• The most common ethical errors associated with the provision of financial advice;
• The factors that influence financial advisers and compliance managers to make ethical or unethical choices;
• The current ethical issues faced by financial advisory participants in their daily advisory practices and within the organisations for which they work; and
• Current trends and patterns in ethical conduct and decision making within the financial advisory sector.

To assist you reading the report, it contains an executive summary and uses a series of text boxes to identify:

• Signposts to Reform,
• Current Roadblocks to Quality Financial Advisory Outcomes and suggestions on
• How to Build Organisational Resilience to Ethical Risk Within Financial Advisory firms.

The report is designed to assist:

Financial Advisers
To understand the factors which influence their decision making	To enhance their awareness of the ethical risks they face in the provision of financial advice
AFS Licensees
To identify and remove current roadblocks to ethical outcomes within their organisations	To build organisational resilience to ethica risk and ensure quality financial advisory outcomes
All Stakeholders
To increase awareness of the current eithical issues associated with financial advice	To understand the advantages of integrity based frameworks in achieving quality financial advice

I welcome your comments on the report or any of the issues raised and would like to generate debate about the role of ethics in financial planning advice on this site. Alternatively, you can email me to share your views privately if you wish.

To coincide with the publication of this report, Argyle Lawyers Pty Ltd is pleased to announce that it now provides advisory and consultancy services in the areas of expertise covered by the report. I would be happy to meet with you in person to discuss these new services in more detail and how they may add value to your advisory practice. Please contact me on 03 8601 1121 to arrange a meeting.

I am also available brief the Board/ senior management/ legal or compliance teams of Financial Services Organisations on the salient features of the report and the key lessons and opportunities that arise from it.

Happy reading! Download the report here.

The post Ethics and Financial Advice: The Final Frontier appeared first on AdviserVoice.

Table 1 below outlines the 10 most common forms of unethical conduct by financial advisers in the provision of advice to clients, as identified from the findings of these external decision makers. In many instances, as outlined in the table, this unethical conduct also constituted a breach of the minimum conduct standards expected of financial advisers under the Corporations Act 2001 (Cth).

The table provides a guide to the most common ethical risks that may be faced by AFS licensees and financial advisers in the provision of advice to consumers. It should assist licensees to identify and remove roadblocks to ethical outcomes within their organisation and build organisational resilience to ethical risk.

Table 1 demonstrates that integrity issues dominate the analysis. This includes unethical conduct associated with misleading statements about the performance, features and risks of recommended financial products or misleading statements about the business reputations of those associated with financial products or managed investment schemes (35 breaches).

In addition, using client funds for the adviser’s own purposes was a clear issue particularly prevalent in ASIC banning orders (29 breaches).

The misleading conduct identified took many forms, from misrepresenting to consumers the risk of loss of capital or guarantees associated with the investments, to actively promoting that the financial product had features it did not have. The data suggested that such conduct was often associated with other forms of unethical conduct, such as not acting in the interests of clients and failing to provide clients
with all information necessary to make informed decisions as to investment choices (22 breaches).

An analysis of the data further reveals that the misleading conduct was linked to an inadequate understanding by financial planners of the financial product itself (23 breaches), which is also indicative of a breach of the competency principle. The misleading conduct also appears to have been contributed to by a failure of the compliance systems and procedures of AFS licensees to specifically prevent the behaviour (13 breaches).

Diligence in the provision of financial advice was another ethical principle that was the subject of recurring breach. The data also suggested that financial advisers are still inadequately researching the features, characteristics and risks of the financial product they recommend. This unethical conduct included the failure to conduct appropriate and independent research into the financial product being recommended (23 breaches) and inadequate explanations and examination of the risks associated with particular investment choices (19 breaches). This leads to a lack of, or inadequate understanding of, the financial product and the commensurate inability to therefore match product to the client’s needs, circumstances and objectives (23 breaches).

Objectivity issues, such as the failure to reveal conflicts of interest or fees and commissions earned (23 breaches) and the failure to disclose information relevant to the client’s decision (22 breaches), were also prevalent in the data. It should be noted that this latter conduct also constitutes a breach of the fairness principle (a failure to provide financial planning services in a manner that is fair and reasonable) in that it
is considered unfair for an adviser not to provide clients with all relevant information they require so that they may make informed choices as to whether or not to accept the advice given.

Another pattern identified in the ASIC banning order data in particular was that misleading and deceptive conduct and the appropriation of client funds were also associated with conduct such as falsifying documents and signatures and/or discretionary dealing in financial products without the consent of the client. These matters should have been identified by the AFS licensee’s compliance systems and
procedures.

If, as suggested by the theory2 that an organisation’s ethical climate helps to determine what advisers believe constitutes ethical behaviour at work and what criteria they should use to resolve ethical issues, then the presence of this type of unethical conduct suggests that an ethical climate based on self-interest may have been prevalent in these organisations.3

The ethical principle of competency is defined as providing competent financial planning services; maintaining the necessary knowledge and skill; and being professional, efficient and responsive in all dealings. Competency breaches such as the failure to provide adequate written advice (21 breaches) that met the client’s objectives or circumstances and that had a reasonable basis (28 breaches) were prevalent in the analysis. These were surprising findings, given that these ethical obligations are also legal obligations that have been prescribed by law since 2004 (see s 945A of the Corporations Act).

Generally, this form of unethical conduct was also associated with a failure to effectively undertake an assessment of the client’s tolerance to risk and then utilise that assessment appropriately, or to match financial product recommendations to the client’s specific objectives.

The implications

One of the current themes in hot debate within the sector is that the remuneration and ownership structures of AFS organisations and the failure to manage conflicts of interest associated with those structures have contributed to unethical conduct by financial advisers.4 Conflicts of interest have previously been ranked highly as an ethical issue identified by both management and employees as affecting Australian
business.5

The theory also suggests that remuneration and reward structures are contextual factors that influenced decision making within organisations.6 No decision by an external decision maker analysed for the purposes of this study overtly identified that a financial adviser had recommended a particular investment due to the pecuniary benefits that flowed to the adviser as a result. However, failures to disclose fees and commissions adequately, and the conflicts of interest associated with the receipt of these pecuniary benefits, were forms of unethical conduct identified by the analysis (23 breaches).

In addition, the systemic nature of some of the unethical conduct by financial advisers across numerous clients suggests motives other than the client’s interests for recommendations made. The receipt of high commissions and benefits from third parties as a result of financial product sales and recommendations to invest in financial products associated with their AFS licensee, whether or not it suited the interests of the client, were practices by financial advisers that were identified in this analysis. This was particularly so of advice to invest in managed investment schemes, although often by a representative who held authorisation to advise in one financial product only. It will be of interest to see whether the same patterns are repeated when advice associated with investments in Great Southern and Timbercorp, among others, is scrutinised as a result of legal action.

The results support the Future of Financial Advice (FOFA) reforms to ban commissions and volume-based payments from July 2012.

The data also demonstrated systemic instances of unethical conduct within AFS licensees by a number of advisers and across a number of clients. For example, the enforceable undertakings given by Patersons Securities Ltd (EU 017029204) and First Capital (EU 017029207) related to advice given to over 500 and 170 clients respectively.

Further evidence supporting this conclusion included the failure by some advisers and officers to follow internal procedures and policies (13 breaches); the failure to keep appropriate records of advice and ensure the integrity of records kept (10 breaches); and the failure of officers of the company to prevent contraventions and to protect consumers (six breaches).

It can be concluded from this data that some unethical conduct may have arisen because of systemic failures in the ethical frameworks within financial planning firms. This is a historical lesson well learnt but seemingly repeated in the sector at regular intervals. Current examples include advisory failures associated with Basis Capital and Lift Capital, as well as the collapse of the Storm Financial Group.

A message to licensees

Many of the forms of unethical conduct revealed by this research should have been identified by the AFS licensees’ risk management and compliance systems and procedures, but were not.

This suggests that the identification of ethical risks associated with the provision of financial advisory services is a difficult task which is not always appropriately undertaken.

The data also suggests a demonstrated failure in some advisory models and processes when advising on investments such as managed investment schemes. In most of the cases analysed, the advice to invest was simply not suitable to the particular client. The speculative nature and risks associated with the Westpoint promissory notes, for example, made them an unsuitable investment for some types of client, such as the elderly, persons from non-English speaking backgrounds, and consumers on low incomes. It is evident from the data that the current legal and ethical frameworks for financial product advice did not operate effectively to protect consumers in some instances.

The findings also raise questions as to the process currently used by some financial advisers to match financial products to the needs and objectives of clients.

Further, the complaints analysis highlights a pattern of overreliance on template statements of advice, that are not tailored to the client’s specific circumstances. A one-size-fits-all approach to the sale of financial products or strategies across client databases poses significant ethical risks. These risks are then compounded when that advice is disclosed through a statement of advice template, where only the
names and contact details of the client have been changed.

The message for compliance officers and responsible managers is as follows.

• Review your risk and ethics frameworks against the issues raised in this article, including the table showing the 10 most common ethical errors by financial advisers.
• Be alert to the overuse of template disclosure documents in the provision of advice and ensure documentation is appropriately tailored.
• Understand that financial advisers still struggle with concepts such as “reasonable basis” and “suitability” and often do not appropriately apply tolerance to risk assessments.
• Ensure that in transitioning to a fee-for-service model, your advisory divisions continue to adequately disclose all payments and soft dollar benefits received.
• Check advice to clients with special needs.

This should assist you in removing roadblocks to ethical outcomes within your organisation and in building organisational resilience to ethical risk.

FOOTNOTES

1 Source: June Smith, above note 1.
2 Martin K D and Cullen J B, “Continuities and extensions of ethical climate theory: a
meta-analytic review” (2006) 69 Journal of Business Ethics, pp 175–94.
3 Victor B, Cullen J B and Stephen C, “An ethical weather report: assessing the
organization’s ethical climate” (1989) 18(2) Organizational Dynamics, p 50.
4 Institute of Chartered Accountants in Australia (ICAA), Reinventing Financial
Planning, paper by Robert M Brown, ICAA, Sydney, March 2007, pp 1–17; D’Aloisio
T, “Regulating financial advice — current opportunities and challenges”, speech
given by the Chairman of ASIC to the Financial Planning Association of Australia
National Conference, Sydney, 28 November 2007.
5 KPMG, A View from the Top: Business Ethics and Leadership, white paper, KPMG
Advisory, KPMG in Australia, October 2005, pp 1–17.
6 Hegarty W H and Sims H P, “Some determinants of unethical decision behaviour:
an experiment” (1978) 64(3) Journal of Applied Psychology, pp 451–57

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If this is a myth, then let’s try it from another angle and consider the sheer cost to organisations of a lapse in organisational integrity in terms of money, distraction and reputation, as evidenced recently with the failure of organisations such as the Storm Financial Group.

The stakes are high. Poor ethical decision-making and unethical behaviour can be a function of a lack of organisational commitment or structure to establish an effective culture, where boundaries surrounding appropriate behaviour are well understood. This structure is only found in part in a traditional legal compliance framework, partly because its focus is on minimum behavioural boundaries, usually those set by the law.

Whilst compliance with the law is a necessary corporate motivator, history has shown it does not seek to improve general human excellence and distinction, nor does it guarantee business integrity and protection from all risks1.

Indeed compliance with the law represents a minimum standard of corporate performance that may fail to respond to key stakeholder expectations, such as Regulators and clients2. For example, whilst there is a legal requirement to disclose commissions and alternative remuneration payments made by third party financial product providers to financial advisers for the commercial sale of financial products to clients, the current view of some stakeholders is that these payments represent an inherent conflict of interest that should be
avoided by banning such payments.3

Promoting an ethical culture by rewarding ethical activities and by giving signals to employees/advisers that the organisation expects certain types of behaviour in certain situations, can be a positive force on individual behaviour and decision-making.4 It may also go some way to reducing the organisational costs of an integrity lapse and move organisations beyond compliance towards that new social mantra I spoke of earlier.

The importance of Ethical Culture to an effective business model

So what is ethical culture in theory and how can organisations influence that culture to achieve positive ethical outcomes within their organisations in reality.

I define the ethical culture of an organisation as a sub set of organisational culture. Theoretically, the ethical culture of an organisation is often articulated in the formal and informal systems of an organisation that are capable of promoting ethical or unethical behaviour.5 These formal systems include policies and procedures such as codes of ethics, authority and reporting structures, performance management systems, training and induction programs. Informal systems include expectations and perceptions about obedience to legitimate authority, peer behaviour and other ethical norms.6

These formal and informal systems define acceptable and unacceptable ethical behaviour for staff, agents and stakeholders of the organisation and can either promote a healthy or unhealthy ethical culture. Research7 has indicated that ethical behaviour should be higher in organisations where leaders and norms encourage, support and reward ethical conduct and discourage and punish unethical conduct through these systems.

Organisations which focus on a legal compliance framework to ensure they meet legal and ethical obligations also run the risk they will be viewed by stakeholders in the future as implicitly endorsing a code of moral mediocrity for their organisations. Enter again my proposition of a new social mantra. Even so, the failure to integrate compliance and ethical obligations into an organisational culture can be significant.8

Implementing the Right Systems and Procedures

So what kinds of systems and procedures should an organisation implement in order to make a difference? The Australian Standard on Fraud and Corruption Control9 8001-2003 and Appendix B of AS 8000 Good Governance Principles are a good start. These documents discuss eleven elements required for a sound ethical culture including an ethical framework, codes of behaviour, allocation of responsibilities, the establishment of ethics committees, communication, training, reinforcement and benchmarking, reporting of complaints and leadership and role modelling from the senior management group.

These are similar elements to those measured by the Ethics Resource Centre, EthicsCulture Survey (2003) and are also found in the Corporate Governance Principles of the Australian Stock Exchange.10

Whilst these Australian standards are not mandatory, they provide significant guidance and assistance concerning the establishment, operation and maintenance of such systems in an Australian context.

My recent PhD research on ethical decision-making within financial services organisations asked both financial planners and compliance officers to indicate the systems and procedures currently in place within their AFS Licensee that were related to ethical culture.

The Table below highlights nine ethical cultural systems and procedures required by the Australian Standard on Fraud and Corruption Control. Column three documents the percentage of respondents who positively identified their AFS Licensee as having that system. Column 4 shows the percentage of respondents who either answered “No” or “Don’t Know” to the question posed.

Table: Response rates concerning ethical culture systems and procedures within Australian Financial Services Organisations.

This data suggests that the financial services organisations that were the subject of the PhD survey appear to have traditional and overt ethical culture mechanisms in place, such as internal codes of ethics/conduct (81.8%); published sets of organisational values (78.2%); adviser training in ethics (73.9%) and whistleblower policies (77.0%).

Yet less than 50% of respondents believed their AFS Licensee referred to the ethical standards expected of staff in their performance systems (Q.7 – 47.9%); had regular reporting on ethical matters within the organisation (Q.5 – 47.9%) and had implemented formal reward systems for ethical conduct (Q.9 – 21.2%). There was also a very low “yes” response rate of 51.5% to Question 6 (Does the Licensee have enforcement mechanisms such as a staff /adviser disciplinary policy?).

The table reflects a 60.2% range between the highest score of 81.8% for the presence of an internal Code of Ethics/ Code of Conduct (Q1) within AFS Licensees, to 21.2% for the presence of formal reward systems for ethical conduct (Q.9).

Given the presence of all nine systems and procedures within an organisation at a minimum and their enforcement through action and leadership can reduce the occurrence of unethical behaviour and poor decision-making, the results outlined in the table are surprising and suggest that there is a current gap in this area.

The question that remains is how effective are the systems and procedures in instilling the organisation’s ethical values and conduct standards into every day practice even when they are in place? The answer may lie in whether the values and standards are communicated, reinforced and upheld. It may also depend on whether those values and standards are exercised by those in positions of authority or whether other organisational norms are allowed to send inconsistent messages.

The data from the survey seems to answer these questions in the negative. Within the financial services organisations studied, the regular reporting of ethical matters was very low (Q.5 – 46.7%). Further, nearly 40% of respondents did not believe or did not know whether their AFS Licensee even had enforcement mechanisms, such as a staff /adviser disciplinary policy (Q.6 – 39.4% No or Don’t know).

If these results are representative of a lack of enforcement mechanisms across organisations, this may be compounding the ability of compliance officers and management to take enforcement action against unethical staff. However, even when such systems are in place, a focus group of respondents conducted as part of the PhD study, perceived that a lack of organisational will to use enforcement mechanisms was one of the top five ethical dilemmas facing management.

These results also demonstrate that some conventional mechanisms, which may assist management and compliance officers in instilling and enforcing a strong organisational ethical culture, may be lacking within organisations. This includes systems and procedures linking ethical behaviour with performance and reward systems.

Further, it can be inferred from the results that the communication and reinforcement of ethical values and behaviour within organisations may be lacking. It is difficult otherwise to reconcile that 71.5% of respondents answered either “No” or “Don’t Know” to question 9, concerning whether people who achieve high levels of ethical conduct within financial services organisations are rewarded.

Whilst offering rewards for ethical behaviour does not necessarily increase that behaviour11, a lack of mechanisms for rewarding ethical conduct in circumstances where there are rewards for reaching pecuniary targets, may send ambiguous messages to an organisation’s staff and agents as to which behaviour is valued more highly, with bonuses and other rewards for meeting sales and finance targets thought to adversely influence ethical decision-making.

The Australian Standard on Fraud and Corruption is not mandatory and its application is subject to size and turnover requirements, amongst other conditions. However, ASIC Regulatory Guide 164 (ASIC 2002a) envisages that AFS Licensees should use such standards as a guide to assist them to meet licensing obligations and to promote a culture of compliance. In addition, the Australian Standard on Compliance Systems 3806-200612 expects organisations to commit to full compliance with laws, industry standards and ethical obligations. Accordingly, the finding of such low rates of compliance with this Australian
Standard amongst the AFS Licensees that were the subject of the PhD study was surprising.

So Lets Recap

There may be a significant gap between the types of formal and informal systems that are in place within financial services organisations related to ethical culture and those that would be expected to be in place pursuant to the relevant Australian corporate standards.

My suggestion: take my test and answer the nine questions used in the PhD survey. Then ask yourself:

1. Does our current compliance framework include these systems and procedures?
2. How do we communicate the organization’s values to staff and report on ethical risk?
3. Have we linked outcomes from compliance audits to performance management systems and do those audits include reference to key indicators concerning ethicalconduct and citizenship?
4. Are we able to effectively use enforcement mechanisms to discipline those who engage in unethical conduct?

The implementation of the formal and informal systems and procedures identified in this article will influence ethical behavior and decision-making within your organization. It will assist you to build organizational resilience to ethical risk within your business and to establish behavioural and decision-making boundaries required for staff and agents alike.

FOOTNOTES

1 Petrick, J. A. & Quinn, J. F. 1997, Management Ethics: Integrity at Work, Sage Series on Business Ethics, Sage Publications Inc, Newbury Park, California
2Etkind, S. 2005, ‘Global round up’, Financial Services Newsletter, vol. 4 no. 2, Lexis Nexis, Sydney, p. 28
3 Taylor, M. 2005, ‘ACA reopens commissions debate’, 6 October, viewed http://www.superreview.com.au/articles, on 7 October
4 Weber J. 1993, ‘Institutionalising ethics into business organisations: A model and research agenda ‘, Business Ethics Quarterly, vol.3, issue 4, pp. 419-436

5 Trevino L. K. & Youngblood, S. A. 1990, ‘Bad apples in bad barrels: A causal analysis of ethical decision making behaviours’, Journal of Applied Psychology, vol.75, pp. 378-385.
6 Trevino, Butterfield and McCabe, 1998, ‘The ethical context in organisations: Influences on employee attitudes and behaviors’, Business Ethics Quarterly, vol.8, issue 3, pp. 447-476.
7 Ethics Resource Center 2005, ‘The 2005 National Business Ethics Survey’, Ethics Resource Centre, Arlington, Virginia, May 21, p 78; p 80.
8 Owen, N. 2003, Final Report: Royal Commission into HIH Insurance Group, Government Printer, Canberra
9 Standards Australia, 2003a, AS 8000-2000: Australian Standard on Good Governance Principles, 23 June, Standards Australia International, Sydney. Standards Australia, 2003b, AS 8001-2003: Australian Standard:
Fraud and Corruption Control, 23 June, Standards Australia International, Sydney.
10 Australian Stock Exchange Corporate Governance Council, 2007, Corporate Governance Principles and
Recommendations, 2nd edition, ASX Corporate Governance Council, Sydney

11 Trevino & Youngblood 1990, op cit.
12 Standards Australia, 2006, Compliance Programs AS3806-2006, March, Standards Australia, Sydney.

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The purpose of this study was to enhance understanding of the ethical decision making of these financial planning participants within this context. This study is therefore a significant one in what is a relatively under-researched area of interest.

The study’s purpose was converted into seven research questions, two of which concerned the primary types of unethical conduct occurring in the provision of financial advice and respondent perceptions of the current ethical issues they face in their respective roles within financial services organisations. Nine hypotheses were linked to the other research questions to measure whether there were statistically significant relationships between different constructs, and to test respondent perceptions of the ethical climate and culture of their organisation.

The conceptual framework underpinning the study recognized that there are numerous individual, situational and contextual predictors of ethical decision making. The predictors measured in this study included cognitive ethical reasoning and other individual attributes of the decision maker, such as their gender (H1), age, education, experience and accreditation to use the CFP® professional designation (H2).

The study also measured the influence of the situational and contextual factors associated with the organisational environment in which the decision was made. construct measured was the size of the organization (Hitt 1990)(H3). Contextual factors included remuneration source, (Bigel 1998) (H4), the respondent’s role within the organization (Pennino 2002; Martin 2000) (H5), the ethical culture (Trevino, Butterfield & McCabe 1998) (H6) and the ethical climate of the organization (Victor and Cullen 1988) (H7 & 8), and the presence of ethical leadership (Schminke, Ambrose & Neubam 2005) (H9).

The research design utilised a mixed methods approach comprising both quantitative and qualitative research methods to test the seven research questions and nine hypotheses posed. The quantitative methods adopted included an analysis of consumer complaints against financial planners between 2006 and 2007, so as to determine unethical conduct patterns. A research questionnaire was also developed for the purpose of hypothesis testing. Qualitative methods adopted included the convening of a focus group to test perceptions of the current ethical issues facing financial planning participants.

The primary dependent variable of cognitive ethical reasoning was measured by a profession specific test developed for the purposes of this study, called the Financial Advisory Issues Test. This instrument was based on previous research instruments, including the Defining Issues Test 2 developed by Rest et al. (1999b). The instrument was influenced by Kohlberg’s (1976) model of moral development and Rest’s (1984) theory of ethical development schemas. In addition, the ethical culture and climate constructs measured in this study were also operationalised by scales derived from previous research conducted by Trevino (1986) and Victor and Cullen (2001).

To achieve the study’s objectives, a number of different methods of data analysis were applied, including descriptive statistics, Pearson’s product-moment correlation co-efficient and Spearman’s correlation co-efficient. Correlation and regression analysis were chosen as the primary methods of data analysis because they are based on linear method, depend on normality assumptions and do not test for causality (Hansen & Morrow 2003).

The study identified the ten primary forms of unethical conduct by financial planners in 2006-2007 and the top five ethical issues facing financial planning participants in their respective roles. The major conclusions drawn from the hypothesis testing included findings that cognitive ethical reasoning among respondents was positively related to older age, years of experience and the CFP® professional designation, thus reaffirming previous research findings by Bigel (1998).

The study also supported conclusions that financial services organisations may not have in place relevant systems and procedures associated with ethical culture and compliance officers and financial planners have different perceptions of the ethical climates within financial services organisations. Perceptions of ethical leadership within an organisation were also positively correlated to certain ethical climate types.

The study makes numerous theoretical contributions to the existing academic knowledge base. In particular, it provides a comprehensive analysis of the patterns of unethical conduct in financial planning and the ethical issues facing financial planning participants in their respective roles. Further, it makes a significant contribution to the knowledge related to the ethical decision making of the respondent groups and the individual, situational and contextual factors that influence it. This thesis has also enhanced knowledge of the attitudes and perceptions of financial planning participants of the ethical culture and ethical climate within Australian financial services organisations. In addition, the study makes a practical contribution to financial planning as it identifies gaps in existing ethics frameworks within financial services organisations.

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