Ethics and your fiduciary duty

01 Aug 2023

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

Running an ethical financial planning practice and acting in clients’ best interests means understanding your fiduciary responsibility to clients.

A financial adviser’s fiduciary duty to their clients is both a legal and ethical requirement. This article, proudly sponsored by GSFM, explores the significance of fiduciary duty in ethical financial planning and how it safeguards clients’ best interests.

Ethical financial planning is an essential aspect of ensuring the wellbeing and financial success of individuals and businesses alike. Within this, fiduciary duty plays a crucial role in establishing trust, integrity and client-focused decision making. Fiduciary duty serves as a guiding principle for financial professionals, compelling them to put their clients’ best interests first.

What is fiduciary duty?

A fiduciary duty is both a legal and ethical obligation that financial advisers and other financial professionals have towards their clients. It entails acting in the best interests of clients, prioritising client needs and exercising professional judgment to help clients meet their investment objectives. Fiduciaries are bound by a high standard of care and are required to disclose any potential conflicts of interest that could impact their decision making.

An adviser’s fiduciary duty is strongly aligned with acting in the client’s best interests, a notion that underpins the Code of Ethics. ASIC describes the best interests duty and related obligations as:

“…designed to ensure that retail clients receive advice that meets their objectives, financial situation and needs, and that you act in the best interests of your clients when providing advice.”

In financial advice, this can be distilled into acting in the client’s best interests at all times, acting with competence, honesty, integrity and fairness. In other words, the way any one of us would expect to be treated by a professional service provider, whether they be medical, legal or financial.

The Future of Financial Advice Reforms (FOFA) introduced in July 2013 included an amendment to the Corporations Act 2001 to enshrine the best interest duty into law. It was an extension of the existing fiduciary duty owed to clients by financial advisers, the one which covered the need to ‘know your client’, know the products you recommend and always act with the interests of those clients front and centre.

This amendment came with an addition – penalties. These include banning and disqualification orders.

Section 961B of the Corporations Act 2001 (as amended) lists the steps an adviser must take to satisfy the ‘best interests’ standard. In summary, these are^[1]:

To identify the client’s financial situation, objectives and needs; these details should be provided to the adviser by the client.
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 the advice sought on the identified subject matter.
To ensure this information is complete and correct and reasonable enquiries should be made if gaps or inconsistencies are apparent.
To assess whether you have the expertise required to provide the client 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 a financial product is deemed relevant, a recommendation should only be made 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 last catch all statement encapsulates the spirit of the legislation; regardless of the client’s requirements, the advice must be underpinned by knowledge of the client and their circumstances. While the best interest duty applies to retail clients, a similar fiduciary duty is required for dealings with wholesale clients. To meet obligations under section 961B of the Corporations Act 2001, is indisputably to act ethically in all dealings with clients.

A failure to act in a client’s best interests would not only breach section 961B of the Corporations Act 2001, it would also breach several of ethical standards, notably:

Practical measures to meet your fiduciary duty

There are a number of practical measures an advice practice can implement to ensure the team meets its fiduciary duties and ethical responsibilities as outlined in the Code of Ethics (figure one).

Client centric decision making

The cornerstone of meeting your fiduciary duty lies in your commitment to client centric decision making. The essence of client-centricity lies in placing the client’s best interests at the forefront of every decision and recommendation.

Financial advisers have a fiduciary duty to act in the best interests of their clients, which requires them to prioritise the client’s life goals, financial objectives, risk tolerance and financial well-being above all else. By adopting a client centric approach, you can ensure that your recommendations align with the client’s unique circumstances and aspirations.

This approach entails actively listening to your clients, understanding their needs and preferences and then tailoring strategies accordingly. As well as benefiting clients, this approach will assist you to foster trust and build long-term relationships, important for a successful advice practice. This will also enable you to deliver personalised financial solutions to empower your clients to achieve their objectives. Ultimately, client centric decision making not only upholds your fiduciary duty, it also enhances the value and impact of the financial advice you provide.

A client centric approach can also ensure you meet a number of standards in the Code of Ethics; not surprisingly this includes those in the sub-section ‘client care’ (standards 4-6).

Transparency and disclosure

Fiduciary duty emphasises the importance of transparency and disclosure. Financial advisers must provide clear and comprehensive information about their remuneration structures (including any fees or commissions they receive) and potential conflicts of interest. There are several ways transparency and disclosure can support your fiduciary duty:

Transparency ensures that your clients have access to all relevant information about their investments, including potential risks, fees and conflicts of interest. By disclosing such information, you enable your clients to make informed decisions and understand the implications of their investment choices. This transparency helps you fulfill your fiduciary duty by avoiding any misleading or incomplete information that could compromise clients’ best interests.

Transparent disclosure of fees enables clients to understand the costs associated with your advice and their investments. This disclosure allows your clients to assess the value they receive from your services and make informed decisions about their financial goals.

Transparency will also ensure you meet standard 7 of the Code; without transparency, a client cannot provide informed consent to the benefits you receive. Being transparent about these benefits, whether they flow to you or your principal, are more likely to result in costs that are fair and reasonable and represent value for money for the client, as required by the standard.

Financial advisers are obligated to avoid or appropriately manage conflicts of interest that could compromise their clients’ interests. By being transparent about any potential conflicts, you can provide clarity to your clients and take necessary steps to mitigate such conflicts. Full disclosure allows your clients to evaluate the advice they receive and helps you to maintain your clients’ trust and meet your fiduciary obligations.

Being transparent about any potential conflict of interest and how it is being managed can help you meet standard 3.

Advisers must be transparent about their investment advice; the strategies, the risks associated with those strategies and any potential limitations or drawbacks. Clients need to be fully aware of the risks involved in their investments and have a clear understanding of how your recommendations align with their goals and risk tolerance.

Transparent disclosure helps clients make informed decisions and ensures you fulfill your fiduciary duty by providing suitable investment advice. Advice and product recommendations are a requirement of standards 5, 6 and 9 and approaching advice with full transparency will help you meet those standards.

Ultimately, transparency will enable your clients to make informed decisions and trust that you have their best interests at heart.

Duty of care and skill

Fiduciary duty also encompasses a duty of care and skill. Financial advisers must possess the necessary expertise and knowledge to provide competent advice. As you are well aware, there is an expectation that you continually update your skills and knowledge, and stay informed about industry trends, regulations and best practices.

By maintaining a high standard of competence – and ensuring your team does likewise – you can be confident that clients will receive advice based on the latest information and the most suitable strategies. Meeting this duty of care and skill demonstrates your professional commitment and will help meet the requirements of standard 10.

Legal protection and accountability

Fiduciary duty also provides clients with legal protection and avenues for recourse if a breach of duty occurs. Clients can seek redress through AFCA, and both ASIC and AFCA can hold financial professionals accountable for any misconduct or negligence that results in financial harm.

The legal framework that governs financial advice creates a strong incentive for advisers to act with integrity and maintain the trust of their clients. Legal protection and accountability is also enshrined in the Code of Ethics. Standard 1 requires that you abide by all applicable laws, while standard 11 requires cooperation with the regulator and other bodies, such as ASIC and AFCA, in the event of a complaint.

Case Studies

The following case studies are based on real complaints submitted to AFCA; however, the names of people and organisations have been changed and some details altered. For each case study, it will be shown where the adviser has potentially breached or upheld their fiduciary duty and how this did or did not comply with the twelve standards that comprise the Code of Ethics.

Case study one: A fiduciary failure?

The complainant, Pauline, received personal financial advice and investment management services from ACME Financial Advice. She believed her adviser Brendan and the financial firm had failed in their fiduciary duty by mismanaging her investments and providing her with inappropriate advice. Pauline believes the advice did not meet her objective of delivering investment performance to match a series of withdrawals she needed to make.

Pauline’s major concerns centred around the fact she told her adviser that her investments were not performing, and he had told her that they would perform. She also believes she told the adviser she needed the returns from her investments to meet her withdrawals so that the investment capital would be preserved.

ACME Financial Advice denied it had mismanaged her investments and claimed the adviser, Brendan, had provided appropriate advice. Further, the financial firm said the decline in the capital value of the complainant’s investment portfolio was due to substantial withdrawals she made over several years.

AFCA’s investigation acknowledged that the complainant firmly believed she told her adviser that she wanted the returns from her investments to meet her withdrawals so that the investment capital would be preserved. However, the contemporaneous written documents (fact finds, file notes, SOAs and ROAs) did not support Pauline’s position.

AFCA gave greater weight to the contemporaneous written documents than to the complainant’s recollection as they were created at the time the complainant communicated with her advisers. Therefore, AFCA considered these documents to be a more reliable source of information about what was said than the complainant’s recollection.

To have achieved the performance required by the complainant, she would have needed to take on significantly more risk to achieve that level of earnings. This would have greatly exceeded Pauline’s tolerance to investment risk and would have exposed her portfolio a higher probability of capital loss. Advice to achieve that level of earnings would have been inappropriate and not in Pauline’s best interests having regard to her risk profile.

AFCA found in favour of adviser Brendan and ACME Financial Advice. As such, no compensation was required to be paid to Pauline. AFCA noted Pauline’s disappointment with the fact her investment portfolio balance had depleted as quickly as it did. However, there was no information to show Brendan or ACME Financial Advice were responsible for this because the advice provided was appropriate and there was no evidence of any mismanagement of her investments.

In this case, Brendan acted in accordance with his client’s best interests. Specific standards in the Code of Ethics that he upheld in relation to this case include:

Case study two: Failure to act in the client’s beset interests

Josh is an authorised representative of financial firm AAA Financial Planning. In August 2021 the complainant, Louisa, informed Josh that she had $500,000 to invest. She says that she wanted to buy a property in the short term and made this clear to her adviser.

Josh made investment recommendations in a statement of advice and Louisa invested $450,000 in accordance with his recommendations. The value of the investments fell. Louisa says that the recommendations were not appropriate as they did not account for her objective of buying a property. She says that if there had been an accounting for this objective, the recommendations would have concerned short-term investments that would maintain their value.

AAA Financial Planning says the appropriate advice was given.

However, AFCA found that Josh did not act in Louisa’s best interest as he did not identify her objective of buying a property in the short term and his recommendations did not account for this objective. The recommendations concerned investments whose value could fall over the short term, and which should be retained for a minimum period of five years. The recommendations should have concerned investments which would not fall in value in the short term, and which did not have a longer term time horizon.

Accordingly, AFCA found that it was fair that AAA Financial Planning compensates Louisa an amount equal to the decrease in portfolio value, together with interest. Within 30 days of Louisa accepting AFCA’s determination, AAA Financial Planning had to pay her $23,418. Because Josh failed to act in Louisa’s best interests, he failed in his fiduciary duty and potentially breached the following standards in the Code of Ethics:

Case study three: Inappropriate advice for an SMSF

The complainants, David and Nicole, have brought this complaint in their personal capacities and as directors of the corporate trustee of a self-managed superannuation fund (SMSF). They say the advice received from the financial firm, AA SMSFs, to establish the SMSF as a vehicle to make a geared investment in a residential property was not in their best interests and inappropriate. Further, they were encouraged to make a personal investment, also in property. The investment properties have since been sold at a loss. The financial firm says the advice was appropriate.

AFCA’s case manager found that the advice for the SMSF and the complainants personally to make geared residential property investments was not in their bests interests and was inappropriate because:

The advice was not capable of meeting the complainants’ objective to reduce mortgage debt.
The advice for the complainants to borrow to buy an investment property was financial product advice because it was made in preference to investing in other financial products and was presented in a Statement of Advice.
The advice to establish an SMSF as a vehicle to make one of the property investments resulted in the complainants having two SMSFs.
The advice resulted in an asset concentration risk.

AFCA also found the poor advice was a cause of the losses incurred by the SMSF and the complainants’ personally and that those losses should be calculated by reference to appropriate advice.

Consequently, AFCA believed it was fair that AA SMSFs should pay compensation because:

The financial firm provided personal financial advice to the complainants personally and to their SMSF that was not in their best interests and inappropriate in the circumstances.
The complainants and their SMSF incurred losses.
The inappropriate personal financial advice was a cause of those losses.

This inappropriate advice was a breach of the fiduciary duty owed to AA SMSFs’ clients and potentially in contravention of the following standards in the Code of Ethics:

Case study four: A misleading SOA

In 2011, financial adviser Esther, authorised representative of ACME Financial Planners, recommended that the complainant, builder Charlie, obtain personal insurance cover. In 2020, Charlie could not work due to an injury and made a claim with the insurer. The insurer denied the claim because Charlie was not ‘significantly disabled’. It was then that Charlie realised that the insurance he’d been sold was not income protection insurance, which is what he had understood the policy to be.

Charlie says Esther knew he required income protection. Further, she caused him to understand that the recommended personal insurance cover included income protection cover when this was not the case.

ACME Financial Planners says that the statement of advice provided to Charlie satisfied applicable industry codes and guidance set out in ASIC’s regulatory guide number 175. It says that the product disclosure statement provided to Charlie shows the criteria for making claims and that he should have followed up any confusion.

However, AFCA found that Charlie’s misunderstanding was not of his own doing and was a result of:

The statement of advice was materially misleading and Esther ought to have known this.
The statement of advice did not have the required content.
It was legitimate for Charlie to rely on the statement of advice and not read the product disclosure document.

AFCA believed that it was legitimate for Charlie to understand, on reading the statement of advice, that Living Expense Cover was a type of income protection cover and that it could be accessed if he could not work due to illness or injury.

The information contained in the statement of advice, in causing these misunderstandings, was materially misleading and Esther ought to have known this given that, a cursory reading of the product disclosure statement, shows that there are obvious differences between income protection cover and Living Expense Cover. In these circumstances there was noncompliance with s1041E of the Corporations Act 2001.

The absence of clarifying information in the statement of advice meant that the content of the statement of advice was not as was required by s947C of the Corporations Act 2001. As at 14 April 2011 a statement of advice had to contain information about the basis on which the advice is given (s947C(2)(b) Corporations Act 2001) and a level of detail that enabled a person to decide whether to act on the advice (s947C(3) Corporations Act 2001).

Charlie relied on Esther, ACME Financial Planners’ representative. Her statement of advice caused Charlie to misunderstand his cover and not consider establishing separate income protection cover. This had the potential to cause significant financial hardship to Charlie; in such circumstances, AFCA determined it was fair that he be compensated.

Esther’s actions mean she and ACME Financial Planners potentially breached the following standards:

Fiduciary duty is a fundamental principle that underpins ethical financial planning. By placing clients’ interests first, financial advisers can establish trust, foster long-term relationships, and ensure the financial wellbeing of their clients. The fiduciary standard promotes transparency, disclosure and client-centric decision-making all which are essential ingredients that underpin the Code of Ethics.

Upholding fiduciary duty not only protects clients but also serves as a benchmark for the financial industry, raising the overall standards of professionalism and ethical conduct.