The important role of trust in ethics and financial advice

29 Jun 2022

From AdviserVoice - This Ethics article is proudly brought to you by GSFM

Understanding the factors that can help build trust with your clients contributes to the running of an ethical advice practice.

Recent research shows trust in financial advisers has risen in Australia…however, 58 percent of prospective clients lack trust in advice. This article, proudly sponsored by GSFM, explores the inextricable links between trust and ethical practice in providing financial advice.

The Oxford dictionary defines trust as:

“The belief that somebody/something is good, sincere, honest, etc. and will not try to harm or trick you.”

Not only does that definition encapsulate all that an adviser should aspire to be, it also aligns with the values of trust, honesty and fairness that underpin the financial adviser Code of Ethics. Further, a number of the standards that comprise the Code of Ethics also embody this definition; standards relating to honesty, integrity and acting in your clients’ best interests.

The importance of trust

Consumers need to trust their service providers. We trust that our accountant will ably manage our tax affairs, our doctor appropriately manage our health and our mechanic capably service our car at a fair price. When that trust is breached, it’s often because the service provider has not acted ethically. The mechanic that substitutes second hand parts but charges for new. The dentist that performs unnecessary procedures. The financial adviser who defrauds their clients.

When there’s a breach of trust caused by unethical behaviour that also involves substantial sums of money, it gets a lot more attention that the dentist filling the odd healthy tooth. Take for example the case of unlicensed ‘financial adviser’ Melissa Caddick. She fleeced her clients – mainly family and friends – of circa $25 million via a ponzi scheme to fund a lavish lifestyle. Her disappearance hours after ASIC and the Federal Police raided her home has increased the interest level to the extent she is now the subject of both a television miniseries and podcast.

While the Melissa Caddick case is at one extreme, the volume of reports about advisers doing the wrong thing is consistent enough to be damaging to the industry. In fact, Standard 12 of the Code of Ethics makes it a breach of the code to fail to uphold and promote the ethical standards of the profession and hold each other accountable for the protection of the public interest. It’s a virtuous circle – a breach of trust is also a breach of ethics, and a breach of ethics will in most cases, be a breach of trust.

Trust and financial advisers

A survey^[1] earlier this year measured the level of trust held by retail and institutional investors in the investment industry. The report found 45 percent of Australian retail investors trust the broader financial services industry and 42 percent trust financial advisers. While this number contains some good news, it also reveals that 58 percent of your prospective clients lack trust in financial advice.

The report identified five factors that have driven trust higher:

strong share market performance
fee compression on investment products
greater level of technology-enabled transparency on investment products
greater investor access to investment markets
new personalised investment products such as those with a focus on environmental, social, and governance (ESG) factors.

Over the five years the CFA Institute survey has been published, retail investors have consistently ranked the same four items at the top of the list for reasons to leave an adviser. These are:

underperformance
fees that are too high
inadequate data security
lack of adviser responsiveness – this factor increased the most as ‘of concern’ in 2022, most likely in response to Covid and its disruption to ‘business as usual’.

What happens when trust is broken?

Trust is a complex topic because it is intangible and personal. The factors that build and break trust can vary from person to person. However, one certain way to breach the trust of your client is to provide them with inappropriate advice or advice that is not in their best interests. As well as being a trust breaker, such behaviour is also a clear breach of ethical standards.

Consumers who believe they’ve been given inappropriate advice or advice that is not in their best interest account for one in four ‘Investments and Advice’ complaints received by the Australian Financial Complaints Authority (AFCA)^[2].

Since the authority’s inception in November 2018, it has received 11,355 ‘Investments and Advice’ complaints, of which 2,788 cases – or 25 percent – were claims of inappropriate advice or failure to act in the client’s best interest. While each case will have potentially breached a range of standards in the Code of Ethic, these 2,788 cases – assuming they were upheld – will have most likely breached one or all of the following standards.

Importantly, once broken, it’s very difficult to rebuild. While only a small portion of the above-mentioned cases resulted in a decision against a financial adviser – just 333 complaints or three percent – broken trust doesn’t always lead to a formal complaint.

Trust can be broken in a myriad of ways, not always within your control. The CFA survey suggests underperformance of investments is a trust breaker. However, if your client understands your recommendations, is educated about why you have recommended them and what the potential risks might be, a period of short term performance is less likely to create trust issues.

How can you build trust in your advice practice?

In short, you can engender trust by acting ethically. By adhering to each of the twelve standards of the Code of Ethics will build trust between you and your clients.

While trust building should be part of your business practice, it’s during turbulent times that it will be tested. Market volatility is increasing, as are rates and inflation. Your clients’ cost of living is rising and for many, the value of their investments will fall, at least over the short term.

To cement your clients’ trust, you must demonstrate that you respect your clients’ concerns. You need to engender a culture that engages in transparent communication, is honest and delivers fast and efficient responses to client queries.

The CFA Institute Investor Trust Study examined investor trust dynamics that revealed three “trust enhancers” for financial advisers:

Technology – investors have more trust in firms that use technology effectively.
What technology can you use in your practice to add value to clients?
Aligned interests – not only should you disclose and mitigate conflicts of interest (per Standard 3 of the Code of Ethics) you should also understand the client’s interests, goals and values and ensure their financial plan is appropriately aligned to them.
Connections – at an organisational level, the research found that investors are increasingly using brands as proxies for trust. At the adviser level, personal interactions are required to build a strong foundation.

In financial planning, client trust has been found to be the most important factor for relationship quality^[4]. Trust comes from building relationships and having deep engagement with your clients.

The degree to which clients trust their financial adviser is positively influenced by the belief that the adviser is acting in their best interests (customer oriented) and is negatively influenced by the belief that the adviser is acting out of self-interest (sales-oriented)^[5]. As well as being a trust breaker, acting out of self-interest will breach several standards in the Code of Ethics, again highlighting the important connection between trust and ethical behaviour.

Figure one illustrates a model of trust developed following research undertaken for a PhD Dissertation in 2015^[6]. As well as illustrating the characteristics of trust as it pertains to financial planning, it can also be used to link the importance of ethical behaviours to the elements that constitute a trust relationship. Let’s explore this interrelationship between trust factors and ethical standards more closely.

Competence – while competence is implicit in a number of standards, it is explicit in Standards 9 and 10 – all advice, not just financial product advice, must be offered with competence. From a trust perspective, this would also flow through to communications and other interactions you have with your clients.

Best interests – the research shows a failure to act in a client’s best interest to be a trust killer, it’s also a sign of unethical behaviour and, while it impacts a number of standards in the Code of Ethics, it is a breach of standards two and five.

Honesty – honesty and ethical practice goes hand in hand. Dishonesty of any type will crush the trust built between two people and in the context of financial advice, destroy the adviser-client relationship and likely put you in breach of several Standards, in particular standard two, which requires for integrity.

Accountable – it is important to demonstrate that you, and other members of your practice, are accountable for all actions in relation to your clients. Particularly in situations where things haven’t gone to plan, accountability is essential to maintaining the trust you have developed with your client.

Feeling – while trust is built over time, it is often driven by a feeling of wellbeing (or lack thereof). By acting your clients’ best interests and adhering to the standards that comprise the Code of Ethics, you’re more likely to engender and maintain a trust relationship with your clients.

Vulnerability/Risk – all clients will have periods of feeling vulnerable. The stronger the trust relationship between you, the knowledge that you have acted in their best interests means the client is less likely to feel vulnerable or concerned during periods of market volatility. By providing informed consent, a client is more likely to understand your role and trust the advice received from you.

Faith – clients want to have faith in their adviser, want to have a trust relationship, want to know you are doing the best by them. By acting in their best interests and building a strong interpersonal connection, your client is best positioned to have faith in your role and their ability to meet their financial objectives.

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 ASIC and the Australian Financial Complaints Authority (AFCA) or its predecessor organisation. For each, potential breaches of the Code of Ethics are identified.

Case study one: Misappropriating funds

Unfortunately such criminal cases do occur and, as with the Melissa Caddick case, can create significant media attention. Such media attention can cast a pall on the industry as a whole and reinforces the importance of the trust relationship between you and your clients. Where there is trust, such scandalous stories are less likely to have a negative impact.

Over a period of two years, it was found that financial adviser PH engaged in dishonest conduct in relation to the provision of financial services to a number of clients of his financial advisory business, ACME Financial Planning.

PH executed more than 150 unauthorised transfers of funds from accounts held in the names of his clients, totalling nearly $3,000,000. The misappropriated funds were used to fund his family’s lifestyle, including paying for private school fees and overseas holidays.

While the case was being heard, a number of victims provided Victim Impact Statements where they spoke of their deep distress as to their personal and financial circumstances as a result of PH’s conduct.

PH was charged for offences against s1041G of the Corporations Act, one of the first financial advisers to face such charges following the enactment of Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019 (Cth), which came into effect on 13 March 2019. It was noted that he had taken ‘positive steps’ to avoid detection, as well as made numerous misrepresentations and concealments when approached by ASIC.

He was sentenced to six years in prison and required to repay the clients’ misappropriated funds, professional fees incurred in seeking to recover the misappropriated funds, management fees charged during the periods of offending, non-economic loss as determined by AFCA and interest calculated at the rate published by the Reserve Bank of Australia plus six per cent with interest accruing from the start date of the charge period for each respective victim until date of payment.

As well as breaching his clients’ trust, PH potentially breached the following standards of the Code of Ethics:

Case study two: Failure to manage cyber risks

Inadequate data security was one of the ‘trust breakers’ identified in the CFA Institute Investor Trust Study. The incidence of cyber attacks has increased dramatically in recent years and most consumers are aware of the risks to their personal information and financial security posed by such attacks.

The Federal Court recently found that an AFS licensee breached its license obligations to act efficiently and fairly when it failed to have adequate risk management systems to manage its cybersecurity risks.

ASIC claimed a number of the licensee’s authorised representatives had experienced cyber incidents during which confidential and sensitive personal information of several thousand clients was compromised. According to ASIC: “It is imperative for all entities, including licensees, to have adequate cyber security systems in place to protect against unauthorised access.”

The licensee was ordered to pay $750,000 towards ASIC’s costs.

A failure to manage risks – particularly ones that put client data in jeopardy – potentially breaches the following standards:

Case study three: Unlicensed adviser

Operating a financial advice business without the appropriate licence is a clear breach of the law, is unethical and likely to undermine any trust between an adviser and their clients.

Financial adviser LB was for a time operating as an authorised representative of an AFS licensee, but then decided to go it alone, despite the fact that neither he nor his company held an AFS licence. During this time, LB traded shares on behalf of clients and used managed discretionary accounts.

ASIC also found LB was not competent to provide financial services as he:

Had failed to identify that he required an AFS licence to conduct a financial services business in Australia
Failed to maintain adequate client records
Failed to demonstrate competence in his use of financial products, even when working as an authorised representative, where he was not licenced to trade shares.

LB was banned for five years from providing any financial services or controlling an entity that carries on a financial services business and is recorded on ASIC’s banned and disqualified register.

His actions saw LB potentially breach the following standards in the Code of Ethics:

Case study four: Investment in the adviser’s best interest

There are many cases where consumers have been encouraged to invest in schemes run by or related to advisers, their practices or their licensees. When these schemes are not in the client’s best interests, not only do they breach the trust relationship, they breach the Code of Ethics.

Susan and her husband Colin had been clients of ED Financial Planning for a number of years. Last year their adviser, Ed, invited them to purchase membership in a timeshare managed investment scheme operated by his licensee. Ed received a financial incentive on sales.

Susan and Colin attended an information session for the investment, during which Ed provided them with information and advice about the investment. During the information session, Susan asked Ed if it was possible to cancel membership in the scheme and was informed they could cancel the investment for an exit fee of $450; she and Colin relied on that statement when deciding to take up the investment.

As it turned out, this statement was misleading; Ed later denied specifying an exit fee or exit clause.

Instead, Susan and Colin were required to pay out the loan they had taken out, find a buyer for their portion of the timeshare and pay an additional exit fee – one much higher than they believe they were told. This was outlined in fine print on page 44 of the scheme’s Product Disclosure Statement (PDS) but was at odds with the information that he provided verbally.

The AFCA investigation found a range of issues with Ed’s advice, including:

Ed’s file notes were incomplete and did not record all the matters referred to by Susan and Colin in their complaint. The absence of this record in the adviser’s file notes was deemed to be important.
The statement of advice (SOA) provided to Susan and Colin was generic and not tailored specifically to them; it did not identify their objectives, nor did it provide advice reasonably likely to satisfy those objectives.
The SOA also failed to discuss the specified risks associated with accepting the advice in this case – investment in a non-liquid managed investment scheme on a long term basis.

Susan and Colin stated they would not have invested had they known they could not easily exit the investment. From the details provided in the case study, Ed potentially would have breached the following standards in the Code of Ethics:

For the financial advice industry to thrive, it needs to engender trust. This is best done by advisers acting ethically and in the best interests of their clients at all times; only then will the advice industry be viewed as a trusted profession by a larger proportion of the Australian population.

Acting ethically and being trustworthy will build trust among consumers and increase their confidence in using financial advice services. The Code of Ethics plays an important role in building trust in the industry and reinforcing its importance to the financial security of all Australians.