(Click here to see CPD: Professional Ethics #1  and here for CPD: Professional Ethics #3)

Graeme is the founding principal of a modest financial planning firm that employs two advisers and two support staff and which has its own Australian Financial Services License.  The firm has just over two hundred clients with around $120 million of portfolios under management.  Many of the firm’s clients have been with Graeme since he established the business in the mid-1980s and as such, are well into their retirement years. He has a very strong professional relationship with his clients and some have become good friends with him.

He regards his nephew Mark as the ‘son he never had’ and they are very close with Graeme filling the paternal void left in Mark’s life after his father died when he was just nine years of age.  Mark is employed with a technology company as its Director of Marketing and he holds 12% equity in the business. The company, ‘TeckEth’, listed on the share market last year with an initial pubic offering that saw 40% of the company sold to investors. The IPO price resulted in a day one market capitalisation of TeckEth of $350 million that saw Mark’s equity valued at around $42 million.

Revised forecasts

However, since listing, TeckEth’s share price has fallen dramatically due to ongoing market concerns about the company’s recurrent failure to meet forecast new product launch dates.  On the back of statements to the market by TeckEth, analysts have revised their earnings forecasts downward and the resultant decline in share price now sees Mark’s equity valued at just $5 million.  In effect the share price has been savaged and the company is going to be hard pressed to meet market expectations unless it can raise $20 million to finalise the Beta testing and subsequent marketing of its new software product.

During their regular ‘last Friday in the month lunch’, Mark explains to Graeme the predicament that TeckEth is facing.  He explains how he believes the company’s share price should return to a substantially higher level once the new software is launched and earnings improve.  Mark delicately raises the question of whether or not Graeme would be able to assist with the raising via recommending it to clients of Graeme’s firm.

Overly pessimistic

Mark goes on to explain that due to falling support for the share price, all of which in Mark’s mind is overly pessimistic, the underwriting broker is not confident of getting all the otherwise modest capital raising filled.  From previous discussions Mark knows that Graeme’s firm manages over a hundred million dollars for clients and suggests to him that a $5 million allocation would represent a relatively small amount of the firm’s overall portfolios.

Graeme explains to Mark that he would need to give the idea very detailed consideration because of the risks involved in technology companies.  As he says that he sees Mark’s facial expression change from one of warmth to one of concern.  It prompts him to say to Mark: “Don’t worry, mate – I’ll see what we can do – but I can’t promise anything – you know that don’t you?”

Subsequently, Graeme begins to think the request through more fully as he drives back to the office.  He knows that there is risk involved with a company like TeckEth but on the other hand, he tells himself, it would be nice to have an investment that is a real winner – an investment that really delivers on capital growth during what has otherwise been a difficult period for portfolios in terms of growth.

Graeme’s clients are mostly retirees and his approach to portfolio construction for them for very many years has centred on allocations to assets that deliver consistent, competitive, income streams in a tax effective manner.  His much-stated mantra to clients of ‘income over growth’ rings loud in his ears as he ponders the discussion with Mark.  He thinks about the extra cash all portfolios have held for several years now and the return on which is declining as the central bank continues its easing program.  He begins to justify such a recommendation to clients on the basis that it would represent a small proportion of portfolios – less than 5%.

Recommendation

Three weeks later and Graeme is writing a letter of recommendation to all clients to apply for shares in TeckEth via the capital raising.  In his advice document Graeme goes to great length to point out that the investment is high risk with no guarantee of success.  He explains that there is a chance that the company could fail completely and that could result in the total loss of capital.  However, he goes on to say that the forecast earnings for the company, once the new product is released, is expected to result in a fully franked dividend of 3.50% p.a. and that this will see the investment fall into line with the firm’s preferred requirements.  Graeme pointed out, in the letter of recommendation, that he too was going to personally invest in TeckEth as he knew this would give clients, particularly the more cautious clients, the final piece of comfort they would need to follow his advice.

In the back of his mind, as he drew closer to completing the letter of recommendation, was the issue of his relationship with Mark.  Graeme knew he was conflicted but justified his actions by the fact that he was also going to be taking the risk – right alongside his clients.

In the following weeks almost all of Graeme’s clients accepted his recommendations and TeckEth was successful in getting all but a million dollars or so of funds required with the shortfall being met by the underwriting broker. After the raising, the share price initially remained relatively stable, in line with overall market movements.

However, several months later the share price moved 25% lower in one day’s trading following Tecketh’s announcement that its Director of Product Development has resigned citing a ‘desire to pursue other endeavors’.  The market knows how to read resignation code and instinctively discounted the share price knowing that there were serious internal problems at TeckEth.  The share price languished for several more weeks while the company commenced a recruiting process and during this time Graeme was under considerable duress as he worried about his clients and the value of their TeckEth holdings.  He constantly agonised over whether or not he should recommend that clients sell their holdings or simply ‘ride it out’?

Mark missed the last two ‘last Friday in the month’ lunches with Graeme and so Graeme phoned him to see if all was well.  Mark was harsh in his criticism of the market’s pessimism about TeckEth and went on to say that he was facing a pay cut because it had become obvious that the product launch would now face further delays.

Graeme, thought it time to front Mark with the question: “Do you think I should sell?” Mark advised in the negative citing the big lift the price should enjoy once the product launched.  Mark claimed that independent analysts have confidentially reported to the board that a product launch that achieves 75% of targets should underpin a substantial lift in the share price – well beyond the IPO price.  On current pricing, on average, clients are facing a loss of around 30% of an investment that originally represented around 4% of their portfolios.

Added complexity

The other adviser in Graeme’s business, Susan, has 10% equity in the firm and has been increasingly concerned about the TeckEth situation.  She is is perplexed as to why Graeme wanted to recommend it in the first instance and why he is now equivocating over whether or not to recommend a sale now.  Susan believed that Graeme had ‘railroaded’ the Investment Committee meeting when he proposed that they recommend it to clients.  She could not understand why Graeme had stepped outside an asset selection process that had been successful for very many years but, as a minority shareholder in the firm, felt she could not override his strident push to recommend it to clients.

Postponed

Over the last three months Graeme has postponed the monthly Investment Committee meetings telling Susan “There is too much on right now – it’ll just have to wait.”  Ordinarily, a matter such as TeckEth would be on the agenda at such meetings and the two advisers would form a consensus view to either confirm a ‘Hold recommendation or a ‘Sell’ in regard to assets on the Approved Products List which were causing concern.

In recent meetings with clients, Susan has found it increasingly difficult to speak with conviction about TeckEth.  Some clients, those who are more attuned to what’s happening in general in markets and who read the daily commentary in mainstream media, have asked her what is the firm’s view on TeckEth given its problems?  She has struggled between telling clients what she really thinks about TeckEth – that they should sell it – and what the current ‘House View’ on the company is which is, based on an Investment Committee meeting four months ago, Hold.

Disclosure, finally

Susan final manages to pin Graeme down to hold an Extraordinary Investment Committee meeting to specifically focus on TeckEth.  As Graeme opens the meeting, she can’t help but notice how reserved he is – how reticent he seems to be about getting the discussion started.  After a minute or so of hesitation, Susan cuts straight through and says: “Look – I’ve got no idea why you wanted to recommend this in the first place but you’re the boss so you always get the final say. It’s bizarre, Graeme, TeckEth is completely left-field of what we normally do for clients – why on earth are we in it?”

Graeme is stumbling to find the words he’s wanted to say for months now but resisted hoping that things would improve for TeckEth and save him from the certain professional and personal embarrassment a full disclosure would cause.  Finally, he comes clean to his business partner and tells her of his relationship with Mark at TeckEth.  She is furious with him but doesn’t say so to him and the meeting concludes with a decision to review the issue next week after, at Graeme’s suggestion, he speaks to Mark again.

A rock and a hard place

That night, as she confides in her husband about the conflicted position she unwittingly finds herself in because of Graeme, Susan contemplates resigning from the firm but is worried about the impact on her 10% equity in the firm.  Over the last three years Graeme has transitioned more than half the clients to her and if she leaves there might be cash flow issues for Graeme’s business if the clients were to follow her to another firm. This would undoubtedly deleteriously impact on the value of her investment in the firm.

Simultaneously, she knows there are restraint of trade clauses in her partnership agreement with Graeme.  She is between the classic ‘rock and a hard place’ – if she resigns on a matter of professional principle she has no certainty of income and risks losing value in her 10% equity in Graeme’s business.  On the other hand, she knows the firm has breached disclosure requirements and that in order to become fully compliant, clients will have to be notified of the conflict. She knows that would jeopardise the professional relationships with clients and the fees they pay which makes the business solvent.

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Conducted by Dr June Smith through Victoria University, the research: Ethics and financial advice: the final frontier, looks at ethical and professional issues associated with the provision of financial advice in Australia. The research represents one of the first studies of its kind in the world.

The study revealed a real reputation risk for financial advisory firms that cannot ensure their planners can meet ever increasing ethical and conduct standards.

Significantly, advisers who hold a professional designation or accreditation were found to have higher ethical reasoning levels than those who do not. In particular, CERTIFIED FINANCIAL PLANNER professionals had the highest level of ethical reasoning and as a result are best prepared to face complex ethical dilemmas in daily practice.

“Ethical conduct and behaviour are pivotal to the ability of financial advisers to retain the trust and confidence of clients and to ensure quality financial advisory outcomes,” Dr Smith said. “Financial Planning, in particular, is also an emerging profession both within Australia and internationally, and requires a strong ethical context to meet stakeholder expectations concerning the conduct and behaviour of its participants.”

“The findings in this study suggest that all financial advisers within the sector should be encouraged to join a professional association and undertake ethics training and education courses as part of an accreditation process.”

The study also recommends financial services organisations use CFP® practitioners in ethical leadership and mentoring roles and supports the move to a professional year in line with FPA standards.

In its new three year strategic plan launched in late 2010, the FPA proposed that from July 2013, new members require an approved undergraduate degree (or higher) qualification and undertake a supervised professional year program to ensure they earn the right to represent FPA professionals in the community.

“As this research concludes, the Future of Financial Advice reforms (FOFA) are just a first step in raising  the conduct and professional standards within the financial advisory sector,” FPA CEO Mark Rantall said.

“Higher educational standards, adherence to a professional Code of Ethics and exposure to professional obligations raise industry standards and best protect the financial future of all Australians.”

For a copy of the research report please click here.

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• 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.

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The FPA previewed its new advertising campaign to conference delegates on the Gold Coast last week. Its focus is on the professionalism of its members. It comes mere weeks after the AFA’s own advertising initiative was launched at its conference also on the Gold Coast. Its message focuses on the need to plan. Both associations have recognised the need for the public to be made aware of professional financial planners and financial planning. They both see a need for the public to recognise their own members are operating under strict ethics and standards – as opposed to financial planners not members of the associations.

Selling the value of advice is almost 20 years in the making, with promises from the FPA of promoting the brand to consumers emanating from its very first conferences. And it follows the cringe-worthy Dazza campaign of some years ago. Its current idea is to promote planning so that at a local barbecue, a FPA member can talk with pride about his profession among his mates.

The FPA stated its mission is to focus “on the things that will elevate our industry to a universally respected profession”. “Financial planning is a young profession, still in its infancy. We may feel a tad envious of the respect that some other professions command, but they’ve been at it for a lot longer – the medical profession first pledged the Hippocratic Oath 2500 years ago.” (from the FPA’s new brand marketing document). Again, the association compares itself with doctors. Is it perhaps a tad arrogant, and certainly not doing itself any favours by perpetuating the comparison? Despite this, the aim of the FPA becoming an association of which its members “adhere to the highest standards of professionalism, inspiring trust and confidence in the community” is certainly achievable, admirable and aspirational.

The FPA has priced its advertising offering on behalf of planners at $220 a year from each member (or $20 a month). The AFA has asked its members for voluntary donations to its “Make a Plan” campaign. It is estimated to be looking at raising over $2.5 million, with firms contributing what they can and some pitching in up to $10,000. While the AFA is looking at a $2.5 million ad spend, the FPA has a large war-chest of its own and is going to claim an additional $1.76 million from its members each year of the 5-year campaign – so its spend can be much larger.

Running dual advertising campaigns will confuse the consumer in an already acknowledged over-complicated industry.

Perhaps to really promote financial planning in the community some more co-operation is needed.  The associations need to agree ethics, educational standards and promote professionalism in tandem.

It is, after all, a single profession no matter which industry Association one supports. Many financial planners are members of both associations from which they derive different value. How can we expect to capture the public with fractured industry campaigns? The industry funds were able to successfully express their message because they were united. At this time, surely we can all see the benefits of a united front?

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A greater focus on ‘responsible investing’ has seen many companies becoming good corporate citizens; examples include companies that rejuvenate land they have mined or contribute to the wellbeing of communities in which they operate.

Increasing investor appetite for such companies led to the emergence of a number of funds, varying described as ‘ethical’, ‘socially responsible’ or simply ESG (which stands for environment, social and governance). Each year, Lonsec researches and rates a number of funds so categorised, to help advisers find the applicable products for their clients.

How to categorise ‘responsible’ funds

The following broad definitions are a guide:

1. Ethical: Negative screening of companies in certain industries deemed to have a harmful societal impact. Avoiding investments in bad companies is the overarching investment motivation.
2. Socially Responsible Investing (SRI): Generally negative screening of certain sectors in line with above but may also include a positive screening element seeking to include socially responsible companies. Rewarding good corporate citizens is a partial investment motivation.
3. Sustainable investing (ESG): A belief that those companies with advanced approaches to environmental, social and governance risk management will exhibit superior performance than companies with sub optimal approaches. While it is likely that these companies will tend to rank highly on corporate ethics, unlike ethical investment, financial performance is the overarching investment consideration.

Lonsec takes fund categorisation a step further, focusing on the depth of responsible investment factors incorporated into the investment process; the output of which is a light, medium or dark green rating.

These classifications are aimed to give a general indication of Lonsec’s assessment of the level of ethical / Socially Responsible Investing (SRI) / Environmental, Social and Governance (ESG) criteria applied to, and evident in, the Manager’s investment process. The classification is not intended as an investment rating or recommendation.
Lonsec categorises the funds in its Responsible Investment universe as follows:

Client considerations –not a one-size fits all

ESG and sustainable investment funds now tend to dominate the Responsible Investment sector replacing traditional ethical and SRI approaches. Broadly, the market seems to have less appetite for funds focused solely on avoiding corporate bad guys compared to those investing in sustainable companies.

Despite progress, the sector still presents challenges for those providing financial advice. Investors in this sector are broadly grouped together under a ‘Responsible Investment’ categorisation, though bring different investment motivations which can make it tricky for advisers to confidently select investment managers for clients. Importantly, Lonsec believes that with some research, responsible investment investors can relatively easily determine a more suitable investment option for their needs than provided by a mainstream equities fund. The following are suggested priority areas for consideration in discussion with clients interested in this sector:

How Green is my client? It is important to sample investors’ green motivations. While Responsible Investors are commonly linked by a motivation to take account of a broader range of factors than solely fundamental financial analysis in their investment decisions and a concern about the community impact of corporate activities, the investment motivations can vary greatly across the sector. Ethically motivated investors may be aggrieved to allocated capital to major miners such as BHP and RIO, while ESG investors may be comfortable with such holdings given those companies’ risk management practices, community engagement, workplace safety record and so forth.

Does investment team buy-in matter? The level of ESG engagement in portfolio management teams varies across the sector. Lonsec believes this aspect is an important credibility test for investment managers and most likely a central consideration for investors in these products. In general a portfolio manager who is motivated and engaged with the Responsible Investment agenda brings added focus to the fund and is an important factor in increasing alignment of interest with investors. While Lonsec is primarily interested in the investment credentials of the Manager, whether the investment team is displaying a degree of engagement with the responsible investment sector is a relevant consideration in Lonsec’s appraisal of these products. This may be evident through the inclusion of positively screened companies at the margins of the portfolio where supported by the underlying investment research. Factors such as elevated corporate commitment to the sector, evident in participation in industry forums, production of research papers and company engagement can also suggest increased motivation.

Manage performance expectations. Spend some time with clients to discuss performance expectations. The depth of ethical screen can significantly constrain the investment universe and may have a performance impact during periods when certain sectors outperform (e.g. materials). Similarly, the screen can make it challenging to obtain adequate diversification in portfolios. The inclusion of a significant weighting to small caps in some funds may alter the risk/return characteristics of funds (e.g. resulting in higher tracking error versus traditional large cap core Australian equity funds).

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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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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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It is a move that has won the support of the FPA, which is already taking a keen interest in the Standards and how they operate in practice. It also represents another tangible expression of Centric Wealth’s very public commitment to moving the advice sector toward true professional status.

According to John McMurdo, Chief Executive, Centric Wealth, there is a clear distinction between what the Centric Wealth Standards offer, which is a benchmark and framework for best practice, and the proposed mandated standards arising from the Federal Government’s Future of Financial Advice (FoFA) reforms.

“We have always welcomed and supported the FoFA reforms and continue to do so,” said McMurdo at a media event announcing the release of the Standards in Sydney today. “However they very clearly represent a much-needed minimum requirement rather than a best practice one which is, in our view, equally important. Centric Wealth believes that Australians should be able to access the best wealth advice available. That is what our Standards seek to encourage.”

The Standards encompass the FPA’s Code of Professional Conduct and go on to cover areas such as education, ethics and governance. They include requirements for both initial and ongoing education and training, including a mandatory Professional Internship Program; the ‘Centric Wealth Promise’, a written commitment to meeting defined ethical and service standards signed annually by all advisers; and the institution of a Client Advisory Board.

“There is a significant groundswell of support in our industry to improve the quality of advice, the reputation of planners and to move the industry as a whole toward professional status, in line with that of accountants and lawyers,” said McMurdo.

“We actively encourage and support constructive moves by members of our industry to promote improvement in advice standards,” said Mark Rantall, CEO of the FPA. “We believe that a concerted move toward a clearly articulated best practice model by industry leaders is what’s needed to drive change for the better. I think it’s also important to note that, as well as providing greater assurances around the quality of advice, adopting a higher bar also provides greater clarity around two other vital areas: that is, what clients can rightly expect and what advisers can objectively deliver.”

Non-Executive Centric Wealth Director Chris Cuffe said “Although professionalism is what our advisers already stand for, I am pleased to be part of our efforts to take it to the next level with the formation of the new Professional Standards and Ethics Committee that includes representation by an independent external expert.”

Mr Cuffe went on to stress that Centric Wealth is in a strong position when it comes to the institution of this Standard. This includes the ability to apply it to all clients, both new and existing, another feature that sets it apart from the proposed FoFA reforms.

“It is our firm hope that these Standards will become a clear roadmap to the kind of best practice our whole industry needs. It is a pioneering move and we know it will take time to meet all the requirements of the Standard.

However we believe that this is what’s required to lift the bar and move our profession to the next level and deliver the best financial outcomes for our clients, so this is what we are doing.”

For the full Centric Wealth position, please click here.

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The Self Managed Super Fund Professionals’ Association (SPAA) has called for amendments to an Accounting Professional and Ethical Standards Board (APESB) Exposure Draft, which, in its current form, will prevent SPAA members, who are also members of certain accounting bodies, from charging asset-based fees. While SPAA is opposed to commissions or fees embedded in a product, the association believes the definition of fee for service should be broad enough to reflect the skill, experience and level of complexity of the work being undertaken and be flexible enough to permit negotiation between a professional adviser and their client.

The APESB governs the rules by which many professional accountants must conduct themselves. A large proportion of SPAA’s members are accountants who also work as financial planners and are likely to be
affected by this proposed new standard.

“SPAA has taken a keen interest in reviewing the Exposure Draft on APES 230: financial advisory services because we believe it imposes unreasonable and unsustainable obligations on some SPAA members, namely accountants working as financial planners,” said Andrea Slattery, SPAA CEO.

“SPAA is committed to the highest professional standards, therefore we support the APESB’s proposed ban on commissions. However, unlike the APESB, we support an SMSF adviser’s right to charge assetbased
fees for service where these are not embedded or set by the product provider. As long as the fee has not been set by the product provider, advisers should have the right to charge a fee which has been agreed to by the client and reflects the services provided. We also note that the Federal Government’s proposed Future of Financial Advice Reforms (FoFA) does not seek to ban asset-based fees either.”

“In our comments on the APESB Exposure Draft, we also expressed our concern that the proposed APESB standard has an implementation date of July 2011, one year before FoFA is due to take effect.”
Ms Slattery said the Government consultation process would highlight other issues that should be considered before the release of APES 230.

“We agree APES 230 should apply to existing clients but only after an appropriate transitional period. It is difficult to foresee how a regime which provides for different standards to be applied to different clients
would be sustainable or desirable over the longer term. This transitional period should be sufficient to enable advisors to make the necessary changes to their existing charging practices and to ensure clients
can be transitioned to a new fee charging regime in an efficient and orderly manner,” Ms Slattery said.

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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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