The following article is based on an address at the Annual Forum of the Australian Securities and Investments Commission in Sydney on 24 March 2015.
Leaders in the financial services industry regularly claim, both in the media and during parliamentary inquiries, that they have responsibly built the structures, safeguards, compliance processes, professional rules, ethical standards and incentives which act to minimise the poor behaviour and hazards to which the title of this session refers.
These leaders tell us that they have struck an “appropriate balance” between the commercial interests of the financial services industry and the best interests of consumers. As a result of this “balancing of interests”, we are told the industry’s problems are not structural or systemic. Rather they are caused by a few “bad apples” who must be removed from the industry’s ranks.
Therefore, it is argued that the industry can and should be trusted, that financial advisers are entitled to be called “professionals” and that the terms “financial planner” and “financial adviser” should be enshrined in legislation so that consumers can be assured that the new profession of financial advice is looking after their best interests.
That sounds like a compelling argument. Sadly, however, it does not reflect reality. It is an argument contradicted by widespread evidence contrasting what the financial services industry claims to do with what much of it actually does in practice.
As a result of this unsettling evidence, governments have been forced to respond to irresistible political pressures by regularly intervening in the so-called “free market” with a view to repairing its failures. The Future of Financial Advice legislation is but the latest example in a line of interventions over the last forty years, none of which has comprehensively addressed the remuneration practices that have been the cause of the hazards; although FOFA came uncomfortably close, which might explain why aspects of it were so strongly opposed by the industry.
Therefore, it should come as no surprise to observe that the hazardous behaviour and the complex workaround legislation introduced to curtail it have continued, ultimately creating a self-inflicted regulatory and compliance nightmare about which the industry incessantly complains (which is a bit rich since the industry’s behaviour caused the problem in the first place).
So why is the financial advice industry not trusted to behave in the way that the traditional professions of medicine, law and accounting have been trusted to behave (more or less) since their inception?
Could it be that much of the industry actually prefers to be regulated by government because existing regulations don’t work?
Could it be that the boards of large financial institutions don’t want to change the product selling culture that is so deeply embedded through the industry’s structure and remuneration?
Could it be that the industry’s claim that many customers will not pay a genuine fee for service for financial advice, including for insurance advice, is driven by its desire to not let go of the remuneration arrangements that are directly tied to product sales?
Could it be that the existence of insurance commissions is causing the so-called underinsurance problem in Australia? After all, commission has been the dominant remuneration for over 100 years of life insurance selling, so why are Australians still underinsured?
Could it be that customers will pay a genuine fee for service if they believe that advisers are acting in their best interests, thereby unambiguously offering value for money?
Could it be that the industry is deliberately avoiding its deeper structural problems by suggesting that all will be resolved by getting rid of a few “bad apples”?
Could it be that the industry is creating rhetorical diversions and deflections from the genuine solution by suggesting that advisers and consumers should become better educated?
Could it be that financial advisers want the right to call themselves professionals without accepting the self-regulatory public interest and ethical obligations that must accompany that descriptor?
Of course, I am under no illusions concerning the power and influence of the industry’s dominant product selling culture and the hazardous remuneration structures that drive it.
This was amply demonstrated in a tragic failure of self-regulation which occurred in my own profession of accounting in 2012/13. Initially, the profession’s independent standard setter, the Accounting Professional and Ethical Standards Board (APESB), showed the courage to defend the profession’s fundamental ethical principles for members offering financial planning services.
In essence, the board announced in November 2012, after an exhaustive five year public consultation process, that the receipt of any conflicted payments, including commissions, asset fees, product/platform bonuses, rebates and any similar incentives, were inconsistent with membership of the accounting profession.
This conclusion should have been uncontroversial, however, a storm of criticism followed. Why? Simply because for the first time, self-regulatory professional rules were to be introduced that would undoubtedly change the culture of financial planning from product selling to advice. This was a horrifying prospect.
As a result, relentless pressure was brought to bear from the financial services industry on the professional accounting bodies which subsequently prevailed upon the APESB to “refine” the principles publicly announced in 2012. Therefore, by early 2013, the relevant standard (APES230) had been watered-down to become an uncomfortably embarrassing set of rules that may reasonably be described as “optional ethics”.
This allows accountants who offer financial advice services to adopt either the highest standard of ethical practice, based on the avoidance and removal of conflicted remuneration; or to adopt a lower standard of ethical practice based on disclosure of conflicted remuneration.
As a result, members of the public should reasonably ask whether they can trust accountants to give them financial advice in their best interests.
This flawed standard, APES230, and the process by which it was derived is a classic case study in how NOT to do self-regulation and how to destroy the public trust on which a profession must build and sustain its reputation. It’s no wonder that some commentators are so skeptical about the willingness and ability of any industry to regulate itself in the public interest.
Of course, the solution to the industry’s “remuneration hazard” problems, identified by the APESB in 2012, has been obvious, but avoided, for decades.
The only way (as the title of this session puts it) to “address the tension between incentivizing employees and ensuring that customers’ interests are put first” is to remove the tension completely by adopting remuneration arrangements that avoid the conflicts and the tensions in the first place.
Professional trust can never be a case of balancing interests or as the latest jargon puts it, adopting a “balanced scorecard” approach in which product sales and the accumulation of funds under management are included in the mix of criteria.
This conclusion has been strongly confirmed through my extensive involvement in the design and presentation of financial literacy education programs. The most commonly asked question from participants in these programs is “who can I trust?”
One recent initiative by a large employer in which I have considerable involvement is the Financial Advice Referral Program for members of the Australian Defence Force. This Program is open to any individual licensed financial adviser in Australia (not to “dealer groups”) provided that the adviser is able to sign a prescribed legal (and ethical) undertaking to avoid any form of conflicted remuneration.
You can see the details of the Program, including the words of the Undertaking and the names of the advisers at www.adfconsumer.gov.au.
I have always hoped that the financial advice industry would become a trusted “hazard-free” profession by a process of self-regulation. Unfortunately, when reform of ethical standards is left to governments, countervailing vested interests usually mean that we end up with the likes of FOFA, a piece of legislation that is so compromised and flawed that it will inevitably lead to more amendments and refinements down the track. Sadly, this is so utterly unnecessary.
Rolling forward to December 2014, the Parliamentary Joint Committee on Corporations and Financial Services issued a series of recommendations to improve the financial advice industry’s ethical, professional and educational standards. Central to those recommendations is a worthwhile proposal to establish what amounts to an industry-funded self-regulatory body that will set and monitor the educational (and inevitably, ethical) framework applying to financial advisers.
Could this be the industry’s final opportunity to transform itself into a true profession and to remove the product driven remuneration hazards that are at the core of the industry’s problems? I suspect so, failing which financial advisers are likely to experience a new world of regulatory pain imposed by future governments that have lost patience with the industry’s obfuscations and deflections and are unwilling to allow poor ethical behaviour to continue unchecked.
However, the industry can have a positive future. If it were to voluntarily remove the conflicted remuneration arrangements to which I’ve referred today, several positive things would happen, almost immediately. The industry would be widely trusted to act in the public interest; many more Australians would enthusiastically seek financial advice; they would happily accept product recommendations; they would willingly pay “hazard-free” fees, confident that the advice is being offered in their best interests; the need for complex regulation and ‘red tape’ would be removed; the cost of doing business would drop substantially; young people would happily join and remain in the financial advice industry, genuinely satisfied that they were making a positive difference to the lives of their customers; and the industry would confidently and profitably grow without the distractions and impediments of a continuing tarnished reputation.
At least for now, the solution is in our hands. So why don’t we do it?
Robert M C Brown AM BEc FCA
ADF Financial Services Consumer Centre