Many will be keen to see the changes to the ban on conflicted remuneration, introduced by the previous government with effect from 1 July this year.
The ban is not a ban on upfront or trailing commissions, although it may stop the payment of some commissions. But not always – only some payments will fall within the reach of the ban and in other cases exceptions might apply.
And so it is worth examining what the ban does and does not do. In our experience, many in the financial services industry think the ban has a wider operation than a close examination suggests. ASIC’s guidance indicates that it, too, may have an overly broad view of the ban.
The influence test
Central to the ban is the so-called influence test. The influence test asks whether a payment or other benefit given to a financial adviser could reasonably be expected to influence the financial advice they give, including their financial product recommendations. If it could, the payment or other benefit will be “conflicted remuneration” unless an exception applies.
The influence test assumes that financial advice is provided. It does not ask whether a payment or other benefit might encourage an adviser to provide financial advice. Rather, it asks whether the payment or other benefit might make it more likely that particular financial advice will be provided.
In order to answer that question, it is necessary to consider the nature of the benefit and the particular circumstances in which it is given.
There will be a range of circumstances that could reasonably be expected to influence the content of a financial adviser’s advice. Some will be benign, others less so. Chief among them is likely to be the “approved product list”. Depending on your point of view, the list might fall into either category.
An approved product list is a list of financial products maintained by a dealer group. The dealer group is licensed by ASIC and the dealer group, in turn, authorises the financial adviser to provide advice to clients. The approved product list is, in part, a risk management tool for the dealer group, as the dealer group is legally responsible for the adviser’s advice. These lists have not been banned and in its guidance ASIC acknowledges their legitimacy.
The terms of the financial adviser’s appointment by the dealer group will prevent the adviser providing financial advice about products that are not on the approved product list. Although there will normally be some exceptions to the prohibition, the list will, self-evidently, exert a very considerable influence on the financial advice provided.
There will also be other circumstances which could reasonably be expected to influence the advice. The financial adviser’s duties to the client should be a powerful influence (as should the prospect of ASIC investigating the adviser’s compliance with his or her duties).
Another circumstance will be the likely desire of the financial adviser to preserve, and not to harm, their relationship with the dealer group, and the associated propensity to take into account the likely effect of their financial advice (if accepted by the client) on the dealer group’s own position, including its own remuneration.
The influence exerted by these and any other relevant circumstances must be carefully considered, before considering the influence, if any, that could reasonably be expected to be exerted by the payment or other benefit that is being tested against the definition of conflicted remuneration.
To add to the complexity, if the influence test is found to be satisfied, the exemptions need to be considered. The most widely used is likely to be the exemption that’s often referred to as the “adviser service fee” exemption. However, despite its name, it is not an exemption for a fee for service. And, like the influence test, it requires a close examination.
The exemption applies to a benefit given by the client, or by someone else but with the client’s authority or clear consent. These fees are often deducted from the financial product that the adviser recommends to the client. Often, like commissions, they are ongoing payments calculated as a percentage of the amount invested by the client.
The prospect of earning an ongoing asset-based adviser service fee clearly has the capacity to influence a financial adviser’s advice. The law recognises as much and so provides an exemption.
The result of all of this is that the circumstances in which a particular benefit, like a performance bonus, is paid – the approved list, the prospect of earning an ongoing asset-based adviser service fee, and so on – might already influence the advice that could be expected to be given, and favour recommendations of particular financial products. If so, the performance bonus, itself, may not satisfy the influence test. The bonus may well reinforce the likelihood of advice to a particular effect being provided, but it may not alter the content of the advice that could otherwise be expected to be given.
The Explanatory Memorandum to the Bill that ultimately introduced the ban on conflicted remuneration said that the structure of the ban “recognises that performance pay can be an important part of any remuneration arrangement, and reflects the need to strike a balance between rewarding performance and avoiding inappropriate influence over financial advice”.
This statement assumes that rewarding performance will necessarily result in satisfaction of the influence test. In our view, that is not something to be assumed. Rather, it must be tested. However, in its guidance ASIC adopts, without analysis, the idea expressed in the EM.
ASIC also says it is less likely to scrutinise performance benefits that are designed to align more closely the interests of financial advisers with the interests of their clients. ASIC gives an example of a performance benefit that only rewards “good quality” financial advice and does not depend on a particular type of product being recommended or the type of advice being provided.
However worthy ASIC’s statements may seem, they do not provide any guidance on the meaning of the law. They merely describe a circumstance in which ASIC may examine a benefit. As such, they go to the likelihood of having to deal with ASIC and defend a position but not to the merits of any assessment of a particular benefit against the influence test.
These are not the idle musings of pedantic lawyers. There is an awful lot of stake. Over the coming months and years ASIC is likely to conduct investigations into whether organisations are complying with the ban.
Our point is simple. Neither ASIC nor anyone else should assume that any particular kind of benefit is conflicted remuneration. By its terms the definition demands a close consideration of the particular circumstances in which the benefit is given. When that process is carried out, prior assumptions made about particular benefits being conflicted remuneration are often undermined.