Conflicts of Interest in The Financial Services Sector

September 2, 2015

Content of Paper

 

Part 1-        Background

 

1          What Is a Conflict of Interest

1.1       Types of Conflicts

1.2       General Definition

1.3       Financial Services Definition of Conflicts

1.4       Examples of conflicts of interest envisaged by this definition include:

1.5       Financial Services Industry – 3 Main Statutory Categories of Conflicts                  

 

Part 2         Having Adequate Arrangements to Manage Conflicts

 

2.1       Background

2.2       Conflicts Management Obligation

2.3       "Conflicts Management Obligation" – Three General Mechanisms to Manage Conflicts

2.4       Conflicts Management Obligation-Retail/Wholesale?

2.5       Compliance with Industry Standards, Practices, Codes, Foreign Rules and Standards

2.6       Ensuring Conflict Arrangements Are "Robust and Effective" ( Adequate)

2.7       More Required Than Just Having "Conflict Arrangements"

2.8       Internal Structures

2.8.1    Consideration of Reporting Lines within Organisation

2.8.2    "Chinese Walls"/"Robust Information Barriers"

2.9       Remuneration (but see also later concerning: "Conflicted Remuneration")

2.10     Avoiding Material Conflicts of Interest Altogether

2.11     Conflicts – Documentation and Record-Keeping

2.12     Disclosing Conflicts of Interest

2.12.1  Full Disclosure to Adequately Inform Client

2.12.2  Timely, Prominent, Specific and Meaningful Disclosure

2.12.3  Disclosures for Financial Product Advice

2.13     Retail/wholesale

2.14     Issues to consider in complying with the conflicts management obligations

 

Part 3         Best Interests Priority 

 

3.1 -     Overview of "Best Interests Duty and Related Obligations - Where there is a conflict with their own interests,             or those of one of their related parties, prioritise the interests of the client (RG 175.20).           

3.2       Conflicts Priority Rule ( S.961J(1) of the Act & RG 175.363)

3.3       Conflict between whom?

3.4       Identifying the Conflict

3.5       Giving the Client's Interests Priority ( S 961J of the Act & RG 175.371)

3.6       ASIC's Illustrative Examples of Remuneration Conflicts – Life Insurance Commissions

3.6.1    Example

3.6.2    Key Features of the Conflicts Priority Rule include:

3.6.3    Overservicing a Client When Advising on an SMSF

3.7       Conclusion

 

 

Part 4         Conflicted Remuneration Provisions

 

4.1       Background

4.2       What are the Conflicted Remuneration Provisions?

4.3       The Ban on Conflicted Remuneration

4.4       What Is Conflicted Remuneration

4.5       ASIC Guidance on Volume-based and Performance-Based Benefits

4.6       Remuneration with Potential to Influence

4.7       Guiding Principles for ASIC's Administrative Approach

4.8       Application to "Advice about Platforms"

4.9       What is covered by the ban?

4.10     Examples of conflicted remuneration

 

The Schedule

Item 1           Some Relevant Legislation concerning adequate arrangements to manage Conflicts

Item 2           Managing Conflicts

Item 2.1        Issues for consideration in controlling and avoiding Conflicts-[reference paragraph 3.15 of this Paper]

Item 2.2        Issues for consideration re-Disclosing Conflicts

Item 3           Relevant Definitions for the purposes of this paper

Item 4           Acting in the Best Interests of the Client

Item 5           Safe Harbour for complying with the best interests duty

Item 6           Treating Clients Fairly

Item 7           Conflicted Remuneration Checklist

Item 8           Report 444 dated August 2015 – ASIC Enforcement Outcomes January to June                           

 

2015 – relevant extracts

 

 

 

Part 1- Background

 

1          What Is a Conflict of Interest

 

1.1       Types of Conflicts

 

Conflicts of Interest may be found in politics, trade unions, churches, schools, legal and accounting professions et cetera. Frankly, conflicts can be found in almost every walk of commercial and even personal life.

 

Conflicts may correctly be described as "actual conflicts" or "perceived conflicts".

An extreme example of an actual conflict would be where a lawyer acts for both the prosecutor (that is the state) and the defendant. It is clear to everybody that such a situation would constitute a clear conflict. Accordingly laws prevent this!

 

A common example of an actual conflict of interest is where a lawyer acts for both the buyer and seller of property. Again it is apparent to everybody how both the buyer and the seller could be hurt in such an arrangement.

On the other hand, a "perceived conflict of interest" can arise in a variety of circumstances. For example, an accounting firm which provided tax advice to Telstra could be considered to have a perceived conflict of interest if it also provided tax advice to Optus. In other words, the management of Telstra and Optus would feel uncomfortable that the tax advice received was not necessarily innovative and exclusive. In fact management of both companies would likely draw the conclusion that such a situation was not tenable.

 

Another common example of a "perceived conflict of interest" is the circumstance where say PricewaterhouseCoopers does the audit for the National Bank and PricewaterhouseCoopers Legal accepts instructions from the Commonwealth Bank to initiate legal proceedings against the National Bank for a breach of some contractual obligation. What would you as the management of the National Bank think about your business relationship with PricewaterhouseCoopers in those circumstances? This is a perceived conflict of interest. While it is not necessarily wrong at law, nevertheless, this commercial relationship could leave a sour taste in the mouths of the management.

 

So generally, the difference between an actual conflict and a perceived conflict is that an actual conflict generally results in some legal impediment to the commercial dealing while a perceived conflict is not in itself illegal but sours the commercial relationship.

 

 

 

1.2       General Definition

 

A conflict exists if the circumstances are reasonably believed (on the basis of past experience and objective evidence) to create a risk that decisions concerning the interest of a client may be unduly influenced by secondary interests.

 

1.3       Financial Services Definition of Conflicts

 

The meaning of the term "conflicts of interest" used in the context of Chapter 7 of the Corporations Act 2001 ("the Act") is not defined in the law itself. Nevertheless, ASIC as the regulator of the law conveniently provides a helpful definition:

            "… Circumstances where some or all of the interests of people (clients) to whom a licensee (or its representative) provides financial services are inconsistent with, or diverge from, some or all of the interests of the licensee or its representatives. This includes actual, apparent and potential conflicts of interest." (RG 181.15).

 

So if a licensee or representative is providing financial services to a client and there is some inconsistency/divergence/tension between some or all of the interests of the adviser and those of the client then this is probably a conflict of interest according to ASIC's definition.

 

Now there may be nothing wrong with this to the extent that the conflict is minimal. For example, it may only be a matter of the adviser disclosing his interest and the client may then be fully satisfied. On the other hand, the adviser may have what is called a "material" interest in influencing the client to go down a particular investment path. In these circumstances there are a variety of laws, regulations and administrative arrangements which impact on the adviser.

 

1.4       Examples of conflicts of interest envisaged by this definition include:

 

            I           Licensee A has an interest in encouraging client B to invest in higher risk products which result in                             high commissions for licensee A. This strategy is inconsistent with client B's personal desire to                                 obtain a lower risk product.

 

            II         Licensee C has an interest in maximising trading volume by its clients (including client D) in order to                         increase its commission revenue. This strategy is inconsistent with client D's personal objective of                             minimising investment costs.

 

            III        Licensee E is the trustee of a retail superannuation fund and has an interest in maximising the fees                           it earns from managing the fund (and therefore maximising the returns to its shareholders). On the                         other hand, the beneficiaries have an interest in minimising the fees they pay as members of the                             fund.

 

1.5       Financial Services Industry – 3 Main Statutory Categories of Conflicts 

                   

1.5.1    An AFS licensee has a statutory obligation to have in place adequate arrangements for the management of conflicts which might arise pursuant to the licence. This obligation is extended through the way the law is drafted to a "representative". This requirement applies to both retail and wholesale clients.

 

1.5.2    Part 7.7A of the Corporations Act requires retail personal advice providers to act in the    best interests of the client and where there is a conflict with their own interests, or those of one of their related parties, prioritise the interests of the client (RG 175.20). This obligation on licensees and representatives is designed to ensure that retail clients   receive advice that meets their objectives, financial situation and needs and that advice providers act in the best interest of their client in providing clients with advice.

 

1.5.3    A third statutory category of conflict for financial advisers is the legislation dealing with Conflicted Remuneration. These provisions affect how AFS licensees and their  representatives are paid for the financial product advice they give and the other benefits they receive. They do not affect how financial product advice is provided.

 

1.5.4    Other statutory and common law obligations impacting on Conflicts in the financial services sector are outlined in Item 1 of the Schedule to this paper.

 

Part 2        

 

2       Having Adequate Arrangements to Manage Conflicts

 

2.1       Background

 

In the financial services industry the federal government has tried hard through legislation to facilitate consumers of financial products and services to make confident and informed decisions in an environment of efficiency, flexibility and innovation (Section 760A of the Act).

 

The government's aim through this legislation and the regulator's focus in its administration of the legislation is to promote fairness, honesty and professionalism by those who provide financial services together with fair, orderly and transparent markets for financial products (Section 760A of the Act).

 

While the above 2 paragraphs summarise the general philosophy underlining the relevant law protecting consumers, another provision specifies the general obligations applicable to financial services licensees and representatives to achieve the level of consumer protection anticipated by government.

 

2.2       Conflicts Management Obligation

 

Specifically, Subsection 912A (1) (aa) of the Act  specifically requires a financial services licensee to have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by the licensee or a representative of the licensee in the provision of financial services as part of the financial services business of the licensee or the representative.

 

This primary obligation is called the "conflicts management obligation".

 

It is ASIC's view that this conflicts management obligation is necessarily linked to the obligation to operate efficiently, honestly and fairly (see 4.1 below).

 

ASIC believes that the licensee is unlikely to comply with the efficiently, honestly and fairly obligation if it has inadequate conflict management procedures.

 

Conversely, ASIC believes that having adequate conflicts management arrangements will help licensees comply with their other obligations including the obligation to operate efficiently, honestly and fairly.

 

The regulator also believes that having adequate conflicts management arrangements will also help licensees establish and maintain a reputation for integrity in the provision of financial services (RG 181.18).

 

2.3       "Conflicts Management Obligation" – Three General Mechanisms to Manage Conflicts

 

The "Conflicts Management Obligation" arising under section 912A (1) (aa) of the Act requires (according to the Regulator) more than simply a disclosure obligation. The primary obligation is to ensure that there are adequate arrangements in place to actually manage conflicts of interest.

 

ASIC believes that there are 3 "mechanisms" that licensees can use to manage conflicts of interest:

 

2.3.1    control the conflict;

 

2.3.2    avoid the conflict; and/or

 

2.3.3    disclose the conflict of interest.

 

2.4       Conflicts Management Obligation-Retail/Wholesale?

 

It is important to note that this primary obligation is not restricted to managing conflicts of interest for only retail clients. The obligation extends to appropriate management strategies for both retail and wholesale clients (RG 181.22).

 

Accordingly, licensees must have in place appropriate arrangements to identify and manage all conflicts of interest except of course if they arise outside of the financial services business. This same broad obligation extends to the licensee's responsibility to act efficiently, honestly and fairly in relation to all clients (not just retail clients).

 

2.5       Compliance with Industry Standards, Practices, Codes, Foreign Rules and Standards

 

When administering the law concerning Conflicts, ASIC has advised that it may take into account an organisation's compliance with industry standards or practices. ASIC also recognises that some licensees are obliged to have regard to foreign rules or standards for managing conflicts of interest. ASIC recognises that the US, Canada, UK and Hong Kong have comparable conflicts of interest management obligations and hence where an organisation complies with these, ASIC anticipates that affected licensees should thereby comply with most of Australia's policy already (RG 181.26)


 

2.6       Ensuring Conflict Arrangements Are "Robust and Effective" (Adequate)

 

Adequate conflict management procedures means that they should be robust and effective. That is, the conflicts management procedures must successfully identify conflicts of interest and control the effects of those conflicts on the provision of financial services so that the quality of those financial services is not significantly compromised.

 

It would be expected that licensees should monitor whether their relevant conflict management arrangements successfully do this.

 

The terms robust and effective have been uplifted from the Explanatory Memorandum to the Corporate Law Economic Reform Programme (Audit Reform and Corporate Disclosure) Bill 2003 at paragraph 5.597 which relevantly provides that the Conflicts Management Obligation "will require internal policies and procedures for preventing and addressing potential conflicts of interest that are robust and effective".

 

ASIC has therefore adopted this terminology in its Regulatory Guide at paragraph 181.30.

 

Robust and effective conflict management procedures therefore would anticipate that licensees would have monitoring procedures in place to ensure that any non-compliance with the licensees conflicts management arrangements are identified and appropriately acted upon. Licensees should record action taken on breaches. Arrangements that are not monitored and enforced are unlikely to be considered by ASIC to be adequate.

 

ASIC believes that licensees should ensure that their conflicts management arrangements are designed or tailored according to the nature, scale and complexity of their respective business. (RG 181.32) Arrangements could therefore include measures such as:

        

- Meeting with affected staff or clients;

          

- Periodic reviews of business operations by an internal or external auditor or other person independent from               the business units; and/or;

         

- Periodic reviews of client files and records of services provided.

 

2.7       More Required Than Just Having "Conflict Arrangements"

 

Just having appropriate policies, practices and procedures in place to address conflict management does not necessarily mean that an organisation has robust conflicts compliance. To be adequate or effective, the arrangements must be implemented and maintained (RG181.34).

 

It is an important observation that the courts have accepted the importance of effective policies and procedures as follows:

                        "a stockbroker employing brokers cannot supervise each dealing they make as they make it. It can,                          however, set down policies…… Policies, however, are worthless without systems and people                                    in place to enforce those policies by checking from time to time that they are being                                                applied": Rahmat Ali v Hartley Poynton Ltd VSC 113 per Smith J at para 365.

 

ASIC considers that adequate/effective policies, practices and procedures are:

 

.           Approved and endorsed by the senior management of the licensee;

 

.           Designed or tailored according to the nature, scale and complexity of the licensee's business;

 

.           Effectively implemented (and accompanied by effective compliance monitoring designed to ensure that the               conflicts management arrangements are actually followed and appropriate action is taken where non-                       compliance is identified);

 

.           Regularly reviewed (internally or by a third party such as an auditor, as appropriate) and where necessary,               updated to ensure that the arrangements are adequate to identify, assess, and evaluate and successfully                 control conflicts of interest; and,

 

.           Overseen by a specific person or persons who take responsibility for their implementation, reviewing and                   updating.

 

2.8       Internal Structures

 

2.8.1    Consideration of Reporting Lines within Organisation

 

Effective management of conflicts of interest requires appropriate internal structures and reporting lines. For example, licensees should carefully consider and query whether it is appropriate to have advisory staff reporting to marketing staff.

 

Or should "stand alone" advice units within the organisation be in the same physical location as sales or investment management staff?

 

Another questionable structure is having compliance or internal audit staff reporting to a business unit. These scenarios are merely illustrative of  the point that effective management in an organisation regardless of size requires some serious thought given to internal structures.

 

2.8.2    "Chinese Walls"/"Robust Information Barriers"

 

For years, law firms, accountants and banks have relied on what has traditionally been called "Chinese walls" to prevent information obtained whilst acting for one client passing to another client of the same firm. A case considered by the House of Lords (Bolkiah v KPMG) is of great importance to the large accountancy firms. It is also of relevance to law firms which compete with forensic accountants.

 

All firms that rely on Chinese walls, and clients whose advisers may use them, should take this opportunity to review their use and ensure that the procedures for establishing and monitoring them are adequate.

 

"Chinese walls" in the financial services industry may be more precisely called "robust information barriers" (see RG 181.36) which may help the licensee manage their conflicts of interest. They may also allow a licensee to insulate one group of staff from the information or other circumstances that give rise to a particular conflict so that the group is not affected by that conflict. To be effective, ASIC suggests that "such barriers must actually prevent information being passed to the relevant group of staff" (RG 181.36).

 

One important aspect of any consideration by a licensee concerning "robust information barriers" is that the person deciding what is or is not appropriate action to take where a conflict of interest arises should not be significantly affected by the conflict him/herself.

 

2.9       Remuneration (but see also later concerning: "Conflicted Remuneration")

 

One element of a licensee operating efficiently, honestly and fairly and thereby avoiding conflicts is the proper consideration of the organisation's remuneration practices including non-monitory benefits. The following circumstances illustrate this point:

 

.           ASIC would expect disclosure to be part of how the licensee manages the conflict where a product provider               pays a higher rate of commission to a financial advisor for achieving certain volumes of sale (RG 181.38).

 

.           Licensees should avoid remuneration structures where advisers are paid exclusively by commission.

 

.           Trustees taking fees based on funds under management should consider how to ensure they address any                 tendency to act other than in the best interests of their clients (beneficiaries)

 

ASIC believes that in some cases, disclosure to clients is an adequate mechanism for controlling conflicts of interest arising from remuneration practices (RG 181.39). Nevertheless, certain remuneration practices that place the interests of the licensee or its representatives in direct and significant conflict with those of the licensee's clients should be avoided and not merely disclosed (RG 181.39).

 

Since Regulatory Guide 181 was written the Conflicted Remuneration provisions have been introduced (see later)

 

2.10     Avoiding Material Conflicts of Interest Altogether

 

The only way to manage those conflicts of interest which have a serious potential to impact on a licensee or its clients is to avoid them altogether. That is, merely disclosing them or imposing internal controls will be inadequate! Accordingly, appropriate management controls must be able to identify those conflicts of interest that must be avoided altogether.

 

Examples of such conflicts include:

 

.           Licensees should not permit any person from offering or publishing or giving positive advice about a                         particular financial product issuer ( or include their product on a recommended list) solely in return for                     benefits or continuing business from that issuer.

.           Licensees should not permit any disclosure of pending client orders to 3rd parties associated with                             the licensee (which would enable those third parties to trade ahead of the client). The most obvious way of               avoiding this conflict would be to ensure that information about pending client orders is not communicated               to 3rd parties at all.

.           Licensees who are fund managers should not permit "late trading" by some of their clients (that is allowing               clients to buy and sell interests in their funds at a particular day's price based on information that                             comes light only after general trading in that fund for that day has closed).

 

ASIC believes that each licensee is responsible for its own conduct and that of their representatives (RG 181.43). Accordingly, the management arrangements of each licensee needs to take this into account. As far as possible, licensees (and their representatives) should avoid placing themselves in a position where there is a material conflict between their own interests and that of their clients. This is to minimise the risk that the licensee will be tempted to unfairly prefer their own interest to those of their clients.

 

2.11     Conflicts – Documentation and Record-Keeping

 

Conflict management arrangements need to be documented meaning that there should be a written conflicts management policy together with appropriate records showing what the organisation has actually done to monitor compliance with its conflicts management arrangements (RG 181.45).

 

Records in this context means records kept for at least 7 years of:

 

.           Conflicts identified and action taken;

 

.           Any reports given to the licensee's owners or senior management about conflicts of interest matters; and,

 

.           Copies of written conflict of interest disclosures given to clients or the public as a whole.

 

ASIC suggests that a licensee should keep copies of written conflict disclosures given to individual clients or otherwise made available on say a website. If similar disclosures are used repeatedly, ASIC would expect a representative sample of conflict disclosures to be kept.

 

The regulator also advises that the licensee should consider what records of oral disclosure should be kept to help them in monitoring their compliance with their conflicts management obligations. That is, a licensee should consider how they will demonstrate their compliance with these obligations in the event of a review (by the licensee, its auditor or ASIC). For example, the licensee may wish to keep copies of oral disclosure "scripts" used by their representatives (RG 181.46).

 

All the regulator requires is appropriate records and each licensee needs to consider how best to keep these documents and records. It may be appropriate to keep the records in the form of a register however documents and records may be kept electronically (RG 181.47). The actual keeping of documents and records enables the licensee to demonstrate to the regulator that it knows whether or not it is complying with the financial services laws.

 

2.12     Disclosing Conflicts of Interest

 

2.12.1  Full Disclosure to Adequately Inform Client

 

As mentioned above, licensees may sometimes manage their conflict of interest problem by disclosure. It is acknowledged that often, disclosure alone will be inadequate nevertheless, it is an integral part of managing conflicts.

 

The underlying principle is that licensees should ensure that clients are adequately informed about any conflicts that may affect the provision of financial services to them.

 

Adequate disclosure involves providing sufficient detail in a clear, concise and effective way to permit clients to make an informed decision about how the conflict may affect the service being provided to them. ASIC expects licensees to focus on material conflicts in this context (RG 181.50).

 

The effect of disclosure assists the client assess the service they are being offered in light of the licensee's own interests thereby facilitating the client in deciding whether to proceed with the acquisition of the service.

 

The Explanatory Memorandum concerning managing conflicts discusses disclosure as follows:     

            "…include ensuring that there is adequate disclosure of conflicts to investors, who can then consider their                 impact before making investment decisions" EM to Corporate Law Economic Reform Programme (Audit                     Reform and Corporate Disclosure) Bill 2003 at paragraph 5.597.

 

2.12.2  Timely, Prominent, Specific and Meaningful Disclosure

 

Where disclosure about a conflict is made then it should be:

 

.           timely, prominent, specific and meaningful to the client; 

 

.           occur before or when the financial services is provided, but in any case at a time that allows the client a                   reasonable time to assess its effect; and

 

.           refer to the specific service to which the conflict relates (RG 181.52).

 

ASIC is uncomfortable with generic or "boilerplate" disclosures because it believes that they are unlikely to satisfy the conflicts management obligation. Rather, disclosures should refer to the specific service to which it relates and should be specific and clear enough for the client to understand the conflict and its potential impact on the service which they are being offered.

 

The nature of any disclosure may be in writing or oral. Where oral disclosures are made however it is an important element of compliance that there should be some evidence available supporting any oral disclosure in the event that the organisation may subsequently require such evidence.

 

2.12.3  Disclosures for Financial Product Advice

 

ASIC believes that the following matters will generally be acceptable where they are provided at or about the time of providing any financial product advice:

 

.           the extent to which the licensee (or any associated person) has a legal or beneficial interest in the financial               product that is the subject of the financial product advice;

 

.           the extent to which the licensee (or any associated person) is related to or associated with the issuer or                   provider of the financial products that are the subject of the financial product advice; and,

 

.           the extent to which the licensee (or any associated person) is likely to receive financial or other benefits                   depending on whether the advice is followed.

 

If the advice by the provider is in writing then the disclosure should be in writing. In other words the disclosure should be in the same form as the advice (RG 181.54).

 

The content of disclosures concerning the provision of advice will depend on the circumstances. For example, a product issuer in giving advice about its own product, should identify itself as both the adviser and the product issuer.

 

A licensee in a group that is owned by a product issuer, in giving advice about a product issued by that product issuer, should disclose this relationship when giving the advice.

 

Where financial product advice is given to retail clients in an FSG and where personal financial product advice is given to retail clients in an SOA, RG 175 concerning Financial Product Advisers – Conduct and Disclosure is helpful and in many cases the disclosures suggested in this paper will already have been provided in an SOA or FSG.

 

2.13     Retail/wholesale

 

The conflicts management obligation applies equally to services provided to retail and wholesale clients (RG 181.58). ASIC recognises that sometimes the disclosure obligation on the licensee to a wholesale client will be less detailed than that required for a retail client. It suggests the following factors should be considered in assessing the disclosure obligations:

 

.           the level of financial sophistication of the client;

 

.           the extent to which third persons are likely to rely, directly or indirectly, on the service (where advice is                     given to a wholesale client in circumstances where it is likely to be passed on to retail clients);

 

.           how much the client already actually knows about the specific conflict; and,

 

.           the complexity of the service.

 

2.14     Issues to consider in complying with the conflicts management obligations

 

Item 2 of the Schedule to this paper provides a practical list of issues for consideration by licensees in managing conflicts of interest.

 

Obviously each of the topics mentioned in the attached list will not be relevant to every licensee and nor is the list exhaustive. Nevertheless, the list represents an excellent management tool to be used as appropriate by licensees. They constitute the types of issues which ASIC will consider when carrying out surveillance in its administration of the Act and its Regulations.

 

Part 3  

         

3.1 -     Overview of "Best Interests Duty and Related Obligations"

 

Under Part 7.7 of the the Act, "providing entities" (licensee or authorised representative) that provide financial services and in particular financial product advice to retail clients must prepare and provide a Financial Services Guide ("FSG"), give a general advice warning when giving general advice and prepare and provide a Statement of Advice ("SOA") when giving personal advice RG 175.1.

 

In addition to the above obligations, Division 2 of Part 7.7A of the Act requires "advice " providing personal advice to retail clients to comply with the "best interests duty" and related obligations which have been introduced as part of the Government's Future of Financial Advice ("FOFA") reform package to improve the quality of financial advice received by retail clients.

 

In summary, Part 7.7 and Division 2 of Part 7.7A of the Act require corporations and natural persons who provide financial product advice to retail clients to comply with certain conduct and disclosure obligations which are designed to ensure that retail clients receive reliable advice about financial products.

 

The conduct obligations under Division 2 of Part 7.7A of the Act require personal advice providers to:

 

.           act in the best interests of the client;

 

.           provide the client with appropriate advice;

 

.           warn the client if their advice is based on incomplete or inaccurate information; and relevantly,

 

.           Where there is a conflict with their own interests, or those of one of their related parties, prioritise the                     interests of the client (RG 175.20).          

 

The above obligations collectively referred to by ASIC as the "best interests duty and related obligations" have been designed to ensure that retail clients receive advice that meets their objectives, financial situation and needs and that advice providers act in the best interest of their client in providing clients with advice.

 

The "advice provider" envisaged by the " best interests duty and related obligations" is generally the individual providing the personal advice (RG 175.22).

 

ASIC's interpretation of the "best interests" obligation is to assess whether "a reasonable advice provider would believe that the client is likely to be in a better position if the client follows the advice" (RG 175.225). This obviously depends on the circumstances and the regulator has identified 6 factors in its consideration (RG 175.226). ASIC also gives another 6 examples to illustrate the concept of what a reasonable advice provider would believe is likely to leave the client in a better position if the client follows the advice (see examples at RG 175.231).

 

3.2       Conflicts Priority Rule ( S.961J (1) of the Act & RG 175.363)

 

One of the "Related Obligations" to the "Best Interests Duty" is the Conflicts Priority Rule.

 

Where an advice provider gives personal advice (see Item 3 of the Schedule to this paper) to a retail client and that provider knows or reasonably ought to know that at the time of giving the advice there is a conflict of interests then there is an obligation to prioritise the client's interests.

 

3.3       Conflict between whom?

 

The conflict of interest referred to in this context is a conflict between the interests of the client and the interests of:

 

.           the advice provider;

 

.           an associate of the advice provider;

 

.           the advice provider's AFS licensee;

 

.           an associate of the advice provider's AFS licensee;

 

.           an authorised representative who has authorised the advice provider to provide financial services (or a                     financial service) on behalf of an AFS licensee; or,

 

.           an associate of an authorised representative who has authorised the advice provider to provide financial                   services (or a financial service) on behalf of an AFS licensee. (RG 175.363).

 

Those parties referred to above other than the "advice provider" are considered to be "related parties" of the advice provider.

 

The Conflicts Priority Rule does not apply if the advice provider does not know of the conflict of interest (RG 175.365) and ASIC does not expect an advice provider to make enquiries to determine what conflicting interests their related parties have.

 

ASIC further advises that it believes that advice providers will be aware of conflicts of interest disclosed in FSG's that are issued by related parties and conflicts that are disclosed in SOA's that the advice provider helps to prepare for their AFS licensee or authorised representative (RG 175.367).

 

Mere disclosure to the client of a conflict of interest or getting a client to consent to a conflict does not (according to ASIC) constitute compliance with the Conflicts Priority Rule.

 

Any condition of a contract or other arrangement between the advice provider and a client which seeks to circumvent the Conflicts Priority Rule will be considered by the law to be void if it seeks to waive any of the legal obligations underlying this Rule (S960A of the Act).

 

3.4       Identifying the Conflict

 

The first step for an advice provider in complying with the Conflicts Priority Rule is to initially identify what interests they or their related parties have by considering what benefits (if any) the advice provider or their related parties will receive if the client adopts the advice. Once a conflict or potential conflict is identified then the law requires that the client's interests receive priority.

 

3.5       Giving the Client's Interests Priority (S 961J of the Act & RG 175.371)

 

So if a conflict is identified then the advice provider is not permitted to further their own interests or those of any one of their related parties over those of the client when giving the client advice.

 

A suitable benchmark to guide an advice provider with this issue is to benchmark what a reasonable advice provider without a conflict of interest would do.

 

ASIC's position in administering the Conflicts Priority Rule is that the greater materiality of the conflict of interest between the client and the advice provider (or its related party), the more the advice provider will need to do to prioritise the client's interests.

 

It should be noted that the mere relationship between the advice provider and a related party will not always prohibit an advice provider from recommending the client acquire interests in a product issued by a related party. In other words, the relationship itself does not constitute a barrier. It is the conflict which could cause damage to the client (RG 175.374).

 

Nor does the Conflicts Priority Rule prohibit an advice provider from accepting remuneration from a source other than the client (e.g. a fee from a product issuer). However, Division 4 of Part 7.7A of the Act prohibits advice providers from accepting certain types of remuneration that could reasonably be expected to influence the financial product advice they give or the financial products they recommend to clients (see below and RG 246).

 

Where an advice provider receives permissible commissions (not covered by the conflicted remuneration provisions referred to above) but gives priority to maximising or receiving the nonclient source of remuneration over the interests of the client, the advice provider will be in breach of the Conflicts Priority Rule (RG 175.376 & RG 175.71).

 

3.6       ASIC's Illustrative Examples of Remuneration Conflicts – Life Insurance Commissions

 

3.6.1    Example 1

 

An advice provider advises a client that it requires additional life-insurance cover of $100,000 in the process of reviewing the clients life insurance policy which currently has a death benefit of $300,000.

 

There is a recommendation that the client obtain a new policy for $400,000 and then cancel the existing policy rather than simply apply for the additional cover within the existing policy.

 

The terms of the life-insurance policies and the annual premiums are the same.

 

The benefit to the advice provider is that he is entitled to a commission of 120% of the annual premium of the whole insured amount which is 120% of the annual premium on the $400,000 rather than 120% of the annual premium on the increased amount of $100,000.

 

A further consequence of this arrangement is that the client is required to have medical checks which would not be necessary if the level of cover was merely increased by the $100,000. Moreover, the client was approaching the 4 year anniversary of the existing policy which would have provided a 5% increase in the level of cover at no extra cost (even if the level of coverage was increased).

 

In these circumstances ASIC considers that the provider has given priority to maximising the nonclient source of remuneration over the interests of the client and hence there is a breach of the Conflicts Priority Rule (RG 175.376).

 

3.6.2    Key Features of the Conflicts Priority Rule include:

 

.           an advice provider should not recommend a product or service of a related party to create extra revenue for             themselves, their AFS licensee or another related party, where   additional benefits for the client cannot be               demonstrated.

 

.           where an advice provider uses an approved product list that only has products from a related party on it,                  the advice provider must not recommend a product on the approved product list, unless a reasonable advice             provider would be satisfied that it is in the client's interests to recommend a related party product rather                   than another product with similar features and costs.

 

.            a practical way for an advice provider to determine this is to benchmark the product against the market for              similar products to establish its competitiveness on key criteria such as performance history, features, fees                and risk. The benchmarking must be reasonably representative of the market for similar products that are                offered by a variety of different issuers (RG 175.377 (b)).

 

.           clients should not be "over serviced" particularly to generate more remuneration for the advice provider or               one of their related parties. Accordingly, there must be a level of service commensurate with the clients'                   needs. For example they must not recommend an unduly complex strategy if the client is unlikely                             to seek ongoing advice.

 

.           any non-financial product solutions relevant to the client situation should be recommended                                     where appropriate, even if this means the client is less likely to need financial advice in the future (e.g.                     advice on debt reduction, estate planning and/or Centrelink benefits) (RG 175.377).

 

3.6.3    – Overservicing a Client When Advising on an SMSF

 

A client seeks advice on looming retirement, enquiring about the best thing to do with her superannuation when she retires. She is told by the advice provider that an SMSF is an easy way to maximise the value of her superannuation.

 

The client has a healthy superannuation balance because she has been contributing to superannuation for 35 years but has no experience with investing.

 

The client's existing employer sponsored superannuation fund has no pension option. The client understands that she needs to start making some decisions about her superannuation but because she has no previous investment experience is nervous about what to do.

 

She explains to the adviser that she wants a simple cost-effective solution so she can easily understand it and so that it does not require too much of her time.

 

The client does not want the burden of watching the market every day as she has noticed some of her colleagues do.

 

The advice provider recommends a SMSF and reassures the client that she does not need to be too involved because the advice provider will look after it for her.

 

The recommended strategy according to ASIC does not prioritise the client's interests. That is, the recommendation means that the client will always need the assistance of the advice provider thereby providing for that advisor, ongoing remuneration. There would also be ongoing remuneration for some of the advice provider's related parties. The recommendation provides a level of service that exceeds the simple solution the client was seeking (RG 175.377).

 

If an advice provider with a conflict is unable to prioritise the client's interests, ASIC believes that advice provider should not provide the advice

 

3.7       Conclusion

 

It should be noted that the Conflicts Priority Rule operates in conjunction with the general obligation in Section 912A (1) (aa) 2001 which specifically requires a financial services licensee to have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by the licensee or a representative of the licensee in the provision of financial services as part of the financial services business of the licensee or the representative.

 

This obligation is imposed by the law on all AFS licensees to manage conflicts of interest.

 

ASIC requires an advice provider (that is a person to whom the obligations in Division 2 of Part 7.7 A of the Act apply) to keep records of the reasoning behind any recommendation that the client acquires new financial products or increases.

 

Part 4 

 

Conflicted Remuneration Provisions

 

4.1       Background

 

The provisions on conflicted remuneration and other banned remuneration in Divs 4 and 5 of the Act   are generally referred to as the ‘conflicted remuneration provisions’ which aim to more closely align the interests of those who provide financial product advice to retail clients with the interests of their clients, and improve the quality of advice these clients receive.

 

The background on the Conflicted Remuneration provisions is seen from, the Parliamentary Joint Committee's report that:

            "A significant conflict of interest for financial advisers occurs when they are remunerated by product                          manufacturers for a client acting on a recommendation to invest in their financial product … These                          payments place financial advisers in the role of both broker and expert adviser, with the potentially                          competing objectives of maximising  remuneration via product sales and providing professional, strategic                  financial advice that serves clients’ interests … Evidence to the committee strongly suggested that the                      current disclosure requirements have not been an effective tool for managing conflicts of interest                              (paragraphs 5.29–5.30 and 5.53).

 

4.2      What are the Conflicted Remuneration Provisions?

 

The conflicted remuneration provisions affect how AFS licensees and their representatives are paid for the financial product advice they give and the other benefits they receive. They do not affect how financial product advice is provided.

 

4.3       The Ban on Conflicted Remuneration

 

The Act prohibits:

 

.           AFS licensees and their representatives (including authorised representatives) from accepting conflicted                     remuneration (s963E, 963G and 963H);

.           Product issuers and sellers from giving conflicted remuneration to AFS licensees and their representatives                 (s963K); and,

.           Employers from giving their AFS licensee or representative employees conflicted remuneration for work they             carry out as an employee (s963J).

 

4.4       What Is Conflicted Remuneration

 

Conflicted remuneration is any benefit given to an AFS licensee, or its representative, who provides financial product advice to retail clients that, because of the nature of the benefit or the circumstances in which it is given, could reasonably be expected to influence:

 

.           The choice of financial product recommended to clients by the AFS licensee or representative; or,

 

.           the financial product advice given to clients by the AFS licensee or representative: s963A.

 

References to ‘client’ mean ‘retail client’ as defined in the Act and Corporations Regulations 2001 and  ‘advice’ means ‘financial product advice’ as defined in s766B of the Act.

 

A benefit is not conflicted remuneration if it only influences financial product advice provided to wholesale clients. That is, the conflicted remuneration provisions do not apply to wholesale clients.

 

There is a presumption that volume-based benefits are conflicted remuneration: s963L. Some performance benefits may also be conflicted remuneration.

 

4.5       ASIC Guidance on Volume-based and Performance-Based Benefits

 

For a general discussion of the ban on conflicted remuneration, see Section B of RG 246 and for specific guidance on volume-based benefits and performance benefits, see Sections C–D of RG 246.

 

There are a number of benefits that are not conflicted remuneration which are set out in the appendix to RG 246

 

4.6       Remuneration with Potential to Influence

 

In addition to the ban on conflicted remuneration, the Act also prohibits other forms of remuneration that have the potential to influence the financial product advice received by retail clients for example:

 

.           a platform operator accepting a volume-based shelf-space fee from a funds manager (see Section E of RG                 246); and,

 

.           an AFS licensee, or its representative, who provides financial product advice to a retail client charging asset-             based fees on borrowed amounts used to acquire financial products by, or on behalf of, the client (see                     Section F of RG 246).

 

4.7       Guiding Principles for ASIC's Administrative Approach

 

The following principles guide ASIC's approach to administering the conflicted remuneration provisions in Divs 4 and 5 of Pt 7.7A of the Act:

 

.           the provisions are designed to more closely align the interests of those who provide financial product advice             to retail clients with the interests of their clients; and,

 

.           this alignment of interests depends on the substance of a benefit over its form; that is, whether the benefit               is one that could reasonably be expected to influence the financial product advice or financial product                       recommendations is relevant rather than how the benefit has been labelled or presented to the client.

 

4.8       Application to "Advice about Platforms"

 

Platforms are financial products under the Act. This includes investor directed portfolio services (IDPSs) and IDPS-like schemes, which ASIC treats as financial products because they are managed investment schemes, as well as superannuation master trusts and other superannuation funds and managed discretionary account services (RG 246.28).

 

The provisions in the Corporations Act relating to financial product advice, including the conflicted remuneration provisions, therefore apply when giving advice about: (a) using platforms; and (b) acquiring financial products through platforms.

 

4.9       What is covered by the ban?

 

The ban applies to certain forms of remuneration for financial product advice to retail clients.

 

The conflicted remuneration provisions apply to both personal and general financial product advice, regardless of the channel used to communicate the advice. For example, the provisions apply to financial product advice that is provided verbally, in paper-based format, or online ( RG 246.33).

 

Benefits covered by the conflicted remuneration provisions may be monetary or non-monetary. Non-monetary benefits could take a number of forms, including some forms of the following:

 

.           free or subsidised business equipment or services (e.g. computers and other hardware, software,                             information technology support and stationery);

 

.           hospitality-related benefits (e.g. tickets to sporting events or concerts and subsidised travel);

 

.           shares or other interests in a product issuer or licensed dealer group;

 

.           marketing assistance; and

 

 .          promotion or other ways of recognising an employee based on product recommendations or sales (RG                     246.37).

 

These benefits will not always be conflicted remuneration. Whether a benefit, including a non-monetary benefit, is conflicted remuneration is discussed in  ASIC's  RG 246 at Sections C–D.

 

There is a presumption that volume-based benefits are conflicted remuneration: s963. ASIC's position on this is explained in Section C of RG 246.

 

There are a number of benefits that are excluded from being conflicted remuneration. A list of these excluded benefits is found at Appendix 1 of Regulatory Guide 246. Illustrative of those exclusions are:

 

.           Benefits for advice on general insurance products: reg 7.7A.12G 

 

.           A monetary or non-monetary benefit, such as a commission, is not conflicted remuneration if it is given for               advice on a general insurance product.

 

.           Benefits for advice on life risk insurance products: reg 7.7A.12A

 

.           A monetary benefit is not conflicted remuneration if it is given in relation to advice on a life risk insurance                 product. A life risk insurance product is generally a life policy or a sinking fund policy that is a contract of                 insurance: see s764A(1)(e).

 

.           Consumer credit insurance The conflicted remuneration provisions do not apply if a monetary benefit is                     given in relation to consumer credit insurance. This is because such benefits are covered by the exclusions               for general insurance products (reg 7.7A.12G) and   life insurance products (reg 7.7A.12A).

 

.           The conflicted remuneration provisions also will not apply if a benefit is given for advice in relation to                       both consumer credit insurance and a non-financial product (e.g. a credit facility), due to regulation                         7.7A.12I, which allows mixed benefits in specified circumstances. 

 

If no exclusion applies, the performance benefit or other benefit will not be conflicted remuneration if it could not reasonably be expected to influence the advice provided by the representative (RG 246.45).

 

4.10     Examples of conflicted remuneration

 

The following are examples provided by ASIC of benefits that are generally conflicted remuneration (RG 246.48): 

 

.           commissions, whether upfront or trailing, fixed or variable, paid by a product issuer to a licensed dealer                   group, whether the payment is made directly or through some other arrangement;

 

.           volume-based payments from a platform operator to a licensed dealer group; 

 

.           volume-based payments from a licensed dealer group to an authorised representative or                                         other representative;

 

.           volume-based bonuses and other payments, such as a commission or one-off payment, to a financial                       adviser, which is calculated by reference to the number or value of financial products acquired by clients                   following the advice of the financial adviser. The payment could be made by:

            -           the financial adviser’s dealer group;

            -           a platform operator; or

            -           a product issuer; and,

            -           a discount on the fees paid by an authorised representative to its AFS licensee                          based on client funds held in a particular financial product.

 

The above payments are not conflicted remuneration if they could not reasonably be expected to influence the advice given by the AFS licensee or representative (RG 246.50).

 

 

 

 

The Schedule

 

Item 1       

 

Some Relevant Legislation concerning adequate arrangements to manage Conflicts

 

Licensees and representatives need to have regard consider the legislative requirements impacting on Conflicts including:

 

.           Subsection 912A (1) (aa) of the Act  specifically requires a financial services licensee to have in place                       adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in                   relation to activities undertaken by the licensee or a representative of the licensee in the provision of                       financial services as part of the financial services business of the licensee or the representative.

 

.           the obligation to do all things necessary to ensure that their financial services are provided efficiently,                       honestly and fairly (section 912A(1)(a));

.           the obligation to have adequate risk management systems (section 912A(1)(h));

 

.           the obligation to comply with financial services laws and to take reasonable steps to ensure their                             representatives do likewise (section 912A(1)(c)&(ca));

 

.           the obligation to have adequate compliance arrangements (reg 7.6.03(g));

 

.           the licensee's (and its authorised representatives') obligation to disclose benefits and relationships in a                     Financial Services Guide before providing financial services to retail   clients (section 941A & 941B);

 

.           the licensee's (and its authorised representatives') obligation to disclose benefits and relationships in a                     Statement of Advice when providing personal financial product advice to retail clients (section 946A);

 

.           a range of prohibitions, including those for misleading or deceptive conduct in the provision of financial                     services, dishonest conduct, unconscionable conduct and insider trading (found within the Act and the ASIC               Act);

 

.           the duties of the responsible entity of a registered managed investment scheme, including duties to act in                 the best interests of the members of the scheme and, if there is a conflict between the members interest                 and its own interests, to give priority to the members interests (section 601FC)

.           Additional but relevant obligations imposed on directors and officers of a Corporation (including corporations             providing financial services advice) include the "care and   diligence" obligations of section 180 of the Act                 and the duty of "good faith" imposed on directors and other officers within section 181.

 

.           There are also important obligations in Sections 182 & 183 dealing respectively with not  using a person's                 position in the Corporation to gain an advantage for themselves or someone else and not improperly using               information to gain an advantage for themselves or someone else.

 

.           There are common law obligations imposed on licensees and authorised representatives in the provision of               financial services because of what are frequently called "fiduciary obligations" imposed on various advisors               to their clients to whom they provide advice or for whom they act in a trustee capacity.

 

Item 2 

        

Item 2.1 – Issues for consideration in controlling and avoiding Conflicts - [reference from paragraph 3.15 of this Paper] 

 

.           What are your procedures for identifying conflicts of interest?

 

.           What are your procedures for assessing and evaluating conflicts of interest?

 

.           How do your conflicts management arrangements enable you to decide how to respond to or deal with                     particular conflicts?

 

.           Do you have a written conflicts management policy?

 

.           When were your conflicts management arrangements last reviewed internally or by a third party (e.g. an                   auditor)?

 

.           When were your conflicts management arrangements last updated?

 

.           What structural arrangements do you have in place to manage conflict of interest?

 

.           How does your organisation's structure support your management of conflicts of interest?

 

.           What information barriers do you have within your organisation? How do they help you manage conflicts                   of interest?

 

.           How do your conflicts management arrangements ensure that conflicts do not affect your compliance with                 your licensee obligations under section 912 A (i.e. obligation to have in place adequate arrangements)? How             do you test their effectiveness in achieving this?

 

.           How do your conflicts management arrangements ensure that your clients are not treated unfairly? How do               you test their effectiveness in achieving this?

 

.           How do your conflicts management arrangements ensure that any personal advice you give is appropriate?                How do you test their effectiveness in achieving this?

 

.           How were your conflicts management arrangements formulated and approved? Were they approved by your             owners, board or governing body (or a delegated body)?

 

,           How are your conflicts management arrangements communicated to staff and other stakeholders (e.g.                     clients, customers and the public)?

 

.           Who are the nominated persons responsible for the implementation, reviewing and updating of your conflicts             management arrangements? Who do they report to?

 

.           What procedures do you have to identify instances of non-compliance with your conflicts management                     arrangements? How is non-compliance dealt with? How is non-compliance recorded and reported to your                 governing body?

 

.           What impact do your remuneration and benefits practices have on your management of conflicts?

 

.           How do you ensure your remuneration and benefits practices do not result in the integrity and quality of the             services you provide being significantly compromised?

 

.           How do your dealing or trading practices affect your management of conflicts?

 

.           How do you assess the impact of conflicts of interest on the quality of the services you provide? What                       processes do you have (if any) to ensure that the quality of your services is not significantly compromised by             the presence of conflicts of interest?

 

.           What are your procedures for assessing the seriousness of a conflict of interest?

 

.           How do you ensure that more serious conflicts are referred to your owners or managers?

 

In what circumstances do you avoid conflicts of interest (as opposed to dealing with them through disclosure or internal controls)? How are these decisions made and recorded?

 

Item 2.2 – Issues for consideration re-Disclosing Conflicts

 

.           What are your procedures for disclosing conflicts of interest to affected clients?

 

.           How do your conflicts management arrangements ensure that your clients receive adequate and specific                   disclosure about conflicts?

 

.           How do you ensure that these procedures are followed consistently and at all times?

 

.           What disclosures do you give for general financial product advice?

 

.           What disclosures do you give for other financial services?

 

.           Do your disclosures vary between wholesale and retail clients? How do they vary?

 

.           How do you deal with conflicts of a confidential nature (i.e. those where disclosure may not always be an                 available remedy)?

 

.           How do you ensure that disclosures of conflicts are timely, prominent, specific and meaningful?

 

.           What disclosures do you give for personal financial product advice?         

  

Item 3 –          Relevant Definitions for the purposes of this paper

 

            3.1       Personal Advice

 

            .           "Personal Advice" is financial product advice given or directed to a person (including by electronic                              means) in circumstances where: 

 

            .           The person giving the advice has considered one or more of the clients objectives, financial situation                         and needs; or,

 

            .           A reasonable person might expect the person giving the advice to have considered  one or more of                           these matters (S766B (3) of the Act).

 

            3.2      Financial Product advice

 

                        Financial product advice means a recommendation or a statement of opinion, or a report of either of                         those things, that:

 

                  (a)  is intended to influence a person or persons in making a decision in relation to a particular financial                         product or class of financial products, or an interest in a particular financial product or class of                                 financial products; or

 

                  (b)  could reasonably be regarded as being intended to have such an influence.

 

            3.3       Section 11 Associates of bodies corporate

 

                        If the primary person is a body corporate, the associate reference includes a reference to:

 

                  (a)  a director or secretary of the body; and

 

                  (b)  a related body corporate; and

 

                  (c)  a director or secretary of a related body corporate.

 

             3.4      Section 13  Associate References in Chapter 7

 

                        If the associate reference occurs in Chapter 7, it includes a reference to:

 

                (a)    a person in partnership with whom the primary person carries on a financial services business;                                 and

 

                 (b)   subject to subsection 16(2), a person who is a partner of the primary person otherwise                                           than because of carrying on a financial services business in partnership with the primary person; 

                        and

 

                 (c)   a trustee of a trust in relation to which the primary person benefits, or is capable of benefiting,                                 otherwise than because of transactions entered into in the ordinary course of business in                                         connection with the lending of money; and

 

                 (d)   a director of a body corporate of which the primary person is also a director and that carries on a                            financial services business; and

 

                 (e)   subject to subsection 16(2), a director of a body corporate of which the primary person is also a                               director and that does not carry on a financial services business.

 

                3.5       Associate definition – Section 15  General

 

                 (1)     The associate reference includes a reference to:

 

                  (a)    a person in concert with whom the primary person is acting, or proposes to act; and

 

                  (b)    a person who, under the regulations, is, for the purposes of the provision in which the associate                              reference occurs, an associate of the primary person; and

 

                  (c)    a person with whom the primary person is, or proposes to become, associated, whether formally                              or informally, in any other way; in respect of the matter to which the associate reference relates.

 

                 (2)     If the primary person has entered, or proposes to enter, into a transaction, or has done, or                                      proposes to do, any act or thing, in order to become associated with another person as                                          mentioned in an applicable provision of this Division, the associate reference includes a reference                            to that other person.

 

Item 4 –          Acting in the Best Interests of the Client

 

In the second reading speech to the Corporation Amendment (Further Future of Financial Advice Measures) Bill 2011 the relevant minister said:

 

            "….. The best interests duty is a legislative requirement to ensure the processes and motivations of financial advisers are focused on what is best for their clients. It is true that this will ultimately lead to better advice in many cases, but first and foremost it is about regulating conflicts, not the intrinsic quality of the advice provided."

 

Item 5 –          Safe Harbour for complying with the best interests duty

 

Section 961B (2) of the Act provides what is called a "safe harbour" whereby if an advice provider can show that they have taken the steps within this provision they are considered to have complied with the best interests duty.

 

The safe harbour provision generally requires an advice provider to:

 

.           Identify the objectives, financial situation and needs of the client that were disclosed by   the client through               instructions;

 

.           Identify:

 

            -           the subject matter of the advice sought by the client…; and,

 

            -           the objectives, financial situation and needs of the client that would reasonably be                                                 considered relevant…

 

.           If it is reasonably apparent that information relating to the clients relevant circumstances is incomplete or                 inaccurate, make reasonable enquiries to obtain complete and accurate information;

 

.           Assess whether the advice provider has the expertise required to provide the client with advice on the                       subject matter sought and, if not, decline to provide the advice;

 

.           If it would be reasonable to consider recommending a financial product:

 

            -           conduct a reasonable investigation into the financial products that might achieve the objectives and                          meet the needs of the client…..; and

 

            -           assess the information gathered in the investigation;

 

.           Base all judgements in advising the client on the clients relevant circumstances; and

 

.           Take any other step that, at the time the advice is provided, would reasonably be regarded as being in the               best interests of the client, given the client's relevant circumstances.

 

6          Treating Clients Fairly

 

Any consideration of what constitutes "treating clients fairly" necessarily involves the licensee to have regard to:

 

I           is any person providing any financial service in a way that unfairly puts the interests of the licensee or its                 representatives ahead of the client?

 

II         is any client being treated in any way whatsoever that advances that client's interests ahead of the interests              of any other client?

 

III        is any person providing a financial service using any knowledge whatsoever about any client in a way which              would advance that providers own interests without disclosure to the affected client/s?

 

IV        the generation of fee income by any financial service provider should be done in a way that does not involve            treating the client unfairly.

 

V         there must be appropriate management of conflicts between the interests of various clients as well as                      conflicts between the licensee's own interests and those of clients.

 

In summary, financial services should not be provided in a way calculated to advance one client's interests unfairly ahead of another client's interests. For example, licensees should avoid any circumstances which unfairly favour one client or group of clients over any other client or clients. This would include avoiding what is known as "late trading" where a client is permitted to trade in interests in a managed fund after the relevant trading period is closed (and in some cases after prices have been set).

 

Item 7 – Conflicted Remuneration Checklist

 

Conflicted Remuneration Checklist 

 

1          Do I understand what Conflicted Remuneration means? (See para 4.4 of this Paper)

 

2          Have I reviewed our relevant financial services remuneration sources having regard to the Conflicted                         Remuneration rules? What are our remuneration sources?

 

3          Do the Conflicted Remuneration rules adverse impact on my business model? Have I considered                               alternative remuneration structures which would not be conflicted?

 

4          Do I need to review my compliance policies, practices and procedures because of the Conflicted                               Remuneration rules?

 

5          How do the Conflicted Remuneration, Priority of Interests obligation and Conflicts Management requirements             outlined in this Paper impact on my business?

 

6          What is the culture of compliance in my business relative to ASIC's enforcement outcomes for January to                   June 2015 (see report 444)

 

 

Item 8-ASIC Report

 

Extracts from ASIC  REPORT 444 dated August 2015: ASIC enforcement outcomes: January to June 2015

 

Overview

 

1 ASIC investigates and enforces the law to give effect to its strategic priorities of: (a) promoting investor and financial consumer trust and confidence; (b) ensuring fair, orderly and transparent markets; and (c) providing efficient and accessible registration.

 

2 ASIC is a law enforcement agency — 70% of its regulatory resources are devoted to surveillance and enforcement.

 

3 In the last six months, ASIC achieved a total of 323 enforcement outcomes. This figure includes criminal, civil and administrative actions, as well as outcomes resulting in an enforceable undertaking, a negotiated outcome or the issue of a public warning notice.

 

4 In the relevant period, ASIC:

 

(a) commenced 136 investigations;

 

(b) completed 137 investigations; 

 

(c) charged 10 individuals with a total of 82 criminal charges;

 

(d) banned 25 individuals from the financial services or credit industries; 

 

(e) accepted six enforceable undertakings; and 

 

(f) disqualified 19 directors.

 

Key points

This report focuses on three current enforcement priorities one of which is relevant to this Paper being: tackling poor culture (see paragraphs 7–18 of report 444). Other topics covered include retail margin foreign exchange (FX) trading (see paragraphs 19–28); and  illegal phoenix activity (see paragraphs 29–44).

 

Tackling poor culture -What is culture?

 

7 Generally speaking, culture is a set of shared values or assumptions. It reflects the underlying mindset of an organisation. It lies at the heart of how an organisation and its staff think and behave. It shapes and influences attitudes and behaviours towards, for example, customers and compliance. In the Criminal Code Act 1995, culture is defined as including an attitude, policy, rule and course of conduct or practice.

 

8 ASIC is concerned about culture because it is a key driver of conduct within the financial services industry. The trust and confidence of investors and financial consumers has been significantly eroded over the past few years due to poor conduct within the financial industry, including: (a) issues around poor advice both in large institutions and in smaller firms, and mis-selling of financial products to consumers and investors; and (b) inquiries into benchmark and FX manipulation both in Australia and overseas.

 

9 In order to restore trust and confidence, ASIC believes that there needs to be a fundamental shift in the culture of the financial industry—to one that focuses on achieving and rewarding good conduct and good outcomes for customers.

 

Poor culture imposes significant costs on businesses and consumers.

 

The cost of poor culture on businesses can include: (a) remediation costs, including compensation costs; (b) fines; (c) costs associated with complying with regulatory inquiries; and (d) costs associated with damaging a business’s brand and reputation.

 

13 Poor culture also often results in poor outcomes for consumers. Sadly, those affected by poor culture are usually everyday Australians that can least afford it. Markets can recover, but often people do not. They are often left with a loss they cannot afford. In these circumstances, remediating consumers, which may include paying appropriate compensation quickly, is critical.

 

16 Over the last few years, ASIC has negotiated a number of major review and remediation programs by financial advice firms: These programs have been large-scale exercises to review personal financial advice provided to retail clients and to compensate those clients where loss has been suffered as a result of non-compliant advice, fraud or other breaches of the law.

 

17 ASIC says it will develop a regulatory guide on review and remediation programs conducted by Australian financial services (AFS) licensees that provide financial advice. We want to ensure that if an AFS licensee needs to provide remediation, they do so in a way that is fair, honest and efficient. Consumers will have greater trust if they can be confident that a remediation program is consistent and transparent.

Promoting Positive Culture

 

18 More importantly in the context of this Paper, ASIC is planning to incorporate examinations of culture into its role as a conduct regulator. ASIC intends to focus on: (a) incorporating an examination of culture into its risk-based surveillance reviews; (b) using the surveillance findings to better understand how culture is driving conduct among its regulated population; and (c) addressing the issue directly with entities when it sees a problem with their culture and conduct.

 

 

 

Retail margin FX trading

 

What is retail margin FX trading?

 

19 Retail margin FX trading often involves leverage and is an extremely complex and risky form of retail investment. Financial services relating to FX being marketed to retail clients—is an area of focus for ASIC.

 

20 Retail margin FX trading—which is becoming more accessible through electronic trading platforms—involves buying a foreign currency and selling another foreign currency simultaneously in the hope that the currency purchased increases in value against the currency sold, and vice versa

 

21 Retail margin FX trading raises the stakes further by letting investors trade with borrowed money. Most retail margin FX trading products are highly leveraged.

 

22 Retail margin FX trading is also very risky because: (a) there are significant investment risks as currency fluctuations may move against the investor, causing them to lose money; (b) retail margin FX is an over-the-counter product, so investors are not trading on a formal exchange; (c) international currency markets are open 24 hours a day, spanning six days a week (due to time zones), so an investor needs to devote a lot of time to monitoring their investment; (d) currency markets are extremely difficult to predict because so many factors affect exchange rates.

 

ASIC’s work in protecting investors

 

23 Over the past few years, an increasing number of businesses have been applying for an AFS licence to set up and operate a retail margin FX broker business in Australia.

 

24 ASIC has been paying particular attention to these businesses to ensure they are complying with Australian regulatory requirements.

 

26 ASIC has been investigating retail margin FX brokers to ensure that they are capable of managing their own risks and any conflicts of interest.

 

Enforcement action highlights

 

Key points

ASIC takes action to protect consumers and financial investors, hold gatekeepers to account and maintain the integrity of Australia’s financial markets. In the relevant period, ASIC has:

 

• commenced 136 investigations;

 

• completed 137 investigations;

 

• charged 10 individuals with a total of 82 criminal charges;

 

• banned 25 individuals from the financial services or credit industries;

 

• accepted six enforceable undertakings; and

 

• disqualified 19 directors.

 

Protecting consumers

 

45 ASIC says that "making sure Australians have trust and confidence in the financial system is at the heart of everything we do". When investors and financial consumers are victims of wrongdoing, they lose trust and confidence in our financial system. It can also have a long-lasting impact on their financial wellbeing.

 

46 ASIC will take on tough, complex matters to promote investor and financial consumer trust and confidence. This includes cracking down on inappropriate lending, misconduct by financial advisers and behaviour that puts the interests of self-managed superannuation fund (SMSF) members at risk.

 

47 In the first half of 2015, ASIC achieved five criminal outcomes, 25 financial services or credit bannings, seven licence cancellations and suspensions and 49 infringement notices, totalling $439,800.

 

Financial Advisers

 

49 In recent years, ASIC has taken extensive enforcement action against both financial advice firms and individual advisers. ASIC continues to crack down on advisers who act dishonestly and place their own interests ahead of their clients.

 

Outcomes

In the first half of 2015 ASIC has the following outcomes:

 

(a) the permanent banning of Brisbane-based financial adviser Lee Robert Robin from providing financial services, for engaging in misleading or deceptive conduct whilst issuing unsecured fixed interest notes in Protect Ensure Pty Ltd and for failing to comply with financial services laws;

 

 (b) the sentencing of former financial advice company director Barry David Hassell to 12 months imprisonment for engaging in dishonest conduct, providing ASIC with false or misleading information and failing to provide a disclosure document to clients (to be released on his own recognisance of $100, to be of good behaviour for a period of 12 months);

 

 (c) Commonwealth Financial Planning Limited employee Rebecca Locksley being banned from providing financial services for 18 months for creating false documents for client files;

 

(d) former Gold Coast financial adviser Ian John Weaver being sentenced to 12 months jail for providing advice without a reasonable basis and for making a number of false or misleading statements;

 

(e) Perth financial advisor Lewis Fellowes being banned for life from providing financial services for engaging in dishonest conduct and in misleading or deceptive conduct in relation to six clients; and,

 

 (f) financial adviser Melinda Scott being jailed for six years and three months after pleading guilty to defrauding more than 150 clients of over $5.9 million over a period of 20 years

 

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