Gap between perception and behaviour of planners: CFA study

A study released yesterday by the Economist Intelligence Unit and sponsored by CFA Institute has shown that although financial services executives overwhelmingly recognise the importance of ethical behaviour in the industry, there is still a significant gap between that belief and the industry’s practices. The study, A Crisis of Culture: Valuing Ethics and Knowledge in Financial Services, shows that strengthening culture based around driving integrity and financial knowledge across firms is a priority for the financial services industry.

Despite the importance placed on creating a stronger ethical culture since the financial crisis, a serious disparity still exists when it comes to executives’ recognition that adhering to those higher standards will help earn trust, foster career progress and support financial performance. Although 91% of survey respondents placed equal importance on ethical behaviour and financial success, more than half (53%) think career progression at their firm would be difficult without being “flexible” on ethical standards, and just 37% believe that their firm’s financials would improve if the ethical conduct of employees improved.

The study also looked at the critical issue of knowledge in the industry. Whilst 97% of respondents said that they are well qualified for their own role, 62% admit that their colleagues know very little about what goes on in departments beyond their own. This shows that a silo culture is pervasive in the industry, with departments acting unilaterally rather than viewing themselves as part of the wider business, suggesting integrated functional and management approaches to risk-proof organisations remains weak.

Paul Smith, Asia Pacific Managing Director of CFA Institute, commented:

“CFA Institute sponsored this study in order to take the temperature of the financial services industry as we begin to emerge from the financial crisis. The results show that the industry has further to go on its journey to drive up ethical standards and embrace professional education. It also shows signs of a shift in culture by recognizing the benefits of global ethical standards and industry knowledge, and addressing agency issues. If we are to move the industry forward it is incumbent upon everyone within the industry to align their personal and organizational values with those that serve client, shareholder and societal needs. Aspiring to adopt these values will create more resilient firms and a stronger future for finance.”

Statistical Highlights:

Ethics

• 91% of financial executives support the notion that aspiring to a globally recognised set of ethical standards would make the financial services industry more resilient
• 67% of firms have raised awareness of the importance of ethical conduct by all employees
• 53% of financial services executives say strictly adhering to ethical standards inhibits career progression at their firm

Financial Knowledge

• 62% of financial executives don’t know what is going on outside their department
• 61% of financial executives highlight gaps in employees’ knowledge as a significant risk for their firm
• 59% of financial executives agree improving knowledge of the industry as a whole would help make their firm more resilient
• 12% say they are confident in their knowledge of the global regulatory environment

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(Click here to see CPD: Professional Ethics #1  and here for CPD: Professional Ethics #2)

Bruce and Anna are partners in a financial planning practice with around 180 clients between them. For several years they have been receiving irregular client referrals from a local accounting firm resulting in a dozen or so new clients in total.

To this point it has been a very informal arrangement – the accountants have trusted Bruce and Anna to provide ethical, professional, advice for the clients they referred. To this point, by all accounts, the accountants have been very happy with the way in which Bruce and Anna have cared for the mutual clients.

No referral fees or share of revenue takes place between the firms and both parties have believed this to be the most appropriate way to conduct the arrangement.  However, the accounting firm has been undergoing some changes in recent months and Anna recently took a call from one of the partners who arranged a lunch meeting with her and Bruce.

As lunch progressed the accountants explained how they had recently taken on a practice manager who was now running the firm on a day-to-day basis and that it had allowed them to think more strategically about their business. The senior partner explained that they had decided to grow the self-managed superannuation fund compliance section of their business.  He went on to say they were in fact very keen to grow that side of their operations.

From previous conversations the accountants knew that Bruce and Anna had around 90 SMSFs under management.  As the clock approached 2:00pm, the waiter took the coffee order and the senior partner nudged the conversation toward the matter of referrals. He went onto explain the partners had decided that in order to keep referring clients to Bruce and Anna there will need to be reciprocal referrals back to the accountants for SMSF accounting and audit work – that they could not keep referring if there was “…nothing coming back.” The senior partner ‘sugared coated’ the ultimatum by saying they would look to more actively refer to Anna and Bruce if the reciprocal referrals were made.

The comments took Anna and Bruce by surprise and Anna stumbled into a half-hearted acceptance of the ultimatum. “Oh OK – well that’s something new, isn’t it? I guess we can see our way clear on that.” while quietly being very taken back by the statement from the accountants.

The senior partner leant back in his chair and then said: “You know – we’ve been thinking of going into financial planning ourselves and we’d be interested in speaking with you about a merger of sorts one day.”

On the way back to the office Bruce expressed concern about the referral ultimatum saying that he felt very uncomfortable about it. “I know you said we can probably do it but we know they’re expensive – I mean, we know their fees are demonstrably higher than what the other firms we have dealings with charge clients.” He said. “And they’re work is no better than other firms – remember when they missed the three years of interest on the Smith SMSF’s cash account and the tax returns had to be adjusted – and the clients paid for the adjustments?”

Anna knew full well what he meant; in order to gain more referrals from that accounting firm, they would have to begin referring clients back to them knowing it would, on a straight cost basis at least, be detrimental to their clients.

“But then again” said Bruce “I guess if they want to talk mergers this could be our succession planning in process.”

Several weeks went by and during that time Bruce and Anna had only discussed the issue briefly. With the day-to-day pressures of client meetings and advice preparation, even their weekly Practice Meeting had not allowed time to have a more lengthy discussion.  In the back of their minds however, was the nagging thought that they needed to have a detailed discussion to make a decision and respond to the accountants.  Privately, they both had concerns about the offer that was made and they knew it was both an offer and an ultimatum.

One morning Anna took a call on her mobile phone from the senior partner at the accounting firm who firstly enquired if they had given the offer any further thought. She went on to explain that they were yet to formally discuss the matter but were hoping to do so soon. The accountant then said: “Well we’ve been thinking about this some too and we’d like to arrange another meeting with just you – in other words without Bruce.”

Later that week Anna attended the accountants’ office and the senior partner opened the meeting in a more formal manner than the earlier luncheon meeting. “Thanks for meeting with us today, Anna – our purpose is to let you know that we’re going to set up our own financial planning service under license from ABC Financial.”

He hesitates for a moment then gathers his thoughts: “This is a rather awkward part of the conversation we need to have with you, Anna. The bottom line is we’re keen to merge the two firms however it’s you we want to come across to us as the adviser. We know that you meet with most of the clients and we feel that it’s mostly your presence in the business that keeps the clients happy. Bruce must be close to retirement and we think it makes good sense for all parties ”

Anna is again taken aback by the topic of conversation. She and Bruce have been in business together for more than a decade and on the whole it’s been a very good working relationship. “And we’re prepared to pay you a year’s salary as a sign-on bonus if you agree however we would require you to sign a confidentiality agreement in that regard.” The senior partner went on to say.
 

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

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(Click here to see CPD: Professional Ethics #2  and here for CPD: Professional Ethics #3)

The series is Case Study based on blends of real situations as recounted by advisers.

James and Sarah have been your clients for several years now and came to you seeking advice and ongoing management of their SMSF investment portfolio.

While you have provided them with several Statements of Advice to apply a portion of their sizeable cash holding within the fund to investments from your Approved Products List, to this point they have failed to implement all of your recommendations.

Your firm is being paid more than $5,000 in fees per year in accordance with the agreement however there is little evidence – in terms of asset allocation – that correlates your advice to the portfolio structure.  There are several real property assets along with unit trust holdings within the fund all of which you have had no input to in terms of their appropriateness for the clients’ objectives.

When the dilemma first became more prominent in your thinking, you phoned the clients and explained that you are not really comfortable with the situation – that you feel as though you’re being overpaid. The clients remarked: “No that’s fine – we’re happy with what you’re doing.”

However, with increasing unease, you remain concerned about the situation. Since that discussion, on several occasions, you have explained to the clients that they are effectively paying you to manage cash and suggested they are not getting true value for money.  However, the clients continue to insist they are happy with the current situation and don’t wish to change it.

To compound the situation, the clients have now moved overseas for several years and you are now required to deal with their Power of Attorney who is Sarah’s nephew, David.  The clients have requested that all correspondence be addressed to them care of David who – they have said – will act for both of them if required.

Commercial issues
Backgrounding the situation is that you and your business partner have become increasingly concerned about overall revenue for your business.  There has been an above average level of client attrition with the subsequent revenue consequences.

With difficult market conditions persisting, client retention has become the main focus for the business and you are implementing a program to ensure client service delivery and client retention.  This is a 180-degree turn-around from the major focus of increasing client numbers that emerged from your annual strategic planning retreat with your business partner and staff.

Following the retreat a plan was implemented to better utilise the new client potential that sits within the network of family and friends of existing clients.

To this end James and Sarah have a strong circle of influence among their family and friends. You sense that in time this might lead to some of these people seeking advice from you and this would be good for the business.  You could choose to retain them as clients and thereby retain the opportunity to have some of their friends/family members become clients.

An inheritance?
In your last review meeting with the clients, Sarah explained that her elderly mother was quite unwell with Parkinson’s Disease and likely has just a few years to live. Sarah went on to explain that she, as the sole beneficiary of her mother’s estate, is likely to inherit several million dollars in due course.

Sarah went on to remark: “… and when that happens we’ll get you to manage that money too.”

Risk to your business?
While you are concerned about the ethical elements that are embedded in this situation, you also recognise the inherent risks to your business in continuing under the current arrangements with the clients. These risks centre on, for example, potential litigation that might arise if the clients were to claim you should have advised them not to invest in a particular asset(s).

You are conscious of the many and varied costs associated with an action by an aggrieved client including damages, if found to be negligent; time costs from dealing with the claim; stress and anxiety of the process even if you are not found to have been negligent.  Regardless of the outcome of such claim, you also know there could be damage to your professional reputation in your community and there could be an impact on all employees of your firm.

Turn a ‘blind eye’?
You explain your dilemma to your business partner and point out the difficulty in meeting all stakeholders’ priorities. The clients want to keep paying fees at the current level; the firm focus is on client (and fee) retention and you want to do the right thing by all parties.  Your business partner argues that you should ‘turn a blind eye’ and act on the clients’ instructions – after all, they did say they are happy and don’t want to change the current situation.

Some options
You have reached the conclusion that there is no perfect outcome in the situation, given the clients’ determination to buy and sell assets as they wish.  So you think about what your options are and justify them as follows:

1. Keep accepting the fees and stay entirely with the current situation – after all, there is the push from management to retain clients.
2. Terminate the agreement now without further discussion with the clients – this will fail the ‘client retention’ test but will reduce litigation risk to you and your business partner.
3. Seek to re-arrange the service agreement with the clients to better reflect the services being utilised. However, this will result in reduced fee income for your firm.

So the key points are…

• The clients are not following your advice
• The SMSF has assets on which you have not advised the clients
• Your firm is being paid $5,000 + per year for professional services
• You and your business partner are heavily focused on client retention and service delivery resultant of the current above average level of client attrition
• Unless her mother changes her Will, Sarah is to receive more than $2 million inheritance when her mother dies
• David and Sarah have a strong circle of influence which in time should result in new clients for your firm
• You have been requested to deal with an, as yet, unseen nephew for all matters
• You are meeting all the agreed service obligations – eg meetings, reports etc – whenever the clients will allow you to
• The clients seem very happy to keep paying the fees

The primary dilemma
There are several issues at play here – not just the $5,000 per year in fees this year and beyond but also the prospect of acquiring new clients via the clients’ spheres of influence along with the prospect of a large inheritance for Sarah.  Added to these aspects is the potential risk to your firm from the clients or, indeed, their estate if they were to die.

However, the primary ethical dilemma facing you right now is: Should you go on collecting more than $5,000 per year in fees for managing and reporting on cash?

or

Should you forego the fees and terminate/modify the service agreement with the clients?

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

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