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This backgrounder article was originally published by Knowledge@Australian School of Business on April 25.
The accountants' ethical standard setter has reached a fork in the road. Everyone is waiting to see if the Accounting Professional and Ethical Standards Board (APESB) will be bold enough to approve a new standard that forces accountants engaged in financial planning to ban all incentives for biased financial advice.
By setting an ethical standard – that more properly aligns the interests of planners with their clients – the standards board is accentuating the sharp contrast between its lofty ideals and the government's Future of Financial Advice reforms which were passed by the House of Representatives in late March. While FOFA will partly deal with the conflict of interest problem for planners by banning commissions, it shies away from providing a complete solution since it allows carve-outs for asset fees and commissions on life insurance.
The legislation implementing the majority of the reforms, including the prospective ban on conflicted remuneration structures, has been pushed back by a year and will now swing into action on July 1, 2013.
The accountants' draft standard, APES 230, released in June 2010, goes much further than FOFA by banning not only commissions but asset-based fees as well. These are ongoing advice fees charged by broker-dealers as a percentage of a client's assets. Asset-based fees can also create conflict since it follows that planners are hardly likely to advise that clients take their money out and make a deposit on a property or invest their money in a term deposit with a bank
Under APES 230, there are no such carve-outs.
The problem is that so much of the industry is based upon asset-based fees, there is a reluctance to embrace FOFA reforms let alone consider what the accountants will likely propose. Institutions and product manufacturers promote the idea of percentages because it more closely aligns their commercial interests with those of the planner. A flat fee/hourly rate does not do that, which is why most institutions have lobbied so hard against a pure fee-for-advice model.
In essence, because the insurance companies and asset managers in the retail market rely on advisers for much of their distribution, these product manufacturers have a vested interest in keeping the conflicts in place. And the consumer voice is notably weak. In December 2010, the APESB said it would extend the consultation on the Exposure Draft of the APES 230 Financial Advisory Services following extensive stakeholder interest. It also deferred the start date of the proposed standard, initially planned for July 1, 2011.
Since the market is shaped by supply-side interests, the demand side is poor. Most people do not have a long-term relationship with an adviser – they tend to approach them only when faced with a trigger event. There is a strong culture of consumer suspicion when it comes to advisers and this is exacerbated by the lack of clarity over the adviser's remuneration.
According to ASIC's 2011 Financial Literacy and Behavioural Change report, only 22% of Australians use a financial planner. Hence the criticism that FOFA is self-serving, that it was captured by the industry, watered down and it changes nothing.
Not everyone's a trailblazer
The accountants are taking the approach of genuine reform. Consequently, the adoption of APES 230 should force the industry and the federal government to reconsider their very conservative position. Trust is critical to the future of the financial services industry. Without it, the industry cannot build transparent relationships with the community and grow the advice business. This is the case for severing the inherent connection between advice and product sales. Industry observers say the industry will lose face if it refuses to follow the accountants.
Getting APES 230 passed is "no slam-dunk" as many accountants find it unacceptable, Peter Day, director of the APESB, reported in late April. "Those who don't support it say they will be disadvantaged compared to their non-accountant associates. Some say they would resign their membership from the accounting bodies if the standard is approved," he says.
Robert Brown, an educator and chartered accountant, shared this view. He says APES 230 is facing noisy and emotional opposition from some accountants as well as the financial planning industry. "If it fails it will be because those who don't support it have managed to convince the board to simply reflect the politically compromised law of the land in the new standard," Brown says. However, those who have made the transition to a fee-only approach instead of a commission model say the value of their practice has grown, not dropped, notes Day.
"A fee-only model helps accountants who are also financial planners (accountant financial planners) to run a better business," he points out." They say the law is playing catch up to what should be the correct position." Brown says "accountant financial planners" would be trusted to act in their clients' best interests because they would not be encouraged to sell products or accumulate funds under management to make a living.
Given the opposition to APES 230, it still is quite possible for the accountants to retreat from leading the market move toward a more fee-based payment system for advice. Yet backing down now would be bad after donning the mantle of trailblazer and saying that the only way to achieve trust and professional status that the financial planning industry so badly wants to achieve is to remove the remuneration conflict.
Reneging on APES 230 will be a huge setback for the financial planning industry, says Jerry Parwada, an associate professor in Banking and Finance at the Australian School of Business. He urges commitment to it. "If they don't approve it, the rest of the industry will just bunker down and put the whole idea of revisiting their business model on the backburner, so it's very important the draft standard is approved," says Parwada. Adopting APES 230 is a clear way for one group of financial planners to differentiate themselves from the other, which can only be good for the market. "Having one group of planners that subscribes to a different model offers greater investor choice."
Despite being a political compromise and a watered-down version of what FOFA initially intended to do, Parwada thinks the FOFA reforms are a starting point. But he says it doesn't go far enough in addressing what sections of the financial planning community have been clamouring for – that their profession be treated like any other. "Would you trust a doctor, a lawyer or an accountant who receives conflicted remuneration? No. The same rule must apply to financial planners if they are going to be trusted as true professionals. They either subscribe to professionalism or they don't," he says.
Without it, the financial planning industry's long-term future is shaky since people will continue to rely on the more credible sources of advice they have at their disposal, Parwada believes. "Clearly, when most people think about financial affairs they don't think of going to a financial planner so you would think the financial planning industry would take the plunge and professionalise rather than delay the inevitable," he says.
Brown also does not have much confidence that the industry will build on FOFA as a starting point due to the opposition by strong vested interests against reform. In his view, FOFA fails to set comprehensive principles, thus allowing the industry to avoid the intention of the legislation. "The reform process is frustrating because most people know what needs to be done," he says. "However, there are many commercial vested interests, which will stop that happening. Therefore, we're likely to end up with a highly politically compromised piece of legislation with which no one is particularly happy."
Relentless industry lobbying may mean FOFA is further diluted to reduce its impact on the conflicts of interest inherent in product sales and distribution networks, according to Brown. "They've already achieved much of that outcome by retaining percentage-based asset fees on investment products, retaining commissions on individual insurance policies (which may lead to some financial planners biasing their advice towards selling more life insurance), retaining trailing commissions on existing books of business and successfully pressuring government to move the opt-in (agreeing to pay for advice) to two years, up from the initial one year."
The next step for the lobbyists is to get rid of the ban on asset fees when gearing is involved, remove the opt-in altogether or make it apply every five years or so, Brown predicts. If the industry manages to achieve those outcomes, FOFA will be impressively bulky, but will mean very little. Despite the good intent by government, the upshot will be no substantial change in behaviour.
Brown's hopes are pinned on FOFA forcing financial planners to think and act properly out of duty to the industry's best interests. "But it's a vain hope for financial advisers when their ability to pay the family bills will continue to depend upon meeting a product sales target on which they will be paid percentage-based remuneration and bonuses," he admits. And, this will continue to be possible under FOFA. "Of course, that's the essential problem with FOFA," Brown says. "While it's good to have a tight best-interests duty, most advisers will continue to act under the influence of conflicted remuneration because of the political compromises within FOFA, such as asset fees, commissions on life insurance and ongoing trails."
Is disclosure enough?
Financial Services Council chief executive John Brogden does not buy the argument. He sees APES 230 as being all about competition for business, not regulation. "Accountants are trying to make out their standards are higher than the law. We don't believe they are," he says.
In his view, FOFA is a massive set of reforms that more than adequately deals with conflicted remuneration. First, Brogden says clients will have a choice about whether they pay a flat fee or a percentage fee. Second, the percentage fee has to be expressed in dollar terms so consumers understand exactly how much they're paying. Third, opt-in reform means planners have to check every two years that clients want to continue paying and receiving advice. Also regular fee statements will be issued.
"If they're not comfortable with that arrangement, they can demand it be changed or walk away," says Brodgen. "I've never understood why there is opposition to properly disclosed fees particularly with the belts and braces of reform that have been put around them." Brogden insists the changes will ensure people will become more aware of the relationship with their planner.
In theory, this is right, argues Brown. Disclosure (and the consequent right of the client to withdraw) is always the industry's argument as to why things should remain the same. "It's been the industry's argument over the last 30 years for maintaining the status quo!"
Brown observes that the industry often claims clients are fully informed about their options and that planners are acting in their clients' best interests – even the promoters of the Queensland-based Storm Financial, which collapsed in 2009, made such claims. However, while clients may be informed about their fees and options, experience shows that the vast majority of clients do not understand these disclosures, even when they are technically and comprehensively informed of them. Financial education will address these issues to some extent, but the problem will not be solved until the industry is trusted. The only way to do that is to align the interests of clients with those of financial planners.
Dante De Gori, general manager of policy and government relations at the Financial Planning Association of Australia, is not opposed to the standards board's proposed changes, but he thinks the draft standard is unlikely to be approved. "It's very much a symbolic standard only at this stage," he says. De Gori anticipates a cultural shift in the industry with the arrival of younger financial planners without the historical baggage of the sales commission regime.
Resistance to reform changes is not surprising. But the broader question is: How easy will it be to train people with a primary focus of adding value for the clients? People respond to incentives and Parwada is uncertain that providing younger people with a different form of training alone will change behaviour.
"When they go out into the world they will face pressure to sell if the business model is not changed," he suggests. Financial education will address these issues to some extent, but the problem will not be solved until the industry is trusted because the interests of clients and financial planners are aligned.
In the meantime, Australia waits to see whether the private sector ethical standard setter will lead reform in a beleaguered industry.