CPD: Managing ethics and referral or outsource partners

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Although financial advisers can outsource some of their business processes, or refer to other specialist practitioners, they cannot outsource or refer their ethical obligations.

It’s a rare financial advice practice that doesn’t have referral partners that they send business to or receive business from. Using third party outsource providers for non-client facing elements of your service offering is also common. This article, proudly sponsored by GSFM, examines your obligations with respect to those relationships and the Code of Ethics.

Ethics and trust go hand in hand, as discussed in prior articles. They are mutually reinforcing; improving one improves the other and conversely, damaging one damages the other. A substantial part of building a successful financial advice business is building trust with your client base. It is hard to imagine a client being willing to provide their personal financial details with someone they didn’t trust and rely on them to act in their best interests to help them meet their financial objectives.

Trust should be the cornerstone of all client relationships. While it may take time to build, it can be destroyed far more quickly.

Trustworthiness is one of the five values that underpin the Code of Ethics and its twelve ethical standards. The legislative instrument defines trustworthiness as follows[1]:

Acting to demonstrate, realise and promote the value of trustworthiness requires that you act in good faith in your relationships with other people. Trust is earned by good conduct. It is easily broken by unethical conduct.  Trust requires you act with integrity and honesty in all your professional dealings, and these values are interrelated.

Acting ethically, with trustworthiness, promotes trust in the profession of financial advice by consumers, enabling the community to feel confidence in accessing and utilising professional financial services.

Roger Mayer, professor of leadership, identifies three pillars of trust in business and everyday life (figure one): benevolence, integrity and competence. This model can help advisers understand how to form trust with their clients and also how to rebuild it if that trust is broken. Any rebuild will, of course, take longer to than the original establishment of the trust relationship.

The model in figure one posits that trust is comprised of three key components, each of which is relevant to the finance advice practice and each which relates to one or more of the core values that underpin the Code of Ethics.

Capability

Do you have the skills, competencies, and other relevant abilities to service your clients? This extends to your staff and beyond. Do your referral partners have the essential capabilities in their field of expertise? Likewise, does each outsource partner have the appropriate capabilities to meet your clients’ needs, rather than simply providing a cheaper option? After all, you won’t be measured solely on your personal capabilities, you’ll be judged on the sum of the parts.

Competence is one of the core values that underpins the Code of Ethics. The legislation describes this value as:

Acting to demonstrate, realise and promote the value of competence requires you to have regard to the knowledge, skills and experience necessary to perform your professional obligations to each of your clients. It requires you to assess the professional services required by each client with regard to their individual needs, priorities, circumstances and preferences, expressed or implicitly identified as the subject matter of the financial advisory engagement. While it may be possible to supplement your professional competence by accessing the expertise of others, the duty of competence is ultimately personal and cannot be outsourced to others.

While capability is implicit in several of the standards that comprise the Code of Ethics, it is directly linked to two standards:

Benevolence

Benevolence is defined by Mayer et. al. as ‘the perception of a positive orientation of the trustee (financial adviser) toward the trustor’ (client). In other words, the situation where your client believes you are on their side and working to help them. Likewise, they would expect referral partners and outsource providers to likewise deliver the same degree of benevolence.

Benevolence is consistent with fairness, another of the values integral to the Code of Ethics and defined as:

Acting to demonstrate, realise and promote the value of fairness requires that you bring professional objectivity to the task of engaging with clients professionally, and when recommending financial products and professional services. It requires you to properly investigate, evaluate and diagnose a client’s need for professional services, and to self-reflect on the limits of your professional competency.

Benevolence permeates most of the standards in the Code of Ethics, but is explicitly captured in those that reference acting in your clients’ best interests:

Character

Character and integrity are used interchangeably in Mayer’s model and is consistent with the remaining values of honesty and diligence. The relationship between integrity and trust involves the client’s perception that the financial adviser adheres to a set of principles – or ethics – that the client finds acceptable.

The value of honesty references integrity:

Acting to demonstrate, realise and promote the value of honesty requires that you conduct yourself with complete integrity in all your professional dealings with your clients and with all others that you engage with in a professional setting. It requires transparency, frankness and fairness to each of your clients, even where this may cause you personal detriment.

Again, integrity is implicit in many of the standards that make up the Code of Ethics and is explicitly required in standard two:

When a client develops a trust relationship with you and believes your company is ethical and is committed to ethical business practices, a higher level of trust is likely to develop. Building trust with your clients is important for your business; it’s imperative for client retention and it’s a requisite for attaining referral business from your clients.

While you control those elements of your business where you’re providing the services, you can’t always control the services provided by others. What happens when you refer business to other finance specialists: accountants, stockbrokers, risk advisers, mortgage brokers and others? Actions by outsource providers such as administrators or paraplanners can also impact your relationships. A misstep by any one of these providers can undermine trust in you and your business, and potentially breach the Code of Ethics. Like competence, your ethical obligations cannot be outsourced.

Referral partners

Given the broad range of financial needs any one client may have – and each adviser’s specific licensing requirements – it’s not unusual to refer clients to other finance specialists, either within the same practice or outside of it.

These relationships are often established at the licensee level, and the adviser is simply told who to deal with for what issues. A negative experience with a referral party may not only reflect badly on you and your business, it can alter your relationship with your client. At its worst, the interaction can result in a breach of an ethical standard and come back on you if you fail to act on an issue.

When dealing with referral partners, standard three is important. While it primarily focuses on conflicts of interest, it also encompasses referral arrangements.

S3 You must not advise, refer or act in any other manner where you have a conflict of interest or duty.

According to guidance[3], you will breach Standard 3 if “a disinterested person, in possession of all the facts, might reasonably conclude that the form of variable income (e.g. brokerage fees, asset based fees or commissions) could induce an adviser to act in a manner inconsistent with the best interests of the client or the other provisions of the Code.”

While debate about aspects of the standards enumerated in Code of Ethics have continued to play out since the demise of FASEA – and have undergone further discussion with QAR – they are enforceable by law as they stand.

It’s important to note that standard three refers to actual conflicts of interest between the duties you owe your client and any personal interest or duty you owe another individual or organisation. According to guidance provided to advisers upon the launch of the Code of Ethics (and as yet to be updated), you would not breach standard three merely by being a duly remunerated employee of an entity that lawfully provides retail financial advice and services and referring to a specialist within that practice. This extends to profit sharing. You are, of course, required to ensure the provision of advice and services are in the best interests of your client and comply with the other provisions of the Code.

Let’s examine some of the relationships that might exist between financial advisers and referral partners.

Accountants

It’s one of the most common referral arrangements in the industry and many businesses have been built around the model of accounting practices acquiring and embedding financial advice businesses, and vice versa. While there’s been a lot of regulatory to and fro over the years, the synergies between tax advice and financial advice are evident.

As well as been synergistic, there are also areas of overlap. For years, accountants have advised clients about investment strategies to manage and mitigate tax. Agribusiness, a model built on tax deferred income was a favourite with accountants but, while potentially providing a tax benefit, it was not always in the client’s best interest from a holistic perspective. Ultimately, although it may have provided tax benefits to some clients, the implosion of the sector caused significant loss for many.

Accountants have long been advocates of self-managed super funds (SMSFs). While in many cases an SMSF may be an appropriate strategy for the client, there may be times where you question its validity. Irrespective of the relationship with the referral partner, your client and their best interests must always come first.

If there’s a scenario where a client’s accountant makes a recommendation about an investment or a strategy, even if it’s tax related, you have the right to question it if it seems not to be in the client’s best interest. While there’s a case for making enquiries of a strategy even if the accountant isn’t a referral partner, if it is a formal referral relationship it’s even more important.

You may query a recommendation because you have a better understanding of an asset class or financial product, or because of your in-depth knowledge about the client’s financial objectives and their risk profile. An accountant’s product or strategy recommendation may be too risky for that client or inappropriate in when you take their total portfolio in account. It’s important to call it out and discuss the whole picture with the referral partner; that way, you can agree on what’s best for the client, will help them achieve their financial objectives (including tax management) and within the agreed risk parameters.

Mortgage brokers

Mortgage brokers have a particular skill set and there may be times you need to refer a client for loan assistance. Their renumeration typically comes from the financial institution where they place the business and, in most cases, they are paid an upfront commission and a trail or ongoing commission for the business. These commissions are paid out once the loan settles and are based on a percentage of the loan amount.

In January 2020, at the same time as the Code of Ethics became law, the Federal Government passed legislation to create a duty for mortgage brokers to act in the best interests of consumers (this came into effect on 1 July 2020). Where there is a conflict, brokers must prioritise consumers’ interests when providing credit assistance.

Stockbrokers

Not all financial advisers are licensed to recommend direct investments, while others may have limitations on what they can recommend. A number of broking firms have ‘intermediary desks’ established to work with financial advisers.

Other advisers may have the requisite licence but lack the time to keep up with the research to ensure they meet their obligations under standards five and nine, to understand the intricacies of each security they recommend. Others may simply use a broker to implement trades.

Irrespective of the level of service, the trust connection between adviser and broker is important. It’s imperative for your relationship with the client that the broker acts in their best interest at all times and does not make recommendations or implementations that contravene the Code of Ethics. Abiding by the Code of Ethics is also a requirement of the Stockbrokers and Investment Advisers Association.

If the referral comes from you, whether the broker is providing advice or implementation only, you need to ensure it’s appropriate for your client. Referring a client to a business or individual where their best interests are not met, and ethical standards are not adhered to, can have negative repercussions for you.

Risk adviser

Risk advice is a specialist area. Some financial planning practices may have an in-house risk expert, others outsource to a specialist business. It would be expected that in-house risk advisers would adhere to a practices’ approach to managing ethics in a way that’s consistent with the Code of Ethics; however, that needs to stipulated and not assumed, as a failure to act accordingly can have negative repercussions for the broader practice, as well as individuals within it.

Where an outsource model is used, it’s imperative that there’s an agreement between you with respect to the risk advice provided. You need to ensure that it’s appropriate for each client, consistent with their estate plan and will meet their needs as and when required.

Legal professionals

Legal professionals often play a crucial role in estate planning. They are responsible for advising and assisting clients with the legal aspects of planning and administering their estates. Some of the key roles and responsibilities of legal professionals in estate planning in Australia include advice, the preparation of legal documents such as wills, trusts and powers of attorney and administering estates.

While legal advice in estate planning should ensure that clients’ wishes are carried out in accordance with the law and in a manner that protects their assets, if it’s a referral you have made you need to ensure the legal advice and implementation is aligned with the client’s objectives and in their best interests.

Managing referral agreements

Referral agreements with financial specialists should detail your requirements with respect to their conduct. If a formal agreement is not already in place, or if it does not cover the requirements stipulated in the Code of Ethics, that needs to be established as a matter of priority. You know how you expect your clients to be treated and the quality of advice you expect – don’t assume that’s what will be provided.

It’s important to review the advice provided by any third party and if you have any doubts or queries about its appropriateness, have a conversation with that referral partner. It may be a difficult conversation, particularly if they feel you are questioning their professionalism. However, if you believe that a recommendation is not in that client’s best interest, you need to act.

Explain your concern in the context of the client’s financial objectives, risk profile, estate plan or existing portfolio, whichever is the most relevant for the conversation. By making the client and their best interests central to the discussion, it becomes less personal and more focused on achieving positive outcomes for your mutual client.

Outsource partners

Many advice businesses look to outsource some of their business processes. Given the onerous paperwork obligations that arise every time personal financial advice is provided, outsourcing elements of the business is not surprising. Typically, administrative and support activities are outsourced, while client facing or revenue generating actions are kept in-house.

A Google search of outsource businesses servicing the advice community show that you can pay other businesses to undertake a myriad of business processes, including:

  • document preparation, including SOAs and regular reviews
  • data input, management and presentation
  • paraplanning
  • portfolio management
  • general administration, including virtual assistants
  • e-commerce
  • CRM management
  • client service functions, including correspondence and reporting
  • business functions such as finance, marketing, IT and compliance.

There are three most common outsourced business models available to advice practices – freelancers, staff leasing and fully managed services.

Freelancers: generally a low-cost option but can be higher risk. Through a variety of online service providers, you can get freelance individuals on a project basis or on an ongoing basis. While there’s no doubt you can find some excellent people freelancing, you need to undertake background checks as you would for an employee, to ensure they have the appropriate experience and credentials for the role. The greatest risk is continuity if they stop working with you.

Staff leasing: often used by an outsource partner to provide a range of services for your business, whether in Australia or offshore. The outsource provider handles the specified business processes and you retain full control of the staff and work quality. On the plus-side, it allows you to build your own remote team dedicated to your business and gives you greater control.

Fully managed services: this is where the outsource provider handles everything for you. You provide a list of requirements and key performance indicators; they do the rest. If you’re looking for a hands off solution, this is ideal; on the downside, the outsource provider will control your business processes.

While outsourcing can be a cost effective measure for scaling an advice practice, many companies are based offshore. This can reduce your control over the quality of services delivered.

Outsourced staff, whether based in Australia or offshore, represent your business and your brand. You want it to reflect your practices, which should include your adherence to the Code of Ethics. Therefore, when choosing an outsource provider, it’s important to choose one that aligns with your business vision and values, and won’t see you in breach of your obligations under the Code of Ethics.

Questions to ask a prospective outsource provider

Once you have determined which parts of your business you’d like to outsource, using the Code of Ethics as a framework, you should ask the provider how they will conform to each standard. Providing scenarios is a good way to test the provider’s approach to ensuring compliance and dealing with any breaches.

Further, ensuring that each standard of the Code is encapsulated in the provider’s key performance indicators can be a good way to manage the outsource provider’s adherence to the Code. This should form part of the outsource provider’s regular reporting to you.

Governance practices should also be reviewed. How is the personal information of each client protected? Given the prevalence of data theft, what checks and balances are in place to ensure there’s no identity theft or exposure to cyber-attack?

You should also ask about staff retention. A firm that experiences high staff turnover is less likely to be able to consistently align to your values and lead to increased risk of breaching the Code.

Staff training is also an importantly element. You need to ensure there is support for appropriate ongoing training to ensure the work they do for you meets not only your requirements, but those requirements applied by law.

Finally, it would be useful to see if you can include relevant staff from your outsource partner in your ethics training sessions for your staff.

Case Studies

While the following case studies are fictitious, they are loosely based on real cases drawn from the Australian Financial Complaints Authority (AFCA) and its predecessor organisations.

Case study one – using an outsourced paraplanner

ACME Financial Advisors opened in North Carlton, Melbourne, an affluent area that had experienced an influx of professional couples. ACME was experiencing rapid growth and the business principals, husband and wife team Cam and Sonia, decided to outsource a number of business processes to scale the business more quickly.

Sonia interviewed some potential outsource providers. After many discussions with the providers and between themselves, they appointed AAA Outsourcing. Part of their decision was based on cost; as AAA had staff based offshore, Sonia and Cam could get a significant portion of their business processes dealt with at a reasonable cost. One of the processes they elected to outsource was paraplanning.

As part of the due diligence process, Cam and Sonia made sure that the paraplanners provided by AAA Outsourcing had appropriate Australian-equivalent accreditation and qualifications, were RG146 compliant and that there were processes in place to ensure ongoing professional development. The couple also ensured that conduct consistent with the Code of Ethics made up part of the criteria the outsourcing company had to meet.

Once Cam and Sonia were satisfied AAA Outsourcing could meet all of the required criteria, the company was appointed.

At the six month review, Cam and Sonia expressed their satisfaction with AAA Outsourcing. It had met all requirements and in the case of paraplanning, provided quality and timely service. However, not long after, they noticed a sudden decline in the quality of Statements of Advice and reporting.

The couple was undertaking a number of client reviews and the information coming in was incomplete and inaccurate. After making several enquiries, they discovered the initial high quality paraplanners had been replaced by inexperienced and unqualified staff; staff that evidently were paid less by AAA Outsourcing.

Because they had used the Code of Ethics to frame the specific paraplanning KPIs agreed with AAA Outsourcing, they were able to refer to them when detailing the issues arising from the change in paraplanning staff. In particular: 

Case study two: estate planning

Sarah is a financial adviser with many years’ experience. Her financial advice practice ACE Financial Planning has, for many years referred clients to a local legal firm, AA Law, to provide estate planning advice and documentation.

One of her clients, Vivienne, had run a successful business as a sole trader for many years and is nearing retirement. Sarah and Vivienne were discussing the impending sale of the business and agreed Vivienne’s estate plan should be updated. While she had a valid will, she had not appointed Powers of Attorney (POA) in the event she should require them. Her plan was to appoint her son as medical POA and her daughter as financial POA.

Following Vivienne’s appointment with AA Law several months later, Sarah discovered that the solicitor had recommended that Vivienne invest the proceeds of her business sale into an unregistered Managed Investment Scheme being operated by the firm.

When Sarah quizzed Vivienne about the MIS, she admitted she didn’t really understand it, however, it was offering attractive double digit returns each year. Sarah contacted the legal firm to discuss the investment scheme into which Vivienne had invested.

The solicitor who recommended it was unable to clearly articulate how it worked, what it invested in or how the returns were generated. He did not disclose, until specially asked, the financial incentive he received to place the investment. He had not informed Vivienne of this arrangement.

Sarah explained to the solicitor how his advice could impact Vivienne’s retirement plans and also took him through the Code of Ethics, to explain how his advice had potentially breached it. Having referred Vivienne to him, his actions could reflect badly on Sarah, or as a worst case, see her face a formal complaint. The standards the solicitor potentially breached are as follows:

Although advisers can outsource many business processes and refer clients to other specialist practitioners, you cannot outsource or refer your ethical obligations. At every point in the advice value chain, you need to ensure your clients’ best interests are being met and, where this is not the case, take appropriate action to rectify the situation as soon as practical. That way you can look your clients in the eye and know that you have consistently behaved with professionalism and embraced the ethical code that frames your industry.

 

 

Take the FAAA accredited quiz to earn 0.75 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.75 hour.

Legislated CPD Area: Professionalism & Ethics (0.75 hrs)

ASIC Knowledge Requirements: Financial Planning (0.75 hrs)

 

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Notes:
[1] https://www.legislation.gov.au/Details/F2019L00117
[2] An Integrative Model of Organizational Trust, Roger C. Mayer, James H. Davis and F. David Schoorman, 1995
[3] FASEA, Financial Planners & Advisers Code of Ethics 2019 Guide, October 2020

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