that your client understood your documents if they contain pro-forma jargon or complex concepts.

AFCA’s advice is to tailor documents to your client’s financial literacy. Statements of Advice must be clear, concise, and effective.

As with tip number two, the careful use of appropriate forms and documents will help you meet your requirements under standards four and five. It will, of course, help support a case that your advice is in your client’s best interests.

7. Use risk profiling tools carefully

It’s important to remember that risk profiling tools are only tools. They may have inherent flaws that must be recognised and addressed by the adviser.

Make sure that the strategy and asset allocation you recommend to a client is consistent with the risk profile generated by the risk profiling tool you use. If there are inconsistencies, or if a client seeks a return that does not match their risk profile, you must clearly explain the risk and impact.

A failure to do so could see you potentially breach several FASEA standards, including:

  • those dealing with acting in a client’s best interests (standards two and nine)
  • informed consent (standard four)
  • taking into account the broad effects of the advice (standard six).

8. Don’t give cookie-cutter advice

The best interests duty requires that advice be reasonably likely to achieve the client’s goals and that alternatives have been considered. For example, if, while examining a complaint, AFCA saw a Statement of Advice for a client with taxable income of $42,000 that stated: ‘Your reasonable level of surplus income and high tax rate should make gearing an appropriate option for you’. This was a clear example of an adviser replicating an advice strategy across clients without regard to their individual circumstances.

A ‘one size fits all’ approach is unlikely to meet the best interests test. That would most likely result in a breach of 961B of the Corporations Act 2001; in turn, this would breach the FASEA requirement to obey all laws (standard one) as well as those standards that deal with acting in a client’s best interests (two and nine).

9. Understand and explain the products

Understand any products you are recommending. Don’t advise on products you don’t understand.

AFCA’s advice is to not simply hand over a Product Disclosure Statement (PDS) – you must explain the PDS to your client and record your discussion in the SOA. Further, it suggests that you don’t cut and paste PDS disclosures into SOAs. You need to demonstrate your understanding the products by using the same words you use to verbally explain the products to your clients.

Standard five in FASEA’s code of ethics requires that advisers make sure their clients understand the financial product recommendations being made and the rationale for those recommendations, including costs and risks.

To advise on products you don’t understand, or where you lack competence, may well result in a breach of standard nine and furthermore, be found to not be in the client’s best interest.

Such actions could also be examined in light of standard ten, which requires advice not to be provided unless you have the necessary skills and competencies.

10. Be clear about the advice relationship with clients you know

If you are giving advice to a friend, relative, colleague, or employee, it is critical to formalise and document the process as you would for any other client.

As with all clients, you want your professional relationships to be that – professional. Ethical behaviour underpins professional behaviour.

It is also important to remember that if AFCA or ASIC do approach you about a potential breach, a failure to cooperate with them could see you breach of standard eleven:

Case studies

The following case studies are based on real complaints submitted to AFCA and/or investigated by ASIC; however the names of people and organisations have been changed, and some details altered. For each case study, it will be shown where the adviser has potentially breached any of the standards within FASEA’s Code of Ethics.

Case study one: MySuper

Under the Government’s Stronger Super reforms, a member’s accrued default superannuation was to be transferred to a MySuper fund by 1 July 2017, unless that member opted out of the transfer. In this case study, Adviser A issued or authorised misleading communications related to his client’s MySuper accounts.

ASIC found that Adviser A allowed or authorised misleading and inaccurate letters about superannuation to be issued to some ABC Master Trust members. As a result of this correspondence, hundreds of members did not fully transition to MySuper. Instead, their accrued default amounts remained in ABC Master Trust’s superannuation platform, which was generally more expensive than the MySuper product. These higher costs were due, in part, to the fact that the administration fees for the ABC superannuation product would continue to include commissions payable to Adviser A.

As a result of this investigation, ASIC banned Adviser A from providing financial services for four years. As a result of these actions Adviser A potentially breached the following FASEA standards:

Case study two

Will is a senior financial planner employed by AAA Planning, a large financial institution. He has, in his words, a tried and tested methodology to make his clients ‘good money’. Unfortunately, the strategies and investments Will recommends are high risk, and are too risky for the majority of his clients’ circumstances and risk profiles.

When approached by AFCA following a client complaint, it was found that Will’s conduct was consistently inappropriate across much of his client base. AFCA’s findings noted Will’s actions included:

  • charging an ongoing advice fee without providing ongoing advice
  • conducting transactions in his clients’ names without authority of those clients
  • inadequately kept files, for which Will blamed the systems provided by his licensee
  • inappropriate financial product recommendations
  • a failure to maintain appropriate level of knowledge and skills, yet he advised on investments where he lacked competence.

Will’s conduct potentially breached the following FASEA standards:

Case study three: Dishonesty offenses

Former financial adviser Barry was a sole practitioner whose financial advice focused on dealing in securities and advising on self-managed superannuation funds. He was investigated by ASIC after clients Joan and Patrick Smith grew concerned about unauthorised funds being withdrawn from their SMSF.

Although Barry did not initially cooperate with ASIC’s investigation, it eventually found that Barry had:

  • made 167 unauthorised transfers, impacting 13 clients, totalling nearly $3 million
  • used those stolen funds for personal purposes
  • made false representations to clients and other third parties about those unauthorised transfers with the intent to conceal his dishonest conduct and avoid detection.

Barry was convicted of 15 dishonesty offences and sentenced to six years’ imprisonment with a non-parole period of four years. He was also banned from providing financial services or from controlling an entity carrying on a financial services business.

ASIC found that Barry took advantage of the trust placed in him by his clients and determined a permanent banning of Bruce was appropriate because of the seriousness of the misconduct and the need to prevent future harm to financial consumers.

Case study four: Failure by licensee

Following several client complaints, ASIC commenced an investigation into adviser Karen. ASIC found she had had breached her best interests obligations by giving inappropriate advice and failing to put her clients’ interests first. At the time, Karen was an authorised representative of ACME Financial Advice.

When Karen’s case went to the Federal Court, it was found that ACME Financial Advice failed to take reasonable steps to ensure that Karen provided appropriate advice to clients, acted in the clients’ best interests and put the clients’ interests ahead of her own.

Further, the Court found ACME Financial Advice did not have adequate processes to monitor the advice given by advisers or identify when their authorised representatives were avoiding advice quality checks or recommending non-approved financial products. The Court claimed these to be serious flaws which should have been apparent to the licensee.

Commenting on the case, ASIC Deputy Chair Sarah Court said ‘Financial advice licensees need to understand that they can be liable if their advisers do not act in the best interests of their clients and do not prioritise their clients’ interests over their own.’

In this case, the licensee ACME Financial Advice was potentially in breach of the following FASEA standards:

Financial advisers are required to act ethically and in the best interests of their clients at all times. While such a requirement might seem a glaringly obvious requirement to many, there have been numerous instances of unethical behaviour since the 2018 Royal Commission. While some are relatively minor, the regular headlines in the industry’s trade press reveals that it’s a requirement overlooked by a small number of practitioners and businesses.

While trust in financial advice has improved, there is significant scope for it to develop and grow. According to an Adviser Ratings report[2], trust in advisers sat around 35% in the wake of the Royal Commission. The situation has improved, with trust now circa 48-50 percent. The best way to improve trust in the industry is to continue taking positive steps towards true professionalism for the industry.

 

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[1] http://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s961b.html
[2] 2020 Australian Financial Advice Landscape, Adviser Ratings

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