Inquiry into the Scrutiny of financial advice

Transcription

1 Inquiry into the Scrutiny of financial advice SUBMISSION

2 ABOUT INDUSTRY SUPER AUSTRALIA Industry Super Australia is a research and advocacy body for Industry SuperFunds. ISA manages collective projects on behalf of a number of industry super funds with the objective of maximising the retirement savings of over five million industry super members. Please direct questions and comments to: Robbie Campo Deputy Chief Executive, ISA Lygia Engert Legal Policy Analyst, ISA ISA Pty Ltd ABN Corporate Authorised Representative No of Industry Fund Services Ltd ABN AFSL

3 SUBMISSION SCRUTINY OF FINANCIAL ADVICE Contents Executive Summary 1 1. The current level of consumer protections Key issues consumer protection is more than buyer beware An environment clouded by commissions, incentives and other conflicted remuneration Recommendations to improve current levels of consumer protections 8 2. Regulatory reforms that would ensure transparency for consumers in relation to misconduct Recommendations transparency for consumers in relation to misconduct Whether existing mechanisms are appropriate in any compensation process Key issues inadequacies in the compensation process Recommendations compensation process Appendix Appendix Appendix 3 19

4 EXECUTIVE SUMMARY ISA welcomes the opportunity to respond to the Senate Standing Committees on Economics Inquiry into the Scrutiny of Financial Advice. In recent years, financial advice has become increasingly important to every Australian due to compulsory superannuation, a greater number of consumers entering retirement and the increasing complexity of financial products. Despite this importance, large scale investor losses, inadequate minimum training and education standards for financial advisers and high profile scandals have exposed a regulatory framework that has continually failed to protect consumers. At the heart of these failings has been: The ability for commissions and incentives to be earned on financial advice The institutional ownership of the bulk of financial planning dealerships where financial advisers are compromised by the commercial imperative of selling and distributing certain products Poor quality advice which has not been in the consumer s best interests Weak professional standards Minimal education requirements A weak framework for consumer protection ISA has been a vocal advocate for policy which addresses the systemic conflicts of interest and removes commissions and other incentives which erode individual and national savings and minimise future instances of financial collapse. In order to achieve these objectives, ISA has continually advocated for a regulatory framework for financial advice that is underpinned by the following principles: Consumers should be able to access basic financial advice that is affordable, in their best interests and suited to their needs Australians should be confident that they are only paying for financial advice that they actually use Financial advisors should be required to act in their clients best interests and they should be paid on a transparent fee-for-service basis There should be effective disclosure in relation to remuneration and adviser profiles This submission does not seek to answer all terms of reference but will focus on: a. the current level of consumer protections b. the role of, and oversight by, regulatory agencies in preventing the provision of unethical and misleading financial advice c. whether existing mechanisms are appropriate in any compensation process relating to unethical or misleading financial advice and instances where these mechanisms may have failed d. mechanisms, including a centralised register, that would ensure financial planners found to have breached any law or professional standards in their employment are transparent, for both the sector and consumers Below is a summary of our recommendations. Submission Professional Conduct and Standards 1

5 Summary of recommendations: 1. The current level of consumer protections ISA supports: The Government should abandon its changes to the Future of Financial Advice (FofA) legislation and FofA as commenced on 1 July 2013 should be given an opportunity to settle All forms of conflicted remuneration should be banned including on life insurance The development and promotion of policy that promotes accessible and low-cost financial advice without compromising consumer protection A universal requirement for monitoring and supervision of new entrants into the advice industry The adoption of a fee-for-service advice model Increasing minimum training and education standards for financial advisers giving personal advice 2. The role of, and oversight by, regulatory agencies in preventing the provision of unethical and misleading financial advice ISA supports: Enhanced powers for ASIC Enhanced funding for ASIC Product suitability obligations 3. Whether existing mechanisms are appropriate in any compensation process relating to unethical or misleading financial advice and instances where these mechanisms may have failed ISA supports: A requirement that licensees demonstrate the adequacy of professional indemnity insurance cover Greater protection for consumers from unlicensed providers Greater powers for ASIC to police the licensing system in regards to compensation Stronger settings to ensure consumers receive adequate compensation, including the potential for a last resort compensation scheme viewed in light of regulatory change 4. Mechanisms that would ensure financial planners found to have breached any law or professional standards in their employment are transparent, for both the sector and consumers ISA supports: The establishment a public register for financial advisers ASIC to establish and approve codes of conduct and minimum education standards Submission Professional Conduct and Standards 2

6 1. The current level of consumer protections 1.1 Key issues consumer protection is more than buyer beware Failings of the regulatory framework to provide adequate protection for consumers of financial advice have been well documented through the Final Report of the Senate Economics Committee Inquiry into ASIC; poor advice practices highlighted by high-profile financial collapses and the Commonwealth Bank Financial Planning scandal; shadow-shopping surveillance undertaken by ASIC and the Final Report of the Financial System Inquiry. The Financial System Inquiry s final report recognises the failings of the current regulatory framework to deliver fair treatment to consumers. The Inquiry defines fair treatment as the concept that financial products and services should perform in the way that consumers expect or are led to believe 1. Shortcomings in disclosure and financial advice are identified as the most significant problems for consumers resulting in an environment where consumers are too often sold financial products that are not suited to their needs and circumstances 2. The report marks an important paradigm shift towards an environment where policy makers, particularly regulators are best placed to make decisions that best balance the desired outcomes of efficiency, resilience and fair treatment. 3 Disclosure alone is simply not enough. One of the overriding themes of the Financial System Inquiry is to enhance confidence and trust by creating an environment in which financial firms treat customers fairly 4. In order to create this environment, it is essential that policymakers address poor consumer attitudes towards financial advice, inadequacy of current regulatory settings, conflicted remuneration structures in financial advice and inadequate training and education standards for advisers Poor consumer attitudes towards financial advice The current level of consumer protection is no doubt impacted by poor consumer attitudes towards financial advice. Member inertia and disengagement are well -documented market failures in the superannuation system. The majority of consumers are passive and disengaged from their superannuation, which is typically the only investable asset they hold. While the average retirement balance for Australian workers is still reasonably modest, balances will increase as our superannuation system approaches maturity (in around 2031). Hence, in the near future, consumers will have even more to lose if the system designed to benefit them and protect their savings fails at this task. Ongoing fee arrangements are particularly erosive of superannuation as it is a long-term savings preserved until retirement. Financial disengagement and low levels of financial literacy also mean that where consumers seek financial advice they are nearly always utterly reliant on their adviser. This provides a strong rationale for consumers 1 Final Report of the Financial System Inquiry, December 2014, p xx 2 Final Report of the Financial System Inquiry, December 2014, p xx 3 Final Report of the Financial System Inquiry, December 2014, p 11 4 Final Report of the Financial System Inquiry, December 2014, p xiii Submission Professional Conduct and Standards 3

7 to be able to trust their adviser. Unfortunately, research undertaken on consumer attitudes towards financial advisers paints the opposite picture. A 2012 State Street survey found that about two-thirds of investors do not believe that advice providers act in the best interests of their client. 5 A 2013 survey conducted by Roy Morgan showed that only 25 per cent of the population rated financial planners as either Very High or High for ethics and honesty. 6 This low rating of the ethics and honesty of financial planners remained unchanged since it was first tracked in Asked, What makes you distrust a financial adviser? 87 per cent of the respondents in an Investment Trends survey stated fees and conflict of interests. 7 Industry research from last year found that only one in three (34 per cent) of Australians know where to find a financial planner they can trust 8 and that the poor perception and experience of financial advice was the most common reason (49 per cent of 2409 respondents) why respondents would not look for a new adviser. 9 In order to improve consumer attitudes and demand for advice services, it is vital that the financial advice industry is supportive of higher standards and obligations for advisers. Further lobbying will only damage their already fragile reputation Inadequacy of regulatory settings to prevent financial advice collapses Over the past decade, Australia has seen a series of financial advice scandals and high profile collapses which have highlighted the inadequacy of conduct requirements and regulatory settings to protect consumers. The detailed work of several Parliamentary Committees which examined in detail the causes and impact of high profile collapses, particularly the 2009 Report on the Storm and Opes Prime collapses, confirmed that conflicted remuneration structures coupled with the absence of a requirement for advisers to act in the best interests of their client were key contributing factors to the collapses, and unanimously and explicitly recommended that reform be undertaken to address these deficiencies in the law. Leading up to the introduction of the FoFA reforms (discussed in detail below), there were a number of high profile financial advice collapses which highlighted the inadequacy of the regulatory settings to protect consumers and to set minimum conduct requirements for providers of financial advice. The Parliamentary Joint Committee on Corporations and Financial Services, in its Inquiry into Financial Products and Services in 2009, emphasised that the regulatory regime (i.e, pre-fofa) was failing to protect consumers from poor financial advice and its consequences. 10 The report pointed out serious problems, including conflicts of interests, commission-based remuneration and the limited regulatory power of ASIC. 5 State Street and Centre for Applied Research, The Influential Investor: How investor behaviour is redefining performance, November 2012, p. 20, quoted in ASIC (2012) Future of Financial Advice: Best interests duty and related obligations, December 2012, p 5 6 Roy Morgan (2013) Image of Professions Survey, April Quoted in Roy Morgan (2013) Superannuation and Wealth Management in Australia, Report 15, Dec 2013, p 50 7 Investment Trends (2013) Advice & Limited Advice Report September 2013, p Financial Planning Association of Australia (2013), Australians eager for financial advice, Tuesday, 10 September 2013, 9 Investment Trends (2013) Advice & Limited Advice Report September 2013, p Parliament Joint Committee on Corporations and Financial Services, Inquiry into Financial Products and Services in Australia, November 2009 Submission Professional Conduct and Standards 4

8 A summary of the major financial collapses in Australia since 2006 and the scope, remuneration arrangements and impacts is set out in Appendix 1. In aggregate, these collapses resulted in total losses over $6 billion and affected over 120,000 Australians. It can be said that at the time of these collapses, the financial advice industry was used as a distribution and marketing channel for financial products to retail customers. There were limited regulatory requirements or assurances of advice quality. The framework at the time was premised on the disclosure of conflicts of interests, which resulted in inadequate protection for consumers. The financial incentives provided by some product providers led to many instances of biased and poor quality advice. The inadequacy of regulatory settings to prevent the following collapses has been a key failing of the financial advice industry and demonstrates the need for a strong focus on legislation that addresses commission-based remuneration, advice that places paramount importance on the interests of the consumers and conflicted advice The proposed watering down of FoFA The bank and financial planning industry s attempts to lobby the government to wind back key aspects of the Future of Financial Advice reforms are an extraordinary instance of policy failure to the detriment of consumers. The disallowance of the Corporations Amendment (Streamlining Future of Financial Advice) Regulation 2014, on November 19, ensures the maintenance of minimum conduct requirements which ensure consumers are protected from poor quality and conflicted financial advice. The Corporations Amendment (Streamlining Future of Financial Advice) Bill 2014 (the Streamlining Bill), however, remains before the Parliament with some uncertainty as to its fate. In light of this uncertainty, it is important to understand the impact that any relaxing of the FoFA laws could have on consumers. The FoFA reforms were several years in the making and sought to improve the trust and confidence of consumers and to ensure the accessibility and affordability of high quality financial advice. Commenced on 1 July 2013, the aim of FoFA was to ensure consumers could obtain quality, impartial financial advice. The laws were premised on two key pillars: the banning of the receipt of conflicted forms of payment for financial advice and the imposition of a requirement for financial advisers to act in the best interests of their clients Notably the legislation: Introduced a best interests duty requiring that financial advice be in the best interests of the client Prohibited sales commissions and other forms of conflicted remuneration for new clients Required advisers to seek biennial client approval to charge ongoing fees (the opt-in requirement) Prohibited sales commissions on life insurance inside super As part of its election promise, the Government sought to windback FoFA by introducing legislation and regulations which dilute key elements. The Government s proposed changes would: Make it possible for an adviser to meet the best interests duty without considering their clients best interests Allow advisers to get client agreement to limit the scope of advice even if a reasonable adviser would know this is not in the client's best interests Create new exemptions (on top of the generous concessions in the original FoFA laws) that allow payment of conflicted remuneration and commissions for advice on complex products like super, debt products and managed investment schemes Submission Professional Conduct and Standards 5

9 Remove the requirement for advisors to get biennial client agreement to pay ongoing fees (the opt in requirement) and limit the annual fee disclosure statement to new clients ISA analysis of the proposed changes to FoFA is set out in Appendix 2. Appendix 3 contains detailed legal advice by Professor Dimity Kingsford Smith commissioned by Industry Super Australia. 1.2 An environment clouded by commissions, incentives and other conflicted remuneration Since 1996, conflicted remuneration has contributed to around $97 billion in foregone national savings due to advisers recommending poorly performing products. 11 Over the past decade, Australia has seen a series of financial advice scandals in which investors have suffered significant losses. At the centre of these scandals was conflicted remuneration, where commissions and other incentives encouraged planners to recommend certain products, coupled with the lack of a legal requirement for financial planners to act in their client s best interests. 12 At the heart of the issue is the institutional ownership of the bulk of financial dealerships. This has created an environment where financial planners are influenced by the commercial objective of selling and distributing products developed by affiliated companies. Despite the widespread systemic problems with financial advice which continue to emerge, the banks continue to lobby the government to legalise the payment of conflicted remuneration, although there is clear evidence that such payments compromise the quality of financial advice and outcomes for consumers. With an estimated 85% of financial advisers associated with a product issuer 13 and nearly all the largest dealer groups now owned by the financial institutions, there is a potential conflict between a financial planner s commitment to that product manufacturer and the requirement to act in their client s best interests. Likewise, if a planner s fee for service is linked in some way to a product transaction then there is conflict between the adviser s interest and the client s interest. Regulation alone cannot change what can only be described as an inherent role-conflict for financial planners. The institutional ownership of the bulk of financial planning dealerships is significant because it reinforces the concern that financial advisers are compromised by the commercial imperative of selling and distributing the products manufactured by their parent or related party organisations. The detrimental impact of commissions on advice has been recognised by the Interim Report of the Financial System Inquiry which found: Accessibility of advice that helps consumers meet their financial needs is undermined by the existence of conflicted remuneration structures in financial advice Conflicts of interest have been a longstanding issue in financial advice and retail investment failures following the Global Financial Crisis, including high-profile cases such as Storm and Trio, highlight concerns with financial advice regulation 11 Industry Super Australia analysis based upon APRA data 12 Parliamentary Joint Committee on Corporations and Financial Services Inquiry into financial products and services in Australia, Nov IBIS World Industry Report, Financial Planning and Investment Advice in Australia: K7515, May 2009, p 7 Submission Professional Conduct and Standards 6

10 The tension between providing financial advice for the benefit of consumers and playing a product distribution role is one of the main areas of conflict FoFA reinstated is a positive step towards banning most forms of conflicted remuneration. However in light of the fact that incentive-based remuneration models remain, including grandfathered arrangements and other specific exclusions 14, the Final Report of the Financial System Inquiry notes that these instances of conflicted remuneration should be monitored, and the Government should intervene if further significant issues are observed Evidence of widespread misselling in the life insurance advice industry ASIC s comprehensive review of the retail life insurance advice (Rep 413) released on Thursday 9 October demonstrates systemic advice failures in life insurance advice, providing the clearest evidence yet why commissions in super should not be allowed. Based on research conducted by ASIC between September 2013 and July 2014, the report found: More than a third of advice (37%) did not meet the laws relating to appropriate advice, a result that ASIC describes as an unacceptable level of failure 96% of the poor advice was given by advisers paid under upfront commission models Where an adviser is paid under an upfront commission model it has a statistically significant bearing on the likelihood of that adviser giving advice that did not comply with the law This demonstrates the prevalence of misselling in the life insurance advice industry and highlights the need for stronger consumer protection in this sector Inadequate training and education standards for financial advisers A need to increase minimum training standards was one of the major recommendations of the Ripoll Inquiry, which found the major criticism of the current system is that licensees minimum training standards for advisers are too low, particularly given the complexity of many financial products 16. Evidence to the Committee contended that the minimum training and qualifications for financial advisers should be raised. 17 A need to enhance education levels across the industry has been recently highlighted by: The Financial System Inquiry The Final Report of the Senate Economics Committee Inquiry into ASIC Poor advice practices highlighted by high-profile financial collapses and the Commonwealth Bank Financial Planning scandal Surveillance undertaken by ASIC The Final Report of the Senate Economics Committee Inquiry into ASIC found education standards to be inadequate and recommended minimum education standards of a relevant university degree and three years' experience over a five-year period for advisers, as well as minimum continuing professional 14 Final Report of the Financial System Inquiry, December 2014, p Final Report of the Financial System Inquiry, December 2014, p The Ripoll Inquiry, 2009, The Ripoll Inquiry, 2009, Submission Professional Conduct and Standards 7

11 development requirements. 18 Following the Inquiry, the Commonwealth Bank announced new minimum education standards for Commonwealth Financial Planning Limited (CFPL) financial planners, supervisors and managers of planners. 19 This has now been emulated by most of the major banks. Shadow-shopping research 20 by ASIC has found advice was generally not of a sufficiently high standard. 21. Where advice was poor, common problems included: (a) Inadequately assessing or addressing the client s personal circumstances, needs or objectives (b) Conflicted remuneration structures (e.g. product commissions and percentage asset-based fees) affecting the type of advice and recommendations, and the quality of advice given (c) Failing to provide adequate justification for recommendations, particularly when advising a client to switch products, where the new product was sometimes less advantageous to the client Shadow-shopping undertaken by ASIC also exposes the incapacity of consumers to assess the quality of advice that they receive, even where it is independently judged as being of a poor standard. Of 64 financial plans for retirement age individuals examined by ASIC, only 3 per cent of the financial plans were found to provide good quality financial advice, despite 86 per cent of participants believing they had received good quality advice and 81 per cent saying they trusted the advice they received from their adviser a lot. Recent reports of advisers cheating on exams, 22 have further shone the spotlight on whether the industry is adequately complying with the existing entry and ongoing continuous professional development requirements for advisers. 1.3 Recommendations to improve current levels of consumer protections Abandon the dilution of FoFA Changes to the Future of Financial Advice Legislation should be abandoned and FoFA as commenced on 1 July 2013 should be given an opportunity to settle ISA strongly believes that any further dilution to the FoFA Legislation will be detrimental to consumers and must be addressed as part of an Inquiry into the scrutiny of Financial Advice. While it may be true that the existing FoFA laws will not prevent every instance of further financial collapse, by re-permitting conflicted forms of remuneration and lowering conduct requirements, the likelihood of future scandals are considerably increased, some would say a certainty Enhancing minimum training standards The Government should enhance minimum training standards for financial advisers In order to enhance minimum training standards for adviser, ISA supports the following recommendations of the Financial System Inquiry to raise the competency of advisers: 18 Final Report of the Senate Economics Committee Inquiry into ASIC, Recommendation Media Release, 18 July 2014, Commonwealth Bank Raises Educational Standards for Financial Planners 20 March 2012: see Report 279 Shadow Shopping Study of Retirement Advice (REP 279) 21 March 2012: see Report 279 Shadow Shopping Study of Retirement Advice (REP 279) 22 Adele Ferguson, Ben Butler, Cheating rife in financial planning, The Age, Saturday August 17 Submission Professional Conduct and Standards 8

12 A relevant tertiary degree Competency in specialised areas, such as superannuation, where relevant Ongoing professional development including technical skills, relationship skills, compliance and ethical requirements Adopting a fee for service advice model ISA supports the adoption of a fee for service advice model ISA believes that there is much merit in the concept of financial advisers working to the same fee-forservice business model as other professionals, such as doctors. Paying fixed fees for advice will help to eliminate adviser reliance on incentives or commissions and will provide consumers with greater transparency in relation to fees and the value of the advice. Importantly, it will actively encourage Australians to engage with their finances in the same way they do with their health Banning all forms of conflicted remuneration ISA recommends that all forms of conflicted remuneration should be banned ISA has continually advocated for the banning of all forms of conflicted remuneration. ISA strongly agrees with the Financial System Inquiry s Interim Report s observation that the principle of consumers being able to access advice that helps them meet their financial needs is undermined by the existence of conflicted remuneration structures in financial advice 23. The law should impose a broad ban on all forms of conflicted remuneration for financial advisers, including indefinite ongoing asset based fees. Such a prohibition is critical to financial planner professionalism Reviewing the current definition of retail and wholesale investors ISA recommends a review of the definition of retail/wholesale investor In order to ensure that consumers receive necessary protection it is vital that the matrix of protection is designed to strike a balance between the needs of everyday investors and sophisticated ones. The current definitions for wholesale and retail investor (761G of The Corporations Act) are extremely complex and enable clients ordinarily classed as retail investors to be classed as wholesale in certain circumstances. With this circumvention comes the benefit of much lower conduct requirements and less disclosure, which has the potential to create outcomes detrimental to consumers. It is essential that these definitions are strict to ensure that the wholesale definition is limited only to clients who have the financial expertise to understand the risk associated with their investment and to undertake appropriate due diligence. ISA submits that the current threshold test is too low and recommends that the test should also involve provider assessment. In addition, any advice involving superannuation should be classed as retail due to the strong public interest in higher standards. 23 Interim Report Financial System Inquiry, March 2014, 3-65 Submission Professional Conduct and Standards 9

13 2. Regulatory reforms that would ensure transparency for consumers in relation to misconduct A need for transparency for consumers in relation to misconduct has been highlighted by the following factors, discussed in detail at section 1. The failure of regulatory settings to protect consumers from financial advice scandals and collapses Widespread acknowledgement that the existence of conflicted remuneration structures are detrimental to the quality of advice Inadequate training and educational standards for advisers Evidence of widespread misselling in the life insurance industry ISA has advocated for the following regulatory and legislative reforms to improve professionalism of the financial advice industry and to deter and prevent misconduct by financial advisers. These include: The development of a public register for financial advisers The enshrinement in law of the term financial advisers The power for regulators to establish minimum professional and ethical requirements for financial advisers 2.1 Recommendations transparency for consumers in relation to misconduct Recommendations arising from the final report of the Financial System Inquiry The Final Report of the Financial System Inquiry makes the following specific recommendations that will improve transparency for consumers in relation to misconduct. ISA is supportive of these recommendations: Introduce an industry funding model for Australian Securities and Investments Commission (ASIC) and provide ASIC with stronger regulatory tools Raise the competency of financial advice providers Introduce an enhanced register of advisers The development of a public register ISA supports the Government s decision to establish a public register for financial advisers as part of its commitment to lifting professional, ethical and educational standards across the financial advice industry. 24 The development of a public register will provide ASIC and consumers with transparency about advisers qualifications and employment history. The register will not only enhance ASIC s capacity to monitor 24 Submission Professional Conduct and Standards 10

14 financial advisers (including employee advisers) but will enable the benchmarking of key metrics in financial planning in its progress towards professionalism. If correctly implemented, this initiative serves to: Create transparency of the industry s progress towards professionalism Empower consumers to make informed decisions about financial advice The current draft of the regulations does not include a requirement for an adviser s professional qualifications or membership to be listed in the Register. However, the Minister has made clear in media statements that this information will be included in the first iteration of the Register. ISA strongly supports the inclusion of this information. In particular, given the significant impact that remuneration practices have on the quality of financial advice, we believe that it is critical for the register to provide a summary of the means by which an adviser accepts payment (remuneration options). This information is relevant at the time a consumer is checking a financial adviser s credentials prior to engagement. ISA also submits that the terms financial planner and financial adviser should be restricted to those who are listed on the Register. Over time, the register could replace the requirement to provide an FSG and would provide more userfriendly, concise, comparable information regarding all financial advisers A high standard for codes of conduct ISA recommends that all financial advisers should be subject to an ASIC approved professional standards/code which has clear guidelines in relation to misconduct ISA supports ASIC Regulatory Guide 183 as providing a sound basis for the approval of codes of conduct which would facilitate a higher standard of professionalism. RG 183 sets out key processes for the development of codes of conduct and the core rules codes should cover. ISA supports ASIC s observation that an approved code responds to identified and emerging consumer issues and delivers substantial benefits to consumers 25. ASIC Regulatory Guide 183 was the result of broad consultation from Industry stakeholders and represents a positive step towards the development of effective and enforceable industry codes by promoting transparency for consumers. 3. Whether existing mechanisms are appropriate in any compensation process 3.1 Key issues inadequacies in the compensation process As part of the Future of Financial Advice (FoFA) reforms announced on 26 April 2010, the Government commissioned Richard St. John to undertake a review to consider the need for, and costs and benefits of a statutory compensation scheme. This review was announced in response to recommendation 10 of the 25 Regulatory Guide 183, ASIC, 2013, p 4 Submission Professional Conduct and Standards 11

15 report by the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Financial Products and Services in Australia. Richard St. John's final report to Government was handed down on and April and considers the need for a statutory compensation scheme, strengthening current compensation arrangements and rebalancing responsibilities of licensees. Key issues highlighted by the report include the inability of individual providers to cover claims, the limitations of professional indemnity insurance and the social impact of lack of compensation Limitations of individual providers to cover claims A key issue in the compensation process has been the compensation arrangements in the investments and advice sector whereby the combination of insurance and the financial resources of the individual provider have not been sufficient to cover claims. The absence of a backup source of compensation has left many consumers without compensation, despite having substantial claims. As noted by the report, there are limits to the extent to which professional indemnity insurance cover will respond to claims against a licensee by retail clients. In circumstances where there is no available cover or the policy does not cover the claim, the licensee s ability to meet claims will depend upon its available financial resources. 26 It is therefore essential that licensees ensure that insurance requirements adequately meet their business needs. The impact of claims that are not met either due to the licensee becoming insolvent or having reached their cap is highlighted in the paragraph below which refers to a study undertaken by ASIC s Consumer Advisory Panel into the social impacts of investors suffering losses due to licensee misconduct: For consumers who lost all their money and/or incurred debt, the financial impact of the loss was immediate and critical and even catastrophic and so significant their life will never be the same. The impact on affected individuals included the loss of the family home, illness, strain in family relationships, and frugal spending on essentials. The study found the emotional wellbeing of affected consumers deteriorated with prolonged anger, uncertainty, worry and depression. The study also found a subsequent lack of confidence in the financial system by those experiencing the loss. 27 Evidence produced by the Financial Ombudsman Service shows that even where determinations for compensation are made, consumers do not always receive the compensation. For example: In the investments, life insurance and superannuation area, the level of unpaid Determinations is 33 per cent of all Determinations made financial services providers haven t complied with Determinations made by FOS in favour of consumers (1 January 2010 to 1 January 2014) 29 $8, plus interest is owed to 99 applicants whose claims FOS upheld but have not been paid compensation. Interest accrues at approximately 5 per cent per annum from the date of the award in most cases Compensation Arrangements for Consumers of Financial Services, Final Report, Richard st John, April 2012, Compensation Arrangements for Consumers of Financial Services, Final Report, Richard st John, April 2012, Submission Professional Conduct and Standards 12

16 3.2 Recommendations compensation process St John s report cautions against the need for a last resort compensation scheme on the basis that given the limited regulatory measures to protect retail clients from the risk of licensee insolvency, it would be inappropriate to require more responsible and financially secure licensees to underwrite the ability of other licensees to meet claims against them for compensation 31. Instead the report suggests the focus should be on developing a more robust and effective system to make licensees responsible for the consequences of their own conduct. 32 ISA, however, submits that there is merit in the establishment of a scheme once regulatory issues such as those outlined in Section 2 and including the finalisation of the FoFA reforms are addressed. ISA agrees with the following recommendations 33 put forth by Richard St John in relation to compensation for consumers who have fallen victim to poor financial advice including: Table: Recommendations from Final Report Richard st John Recommendation Recommendation 2.1: Licensees to demonstrate adequacy of their insurance Require licensees to provide ASIC with additional assurance that their professional indemnity insurance cover is current and is adequate to their business needs. Recommendation 2.2: Licensees to hold appropriate capital resources More attention should be given, on a risk targeted basis and in conjunction with the level of their insurance cover, to the adequacy of licensees financial resources to enable better management of risks and unexpected costs such as compensation liabilities. Recommendation 2.3: A more pro-active stance by ASIC ASIC should take a more pro-active approach in monitoring licensee compliance with the requirement to hold adequate professional indemnity insurance cover and any new requirement in regard to financial resources, and in targeting licensees who are most at risk. Recommendation 2.4: Policing the licensing system in regards to compensation To assist ASIC in playing a more pro-active role in administering the licensing regime with respect to compensation arrangements, consideration should be given to clearer powers to enforce standards and to sanction licensees who do not comply Recommendation 2.5.1: Compensation where licensees cease to trade In dealing with licensees who give up their licence or reduce the scope of their licensed activities, ASIC should seek where possible to secure ongoing protection for retail clients including by imposing appropriate conditions in relation to the termination of a licence or the amalgamation or takeover of a licensed business 31 Compensation Arrangements for Consumers of Financial Services, Final Report, Richard st John, April 2012, p iii 32 Compensation Arrangements for Consumers of Financial Services, Final Report, Richard st John, April 2012, p Compensation Arrangements for Consumers of Financial Services, Final Report, Richard st John, April 2012, 7.51 Submission Professional Conduct and Standards 13

17 Recommendation 2.5.2: Protection from unlicensed providers While acknowledging the difficulties in identifying outlaw activity, the importance of concerted enforcement effort by ASIC to police the boundaries of licensed financial service activities is emphasised. In its approach to the handling of complaints about outlaw activities ASIC should be transparent and provide as much feedback Recommendation 2.5.5: External Dispute Resolution scheme processes Given their key role in the regime for the protection of consumers of financial services, and marked increases in their jurisdiction, External Dispute Resolution schemes and ASIC should give more attention to the adequacy of the EDR scheme processes as those schemes grow beyond their origins as forums for small claims Submission Professional Conduct and Standards 14

18 4. Appendix 1 Financial collapses in Australia between 2006 and 2010 Company Year Scheme Commissions and Fees Clients Affected Total Losses Storm Financial 2009 Margin lending/ $830 million 3 $136 compensation Timbercorp / Great Southern Financial Planning 2009 Managed Investment Schemes (MIS) 6-7 per cent upfront commission with two trail commissions of between per cent and 0.33 per cent pa. 1 Volume based rebates also paid. 10 per cent up front commission, ongoing fixed based fee, and 27.5 per cent performance fee 4 trail commissions of up to 0.75 per cent to referring brokers 8 14, of who were leveraged investment clients. 18,000 5 (Timbercorp) 47,000 (GS) 6 $3 billion+ 7 Opes Prime 2008 Non-standard margin loan, or equity finance scheme 1,200 retail customers 9 $630 million $226 compensation. 10 Bridgecorp 2007 Property Investment Unknown 14, $459 million 12 Westpoint 2006 Margin Lending 10 per cent up front commission 13 3, $388 million 15 $93 recovered Fincorp 2007 Property Investment $3 million in fees 16 8, $201 million 18 Trio/Astarra 2009 Corporate and Retail Super Commonwealth Financial Planning Limited Financial Planning 4 per cent up front commission 19 and 1.1 per cent trail commission 20 Additional volume rebates also paid to advisers 21 Unknown. But there was report of trailing commissions of 0.44 per cent per cent 24 6, $194.5 million 23 1,127 clients receiving compensation 25 $51 million in compensation. Actual losses unknown. 26 Submission Professional Conduct and Standards 15

19 Table 1 Sources 1 Financial Planning Association of Australia, Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Financial Products and Services in Australia Submission by the Financial Planning Association of Australia, July p Osbourne, Paul, Storm Financial Collapse Plan Outlined, The Age, 2009 < [accessed 15 August 2011]. 3 Australian Securities & Investments Commission, ASIC and CBA Storm Financial settlement, March Kohler, Alan, The Trouble with Fee Huggers, Business Spectator, 2009 < [accessed 11 August 2011]. 5 Hopkins, Philip, Troubled Timbercorp Calls It Quits, The Age, 2009 < agrv.html> [accessed 15 August 2011]. 6 Great Southern Limited, Financial Statements 30 September 2008 (Great Southern Limited, 2008), p 7. 7 Schwab, Adam, Agribusiness: Where You Lose Some, Then You Lose Some More Crikey, Crikey, 2010 < [accessed 11 August 2011] 8 Glenda Korporaal, How Opes snared its rivals' clients, News.com.au, [accessed 18 February 2014]. 9 Kohler, Alan, OPES PRIME COLLAPSE: Billion dollar bust, Business Spectator, 2013 < > [accessed 10 October 2013]. 10 ASIC, Financial System Inquiry: Submission by the Australian Securities and Investments Commission April 2014, Table 24: Major collapses: Recent ASIC outcomes, p NZPA, Bridgecorp Investors Likely to Get Less Than 10c in the Dollar - Business - NZ Herald News, NZ Herald, 2011 < [accessed 15 August 2011]. 12 Bridgeman, Duncan, Bridgecorp Investors to Receive Tiny Payout The National Business Review, National Business REview, 2011 < [accessed 15 August 2011]. 13 Kohler, Alan, Westpoint Wreck Shows How Deep Commissions Can Cut, The Age, 4 February 2006, section Business < [accessed 15 August 2011]. 14 Ibid. 15 Australian Government, Australian Securities and Investments Commission, Westpoint Investors Website: Westpoint milestones, Australian Securities and Investments Commission, 2001 < > [accessed 11 October 2013]. 16 Thomson, James, Founder of Collapsed Property Company Fincorp Facing Jail After Being Found Guilty of Dishonest Payments, Smart Company, 2011 < [accessed 15 August 2011]. 17 Australian Securities & Investments Commission, Updated statement on Fincorp, 23 August 2007 < > [accessed 10 October 2013]. 18 Australian Securities & Investments Commission, Updated statement on Fincorp, 23 August 2007 < > [accessed 10 October 2013]. 19 Freed, Jamie, and Michael West, Watchdog Silent on Court Order Against Trio Funds, Sydney Morning Herald, 2009 < [accessed 19 August 2011]. 20 Washington, Stuart, Trio Capital Forged Iron Triangle of Self-interest, The Age, 2011 < [accessed 19 August 2011]. 21 Astarra PDS, 31 August ASIC, Financial System Inquiry: Submission by the Australian Securities and Investments Commission April 2014, Table 24: Major collapses: Recent ASIC outcomes, p ASIC, Financial System Inquiry: Submission by the Australian Securities and Investments Commission April 2014, Table 24: Major collapses: Recent ASIC outcomes, p Adele Ferguson and Chris Vedelago (2013) Targets, bonuses, trips - inside the CBA boiler room, Sydney Morning Herald - Business Day, June 22, [accessed 18 February 2014]. 25 ASIC (2013) Initial submission by ASIC on Commonwealth Financial Planning Limited and related matters, Senate inquiry into the performance of the Australian Securities and Investments Commission, August 2013, 26 Ibid., p 14. Submission Professional Conduct and Standards 16

20 5. Appendix 2 ISA analysis of the proposed watering down of FoFA Dilution of the Best Interests Duty The Bill substantially dilutes the best interests duty in the following ways: 1. Removal of the requirement for planners to consider a client s best interests The existing best interests duty includes a list of the steps a planner must take to legally meet the best interests duty. The proposed change removes the last step [S 961B (2)(g)], the only step that refers to the client s best interests. This would make it possible for an adviser to meet the best interests duty without considering the client s best interests, or exercising objectivity and care. 2. Allowing planners and clients to agree on the scope of advice provided the advice is appropriate An adviser can limit the scope of advice through client agreement, even if a reasonable adviser would know that the limited scope is not in the client s best interests. Problematically, under such an agreement, advisers can limit their advice to their employer s products irrespective of how uncompetitive those products are. The adviser doesn t need to warn the client about the impact of limiting the advice. Removal of the annual fee disclosure requirement Prior to FoFA there was no obligation for financial advisers to provide a consolidated annual statement of the fees they received on behalf of clients. The Bill would allow the annual fee disclosure statement to only apply to new clients. Therefore, already committed clients will have no consolidated communication of ongoing fees. Removal of the opt-in requirement The Bill removes the opt-in requirement, which obliges an adviser charging an ongoing fee to ask their client at least once every two years if they can continue to deduct the fee. Without opt-in, ongoing fees can be charged even when no ongoing advice is being received by the client. In 2011 around 3 million Australians were paying ongoing fees for advice without receiving ongoing advice. A 0.5 per cent ongoing fee can cost an average member around $46,000 from their super over their working life. Re-permitting conflicted remuneration The Government has proposed a number of exemptions that allow payment of conflicted remuneration and commissions for advice on complex products like super, debt products and managed investment schemes. The exemptions are: Exemption Allowing conflicted remuneration to be earned by staff giving general financial advice (ie verbal advice in which a product is recommended). Allowing commissions on execution services, even when personal advice has been provided to the client by another representative Analysis Enables incentives to be paid based on: - aggregate revenue targets generated by sales - aggregate sales targets across a range of products - per product sales targets which are combined with other measures (i.e. customer satisfaction) The exemption has broad application to advisers and other staff working for banks, their subsidiaries and any licensee selling an in-house product. This permits incentives to drive mis-selling of complex products, given that basic banking products are already completely exempt Creates an obvious loophole by allowing commissions and other incentives to be paid/received when advice is implemented by a planner other than the planner who provided the advice Submission Professional Conduct and Standards 17