For financial advisers the winds of change were blowing prior to the establishment of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), however following the release of the Royal Commission's Final Report on 4 February 2019 that gentle breeze has been replaced by the full fury of Hurricane Hayne. We outline below the Royal Commission's findings, their likely effect on the broader financial advice industry and the implications for insurers operating in the sector.
Royal Commission findings
In his Final Report, Commissioner Hayne expanded on the issues in his interim report making four broad findings and associated recommendations:
The industry finds itself in an identity crisis, trapped in an incomplete transformation process which, he seems to suggest, must be forced to complete by any means:
"For some time now, a financial adviser has been something between a salesperson and a professional advisor. The industry has moved from scandal to scandal, causing financial harm to clients and damaging public confidence in the value of financial advice. This cannot continue."
Fees for no service
The "endemic" practice of charging fees for no service was plainly dishonest and steps must be taken to end the practice to restore public respect and trust necessary for 'financial advice' to be considered a profession.
Prior to the Royal Commission, ASIC was aware that major financial institutions had been charging clients for financial advice where the advice had not been provided.
However, until immediately prior to the Royal Commission, ASIC had not sought to prosecute these entities for their misconduct. Instead ASIC had opted to note its "concerns" in an 'enforceable undertaking' and worked with the financial institutions to put in place customer remuneration and reimbursement packages. No public admonishment or scrutiny, despite the financial institutions reaping in excess of $850M from the practice.
In Commissioner Hayne's view ASIC has not gone far enough, his comments all but characterising the conduct as plain theft and referring the matter to ASIC for consideration of both civil and criminal prosecution of financial advisers.
Commissioner Hayne also recommended controls be put in place to better monitor advice fees and the basis upon which they are being charged, including express consent from the client to charge them.
Three rectifiable industry wide issues have been identified as having contributed to the provision of inappropriate advice:
- the inherent conflict of interest in advisors providing financial advice where they (or the relevant licensee) stood to gain financially from the type of advice given and financial products recommended;
- advisers lacking skill and judgment; and
- employers and financial services licensees unwilling to identify poor advice where given and put it right.
Commissioner Hayne noted that industry wide educational requirements were already being implemented to promote consistency across the industry for the provision of skilled advice.
As to the remaining issues, Commissioner Hayne made numerous recommendations aimed at identifying and removing conflicts by disclosing the advisor's lack of independence to customers and the removal of commission structures that promoted inappropriate advice.
He stopped short of recommending the 'safe harbour' provision in the Corporations Act be abolished, allowing the industry a period of three years to improve before that is further considered. 'Grandfathered commissions' on the other hand, were specifically targeted by Hayne for repeal.
The fragmented regulatory system in place for financial advisers does not work. As Commissioner Hayne noted:
"All too often, the fragmented disciplinary arrangements for financial advisers have meant that advisers who engage in poor or unlawful conduct have not faced appropriate consequences for their actions…Those who feel they are unlikely to face consequences are much more likely to engage in that conduct"
A hallmark of a profession is its compliance with and enforcement of industry standards and regulations which Commissioner Hayne identified as being almost entirely absent for the financial advice industry.
To rectify this, Commissioner Hayne recommended:
- registration of all financial advisers;
- creation of a single disciplinary body with the power to impose sanctions on financial advisers with only the most serious matters to be investigated and enforced by ASIC; and
- imposing mandatory reporting and investigation obligations on employers where the conduct of financial advisers is suspected or called into question.
Implications for the industry
Commissioner Hayne's findings were not unexpected. With an increased scrutiny on ASIC, expect to see the regulator ramp up its public prosecutions of financial advice licensees. ASIC already has three Federal Court proceedings on foot against AMP, MLC Nominees Pty Ltd and NULIS Nominees (Australia) Limited (the latter two NAB subsidiaries) for 'fees for no service' practices.
Even that might not be enough. Commissioner Hayne was scathing in his assessment of the conduct as 'dishonest' (if not criminally so) and recommended proceedings against relevant entities based on a breach of 1041G of the Corporations Act 2001 (Cth) which carries penalties of 45,000 penalty units (currently AUD9,450,000), three times the total value of the benefits obtained by the entity reasonably attributable to the offence or 10% of the entity's annual turnover, whichever is the greatest. Watch this space.
More generally, with the Australian Government indicating its intention to act on Commissioner Hayne's recommendations the catalyst for change in the industry appears to be upon us.
This final iteration will likely see the implementation of:
- formal education and registration requirements;
- increased transparency with respect to financial advisers' various allegiances and fee structures for services rendered; and
- increased industry regulation with mandatory notification for breaches of conduct standards and the creation of a centralised disciplinary body with the power to impose sanctions on individual financial advisers.
For the industry, the increased regulation and public scrutiny should lead in the short term to increased operating costs for entities as the government forces the industry to implement the recommendations (or forces out entities that can't). It is also reasonable to expect a short term spike in ASIC activity with that eventually plateauing as the industry settles into the new regulatory environment.
Potential impact on the insurance industry
An increase in ASIC's appetite to enforce civil (and criminal) penalties for perceived breaches of standards of conduct will likely result in increased notification and claim activity under both Professional Indemnity and Directors' and Officers' type policies over the coming years. The potential reduction in profitability (at least in the short to mid-term) on those policies will see premium increases and self-insured retentions also increase (to the extent that they are not already) across the board.
Financial adviser entities will also now be paying increased attention to Investigations cover which presently varies significantly between insurers and policy wordings.
Conversely, in the longer term the introduction of increased regulation and the implementation of Commissioner Hayne's recommendations may see a decrease in large scale misconduct and large scale insurer losses in the longer term.
In any event, these are interesting times for the financial advice industry the outcome of which should ultimately see initial disruption but eventually (hopefully) the creation of a well-regulated and transparent industry that moves from a commission based sales culture to a true 'profession'.