CPD: Ethics and recommending listed investments

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Advisers need to understand their ethical obligations when recommending listed securities to their clients.

Despite volatile markets, Australian investors continued their love of ETFs. In fact, the Australian ETF industry recorded its highest annual increase in funds under management over 2023[1]. This article, proudly sponsored by GSFM, examines some of the ethical issues pertinent to the use of listed securities, including ETFs, in client portfolios.

2023 was yet another year characterised by volatile financial markets, affected by geopolitical uncertainty, rising inflation and central bank machinations to manage it. Despite this backdrop, investment in listed securities continues unabated, particularly into ETFs.

Over the year ended 31 December 2023, the market cap of Australia’s exchange traded products (ETPs) – which is largely comprised of ETFs – had increased by nearly one third at 32.5 percent. Over the same period, a further 49 new exchange traded products had been launched[2]. This continues the trend of investor interest in ETPs, an interest that has resulted in the consistent growth in both the number of available products and value of those products, despite the vagaries of market movements (figure one – left hand side). That growth was largely the result of high levels of market activity (figure one– right hand side).

Listed securities don’t just include ETPs. Other investments under this umbrella include:

  • Shares
  • Listed Investment Companies (LICs)
  • Listed Investment Trusts (LITs)
  • Australian Real Estate Investment Trusts (AREITs)
  • Listed infrastructure funds
  • The soon to be wound up mFunds.

Excluding shares, the market cap of listed securities was $438.54 billion at 31 December 2023, a 15.5 percent increase year on year and a jump of 6.2 percent over the month[3]. As investor interest continues to spur growth in the sector, it’s important that advisers are aware of their ethical obligations with respect to providing advice and recommendation about listed securities.

Ethics and listed securities

Financial advisers are guided by a number of frameworks when making financial product recommendations – including those involving listed securities: the law, the Financial Planners and Advisers Code of Ethics 2019 (Code of Ethics) and requirements and obligations from the licensee. Advisers who are also members of the Stockbrokers and Investment Advisers Association (SIAA) are required to abide by the standards outlined in its Code of Ethical Conduct, last updated in February 2023.

As with all financial product advice, recommendations both listed and unlisted are underpinned by the need to act in each client’s best interests. Not only is it fundamental to good advice, it is essential to abiding by both the Corporations Act 2001 and both Codes of Ethics.

Acting in a client’s best interests requires you to know and understand the intricacies of each financial product recommended and whether it is suitable for the respective client. It’s also important to ensure that the client understands any financial product that you recommend to them. The above-mentioned increase in the number and variety of listed securities available has increased demand for listed investments; as a result, the demand for professionals to provide financial advice that includes these securities has also increased.

As outlined above, those advisers who are members of the SIAA are required to abide by the principles outlined in its Code of Ethical Conduct. The code, which is enforceable, prescribes the ethical conduct of members and applies to Stockbrokers and Investment Advisers Association Principal Members (organisations) and Practitioner Members (individuals).

The objective of the SIAA’s code is to:

“Maintain and improve ethical behaviour in the stockbroking and investment advice profession and the conduct of members of the profession with the consumers of their services”

The SIAA code stipulates that for those members who are subject to other codes – such as the adviser Code of Ethics – the two codes must be read in conjunction. It notes that a breach of any other codes may be taken into account by the SIAA when considering compliance of members with their obligations under the SIAA’s Code of Ethical Conduct.

The SIAA Code of Ethical Conduct is comprised of a number of principles that specify enforceable rules and provide guidance on ethical conduct, much like the adviser Code of Ethics. Figure two provides a summary of the SIAA Code of Ethical Conduct and outlines both the ethical principles and industry specific issues. As with the standards in the adviser Code of Ethics, the intent is that each should be interpreted broadly, rather than by narrow and strict interpretation.

 The Adviser Code of Ethics

The Financial Planners and Advisers Code of Ethics 2019 imposes ethical duties on financial advisers and has been designed to encourage higher standards of behaviour and professionalism across the financial services industry.

The Code of Ethics addresses five core values: trustworthiness, competence, honesty, fairness and diligence. It requires that financial advisers must act at all times and in all cases, in a manner that is demonstrably consistent with Code’s twelve ethical standards, summarised in figure three. These standards are regulated and monitored by ASIC’s approved compliance schemes.

The interplay between two codes of ethics in practice

Following is an assessment of the some of the key principles from the SIAA Code of Ethical Conduct and the interplay between those and the standards in the adviser Code of Ethics. The following encompasses those topics most pertinent to financial advisers recommending and/or dealing in listed securities.

Obey the law

The first principle or standard in both ethical codes is to obey the law.

Advisers must obey all applicable laws that govern the industry, which include legislation, statutory rules, regulatory and self-regulatory requirements. As readers will be aware, laws are frequently revised and updated – it is incumbent on you to remain up to date, and your licensee to ensure that you and others in your practice do so.

Honesty and integrity

That members must act with honesty and integrity, and in the best interests of their clients is consistent with standards two and nine of the Code of Ethics. However, both honesty and integrity are implied across most of the standards.

The requirement to not bring the profession into disrepute is consistent with adviser Standard 12.

Respect the Rights of Clients

This requirement focuses on the notion of ‘informed consent’, particularly in relation to recommendations made (in line with Standard 4) and fees charged (consistent with Standard 7).

Competence

The enormous growth in the number and types of listed securities available to Australian investors has increased the need for adviser knowledge and client education about this sector. To recommend listed investments with competence, advisers need to understand the intricacies of all potential investments, including: the risk and return profile of each security, the underlying investments and the approach taken to managing the investment.

In addition, recommending listed investments requires additional knowledge; advisers need relevant market and product knowledge and importantly, must understand and abide by market rules. All relevant information needs to be clearly communicated to clients.

The SIAA code requires members to take reasonable action to ensure that they have sufficient knowledge of stockbroking and investment advice practice, relevant legal requirements, and where relevant, the adviser Code of Ethics. Members are also expected to maintain this competence through continuing professional development; this is consistent with Standard 10 of the adviser Code, which focuses on the development, maintenance and application of knowledge and skills.

Principal members of the SIAA must provide staff with information, training and supervision that enables them to do their work competently and comply with the law in the performance of their profession; the same expectation is levelled at AFSL holders.

Conflicts of Interest

Members must avoid and disclose conflicts of interest where reasonably practicable before or when the service is provided; principal members must minimise the potential adverse impact of conflicts of interest by having adequate arrangements for controlling such conflicts. The SIAA also requires members comply with the adviser’s Code of Ethics; within this, Standard 3 covers the requirement for both licensees and practitioners to manage conflicts of interest.

Cooperation and Whistleblowing

While the requirements for SIAA members are more detailed, they are broadly consistent with Standard 11 of the adviser Code of Ethics, which states that advisers have a duty to cooperate with any investigation of a breach or potential breach of this Code by a monitoring body or ASIC.

Fair & Orderly Market

Members must compete fairly in the market, including not taking unfair advantage of other members and not engaging in anti-competitive or unconscionable conduct. Importantly, members must not knowingly engage or induce another person to engage in conduct that will or is likely to mislead or deceive in the performance of their profession.

There are several important elements to consider with this standard; advisers working with listed securities need to understand and manage these risks, each of which could see them in breach of the law and, at the very least, Standard 1 in the adviser Code of Ethics.

Some of the requirements to ensure a fair and orderly market include:

Best execution

ASIC’s regulatory guide RG-265 provides guidance on market integrity rules for participants of securities markets. In terms of best execution, RG265 states:

Market participants must take reasonable steps to obtain the best outcome for their clients. For retail clients, it means best total consideration, which market participants may interpret as best price while there are not material differences in transaction costs between licensed markets.

This applies to trades executed via any exchange. There are additional rules applied in the case of trading derivatives. The notion of ‘best total consideration’ means that for buy orders, investors pay as low a price as possible. Conversely, for sell orders, investors should receive the best possible price. Best execution also means paying the lowest possible transaction costs and applies to all listed securities, whether a share, a passive or actively managed ETF or an AREIT.

From the perspective of the Code of Ethics, this addresses acting in the clients’ best interests (Standards 2 and 5) and acting with competence (Standard 9).

Insider trading

Inside information refers to confidential information about a company that has not been publicly disclosed and that may impact the value of a ‘financial product’. Financial products include all securities able to be traded on a financial market.

The information that could be regarded as inside information may include:

  • advanced knowledge of unexpected increases or falls in revenue or profit
  • proposed mergers or acquisitions
  • prospective legal actions against a company
  • new product development
  • the awarding of export contracts or significant client accounts.

Individuals with access to insider information can have an unfair advantage in the market if they were to trade using that information and it is an offence for a person to trade using inside information or to communicate inside information to others who are likely to trade based on that information.

Even if a transaction using inside information is undertaken to only benefit clients, using this knowledge will breach the Corporations Act 2001, section 1043A and therefore a contravention of the first standard in the Code of Ethics, as well as the first principle of the SIAA code.

Pump and dump

‘Pump and dump’ is a form of securities fraud. It starts with an individual or group who buys shares in a company and starts an organised program to increase (or ‘pump’) the share price. They often do this by using online forums, including social media, to create a sense of excitement in a company or spread false news about that company’s prospects. Once the price rises, they then sell (or ‘dump’) their shares and take a profit. Other shareholders suffer as the share price falls.

While not new, pump and dump activity has been on the rise, largely driven by social media and the rise of the finfluencer. In recent years, both this activity and the proliferation of the largely unlicensed finfluencers have been under increased scrutiny by ASIC.

It’s clearly unethical to engage in pump and dump activity; being able to recognise such schemes comes back to competence (Standard 9) and always acting in your clients’ best interests (Standards 2 and 5).

In announcing its 2024 enforcement priorities[5], ASIC noted several enduring priorities that consistently remain on ASIC’s radar. The first of these is “Misconduct damaging to market integrity including insider trading, continuous disclosure failures and market manipulation.”

Case studies

The following case studies are loosely based on ASIC’s enforcement activities or AFCA cases; however names and other details have been changed for privacy reasons.

Case study one – The Finfluencer’s pump and dump strategy

Adviser Pete at ACME Financial Advice has a keen interest in the share market and follows a number of market commentators across a variety of forums, both on and off social media. He encouraged several of his share loving clients to follow a specific unlicenced finfluencer ‘The Archer’; his schtick was to ‘get the bullseye’ and pick the right time to buy and sell specific small and mid-cap stocks.

Pete did not transact for these clients. He knew they traded using online platforms and suggested they follow ‘The Archer’ on an online forum for trading ideas.

However, ASIC did not have such a rosy view of ‘The Archer’. He was accused of market manipulation activity, a breach of s1041D of the Corporations Act. It was found that ‘The Archer’ used an online share trading forum as an integral part of his market manipulation. He promoted certain shares that he had an undisclosed interest in, and which he had manipulated, with a view to selling out at a higher price.

‘The Archer’ also illegally disseminated information about his activity; he was seeking to increase (or pump) the share price, then selling (or dumping) the listed stocks at a higher price.

Consequently, ‘The Archer’ was fined $50,000 and given two years jail; the same offence is now subject to up to 15 years jail.

Pete’s clients were among those who lost money thanks to the activities of ‘The Archer’. Although not acting directly for his clients with respect to the related securities trading, a case could be made that he did not act in their best interests and could be found to have breached some standards of the Code. If Pete’s conduct was reviewed by the regulator, it could be said he breached the following standards:

Case study two: Inappropriate listed securities for a ‘balanced’ client

Nicole (aged 42) and Anthony (aged 47) sought advice from Andrew Copperfield, senior adviser at ACME Advice, in 2018. It was agreed that their risk profile was ‘balanced’ and their financial goals were threefold: to pay out their mortgage by the time Anthony reached age 55, to fund the private education for two children and start to increase their retirement savings.

Andrew had established a plan that included a range of investments, both unlisted funds and listed securities. Andrew recommended a managed discretionary account so he was able to buy and sell financial products and listed securities that he believed would meet the couple’s objectives. As part of the SOA, they established some parameters as to the types of financial product and listed securities their portfolio would invest in.

In 2020 he told the couple that they were on track to meet their investment objectives. Over the next two years, Nicole and Anthony had little communication with their adviser (which they attributed to Covid) although they continued to pay the annual advice fee.

When they finally received an annual update (but not a client review) from ACME Advice, the couple discovered that not only were they most unlikely to meet their financial objectives, their investment portfolio was comprised of a high number of smaller, speculative type stocks as well as some niche ‘thematic’ exchange traded products. Because of the prevailing market conditions and speculative nature of many of the investments, their portfolio had lost significant value.

An ASIC investigation found that Andrew Copperfield:

  • had engaged in misleading and deceptive conduct
  • had engaged in trading securities outside those agreed by the clients
  • was not adequately trained or competent in relation to financial services
  • had caused or allowed ACME Advice to collect annual review fees from Nicole and Anthony and other clients when those annual reviews had not been undertaken
  • failed to have systems in place to ensure that all clients received the annual client reviews that they had paid for
  • failed to ensure that file notes of annual client reviews were uploaded to a document management system within reasonable time after the review occurred and therefore failed to maintain complete, accurate and reliable records.

Consequently, Andrew was banned from providing any financial services for a period of seven years; this includes controlling an entity that carries a financial services business or performing any function involved in the carrying on of a financial services business.

Given ASIC’s findings, Andrew potentially breached the following standards in the Code of Ethics:

Case study three: Insider trading

Wayne was a corporate adviser at a mid-tier investment bank that did a lot of work with companies in the resource sector. In his role he became aware of a funding proposal that included a multi-million-dollar placement of CompanyX shares and a restructure of the CompanyX board that would see two well-known and well-credentialed directors join the board.

Wayne contacted his financial adviser Bill and told him about CompanyX and the expectation that when the news became public, the company’s share price would increase significantly. They concocted a scheme whereby Bill would invest $120,000 in the company; $50,000 of his own money and $70,000 on behalf of Wayne. Wayne knew that if he invested in his own name that there would be ramifications.

ASIC alleged that over a seven day period in July 2021, Bill acquired over one million shares in CompanyX while in possession of inside information. The following week, the information became public when CompanyX published an ASX announcement. Subsequently, the share price jumped by 165 percent.

Market surveillance activity identified this unusual transaction and ASIC investigated. As a result, both Wayne and Bill were charged with applying for shares while in possession of inside information in breach of Section 1043A of the Corporations Act. At the time of the offence, a breach of s1043A of the Corporations Act carried a maximum penalty of 15 years imprisonment.

Bill sought to benefit himself and his client. His actions would have likely breached the following standards in the Code of Ethics:

The ethical dimension of financial advice revolves around offering well-founded recommendations that align with the client’s best interests and contribute to the attainment of their financial and lifestyle objectives. Additionally, it involves ensuring that the client understands the advice and all investment recommendations, whether they pertain to listed or unlisted securities.

Upholding ethical standards, establishing trustworthiness, and showcasing integrity are essential in fostering trust among consumers. This will ultimately increase consumer confidence when engaging with advisers and using financial services more broadly. The adherence to the Adviser Code of Ethics (and, for SIAA members, the Code of Ethical Conduct) plays a pivotal role in cultivating a positive reputation for the advice industry.

 

 

Take the FAAA accredited quiz to earn 1.0 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 1.0 hour.

Legislated CPD Area: Professionalism & Ethics (1.0 hrs)

ASIC Knowledge Requirements: Securities (1.0 hrs)

 

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Notes:
[1] Betashares Australian ETF Review: End of 2023 Review, January 2024
[2] ASX Investment Products Report, 31 December 2023
[3] ASX Investment Products Report, 31 December 2023
[4] Stockbrokers and Financial Advisers Association, Code of Ethical Conduct, February 2023
[5] https://asic.gov.au/about-asic/asic-investigations-and-enforcement/asic-enforcement-priorities/

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