When forced to choose between process and outcomes, most auditors make the wrong choice. It’s not, and never has been, a binary decision.
Making the right choice
The ‘Best interests’ duty imposes on advisers a range of statutory and fiduciary-like duties including obligations to:
- Act in the best interests of their client;
- Only provide advice if it would be reasonable to conclude that their advice is appropriate for their client;
- Warn their client if your advice is based on incomplete or inaccurate information; and
- Prioritise their client’s interests.
The problem with principles
There’s only Ten Commandments; but an entire global industry that emerged to explain their practical application and the consequences and implications of non-compliance.
The best interest duty is much simpler – “The provider must act in the best interests of the client in relation to the advice” – but advisers, and more importantly, compliance reviewers, often struggle to explain its practical application. The consequences and implications of contravention are, however, much easier to understand.
In my opinion, one of the great failings of reviewers is their deification of process.
I appreciate that checklists and impassive, industrialised processes deliver the consistency and margins preferred by some consultants, but emphasising consistency over quality continues to deliver confusion and sub-optimal outcomes for our clients.
With respect, while process is an important component of the best interests duty; it is only one component.
To be clear, the priority given to the ‘safe harbour steps” (s961B(2)) to prove that an adviser has acted in their client’s best interests is inverted; the reviewer should start with the principle before moving to process.
Best-interests might be found inland
“Another option would be to remove the safe harbour provision entirely.
In my view, such a change would not be without merit. As I have said, the safe harbour provision currently has the effect that, in practice,an adviser is required to make little or no independent inquiry into, or assessment of, products. By prescribing particular steps that must be taken, and allowing advisers to adopt a ‘tick a box’ approach to compliance, the safe harbour provision has the potential to undermine the broader obligation for advisers to act in the best interests of their clients.”
— Commissioner J Hayne, Final Report of The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, p177
Some reviewers believe that it’s difficult to know if an adviser’s complying with their Best Interest Duty.
We think there are two main ways you can identify when an advice professional has acted in their client’s best interests.
Although Golden Financial Group (NSG) and other cases have focused on the advice process as the core of BID, the Royal Commission suggested that this may, in fact, be the wrong approach and one that tends to reduce a professional duty to a box ticking exercise.
We agree. In our view, practically, there are three components to proving you have acted in your clients’ best interests:
- Did the adviser approach the engagement with ‘clean hands’, an absence of material conflicts and an acknowledgment of potential conflicts of their interests and their duties to their client?
- Did they prioritise their clients’ interests and focus on securing engagement based on their client’s free, informed and prior consent?
- Did the adviser follow a methodical, considered and objective advice process?
- Did their process meet, or exceed, industry and legal standards?
- Does their process reflect their fiduciary-like obligations and a professional standard of competence?
- Did the adviser reasonably consider the potential outcomes for their client if they implemented the recommendation?
- Did they address the reasonably foreseeable consequences and implications?
- Will the recommendation materially improve their clients’ position?
- Will their recommendation make it more likely that their clients will achieve their goals and objectives?
These may seem too subjective but, in fact, motives, processes and outcomes were precisely the elements identified by the parliament when they introduced the legislation.
Prioritising process over duty
I think that the current debate over the best interests duty, and the value of the safe harbour provisions, is representative of the broader challenge to advice. If one believes that industrialised review processes are the future of compliance, then this process focus is the key to efficiency.
However, if one believes that an effective review process must be qualitative, contextual and risk-based, then advisers’ intent and their consideration of likely outcomes needs to be given equal, if not more, emphasis as the processes they follow to serve their clients’ needs.
In my experience, while great advisers embrace process, they don’t allow an obsession with process to distract their attention from either the desired result or the steps required to achieve it.
This appears to be controversial, only if one misreads the law and misinterprets Moshinsky J’s reasoning to suggest that s961B is only concerned with the process of giving advice. It’s simply wrong to assert that outcomes are entirely irrelevant, or somehow less important than complying with steps designed to provide, at best, a partial defence against failures to act in a client’s best interest.
For some compliance reviewers, embracing this perspective may profoundly change both their approach and their inevitable conclusions. Consider what outcomes may result if reviewers, instead of using the safe harbor steps to demonstrate compliance with the ‘best interest duty’, make an assessment about 961B(1) first, and then, only if they believe the adviser failed to discharge their best interest duty, consider whether the process steps provided by 961B(2) mitigate, or entirely invalidate, the identified failure.
To make my contention clear, the safe harbor steps don’t, and aren’t necessary to, prove compliance with 961B(1); but they can be used, defensively, to refute the presumption that an adviser failed to comply with 961B(1). For some reviewers, this change requires a considered, contextual assessment that appears radically inconsistent with regulatory guidance.
I don’t agree that it is. Even if it appears that way, it’s important to understand, as my colleague Angelique often observes, that the Regulatory Guides merely re-interpret the law and provide guidance to regulated entities; the relevant obligations and duties are enshrined in the Corporations Act and related instruments.
“In his decision on liability Justice Moshinsky noted that ASIC contended that “in a “real world” practical sense, section 961B(2) was likely to cover all the ways of showing that a person had complied s 961B(1) and, in this way, a failure to satisfy one or more of the limbs of section 961B(2) is highly relevant to the Court’s assessment of compliance with the best interests duty”.”
— NARELLE SMYTHE, CRAIG HINE “Big penalties imposed for breaches of the best interests duty.”
I understand that uncertainty engenders caution, but I think that we, as compliance professionals, need to accept the view that the best interests duty is a more than a “legislative requirement to ensure the processes and motivations of financial advisers are focused on what is best for their clients.”; it is not just process, but is a broad series of duties with a critical substantive core.
While the retrospective testing of advice outcomes is unhelpful, the adviser’s motivations and their consideration of likely outcomes must be a key component of any assessment of their compliance with the law.
In this respect, reviewers need to place less reliance on checklists and rely more on their ability, intuition and analysis. The value of a review is seldom the mechanistic process of confirming procedural elements but the insights gained from the contextual assessment of the advisers’ skill, competence and professionalism.
The irrefutable truth is that an adviser’s motivation, capability and competency, the processes they follow, and the likely outcomes of their advice are all essential elements of the best interests duty.
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 – their intent, process and consideration of outcomes – are the critical determinants for assessing their compliance with this duty.
In my view, advisers’ actions should transparently demonstrate their intent and the priority they place on their clients’ interests. A key purpose of a licensee’s monitoring and supervision framework is to identify those advisers that cannot meet these expectations or provide financial services efficiently, honestly and fairly.
At the risk of over-simplification, an effective review process should ensure that advice professionals:
- Clearly disclose any financial, direct or other interests that may influence any recommendation they might make;
- Clearly disclose any associations or relationships with any product or other service providers (e.g. insurers, investment companies, financiers etc.);
- Ensure that any personal advice given to retail clients is appropriate to their needs, objectives and financial circumstances;
- Ensure any advice given to retail clients is appropriate and, in the client’s, best interests;
- Clearly disclose to any retail client the amount of the remuneration (including commission) that may be received either by us, the representatives or any associated party; and
- Neither advise, deal with nor refer any retail client where they are conflicted or likely to be seen to be conflicted. To be clear, representatives should avoid any situation where their interests conflict with their duties to their clients.
Luck, processes and professionalism
A good outcome in the absence of good process is not professionalism; but neither are spectacular processes without empathy, objectivity and disinterested service.
The processes followed by the adviser may, at best, suggest their advice was provided in the best interests of their client but it does not prove it.
Let’s hope more compliance professionals start with the duty instead of cleaving to the empty processes that promote pedestrianism over professionalism.
Let’s sideline our obsession with processes and instead work to identify and encourage exceptional advice.