“The world dies over and over again, but the skeleton always gets up and walks”
— Henry Miller, graphic novelist
Across the thousands of files we review annually, it is often the ongoing advice client files rather than the new advice files that contain material compliance issues.
Putting aside for now the “housekeeping” issues such as Fee Disclosure Statements or ongoing advice agreements, it is not uncommon that a “skeleton in the closet” is lurking within the ongoing advice file – and that an issue the adviser has inadequately addressed in the past is still putting the adviser or Licensee at regulatory risk or the risk of a client complaint.
How an adviser identifies and deals with the skeletons in the review closet is actually a clear marker of the quality of an advice business – and whether it has the resources and culture to ensure quality advice is provided to each client at each review.
So, without further ado, here are 3 representative skeletons that I have observed that were not dealt with sufficiently or appropriately, and suggestions for how the adviser could have better addressed these skeletons at the 2023 annual review.
The SMSF limited scope scenario
In 2019 a Statement of Advice (SoA) was provided to a client, Mr Smith, who had $900k in cash within an SMSF and was referred to the adviser by a linked accountancy firm. The SMSF had two members (Mr & Mrs Smith) and a corporate trustee, but only Mr Smith met the adviser or signed documentation (other than AML and application forms). The fact find document from 2019 listed Mr Smith’s balance in the fund as being $900k (100%). Mr Smith wanted limited scope advice on investing $300k of the funds in the SMSF. Mr Smith did not provide the adviser with SMSF financials, member statements, Trust Deed or investment strategy. Mr Smith had ample assets outside of super and was very much “directing” the scope of advice. The advice provided was a recommendation for investing $300k into managed funds held via a wrap platform. The SoA and ongoing service agreement were addressed to Mr Smith (not the Trustee of the SMSF).
Advisers’ conduct at annual review in 2023
A meeting was held with Mr Smith, a review document (with portfolio balance & transactions summary for the wrap account etc.) provided, and a Record of Advice (RoA) “no change” retained on file.
There was an inadequate fact find conducted in 2019 for the original advice. The fact finding conducted remained inadequate as of 2023. Mr Smith stated the funds in the SMSF were his – but there was no proof retained on file that Mrs Smith (the other member of the SMSF) had not made any contributions to the fund. Hence, several Code of Ethics standards were not met (e.g., Standards 4, 5, 6 & 8), and the recommendations may not have been in the best interests of all members of the fund (who were jointly and severally liable for any penalties for non-compliance).
Continuing to provide advice with inadequate fact finding creates a real risk for the adviser and Licensee.
Possible options the adviser could have taken:
One approach would be to ensure all advice documentation was addressed to the Directors of the Corporate Trustee of the SMSF (rather than to “Mr Smith”) and to provide very clear limitations about the scope of advice provided, as well as incomplete information warnings. The SoA from 2019 and ongoing service agreement were all addressed to Mr Smith (as an individual). However, the adviser needed to correctly identify who the client(s) was(were); the Australian Financial Complaints Authority (AFCA), for example, takes the view that investment advice to an SMSF is properly addressed to the Trustee and not the members.
A second approach would be to request the essential missing information from Mr Smith and cease to provide advice immediately until the client provided the additional fact find information.
A third approach would be to request the essential missing information from Mr Smith and Mrs Smith, and if this was not provided, decline to renew the ongoing advice agreement at the next annual review.
A combination of the above approaches would be prudent: Step 1 could be used in conjunction with Step 3, for example. The situation should be raised and discussed with the Licensee, with risk management at the core of the discussion.
TIP: We recommend advisers implement a checklist for annual review clients with SMSFs that ensures all the crucial questions are asked and the required documents obtained. ASIC INFO 274 provides further guidance.
The SMSF with a low starting balance
In 2018 an SoA was provided to a 57yo client (Mrs Jones) who had $170,000 in an SMSF she had recently set up “of her own volition” in discussions with her accountant. The SoA recommended the SMSF purchase a property funded by an LRBA, and that a small portion of the SMSF surplus cash was invested into managed funds for the purpose of diversification. Mrs Jones was referred by a linked accounting firm. She was single and had debt outside of super (on her principal place of residence).
Advisers’ conduct at review in 2023
At the annual review, an RoA (no change) was retained on file. The SMSF now had assets of $580k and an LRBA loan of $200k, i.e., net assets of $380k.
The recommendation in 2018 was one that would not generally be made by many advisers now, given the messaging from ASIC about proportionately higher expenses for low-balance SMSFs. Fortunately for Mrs Jones and the adviser the valuation for the property in the SMSF had increased rather than decreased, so the fund performance had been relatively strong.
However, at 61 years old, it was unclear how Mrs Jones would pay off her debts (and how the SMSF would pay out the LRBA loan) prior to her intended retirement at age 67. The adviser needed to step back and clarify this.
The original advice was very risky – it was largely good fortune in terms of property prices that the SMSF was somewhat more viable now – and the client still held material debt.
Also, Mrs Jones did not have a Power of Attorney in place, and her 21-year-old daughter was not interested in financial matters. It was unclear what discussion had been held about what would happen if Mrs Jones were to lose capacity to be the Director of the SMSF Trustee.
Possible options the adviser could have taken:
As the adviser noted, given that Mrs Jones was not wanting to sell the SMSF investment property yet, there were limited strategic options available.
One available product option would be to recommend the small investment portfolio in the SMSF be sold down to reduce the LRBA loan. This would reduce diversification but in an environment of rising interest rates would provide a guaranteed effective return.
Another option was to provide modelling and a strategy paper that mapped out the strategic options available – and the path towards debt reduction and retirement.
A third option would be to provide the RoA to the client and provide warnings that if the SMSF investment property valuation did not continue to appreciate (or even fell) in the short to medium term, the client’s long-term retirement planning may be jeopardised.
A fourth option would be to provide an updated SoA to the client that included debt reduction (personal and SMSF) and retirement funding in the scope of advice, as well as consideration of exit strategies from the SMSF.
Best practice would be to refresh the advice with a new SoA (option 4). Whilst Mrs Jones did not want to sell the property in the SMSF at this point, the adviser needed to provide very careful analysis about the pros and cons of holding the asset in relation to her broader circumstances, and provide a considered recommendation.
The deceased SMSF client
Retirement advice was provided to a couple in 2018. Mr Williams (65yo Accountant) and Mrs Williams (61yo part-time Admin) had $50,000 and $650,000 respectively in an SMSF with a corporate Trustee, invested into managed funds via a platform, and they had debt of $700k on the family home. In 2021, Mr Williams was diagnosed with a terminal illness, and in early 2022 he passed away. During 2022, the adviser assisted Mrs Williams with the transfer of Mr William’s funds to Mrs Williams (as death benefit pensions), as well as partially redeeming super to pay down debt and fund cost of living expenses, and other administrative matters. An RoA for redeeming $50k from super was on file from Nov 2022.
Advisers’ conduct at the annual review.
An annual review meeting was held in March 2023, following which a RoA (rebalance) was provided to the client.
The obvious regulatory issue is that the adviser should not have provided a RoA in 2023 that was further to the SoA from 2018. The changes in Mrs Williams’ relevant circumstances between 2018 and 2023 were too material. Not providing an updated SoA and instead using an RoA was a reportable breach because an appropriate advice document was not provided.
A second issue is that the 2018 SoA scoped out debt reduction advice, but debt reduction was central to the financial issues and challenges Mrs Williams faced in 2022 and 2023.
The adviser was of the view that that the client was not ready to deal with the process of doing a full SoA in 2022 or early 2023. However, this belief represented a misunderstanding that an SoA needs to be a definitive action plan; ASIC in RG174.264(d)(3) indicate that advice can also be about providing reassurance and guidance rather than making recommendations to alter or replace products. For example, Mrs Williams’ Age Pension position as a widow was very different to being part of a couple, and this would impact on her options for retirement funding.
Possible options the adviser could have taken:
The obvious solution would have been for the adviser to provide an updated SoA following the annual review.
The SoA could have been a straightforward document outlining the relevant circumstances of Mrs Williams and the SMSF, and noting the key issues that would need to be addressed in further advice in the coming months as the client was ready and willing to address them.
Alternatively, the scope of advice for the SoA could have been increased to include debt reduction as well as retirement funding, Centrelink Age Pension projections, and the suitability of the SMSF itself (versus winding it up and rolling over to a retail fund, or redeeming super entirely).
Both types of approach above would have merit depending on whether the client was able and willing to provide the time and attention to making real change.