CPD: Ethics and referrals

Most financial advice practices have referral partners they send business to or receive business from. You may also use a number of third party outsource providers for non-client facing elements of your service offering. This article, proudly sponsored by GSFM, examines your obligations with respect to managing those relationships and upholding the Code of Ethics.

Ethics and trust are deeply interconnected, each strengthening the other. When one is enhanced, the other naturally improves…but when one is compromised, so is the other.

A key component of creating a thriving financial advisory business is to establish a strong client base and earn the trust of each client. After all, people are less likely to share their personal financial information or depend on someone to act in their best interests if they don’t trust them. Trust should be the foundation of every client relationship. While it takes time to build, trust can be shattered in an instant.

Building trust

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.

There are a number of models that examine the attributes that create a trust relationship. One of these models^[2] discusses four elements – or the four Cs – of trust. These are:

• Competency: your client trusts you to provide your advice in the right way to help them achieve their long-term goals.
• Consistency: your client trusts you to provide appropriate advice over time.
• Character (Integrity): you client trusts you to do the right thing and act in their best interests at all times.
• Compassion: your client trusts you to do the right thing for them because you care about them, you value your relationship and want to nurture it over the long term.

This model suggests that trust is dependent on the way humans behave, individually and collectively.

A second trust model, the Integrative Model of Organisational Trust, was designed by Roger Mayer, professor of leadership. It identifies three pillars of trust in business and everyday life: these are benevolence, integrity and competence (figure one). This model can assist advisers to understand how to build trust with their clients and, in the case where trust has been broken, it can also help to rebuild trust. Any rebuild will, of course, take longer to than the original establishment of the trust relationship.

The Integrative Model of Organisational Trust postulates that trust is comprised of three key components, each of which is:

• relevant to the delivery of finance advice
• relates to one or more of the core values that underpin the Code of Ethics
• relates to one of more of the twelve standards that comprise the Code of Ethics.

Capability

Do you have the skills, competencies, and other relevant abilities to deliver quality advice to your clients? Does this extend 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 twelve 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). Or to put this another way, your client believes you are working in their best interest, working to help them meet their financial and lifestyle objectives. Clients would reasonably expect any person or business you referred them to would deliver the same degree of benevolence. Likewise, any outsource providers you use would be expected to display benevolence in their actions.

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 many 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 are consistent with the remaining values of honesty and diligence. The relationship between integrity and trust involves your client’s perception that you adhere 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, IT specialists or paraplanners can also impact your trust relationships. A misstep by any one of these providers can undermine trust in you and your business, and potentially breach one or more of the standards that make up the Code of Ethics.

Referral partners

Each of your clients will have a range of needs. Some may provide competency and specialisation that you can’t provide. As such, it’s not unusual for advisers to refer clients to other finance specialists, either within the same practice or outside of it.

These referral relationships are often established at the licensee level, and the adviser may simply be told who to deal with for risk advice, tax and accounting services, SMSF administration…the list goes on.

If a client has a negative experience with a referral partner, it might not just reflect badly on that partner, it can damage 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.

Standard three of the Code of Ethics requires that you must not advise, refer or act in any other manner where you have a conflict of interest or duty.

According to guidance^[4], 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 (notably around standard three) have played out for some years, they remain enforceable by law as they stand.

In its current form, standard three refers to actual conflict 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.

Accountants

It’s one of the most common referral arrangements in the industry. Many a business has taken advantage of the natural synergies between accounting and financial advice to build a business where an accounting practice acquires and embeds financial advice businesses – or vice versa.

As well as being synergistic, there are also areas of overlap. For years, accountants have advised clients about investment strategies to manage and mitigate tax and have been advocates of self-managed super funds (SMSFs). While in many cases an SMSF may be an appropriate strategy for a client, there may be times where you question its validity as an appropriate approach for your mutual client. 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, particularly if you don’t believe it 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 when you consider their total portfolio.

In such cases it is important to call it out and discuss the holistic view with the referral partner; that way, you can agree on what’s best for the client, what will help them achieve their financial objectives (including tax management) and what works within the agreed risk parameters.

Risk advice

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

Where you refer to a specialist risk practice, it is important to have an agreement with respect to the service provided. You need to ensure that it’s appropriate for each client and will meet their needs over time.

Mortgage brokers

Its less common for advice practices to have in-house mortgage brokers. They have a particular skill set and there may be times you need to refer a client for loan assistance. Renumeration for mortgage brokers 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. It is important your client understands this, and you both need to be confident that the loan has been placed with the most appropriate institution for the client, not that which offers the most handsome remuneration.

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. The legislation requires mortgage brokers to prioritise consumers’ interests when providing credit assistance (known as the conflict priority rule)^5]

These obligations came into effect from 1 January 2021 (note: they were delayed by six months because of the COVID-19 pandemic).

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 necessary 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. Other advisers may do the research and 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 your client and for you.

Legal professionals

Legal professionals 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 specialists should include a service level agreement (SLA) that includes your requirements with respect to their conduct. If a formal SLA is not already in place, or if it does not cover the requirements stipulated in the Code of Ethics, it needs to be established (or amended) as a matter of priority. You know how you expect your clients to be treated and the quality of advice you expect them to receive – don’t assume that’s what will be provided.

It is important to review the advice provided by any third party to whom you have referred a client. Should you have any doubts or queries about the appropriateness of the advice provided, you need to have a conversation with that referral partner. It may be a difficult conversation, particularly if the referral partner considers you’re 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 practices outsource some of their business processes. Typically, the more administrative and support activities tend to be outsourced, while client facing and revenue generating actions are kept in-house.

A Google search of outsource businesses servicing the advice community shows that you can engage 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 most common outsourced business models available to advice practices are as follows:

Freelancers – generally a lower cost option but can be higher risk. Through a variety of online service providers, you can get freelance individuals on a project base or on an ongoing basis. While there’s no doubt you can find some excellent people who provide freelance services, 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.

Outsourced staff, whether based in Australia or offshore, represent your business and your brand. You want the work they do for you to reflect your business and its values, which should include 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 enshrine this in the SLA.

Offshoring services

Offshore outsourcing can be a cost effective measure for scaling an advice practice, which can reduce your control over the quality of services delivered. Some of things to be aware of include:

• Navigating time zones can sometimes be challenging, and staff may not be available to answer questions when you most need them to be.
• Language barriers and cultural differences can present a challenge in some circumstances, especially when it comes to discussing values and the importance of the work they do for you supporting the Code of Ethics.

Ultimately, an offshored outsourced provider is an extension of your business and a representative of your brand. The work not only needs to be of a high quality, but needs to meet all elements of your SLA, which should include supporting those standards of the Code of Ethics relevant to their service.

For example, if you were outsourcing some elements of your administration, you’d need to ensure the provider managed and maintained client records in a form that is complete and accurate to ensure compliance with standard eight.

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 relevant standard. One way to test the provider’s approach to managing compliance and dealing with any breaches is to provide scenarios and ask how they would deal with each.

Further, ensuring that each standard of the Code is encapsulated in the provider’s SLA and key performance indicators can support the outsource provider’s adherence to the Code. Compliance 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 standards, but those requirements applied by law.

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

Case studies

The following case studies are based on real events, but some details have been amended to make them relevant to the article’s topic. Names of people and organisations have been changed. The case studies have been drawn from the Australian Financial Complaints Authority (AFCA) or ASIC. For each, potential breaches of the Code of Ethics are identified.

Case study one: The FX Dealer

Tom is an adviser with ACME Advice in Sydney’s eastern suburbs. His client base is primarily comprised of professional millennials; high earning and engaged investors. Tom introduced his clients to several external parties offering specialist investment opportunities, including FX trader Edward, the principal of SimplyFX.

SimplyFX offered retail clients access to over-the-counter (OTC) derivative products issued, including contracts-for-difference (CFDs). A number of his clients subsequently invested in products offered by SimplyFX. Because Tom was not licensed to advise on derivatives, clients entered into a direct relationship with SimplyFX.

After a number of complaints about SimplyFX, ASIC found that Edward:

• exercised very little oversight of SimplyFX’s operation and did not take steps to mitigate or address any problems within the operation of the business
• abrogated his responsibilities for supervision and oversight to persons offshore, without any organised and proper monitoring structures in place
• failed to maintain proper client records
• failed to address or take adequate steps to investigate issues that arose particularly in relation to client complaints
• did not cooperate with ASIC’s investigation.

Further, ASIC found it has reason to believe Edward is not competent to act as an officer of a financial services business, nor a fit and proper person in this respect and should be banned from performing this function for a period of five years.

The failures exhibited by Edward and SimplyFX will have reflected badly on Tom, as the person who referred his clients. Tom’s referral partner potentially breached the following standards in the Code of Ethics:

Case study two: The mortgage broker

Alex was a mortgage broker with Brisbane-based ACME Mortgage Broking. She provided mortgage broking services to a number of financial advice practices in the Brisbane area from 2013 to 2022. Between 2015 and 2021, Alex dishonestly obtained funds from her employees, clients and people purchasing goods on Facebook Marketplace.

She was convicted of 17 counts of dishonestly obtaining a financial advantage by deception, three counts of dealing with identity information to commit an indictable offence, and one count of dishonestly obtaining property by deception. She was sentenced to four years’ imprisonment.

Under the Corporations Act and the National Consumer Credit Protection Act, ASIC may permanently ban a person from the financial services and credit industries if they are convicted of fraud. Consequently, based on her convictions, Alex has been banned permanently, which means she cannot:

• provide any financial services or engage in any credit activities,
• control an entity that carries on a financial services business or engages in credit activities
• perform any function for an entity carrying on a financial services business or engaging in credit activities, including as an officer, manager, employee or contractor.

Kate and Rosa from AAA Advice referred a number of clients to Alex; five were among those she defrauded. While Kate and Rosa had conducted due diligence before forming a referral relationship with Alex, her actions reflected badly on them. It affected their client relationships and sullied their reputation to be associated with Alex.

By defrauding clients, Alex would have potentially breached the following standards in the Code of Ethics:

 Case study three – the outsourced paraplanner

ACME Financial & Investment Planners was a new office in Melbourne. The firm planned for rapid growth and the business principals, Callum and Lola, decided to outsource a number of business processes, including paraplanning, to quickly scale the business.

Lola interviewed a range of potential outsource providers, some of which had been recommended by industry peers. After discussions with four potential outsourcer providers, Callum and Lola appointed ABC Paraplanners to meet their paraplanning needs. The firm also provided ongoing client reporting as part of this service.,

As part of their due diligence process Callum and Lola made sure that the paraplanners provided by ABC Paraplanners 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 comprised part of the Service Level Agreement (SLA) the outsourcing company had to meet.

At their six month review, Callum and Lola expressed their satisfaction with ABC Paraplanners. It had met all requirements of the SLA and provided a quality and timely service. However, several months later, they noticed a sudden decline in the quality of the service and documentation. Some of the more recent SOAs included inappropriate recommendations, as well as a number that had evidently been cut and paste from earlier clients with different risk profiles.

The advisers were undertaking their biannual client reviews and the information being received from ABC Paraplanners was incomplete and inaccurate. After making enquiries of the outsource provider, they discovered the initial high quality paraplanners had been replaced by less experienced and underqualified staff; staff that evidently were paid a lower rate by ABC Paraplanners.

Because they had used the Code of Ethics to frame the specific SLA agreed with ABC Paraplanners, they were able to refer to the standards when detailing with specific issues arising from the change in paraplanning staff. In particular, Lola and Callum were able to draw on the following standards:

Case study four: The lawyer’s investment advice

Blake is an experienced financial adviser working in Melbourne’s eastern suburbs. His advice practice ACME Financial Planning has a referral arrangement with a local legal firm, AAA Law, which provides estate planning advice and documentation.

One of Blake’s clients is a successful businesswoman; Liza had run a successful fashion boutique for many years and was approaching retirement. Blake and Liza were discussing the impending sale of the business and agreed Liza’s estate plan should be updated.

Following Liza’s appointment with AAA Law several weeks later, Blake discovered that one of the firm’s senior partners had recommended Liza invest the proceeds of her business sale into an unregistered Managed Investment Scheme being operated by the firm.

When Blake quizzed Liza about the MIS, she admitted she didn’t really understand it, however, it was offering attractive double digit returns each year. Blake contacted the legal firm to discuss the investment scheme into which Liza had invested, to learn how the money was invested, the liquidity of the investment and obtain more information about fees and charges.

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

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

In the world of financial advice, trust is the cornerstone upon which successful client relationships are built. An adviser’s credibility and the confidence clients place in them are hard-earned and should be protected. When a referral partner breaches this trust, it doesn’t just tarnish their own reputation, it directly undermines the adviser’s relationship with their client, potentially causing irreparable damage.

Advisers must be vigilant to choose referral or outsource partners that share their commitment to integrity and transparency and importantly, an ethical framework that encapsulates the twelve standards that comprise the Code of Ethics. By carefully selecting and regularly reassessing these partnerships, advisers can safeguard the trust they’ve cultivated with their clients, ensuring that their relationships remain strong. After all, the foundation of any prosperous financial advisory practice lies in the unwavering trust between adviser and client, a trust that must be protected at all costs.
 

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Notes:
[1] https://www.legislation.gov.au/Details/F2019L00117
[2] https://theattributes.com/blog/how-to-develop-the-4-elements-of-trust
[3] An Integrative Model of Organizational Trust, Roger C. Mayer, James H. Davis and F. David Schoorman, 1995
[4] Financial Planners & Advisers Code of Ethics 2019 Guide, October 2020