“It’s just the danger, danger,
When you’re riding at your own risk.”
— Dire Straits, “The Tunnel of Love”
The Funnel: Limiting errors and assumptions
In theory, in the financial advice process, every client is a new client, and every investigation into relevant circumstances is open-ended. Cue the music for the safe harbour steps, which represent a kind of “advice funnel” for narrowing down the broad fact find to a defined scope and ultimately a Statement of Advice.
In practice, though, many advisers work backwards as often as they work forwards – based on an initial meeting with a client(s) they have a range of “go to” strategies and products in mind, and then seek to validate these and provide supporting evidence on file as to why these are reasonable and appropriate for the client. This may involve, for example:
- Doing some back-of-the-envelope calculations, deciding on the likely best approach and sending this off to the para-planner to model versus alternative scenarios, or
- Deciding which product is likely to suit a client and asking the support team to verify this by running the numbers and gathering supporting research.
It is not surprising advisers may take this approach – good advisers have a depth and breadth of current specialist knowledge and are dealing with many clients – hence can form reasonable working assumptions very quickly.
However, the key is that there should be no short-cuts in the process, and that when new information comes to light – this be acted on.
“It’s no use going back to yesterday, because I was a different person then.”
— Lewis Carroll, “Alice in Wonderland”
Efficient process is reasonable. However, reverse-engineering, or relying on assumptions, leads to significant problems.
Below are four examples of where assumptions, research or new information should have been checked, but wasn’t – with unfortunate results.
The SMSF non-member
Collecting key SMSF documentation but not reading it can lead to an outcome as bad or worse than not collecting it at all. For example, this example was a real-world client file scenario:
- Insurance advice was provided to two clients, in relation to acquiring insurance in an existing SMSF.
- Client 1 played a dominant role in the discussions; Client 2 was barely present.
- The subsequent recommendation in the SoA was for Client 1 and Client 2 to acquire new Life & TPD cover, owned by the SMSF.
- The Licensee required the adviser to collect the Trust Deed from the client – this was collected by the adviser, along with company information on the corporate trustee from the ASIC register.
- The insurance application was placed with insurer and accepted and put into force.
However, Client 2 was not actually a member of the SMSF. Client 1 had told the adviser that Client 2 was a member. While the intention had been for her to become a member, but it had not yet occurred.
Now, you could argue who was responsible here – the clients, the adviser, or even the insurer. But the outcome at time of claim would be a big headache for all.
ADVISER ERROR: Assuming there was nothing in the Trust Deed and key SMSF documentation that would impact this advice.
REALITY: Reading the Trust Deed was vital to the outcome of the advice.
TIP: Read the Trust Deed. It’s often critical to the outcome of the advice.
The SMSF investment strategy
“For ‘tis the sport to have the engineer hoist with his own petard”
— William Shakespeare, “Hamlet”, Act 3 Scene 4
Many advisers give limited scope advice to SMSF members and trustees – and for good reason. This area of advice can be complicated, and some Trustees are very much true-to-label (self-managed). That said, there can be pitfalls, as per the following quite common example:
- Limited scope advice was provided to the Trustee(s) of an SMSF, about “investing X dollars of surplus cash in the SMSF bank account for better returns and to increase diversification”.
- The Licensee’s SMSF advice policy required the adviser to collect the Trust Deed & Investment Strategy. These were collected – but not before the SoA was prepared.
- The initial meeting file note referred in generic terms to a discussion with the client about the SMSF’s relevant circumstances and investment strategy and stated the client was “comfortable with the current administration support from their accountant” and “only needed advice about the lump sum investment”.
- Unfortunately, the recommendations made by the adviser weren’t consistent with the investment strategy.
The adviser could (and did) argue that technically the SMSF investment strategy was out of scope. We prefer to take a more cautious approach and recommend that key documents are collected and read – to avoid future issues. For example, an inappropriate investment strategy may be indicative of deeper issues that should be flagged with the Trustees.
ADVISER ERROR: For limited scope investment advice to an SMSF, reading the investment strategy is out of scope therefore not the adviser’s responsibility
REALITY: This is not a prudent approach. Fact finding should not be omitted.
TIP: The law (and professional practice) requires investigation, consideration and reflection. Advice professionals test assumptions, rather than relying on them.
Inaccurate file notes
File notes are a key part of the advice process, and it is tempting to rely on templated file notes as the backbone, to ensure nothing is missed.
However, this only works if the file note is edited to cover what actually happened.
The following was representative of a typical problem that can arise:
- The plan presentation file note stated that: “We went through each page of the SoA … we discussed the product costs and the increase in costs due to the replacement in detail”.
- However, the product replacement section of the SoA contained an error in the product costs. $1,000,000 of cash was to be invested in a money market platform and $600,000 of that into a property fund 1-year account, with a product cost of about $10,000 pa.
- The SoA said there was a zero cost for the product.
- This created an inconsistency – if the adviser went through each page in detail, how was it that he or she missed $10,000 pa of missing product fees?
ADVISER ERROR: Templated file notes can be helpful, but they are far less helpful than considered and contemporaneous records.
REALITY: Templated file notes are a double-edged sword … they need to be tailored to what actually happened. Everyone makes mistakes and SoAs frequently have errors. Therefore, don’t say you went through the SoA in detail … if you didn’t!
TIP: Take your own notes. While your process should be consistent, your accounts of different meetings should be different.
Flawed product replacement
Like-for-like comparisons can sometimes be anything but like-for-like … because the asset allocation or investment style may be totally different between “product A” and “product B”. This is a specialist area of knowledge, and the adviser needs to ensure comparisons are relevant.
This is a serious issue: product replacement has its very own section in the Corporations Act (s947D). Take the following example:
- A product comparison generated by a popular advice software program showed Product A (existing), Product A (modified to risk profile), Product B (a “wrap” account), and Product C (a “wrap” account).
- Product A was a simple retail super fund.
- The portfolio used in Product A (modified), Product B and Product C was the same for all three – comprising of 12 wholesale managed funds.
- However, a review of the PDS of product A quickly reveals it did not allow for any of these managed funds – it was not a “wrap”, and they were not viable options. Somehow, somewhere, there had been an “input error” in the process of generating the report.
- The SoA used the information in the report and indicated that “product B” was the cheapest option and hence it was the recommended option.
This was not a good basis for the product replacement. In fact, an unfavourable third-party reviewer may have concluded the adviser had not actually read the supporting research at all. This may or may not have been the case (there could have been an issue in how the report was generated and saved on file) but at the very least it would lead to unnecessary doubt about the quality of the advice.
Another common issue is that the supporting research indicates the product being replaced, or the alternative, had better performance for the same or less risk over a relevant time period – but this is not noted or discussed in the file. Again, this does not suggest that the adviser has genuinely read and considered the supporting research.
ADVISER ERROR: Assuming that the researching, and considering relevant research, can be left to the support team.
REALITY: This is a critical area of the advice process and advisers abrogate responsibility at their peril.