Following completion of its consultation process, ASIC released its regulatory guide relating to conflicted remuneration, ASIC RG 246 Conflicted Remuneration (RG 246), yesterday.
RG 246 explains how ASIC interprets legal compliance with Divisions 4 and 5 of Part 7.7A of the Corporations Act 2001 (Cth) (FOFA provisions) and provides practical guidance on compliance with the FOFA provisions.
The legislative intention behind the FOFA provisions is to more closely align the interests of advisers providing financial product advice and the interests of retail clients receiving that advice. While laudable and certainly a response to the losses suffered by retail investors during the global economic downturn, the practical expectation and application has been difficult to perfect.
Early legislative thinking suggested that only by ensuring that an adviser's source of income was from its client could the client be sure that the adviser is working for the client rather than a product provider. However when applied to capital markets, this would have had the unintended consequence of requiring a class of investor (retail investors) to pay to participate, and another class of investor (wholesale investors) to not. It was expected that retail participation would fall away if this were set in legislative stone.
The Federal Government introduced legislation (Corporations Amendment (Future of Financial Advice) Act 2012 and Corporations Amendment (Further Future of Financial Advice Measures) Act 2012), which has become known as the Future of Financial Advice reforms or FOFA reforms, in response to the report produced by the Parliamentary Joint Committee on Corporations and Financial Services in 2009 (Inquiry into financial products and services in Australia) (Report).
The Report concluded that: "[A] significant conflict of interest for financial advisers occurs when they are remunerated by product manufacturers for a client acting on a recommendation to invest in their financial product…These payments place financial advisers in the role of both broker and expert adviser, with the potentially competing objectives of maximising remuneration via product sales and providing professional, strategic financial advice that serves clients' interests."
Further, despite ASIC's more recent attempts to improve and streamline disclosure communications to retail investors (RG 228: Effective Disclosure for Retail Investors), the Report also concluded that the disclosure regime in Australia had not been effective to manage this conflict of interest. Importantly, the FOFA provisions and RG 246 do not apply to benefits that may influence financial product advice to wholesale clients. Protection in the form of these reform measures is for retail investors only.
When do the FOFA provisions and RG 246 apply?
RG 246 follows ASIC's Consultation Paper 189: Future of Financial Advice: Conflicted remuneration and applies on release. A number of aspects of the FOFA provisions commenced on 1 July 2012 and others only apply to those who lodge a notice with ASIC stating that they agree to comply; otherwise those provisions will be enforced on a mandatory basis from 1 July 2013. Note also that exposure draft regulations were released yesterday which seek to provide certainty on the breadth of the grandfathering provisions as they apply to conflicted remuneration.
What is "conflicted remuneration" and what do the FOFA provisions prohibit?
Conflicted remuneration is defined by the Act as being any benefit, whether monetary or non-monetary, given to a financial services licensee, or its representative, who provides financial product advice to retail clients (as defined by section 761G of the Act and Division 2 of Part 7.1, Chapter 7 of the Corporations Regulations 2001) that, because of the nature of the benefit or the circumstances in which it is given, could reasonably be expected to influence the choice of financial product recommended to retail clients or could reasonably be expected to influence the financial product advice given to retail clients (section 963A of the Act and RG 246.8 and RG 246.24).
Examples of conflicted remuneration are described in RG 246 and may apply to both personal and general financial product advice (RG 246.33). Monetary benefits may include commissions, volume-based payments in the form of dividends or other profit-sharing arrangements (however this may depend on how such an arrangement is structured). Volume-based benefits may also be deemed to be conflicted remuneration if they are caught by section 963L of the Act. Non-monetary benefits may include hospitality-related benefits and marketing assistance (RG 246.37).
An entity will breach the FOFA provisions if ASIC determines that the benefit is conflicted remuneration; this will involve an assessment of the substance of the benefit over its form and the overall circumstances in which the benefit is given or accepted (RG 246.51). Further factors to which ASIC will have regard in making an assessment of a benefit include:
- how the Australian Financial Services licensee or its representative gains access to the benefit;
- who is giving the benefit;
- when the benefit is given or accepted;
- what reasonably appears to be the likely reason why the benefit is being given;
- how the value of the benefit is determined; and
- what the benefit is and its features (RG 246.53).
What is not conflicted remuneration in terms of a monetary benefit is described in section 963B and what is not conflicted remuneration in terms of a non-monetary benefit is described in section 963C. Further, benefits that are specifically authorised by a retail client will not be conflicted remuneration – irrespective of whether the benefit is monetary or non-monetary (RG 246.61). However any such authorisation must be referrable to a direction given by a client or the client's consent which is genuine, express and specific (RG 246.64).
Retail brokers in equity capital markets transactions
Retail brokers were initially very concerned about the impact the FOFA reforms would have on capital raisings in Australia and in particular retail investor participation. Federal Treasury was presented with submissions which evidenced the statistics supporting retail investor participation particularly for entities that were less well known and how this was critical to their growth and enhanced market capitalisation.
This issue has now been settled and both the FOFA provisions and RG 246 exclude "stamping fees" from being construed as a benefit that is conflicted remuneration. Therefore a monetary benefit is not conflicted remuneration if the benefit is given to an Australian Financial Services licensee by or on behalf of an entity in relation to the person dealing in a financial product issued by the entity, on behalf of a client or if the benefit is given to a person by or on behalf of an entity for dealing in a financial product issued by the entity, on behalf of a client and the person gives the benefit, directly or indirectly, to a representative of the provider. The "stamping fee" exception applies only in relation to financial products that are:
- shares, debentures or bonds that are, or are proposed to be, issued by a government;
- shares in, or debentures of, a body that are, or are proposed to be, listed on a prescribed financial market;
- interests in a managed investment scheme that is, or is proposed to be, listed on a prescribed financial market;
- a right to acquire, by way of issue, the shares, debentures or interests referred to in the two bullet points above.
What happens if the FOFA provisions are breached?
The consequences of breaching the FOFA provisions are set out in RG 246.47:
Click here to see chart.
Documentation and key takeaways for Australian financial services licensees
Disclaimers will not assist an entity in determining whether remuneration is conflicted. Both RG 246 and the FOFA provisions make clear that affected entities cannot contract out of complying with the FOFA provisions or waiving any right conferred by the FOFA provisions (section 960A and RG 246.19) and stating in any documentation that the benefit is not intended to influence the advice given or renaming conflicted remuneration that is not prohibited by the Act – for example an asset based fee or advisory fee.
Further, ASIC provided in its Consultation Paper (189: Future of Financial Advice: Conflicted Remuneration) that it will administer the FOFA provisions in light of other obligations that apply to Australian Financial Services licensees and their representatives (including authorised representatives) which may include:
- common law obligations (such as the duty of care and fiduciary obligations);
- contractual obligations;
- compliance with relevant industry standards and codes;
- regulatory requirements including the managing of conflicts of interest, providing services efficiently, honestly and fairly, ensuring adequate representative training and maintaining dispute resolution systems;
- other FOFA reforms (including acting in the best interests of clients – Part 7.7A);
- regulatory requirements under Division 2, Part 7.10 (including market manipulation, false trading and market rigging, false or misleading statements and misleading or deceptive conduct).
While paragraph 19 of the consultation paper has not been carried into RG 246 it is worthwhile noting that ASIC may in making any assessment of a benefit or undertaking any investigation, make reference to broader compliance as outlined above. Australian Financial Services licensees that are affected by the FOFA reforms will no doubt have undertaken a wholesale review of their operations and practices in order to comply with RG 246 and the FOFA provisions (by 1 July 2013).
This review will encompass the many features introduced by the FOFA reforms including payment structures, delivery channels and performance-based benefits for staff who advise retail clients as well as record-keeping of benefits, monitoring of networks and documentation (including policy and engagement contracts). Any activity undertaken in response to such a review will of course need to be considered in light of the very broad anti-avoidance provisions which commenced on 1 July 2012 (see section 965 of the Act).
There may be an expectation by ASIC for policies to be revised in light of the FOFA reforms. Specifically with respect to conflicts of interest, ASIC has commented in RG 246 that "AFS licensees need to have in place adequate arrangements to manage conflicts of interest that may arise in relation to activities undertaken by the licensee where a benefit is excluded from the conflicted remuneration provisions. Some benefits that are excluded from the conflicted remuneration provisions can create conflicts of interest for an AFS licensee and/or its representative." This should be read in addition to ASIC's Regulatory Guide 181: Licensing: Managing conflicts of interest.