=Ethical standards – a review (Part one)
The Code of Ethics has made ethical practice a binding requirement for financial advisers for three years.
The Code of Ethics became law on 1 January 2020 to ensure best practice across Australia’s financial advice providers. In this article, proudly sponsored by GSFM, standards one to six are examined. A subsequent article will scrutinise standards seven to twelve.
Despite the dissolution of FASEA, the body responsible for creating the Code of Ethics (Code) and its twelve standards, it remains law. In fact, under section 921E of the Corporations Act 2001 (Act), all relevant providers must comply with the Code of Ethics. Responsibility for monitoring compliance with the Code has passed to ASIC and, although there is talk of changes to the Code and its standards in the Quality of Advice Review, it remains law in its current form until the Act is formally amended.
The 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, to build trust among consumers and deliver better outcomes for all. This Code imposes ethical duties that go above the requirements outlined in law.
The Code requires that financial advisers must act at all times, in all cases, in a manner that is demonstrably consistent with the twelve ethical standards that comprise the Code; this will be monitored by ASIC’s approved compliance schemes.
Licensees have an important role under the Act; they must monitor and enforce compliance with the Code with respect to all advisers operating under their remit. Licensee are expected to structure their business operations in a manner that facilitates advisers being able to operate ethically and meet each of the twelve standards that comprise the Code of Ethics.
Values-based
The Code of Ethics addresses five core values and its twelve standards reflect these in practice. As highlighted in the legislation, these values are paramount, and all provisions of the Code must be read and applied in a way that promotes these five core values.
Code of Ethics
The financial adviser Code of Ethics is comprised of twelve standards; these are grouped under four ethical competencies:
- Ethical Behaviour (standards one to three)
- Client Care (standards four to six)
- Quality Process (standards seven to nine)
- Professional Commitment (standards ten to twelve)
It is expected that advisers will exercise professional judgement against the ethical principles in each standard, depending on the particular circumstance. Importantly, the standards are not a compliance checklist.
Ethical Behaviour
Ethical Behaviour encompasses standards one to three and encapsulates the spirit of the values that underpin each of the twelve standards.
The first of those values, trustworthiness, is particularly important to highlight when discussing ethical behaviour. It’s through ethical behaviour and good conduct that a service provider builds trust and maintains with clients; breaching that trust is often the result of unethical conduct.
Australian investors’ trust in financial services stood at 45 percent this year[1]. On the upside, this represents an increase on previous years; however, Australians ranked lower than global peers such as the US (64 percent), UK (51 percent), and Singapore (62 percent). A continued focus on ethical behaviour will help build trust over time.
Figure one highlights each of the standards that fall under the competency ‘Ethical Behaviour’.
Standard one
Since the Corporations Act first came into being, financial advisers have had to abide by those laws that guide their profession. While the vast majority operate within the prescribed legal boundaries and within the spirit of the law, there’s a small number of advisers who avoid or circumvent the intent of the Act – the laws that exist to protect consumers from unscrupulous operators.
Standard one – acting in accordance with applicable laws and the Code of Ethics, is highlighted as the minimum ethical obligation financial advisers must meet.
This standard requires that advisers:
- will take steps to understand their legal obligations, under both the law and the adviser Code of Ethics
- must ensure the advice they provide is not intended to circumvent the intent of financial services laws or the Code of Ethics
- must not establish business structures to circumvent their ethical obligations
- must always act in the best interests of their clients.
Importantly, standard one encourages advisers to consider both the legalities and ethics of each course of action they take. Because the Code is enshrined in legislation, a breach of the code will result in a breach of the law.
Case study* – failure to comply with financial service laws
ACME Advice operated two Sunshine Coast-based financial services businesses between 2013 and 2018. This included running a managed discretionary account service and a superannuation rollover business. ASIC cancelled ACME’s AFSL in May 2020 following concerns it had breached a number of its legal obligations.
A hearing before the Administrative Appeals Tribunal (AAT) in 2021, found that ACME’s contraventions included:
- engaging in unconscionable conduct
- prohibited hawking
- misleading or deceptive conduct
- false or misleading statements
- failing to provide appropriate advice
- failing to act in the best interests of clients.
While ACME and its advisers are likely to have breached several of the Code’s standards, the fact that it breached the Act (unconscionable conduct, hawking, failing to act in client best interests among others), as well as the Code of Ethics, is an obvious violation of standard one.
The AAT upheld ASIC’s decision to cancel ACME’s Australian financial services licence.
Standard two
Standard two requires that financial advisers act with integrity and in the best interests of their clients. Although encapsulated in a range of earlier laws, the Code makes clients – and their best interests – front and centre.
Integrity is an essential component of trust, the first of the values upon which the Code is built. A professional who does not act with integrity will not be able to build trust with clients. Integrity is also inextricably linked with the third value, honesty; for without integrity, acting honestly may be sidelined.
Acting in the best interests of clients demonstrates each of the five values and is the pivotal requirement that underpins each of the twelve standards.
This standard requires that advisers:
- consider each client, and their needs, individually
- are honest, open and frank in all dealings with clients
- prioritise their clients’ interests over their own or their licensees’ interests
- must honour commitments made to their clients.
Front and centre of standard two is putting each and every client’s interests first. This requires that advisers ensure that the advice, products and services recommended are appropriate to meet the client’s objectives, financial situation and needs. This needs to include consideration of the client’s longer-term interests and expected future circumstances.
Case study* – a demonstrated lack of integrity
In 2021, Adelaide-based financial adviser Bob was found guilty of dishonestly obtaining over $65,000 from his clients’ superannuation accounts.
ASIC found that he had obtained First Nations consumers’ superannuation details and then submitted falsified benefit access applications or hardship applications to the respective superannuation funds.
These applications were made in the members’ names, without their specific consent and contained Bob’s own, or his associates’, bank account details as the payment destination. Bob also provided false contact details on the forms, including his own phone number and address, and created false email accounts in the members’ names, to communicate directly with their superannuation funds. In some cases, Bob impersonated clients over the phone in communications with the funds.
After funds were successfully released into the bank accounts, Bob retained up to 100 per cent of the pay out in fees before forwarding the balance to the consumers.
Bob was sentenced to three years imprisonment. When sentencing, the presiding judge described his conduct as “deliberate and calculated acts of deceit” which constituted “a significant breach of trust”.
It is evident that Bob paid scant regard to the clients’ needs and failed to prioritise their interests over his own. His actions were dishonest and an evident breach of standard two.
Standard three
Standard three has long been the most contentious of the Code’s standards and appeared most often in discussions of the Code of Ethics and its standards in the Quality of Advice Review. It states advisers must not advise, refer or act in any other manner where they have a conflict of interest or duty that is contrary to the client’s best interests.
This standard focuses on an actual conflict that might arise between the duty an adviser owes to a client and any personal interest they have or duties they owe another individual or organisation, such as their practice or licensee.
Avoiding conflicts by putting client interests first demonstrates each of the five values that underpin the Code; it also links to the pivotal requirement of always acting in the clients’ best interests.
This standard requires that advisers:
- make an assessment as to whether their personal interests are compatible with the best interests of their client
- must ensure the advice they provide is not in conflict with personal interest
- must remain aware of changing circumstances and whether than can result in conflicts of interest with some or all clients.
Case study* – conflict of interest
Pamela was the sole director of PG Advice and an authorised representative of an AFS licence holder, ABC Financial. She recommended her clients invest in the ABC Income Opportunity Fund, a registered managed investment scheme operated by her licensee.
An ASIC investigation found that over a three year period, Pamela recommended that the majority of her clients invest in the ABC Income Opportunity Fund, which was considered to be a high-risk financial product. Pamela had a specific interest in the Fund via personal borrowings and ASIC found that she failed to prioritise her clients’ interests above her own when recommending they invest in the Fund.
Further, the high-risk nature of the investment did not match her clients’ risk profiles or experience, and Pamela was found to have failed to conduct a reasonable investigation into alternative financial products that could have met her clients’ needs.
ASIC banned Pamela from providing financial services for three years; this also prohibits her from managing, supervising or auditing the provision of financial services and from providing training about financial services and products.
Client care
Client Care is the second area of ethical competence and encompasses standards four to six. As with Ethical Behaviour, this area of ethical competence encapsulates the spirit of the values that underpin each of the twelve standards.
While honesty and trustworthiness continue to be crucial, the values of competence, diligence and fairness are particularly pertinent when it comes to client care; for without these, the standard of care for your clients may not comply with the best interests duty.
Figure two highlights each of the standards that fall under the competency ‘Client Care.
Standard four
Standard four requires that financial advisers may act for a client only with that client’s free, prior and informed consent, which now should have been obtained from clients dating prior to the introduction of the Code. The fundamental concept encapsulated in standard four is to ensure clients are well informed and freely consent to personal financial advice before they act.
This standard requires that advisers:
- ensure each client freely consents to the ongoing services and fees payable, as well as payments for any additional services offered
- use professional judgement to be satisfied each client has provided free, prior and informed consent; where uncertainty prevails, the adviser should take appropriate action
- must obtain informed consent as part of the initial engagement with each client and not proceed to deliver any services until that consent is received
- obtain consent from any retail client to whom they have provided financial advice and implemented a recommendation prior to the introduction of the Code
- may need to use a range of techniques to be satisfied each client has provided informed consent, depending on the client’s financial literacy and understanding.
It’s important to note that ‘free consent’ comprises an agreement between adviser and client that’s free any form of coercion or pressure, from the adviser or another party.
Case study* – informed consent
Husband and wife Jeff and Niamh sought investment advice in their capacity as corporate trustees of their company’s SMSF. This advice was provided by Anthony at AA Financial Planning.
One of the recommended investments was a structured product that obtained exposure to high yield fixed income through derivatives. A serious market correction resulted in a significant loss to the financial product; it was ultimately deemed to be unviable and the product was wound up. This crystallised a substantial loss for the SMSF.
Jeff and Niamh claim they were not advised of the high risk nature of the investment. Further, the couple stated they would not have consented to making the investment had they been properly informed about the associated risks.
Anthony disputed this claim and said he was supported by the Statement of Advice he provided, one which was signed by the clients, which adequately disclosed the risks associated with the financial product.
However, following an AFCA review, AFCA’s case manager was not satisfied that Jeff and Niamh had sufficient opportunity to read and fully understand the SOA, because it was signed by them at the same meeting where it was provided to them.
Anthony also provided copies of his file notes relating to the meeting at which this investment was discussed. Those notes did not record that there was any discussion about the high risk nature of the investment. As such, AFCA did not believe the file note supported Anthony’s statement that he verbally disclosed the risks and explained the risk/return profile of the structured product and its investments to the complainants.
AFCA found in favour of the complainants and determined that the licensee makes good the couple’s losses plus interest calculated at the rate of 5% pa compounded annually from date of the determination to the date of payment.
Advisers can only act for a client with the client’s free, prior and informed consent; arguably, by providing his clients with incomplete information, Anthony could not obtain informed consent from his clients.
Standard five
Acting in each client’s best interests is, once again, central in this standard and is an essential element when it comes to providing ‘Client Care’. The standard requires that all advice and financial product recommendations given to a client must be in the best interests of the client and appropriate to their individual circumstances.
Further, advisers must be satisfied – and have reasonable grounds to be satisfied – that the client understands the advice and the benefits, the costs and risks of the financial products recommended.
This standard requires that advisers:
- ensure that financial advice and product recommendations are appropriate to each client’s individual circumstances
- are aware of, and knowledgeable about, available financial products that would meet each client’s needs
- focus on each client’s individual circumstances and do not apply a ‘one size fits all’ approach to advice and recommendations
- provide the advice and information in a way that ensure client understanding; this may mean a different approach for different clients, depending on their sophistication and understanding
- must be satisfied that each client understands the advice received and the products recommended – this includes benefits, risks and costs associated with each product or service.
Case study* – failing to act in client best interests
ASIC recently cancelled the AFS licence of ACME Advisers because it failed to ensure that financial services covered by the licence were provided efficiently, honestly and fairly and importantly, in the best interests of clients.
ACME Advisers adopted a ‘layered advice’ strategy whereby the licensee separated the advice into pre-determined groupings, irrespective of the client’s personal circumstances, goals or advice needs. The ‘layered advice’ strategy was found to actively impede financial advisers from complying with financial services laws and the Code of Ethics, as clients were provided with expensive and templated advice that was inappropriate for their personal circumstances.
One of the company’s responsible managers, Joe, also provided financial advice to clients. In samples of advice he provided, ASIC found he did not act in the best interests of clients, the advice was not appropriate, and he prioritised his interests (or that of the AFS Licensee) over the interests of the client.
As this advice was provided in accordance with the ‘layered advice’ strategy, the advice was templated, inappropriately scoped, and he failed to identify or consider the relevant circumstances of the clients when preparing the advice.
Further, ASIC found that the statements of advice provided by Joe were defective, containing projections not based on recommendations provided and failed to include all costs associated with implementing the recommendations.
ASIC found that these projections were included to persuade the clients to proceed with the advice. The omission of these costs may have led clients to believe that they would have more funds available in retirement than they could realistically expect.
ACME Advisers had its AFS licence cancelled and the company’s responsible managers banned from providing advice for a period of 10 years.
Standard six
Standard six requires advisers to consider the broad effects arising from the client acting on their advice. It’s expected that advisers actively consider the client’s broader, long-term interests and likely circumstances.
This standard requires that advisers:
- consider the long-term interests of each client
- consider the ‘likely circumstances’ of each client – while one cannot foretell the future, likely circumstances include reasonably foreseeable events given the client’s current and likely circumstances.
In terms of limited advice, ASIC acknowledges it can be highly effective in meeting a client’s immediate needs. Limited advice scenarios might include SMSF advice, insurance, stockbroking, investment and intra-fund advice. The Code does not prohibit this type of advice but aims to make sure it is only provided in appropriate circumstances.
Case study* – failure to consider long term implications of advice
Tom had held a number of part time hospitality jobs while he was at high school and then university. He was then able to fulfil a lifelong dream to became one of the youngest train drivers on the Victoria’s country rail system. By his 25th birthday, Tom had accumulated over $20,000 in superannuation, most of which was in an industry fund widely used by hospitality workers. His father suggested he should see a financial adviser to make sure his super was set up appropriately to maximise his future retirement benefit.
Tom went to see Neil, an authorised representative of ACME Advisers. He advised Tom to rollover his superannuation from his industry fund into a new (retail) fund. He also recommended he cancel his 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.
Tom claimed the advice was not in his best interests. The premiums and advice fees amounted to 36% of his balance in the first year and he lost his entire balance within three years. AFCA found the advice to rollover the Tom’s funds and obtain new insurance was not in the complainant’s best interests as it resulted in his entire balance being eroded in less than three years. As well as not acting in his client’s best interests, Neil did not consider the broad, long term effects arising from Tom acting on his advice.
The case was found in Tom’s favour; the firm had to compensate him $22,326.75 plus interest.
Ethics can be defined as ‘moral principles that govern a person’s behaviour or manner of conducting of an activity’. 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. Standards one to through to six, spanning Ethical Behaviour and Client Care encapsulate reasonable expectations that Australian consumers would expect from financial advice (and other) professionals.
Financial advisers are required to act ethically and in the best interests of their clients at all times. While that might be an obvious requirement for many reading this, the frequency of media releases from ASIC announcing convictions of financial advisers demonstrates that acting in the best interests of all clients is a requirement overlooked by some practitioners and businesses.
The Code of Ethics has made ethical practice a binding requirement for financial advisers for three years. Ongoing support of the Code and the ethical behaviour it supports will build trust in the profession and is a positive step towards ensuring financial advice is seen as a respected profession, one that’s important to the financial security of all Australians.
Read Part two: Ethical standards – a review (Part two)
=
———-
You must be logged in to post or view comments.