2009 has been a big year in superannuation, but unlike previous years where significant changes have been legislative, the changes this year have been around policy and industry standards. Three major inquiries that will impact the superannuation system have been announced by the Federal Government - the Parliamentary Joint Committee on Corporations and Financial Services chaired by Bernie Ripoll, the Super System Review chaired by Jeremy Cooper, and the Australia's Future Tax System review chaired by Ken Henry. Only the Parliamentary Joint Committee has formally reported at this stage although the Cooper Review has released some preliminary recommendations - but the debate raised by the terms of reference and submissions made to the inquiries have focused the industry on how it operates.
Let's look at three of the more significant issues that have fallen out of the debate.
One of the most significant recommendations flowing from the report of the Parliamentary Joint Committee was the recommendation that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an Australian Financial Services Licence (AFSL), requiring them to place their clients' interests ahead of their own. As the Committee examined the root causes of failures such as Westpoint and Storm, it became clear that the self-interest of financial advisers was one of the reasons for structural deficiencies in the system that impacted on the way financial advice is delivered and paid for.
The Australian Securities and Investments Commission (ASIC) had argued strongly in its submission to the inquiry for imposing a fiduciary duty on financial advisers to mitigate the impact on consumers of conflicts of interest. This extract from ASIC's submission gives an idea as to how ASIC sees the industry operating if such a duty is imposed on financial advisers:
'It would mean that where there is a conflict between the interests of the client and the interests of the adviser, the adviser must give priority to the interests of their client. For example, under the current test, an adviser may have a reasonable basis to recommend a client invest in any of three different products. Of the three products, the adviser could recommend the product that delivers the adviser the greatest fee revenue, provided that this conflict of interest and the amount of the fee is clearly disclosed to the client. However, under the higher standard proposed above, they would be required to recommend the lower fee product because the adviser is required to prioritise the interests of their client (ie in paying the lowest fees possible) before their own interest in receiving higher remuneration'.
This is an important point and one that appears to have been lost on many of those in the debate who think that a fiduciary duty will not create much change. A person under a fiduciary obligation has an overriding obligation to put the interests of their fiduciary before their own. If there is an inherent conflict of interest which cannot be managed, the person needs to avoid the conflict by ceasing to act. Also, as ASIC points out in its submission, any profits that a fiduciary receives where they have acted in conflict of interest must be handed over to the client.
For these reasons, it was somewhat surprising to see the Financial Planning Association of Australia (FPA) in its submission encouraging the Committee to recommend such a duty be imposed on financial planners. It may be that the FPA had taken some comfort from the school of thought that contractual terms can modify fiduciary obligations relating to conflicts of interest, so terms could be included in the client agreement allowing an adviser to retain profits where the adviser has acted despite having a conflict of interest. However, recent cases (such as the Citigroup case) suggest that contracts can only be used to exclude fiduciary obligations, not modify them. In circumstances where there is a fiduciary obligation imposed by statute, courts are likely to take the position that such obligations prevail over any inconsistent contractual terms.
The Committee made it clear that it was drawing no conclusion about whether imposing a fiduciary duty on advisers would automatically preclude the payment of commissions. It is hard to see how it could, provided the entitlement to the commission was not earned in a situation involving a conflict of interest - the commission is more the form rather than the substance of how the remuneration is earned. A fiduciary obligation doesn't necessarily prevent an adviser recommending a product from a related manufacturer, provided the adviser could justify doing so was in the client's best interests. However, the regulator would closely scrutinise the basis for giving such advice in vertically integrated businesses if a fiduciary obligation is imposed on advisers under the Corporations Act.
Disclosure of fees and commissions
The Committee recommended that the Corporations Act be amended to require advisers to disclose more prominently in marketing material restrictions on the advice they are able to provide consumers and any potential conflicts of interest.
The recommendation is a reaction to the perceived failure of the current regulatory regime regarding disclosure of conflicts of interest, where associations between advisers and product manufacturers are buried in the small print of Financial Services Guides so consumers are not made aware of the relationship between their adviser and the manufacturer of the product being recommended. The clear message in the submissions to the Committee is that retail consumers either do not read or do not understand the disclosure about these issues in Financial Services Guides and continue to make investment decisions without an appreciation of the influence of associations on the advice they have been given.
This disclosure appears to be a compromise to the suggestion made in some submissions that Australia should go down the path of separating sales and advice. This would be done by using a model preferred in other countries where advisors are required to disclose whether they are giving 'restricted advice' or 'independent advice', and imposing different statutory obligations on the adviser depending on which form of advice is being given. However, this proposal has been floated before (in 2006) and discarded because of concerns that the industry would become dominated by sales-based advisers, as the cost to the consumer of obtaining 'independent advice' would be prohibitive.
Methods of remuneration
The Committee didn't explicitly recommend that payment of commissions from product manufacturers to advisers be banned, perhaps considering that it was an inevitable consequence of imposing a fiduciary duty on advisers. However, the Committee recommended that the government consult with and support industry in developing 'the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers'. Again, this is no great surprise given the Federal Government has been advocating that fee-based remuneration become the standard model for financial planning advice, and the FPA (perhaps having seen the writing on the wall) had announced that fee-for-service will become its standard from 2012.
However, before any of the Committee's recommendations are taken up by the Federal Government, many institutions need to consider the impact of the IFSA Superannuation Member Charter, which was released in draft in July and finalised in November. One of the four key recommendations in the Charter is in relation to a Member Advice Fee (MAF), by which new superannuation members who receive personal financial advice will be asked at the outset of their engagement with their planner to agree to both the amount and method of payment. If members wish to cease their relationship with their financial planner, they will be able to 'turn this fee off'. Under the Charter, no superannuation member will be charged for personal advice unless they actually receive that advice and agree to the charge.
The mechanism of payment to the adviser may be either one or a combination of:
- an up-front dollar or percentage based fee paid from either their super account or outside their super account; and/or
- an ongoing dollar or percentage based fee paid from either the member's superannuation account or outside the superannuation account. However, the member will be able to 'turn the fee off' if they wish to cease the relationship with their adviser, meaning advisers won't be able to protect income streams from these arrangements.
IFSA's member companies have been encouraged to implement IFSA's Superannuation Member Charter as soon as practicable, with a managed transition period in the 24 months from 1 July 2010 to ensure implementation is completed by 30 June 2012. However, many IFSA members have announced that they will have implemented the Charter prior to 1 July 2010.
A significant issue for some institutions addressing the impact of these changes on their business will be how to protect the revenue that is earned within the corporate group through such arrangements, given the member's ability to 'turn fees off' means income streams from these types of arrangements are no longer reliable. Institutions will need to consider whether the form, but not the amount, of the fees can be altered so the institution doesn't lose any revenue and the member isn't materially disadvantaged by the change in arrangements. This will take a bit of work. Trustees will need to review trust deeds and platform and rebate agreements, as well as disclosure documents, to determine whether any changes need to be made to those documents so they are consistent with the obligations under the Charter.
To review further discussion on the Parliamentary Joint Committee report, refer to the article 'PJC releases financial services inquiry report' which discusses specific recommendations set out in the report and the impact on financial product issuers and distributors and financial advisers.