Having moved into the Future of Financial Advice (FOFA) implementation phase, subject to any disallowance of applicable FOFA provisions, various issues have emerged concerning the proper interpretation of some key provisions of FOFA which need to be considered. Accordingly, this Alert considers 3 key areas and explains how these areas should best be interpreted, in our view.
Scoped advice and best interests duty
In the recent ASIC survey of FOFA, one licensee is quoted as saying that scoped advice is not possible because of the operation of the best interests duty, viz "Scaled advice has been thrown out of the window with best interests. Best interests provisions mean that you can never reduce [the scope of] the advice".1
Scoped advice is absolutely doable. The best interests duty requires that various enquiries are made and that various steps are taken to obtain information from, and to provide information to, the client, but all of these steps operate within the scope of the agreed subject matter of the advice.
Establishing the scope of advice is a necessary preliminary step to ascertaining what advice will be given. The scope is set by the client and the adviser and is determined by a meeting of the minds on what should be the sphere of advice. Scoping can occur in terms of the type of needs of the client and/or the class of financial products which are to be considered (e.g. where the scope is focussed on the client’s retirement objectives which may restrict advice to superannuation products).
The best interests obligations under FOFA still require the advice to be appropriate but also require the adviser to prioritise the interests of the clients. Scoping around a limited approved product list or even scoping limited to one provider’s products is absolutely possible provided the advice is appropriate and prioritises client interests and there is a 'meeting of the minds' on this scoping.
Payments made to licensees only
Views have emerged that a payment made by a product issuer or other party to a licensee where the payment is not passed on to a representative who provides the advice is not conflicted as a matter of law.
This is, with respect, not necessarily correct.
The conflicted remuneration provisions apply to payments to a licensee or representative who provides advice (see the definition in section 963 of the Corporations Act 2001 (Cth) (Corporations Act)). However, a licensee provides advice ordinarily through its representative. So in this sense ordinarily both the licensee and the representative provide the relevant advice.2
Once this is realised, it is clear that payments of benefits to a licensee which can influence advice, are prima facie conflicted regardless3 of whether they are passed onto a representative. This interpretation is supported by the fact that the conflicted remuneration provisions do not assume that there is one primary party who provides the advice, either the licensee or the representative, as other provisions of the Corporations Act do. See, for example, the concept of 'providing entity' in section 944A of the Corporations Act relating to statements of advice and the use of 'provider' in section 961B of the Corporations Act relating to best interests which is used to identify the individual who provides advice. This stance is also consistent with Regulatory Guide 246 (RG 246), where payments made to corporate licensees can be seen as conflicted because they might reasonably be expected to influence advice (for example paragraph 112 and paragraph 123 of RG 246 – see below).
Under section 963K of the Corporations Act, an issuer of a financial product is under an obligation to not pay conflicted remuneration and in this sense has an independent obligation which it must be satisfied it complies with. This is not to say that a payer cannot be satisfied that a payment to a licensee may not be conflicted where it is not passed onto a representative, but the payer must attain this satisfaction by appropriate steps such as due diligence enquiries.
The provision prohibiting an entity from paying conflicted remuneration is a civil penalty provision. If breached knowingly, intentionally, recklessly or dishonestly, the payment of conflicted remuneration will be a criminal offence and therefore, strict compliance is essential.
It is relevant that ASIC has indicated less likelihood of concern where payments are made by a payer to a licensee but are not passed onto a representative but this demonstrates the starting point that payments to a licensee are or can be conflicted.
It is very relevant to note that ASIC does not take the view that payments made to a licensee but which are not passed onto representatives are not conflicted as a matter of law. For example, ASIC notes that it is less likely to scrutinise such payments "if there are controls in place to ensure that the benefit does not influence the advice given by representatives of the dealer group" (at paragraph 123 of RG 246). Again if the payer wishes to take advantage of such a position, it is submitted that due diligence must be exercised. As a paying product issuer, it would not be enough usually to take the word of the licensee that it is not passing on benefits to representatives.
It should be noted that conflicts can arise not just because representatives receive benefits, but also because payments to the licensee may influence the representatives to promote financial products of an issuer. The representative may do so in anticipation of salary increases, bonuses, promotions etc.
Volume-based shelf space fees
Views have been expressed that volume based shelf-space fees can escape the prohibition on the basis of being a fee for service.
This statement is not wrong per se. Indeed the Corporations Act contains an exemption for a reasonable fee for service from the prohibition (in section 964A(3)(a)). A volume-based shelf-space fee could be a fee for service although a fee for service typically would often, if not mostly, not be based on volume but on some other basis, such as an hourly rate. Certainly there must be a correlation between the value of the services provided and the benefit paid for those services. Where the relevant service is the distribution of the underlying financial product by the platform operator, a percentage volume-based fee would prima facie be more in the nature of a commission than a fee for service.
Whilst a volume-related shelf-space fee is not presumed to be prohibited (as it is for conflicted remuneration), it is submitted that for prudence one should treat a volume based shelf space fee as prohibited prima facie unless it can be substantiated that it is a fee for service.
A related issue is whether the proposed exemption for a fee for custodianship of an insurance product (section 964A(3)(c) of the Corporations Act) allows a volume based shelf space fee to be paid without any restrictions as to quantum. It is strongly submitted that it does not. The fee must relate to custody and that means it must bear some monetary connection to the value of the custodian services provided.