Claire Wivell Plater

The Australian Securities and Investments Commission (ASIC) is reminding Australian Financial Services (AFS) licensees that significant or likely breaches of their obligations must be notified within 10 days.

Managing Director of The Fold Legal (The Fold), Claire Wivell Plater says in ASIC’s view, AFS licensees become aware of a breach when the person responsible for compliance becomes aware of it. “However, they are often reluctant to report breaches until they have been considered by their directors or lawyers; they have rectified the breach; or, in the case of likely breaches, the breach has actually occurred.”

Ms Wivell Plater says ASIC is concerned that lengthy efforts to rectify a breach, even if well-intentioned, can compromise the regulator’s ability to take action. “Licensees should not panic when faced with a breach, because ASIC has indicated a strong willingness to work with licensees who take their breach reporting obligations seriously,” she says.

The industry received a heads up that ASIC is reviewing breach reports and licensees considered to be at high risk of non-compliance, in a speech made by ASIC Deputy Chairman Peter Kell to the Risk Management Association of Australia CRO Forum this week.

Ms Wivell Plater says ASIC makes decisions about what matters to prioritise for investigation from industry intelligence. “ASIC does not take action in relation to every breach but does look for patterns of misconduct within individual firms or across a market sector. ASIC also considers whether AFS licensees have robust systems for identifying and reporting problems.”

ASIC may consider an inadequate or late notification to mean that breach identification and reporting systems of the AFS licensee are not robust and/or that they have poor compliance culture, she says. “Failure to report a significant breach in itself is a breach. Not reporting until the problem is fixed can get licensees into more trouble than the underlying breach.”

If a licensee is already working on or has rectified a breach and it’s not serious or systemic, ASIC may decide not to make any further enquiries. “If the breach has not negatively impacted a consumer and no market harm has been done, ASIC may be willing to provide technical relief from the law or a no-action position. But the bottom line is, when in doubt, report.”

The Fold has extensive experience and a good track record in working with licensees and ASIC to efficiently minimise the impact of breaches.

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Ken Blayney has extensive industry and business experience and expertise gained over 25 years working for a number of financial services companies in senior sales and management positions.

In welcoming Ken Blayney back to the dealer group, Peter Daly said he was one of AFS Group’s most successful Regional Managers and the organisation’s West Australian and South Australian based advisers and practice managers have warmly welcomed his return.

“2012 will be a milestone year for the AFS Group,” said Peter Daly. “We are most definitely in growth mode and the programs and initiatives that will be delivered during the course of the year will positively position the dealer group’s advisers to capitalise on unprecedented business expansion opportunities.”

Ken Blayney commenced on 3 January in his role as Regional Manager and will be based in AFS Group’s Perth office.

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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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