Most Australians would be aware that over the last 12 months there has been an extensive enquiry (a Royal Commission) into misconduct of banks, superannuation funds and the financial services industry.
Chaired by retired High Court judge, Kenneth Hayne AC, the Royal Commissioner called more than 130 witnesses and reviewed over 10,000 public submissions. He published his damning report in February 2019, making 76 recommendations for urgent reform. It’s encouraging that both Government and Opposition have promised to implement his recommendations. It can be argued that they have no other option, given the disturbing revelations of greed, conflicts of interest, rip-off and systemic malpractice contained in the report. In fact, the political risk lies in not undertaking to act with strength and resolve.
Nevertheless, consumers should be cautious and realistic. The history of reform in financial services demonstrates that once the media “tumult and shouting has died”, so does the political enthusiasm for hard decisions, particularly in the face of ferocious and well-funded lobbying. Experience shows that once the inevitable “industry consultations” commence, politicians become nervous and will be open to compromises. We’ve already seen mortgage brokers, insurance agents and financial advisers calling for the retention of their commissions……and the legislative process hasn’t even started.
So just for the record, here are the top ten objections that have been rolled out for decades to stop or dilute genuine ethical reform, especially in the area of financial advice (aka financial planning) which was a key area of examination by the Royal Commission. Rest assured, most of these will be rolled out again over the next twelve months as the recommendations of the Royal Commission are debated:
Response: There is a mountain of evidence to the contrary. Many financial advisers reject commissions and successfully offer their services on a genuine fee for service basis (hourly rates or flat fees). And, of course, just because something is difficult or commercially inconvenient doesn’t mean the ethical principles behind it should be discarded. Instead, the principles should be supported and accompanied by a reasonable transition period.
Response: This claim denies that there is a systemic problem, or that if there was one, it doesn’t exist now. The facts (and the Royal Commission) don’t support these claims, but the industry persists with them. In addition, removal of conflicts, not just their disclosure, is a fundamental principle of professional practice and must not be ignored just because it suits the business models of those who view financial advisers as a product sales channel.
Response: Years of experience in dealing with clients of limited means has demonstrated that consumers will pay genuine fees for service (hourly rates or flat fees) where they see value in doing so. Many people are naturally sceptical about the worth of percentage-based fees (aka commissions) which they correctly suspect is an opportunity for an adviser to sell them a product which they don’t want or need.
Response: Sometimes hourly rates arrangements can be inefficient or excessive. This can be overcome by the adoption of flat fees. Importantly, hourly rates and flat fees do not lead to the inappropriate sale of financial products or to the accumulation of funds under management which is the principal mischief caused by percentage-based arrangements.
Response: Financial advice is not a free market. It’s a professional market in which participants are bound ethically and legally to act in their clients’ best interests. This will often require them to offer advice that is contrary to their commercial interests. In such a market, professional advisers are obliged to avoid conflicts, not just to disclose them. Given the perceived commercial advantages of percentage-based fees (aka commissions), many advisers promote them over genuine fees for service while disingenuously suggesting that the client has a real choice which they don’t (and shouldn’t in a genuine professional environment).
Response: Having a university degree might indicate that a person is well-educated, but like all humans they are subject to the temptations that percentage-based remuneration creates. So, faced with a decision about whether to receive a percentage on a product sale or to receive nothing because a product is not appropriate, advisers will be often tempted to recommend a product. They will then rationalise why that decision was ethical. Financial advisers who purport to act in their clients’ best interests should not be put in this position of conflict because it destroys trust between advisers and the public.
Response: Most commissions paid to advisers by third parties (e.g, a financial institution) are banned by law, whereas commissions paid by clients (aka an asset fee) are not. Therefore, many advisers use asset fees to avoid the ban on conventional commissions. This form of fee/commission was identified by the Royal Commission as “fees for no service”.
A useful way to analyse asset fees is to consider a common circumstance where a person who has inherited money requires advice on whether to pay off a mortgage or invest the inheritance through an adviser. Clearly, where the adviser receives asset fees, there is a significant conflict because asset fees cannot be charged if the mortgage is reduced. There are many other examples, including where a person must decide on an industry superfund (e.g., ADF Super) versus a self-self-managed superannuation fund or deciding whether to take a lump sum vs a government-guaranteed pension from military superannuation.
In each of these circumstances, asset fees are conflicted, leading to potentially damaging decisions by clients. A genuine fee for service adviser has no such conflicts.
Response: Of course, consumers make mistakes and we must continue in our efforts to better educate them. But just as we don’t expect laypeople to be experts in medicine, law and accounting, we should not expect consumers to be financial experts. Given the considerable knowledge and power imbalance that will always exist between advisers and their clients, the industry has an obligation to lift its ethical game and to not blame bad outcomes on consumers whose reasonable expectation is that they should be able to trust financial advisers to advise in their best interests. The same goes for the regulator. Of course, the Australian Securities and Investments Commission (ASIC) could improve its performance, but the industry must not be allowed to shift the blame for its own poor behaviour onto the regulator.
Response: This is the classic delaying tactic. It is designed to create doubt in the minds of politicians and policymakers who may not be across all the details. Typically, the industry claims that reforms are an attack on hard working small business owners and an assault on free enterprise. We’ve already seen this claim from mortgage brokers.
This approach often works well to delay or compromise decisions. It is usually accompanied by claims that decision makers should “balance stakeholders’ interests” (which means that the industry status quo should be maintained). The appeal to doubt can be best handled by decision makers having a clear understanding of the ethical principles behind reform and why they must be supported in the public interest.
Response: In conjunction with “unintended consequences”, this is a powerful tactic employed by many industries facing the prospect of reform. It’s often combined with statements from industry leaders that while they accept the fundamental ethical principles, “now is not the right time”. This the St Augustine excuse. As a youth, he was reported to have asked God to make him holy, “but not yet”.
The Hayne Royal Commission presents the opportunity of a generation to reform the financial planning industry permanently and genuinely. Whether that occurs depends on the resolve of parliament to resist the temptation to cave-in to disingenuous objections and to compromise in order to get “something” done. If history is any guide, the prospects for comprehensive ethical reform are problematic. But it’s just possible that 2019 will be different. Let’s hope so.