CPD: The ethical consequences of inappropriate advice

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Providing inappropriate financial advice can breach the ethical standards that comprise the Code of Ethics.

The Australian Financial Complaints Authority (AFCA) has opened a consultation into how it determines compensation for complaints involving financial advisers. A week or two before that announcement was made, AFCA’s Annual Report was published. From the report, headline news was the 50 percent increase in investment and advice complaints in financial year 2022–23.

As it transpired, two investment firms made up nearly half (49 percent) of these complaints, which meant the number was, in fact lower than the previous year. By excluding the two firms, the number of investment and advice complaints was 2,466, a number that was 22 percent lower than 2021-22 and a continuation of a downward trend in complaints.

Despite this good news, there was a jump in the number of complaints received about inappropriate advice, rising from 241 to 1,662, a rise of 589 per cent. Again, the aforementioned two financial firm were responsible for a reasonable proportion of those complaints.

Allowing for a return to ‘normal’, that’s still a lot of clients who believe the advice they received was inappropriate. So, what are the consequences of inappropriate advice?

Consequences of ‘inappropriate advice

When a financial adviser provides inappropriate financial advice to a client, as well as resulting in a complaint to AFCA or an ASIC investigation, it can lead to significant damage to the client-adviser relationship and their business more widely. It can often have ramification that impact colleagues in the business, as well as issues for the licensee.

Potential consequences for the client and adviser may include:

  • Financial loss – the client may suffer financial losses as a result of following unsuitable advice, affecting their trust in the adviser’s competence. This may result in a complaint and requirement for the adviser (or their insurance provider) to pay compensation.
  • Deterioration of trust – inappropriate advice erodes the trust between the client and the adviser. Trust is crucial in financial relationships; once damaged, it can be challenging to rebuild.
  • Emotional stress – finance and money can be a root cause of stress; inappropriate advice can lead to stress, anxiety and emotional distress for the client. An investigation by AFCA or ASIC can create stress for the adviser and others in the business.
  • Legal consequences – if the inappropriate advice results in significant financial harm, the client may lodge a claim with ASIC or in some instances, take legal action against the adviser. This can result in legal expenses and potential damage to the adviser’s professional reputation.
  • Reputation damage – word-of-mouth is powerful in the financial industry. Negative client experiences can tarnish an adviser’s reputation, which will affect their ability to retain clients and attract new clients.
  • Regulatory issues – in some cases, inappropriate financial advice can lead to scrutiny from ASIC and result in fines and/or sanctions, and potentially jeopardise the adviser’s license and professional standing. This can also affect the broader business and licensee.
  • Loss of referrals – many advisers build their business from client referrals, as satisfied clients are comfortable to refer friends and family to advisers they trust. However, if this trust is compromised due to poor advice, the adviser is likely to lose out on potential referrals.

Inappropriate advice has widespread consequences for client and adviser, as well as broader ramifications. This emphasises the necessity for financial advisers to prioritise ethical practices in their business.

A values-driven code

The Code of Ethics is underpinned by a series of core values that provide the foundation for financial advice to be perceived as a ‘true profession’. Five values (figure one) underpin the twelve standards that comprise the Code of Ethics (figure two). The Code of Ethics is a set of principles and core values in the areas of ethical behaviour, client care, quality process and professional commitment.

Financial advisers are required to act in a way that demonstrates, realises and promotes each of these values and all provisions of the Code of Ethics must be read and applied in a way that promotes the values.

Each of the five values relates to specific ethical standards that must be applied to all interactions with every client. It is important to note that these values also require advisers to meet their obligations under law in respect to the advice provided to each client, including the appropriateness of advice provided to each client.

Avoiding inappropriate advice

When a client’s financial strategy is meeting their objectives and generally going to plan, it’s unlikely that the spectre of inappropriate advice would be raised. However, where things don’t meet expectations, even from events beyond anyone’s control, they’re more likely to closely examine their adviser’s advice.

Two key strategies for advisers to avoid a claim of inappropriate advice are education and communication. For example, financial markets experience periods of volatility – and there’s nothing quite like financial loss for clients to question a given strategy.

However, a client who is educated about their investments – what they are, why they are recommended and how they will help the client meet their financial objectives – is more likely to weather a period of underperformance.

Similarly, frequent communication to reinforce key strategies and explain what’s happening and why can go a long way toward keeping clients comfortable with their financial strategy.

It’s important to consider the provision of advice from a client’s perspective. ASIC’s Money Smart site[3] offers the following advice to consumers who are concerned they may have received inappropriate advice. For each point, potential breaches of the Code of Ethics is identified.

“You may have problems with a financial adviser if they:

  • Seem to be pushing one solution, regardless of your needs (for example, an SMSF or borrowing to invest)

This is an example of failing to act in a client’s best interests; as such, such action would potentially breach standards one, two and five.

It would also suggest that the adviser is not offering financial product advice with good faith and competence, thereby breaching standard nine.

  • Pressure you to sign documents that you haven’t read or don’t understand

As well as failing to act in the client’s best interests, an adviser who behaved in this way would likely breach standard four, which requires informed consent.

  • Give you advice that doesn’t fit with your goals or risk tolerance

Such advice would also breach the standards relating to acting in the client’s best interests. It could also breach standard six which requires advisers to take into account the broad effects arising from the client acting on their advice and actively considering the client’s broader, long-term interests and likely circumstances.

  • Make you feel intimidated or uncomfortable if you ask questions

Such a scenario would most definitely not be in the client’s best interests.

  • Are not upfront about how they make their money and the costs of the advice

As well as requiring action in the client’s best interests, standard five also states that advisers must be satisfied that the client understands the costs of the advice and products that are recommended, and advisers must have reasonable grounds to be satisfied.

Further, standard seven requires that informed consent must be obtained for all benefits an adviser and their principal will receive in connection with acting for the client, including any fees for services that may be charged.

  • Leave you in a worse financial position than before you received the advice

Such a scenario could result in breaches of several standards, including one, two and five dealing with best interests, standard six dealing with long-term implications and standard nine that requires financial advice to be offered with good faith and competence.

  • Charge you for advice that they never provide

This could breach those standards relating to acting in the client’s best interests (one, two and five), as well as those relating to informed consent about both advice and fees to be charged (four and seven).

Each of those points raised by ASIC is rightfully a red flag for consumers and would most likely result in the adviser who exhibits such behaviours being in breach of one or more standards of the adviser Code of Ethics.

Case studies

The following case studies are 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 or the Australian Financial Complaints Authority (AFCA) or its predecessor organisation. For each, potential breaches of the Code of Ethics are identified.

Case study one: Inappropriate financial advice

Nicole and Paul made a complaint to AFCA both personally and on behalf of, as directors, the corporate trustee of their self-managed superannuation fund (SMSF). The couple received personal financial advice from financial adviser Liam to set-up the SMSF, roll over funds from their industry super accounts to the SMSF and use the SMSF as a vehicle to invest $130,000 in the AAA property trust.

The couple said this advice was not in their best interests and was inappropriate. They also raised concerns about the appropriateness of insurance advice provided by Liam, who was an authorised representative of ACME Financial Advice at the time of the disputed advice. The AAA property trust investment resulted in losses; Nicole and Paul sought compensation for those losses and the insurance advice.

AFCA’s findings were that:

  • Liam provided personal financial advice:
    • to the couple and the corporate trustee in a Statement of Advice (SOA) to rollover $208,000 from Nicole’s industry super account and $57,000 from Paul’s industry super account to the existing SMSF (he also made insurance recommendations)
    • to Nicole during a property seminar about an investment in the AAA property trust where he told her that the trust was a “sound investment” and would help with her goal to purchase investment properties.
  • The corporate trustee invested $130,000 from the SMSF in the AAA property trust.
  • While there was no evidence to show Liam recommended the SMSF, he endorsed the SMSF and its use as a vehicle to make the AAA property trust investment.
  • Liam failed to act in the best interests of Nicole, Paul and the corporate trustee because:
    • the result of the disputed advice was an SMSF holding a poorly diversified portfolio of assets with the majority of the SMSF‟s funds “tied up” in an illiquid property trust
    • the SMSF vehicle was not cost effective.
  • Liam failed to provide Nicole with advice in her best interests in relation to her income protection needs because he did not adequately consider her existing income protection policy.
  • Liam did not provide ongoing advice the corporate trustee paid for.
  • Liam’s breaches caused the SMSF a loss of $221,835.59 assessed by a comparison between the actual financial result of those breaches with the estimated financial position had Nicole and Paul received appropriate advice.
  • The assessment of the SMSF’s loss attributed zero value to its units in the AAA property trust.
  • Liam’s inappropriate income protection advice caused a loss of $5,727.

AFCA’s determination was in favour of the complainants, who were compensated for losses incurred as a result of Liam’s poor-quality advice and failure to provide ongoing advice. Liam potentially breached the following standards of the Code of Ethics:

Case study two: Inappropriate ‘cookie cutter’ advice

Kaye, a financial adviser with over a decade of experience, managed a diverse portfolio of clients at XYZ Financial Services. Despite her credentials and apparent success, concerns began to surface regarding the uniformity of advice provided to her clients.

XYZ Financial Services catered to clients with varying financial goals, risk tolerances and investment horizons. However, interviews with Kaye’s clients revealed strikingly similar investment strategies and asset allocations, suggesting a lack of personalised advice.

An investigation uncovered that Kaye had been recommending a standard set of investment strategies to all clients, irrespective of their individual needs. Her reliance on these ‘cookie-cutter’ solutions led to poorly diversified portfolios and an overemphasis on high-risk assets, exposing clients to unnecessary market volatility.

Further scrutiny revealed that Kaye failed to conduct thorough assessments of her clients’ financial situations. She neglected to consider factors such as income levels, time horizons, as well as short- and long-term financial goals. This resulted in advice that was not aligned with each client’s unique circumstances.

Kaye potentially breached the following ethical standards:

Case study three: Inappropriate advice #1

Christine was an experienced financial adviser with ABC Financial Planning. She was subject to a series of client complaints and an investigation by ASIC. The investigation revealed a pattern of misconduct, leading to severe consequences for Christine’s career and reputation within the financial services industry.

ASIC identified the following issues:

  • Inappropriate recommendations – one of the key issues that came to light during the investigation was Christine’s tendency to make recommendations that did not align with her clients’ risk profiles. This raised concerns about the suitability of the investment strategies she proposed, potentially exposing clients to undue risks.
  • Non-compliant Statements of Advice – the ASIC investigation uncovered instances where Christine had provided clients with SoAs that did not comply with regulatory standards. Non-compliant SoAs can hinder clients’ ability to make informed decisions about their finances.
  • Inadequate record keeping – another critical finding was Christine’s failure to maintain adequate records. Proper record-keeping is essential in the financial services industry to ensure transparency, accountability and regulatory compliance. The lack of proper documentation raised concerns about the integrity of Christine’s practices.
  • Failure to act in her clients’ best interests – Christine’ breached this most fundamental obligation.

As a result of ASIC’s investigation, Christine was banned from providing financial services for a period of five years.

According to the information provided, Christine potentially breached the following standards:

Case study four: Inappropriate advice #2

The complainants, Julie and Carl, were 71 and 74 at the time of seeing adviser Matthew, an authorised representative of financial firm ACME Financial Advisers.

Matthew recommended that Julie and Carl invest in a Capital Protected Fund (the A Fund). At the time Carl had $445,510 and Julie had $376,220 to invest.

Julie and Carl were classified by Matthew as ‘Assertive – Balanced’ investors. This risk profile resulted in a recommended asset allocation of 30% defensive assets and 70% growth assets. The complainants say they understood from Matthew that the A Fund was capital protected, and that they would get the highest return for the year locked in.

They later found out that they would only get the return available at the anniversary of the product. They claimed had they known this, they would not have invested as the return on the anniversary was significantly lower than they had been led to expect. Julie and Carl also claimed that Matthew charged higher fees than initially declared.

AFCA determined that Matthew failed to adequately explain how the A Fund worked. Had the complainants known the level of uncertainty associated with the product, they would not have invested.

The determination also noted that Matthew failed the best interest duty by not providing appropriate risk profiling and advice to his clients. Finally, AFCA accepted that the complainants would have been conservatively invested if appropriately advised, which resulted in a total loss of $95,725.

This determination was found in favour of the complainants. Total compensation equating to the couple’s loss, plus 1.5% interest per annum compounding annually from the determination to the date of payment, was ordered.

By inadequately describing how the product worked and failing to provide appropriate risk profiling and advice to his clients, Matthew potentially breached the following standards in the Code of Ethics:

In the face of a contracting financial advice industry amid a growing demand for guidance, it is imperative for the industry to continue the process of regaining trust and enhancing professionalism. The path to rebuilding trust among Australian consumers and instilling confidence in financial advice lies in a commitment to ethical conduct. Upholding ethical standards not only fosters trust over time, but also serves as a crucial preventive measure against allegations of inappropriate advice.

Central to the restoration of the industry’s positive reputation and reaffirmation of its significance in ensuring the financial well-being of all Australians is the adherence to a Code of Ethics. Integrating this code into one’s professional practice and making it an integral part of daily routines represents a pivotal step in this journey.

 

 

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] Ibid.
[3] https://moneysmart.gov.au/financial-advice/problems-with-a-financial-advisers

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