Ethical standards – a review (Part two)

08 Feb 2023

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

How do standards seven to twelve of the financial adviser Code of Ethics impact on advisers’ professionalism?

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 seven to twelve are examined. Standards one to six were scrutinised in a previous article you can read here.

The Financial Adviser Code of Ethics is principles based. It applies to a wide range of situations that require advisers to exercise their professional judgement; after all, as is an often repeated topic of discussion, professionalism is integral to ensure a successful future for the financial advice industry.

What is professionalism?

“Professionalism is not the job you do, it’s how you do the job”
(Shiv Khera, author and management trainer).

Professionalism is a many faceted word. It means to deliver on your promises, to always put your client first and to act to the best of your ability. It also means to keep up your knowledge and training requirements, to understand the laws and principles that define and direct your role and operate within them. Professionalism can help you inspire others, both within and outside the industry. Importantly, professionalism can give you a sense of satisfaction at having delivered valuable information, guidance and advice to your clients.

A guiding principle of being a professional financial adviser is to act – always – in the best interests of your client. That is, to act in the same way any reasonable person would expect their doctor or dentist, accountant or lawyer to act – professionally, with their interests front and centre.

A focus on professionalism benefits you, your practice, your industry and crucially, your clients. The more professional the industry becomes, the more the unprofessional advisers stand out and, over time, get cleared out. Professionalism builds trust and trust builds long term relationships, both of which are integral to a successful advice practice.

The Code of Ethics

The Code of Ethics is comprised of twelve standards which, in turn, are based on five values. These were detailed in part one of this article.

The standards are not intended to provide a compliance checklist; rather, the intent is for financial advisers to make active decisions that result in them acting ethically and prioritising each and every client’s best interests.

Section 961B of the Corporations Act 2001 (as amended) lists the steps an adviser must take to satisfy the ‘best interests’ standard, which is central to the Code of Ethics.

In brief, these steps are:

To identify the client’s financial situation, objectives and needs.
To identify the subject matter of the advice sought by the client (whether explicitly or implicitly).
To identify the client’s relevant circumstances – the objectives, financial situation and needs that would reasonably be considered as relevant to advice sought on that subject matter.
To ensure this information is complete and correct; enquiries should be made if gaps or inconsistencies are apparent.
To identify whether you have the relevant expertise to provide the client with advice on the subject matter sought and, if not, decline to provide the advice.
When considering the advice sought, whether it would be reasonable to consider recommending a financial product; if it is deemed relevant, they should only recommend a product after thoroughly investigating the most appropriate products relevant to the client’s circumstances.
When advising the client, the financial adviser must base all judgements on the client’s relevant circumstances.
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 final point is designed as a ‘catch all’, a statement that encapsulates the spirit of the legislation. Irrespective of the client’s requirements, the advice must be underpinned by knowledge of the client, their circumstances, and any financial product recommended as part of the advice process.

While the best interest duty applies to retail clients, a similar fiduciary duty is required for dealings with wholesale clients. To meet the obligations imposed by section 961B of the Corporations Act 2001 is the basis of ethical behaviour in dealing with clients.

Relevant providers

The Code of Ethics identifies ‘relevant providers’ as those who must abide by the Code. Those relevant providers are defined as an individual who is:

a financial services licensee
an authorised representative, an employee or director of a financial services licensee
an employee or director of a related body corporate of a financial services licensee.

Any individual listed on ASIC’s Financial Advisers Register as authorised to provide personal financial advice to retail clients – as the licensee or on behalf of the licensee – in relation to relevant financial products is considered to be a relevant provider.

The Code of Ethics is compulsory for all relevant providers, and responsibility for applying the principles of the Code of Ethics falls on individual financial advisers. In the case of a review by a licensee or ASIC, advisers must be prepared to provide details of their interpretation and application of the Code of Ethics in relation to specific situations.

Financial services licensees also have a role under the Corporations Act (2001) in monitoring and enforcing compliance with the Code of Ethics. Licensees must structure their business operations in a manner that facilitates their authorised representatives being able to operate ethically and comply with each standard in the Code of Ethics.

Ethical competencies

The Code of Ethics contains twelve standards that 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).

Each of these ethical competencies contains three standards; these, in turn, contain ethical principles. Ethical competencies one and two were explored in part one of this article.

In applying these principles, advisers are expected to exercise professional judgement according to the specific circumstances of each individual client. As stated earlier, the standards are not a compliance checklist. Instead they are a set of guidelines to ensure your advice is in the best interests of each client, steered by the values and standards that underpin the Code of Ethics.

While ethics is defined in many different ways, it can be broadly distilled as a system of moral principles that is concerned with what is good for individuals and society. The term is derived from the Greek word ethos, which can mean custom, habit, character or disposition.

In the world of financial advice, it means treating your clients fairly, acting in their best interests always and acting with honesty, integrity and competence. In short, embodying the values upon which the Code of Ethics is based.

Quality process

Quality process encompasses standards seven to nine and while these standards encapsulate all the values upon which the standards are based, those of honesty, integrity and competency are highlighted.

Figure one highlights each of the standards that fall under the competency ‘Quality Process’.

Standard seven

The purpose of Standard seven is to ensure clients freely give ‘informed consent’ to benefits the adviser (or licensee) will receive, and that this consent is obtained before the client receives advice. It is important to note that benefits are not limited to fees and charges.

As well as disclosing – and receiving consent for – the charges to the client and benefits to the adviser or licensee, standard seven requires that:

unless expressly permitted by the Corporations Act 2001, advisers may not receive any benefits, in connection with acting for a client, that derive from a third party other than that adviser’s principal
fees should reflect the benefit to clients over the long term balanced by the costs in providing the advice
advisers must be satisfied that any benefits received in connection with acting for the client are fair and reasonable and represent value for money.

For existing clients, the standard required that relevant consents be obtained as soon as is practicable from the date of implementation, 1 January 2020. Advisers had twelve months in which to do this, and this informed consent should well and truly have been achieved by now.

Consent needs to be in the form of a formalised signed, not verbal, consent. Advisers can use existing forms, such as an Initial Service Agreement or Ongoing Service Agreement to record consent.

The requirement to limit the benefits an adviser may derive from a third party is intended to reduce the likelihood of third party influence on the advice given. Many of the examples of poor advice presented at the 2018 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, as well as subsequent cases prosecuted by ASIC, would have likely breached standard seven. Many cases of malpractice or criminal practice involved scenarios where clients either did not consent to the charges they incurred, or those charges were unreasonable and did not represent value for money.

As regularly highlighted by the trade media, breaches of standard seven continue to blight the financial advice industry, which reflects poorly on all participants. This itself is a breach of an ethical standard, as you will read later in this article).

Case study* – a failure to disclose benefits

Mick and Rebecca had been receiving financial advice from Luke at LL Financial Planners in Brisbane for several years. Mick worked as an IT contractor and Rebecca ran a catering business. They had a strategic financial plan that has been implemented 10 years earlier and, as they were in their late 50s, wanted to increase their focus on building their retirement savings. Luke kept the couple informed; they trusted him and were comfortable with his advice.

After a decade of service, the couple received a letter informing them that Luke was moving to another financial planning practice. It provided details of his new licensee and focused on the benefits Rebecca and Mick would be able to take advantage of with him moving to that organisation.

As clients, they would have access to a broader product suite, administration services, and if required, stockbroking services. It also outlined a change to fee arrangements to be implemented some months into the future. Because their relationship had been with Luke, Mick and Rebecca decided to move their business to his new firm.

A few months later they had their mid-year review at Luke’s new offices. He enthusiastically described his new firm and the broader range of financial products on offer. He recommended that they switch their superannuation accounts from their existing default arrangements (one, an industry fund, the other a corporate fund) and invest in a superannuation wrap. He extolled the benefits, primarily the ability to access a range of listed and unlisted investments. He discussed the fees and ensured the couple understood the fees and charges, as well as insurance options that were available.

Mick and Rebecca accepted his advice and signed the paperwork to switch their funds to the superannuation wrap. This was a badged product, for which Phil’s licensee received financial benefits, a fact that was not disclosed to Rebecca and Mick.

Although he ensured the couple understood the fees and charges relating to the new structure, Luke recommended his clients should replace one product with another, without disclosing the benefits his licensee would receive. Accordingly, Luke breached standard seven of the Code of Ethics, as well as section 947D of the Corporations Act (2001), which outlines the requirements to be met when a financial adviser recommends replacement of one financial product with another.

Standard eight

Standard eight requires financial advisers keep complete and accurate records of advice and services provided to clients both past and present. It also requires that:

advisers meet legislative requirements relating to the secure storage of client records
client records must be both complete and accurate for both current and former clients
records should include file notes of discussions
client records must be easily accessible.

Whether using a paper or online record system, client records should be kept in one place, with appropriate security measures in place. Because of the increasing propensity to use cloud services to store records, cybersecurity is of mounting importance.

Case study* – complete records

Financial adviser Huw Nguyen was an authorised representative of several licensees over a fifteen year period. Huw was permanently banned from providing financial services after an ASIC investigation found that he had engaged in dishonest conduct.

ASIC found that Mr Nguyen is likely to have contravened financial services law for reasons including that he had engaged in dishonest conduct while he was an authorised representative of one licensee and continued to do so while he was an authorised representative of another. In addition, Huw acted dishonestly in the course of responding to an ASIC statutory notice.

ASIC found that Huw had:

dishonestly backdated advice documents to clients
incorrectly witnessed binding nomination of beneficiary forms
allowed the incorrectly witnessed binding nomination forms to be submitted to insurers on behalf of clients
inserted signatures and dates into documents to look like he was compliant with his obligations as an authorised representative of the Australian financial services licensee
falsified company books while carrying out his financial planning and advice business
implemented financial advice to clients before they were provided with a statement of advice
created or modified documents on client files produced to ASIC and attempted to induce a client to mislead ASIC.

As well as being banned from providing financial services, Huw was placed on a good behaviour bond for two years. The sentencing judge commented that the falsification of records “is a breach of trust of those who you’re engaged to act for.”

By falsifying records, Huw breached the requirement to keep complete and accurate records of advice and services provided to clients as required by standard eight.

Standard nine

Standard nine requires that any financial product advice, and all financial products covered by that advice, are offered to each client in good faith. It also requires that:

advisers offering financial product advice and recommendations must have the knowledge and competency to provide the advice
the advice and product recommendations must be in the best interests of each client
the advice and product recommendations must be delivered in a way the client can easily understand and take at ‘face value’
advisers identify any risks to the client and discuss them openly and honestly.

It is expected that advisers will investigate each financial product they recommend to clients. Advisers must exhibit sufficient knowledge, skill and understanding of the financial product to be able recommend it to clients – this includes clear understanding of each financial products’ benefits, risks and costs. Without this understanding, it’s difficult to be sure that a financial product is in a client’s best interest.

Further, the legislative outline stipulates that you will not be acting in good faith if there is something you are aware of, or ought to be aware of, that would lead to the conclusion that your advice is not in the clients’ best interests once you have taken into account the broad effects arising from the client acting on your advice and the broader, long-term interests and likely circumstances of the client.

Finally, standard nine also reflects the current law requiring that financial product advice given, and financial products recommended, not be misleading or deceptive.

Case study* – Inappropriate financial product advice

Kate received an inheritance of $275,000 and sought advice about investing some of it. She intended to use around $110,000 to clear some debts and invest the remainder.

Will is an authorised representative of ACME Advice, her local financial planning practice. Will convinced Kate to invest the whole sum given the low interest rate environment that prevailed at the time of the advice. With mortgage rates so low, Will advised Kate that she would be better off investing the money from which she would earn higher returns. She could then pay out her mortgage and other debts with the proceeds.

Will’s licensee had informed its authorised representatives that its in-house product suite would be in the best interests of ‘most’ clients; further, the licensee set the expectation that a high proportion of financial product recommendations are directed to the in-house product suite.

Because Kate was keen to pay of her mortgage within a three year period, Will recommended a ‘cash like’ product he said was likely to return 7-8 percent per annum. He didn’t go into detail of what was, in fact, a high risk credit fund in which defaulting securities could cause capital loss.

Kate did not understand the investments in the fund, nor the risks she was exposed to. She understood ‘cash like’ to mean safe and unlikely to be subject to capital loss. Will also did not inform Kate that his recommendation was an in-house product.

The Financial Planners and Advisers Code of Ethics 2020 Guide^[1] recommends that when assessing whether you have adequately considered the requirements of standard nine, you should reflect on the following questions:

Have I undertaken sufficient research and investigation of the product that I am considering for the client?
Do I understand the risk, benefits, cost and customer implications of the product that I’m recommending?
Do I have the knowledge, skills and experience to give the advice or should I seek assistance from a specialist?
Have I acted at all times in good faith in the interests of the client?
Have I identified risks to the client and discussed these openly and honestly with the client?

Will’s failure to disclose and explain investment risks to Kate suggests a lack of understanding – and therefore competence – on Will’s behalf. Given the lack of explanation and the risk profile of the product, he could not have been satisfied that the product recommendation was in Kate’s best interests.

In light of the investment risk associated with the product and given Kate’s medium term objective to pay out her mortgage, it was not appropriate financial product advice and in breach of standard nine.

Professional commitment

Figure two highlights each of the standards that fall under the competency ‘Professional Commitment’.

Standard ten

Closely linked to standard nine, the focus of standard ten is to ensure that financial advisers have and maintain an appropriate level of relevant knowledge and skill to provide competent financial advice that is in the best interests of their clients.

Section 921B of the Corporations Act (2001) sets out the education and training standards for a person who is, or is to be, a relevant provider. It, in turn, is made up of four standards:

Financial advisers are required to hold a bachelor or higher degree – or equivalent qualification – that has been approved by the Minister. Where an adviser has been educated overseas, the Minister must have approved the foreign qualification under section 921G of the Act.
Financial advisers are required to have passed an exam administered under this subsection by ASIC in accordance with principles approved by the Minister.
The relevant provider has undertaken at least one year of work and training that meets the requirements set by the Minister.
Advisers must meet the requirements for continuing professional development set by the Minister.

Standard ten also requires that:

Financial advisers provide advice only in areas where they have the necessary skills and competencies to do so in a professional way.
Advisers undertake sufficient continuing professional training to maintain competence at an appropriate level for the professional services, including financial product advice, provided.
Advisers keep up to date with industry, regulatory and product developments relevant to their practice.
Where an adviser specialises in a particular area, they don’t provide advice outside that area unless they have the necessary skills and competencies to do so in a professional way.
Where an adviser doesn’t have the skills and competencies to provide advice sought by a client, that client should be referred to an adviser with relevant skills and knowledge.

Financial advisers are required to complete 40 hours of continuing professional development each continuing professional development year^[2]. Licensees are responsible for approving at least 70 per cent of activities, including a maximum four hours of professional reading.

The minimum hours for continuing professional development across the mandatory categories are:

Technical – five hours
Client Care and Practice – five hours
Regulatory Compliance and Consumer Protection – five hours and
Professionalism and Ethics – nine hours.

The balance up to 40 hours must consist of qualifying continuing professional development.

Case study* – lack of competence

Mary-Anne was formerly a director of Acme Advice, now known as Acme Financial Advisors. She operated a financial services business with contracted investment manager Acme FA Pty Ltd, which offered managed discretionary account investments to wholesale investors through the Acme Service over several years.

ASIC found that Mary-Anne engaged in misleading and deceptive conduct or conduct that was likely to mislead or deceive when she was involved in the creation and publication of promotional materials for Acme FA. This had the consequence of denying investors the opportunity to make investment decisions based on factually correct information. ASIC also found that Mary-Anne lacked the training and competence to participate in the financial services industry.

As a result, Mary-Anne has been banned by ASIC from providing financial services for a period of five years. The ban prevents Mary-Anne and Acme Financial Advisors from providing any financial services, performing any function involved in the carrying on of a financial services business (including as an officer, manager, employee, contractor or in some other capacity) and controlling an entity that carries on a financial services business.

ASIC was satisfied that Mary-Anne’s conduct was careless and incompetent, as opposed to deliberate or dishonest. The banning orders have been recorded on the Banned and Disqualified Persons Register.

The focus of standard ten is to ensure that financial advisers have and maintain an appropriate level of relevant knowledge and skill to provide competent financial advice that is in the best interests of their clients. From ASIC’s actions in this case, it is evident that Mary-Anne breached this standard by failing to exhibit competence in her delivery of financial services.

Standard eleven

Standard eleven requires financial advisers to cooperate with ASIC and other monitoring bodies in any investigation of a breach or potential breach of the Code of Ethics. The standard places personal responsibility onto financial advisers to uphold the ethical values of the Code by proactively cooperating with ASIC and monitoring bodies in any investigation. This includes responding to requests in a timely and open manner and providing any requested documentation or records that will assist the investigation.

Standard eleven also requires:

advisers cooperate with the appropriate regulator or disciplinary body when instructed under an investigation
advisers respond to requests for information or documentation in a timely and open manner.

This duty applies in addition to the offences outlined in sections 921M and 921P of the Corporations Act.

Case study* – a failure to comply with an investigation

After selling a small business, Alison and Paul had $275,000 to invest. Friends had recommended an adviser from their local area in suburban Melbourne, Alex from AX Financial Planning.

Alison and Paul planned to use the money within two to three years to seed a new business; accordingly, they told Alex they only wanted to invest for a short period and did not want to risk their capital.

Alex suggested they invest in a ‘term deposit’ offered by his licensee. However, this was not a bank guaranteed term deposit as suggested by the name, it was a loan agreement in which the licensee borrowed amounts from clients to loan to other clients. It was in fact an unregistered managed investment scheme.

The Statement of Advice provided by Alex contained misleading or deceptive statements as to the nature and risks associated with the investments. It claimed the product had an objective to provide clients with a guaranteed return for their cash investments as well as guaranteed security. The SOA also claimed it paid a competitive fixed term interest rate and used the strength of the government guarantee on the deposits as a selling point.

In fact, the funds were packaged up and loaned to other clients; the practice earned the difference in the rate at which the money was loaned, less the rate paid to clients. The funds were in no way government guaranteed and could not be guaranteed by the practice if a borrower defaulted. It did not disclose that the client’s money was packaged up and loaned to other clients and although technically a managed investment scheme, there was no PDS or other form of documentation.

Alison and Paul were unable to withdraw their money when they required it to fund a new business and, when they eventually received it, they had experienced a loss of capital. The couple made a complaint to AFCA. Alex failed to respond to requests for information or documentation in a timely and open manner and both he and his licensee did not readily cooperate with AFCA’s personnel to help them investigate the matter.

This refusal to cooperate with an investigation and provide relevant records is a breach of standard eleven.

Standard twelve

For financial advisers to be perceived as a professional group, they need to embody the values that underpin the Code of Ethics: trustworthiness, competence, honesty, fairness and diligence.

Standard twelve requires financial advisers, both individually and in cooperation with their peers, meet the values and standards of the Code of Ethics. It also requires that:

advisers promote meeting and maintaining the values that underpin the Code of Ethics in all dealings with the profession and the public
advisers maintain professional relationships with each other and aligned to the profession as a whole
advisers hold one other accountable; it suggests advisers should challenge others who are not upholding the values and standards of the Code of Ethics.

Importantly, standard twelve is looking for financial advisers to support the promotion of financial advice as a trusted profession and not undermine the good work accomplished by the majority of industry participants.

An important element of standard twelve affects relevant providers who are acting as supervisors for provisional relevant providers undertaking the professional year. This Standard requires that in this situation, you must provide supervision that is in the best interest of the provisional relevant provider; in other words, supervision that actively assists that person to get the full benefit of the professional year.

Case study* – Misappropriation of funds

If there’s one thing that reflects particularly badly on the financial advice industry, it’s advisers misappropriating client money. Such cases tend to make headlines and tarnish the industry as a whole. Nearly all of the case studies provided could be said to breach standard twelve – after all, anything that brings the industry into disrepute raises questions about professionalism and risks tarnishing all participants.

A very recent example pertains to a Melbourne based adviser, Michael, who in January 2023 pleaded guilty to three counts of engaging in dishonest conduct while running a financial services business.

ASIC alleged that Michael engaged in dishonest conduct on five occasions when he transferred monies between two of his clients’ Self-Managed Superannuation Funds (SMSFs) to three separate companies of which he was the sole director.

On a further seven occasions Michael dishonestly transferred shares and convertible notes owned by his clients’ SMSF to a fund, without adequately advising his client that it was a company of which he was the sole director and in which he had a personal interest. He also failed to advise his clients that ASIC had sought the winding up of entities related to him and that he was banned from providing financial services by order of the Federal Court.

The matter has been listed in the Victorian County Court later in 2023 for a plea and sentencing hearing. At the time of the offending, each breach of s1041G(1) of the Corporations Act carried a maximum penalty of 10 years imprisonment.

Michael has breached numerous laws and ethical standards. This is the type of behaviour that reflects poorly on the financial planning industry and underscores the need for a robust regulator and for advisers to hold one other accountable.

That financial advisers are required to act ethically and in the best interests of their clients at all times is an important tenant in building the professionalism of the industry as a whole. While the media continues to run articles detailing practices that range from poor to downright dishonest, it will be more challenging to build the professionalism required.

As detailed in standard twelve, it is incumbent on all participants to not only act in a professional manner and abide by the Code of Ethics, it is in your best interests to ensure that others do too. That is the best way to ensure financial advice as perceived as a trusted profession by the broad public and to not undermine the good work accomplished by the majority of industry participants.