In 1995 I presented a paper, at the FPA’s annual conference, titled: ‘Gaining control of your business destiny – becoming a licensed dealer’ (prior to the Financial Services Reform Act, 2002, most licensees were known as ‘Licensed Securities Dealers’.  The key messages in the paper were around the advantages (and disadvantages) of advisers having their own license.  In 1995, the incentives were driven around profitability along with advisers having the capacity to build their own business with much greater flexibility. In that regard, nothing much has changed.

Many advisers the nation over would be familiar with both the advantages and disadvantages of being attached to what are most often larger capital city based licensees. Representative advisers have to take the good with the bad and there are entries of both sides of that ledger. But for advisers who have been around for a while, they reach a point where they question the value they receive for the contractual obligations they submit to in being attached to a licensee.

Some decide that they’re happy to keep on keeping on with their licensee while others – perhaps those with a more entrepreneurial spirit – decide that they need to have a much greater say in how they build their business and the advice they give to clients.

In raw commercial terms, for very many financial advice business owners attached to a licensee, there reaches a point where the fees paid to the licensee outstrip what it would cost for the adviser to operate her own license. And it’s at that point that many will question the value for money. Those who really understand their business will know well before that point is reached.

Notwithstanding, frankly, I don’t think becoming an AFS Licensee is for every adviser – many really should stay under the hopefully ever watchful supervisory eye of a larger organisation. However for others with sufficient experience and education, it’s a viable opportunity to really build something of significant value in their business. In addition, it remains a mark of distinction that an individual has been prepared to step up to the plate and, in effect, make a statement that she is extremely serious about her legal obligations to clients.

The bottom line with becoming an AFS Licensee is that for most advisers, their largest asset (their business) is on the line for damages recovery if they are found to be negligent. While litigation can eventually find its way back to ‘representative advisers’, I think there is a lot to be said for advisers taking first and full responsibility for the advice they give.

Despite the seemingly incessant legislative change environment that financial advisers continue to work under, I suspect that we will witness a continuation of this trend for advisers to make application for their own AFSL. As I alluded to earlier it represents the professional maturation of the current cohort of Australian financial advisers.

For some larger licensees, within this trend lies opportunities for them to provide services to advisers establishing their own AFSLs. For many it will mean a rethink of their business model with the associated strategic planning issues. If the trend were to ‘morph’ into a groundswell of movement to quasi individual AFSLs, some larger licensees might not survive.  But that’s evolution in its purest form – it’s not the largest that survive but those that are best able to adapt to a changing environment.

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“Recent events and judicial comment highlight the need for a broad review of licensing criteria for Responsible Entities, as the current approach is clearly failing many investors.

“There is increasing evidence that existing licensing criteria are now weighted too heavily in favour of fund promoters, without adequate consideration of who they are,” he said.

Mr Kalman pointed to recent comments by Supreme Court of Victoria judge Justice Judd, where he said that there was irreconcilable conflict between a particular manager’s duty to investors and its self interest regarding its role as Responsible Entity.

“New legislation may not necessarily be required, as the clear conflict of interest of fund managers and scheme promoters, and the inadequacies of investor protection that are increasingly apparent, can largely be corrected by strengthening licensing requirements,” he said.

Mr Kalman added that the Wallis Report released in 1993, which led to the introduction of the Responsible Entity concept, was called “Other People’s Money”.

“However, this investor protection factor appears to have been eroded. It is not only that the Responsible Entity concept has generally evolved into something less than was envisaged at the time, it is also that collective investments now being developed and offered to investors are more complex than when the Responsible Entity concept was developed and finally introduced.

“We have seen increasing mismatches between the complexity and liquidity of managed investments, and the type of investors to whom they are promoted – for example open-ended, daily priced, direct property funds offered to retail investors.

“As Responsible Entities are a relatively new concept, they are previously untried in a crisis and have not been used elsewhere in the world. The concept clearly appears to have weaknesses that have been exposed by the financial crisis and now need to be addressed.

“While the financial strength of a Responsible Entity and the people behind the fund is important – so that there is someone left standing, and worth suing if there is inappropriate behaviour – there are other areas requiring examination that are just as critical.

“Better investor protection starts with recognition that many investment schemes are now extremely complex and that there is a need for a greater degree of separation between a fund manager and the Responsible Entity.

“Greater deterrents in the form of punishment for wrongdoing should also be considered.”

He said that he believed licensing changes should be introduced that take today’s needs into account to better protect investors.

“For example, we could have two levels of licensing that recognise some of the more complex products now being marketed need different levels of control and protection.

“As identified by ASIC, increased capital protection for investors, whether through capital requirements placed on internal Responsible Entities or through higher levels of insurance, is also needed.

“The effect and circumstances of some of the recent collective investment collapses and the role of the Responsible Entity in funds such as the MFS Premium Income Fund and the Astarra Growth Fund, where there is speculation investors are facing losses following apparent improper use of the fund’s capital, need to be considered.

“The common denominator in these cases is an internal Responsible Entity which, as Justice Judd said, can be severely conflicted.”

Mr Kalman said that it is usually only during and after severe market downturn that malfeasance, incompetence or conflict of interest is discovered, and when this happens it nearly always costs investors.

“Inevitably, when it does happen and when systems fail, there are reviews and changes, so it is timely that all the issues surrounding the role of Responsible Entities are looked at before the next boom starts and before current problems are forgotten,” he said.

Mr Kalman added that the Responsible Entity system can work well if there is adequate separation between the Responsible Entity and the fund manager/promoter to ensure the Responsible Entity will not fail if the promoter fails.

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Between now and late 2010, ASIC will be in the field, across Australia, to detect businesses or people engaging in credit activities who are not registered with ASIC.

As of 1 July this year, it has been an offence to engage in credit activities (e.g. acting as a lender, or as a credit broker) if not registered with ASIC.

More than 14,000 people or businesses registered with ASIC before 30 June 2010, as a precursor to applying for a credit licence. Licensing is now underway and will be complete by 30 June 2011 or before. As of 23 September 2010, 292 licences have been issued.

As set out in the National Credit Transitional Act, ASIC can prosecute non-compliance or seek a civil penalty from the Courts.

The maximum criminal penalties for operating without registration or a licence are $22,000 for individuals and $110,000 for corporations, or two years imprisonment, or both; or civil penalties of up to $220,000 for individuals and $1.1 million for corporations, partnerships or multiple trustees.

ASIC’s primary focus of this surveillance activity is to ensure firms and people engaging in credit activities are registered and apply for a licence to meet the requirements of the National Credit Transitional Act.

ASIC Commissioner Peter Boxall, said ASIC was most likely to pursue prosecutions where firms or people persisted in engaging in credit activities without being registered or licensed. ASIC may take action – other than prosecution – at its discretion.

‘All indications to date are that the new regime enjoys widespread support from people working in the credit industry, and that people and businesses who have registered welcome action by ASIC to deter non-registered businesses.

‘ASIC is serious about its responsibilities in enforcing the regime and our decision to undertake surveillance action – shortly after registration has closed – demonstrates our determination to ensure the effectiveness of the new national consumer credit regime in providing a better business environment for the industry and for consumers,’ Dr Boxall said.

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