The Future of Financial Advice reforms are placed to take effect from 1 July 2012. The impetus for the changes is improved transparency and increased access to financial advice. Both were concluded to be necessary by the Federal Government's 2009 'Ripoll Inquiry'. Following the introduction into Parliament of Bills seeking to implement the reforms, the question is whether the legislation will be enough to meet the 'Ripoll Inquiry's' focus of rehabilitating the public perception of the industry.
In our June 2011 Insurance & Financial Services Bulletin, we outlined the Federal Government's proposed Future of Financial Advice (FOFA) reforms. Since then, the Federal Government has released, in two separate tranches, Bills seeking to implement these reforms. On 13 October 2011, the Corporations Amendment (Future of Financial Advice) Bill 2011 was introduced into Federal Parliament. This was followed on 24 November 2011 by the introduction into Parliament of the Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011. Both Bills have since been referred to the Parliamentary Joint Committee on Corporations & Financial Services.
The FOFA reforms were largely driven by allegations of conflict of interest which featured in a number of the high profile Australian corporate collapses arising out of the GFC. The underlying objective of the reforms is cited in the Explanatory Memorandum as "building trust and confidence in the financial planning industry".
To this end, the FOFA legislation proposes key amendments of a 'best interests' duty, 'opt-in' disclosure requirements and increased watchdog powers for the Australian Securities and Investments Commission (ASIC).
Best Interests
Currently, the Corporations Act 2001 (Cth) (the Act) does not require a financial adviser to act in the best interests of the client or to prioritise a client's interests over their own. In practice, this has meant that an advice need only meet the requirement of appropriateness (s 945A) and that the necessary disclosures be made by the "providing entity" (the licensee) (Part 7.7). These necessary disclosures are currently limited to issues such as the provision of a Financial Services Guide (s 941B) and Product Disclosure Statement, the requirement to warn that a general advice does not take account of a client's objectives (s 949A) and also to warn where an advice is based on incomplete or inaccurate information (s 945B(1)).
The new legislation introduces a more onerous framework requiring obligations for all individuals who provide personal advice to "act in the best interests of the client in relation to the advice" (s 961B(1)). Relevantly to basic banking and general insurance products, this can be established through compliance with the first three of the following seven steps:
- identifying the objectives, financial situation and needs of the client;
- identifying the client's circumstances relevant to the subject matter of the advice sought – being termed in the industry as the "know your client rule";
- making reasonable inquiries to obtain complete and accurate information;
- assessing whether the provider has the expertise to provide the advice sought and, if not, declining to provide the advice;
- conducting a reasonable investigation into and assessing any financial products it considers recommending – the "know your product rule";
- basing all judgements in advising the client on the client's relevant circumstances; and
- taking any other steps that would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances.
It is acknowledged in the Explanatory Memorandum that these steps are based on the current regime and what is expected of licensees. Under the new legislation, whether a provider has acted in the best interest of the client will also be tested according to what would "objectively and reasonably" be considered appropriate for the client (s 961G) – this is also the current test relevant to "appropriateness" under s 945A.
In addition to the 'best interests' duty, s 961J of the new legislation will also require the provider to give priority to the client's interests when providing the advice. There is no existing statutory duty to do so.
Ongoing fee arrangements
The current regime allows advisers to obtain ongoing 'trail fees' from their clients' investment portfolios in lieu of a higher initial commission or fixed fee for service. Despite receiving ongoing remuneration for these services, an adviser has no corresponding obligation to provide an ongoing service. This has led in some instances to disengaged clients paying ongoing fees for little or no service.
Notwithstanding public criticism, the Federal Government acknowledges in the Explanatory Memorandum accompanying the Bills that trail commissions have a role to play in the financial services industry and subsequently, these have not been entirely abolished. The legislation does however seek to redress the adviser/consumer imbalance by imposing two separate disclosure requirements on advisers providing advice to a retail client and proposing to charge an ongoing advice fee:
- an annual fee disclosure statement to the client (s 962G) detailing advice fee and service information for both the previous and upcoming 12 months (s 962H); and
- an additional 'opt-in' renewal notice to the client every two years (s 962K).
For ongoing fee arrangements, the client is also entitled to 'opt-out' or terminate the arrangement at any time (s 962E). Significantly, in the case of the renewal notice, where the client opts not to renew (s 962M) or simply does not respond to the renewal notice (s 962N), the arrangement ceases and an ongoing advice fee can no longer be charged to the client. The opt-in will apply to new clients from 1 July 2012.
ASIC powers
The legislation also enhances the regulatory powers of ASIC to supervise the financial services industry through changes to its licensing and banning powers.
Under the current legislation, the threshold for entry into the licensing regime is relatively low whereas the threshold for cancelling licences was acknowledged in the 'Ripoll Inquiry' to be comparatively high. The laws contained in the first of the two Bills will enable ASIC to refuse or cancel a licence if it believes a licensee is "likely to contravene its obligation" (s 915C(1)(aa) rather than the current requirement to establish that a licensee "will not" comply. The Explanatory Memorandum refers to these provisions as "an enhancement of ASIC's powers to deal with unscrupulous operators."
The legislation will also give ASIC the capacity to act at an earlier stage if it has concerns about either individuals or a licensee (as opposed to only a licensee), enabling it to ban a person who it "has reason to believe" is "not of good fame or character" or "not adequately trained or not competent to provide a financial service" (s 920A(1)(c ). While the legislation sets out a limited number of circumstances that would tend to suggest a person is "not of good fame or character", including the conviction of an offence, suspension or cancellation of an Australian Financial Services licence or the making of a banning or disqualification order under Division 8 of the Act, the proviso "any other matter ASIC considers relevant" makes it clear that ASIC's powers under the new regime are intended to be broad-sweeping. In fact, the legislation is now being criticised by some industry bodies as giving ASIC too much discretion. There have also been demands for more certainty as to how ASIC intends to prove a licensee is ''likely to'' breach its obligations
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Implications
The reforms seek to expand the regulatory framework in which financial providers are currently operating. Insofar as the 'best interests' component has not previously been codified and the new legislation targets individuals as opposed to licensees which are currently regulated, these reforms could lead to increased levels of exposure. However, the 'best interests' threshold does not appear unduly high, requiring compliance in some cases with only the first 3 of 7 steps which are based on current practice, calling into question the extent of the claims impact which will be felt.
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