Honesty, integrity and best interests

 
Integrity has no need of rules
— Camus, Albert “The myth of Sisyphus” (1942). [i]

When William Mungomery introduced the cane toad to Australia in 1935, he did so with the best of intentions. In retrospect, it was imprudent, disastrous and potentially catastrophic.

The statutory Best Interest Duty was also introduced with similar intentions.

 My position on the Best Interest Duty is clear – professional advisers already act, and should always act, in the best interests of their clients but professionals don’t need legislation to act with objectivity, care and diligence.


 

Whose interests?

Despite the popular call for regulatory intervention, real professionals don’t need a duty tied to a series of procedural steps (particularly one that frustrates clarity and is internally contradictory).

But we have what we have, because we deserve it.

If you're an advice professional, you know that misconduct, mismanagement and consistently critical media coverage has undermined confidence in our industry and led calls for increased regulation.

We have the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry and, recently, the Australian Securities and Investments Commission pursued two high profile matters based, to a large degree, on the Licensees' failures to ensure that their representatives complied with the law and complied with their 'best interest' duties.

I’m sure you understand that there are two main ways in which an adviser can be determined to have acted in a client’s best interests. The first approach considers that s961B is concerned with the process of giving advice and that “retrospective testing against financial outcomes”[ii] is not, and was never, intended to be the measure by which compliance with s961B is assessed.

The second approach is ASIC’s “better position” compliance test[iii]. This requires that services provided in the best interests of clients will leave the client in a better position than had they not received those services. RG175.44 states ASIC’s considered view that advice is appropriate if, at the recommendations were, at the time they were provided:

a.          likely to satisfy the client’s relevant circumstances (fit for purpose); and

b.          likely to place the client in a better position if implemented (better position).

 

Appropriateness, context and circumstance

Appropriateness does not require the adviser to provide perfect or ideal advice. Nor does it require the adviser to provide the highest level of care.

Notwithstanding my view that appropriate advice only needs to place a client in an equal or better position, the Regulator’s view provides parameters for appropriateness that are generally accepted by the advice industry.

However, neither approach is entirely satisfactory and I do not agree that outcomes are entirely irrelevant.

Instead, I accept that the “best interests duty is a legislative requirement to ensure the processes and motivations of financial advisers are focused on what is best for their clients.”[iv] While the retrospective testing of outcomes is not always helpful, I believe that the consideration of likely outcomes is, and must be, a key component of the best interest duty.

While I admire the practicality of ASIC’s “better position” compliance test[v], it's an aspirational standard rather than a compliance obligation imposed by 961B. In fact, the limitations of this outcomes-based assessment are obvious. For example, advising a client to maintain their existing strategy may be both appropriate and in their best interests, notwithstanding that they are not in a “better position”.


 

The nature of advice

An advice relationship involves elements of trust, dependence and reliance.

This relationship creates (and demands) a moral and legal obligation for advisers to act objectively and disinterestedly in their clients’ best interests. This means that advisers must act in good faith and demonstrate reasonable care, diligence, transparency and loyalty.

Further, an adviser’s obligation should be given higher priority when advice is provided to unsophisticated persons[vi] or those in a vulnerable position.

An adviser’s motivation, capability and competency, the processes they follow, and the likely outcomes of their advice are the essential elements of the best interests duty, but compliance with this duty does not necessarily require a client to be “better off” as a result of the advice.

This understanding underpins my view that while the statutory defences outlined in s961B(2) may suggest whether, or to what extent, an adviser has complied with s961B(1), the adviser’s substantive conduct is, in fact, the key determinant for assessing their compliance with this duty. Furthermore, my view is that following the formal process steps outlined in s961B(2) may, at best, suggest compliance with s961B(1).

“the characterisation of … [misconduct] requires regard to context and circumstance.”
— Abichandani and Australian Securities and Investments Commission [2016] AATA 879 (8 November 2016)

 

Whether an adviser has acted in a client’s best interest can only, in my view, be inferred from a consideration of the context and circumstances of the interaction.

To put it another way, the mechanics of the advice process may influence any conclusion on their advice was provided in the best interests of their client, but it does not prove it. The adviser’s motivation (their intent and influences) should be the key determinant of whether they acted in accordance with their duties. Motivation is difficult to prove (except by inference) and outcomes are variable and unpredictable. So we fall back on process because and mechanistic solutions.

This is the reason why we see Statements of Advice that state

I embrace the concept of Best Interests Duty and give priority to your interests ahead of my own. My commitment is to act in [your] best interests and to act honestly, professionally, fairly and objectively in the provision of financial services”.

The statement seems dishonestly aspirational when the recommendation that followed it left the client more than $170,000 worse off as a result of implementing the recommendation.

While this is not representative of the broader industry, neither is it a one-off. I’ve seen similar statements, and strident commitments to Association Principles, supporting recommendations that

  • immediately reduce superannuation balances by over 40%,
  • push the client into more expensive products,
  • justify the replacement of products on the basis of obtaining additional benefits already present in the existing product;
  • Charge fees that are so significant that the client will take almost four years to return to their pre-advice position;
  • Rationalise ‘cookie-cutter’ advice on the basis of efficiencies (that benefit the adviser more than the client);
  • Deliver SMSF and LRBA recommendations to clients without adequate income or ‘real’ capacity to service the debt;
  • Use fanciful projections of possible savings being preferred over the demonstrated inability to save, reduce debt or eliminate regular reliance on short-term credit.
 

These failures were, if not obvious, at least plainly evident when the recommendations were considered in the context of the likely consequences, the advisers’ limited knowledge of their clients’ relevant personal circumstances and the advisers’ failures to take other reasonable steps “in the best interests of the client”.

In a significant number of these cases, the clients were significantly worse off after receiving, and accepting, advice. In many cases the adviser failed to address the root cause of the client’s need, prioritise their objectives or implement effective strategies to address their specific circumstances. In all cases, formal disclosure of the BID concealed the advisers’ failures to act in a manner consistent with the BID.


The problem with disclosing 'best interests'

 

If there's a common theme in our writing it is that over-reliance on disclosure not only hampers the development of an advice profession but, paradoxically and perversely, works counter to clients’ interests[vii].

Disclosure can also lead to problems of “moral licensing” where the act of disclosure frees the adviser from the obligation to comply with the norms of their profession.

Simply put, by disclosing conflicts of interest, for example, the adviser becomes less concerned about the partiality of their advice.

In a perverse and paradoxical fashion, disclosure seems to shift the advice relationship from one of trust and reliance and asymmetric knowledge to one of equals where the client is fully responsible for the choices they make about the adviser’s recommendations. The problem is that most clients lack the knowledge and capability to properly assess the recommendations they receive. (Information asymmetry)

I suspect moral licensing and culture were the reasons the advisers “committed to [their clients’] best interests” recommended, and implemented, courses of action that significantly worsened their position.

I am not suggesting that all advisers are acting in a similar way but I challenge all of you to consider whether you are disclosing a commitment to act in a clients’ best interests rather than actually acting in their best interests.

In respect of your professional obligation to act in your client's best interests - Are you stating, demonstrating or doing?

 

 

 
 

[i] Camus, Albert “The myth of Sisyphus” (1942). “There can be no question of holding forth on ethics. I have seen people behave badly with great morality and I note every day that integrity has no need of rules.”

[ii] Revised Explanatory Memorandum, Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 (Cth) [1.23]

[iii] ASIC Regulatory Guide 175, Licensing: Financial product advisers – Conduct and disclosure, March 2017, 175.225

[iv] The Hon Bill Shorten, then Minister for Financial Services and Superannuation, second reading speech to the Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011

[v] ASIC Regulatory Guide 175, Licensing: Financial product advisers – Conduct and disclosure, March 2017, 175.225

[vi] Commonwealth Financial Planning Limited v Couper [2013] NSWCA 444 at 85. ”It was within the scope of the duties of a financial planner giving an unsophisticated person advice to ensure that the person in question was being given recommendations that were in his best interests, without a conflict arising with the interests of the seller of the products being recommended.”

[vii] The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest Cain, Daylian M ; Loewenstein, George; Moore, Don A Journal of Legal Studies; Jan 2005; 34,