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Chapter 7 - Remuneration models for financial advice
7.1
This chapter analyses the effect of different remuneration models on the
standard of superannuation advice. The committee discusses potential conflicts
of interest in commission-based remuneration models. It also notes issues associated
with paying ongoing trailing commissions, the use of approved product lists and
'tied' adviser relationships. Remedies to improve the quality of superannuation
advice are then examined including suggestions to ban commissions and shelf
fees, improve disclosure of conflicts of interest, mandate a higher standard of
advice and facilitate the provision of fee-for-service advice. Finally, the
committee discusses the important role of education and financial literacy to
equip current and future superannuation fund members with the capacity to
navigate the new superannuation environment.
Legislative standard for financial advice
7.2
The standard imposed by the Corporations Act 2001 (Corporations
Act) is for there to be a reasonable basis for advice. In meeting this
standard, section 945A stipulates that the entity providing advice must comply
with the suitability rule, which is comprised of the following three criteria:
- knowing the client's personal circumstances;
- knowing the product or subject matter the advice is given on; and
- ensuring that the advice is appropriate to the client.
7.3
ASIC has indicated that 'personal advice does not need to be ideal,
perfect or best to comply with the Corporations Act'.[1]
Therefore, so long as disclosure requirements are met, it is legally
permissible for an adviser to recommend a product privately knowing it is not
the best option for the client.
7.4
The standard of advice on superannuation has been most questionable
where clients have been advised to transfer their fund balance from one product
to another. The introduction of ASIC's policy statement on providing financial
product advice states that:
In the case of advice to replace one product with another product
(or to switch between investment options within a financial product), we
consider that consideration and investigation of both the new product (or
option) and the old product (or option) is generally required under
s945A(1)(b).[2]
7.5
It indicates that switching advice would not be appropriate if there is no
net benefit to the client in doing so:
In the case of advice to replace one product with another product
(or to switch between investment options within a product), we consider that
the advice will generally be inappropriate if the providing entity knew (or
ought reasonably to have known) that the overall benefits likely to result from
the new product (or option) would be lower than under the old product (or
option).[3]
7.6
In evidence, ASIC reiterated the importance of enquiries being made into
the exit fund:
The AMP enforceable undertaking deals with that issue. That is
one of those examples where I think there is still some industry anxiety about
obligation of inquiry. We are sympathetic where it is quite difficult to get
details about the possible exit fund, but we have stayed firm that you cannot
provide people with good, reliable advice to go from A to B without knowing
something about A as well as B.[4]
7.7
The examples of unreasonable advice in a 'switching' scenario were highlighted
by the results of ASIC's shadow shopping survey on superannuation advice,
released in April 2006. Most significantly, ASIC reported that unreasonable
advice was between three and six times more likely where a conflict of interest
was present.[5]
Remuneration models
7.8
As referred to in the previous chapter, the majority of fund members do
not seek professional advice on the management of their superannuation balance.
For those who do seek professional guidance, there are a number of ways in
which the adviser can be remunerated for it. These include fee-for-service and
commission-based payments, the latter being utilised in the financial advice
market with a few different variations.
Fee-for-service
7.9
Fee-for-service remuneration is an up front payment negotiated on the
basis of the agreed value of the advice provided, which is normally determined
by, and charged at, an hourly rate. This reflects the arrangement clients
generally have with other professional advisers such as lawyers. Advisers being
paid through this arrangement usually rebate back to their clients any
commissions paid to them by the funds.
7.10
As referred to in the previous chapter, rigorous disclosure requirements
have rendered this an expensive payment option, particularly where it cannot be
paid out of a person's superannuation account balance.
7.11
Some superannuation funds have established a mechanism whereby the cost
of fee-for-service advice may be deducted from account balances. For instance
HostPlus reported that:
...from 1 January 2007, members will have the ability to choose
an additional method of payment for financial planning advice for
superannuation only. Members will be allowed to deduct a set amount from a
member’s account in order to pay for that advice.[6]
7.12
REST Superannuation outlined its own model for outsourcing the provision
of advice:
REST has engaged the services of Money Solutions Pty Ltd to
offer personal advice to our members while operating under its own personal
advice licence. This model allows members access to one off coaching for
individual issues rather than a full financial plan. We believe that it is
appropriate to allow for payments for such advice to be deducted from a
member’s superannuation account, subject to the sole purpose test rules. Our
experience shows that over 92% of our members who receive single issue
superannuation advice under this arrangement do not wish to go to a full financial
plan and consequently would go unserviced or be poorly serviced by the traditional
financial planning industry.[7]
7.13
As REST mentioned, the capacity of funds and members to utilise this
payment option is limited by the sole purpose test. Section 62 of the SIS Act
stipulates that superannuation fund trustees must maintain the fund for the
benefit of members. In the context of deducting fees from members' accounts, the
Australian Prudential Regulatory Authority (APRA) has indicated that superannuation
fund trustees are 'not permitted to apply members' contributions or fund assets
for services provided outside the core and ancillary purposes'.[8]
7.14
Account deductions for advice on superannuation only are permitted on
the basis of the connection between that service and the core purpose of the
fund. APRA's guidance states:
41. It is open to trustees to develop features of their fund
which add value to, or differentiate it from, other funds. For example, fund
sponsored member awareness, education and financial advice programs, targeted
at fund specific issues such as benefit features (including insurance options,
the making of binding death benefit nominations etc) or investment choices
offered in the fund, may be appropriate. ...
...
43. Financial planning is now a service which many trustees
are considering offering to members. As noted in paragraph 41, if the service
is aimed only at a member's interest in the fund, such services would generally
fall within the sole purpose test. If, however, broader advice is offered, it
would be inappropriate for the cost to be borne by the fund.[9]
7.15
A number of organisations expressed uncertainty as to the scope of the
sole purpose test with regard to deducting the cost of financial advice from
member accounts. This matter is discussed later in the chapter in the context
of providing a remedy for the provision of conflicted advice.
Commissions
7.16
Commission-based payments are paid by retail and some industry superannuation
funds to financial advisers in exchange for distributing their products in the
marketplace. From the funds' perspective, paying commissions is more effective
than deploying numerous salespeople to go out and sell their product. Significantly
though, commissions are also a useful mechanism for remunerating advisers for
the cost of providing advice without their clients needing to find the money
from elsewhere, as is generally the case with fee-for-service advice. In this
way, paying for advice via commissions is appealing to those who cannot afford
costly up-front advice from their discretionary monies.
7.17
In a superannuation context, commission payments are either deducted
from a member's account at the beginning, or as a regular payment that may
continue for as long as he or she remains in the fund. This latter variety is
referred to as a trailing commission. Advisers may be paid a mixture of
up-front and trailing commissions.
7.18
ASIC's consumer website outlines the normal range paid in commissions as
follows:
Entry fees for standard investment and superannuation products
range from nil to 5% of the amount you invest. About 2% to 3% is common, so you
would invest only $98 or $97 of every $100 you pay. Trailing commissions range
up to 1% each year, so you would pay $1 every year for every $100 in your
account.[10]
7.19
Trailing commissions are generally deducted on an annual basis on the
premise that a financial adviser, while receiving an ongoing commission
payment, will continue to provide his or her client with ongoing financial
advice with respect to that fund. Trailing commissions may also result in lower
up-front commissions. Some trailing commissions may be able to be switched off
or 'dialled down', that is reduced. Many advisers also make arrangements with
their clients to rebate trailing commissions earned from the fund back into the
member's account.
Sales-based remuneration and the quality of advice
7.20
Commission-based remuneration was the subject of extensive criticism, principally
from the industry fund sector, throughout the inquiry. The dual purpose served
by commission-based remuneration of funding the cost of advice and serving as a
distribution mechanism for the funds raised a number of issues pertaining to
conflicts of interest and the quality of advice.
Commission-based conflicts of
interest
7.21
A number of organisations expressed the view that remunerating advisers
for sales and advice with the same payment mechanism generates a substantial
conflict of interest for advisers, often leading to the provision of advice
that is not necessarily in the client's best interests. Commissions encourage
advisers to recommend, in spite of quality or suitability, superannuation
products that pay commissions over those that do not or to favour products that
pay high commissions over those paying more standard rates. The committee notes
that products offering higher than usual commissions in return for distribution
to clients are not generally able to compete on the basis of quality, as the
Westpoint collapse demonstrated. However, it is also worth noting that none of
the major financial product platforms had Westpoint, Fincorp or ACR on their
approved product lists.
7.22
Corporate Superannuation Association offered the view that
commission-based conflicts of interest are inevitable:
You cannot expect a person who has a family to feed to be
dispassionate and advise somebody who comes in where there is no product to be
sold, because the person is currently perhaps in UniSuper or Rio Tinto, which
are very superior funds. If you go into the average planner and get some
advice, if they knew their product and they knew your product, they would say,
‘Well, you may as well leave now.’ But that is not what happens.[11]
7.23
Industry Super Network asserted that 'unsuspecting consumers' were let
down by a system of remuneration that is geared towards promoting lucrative
sales rather than the best advice:
While consumers believe they are paying advisors for
professional advice, financial planners are actually paid a sales commission by
the financial institution which employs them or which provides the product.
Most financial planners do not recommend that consumers consider putting their
superannuation in an industry super fund, despite the fact that this would in
many cases provide the best retirement outcome for consumers. The structure of
commissions ensure that they promote good sales rather than good advice and we
submit that recent investigations by ASIC demonstrates that current legislative
obligations fail to adequately protect consumers.[12]
7.24
Choice estimated that $772 million in commission was paid on compulsory
superannuation investments between March 2005 and March 2006, with an
additional $93 million paid in ongoing trailing commissions during that period.[13]
Choice commented:
These remuneration structures can link financial advice about
superannuation with how the adviser is remunerated. Fund managers compete with
each other based on the commissions and other enticements that they can offer
planners to promote their superannuation products. These incentives can distort
how advice is framed to consumers and this can lead to inappropriate advice.[14]
7.25
Choice told the committee that the payment of commissions on
superannuation products has evolved from the old life insurance model where
products needed to be distributed, or sold, using this remuneration mechanism.
However, Choice argued that this approach is no longer appropriate in the
context of superannuation: 'A compulsory system should not need distribution
mechanisms'.[15]
7.26
Superpartners submitted that industry funds were often disregarded by
advisers as they do not pay commissions:
Industry funds do not generally pay commissions to personal
advice licensees which results in consumers not being advised about the option
of moving to an industry fund. The consequence is that personal superannuation
advice is not given on the basis of the product that is most suitable for the
client’s needs.
ASIC has conceded that it “made no secret” that the commission
model has meant many advisers did not advise their clients of industry funds.
The experience in the United Kingdom with pension fund switching carries a
salutary warning of the dangers of commission-driven advice. The potential
influence of a commission in advising consumers about switching presents
industry funds with a structural competitive disadvantage with retail funds.[16]
7.27
Other organisations argued that commissions provide fund members with
access to advice that would be otherwise unobtainable. For instance, the
Financial Planning Association of Australia (FPA) indicated that commission
payments are an effective remuneration method for clients to use when accessing
ongoing advice:
...from a commission point of view that there is a huge amount
of ongoing advice required in some cases. You can often put a set and forget
strategy in place, but in some cases—and we can talk through this in quite an
amount of detail—you do need to review your strategies, you need to look at
your contribution levels, you might like to look at your asset allocation,
there might be market movements, or in fact you might simply want advice to
say, ‘Don’t do anything.’ So that commission is not only about the initial
piece of advice and a product. It is also about providing ongoing advice, being
able to ring your adviser whenever you like, being able to ask them questions
across a whole range of different issues without necessarily having to sign a
cheque.[17]
7.28
This position reflects the view that conflicted advice, properly managed
to ensure that appropriate advice is still given, is preferable to no advice on
superannuation at all. Or in other words, to prohibit commissions because of a
potential for inappropriate or inferior advice would be an overreaction to a
manageable problem.
ASIC's shadow shopping survey and
related action
7.29
In April 2006 ASIC released the results of its shadow shopping survey on
superannuation advice, which surveyed 259 individual advisers and assessed the
standard of their advice. Significantly, ASIC reported that advisers are
between three and six times more likely to provide unreasonable advice where a
conflict of interest is present. It identified as major problems the following
practices:
- not examining existing funds before recommending new ones;
- not disclosing the reasons for recommended action; and
- not disclosing the consequences of switching funds.[18]
7.30
Perhaps most worryingly, ASIC concluded that most clients who had
received poor advice did not realise it was so.[19]
7.31
Following this exercise, in July 2006 ASIC accepted an enforceable
undertaking from AMP Financial Planning Pty Ltd to modify the way in which it
provides financial advice to customers. ASIC reported that a significant
proportion of AMP planners had been advising clients to shift from rival funds
into AMP products without disclosing a reasonable basis for the advice. As a
consequence AMP undertook to change a number of its internal procedures and
offered to review its clients' advice.[20]
Nevertheless, AMP disputes the conclusion that the advice was inappropriate in
all of the shadow-shopping cases.
Trailing commissions: paying for
ongoing advice
7.32
One form of commission payment attracted particular criticism during the
inquiry: trailing commissions. This remuneration model operates on the basis
that an annual commission is paid from the fund to the adviser in return for
ongoing access to superannuation advice.
7.33
The focus of criticism of trailing commissions related to value for
money; the payments could continue indefinitely without a commensurate
provision of advice in return. For example, Superpartners told the committee
that trailing commissions often cost more than the value of the advice
provided:
What we are concerned about ... is the issue of trailing
commissions going on and on, in relation to advice that may have been given
many years ago, that the member is not benefiting from it and that the advice
has no application to the current circumstances of that member.[21]
7.34
It submitted that such remuneration worked against the interests of the
member:
A fundamental premise of transparency of commission disclosure
is that the commission should properly represent a fee for service. ...
Commissions that amount to a persistency or volume bonus are incompatible with
the purpose of superannuation to provide retirement incomes in trust for the
benefit of the members. [22]
7.35
Treasury commented that trailing commissions did not ensure a connection
between the value of advice and its cost:
...there should be a connection between the value of the advice
given and how much you are paying for it through the commission. The real
difficulty comes when you have things like trailing commissions, where there
does not seem to be any connection between the value of the advice provided and
how much the adviser is being remunerated. That is an issue that the government—as
well as this committee and many others in the community—have identified as a
significant problem for consumers in the marketplace. The government have said
that the industry has to examine this and has to look at how it is going to
deal with this particular situation. Within that context, that is why the sales
recommendations idea has been developed—it is in order to try to make what is
really happening much more transparent to consumers.[23]
7.36
In defence of the practice, CPA Australia told the committee that the
majority of planners rebate commission fees to their clients.[24]
MLC told the committee that the difference between commissions and fees 'is not
that great'.[25]
Instead it is mostly a difference in transparency rather than cost:
The difference between a commission and a fee is that a fee
gives a client two fundamental rights. One is to negotiate that fee up-front
and agree it and understand it with the adviser. The second is that they can
stop paying it if they no longer think they are getting value for it. It could
be exactly the same amount of money, the same dollars: two per cent is two per
cent, whether it is a fee or a commission. It is simply that the client can see
a fee more clearly and they can stop it if they do not like it at a future
point in time.[26]
7.37
The Association of Financial Advisers (AFA) described trail commissions
as 'another form of remuneration' that enabled ongoing advice:
Whether the client wishes to pay for it by a monthly debit or
whether they wish to pay for it out of their investment, that is their choice.
I think if we give clients the choice of how they want to pay for the advice
that they receive then that is a lot easier than legislating for it.
...
There is an ongoing need for advice. Under the regulations we
are supposed to review clients every year. Personally, it is not my favourite
thing because I think superannuation particularly is a long-term investment.
However, within that environment, as I said, the circumstances will change.
There is a need for insurances earlier on and there is a need for, I suppose, a
specific investment profile if you look at the requirements of the legislation.
But I hold with a view that is really trying to keep the clients focused on
their end goal and maintaining a source of information and education all the
way through.[27]
7.38
Fiducian Portfolio Services also argued that the cost was justified by
the benefits:
Superannuation and retirement planning involves far more than
simply looking at fees. Professional retirement planning advice to a client will
involve consideration of issues such as the client's retirement goals, the
breadth and depth of investments based upon their risk profile, salary
sacrifice strategies and determining adequate levels of risk insurance.[28]
Approved product lists
7.39
The problem of advisers preferring to recommend superannuation products
returning commissions appears to have manifested itself through AFS licensees'
approved product lists. Ostensibly, approved product lists function as a risk
management tool for licensees, ensuring that their authorised representatives
only recommend products into which the licensee has conducted appropriate
checks. This level of control avoids the legal risk associated with individual
advisers recommending products that his or her licensee would not itself have
the confidence to recommend.
7.40
However approved product lists may also be used as a way of sidelining
superannuation products that do not pay commissions or shelf fees,[29]
or do not benefit the vertical integration strategies of the licensee. Industry
funds feel particularly aggrieved that, despite offering competitive returns to
members, they are notably absent from the approved product lists from which
licensed advisers may recommend specific products. Even if an adviser wishes
to, he or she may not recommend an industry fund when it doesn't appear on the
list. For example, HostPlus told the committee that 'product lists are a
convenient way to lock us out'.[30]
At a recent ASIC oversight hearing with the committee, ASIC commented that:
...the remuneration model at the moment often means that many
financial advisers do not advise about industry funds. We are not making any
secret of that.[31]
7.41
Where a large portion of the market is locked out of being distributed
through the network of licensed advisers, there are potential implications for
the quality of advice. Equipsuper indicated that recommending the best product
is not always possible in the context of approved product lists:
Most if not all financial planners work from an approved product
list. In order to get onto the approved product list, the product must meet
certain criteria and go through a research process that says, ‘Yes, this is an
appropriate product for most of the people who will come to us.’ Clearly,
owning the body that creates the approved product list is a particularly useful
way of ensuring that your own products achieve sales targets or are distributed
widely. Certainly, you would like to think that financial planners will in all
cases recommend the best product, but that may not be immediately apparent from
the circumstances or the information that is provided. In most cases, the best
that you could hope for is that the consumer will be recommended what appears
to be the best product at that time and is appropriate for them. What is the
best product is not always going to be entirely clear.[32]
7.42
Approved product lists also generate difficulties for clients seeking
advice on choice of fund or consolidation where they hold an account with an
industry fund. In accordance with the 'know your product' provision of the
Corporations Act, advisers may not recommend a switch from one superannuation
product to another without being able to assess the relative merits of both the
existing fund and the recommended fund. Consequently, clients with an industry
fund account are often told they cannot be advised on choice of fund as their
potential 'from' fund is not on the adviser's approved product list.
7.43
Alternatively, if an adviser recommends a switch without knowing the
features of the industry fund he or she is recommending a switch from, the act
has been contravened. Speaking on the outcomes of its survey into
superannuation advice at a recent oversight hearing, ASIC commented:
Where you are recommending a switch, you need to look at the
existing arrangements that the customer has and assess the plusses and minuses
of moving out of that product and into a new product. You need to explain those
to the client and then include them in the statement of advice. The report that
you were referring to, the super switching report, had some rather unhappy
outcomes. For example, people had existing funds, where they had quite
reasonable insurance, and through lack of care on the part of the adviser it
was recommended that they move into another product. They either lost that
insurance or ended up having to pay much more for it. We set all that out in
that report. That is really a summary of the legal obligation. It makes perfect
sense. If you are giving professional advice to someone about whether they
should move out of a fund, it is not rocket science to expect that you would
have a look at what fund they are already in and see how it stacks up with what
you are recommending. It is that simple.[33]
7.44
Some respondents, though, defended individual advisers working within
the parameters of their licensees' risk management structures. For instance,
Rainmaker argued that:
Financial planning provides a really valuable service and, like
any service, it has to be delivered properly. We have to get rid of the
conflicts of interest. But if planners are only allowed to talk about
particular products because that is what they are licensed to talk about, then
we cannot crucify them for talking about other products. What we should be
doing is thinking about the regulation that is overrestricting them. Shadow
shopping is fantastic, but I think to bag planners for doing what the law tells
them to do is just silly. [34]
7.45
MLC argued that advisers were not recommending industry funds because
they do not offer investment options other than superannuation:
...I do not think [advisers] are not choosing to use an industry
fund because it does not pay commission; I think they are not choosing an
industry fund because it does not offer, in many cases, all of those services
they need to implement their advice. That might change over time. Industry
funds might start to move into ordinary money and insurance. That might mean
that they become more appropriate as a choice.[35]
7.46
Total Portfolio Management suggested that a lack of obtainable
information often meant that advisers are not able to offer advice on industry
funds:
When seeking information from Industry Funds quite often the
full extent of their fees are not shown. The actual management fees relating to
the individual investments are not easily obtainable, and if we don't receive
this information no advice can be given. Again the people who are being
disadvantaged are those in the most need.[36]
7.47
Industry Funds Forum (IFF) rejected the argument that industry funds did
not appear on approved product lists because critical information about them
could not be accessed:
I think that argument might have had some credence 10 years ago,
but it has next to no validity now. There might be reasons why certain types of
funds are not on a recommended list, but you cannot credibly say it is because
we do not have access to information or we do not know where to obtain the
information. That is just a nonsense.[37]
7.48
Treasury defended the basis for approved product lists:
The authorised product list is driven by the structure of the
legal obligations that flow on to the licensee about giving advice. ... [W]e
have said that the licensee has to be responsible for the advice given and has
to be confident in the products that are being recommended. So there is
certainly a very strong and valid argument on the side of industry advisers
saying, ‘We need to be sure about the products that we are making
recommendations for’.[38]
7.49
However, the department did indicate that the situation was being
monitored:
...we are keeping a close eye on the way these things are done
and the impact it is having on the marketplace and whether or not there are any
distortions coming about as a result of the way products are being sold in the
market.[39]
7.50
The payment of 'shelf fees' (in addition to commissions) to facilitate
the placement of particular products on the list also received attention during
the inquiry. In its April 2006 discussion paper on managing conflicts of
interest in the financial services industry, ASIC indicated that licensees
should avoid listing companies that pay shelf fees as it generated a conflict
of interest, meaning that 'comparable or better' products that do not pay the
fee are more likely to be excluded from the list.[40]
7.51
Choice told the committee of their concern over the apparent requirement
to pay shelf fees to have products listed:
...we have become concerned about authorised lists becoming
attached to platform fees. The product might make the authorised list because
it has paid a platform fee. It might not make the list on its own merits but it
might make the list because it has paid for the research to be done on the
product—the various things that they have to do to change their computer
systems to be able to list it. Our concern is that other products that are
possibly good value and at lower cost to consumers are not making those lists.[41]
7.52
MLC told the committee that it does not pay shelf fees in order to avoid
the perception of a conflict:
...whether or not shelf-space fees in reality introduce actual
conflict, the perception must be that the reason why you are paying a
shelf-space fee is to get on the platform, and there must be a question about
whether that biases towards that fund the underlying advice that is given.[42]
'Tied' advisers
7.53
The committee also heard concerns in relation to a lack of transparency
over the relationship between advisers and superannuation product providers. In
instances where advisers are licensed under the financial planning arm of a
company that also distributes financial products, the distinction between the
financial advice sector and the financial product sales sector can become
blurred. Although consumers are aware of the sales motivations of the
supplier's representative when visiting a car dealership, in the financial
planning sector the incentives may not be as apparent to consumers where a
financial services company integrates product supply and sales through its team
of financial planners.
7.54
Presently, the nature of
these relationships is not reflected in the labels, or nomenclature, attached
to purveyors of financial advice. For instance, advisers are not required to
describe themselves as an 'agent' or 'franchisee' where their status would be
accurately reflected by these generally understood terms. Consequently, when
consumers seeking advice on superannuation products try to identify a suitable
financial adviser, the broad 'financial adviser' or 'financial planner' labels
do not provide them with an instinctive feel for the adviser's motivations.
Consumers in this sector are therefore less likely to be able to adequately
filter conflicted advice.
7.55
Members Equity Bank highlighted the influence of the major banks in the
superannuation product and advice market:
During the course of the nineties all the major banks, rather
than develop their own product offerings around superannuation ... acquired
fund managers and superannuation providers. ANZ had a joint venture with ING,
Westpac with BT and Rothschild, CBA with Colonial, NAB with MLC. So during the
course of the nineties they acquired fund management and superannuation
services. They then also acquired a large proportion of the financial planning
networks, so they now have vertical integration from the advice through to the
transactional banking capability, the banking relationship through to superannuation.[43]
7.56
It warned that many consumers would be unaware of the 'tied'
relationship between certain advisers and products.[44]
7.57
The Association of Financial Advisers (AFA) told the committee that
disclosure in this regard is inadequate, as the owner of an adviser's licensee
does not have to be disclosed.[45]
7.58
The committee notes ASIC's policy statement on managing conflicts of
interest, which states that disclosures on the following will 'generally be
appropriate':
- the
extent (if any) to which the licensee (or any associated person) has a legal or
beneficial interest in the financial products that are the subject of the
financial product advice;
- the
extent (if any) 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 (if any) to which the licensee (or any associated person) is likely to
receive financial or other benefits depending on whether the advice is
followed.[46]
7.59
AFA speculated that the tied adviser relationship is a product of the
licensing of financial product providers, rather than individual advisers:
...part of the function of FSR has been that the majority of
advisers are actually receiving remuneration from one source, although that
source has a plethora of products. It would have been a better choice had they
gone down the original line, which was individual licensing of advisers. We did
not get that, so now we have to deal with what we have. I think it is a better situation
than it has been previously, but in the AFA’s submission back in about 179 we
said that the biggest fear we had was that we would go back to a tied adviser
relationship, which meant the major distributors virtually corralling the
advisers and which was what we went away from during the 170s—and it has
happened.[47]
Remedies to improve the quality of advice
7.60
The present legislative arrangements to ensure that consumers receive an
appropriate standard of advice are as follows. Firstly, section 945A of the
Corporations Act stipulates that advice must be appropriate to the needs of the
client having regard to his or her circumstances and knowing the subject matter
being advised on. Secondly, advisers must manage conflicts of interest. The
committee outlined the Corporations Act disclosure requirements with respect to
conflicts of interest in Chapter 6.
7.61
ASIC has indicated that there is no prohibition on conflicts of interest
when providing financial services, rather that they should be adequately
managed through internal controls and disclosure. Where this is not sufficient
the conflict must be avoided.[48]
On the more specific issue of managing remuneration-based conflicts of
interest, ASIC has indicated that while some conflicts can be managed through
disclosure others should be avoided altogether:
In some cases, disclosure to clients is an adequate mechanism
for controlling conflicts of interest arising from remuneration practices. Part
7.7 of the Act generally approaches remuneration issues from a disclosure
perspective (i.e. remuneration must be fully disclosed). However, licensees
should consider whether any particular benefits, compensation or remuneration
practices are inconsistent with the requirement to have adequate arrangements
in place to manage conflicts of interest or with the requirement for the
efficient, honest and fair provision of financial services. For example, those
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).[49]
7.62
In evidence to the committee ASIC stated:
...if a product manufacturer or an advisory network uses
commissions as a form of remuneration then they need to be more cautious in managing
the potential conflicts caused by those arrangements and in making sure that
they do not undermine the integrity of the advice that is given. It is not an
argument for or against commissions; it is simply to say that if you choose a
particular business model that has in it a risk that is not inherent in another
business model, the law obliges you to make a special effort to make sure that
that business model does not cause any damage to the integrity of the advice
which the law requires you to provide.[50]
7.63
The committee heard evidence, however, that the current mechanisms for
managing conflicts of interest were not always sufficient to protect consumers
from receiving an inadequate standard of advice. The results of ASIC's shadow
shopping exercise lend credence to these concerns. The committee also notes
that the introduction of Super Choice has exacerbated the possible deleterious
effect of poor quality advice on superannuation. The following section examines
possible remedies for addressing perceived deficiencies in the regulatory
system to ensure fund members receive a high standard of superannuation
advice.
Commissions and shelf fees
7.64
Instead of ensuring that consumers are fully aware of the conflicts of
interest associated with commission-based remuneration for advice, some
organisations advocated banning commissions on superannuation advice
altogether. As justification for ending the practice, the compulsory nature of
involvement in the superannuation system was regularly highlighted. For
example, Members Equity Bank wrote in its submission:
There can be no justification for consumers’ superannuation
guarantee charges being reduced by the imposition of a sales commission as the
contribution is mandatory, paid by the employer, and is part of an employee’s
remuneration.[51]
7.65
The Australian Institute of Superannuation Trustees (AIST) was another
organisation advocating the prohibition of commissions on superannuation
contributions. It was particularly critical of commissions on compulsory SG
payments:
To allow a financial adviser or financial planner to reap a
financial benefit via a trailing or one-off commission on an amount that must,
by law, be paid into an employee’s superannuation fund is unfair and
unreasonable. (An adviser or sales agent does not have to work very hard to
obtain funds that are legislated that an employee must receive.) Yet, the
adviser or sales agent may be able to obtain a financial benefit from those
contributions.[52]
7.66
In evidence to the committee it called for a total ban:
We should not only go halfway; we should go all the way and get
rid of commissions. It is outrageous that, on a nine per cent compulsory
contribution, every Australian worker has to pay—that someone can sell someone
that product and get a trailing commission on it. They did not have to actively
go out and seek this. It is law. [53]
7.67
Industry Super Network also argued that commission-based remuneration
should be banned entirely. It submitted:
...financial planners remunerated by commission suffer a direct
conflict of interest and this has a deleterious effect on the quality of advice
consumers receive from commission-remunerated planners.
If commissions dominate the advisory industry, then products not
paying commissions will rarely be recommended even if they are superior (indeed
such products will not appear on the advisory firm’s “approved product list”). Differential
percentage commissions will inevitably encourage some advisors to favour high
cost products even where they are inferior (the extreme example being Westpoint).[54]
7.68
However, it should be noted that Westpoint was not a superannuation
product.
7.69
IFF argued that:
...customer-focussed financial advice and commission payments
are not compatible with each other and the only way to ensure that appropriate
financial advice is given, is to remove the temptation of commissions and soft
dollar incentives in connection with financial advice.[55]
7.70
While still expressing their opposition to the practice, others adopted
a more moderate stand. SuperRatings told the committee that commissions on
mandated superannuation contributions should be phased out over a two to three
year period.[56]
Choice suggested to the committee that trailing commissions should either be
banned or, at the very least, be more easily switched off when consumers are not
receiving advice.[57]
7.71
Superpartners suggested that trailing commissions should be rebated
where unaccompanied by the provision of advice:
Pending regulatory change, [trailing] commissions so earned
should be rebated to the affected members. Rebates should be recommended in
ASIC guidance.[58]
7.72
IFF advocated forcing a shift through ensuring the complexity of
maintaining commission structures:
If the element of the mandated superannuation under advice was
prohibited from having commissions applied against that, one would think that
it would be a very complex model to charge in discretionary pieces for that
advice. That would hopefully accelerate a move towards a more transparent
fee-for-service across the whole gambit of money under advice. [59]
7.73
While acknowledging the limitations of commissions, MLC told the
committee that a voluntary shift to a fee-for-service model is preferable to
banning them altogether:
We would like the industry to voluntarily move towards a fee
model over time. We think it is more transparent, we think it is more in the
interests of advisers because they will attract more customers and we also
think it is better for the customers in terms of understanding how they are
paying for the advice they are getting. We do not advocate any bans or changes
to the regulations. We think the industry can move on this in a fairly short
period of time to avoid the need for that, as any responsible industry should.
It does take some time. The industry has been structured around commission for
many, many years and it is very difficult for people to go home over the
weekend and come back and change their business model.[60]
7.74
Contradicting these recommendations was the firmly held view among
sections of the financial planning industry that commissions enable those who would
not otherwise be able to afford financial advice to access it. The basis for
support of commission-based remuneration is that it is preferable for people to
have access to affordable yet conflicted advice, properly managed and
disclosed, than to no advice at all. For instance, IFSA argued that:
Commissions allow people to access advice and pay for it over
time via their savings. Commissions also tie the interest of the consumer and
the financial planner, and give an incentive for the planner to maximise a
consumer’s savings.
Removing commissions from the remuneration mix will be to the
detriment of middle to lower income consumers who cannot afford to pay the fee
for service. IFSA believes that commissions are an important means of paying
for advice, and any perceived conflicts of interest can be managed by
disclosure.[61]
7.75
Similarly, in its submission to the committee FPA wrote that:
...if there is advice or some other service provided in relation
to that money, it is legitimate for the provider of that service to be paid for
that service. Any mandated move toward up front fee-for-service might
disenfranchise lower income earners who simply cannot afford to pay for advice
through an up front lump sum.[62]
7.76
However, Industry Super Network rejected the argument that eliminating
commissions would exclude poorer clients from accessing advice. It raised the
following three points:
- Firstly, there is no obligation for ongoing advice or service to
be provided in order for the planner to earn the trail commission on an ongoing
basis.
- Secondly, we do not accept that most Australians require detailed
financial advice on superannuation. The average Australian has an account
balance of $25,800. While they may need education and perhaps some limited assistance
in relation to matters such as investment choice selection and maintaining
appropriate insurance, a full scale financial plan (let alone ongoing advice
for their entire working life) is unlikely to be justified. Claims made by the
financial planning industry that the absence of ongoing advice will lead Australians
to having insufficient superannuation to retire upon is self serving and not
backed up by the ‘net benefit’ evidence already included in this submission.
- Finally, the consumers who are unable to pay upfront commissions
would also be unlikely to be able to afford to have their retirement incomes
eroded by trail commissions. A fee for service model provides a fair and
transparent method of paying for advice which is less likely to erode a
consumer’s ultimate retirement benefits.[63]
7.77
IFSA rejected any interference from ASIC over the form of remuneration
used, provided disclosure requirements are met. They maintained that a
competitive financial services market would keep fees at reasonable levels:
ASIC should ensure that it does not limit the remuneration
methods available to both consumers and advisers. It is not for ASIC to
determine whether commission or fee-for-service arrangements are the most
appropriate form or remuneration. Indeed the current disclosure requirements in
the law and the significant investment by both Government and industry in
raising the standards and enhancing the regulation of financial advisers should
not be undermined by the regulator. Instead, in a highly competitive and
transparent market (driven by FSRA disclosure provisions on fees), competition
should be the effective regulator on remuneration structures and payment
levels.[64]
7.78
A number of contributors also drew on the significance of consumer
choice when determining the methods of paying for advice that should be
permitted. AXA commented that although FSR had raised the standard of advice,
its cost had also increased. Consequently, clients should be entitled to choose
how they pay for advice:
More needs to be done to increase access to financial planning
services, and at an earlier stage but undoubtedly one of the barriers to such
access is the cost. During the earlier stages in life, when people are
purchasing a house and starting a family, they have less disposable income and
more competing demands for the money that could be spent on financial advice.
Many individuals are reluctant to obtain financial advice because of the up
front cost of doing so, and yet decisions made during these earlier stages in
life can be critical to a family's future financial wellbeing.
AXA supports the individual's right to choose how they pay for
advice.[65]
7.79
The Association of Independent Retirees (AIR) expressed the view that
commissions allowed consumers to test the market for advice without incurring
great expense:
We take the view that the marketplace should essentially
determine those things. The reason for that is that quite a number of people
when they are about to retire or are retired want to get advice from a number
of people. They do not want to pay a fee to every one of those people to get
advice, so if they are going to pay an up-front fee they are almost locked into
one person. But if they adopt the commission model, they can go to a number of
people at no charge and they can then determine the best approach. So it is a
bit of horses for courses. In our view, from the considerable experience of our
members, it is better to leave that open because the providers of services will
meet the market need. Some will operate on commissions and some will operate on
fee for service.[66]
7.80
However, AIR did advocate a legislative prohibition on trailing
commissions:
They cause a lot of credibility problems and a lot of
disenchantment, and there is no real rationale for them. [67]
7.81
ABA indicated that consumers should be able to choose in an environment
in which fees were transparent:
Whether a consumer chooses to pay commissions or fee-for-service
should be at the discretion of the consumer, depending on what model suits
their needs and financial situation. Therefore, it would be useful for there to
be greater transparency around fee structures so that consumers can better
understand fees and commissions and identify triggers that they may need to
consider with respect to a particular investment.[68]
7.82
The committee earlier described the restrictions imposed on advisers by
approved product lists, including evidence on the effect shelf fees may have on
the likelihood of any given product making the list. One solution is to ban
such fees being paid. ASIC has suggested that the conflict of interest
generated by the practice should be avoided by platform providers not listing
products that pay a shelf fee.[69]
7.83
AFA told the committee that shelf fees should be permitted, but they
should be disclosed to clients:
Our view is simple. It is around transparency, openness and
disclosing to clients. In a sense it is a commercial piece of work and as long
as people know what is going on and clients are fully informed about it then we
are comfortable with that.[70]
7.84
AFA indicated that presently only the remuneration being paid to the
adviser needed to be disclosed, but this should be extended to fees paid by
fund managers to licensed product providers.[71]
Committee view
7.85
The committee recognises the problems associated with commission-based
remuneration. It generates conflicts of interest for advisers that in many
cases lead to inappropriate advice, as demonstrated by ASIC through its shadow
shopping survey. Furthermore, trailing commissions potentially lead to
significant sums being paid to advisers throughout the life of a financial
product without a commensurate return in the form of ongoing superannuation
advice.
7.86
The industry funds sector argued most strongly for the prohibition of
commissions for superannuation advice/product distribution, a position the
committee can understand well. Most industry funds do not pay commissions and
their products are generally not recommended by financial planners, for whom
commissions form at least a significant proportion of their income. However,
some industry funds do pay commissions, examples being Health Super and
Statewide Super.
7.87
However, the committee does not recommend the prohibition of commissions
on superannuation products. Many consumers cannot afford to pay for up front
fee-for-service advice on their superannuation, especially with the unresolved
problem of the current disclosure regime causing advice to cost more than its
inherent value. The committee also acknowledges that the remuneration
environment in which superannuation advice is provided is evolving. Super Choice
has not been in existence for long and refinements to the regulatory framework
have recently been implemented and more are proposed. According to ASIC, advice
is increasingly being paid for through fee-for-service transactions and less
through commission-based structures.[72]
7.88
Furthermore, banning commissions will not remove all potential conflicts
of interest in the industry. Superannuation funds, including industry funds,
have other remuneration practices such as bonuses and incentive plans for sales
people which may give rise to conflicts.
7.89
The committee is therefore of the opinion that it would be premature to
recommend the prohibition of commissions as recommended by industry funds. The
financial planning industry appears to be shifting towards a fee-for-service
model and superannuation funds themselves are moving to facilitate the use of
member accounts to pay for up front advice. These are welcome trends. Given the
weight of regulatory change in this area over the past two to three years it is
reasonable for financial planners to be allowed to move away from
commission-based remuneration models on a voluntary basis. Other strategies
such as improving disclosure and education, mentioned later in this chapter,
should also be given an opportunity to be implemented before prohibitive
measures are taken.
7.90
The committee has more concern regarding shelf fees. Shelf fees can be
anti-competitive and may encourage products to be listed and subsequently
recommended that may not be in the best interests of the client. Unlike
commission-based remuneration, shelf fees cannot be said to facilitate access
to advice by making it more immediately affordable to those without
discretionary funds to pay up-front fees.
7.91
On the other hand, it is argued that shelf fees result from the fact
that the product platform incurs costs in putting a fund manager on an approved
list. These include due diligence costs, information technology costs and
publishing costs. There is also the risk that having put a particular fund
manager on a platform, investors using the platform might not choose to invest
in that particular product, so the shelf fee is the only means whereby the
platform can recoup those costs.
7.92
There was no evidence before the committee that shelf fees have hindered
consumer choice or reduced competition.
7.93
It is noteworthy that none of the major product platforms had Westpoint,
Fincorp or ACR on their approved product lists. It therefore appears that the
due diligence procedures undertaken in establishing approved product lists is effective.
7.94
Nevertheless, the committee has concerns about shelf fees. As the
industry is progressively moving from commission-based to fee-based advice
fees, so it should move from shelf fees to a more competitive means of meeting
the cost of product listings. The ultimate ideal for the industry would be
movement towards fees for advice, payment for funds management and payment for
administrative services.
7.95
In the meantime, the Committee is of the view that the key issue is
transparency and disclosure.
Recommendation 21
7.96
The Committee recommends that ASIC work with the industry to provide to
investors more effective and detailed disclosure of shelf fees.
Better disclosure
7.97
The purpose of requiring commission-based conflicts of interest to be
disclosed is to allow the client to reach their own determination as to the
significance of the conflict and, in that light, the extent to which they will
rely on the advice. However, the committee received evidence that the
disclosure of conflicts of interest needs to be more effective to ensure
consumers are better able to measure its likely affect on the quality of advice
they receive.
7.98
FPA suggested that disclosure of fees and other critical information
could be made more prominent for consumers:
Clearly, we would like all of our advisers to be entirely
professional and provide appropriate advice in the interests of the client. But
if that is not going to be the case and we cannot completely control that, what
are the warning signals from a client’s point of view as well, and how do we
provide information that sets warning bells going in the client’s mind? We are
talking, for example, about a five-point summary on top of a statement of
advice, ‘These are the things you must know.’ Statements of advice can be 50 or
60 pages long. Does the client always understand that the commission is high?
Do they always understand their particular risk profile and so forth? We are
looking at putting some key risk, remuneration and service parameters on top of
the statement of advice so that we can set the alarm bells going.[73]
7.99
Superpartners did not support banning trailing commissions or imposing a
time frame beyond which they could not be paid. Instead, it also advocated
improved disclosure:
We have proposed a third solution, and that is a more targeted
disclosure of the commission to members so that the member is informed that
there is a commission payable for persistency rather than being misdescribed as
a commission paid for advice.[74]
7.100
Count Financial Ltd highlighted the problem of providing reasonable
advice on 'to' and 'from' funds that were differently structured and hard to
compare. They suggested:
To allow a fair and accurate comparison between a client's
current super fund and a possible recommended super fund, we ask the Committee
to consider recommending that a succinct client-specific comparison disclosure
document be required to be produced by all super funds, in a format that allows
for comparability.[75]
7.101
Another proposition put to witnesses was for different categories of
advisers to be enshrined in legislation. This
approach is founded on the view that effective disclosure is dependent on the
label attached to financial advisers adequately reflecting their relationship
with the products they subsequently recommend. For example, advisers
could be licensed either as franchisees, agents or independent advisers
utilising well-recognised labels to provide consumers with a more instinctive
sense of the motivations behind the advice they receive.[76]
7.102
Although advisers whose
advice is 'tied' to the products sold by their employer are not currently
permitted to describe themselves as 'independent', they do not have to qualify
their advertised 'financial adviser' status by using prescribed nomenclature
such as 'agent' or 'franchisee'.
7.103
Treasury, though, told the committee that the legislative codification
of this approach had not worked in the United Kingdom:
They basically polarised it into two extremes: you had the pure
product sales advice where you could only deal with your own product provider’s
product line, so you were really like a salesman, and then you had the people
who were completely independent and offered a whole range of things.
They found it extraordinarily difficult to make that work in the
UK and they have had to move back from it into a situation that is much
closer to the idea of authorising product lines that occurs here.[77]
7.104
However the committee notes the apparent inconsistency of this position
when held against the government's proposed legislative changes described
below.
7.105
ASIC stated that the law already restricts advisers from the labels they
may attach to themselves:
...the law already provides that a person may not call
themselves independent unless that is in fact true. So we do not need to create
a new category of independent adviser, because the law already does that. A
person is not entitled to call themselves an independent adviser unless that is
actually factually true in every respect.[78]
Recent initiatives
7.106
The committee notes two initiatives that reflect an attempt to improve
the efficacy of disclosure in this area. From a regulatory perspective, in
November 2006 the government released a proposals paper on corporate and
financial services regulatory reform. These proposals were to be incorporated into
the Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007
that was introduced into the parliament on 24 May 2007.[79]
7.107
One of the proposals was to enable financial product sales
recommendations to be made without triggering personal advice disclosure
requirements. Referring to the common scenario whereby agents of financial
product issuers, solely responsible for selling products, are required to meet
the SoA requirements triggered by the provision of personal advice, the
proposals paper stated:
In those situations, it may not be appropriate for that client
to be under the impression that they are being given (and possibly charged for)
advice. It may also not be appropriate for the agent to be purporting to
provide advice or to be regulated as a financial adviser.
The issues that arise in such transactions are whether the role
of the service provider and the nature of the service being provided is
transparent to, and understood by, the consumer, and whether such salespeople
should be presented and/or regulated as though they are providing advice.[80]
7.108
The paper outlined the proposed new category of financial service,
separate to financial product advice, as follows:
It is proposed to provide that, in certain situations, financial
product providers and their representatives would be able to recommend
financial products based on a client’s objectives, financial situation and
needs without that recommendation constituting financial advice (either
personal or general). Under the proposal, this would be defined as a financial
product sales recommendation (sales recommendation).
A sales recommendation may contain elements of personal and/or
general advice and would still be a form of financial service, but it would not
be captured by the personal and general advice definitions. Persons permitted
to provide sales recommendations would only be able to sell financial products for
issuers that they act on behalf of. They would not be able to also deal in financial
products where they do not act on behalf of the relevant issuer. The sales
recommendation definition would be subject to its own regulatory requirements.[81]
7.109
The disclosure requirements associated with this category of financial
service would be contained in a 'Sales Recommendation Warning' that could form
part of the Financial Services Guide (FSG). This would include information on
which entity they are acting for, as well as commission payments and related
conflicts of interest.[82]
In addition, individuals would not be authorised to provide both licensed
financial advice and sales recommendations, which Treasury described as
'ring-fenc[ing] a sales recommendation service to ensure that it is separate
from the financial advice stream'.[83]
7.110
Treasury told the committee that the government's intention was to better
enable clients to recognise instances where the advice they are receiving is
driven by a sales motivation:
...the government has come forth with the proposal in regard to
sales recommendations, which is aimed at making much more transparent and distinguishing
more clearly for consumers the relationship between a provider of a product and
those who are giving, let us say, more disinterested client focused advice.
...
...we want to make as transparent as possible for consumers the
relationship between the seller, or the person holding themselves out to give
advice, and the product provider. We feel that this is the real difficulty. For
example, if you are buying a car and you walk into a Holden dealer, you know
that there is a clear relationship there and you assume that there are
commissions being paid, even if you do not know the details. That relationship
is very transparent and consumers understand it quite intuitively. At the
moment, the way the personal advice model is set up, in many cases it appears
to the consumer that they have an adviser who has only their interests at
heart. We are saying that we think it is desirable to have a much clearer
delineation between those two situations...[84]
7.111
However, the applicability of this proposal to the provision of
superannuation advice/product sales was unclear. Despite Treasury's statements
to the committee, the proposals paper indicated that the sales recommendation
framework would not apply to a superannuation product or retirement savings
account.[85]
When the bill was introduced into the parliament the proposal had not been
included.
7.112
Turning to the realm of industry self-regulation, in January 2005 FPA
released a paper providing information to its members on managing conflicts of
interest in the financial planning sector. FPA told the committee that its
conflict of interest principles are based on disclosing to clients the way
commissions operate:
...our conflict of interest principles require that the
commission be split between advice and product so that you can see which
component goes to advice and which bit goes to product, and our conflict of
interest principles also require that the remuneration does not bias the advice
that is given, and that in fact the advice and necessarily the implementation
of advice is in the interests of the client. I think that is a legislative
requirement, anyway. It is not that we have come up with some revolution here.
We are just demanding of our members that these things are put on the table and
the clients absolutely understand what it is they are paying for. [86]
Potential effect of disclosure
7.113
Despite these initiatives from government and the industry, many
contributors to the inquiry strongly maintained that disclosure of
commission-based conflicts of interest does not offer sufficient consumer
protection from poor advice, particularly given poor financial literacy across
the community. Choice was one such organisation to argue this position:
...the research that we have seen on declaring commissions shows
that it has the perverse effect. How does a consumer discount, for example, a
four per cent commission and a three per cent commission? How do they discount
the value of the advice on the basis of that commission? It is very difficult
for them to do that. When the commission is disclosed, the behavioural finance
research is that they trust the adviser more because they feel that they have
been told a secret. The other side of it is that the adviser then thinks that
their advice is objective because they have disclosed the commission to the
consumer, so it can have a perverse effect.[87]
7.114
Industry Super Network also highlighted widespread financial illiteracy
when commenting on the inadequacy of disclosure in this context:
...in no other professional relationship is such a conflict permitted
to exist. The planning industry generally holds up disclosure as an answer to
the problem of commissions; however, we think it is a grossly inadequate
solution. We do not believe that the average consumer fully appreciates the
compounding effect of higher fees and commissions, which significantly erodes
retirement savings over a working life.
What should be done? We submit that a legal requirement for
financial advisers to act in their clients’ best interests is required.[88]
7.115
Superpartners raised concerns over 'certain industry practices where
disclosure of commissions may not be adequate'. These were nominated as:
- commission paid for procurement of members;
- trail commission misdescribed as ongoing service commission; and
- commission paid by an interposed entity.[89]
7.116
Fiducian Portfolio Services, however, criticised the focus on disclosing
the cost of fees, rather than ensuring clients received the value of advice:
Even superannuation Product Disclosure Statements are prescribed
to display a "Warning" that a lower fee can result in a higher
saving. We believe that it is derogatory to have to present fees with a
"Warning" sign akin to a cigarette packet that has connotations of
death. As a consequence, investors could probably divert their funds to a
product that could be 0.1% or 0.2% cheaper, but not realised that they could
have earned 3% to 5% more on their assets through careful financial planning,
risk profiling and product Election, They might have saved $10,000 to $15,000
on their fees over a lifetime, but ended up hundreds of thousands of dollars
worse off.[90]
7.117
IFSA maintained that disclosure is sufficient and expressed concern that
ASIC was targeting businesses that integrated financial product supply and
sales:
The Discussion Paper released by ASIC in April 2006 entitled
MANAGING CONFLICTS OF INTEREST IN THE FINANCIAL SERVICES SECTOR gave rise to a
significant level of concern amongst industry participants.
...
The ASIC Discussion Paper appeared to express a bias
particularly against conglomerate arrangements and institutional ownership of
advisor groups. The fact is that many customers prefer to obtain advice from an
adviser who is backed by the financial strength and security of a large
financial institution and to invest through a product from the parent
institution as long as it is clearly disclosed and they receive choice and
appropriate advice regarding their underlying investment and insurance options.[91]
Mandating a higher standard of
advice
7.118
The regulatory standard stipulating the quality of financial advice is
that it meets the threshold of appropriateness for the client. IFF told the
committee that it should be higher:
We ... believe that financial planners should have a legislative
obligation to act in the best interests of their clients. Many planners do that
now, but we cannot think of a good reason why there should not be mandatory
obligation on all planners to do so.[92]
7.119
However, in the context of approved product lists IFSA stated:
The regulator has raised the question as to whether the [approved
products and services list] APSL may prevent a planner meeting the reasonable
basis of advice obligations, particularly when switching advice is given. IFSA
believes that the law requires a planner to ensure that any product
recommendation that is made must be appropriate for the client. The planner is
not required to recommend the best product in the market.
Therefore, as long as the products on the planner’s APSL
contains products that are appropriate to meet their client’s needs (regardless
whether they are in-house products), then a restricted APSL should not prevent
a planner meeting their reasonable basis obligations. The law requires planners
to recommend appropriate, not best products.[93]
Facilitating affordable
fee-for-service advice
7.120
With poor quality advice on superannuation being widely attributed to
the conflicts of interest inherent with commission-based remuneration, many
contributors to the inquiry focused on the importance of facilitating the
provision of fee-for-service advice. There was uncertainty though over the
extent to which the sole purpose test under section 62 of the SIS Act
constrained the use of superannuation accounts to pay for up-front financial
advice.
7.121
RCSA and PASL advocated a clarification of the sole purpose test to
facilitate remunerating financial advisers from a member's account:
At present it appears that the Sole Purpose Test may present a
barrier to using money from accounts to pay for advice. We believe this
situation should be clarified and argue that this method of payment is preferable
to the alternative situation where a fund provides free financial advice to
members.[94]
7.122
A number of organisations argued that the scope of the sole purpose test
is too narrow in this context, restricting members from using their accounts to
pay for advice not specifically related to superannuation that will nonetheless
maximise their overall retirement income. For example, IFF noted the
limitations on the provision of beneficial financial advice imposed by the sole
purpose test:
Currently there is very limited scope for use of retirement
savings to fund financial advice. This is due to the constraints imposed by
the sole purpose test under Section 62 of SIS. This limits use of
superannuation funds to advice concerning the superannuation product a member
has invested in and superannuation advice generally. This prevents members
using retirement savings to fund financial advice on their overall financial
position, which requires consideration of what other assets they have at their
disposal.[95]
7.123
Equipsuper told the committee:
If a member approaches a financial planner seeking advice on
retirement planning, the planner is required to consider both the member’s
superannuation and non-superannuation assets. However, superannuation funds are
currently permitted to deduct from the member’s account only the cost of that
part of the advice which relates to superannuation affairs, which clearly
complicates the whole process.[96]
7.124
MLC suggested that:
It will divert money out of the superannuation account in the
short term, but it is recognising that somebody’s holistic affairs revolve
around more than just superannuation. A significant impact to their retirement
outcome could be had by dealing with advice around cash flow issues or advice
around how they structure their debt—with regard to the amalgamation of debt,
with regard to gearing, and with regard to investing in moneys outside
superannuation. So we suggest that thinking about protection of superannuation
to the extent of ‘We will not take fees out of that to help us to pay for
advice on the whole lot’ might slightly impact on their superannuation outcome
but the advice, when taken in its totality, might have a huge impact on them.[97]
7.125
Sunsuper recommended allowing for the provision of broader financial
advice funded by superannuation savings, with appropriate limits. It submitted:
The main barrier to seeking advice for many of these people is
access to appropriate and affordable advice.
...
Allowing members to access a small amount of their
superannuation savings to fund appropriate retirement advice can overcome this
barrier to some extent. However, the sole purpose test under Section 62 of SIS
limits the use of superannuation funds to advice concerning the superannuation
product a member has invested in and superannuation advice generally. This
prevents members funding advice on their overall financial position from their
superannuation account.
We support access to superannuation savings to fund financial
advice relating to retirement, however we acknowledge there must be appropriate
protections on this to ensure it is not subject to abuse. The types of
protection would include:
- An annual cap on the amount withdrawn from the account in the
order of a few hundred dollars
- Adviser remuneration on a true ‘fee for service’ basis only
- Advice provided only by advisers approved by the trustee.
We also support improved clarity on the sole purpose test under
Section 62 of SIS regarding the use of superannuation savings to fund financial
advice.[98]
7.126
Members Equity Bank offered a broad interpretation of the sole purpose
test:
...we would take the view that traumatic events that interrupt
their employment, their earning capability and their ability to contribute to
super are matters that bear more directly than indirectly upon the members’ end
benefits.[99]
7.127
AIST also stated that a broader interpretation of the sole purpose test
would be of net benefit to consumers:
...there is quite a strong correlation between employment,
superannuation and the benefits of having salary continuance insurance or death
and disability insurance. If you cannot work, you then do not get super. That
is where the insurance and those sorts of benefits kick in. ... On the
proposition that insurance should be excluded from coming out of the
superannuation accounts because it reduces the retirement income, we would
firmly put the view that the benefits of things like insurance and salary
continuance to ordinary Australians, and every Australian that has
superannuation, far outweigh the reduction of that retirement benefit.[100]
7.128
IFF offered cautious support for a loosening of the restrictions imposed
by the sole purpose test in this area:
This practice needs to be properly controlled and addressed in
the legislation to ensure that use of superannuation savings for this purpose
is not subject to abuse. This would include:
- a blanket prohibition on commission being earned from advice
funded in this way;
- a requirement that the advice be in the best interests of the
member ; and
- the type of financial advice that can be given on this basis
(i.e. confined to advice on superannuation issues).
7.129
It added:
The industry needs greater clarity about what superannuation
funds are able to do in this area, so there is a consistent approach and so
members are aware they can fund access to financial advice in this way.[101]
Altering the effect of trailing
commissions
7.130
Other proposals attempted to address the problem of ongoing trailing
commissions not matched by the provision of advice, a problem identified
earlier in the chapter. Suggestions focused primarily on enabling consumers to
trigger commission payments when they actually receive advice, rather than
expecting them to take positive measures to 'turn off' the commission upon
realising they are not receiving the benefit of advice.
7.131
SuperRatings suggested that payments for advice should be based on the
principle that clients should be able to opt in to the charge, rather than opt
out when they realise they are not getting the advice they are paying for. It
said: 'the cost of that advice component or services component needs to be
stripped out of those fees and then the member applies for advice'.[102]
7.132
IFF cautiously expressed its preference for dial up fees:
It is certainly a better model to dial up than to dial down.
There would need to be a lot of consideration given to the actual operation of
that model. Whilst it is theoretically a better model, if it operates de facto
as a dial-down situation in the privacy of an adviser-client discussion, then
of course that does not progress it very far at all. The notion of the product
having a cost or a fee attached to it and then, quite separately, a cost or fee
attached to the provision of advice is a good model.[103]
7.133
Choice also suggested that dial up is preferable, but not ideal:
In an ideal world we would not need to have the remuneration
structure attached to product recommendation. But if we were going to talk
about a commission, then probably dial up gives the consumer more market power.
That having been said, you might only need a relatively small amount of advice
and the adviser, to be able to expand their dial-up commission, starts to throw
in all the bells and whistles he possibly can to expand the size of that
commission.[104]
Committee view
7.134
The disclosure of conflicts of interest caused by commission-based
remuneration arrangements is critical. However disclosure must be effective and
meaningful, rather than a perfunctory process simply undertaken to comply with
legislative requirements. The regulatory framework for disclosure should ensure
that consumers comprehend the nature of the material being disclosed. Ideally,
clients should be able to interpret the advice they have received in the
context of the remunerative motivations of their adviser. In other words, he or
she should be in an informed position to answer the question: is this advice
conflicted to the extent that an alternative source of advice should be sought?
7.135
As with product disclosure statements, statements of advice should
display critical 'warning bell' information prominently. The committee supports
FPA's voluntary endeavours to improve industry practice in this regard and
urges it to use its authority to ensure that practical improvements are
achieved. This is preferable to using the blunt instrument of mandating
standard SoAs by regulatory means. The committee also notes that education is
relevant to improving the effectiveness of disclosure, an issue discussed later
in this section.
7.136
The proposal to raise the threshold of the standard of financial product
advice from 'appropriate' to 'best' is not supported by the committee. Although
it is preferable that clients are given the best advice possible, the reality
of providing financial advice within the constraints imposed by approved
product lists render this an unobtainable objective. Advisers on superannuation
products cannot offer that which does not appear on the list authorised by
their licensee, which in the opinion of the committee is a reasonable risk
management tool to use.
7.137
Therefore the committee is of the view that instead of changing the
legislative threshold for the standard of advice, the less conflicted
fee-for-service remuneration model should be encouraged and consumers should be
better equipped to interpret the advice they receive. The committee deals with
the latter approach in its comments on disclosure above and education and
financial literacy below.
7.138
The committee was told that although some superannuation funds are
increasingly implementing the framework to allow payments for up front advice
from member accounts, uncertainty as to the legal constraints on such measures
was also prevalent. The sole purpose test seems straightforward in this
context, clearly stipulating that superannuation account funds may only be used
to pay for advice on superannuation. However the breadth of what constitutes
advice on superannuation is contestable. For instance, does advice not directly
related to superannuation assets but to maximising retirement income more
broadly accord with the sole purpose test? Undoubtedly, professional advice on
managing non-superannuation assets can affect the amount of money a person is
able to contribute to superannuation.
7.139
Given the level of uncertainty over the scope of the sole purpose test
in this context, the committee is of the opinion that detailed guidance for the
industry on this matter would be beneficial.
7.140
The committee would further support an interpretation that is less
restrictive than it appears to be at present. Caution should be exercised in
this regard, though. Superannuation funds should not be permitted to be used to
pay for all types of financial advice, which would leave the system open to
abuse. The purpose of superannuation is to provide an income stream for
retirees and the advice that it pays for should be directed to that purpose.
Accordingly, the committee is of the view that limitations would need to be
applied to any loosening of the constraints currently imposed by the sole
purpose test. Limitations that ought to be considered would include applying a
cap on the amount that could be withdrawn to pay for advice, prohibiting
advisers from earning commissions on advice paid for through this mechanism and
ensuring a connection between the advice and long term financial objectives.
7.141
The committee is therefore of the opinion that, in consultation with the
superannuation industry, the government should refine the application of the
sole purpose test to allow the payment of up front financial advice from
superannuation accounts.
Recommendation 22
7.142
The committee recommends that the government consult with the
superannuation industry with a view to reducing, with appropriate limitations,
the constraints imposed by the sole purpose test on the payment of up front fees
for financial advice from superannuation accounts.
7.143
The committee also notes the suggestion to nullify the effects of
trailing commissions by implementing a system whereby clients needed to opt in
to paying commissions for superannuation product advice as opposed to having to
opt out. This puts the onus on advisers to request that the commission be
dialled up, rather than expecting consumers to take positive action to have the
commission turned off, or 'dialled down', when the fee is not complemented by
the provision of advice. The effect would be to better alert consumers to the
nature of the charge and encourage them to consider its merit.
7.144
Unfortunately, it is difficult to contemplate how such an arrangement
could be mandated without being manipulated by advisers to enable them to
receive the same level of commission anyway. As Choice told the committee,
clients could be easily convinced that they require 'bells and whistles' to
justify paying commission for services they do not particularly need. While the
practice ought to be encouraged on the basis that it could assist in separating
the superannuation product sales and advice components of commission payments,
the committee believes that the objective for the government and the industry
should be to phase out the practice entirely.
7.145
Finally, the committee is concerned about insufficient transparency with
regard to the relationship between advisers, their licensees and superannuation
product providers. It is apparent clients may not be aware of the integration
of superannuation product supply and sales advice and the incentives that stem
from such an arrangement. The
committee is of the opinion that disclosure will not be effective unless the
nomenclature attached to financial advisers accurately conveys to consumers the
adviser's relationship with, and interest in, the superannuation products they
recommend. Accordingly, the government should investigate the most effective
way to prescribe appropriate nomenclature where the product recommendation
advice available to consumers is limited by sales imperatives.
Recommendation 23
7.146
The committee recommends
that the government investigate the most effective way to develop with the industry
appropriate nomenclature where the product recommendation advice available to
consumers is limited by sales imperatives.
7.147
The committee is also of the view that financial advisers should be
required to disclose to their clients the ownership structure of the licensee
under which he or she is operating.
Recommendation 24
7.148
The committee recommends that ASIC should release a policy statement
mandating that financial advisers disclose the ownership structure of their
licensee when making a superannuation product recommendation.
Education and financial literacy
7.149
A major theme throughout the inquiry was the importance of arming
consumers with the skills to interpret the quality and independence of the
advice they receive. For instance, Superpartners summed up the vulnerability of
consumers when it stated: 'A lot of members do not have the level of financial
literacy required to even accept advice'.[105]
Members' Equity Bank argued that low levels of financial literacy, combined
with a choice of fund regime, had created a 'high risk environment' for
consumers.[106]
7.150
AFA espoused education as the long term solution to consumers making
informed decisions about advice on superannuation:
Disclosure is key and critical, but the longer term solution is
education. You have seen pretty much all of the mainstream press—television
shows, websites and so on—driving education to consumers. The literacy
foundation is another key part. If we start education about finances when our
kids are in school, we will be better positioned to make informed decisions as
we get to our 20s and so on. Obviously, because superannuation for all has only
come in in the last 15 to 20 years, we have to grow people through that
process. They now face key and important decisions about big amounts of money.
There are practice based things and then there are broader industry things that
can happen.[107]
7.151
As described in the previous chapter, superannuation funds have
complained that FSR has prevented them from providing educational material to
members. Some funds argued that the FSR restrictions on targeted educational
material had fostered a conservative approach to educating members about their
options, denying them an important source of information.[108]
Criticism was also levelled at the regulation of providing mechanisms to
calculate projected benefits, which assist members in determining appropriate
contribution levels to meet future retirement income needs.[109]
7.152
However notwithstanding the impediments created by FSR, ASFA explained
that education at the fund level is still difficult in the face of widespread
apathy:
Large funds use a variety of communication methods. There are
mass mail-outs. They are big customers of Australia Post. Much of that
information gets binned. It is just the nature of it. It is a turn-off for some
people.[110]
7.153
The financial advice industry also highlighted their educative role,
telling the committee that access to professional advice is an important
element in assisting consumers to become financially literate. For example, FPA
told the committee:
...the role of the financial planner is very much to provide an
ongoing education process. You cannot teach somebody everything all at once,
but as part of an ongoing relationship they develop more and more understanding
of risk and return.[111]
7.154
AFA told the committee their role is to educate 'vulnerable' clients:
I tend to think that most of my clients when they come to see me
are financially illiterate. Therefore, it is our role to educate them about
what is available, what we expect of them in managing their financial affairs,
what their goals and objectives are and what their risk profile is. That is
part of our education process; that is what we get paid to do: to help them. I
agree with you that they are in a very vulnerable situation.[112]
7.155
IFSA stated that advisers were needed to complement the government's
literacy initiatives:
There needs to be a recognition that the industry in advice in Australia
is fundamentally sound and that sustained criticism of the advice industry runs
counter to recent government attempts to improve financial literacy and
financial understanding.[113]
7.156
Previous discussions in this report related to the advisers' view that
they are an important element in improving financial literacy. In Chapter 6 the
committee explored the difficulty of accessing affordable professional
financial advice due to onerous disclosure requirements. The remuneration
debate outlined above is also relevant, with some contributors arguing that
commission-based fees improve the likelihood of consumers affording educative
guidance on superannuation from their financial adviser.
7.157
There are two distinct elements to this debate. One, as correctly
identified by advisers and funds in the context of their own educative role,
relates to understanding the choices available within the system. The other
relates to understanding how the system works, allowing consumers to make
informed decisions about the quality of the information they are exposed to.
While advisers can provide useful guidance on superannuation, the proposition
that advisers can bestow consumers with the understanding to better interpret
financial advice is problematic. Such a role is best left to government-led
initiatives.
7.158
In this respect, the federal government has introduced measures aimed at
improving financial literacy standards. On 6 June 2006, the government launched the Financial Literacy Foundation, which includes the following
initiatives:
- a media campaign and website titled 'Understanding Money',
designed to raise awareness of, and provide information on, financial literacy;
- working with state and territory governments to include financial
literacy in the curriculum for Years 3, 5, 7 and 9 from 2008;
- working with employers to improve access to financial literacy
information;
- undertaking research to establish a benchmark for national
financial literacy and ascertaining the most effective way to deliver
information to consumers;
- establishing a web-based catalogue of financial literacy
resources.[114]
7.159
With a more specific focus on consumer protection in the financial
services market, ASIC has also developed an education-based website, titled
FIDO. It provides a broad range of information on the superannuation system,
superannuation products and seeking financial advice.[115]
7.160
However SuperRatings told the committee that even more funding for
education is needed:
There is still a significant level of apathy among Australians
with regard to superannuation. Given that it is there to fund Australians’
retirement income in the future, the education level needs to be stepped up.
Following on from that, the financial literacy board that the government has
put in place appears to be underfunded and more should be done with regard to
that.[116]
7.161
It also emphasised the importance of improving broad financial literacy
before attempting to resolve some of the more technical issues related to
choosing appropriate investment or insurance strategies:
I think those things are thrown up too often before we have even
sorted the macro position, which is that Australians do not care about super.[117]
7.162
Superpartners suggested that standard, simple terminology was an
important aspect of the education process:
...there are plenty of opportunities for us to standardise the
way things operate around superannuation funds, thereby acclimatising members
to one terminology and the processes that are used to access or get out of a
fund. That takes a layer of cost out of it and simplifies the process. It is a
bit like a tax return. If we all had different tax return forms, given our
circumstances, it would make it a very complex environment. I think there is
plenty of opportunity for us to standardise and simplify elements of our
superannuation system.[118]
7.163
In addition to the provision of educational information on
superannuation, ASFA suggested that facilitating an alternative disciplinary
framework for fund members to make decisions in was also important. It
advocated a form of 'soft compulsion' utilising a triggering event such as
changing employers to automatically increase an employee's post-tax
contribution, but allowing that person to opt out should they so desire. ASFA
said:
Education is a very important element. The research has been
done overseas and, when we look at international examples, education is just
one plank. In fact the idea of having a structure and discipline which people
work within is also very important. So one of the very important things is
changing people’s awareness that nine per cent is not quite enough. At the
moment people think nine per cent SG: that is what the government thinks,
therefore that must be enough. We need to change the norm more from nine per
cent to 12 per cent. The idea of the soft compulsion or having a structure
which is not compulsory or obligatory does two things. It says that the norm
should really be 12 per cent and it also provides a structure which provides an
easy discipline for people to work within.[119]
Committee view
7.164
The shift from passive superannuation investments in which employers
bore investment risk, to today's competitive market in superannuation products
where investment risk has transferred to employees, has left consumers more
vulnerable to the vagaries of the marketplace than they previously were. This
transfer of risk has left superannuation fund members with the responsibility
for taking a number of decisions that were previously not required of them. As
such, measures need to be taken to enable consumers to adapt to their acquired
responsibility.
7.165
The committee firstly recognises that the provision of information from
the superannuation industry to its clients has an important educative role.
Government initiatives can stimulate people's interest on the subject and
provide generic material on the system and interpretive information and advice,
but the funds and advisers usually have a more direct input into educating
consumers on their own superannuation arrangements. Thus it is important that
the government clarify what information provided by superannuation funds
represents personal financial advice under the Corporations Act.
7.166
Many of the problems with the provision of superannuation advice
identified in this report are a consequence of consumers not having the
knowledge to interpret the information they receive and the motivations of
those that have provided it. Consequently, education is critical to improving
the effectiveness of disclosure. If consumers were more financially literate then
conflicted advice thus disclosed could be more meaningfully interpreted and
superannuation products paying ongoing trailing commissions could be eschewed.
Clients would be more cognisant of the relationship between their adviser and
the products they recommend and they would be in a much more secure position
from which to exercise their choice of fund options.
7.167
The committee recognises the difficulty of the task. Measurably
improving overall financial literacy is not an undertaking that will yield
results in the short term. Many Australians with money in superannuation do not
take an active interest in superannuation issues, making education campaigns
problematic in terms of their effectiveness. The committee believes this
challenge can effectively be addressed by improving the accessibility of advice
for those already in the system, from funds and licensed financial advisers, as
well as ensuring that future superannuation fund members are provided with
appropriate guidance during their school years.
7.168
The committee notes with approval the government's Better Super
television and radio advertisements designed to inform and educate people about
the reforms to superannuation which came into effect on 1 July 2007.[120]
7.169
The committee also supports the government's Financial Literacy
Foundation initiatives. However it is important that the initiatives be
actively monitored to ensure that resources are spent wisely. In addition,
programs that are designed to bring progress in this area should be provided
with additional funding if so needed. Consumers are in an increasingly
vulnerable position with respect to their superannuation investment and
consequently deserve to be provided with the tools to manage the risks they now
shoulder.
Recommendation 25
7.170
The committee recommends that the government conduct a review of its
Financial Literacy Foundation initiatives when their effectiveness is able to
be measured against clear performance benchmarks.
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