Today the first tranche of the Future of Financial Advice (FoFA) legislation was released and the Federal Government clarified some other elements of what will be in subsequent tranches.

This first tranche is in an exposure draft Bill and covers three main reforms - a statutory best interests obligation, an opt-in regime for ongoing advice fees and an expansion of ASIC’s powers.  A second tranche, which is expected in September, will cover the proposed ban on conflicted remuneration, volume payments and soft-dollar benefits.

The best interests duty, duty of priority and duty to take a number of steps 

New duties replace the reasonable basis test

The Bill will introduce new duties that will apply to a person who provides personal advice to a retail client.  These obligations will replace and enhance section 945A (requirement to have reasonable basis for the advice) and section 945B (obligation to warn client if advice based on incomplete or inaccurate information).  The existing legal duties are illustrated in the chart below:

Click here to see chart

The proposed legal duties are illustrated in the chart below:

Click here to see chart

Statutory best interests duty

The key duty is:  “The provider must act in the best interests of the client when giving the advice”.  Normally the provider is the individual rather than the licensee or corporate authorised representative.  This best interests duty applies in addition to any other obligation but only “when giving advice”.  This raises a question about the nature of an adviser’s duty when they have an ongoing relationship with their client, including one which is paid for under an ongoing fee arrangement. 

The Bill also sets out steps which the provider of advice must take in complying with its statutory best interests duty (see below).  The prescribed steps are not exhaustive. 

This means that:

  • the Corporations Act will not displace the adviser’s general law fiduciary duty or common law duty of care; and
  • an adviser will, in addition to complying with the prescribed steps, need to consider whether any other steps should be taken in order to comply with their general law duties and the best interests duty.  

As a practical matter, the prescribed steps are such that there may be little room for an adviser to breach a common law duty of care where they have complied with their statutory duty.  The fiduciary obligation may still have an impact.  The steps are all things which are associated with a duty of care - what does the adviser need to do to ensure that they give sound and appropriate advice to their client.  They do not go to the questions of loyalty and conflict with which fiduciary principles are concerned. 

Duty of priority

Providers of personal advice will also have a new duty of priority:  “If there is a conflict between the interests of the provider and the client, the provider must give priority to the interests of the client”. 

This duty of priority suggests that it is open to an adviser to provide advice despite a conflict of duty or interest provided the adviser gives priority to the client’s interests.  Advisers will need to put procedures in place that demonstrate that they have complied with the duty of priority.

Duty to take steps in acting in the client’s best interests

What are the steps which must be taken?  The steps include:

  • identifying the objectives, financial situation and needs of the client that are disclosed;
  • identifying the advice that is wanted;
  • undertaking reasonable investigations where it is reasonably apparent that information is incomplete or inaccurate;
  • where it is reasonably apparent that the client should get advice on another subject matter, warning the client in writing;
  • declining to give advice where the adviser does not have the expertise;
  • assessing whether the client’s needs could be met other than through the acquisition of financial products;
  • conducting a reasonable investigation into the financial products which might meet the client’s needs (or assessing information provided to the adviser where another person has undertaken the reasonable investigation);
  • where an approved product list is used and it is reasonably apparent that there is no product on the list which meets the client’s needs, the adviser not recommending a product from the list.

There are definitions of reasonably apparent and reasonable investigations.  There are additional obligations where advice is based on incomplete information or where a switch between financial products is recommended. 

The steps provide, explicitly, for many of the things that ASIC has been saying are already required by the existing law:  that advice is “scaleable” and can be limited to single or a limited range of topics and that there are circumstances where an adviser should decline to provide advice.  They go to process, mainly.  However, they do not ignore the content of the advice.  The Bill includes:  “The provider must only provide the advice to the client if it is reasonable to conclude that the advice is appropriate to the client, had the adviser complied with the duty under section 961C to act in the best interests of the client”. 

Penalties

There are penalties for breach of these duties and a client is entitled to compensation for loss or damage where the adviser has breached their duties.  Clients may claim their money back and interest.

Charging ongoing fees for advice to retail clients

The second reform in the Bill limits the ability to charge retail clients ongoing fees where the client has been given financial product advice.

For ongoing fee arrangements with retail clients, advisers will be subject to a fee disclosure obligation every year, and an opt-in requirement every two years.  The client is not liable to pay any ongoing fee if the annual disclosure obligations or the bi-annual opt-in requirements are not met.

What arrangements are covered?

An “ongoing fee arrangement” is defined as an arrangement under which:

  • a person to whom an AFS licensee, or a representative, provides financial product advice as a retail client, agrees to pay a fee (however described or structured); and
  • the fee cannot reasonably be characterised as relating to advice that, at the time the arrangement is entered into, has already been given.  

This definition raises a number of questions:

  • the first limb is very broad.  It appears that the agreed fee need not relate to the provision of advice.  It could, for example, relate to execution services or a financial product; and
  • the reasonable characterisation of the fee as relating to advice already given must be made at the time the arrangement is entered into.  However, generally most advice will be given after the ongoing fee arrangement is entered into.  The operation of this carve-out seems inconsistent with its description in the explanatory statement to the Bill which refers to “a fee which does not relate to advice that has already been given”.  

It is a condition of all ongoing fee arrangements that the client can terminate the arrangement at any time and any termination fee is void.

Annual fee disclosure

The annual fee disclosure obligation requires the fee recipient under an ongoing fee arrangement to give the client a fee disclosure statement each year which sets out:

  • the amount of the fee in the preceding 12 months and the anticipated fees in the following 12 months;
  • details of the services the client was entitled to receive and the services the client did receive, in the preceding 12 months; and
  • details of the services that the client is entitled to receive and the services the fee recipient anticipates that the client will receive, in the following 12 months.  

Where ongoing fees are dependent on variable factors (eg a percentage of assets under management as at the end of a period) it is unclear how the obligation to disclose the actual amount of the fee paid by the client in the preceding 12 months will be able to be discharged, given that the fee disclosure statement must be provided at least 30 days before the relevant disclosure day.

Two yearly renewal

The early renewal obligation requires the fee recipient under an ongoing fee arrangement to give the client a renewal notice every two years (along with a fee disclosure statement) that includes statements:

  • that the client may renew the ongoing fee arrangement by written notice;
  • that the ongoing fee arrangement will terminate, and no further advice will be provided or fee charged under it, if the client does not renew the arrangement; and
  • that the client will be taken to have elected not to renew the arrangement if they do not give the fee recipient a written renewal notice before the end of the renewal period (30 days after the renewal notice is given to the client).  

Failure to opt-in

If the client does not notify the fee recipient in writing within the 30 day renewal period that the client wishes to renew the ongoing fee arrangement, the arrangement terminates 30 days after the end of the renewal period.  On termination of an ongoing fee arrangement, the adviser’s obligation to continue to provide the relevant service also terminates.

Today’s media release which accompanied the release of the Bill stated that electronic channels “such as phone …” could be used to communicate a client’s renewal of an ongoing fee arrangement.  However, the requirement for written notice indicates that telephone or other oral opt-ins will not be effective.

Expanding ASIC’s powers

The Bill will strengthen the Australian Securities and Investments Commission’s  (“ASIC”) licensing and banning powers in several ways.  ASIC will be able to refuse a licence, or cancel or suspend a licence, where a person is “likely to contravene” (rather than “will breach”) its obligations.  In relation to ASIC’s banning power, ASIC will be able to ban a person who is not of good fame and character or not adequately trained or competent to provide financial services.  This change is intended to introduce a “fit and proper person” test.  Further, ASIC will also be able to ban a person if they are “likely to” (rather than “will”) contravene a financial services law.  Finally, ASIC will be able to ban a person who is involved, or likely to be involved, in a contravention of obligations by someone else. 

Importantly, these changes are not limited to the field of financial advice.  They will apply to ASIC’s licensing and banning powers generally.

Ban on conflicted remuneration, volume payments and soft dollars: tranche two

A second tranche of draft FOFA legislation will be released shortly as well an announcement on a decision on the replacement of the accountants’ exemption.  The second tranche will include the ban on conflicted remuneration (covering commissions and volume payments), the ban on “soft dollar” benefits, the ban on asset-based fees (where there is gearing), and the definition of intra-fund advice.  The media release announced the following:

  • the ban on commissions for risk insurance in super will now only apply to commissions paid in respect of any group policies held by a super fund or any individual policies held by a super fund for a MySuper member.  The ban will apply from 1 July 2013.  The relief will largely apply to policies held in respect of self managed fund (provided there is only a single life insured).  These risk policies will be treated in the same way as risk insurance outside super and will not be subject to a ban on commission.  Advisers will be subject to the statutory best interests duty when providing advice about risk insurance;
  • a carve-out to allow brokers to receive “stamping fees or similar payments relating to capital raising in order to preserve an important channel for companies to continue accessing the retail investor market in order to raise capital”.  

It is not clear from the media release that the second tranche will include other parts of the proposed FoFA reforms such as:

  • an amended retail/wholesale client test;
  • new anti-avoidance provisions;
  • a statutory compensation scheme; and
  • scaled advice provisions.

Timing and grandfathering

Comments are due on the draft Bill by 16 September 2011. 

Based on the Bill and the latest announcements, the Government intends that FoFA reforms will apply as follows:

Click here to see table

The FoFA legislation is expected to be introduced into Parliament this year.  Already some of the independents have indicated that they will oppose the opt-in provisions. 

Conclusion

Some initial thoughts on today’s release:

  • advisers and dealer groups will need to amend their systems and procedures to comply with the new duties (especially the prescribed steps) and the opt-in for ongoing advice fees - they do not have much time to do so;
  • it will be interesting to see how ASIC uses its more extensive banning and other powers and whether their use will withstand court scrutiny;
  • we eagerly await the second tranche of FoFA legislation.  

If you would like to discuss any aspect of the proposed FoFA legislation or your submission, please contact your usual contact or any of the other contacts listed in this alert.