Ethics and inappropriate financial advice
Advisers need to have deep understanding of their obligations as they navigate the financial adviser Code of Ethics.
Earlier this month ASIC revealed that six of Australia’s biggest banking and financial services institutions have paid or offered over $3 billion in compensation for financial advice-related misconduct. Much of this resulted from the 2018 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the ripples from which are still being felt by licensees, advisers and investors today.
The financial adviser Code of Ethics followed hot on the heels of the Royal Commission, to provide guidance to advisers and licensees and comfort to a nervous public. The intent of the Code of Ethics has been to increase the level of professionalism across the financial advice industry and ensure all advisers put the interests of their clients first.
A values-driven code
The Code of Ethics is underpinned by a series of core values that provide the foundation for financial advice to be perceived as a ‘true profession’. Five values (figure one) underpin the twelve standards that comprise the Code of Ethics (figure two). The Code of Ethics is a set of principles and core values in the areas of ethical behaviour, client care, quality process and professional commitment.
Financial advisers are required to act in a way that demonstrates, realises and promotes each of these values and all provisions of the Code of Ethics must be read and applied in a way that promotes the values.
Each of the five values relates to specific ethical standards that must be applied to all interactions with every client. It is important to note that these values also require advisers to meet their obligations under law in respect to the advice provided to each client, including the appropriateness of advice provided to each client.
AFCA and inappropriate advice
In its 2020-2021 Annual Review[3], AFCA noted 70,510 complaints were lodged against banks, insurers, super funds, investment firms and financial advisers over the 12-month period, a figure that was down slightly on the previous 12-months.
Although many complaints were resolved in favour of the financial firm, more than $240.5 million was paid to consumers as compensation or refunds. There were also other forms of compensation, such as fee waivers, debt forgiveness and apologies.
Complaint trends remained similar to previous financial years; issues pertaining to investments and advice comprised just six percent of all complaints made to AFCA. However, this six percent is made up of 3,888 complaints made between 1 July 2020 and 30 June 2021.
As illustrated in figure three, service quality topped the list of complaints about financial advice, closely followed by inappropriate advice. While inappropriate advice was also in second place in the previous year’s annual report, the number of complaints has marginally fallen. Service quality was ranked issue number five in the previous year – complaints that fell into that category almost doubled in the most recent report.
Incorrect fees/costs was not a top five issue in the previous report; it’s emergence as an issue is of concern because this, like each of the above issues, has the potential to breach the Code of Ethics.
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 explicit 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 seven) or maintain complete and accurate records of advice (standard eight).
Inappropriate advice
Advisers subject to complaints about providing inappropriate advice could potentially breach the following standards:
Failure to act in a client’s best interests
Acting in a client’s best interests, putting the client first underpins the Code of Ethics. Although there are two standards that explicitly reference 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:
Incorrect fees or costs
Charging incorrect fees or costs may not be a deliberate action on behalf of the adviser; it could be an administrative error resulting from a glitch in systems or processes in their practice. As such, and assuming it’s addressed swiftly and appropriately, the adviser or licensee is unlikely to have breached the Code of Ethics.
On the other hand, a deliberate move to generate excess fees, overcharge or otherwise inappropriately increase returns from a client may well breach the Code of Ethics. The extent of the action would determine the breach. For example, an illegal action such as theft would breach standard one, which requires advisers to comply with all laws. Other gains might come from an undisclosed conflict of interests (standard three) or inadequate fee/costs disclosure (standard five). The requirement for ‘informed consent’ with respect to fees is covered by standard seven.
Failure to follow instructions/agreement
Where advisers have failed to follow instructions or acted in contravention of an agreed course of action, they will have likely breached the following standards:
Avoiding inappropriate advice
When a client’s financial strategy is meeting their objectives and generally going to plan, it’s unlikely that the spectre of inappropriate advice would be raised. However, where things don’t meet expectations, even from events beyond anyone’s control, they’re more likely to examine your advice.
Two key strategies for avoiding a claim of inappropriate advice are education and communication. For example, financial markets experience periods of volatility – and there’s nothing quite like financial loss for clients to question your strategy.
However, a client who is educated about their investments – what they are, why they are recommended and how they will help the client meet their financial objectives – is more likely to weather a period of underperformance.
Similarly, frequent communication to reinforce key strategies and explain what’s happening and why can go a long way toward keeping your client comfortable with their financial strategy.
It’s worth thinking about the provision of advice from a client’s perspective. ASIC’s Money Smart site[5] offers this advice to consumers concerned they may have received inappropriate advice:
“You may have problems with a financial adviser if they:
- seem to be pushing one solution, regardless of your needs (for example, an SMSF or borrowing to invest)
- pressure you to sign documents that you haven’t read or don’t understand
- give you advice that doesn’t fit with your goals or risk tolerance
- make you feel intimidated or uncomfortable if you ask questions
- are not upfront about how they make their money and the costs of the advice
- leave you in a worse financial position than before you received the advice
- charge you for advice that they never provide.”
Each of those points raised by ASIC is rightfully a red flag for consumers and would see any adviser exhibiting those behaviours in breach of one or more standards of the adviser Code of Ethics.
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 or the Australian Financial Complaints Authority (AFCA) or its predecessor organisation. For each, potential breaches of the Code of Ethics are identified.
Case study one: Inappropriate ‘cookie cutter’ advice
ASIC is taking legal action against a financial advisory practice ABC Financial Planning and one of its advisers, Adam, for giving inappropriate ‘cookie cutter’ advice to retail clients.
Adam’s clients were encouraged to invest in a complex structured financial product without taking into account their financial goals or risk tolerance. Many of the impacted clients were preparing for retirement and were both risk averse and more focused on capital protection than capital growth.
ASIC alleges Adam received upfront and ongoing commissions for each of his clients’ investments in these structured products. The maximum civil penalties for ABC Financial Planning and its adviser Adam respectively are $1 million and $200,000 per contravention.
If Adam is found guilty, from the information provided he have may have breached the following standards in the Code of Ethics.
Case study two: Inappropriate SMSFs advice
Adviser Noel was banned from providing financial services for seven years after ASIC found he had failed to act in the best interests of his clients when advising them to establish a SMSF to purchase properties.
ASIC alleged that Noel failed to provide advice that was appropriate to his clients and said he failed to identify what it was that his clients wanted advice on. ASIC also stated that he failed to understand what was required of him to comply with the best interest duty.
Noel was fined and disqualified from providing advice for seven years.
According to the information provided, Noel potentially breached the following standards:
Case study three: Inappropriate advice #1
Mathilde was a financial planner with MM Financial Planning for several years. After several client complaints and an ASIC investigation, she was found to have:
- Made recommendations that did not accord with her clients’ risk profiles
- Provided non-compliant Statements of Advice
- Failed to keep adequate records
- Failed to provide advice in the best interests of her clients.
Mathilde was banned from providing financial services for two years.
According to the information provided, Mathilde potentially breached the following standards:
Case study four: Inappropriate advice #2
The complainants, Monique and Peter, were 69 and 72 at the time of seeing adviser Jack, an authorised representative of financial firm ACME Financial Advice.
Jack recommended that Monique and Peter invest in a Capital Protected Fund (the A Fund). At the time Peter had $442,251 and Monique had $392,320 to invest.
Monique and Peter were classified by Jack as ‘Assertive – Balanced’ investors. This risk profile resulted in a recommended asset allocation of 30% defensive assets and 70% growth assets. The complainants say they understood from Jack that the A Fund was capital protected, and 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 as it was significantly lower than they had been led to expect. Monique and Peter also claimed that Jack charged higher fees than initially declared.
AFCA determined that Jack failed to adequately explain how the A Fund worked. Had the complainants known the level of uncertainty associated with the product, they would not have invested. The determination also noted that Jack 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, which resulted in a total loss of $94,743.
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 ordered.
By inadequately describing how the product worked and failing to provide appropriate risk profiling and advice to his clients, Jack potentially breached the following standards in the Code of Ethics:
For the financial advice industry to grow and thrive at a time when the industry is shrinking, 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. Acting ethically will also go a long way toward avoiding accusations of inappropriate advice.
Abiding by the Code of Ethics, embedding it in your practice and making it part of your daily routine is an important element of the journey to restore the industry’s positive reputation and re-establish its importance to the financial security of all Australians.
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