CPD: Ethics – The many shades of grey

01 Nov 2023

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

The financial adviser Code of Ethics seeks to impose ethical duties that go above the requirements of the law. While the law may be clear, any aspect that is open to interpretation can be susceptible to ‘shades of grey’, those situations that aren’t clear cut with a course of action immediately apparent. In this article, proudly sponsored by GSFM, those shades of grey are explored in the context of ethics and financial advice.

Both the trade and mainstream media have recently been full of the case of a financial adviser banned for life for stealing more than $10 million from his clients after promising excessive returns. There is nothing grey here – a black and white case of malfeasance, dishonesty and immorality. Several lives ruined thanks to a flagrant disregard of both the laws and ethics that bind the profession.

Life – and providing financial advice – would be simple if everything was as clearly black and white, an evidently right or wrong, a strong yes or no. Unfortunately, situations are not always quite so straightforward…instead, there are many shades of grey in all walks of life, including financial advice.

Defined by the online Oxford Dictionary as ‘…an ill-defined situation or area of activity not readily conforming to a category or set of rules’ shades of grey exist on a continuum between black and white and can be nebulous, not always easy to recognise or define – and not always able to be readily categorised as the right or wrong way to act.

From an ethics perspective, shades of grey exist where two or more courses of action are available; right and wrong become blurred and generally requires some form of moral judgement. These situations may involve a lack of clear guidelines, a conflict of values or even a clash between ethical principles. Shades of grey become problematic when the process for dealing with them is flawed and can provide wiggle room when coping with ethical dilemmas in organisations^[1].

Even in the law, which seeks to eradicate the grey, there can be ambiguity; similarly, when examining ethics in a financial practice, it’s important to be aware that shades of grey can exist. Academic research suggests that all organisations have grey ‘zones’ where a fine line between right and wrong behaviour may be indistinct; however, this is where a major part of organisational decision-making takes place. While those grey zones can be a source of problems for organisations, they can also have benefits^[2].

Moral dilemmas

In situations where a clear-cut response is elusive, the onus falls upon an individual’s moral compass to offer guidance. This can be defined as ‘…a term used in reference to a person’s ability to judge what is right and wrong and act accordingly.’ However, the realm of morality itself is replete with shades of grey, and each person’s moral compass can vary significantly.

According to Kohlberg’s six stages of moral development^[3], this journey commences in childhood at a pre-conventional level, where we lack a personal code of morality. Instead, our moral outlook is moulded by the adults around us and the consequences of adhering to or flouting their rules. As children grow, they begin to realise that the people around them possess diverse perspectives, and there isn’t always a single “correct” point of view.

As individuals mature, they start to internalise the moral standards of valued adult role models – parents and relatives, teachers and coaches, and increasingly, celebrities and others with a strong media or social media profile. At this stage, reasoning is generally based on the norms of the group to which the person belongs, and individuals’ moral judgments or decisions are frequently influenced by how they anticipate others will perceive them.

Often, decisions are actively made to obey the law and avoid feelings of guilt at straying from one’s morality. Kohlberg posits that this level of moral reasoning is as far as most people get. Further, he believes most people take their moral views from those around them; only a minority think through ethical principles for themselves.

For advisers, their moral compass or moral reasoning must not only discern right from wrong in a given scenario but also empower them to chart a course of action that serves the greater good or the best interests of their clients. A robust sense of morality can serve as a valuable guide for advisors when making sound decisions, especially in situations that lack clear-cut answers.

Morals and the Code of Ethics

Ethics problems are not always clear cut. Detailed codes of conduct, such as the financial adviser Code of Ethics, target what is and isn’t acceptable in a particular situation or workplace. Such codes aim to bring clarity to decision making and can be used to examine actions after the fact.

Investopedia defines a code of ethics as “a guide or principles designed to help professionals conduct business honestly and with integrity.” Typically, a code of ethics outlines the principles that underpin an industry or organisation, as well as the approach professionals should take when they encounter a problem. It is this approach that draws on an individual’s morals.

Despite the existence of the financial adviser Code of Ethics, you are likely to encounter ethics problems that aren’t definitively black or white, right or wrong, but are instead a shade of grey and require professional and moral judgement to resolve.

A study^[4] that investigated the effects of codes of ethics on perceptions of ethical behaviour found the presence of a code in businesses improved the organisational climate. It provided:

support for ethical behaviour
freedom to act ethically
greater satisfaction with the outcome of ethical problems
a positive impact on perceptions of ethical behaviour in organisations.

Further, it’s been determined^[5] that a code of ethics – whether industry or organisation wide – can provide benefits, including:

Sets the right culture: a code of ethics can foster an environment of trust, ethical behaviour, integrity and excellence. Earlier articles in this series have discussed the importance of trust in relationship building; this is as important to the profession as a whole as it is to advisers at the practice level.
Builds a good reputation: the advice profession has taken its fair share of knocks over recent years, each of which can damage reputation at both the industry and individual level. Building and maintaining a reputation for professionalism, trustworthiness and ethical practice is essential for the industry’s future.
Compliance with laws and regulations: the adviser Code of Ethics requires compliance with all laws, including the Code. This will further advance trust with clients and trust in the industry.
Attracts outstanding employees: evidence suggest more financial advisers are needed to service Australia’s ageing population. Attracting the right people, those who will uphold the requirements and the spirit of the profession, is integral to building both a robust and successful industry and practice.
Promotes social change: a stronger, increasingly professional industry will attract more clients to use its services. This ‘normalisation’ is an important change; as the population ages (and lives longer), professional financial advice becomes even more important to ensure the financial wellbeing of Australians.

Financial adviser Code of Ethics

The financial adviser Code of Ethics was designed to increase public confidence by raising standards for financial advisers. It introduced ethical duties on advisers that go above the requirements in existing law and are designed to encourage and embed higher standards of behaviour and professionalism in the financial advice sector.

The Code of Ethics appropriately places personal responsibility on advisers to understand and apply their professional judgement to their ethical obligations in client engagements so that their professional conduct is focussed on providing advice that is in the best interests of the client^[6].

Further, the Code of Ethics requires financial advisers to act in a manner demonstrably consistent with the twelve ethical standards summarised in figure one.

It is acknowledged by regulators that these standards are not intended to provide definitive guidance. Individual circumstances will differ in practice and there is allowance for differences of professional opinion on how the ethical rules of the profession should apply in a particular case. This is where the varied shades of grey may be encountered.

Doing what is right will depend on the particular circumstances and requires you to exercise your professional judgement in the best interests of each of your clients.

Black, white and grey in practice

Ethics plays an important role in your financial practice – it’s not simply how you conduct your business, but how your colleagues and referral partners conduct theirs. That’s why it’s important to educate and reaffirm, on a regular basis, the importance of ethical practices in your business and with your referral partners.

While ‘grey’ issues often necessitate time and effort for a satisfactory resolution, problem solving around such matters can provide valuable insights to your practice and help avoid or resolve issues in the future.

Ethical challenges can be used to your benefit. Being aware of the shades of grey, using examples and case studies that aren’t black and white provide an excellent opportunity for training and discussion.

A useful strategy is to document the situations your team may encounter in their day-to-day work. These can be used in staff training sessions, and, as a team, work through possible resolutions for the best outcome for clients. Being proactive today might prevent the development or escalation of an ethical challenge tomorrow.

Importantly, the existence of shades of grey highlight the importance that all employees of a financial advice business are aligned with its values and practices. You can’t assume everyone in your practice has a highly developed sense of ethics, or that it’s consistent with your expectations. This is why it is important to educate, restate and reinforce the importance of integrity, your corporate values and ethical behaviour as a regular part of your education practices.

If you are transparent about how to deal with ethical issues, there’s a reduced chance of breaching the Code of Ethics and, therefore, less likelihood of you, your peers or your practice facing enforcement action.

Some unethical behaviours are obvious and (relatively) easy to deal with. These are black or white. Examples include:

abusive, coercive or intimidating behaviour toward clients, staff or third parties
discrimination or harassment
theft, fraud or receiving kickbacks
failing to adequately deal with conflicts of interest
failing to obey the relevant laws and codes that pertain to financial advice.

When establishing ethical standards in your practice, it’s important to remember that the law is the beginning, not the endpoint. However, there are many shades of grey.

An example of this is having possession of inside information.

While everyone knows that insider trading is against the law, there’s a broad range of inside information that can come across an adviser’s path. Examples include:

an acquaintance working at the local council who happens to mention the reclassification of an area of commercial property to residential zoning
a client who discusses a significant new contract won or issued by their business
a friend who bemoans a substantial revenue hit for the listed company they work for and the potential ramifications
dinner party conversation in which you learn of a major merger between two listed companies
an event at which a fellow attendee excitedly tells you how close his firm is to a significant innovation.

Having this information isn’t breaking the law. Acting on it for personal gain is. That’s black and white; section 1043A of the Corporations Act 2001 prohibits a person from trading in listed securities while in possession of non-public, price-sensitive information. The ASX regulatory guide explicitly states that Key Management Personnel, employees and family members are not permitted to trade when there is sensitive information not yet publicly disclosed.

Tipping off a property developer client about the pending reclassification of land is a shade of grey. It might not breach the law, but is it ethical?

Case studies

The following case studies are mostly based on real events; however, the names of people and organisations have been changed, and some details altered. The case studies have been drawn from ASIC and the Australian Financial Complaints Authority (AFCA) or its predecessor organisation. For each, potential breaches of the Code of Ethics are identified.

Case study one: Using inside information

Investment adviser Avi had recommended a number of his clients invest in a significant new aquaculture project on South Australia’s Eyre Peninsula. It was said it would rival Tasmania’s salmon industry and provide a broad range of fresh fish to table both in Australia and the lucrative Asian market. Avi knew the company well as he had previously worked with two of the directors.

When the company listed on the Australian Securities Exchange, Avi himself, along with 35 of his clients, supported the Initial Public Offering. Following the IPO, Avi bought as many shares on market that he could, for his own portfolio and for his clients.

After two years of good performance, Avi received a disturbing call from his friend, the CFO of the company. Unseasonably warm waters had killed the majority of the fish spawn, which meant a drastic reduction in the number of fish available for market and a major hit to the bottom line. This would be reported to the ASX later that day. With the prospects of warmer waters due to climate change being front of mind, this did not bode well for the longer term success of the business.

When the market opened and before the ASX was advised of this event, Avi sold his client’s holdings; note, not his own shareholding, only that held by clients. An ASIC investigation found he had breached Section 1043A of the Corporations Act 2001. He was jailed and received a lifetime ban from the finance industry.

While Avi’s breach of the Corporations Act 2001 is black and white, he made the case that he acted solely in his clients’ best interests and not his own – a definite shade of grey. How would this have impacted the standards in the Code of Ethics?

Case study two: SMSF advice

Self-managed superannuation funds (SMSFs) continue to be a popular retirement savings option for many Australians. On 31 March 2023, there were 606,217 funds with 1,136,234 members; in total, these SMSFs held estimated assets under management of $ $889.5 billion^[7] and represented nearly one third of total superannuation assets.

The decision to establish an SMSF may stem from advice received from an accountant or other third party, or be a decision made by the client. It’s important to understand the rationale behind the decision to establish an SMSF, particularly if you have any concerns as to the appropriateness of an SMSF structure for the client and their ability to meet the obligations in managing it.

In the event a third party has established the SMSF on their behalf and they come to you for investment advice, you need to ensure your clients understand their responsibilities as trustees of the SMSF, that they are personally liable for all decisions made by the fund. This includes following any advice you or other service providers give them.

Matt and Fiona sought financial advice after their accountant recommended the couple establish an SMSF. Fiona has run a successful home décor business for many years, which she plans to sell in 2-3 years, and Matt holds a senior executive position with a property development company that also offers a range of managed investment schemes. Matt plans to retire around the time the business is sold. Matt has sizable super savings in a corporate account, whereas Fiona’s retirement savings will result from the sale of her business. Their accountant believes they should establish an SMSF now and transfer Matt’s super balance, followed by the proceeds of the business sale once complete. Matt is keen to do that so he can invest in some of the managed investment schemes his company operates.

The couple meets with financial adviser Tim to get an investment strategy for the SMSF, as well as assistance with the strategy’s implementation. This is Tim’s first meeting with Matt and Fiona. When he probes them about the SMSF and their roles and responsibilities, he realises they do not understand what’s involved with the ongoing management of an SMSF.

Tim explained their responsibilities as trustees of the SMSF and that they could be penalised for non-compliance in several ways:

Their fund losing its concessional tax treatment.
Being disqualified from their role as trustee – this means they can no longer be members of the SMSF, and they are unable to start a new one.
Fines or imprisonment, depending on the seriousness of the breach.

After lengthy discussions, Tim concluded that Matt and Fiona were unlikely to have the requisite knowledge or time required to make an SMSF viable. As a result, he advised against this course of action.

Had Tim simply accepted the accountant’s advice to establish the SMSF and created an investment strategy and implementation plan as requested, he could make the case he was acting on his clients’ wishes and their accountant’s recommendation. The situation is not black and white. However, by engaging with Matt and Fiona and understanding their capacity, Tim has acted in their best interests by recommending against the course of action.

Tim acted in his client’s best interests. Had he not taken that course of action and the clients were adversely impacted, the case could be made that he had breached the following standards in the Code of Ethics.

Case study three: Life insurance premium structure

When it comes to risk advice, ASIC has several red flags it watches for. Has your client understood the risk advice provided? Has it been clearly explained, do they understand the ongoing cost structure and what they are covered for? If not, it could be in breach of standard five: advisers must ensure their client understand the recommendations made, the benefits of any financial products recommended, the costs and risks involved in acquiring, holding and disposing of the recommended products.

Does the advice consider the financial wellbeing of the clients’ family? Is a bundled product appropriate, or would separate policies be more effective for the client’s situation? If not, it could be in breach of standard six: advisers must take into account the broad effects of the client acting on their advice…these effects are not limited to effects on the client but may include implications for the client’s family members.

Does the client understand the fees and charges, and do they know how you will be remunerated for the advice? If they are being moved from one risk provider to another, do they understand how the remuneration structure works? If not, that could breach standard seven: the client must be provided with a clear and simple explanation of the fees and charges, including any benefits you or your principal will receive.

A common policy type across the risk insurance industry is a stepped premium policy. It has a premium that increases – or ‘steps up’ – each year according to a range of risk factors, such as age. Stepped premiums generally offer initial cost savings and are often considered suitable for short-term insurance needs. Level premiums typically provide long-term stability and consistent payment amounts. An ASIC review^[8] found that stepped insurance policies lapse at particularly high rates after the first year.

Michael and Rebecca went to see Mary at ACME Advice Pty Ltd. The couple had recently had their second child and wanted to be sure they had enough cover should either of them get seriously ill, suffer an injury or illness, or die. There was a mortgage to cover, and they wanted to ensure their children were provided for.

After agreeing on the policies, Michael and Rebecca signed up and felt comfortable that they were suitably covered for unforeseen circumstances. When renewal time came, they noted their premiums had increased significantly. Michael called Mary and asked about the premium increases. Mary suggested they could switch to another policy, one which would provide the same cover but with a lower premium. Remuneration for this was not discussed.

Michael and Rebecca agreed and the paperwork was duly finalised. The following year, the clients were faced with the same issue – a significant premium increase. When Mary was contacted, she again suggested a policy switch.

Despite the fact Mary ensured the coverage of new policies met the couple’s needs, did not charge a fee for making changes, and sourced cheaper policies each year, she potentially breached several standards in the Code of Ethics, including:

The Code of Ethics makes ethical practice a binding requirement for financial advisers – whether the situation is black and white, or one of many shades of grey. Financial advisers have a fundamental obligation to consistently prioritise their clients’ best interests and uphold ethical standards. Despite this being an obvious expectation, frequent media reports detailing misconduct by advisers and the resulting repercussions highlight that some practitioners and advice practices may neglect these responsibilities.

A truly ethical and professional partnership between an adviser and a client is established when the client comprehends the adviser’s recommendations and trusts that the advice is genuinely in their best interest. If there is any uncertainty regarding the advice provided, especially in situations where the right course of action isn’t entirely clear-cut, it is imperative to consider the ultimate benefit to the client.

Will your client be in a better position if this advice is put into action? Does the advice contravene any standards outlined in the Code of Ethics? Does it align with your personal moral code? If there remains any ambiguity, it is wise to discuss this with your colleagues and licensee.

At its core, ethics is about discerning the right course of action for your clients and steadfastly following through with it – always with the best interests of every client at heart.