Alert – Lifting the lid on FOFA

29 April 2011

On the first anniversary, almost to the day, of the release of the Future of Financial Advice reforms (FOFA), the Australian Government has announced the outcome of consultations on its proposals.

Key elements of the long-awaited Future of Financial Advice 2011 Information Pack, released by Mr Bill Shorten MP, Assistant Treasurer and Minister for Financial Services and Superannuation, on 28 April 2011 (2011 Paper) include:

  • client opt-in to advice fee arrangements every two years with annual disclosure statements

  • broad-based ban on volume-based payments and sales targets

  • soft dollar benefits of more than $300 will be banned

  • extension of the ban on commissions to life risk through superannuation

  • ban on commission, volume-based payments and soft dollar benefits applies to both personal and general retail advice

  • no bans for other risk insurance and basic bank products

  • amending reasonable basis for advice requirement to facilitate scaled advice

  • possible ban on asset based fees where any part of a client’s portfolio is geared

  • possible restrictions on use of 'financial planner/adviser'

  • application of a best interests duty to personal advice but no specific wording proposed

  • no proposal to provide a tax deduction for personal advice – the Minister has said recently this is 'not on the table'.

The start date for these changes remains 1 July 2012, with the exception of the ban on superannuation life risk commission which will commence on 1 July 2013.

The 2011 Paper has clarified some concerns and issues, however for industry the pressing concern is that many more have been introduced or remained unresolved.

It will remain difficult to assess the full impact of the proposals until draft legislation is released, due to occur 'after the middle of the year'. In the meantime, consultation on specific details will continue.

We discuss each of the above elements in the 2011 Paper and identify likely concerns and issues that will require further attention during the consultation phase.

Two year opt-in

The Government has extended the opt-in period from 12 months to, in effect, 25 months. Advisers charging ongoing advice fees will be required to send a prescribed notice to clients 30 days before the two year anniversary date and may continue to charge fees until 30 days after that anniversary (unless the client opts-out earlier). However, advisers will have to send a disclosure notice regarding ongoing advice fees every other year. The 2011 Paper does not refer to payment plan arrangements (eg arrangements to effectively spread the initial cost of advice over the expected retainer period) and it is unclear how they would be affected by these proposals.

Failure to respond to an opt-in notice will be taken to be opting-out from receiving further advice and the Government has stated that the adviser's liability for providing ongoing advice will cease from that time.

There is no suggestion that the opt-in requirements will apply to purely discretionary management services provided to retail clients where there is no ongoing advice obligation. The Government is also considering whether a penalty should apply to a breach of the opt-in obligation.

The annual disclosure obligation will naturally cause advisers to emphasise the services they have provided in exchange for the fee charged. There is a possibility that the scope of services described in the annual disclosure document could inform or influence the extent of the adviser's best interests duty, so advisers should be wary of this.

The Government has not yet addressed the issue of when legacy clients (ie existing clients who will not automatically be subject to opt-in from 1 July 2012) cease to be legacy clients. Urgent clarification is needed on the transitional arrangements for clients with trailing commission that continues to be payable after 1 July 2012. Presumably, clients who are receiving an ongoing service for which they are paying a fee (including through platform dial-up arrangements) will be treated as opt-in clients (whether automatically or upon initial contact post 1 July 2012). Again, however, this needs to be confirmed.

Banning soft dollar benefits

In the original FOFA paper, the Government indicated that it would be reviewing how to ban soft dollar benefits and it has now announced that it will ban any benefit received by a 'financial planning firm' and its representatives and associates other than direct client advice fees valued at over $300 per benefit. Identical and similar benefits paid other than infrequently or irregularly will be bundled for the purpose of this threshold. The ban will not apply to professional development or administrative IT benefits.

Again, this does not apply to risk products outside superannuation. Apart from this aspect, the ban clearly follows the approach followed by the FSC and FPA in their Alternative Remuneration Code of Practice, with the important distinction that the soft dollar register becomes redundant as the ban is not restricted to material benefits but applies to all regulated soft dollar benefits.

Banning volume payments

Many in the industry will be dismayed to know that this ban will be applied in its entirety without any recognition that not all volume payments are bad where they simply reflect an appropriate fee reduction for scale.

The ban will apply to any form of payment relating to volume or sales targets from any financial services business (issuer, platform operator or licensee) to a licensee, authorised representative or adviser in relation to distribution or advice or conditional on amount of funds under management (apart from asset based fees a client agrees to pay for advice). Volume based shelf space fees paid from a fund manager to the platform and from the platform to a licensee are also to be banned. What is not clear is whether shelf space payments from a fund manager to a platform will be banned if they are not paid on to a dealer group/advisers.

The ban on volume payments is likely to result in further consolidation in the advice space, as the continuing operation of some smaller, independent dealers with a heavy concentration of platform business is likely to become unviable without the ongoing support of volume payments. Alternatively, smaller licensees may seek to diversify their earnings by branching out into product manufacturing. It remains to be seen whether this will be positive or negative, because the benefit of increased product choice and competition may be offset by the proliferation of marginal operators without the resources to manage product appropriately.

The Government will consult on anti-avoidance provisions to address arrangements such as equity schemes and special purpose vehicles to get around the volume payment ban. It is highly unlikely that any equity scheme which relies on the ongoing capture of volume rebates and similar payments will be grandfathered. The broad-based principles approach and inclusion of anti-avoidance provisions will presumably also preclude setting the following year's rebate by reference to prior year’s funds under advice.

Cryptically, when discussing the advantages of the volume bonus ban, the paper states that platform operators should be focusing on the consumer as the client and not on the adviser. While unlikely, this perhaps signals an intention to consider the duties owed by non-superannuation platform operators to clients.

Interestingly, participating rebates paid by insurers (presumably to avoid exacerbating the underinsurance problem) and on basic banking products will not be caught by the ban.

Banning life risk superannuation commission

While the Minister's media release states that 'a decision [has been made] to ban all trailing and upfront commissions and like payments from 1 July 2013', the 2011 Paper makes it clear that this date only applies to life risk products taken out through superannuation. The ban will apply to all life risk through superannuation – group risk as well as individual policies.

It is unclear whether any fee for advice charged by an adviser recommending insurance via superannuation can be deducted from the superannuation fund. This would extend the availability of "preferential tax arrangements" for insurance through superannuation referred to in the 2011 Paper. If not, one consequence may be a reduction in the level of insurance taken out through superannuation (although, as the Government notes, advisers will be subject to the best interests duty when making such recommendations).

Even if the ban is appropriate for group risk, it is not clear why it should apply to stand alone individual policies made available through a superannuation fund as this type of arrangement does not typically provide any other benefits to the customer. Advisers and clients will be in the anomalous position of the adviser being able to receive commission if the client chooses to buy a policy outside superannuation, but the adviser will need to charge a fee (to be compensated for its services) if the client chooses to buy the same policy through superannuation.

The Government also indicates that it will be monitoring the effect of the ban on commissions within superannuation and the extent of churn outside superannuation.

General advice

The original FOFA paper did not specifically indicate whether the ban on conflicted remuneration arrangements extended to general advice. However, this has now been clarified in the 2011 Paper which expressly states that the ban on commissions, volume based payments and soft dollar benefits will also apply to general advice.

This will pose a significant challenge for any low advice distribution models. It seems however that there is no intention to extend the ban to dealing only models.

The opt-in and best interests duty will not apply to general advice.

Scaled advice

The Government proposes to facilitate a new category of advice - 'scaled advice' – which will be able to be provided by a range of businesses. It will not be restricted to superannuation trustees like the current intra-fund exemption, which will be reviewed to determine if it remains necessary or should be extended in light of this proposal.

ASIC will issue a consultation paper to provide guidance about how simple, single issue advice can be provided. The reasonable basis requirement in s 945A will also be amended to make it clear that it is scaleable to the client’s needs.

Unfortunately, it appears that the Government is not prepared to take the issue of limited advice by the horns. Amending the reasonable basis requirement may assist. However, it is arguable that scaleability is already embedded in it with references to circumstances ‘reasonably considered to be relevant’, ‘reasonable inquiries’ and reasonable consideration and investigation. More decisive action is required.

Consideration should be given to defining a new category with different obligations than those applying to full personal advice, with the possible exception of the new best interests duty.

Statutory best interests duty

The Government has not provided any formulation for the statutory duty to be imposed on retail advisers. The 2011 Paper only states that it will be consistent with 'best interests' duties contained elsewhere in the Corporations Act.

This suggests the duty will include a requirement to act in the 'best interests' of clients, despite the uncertainty such a duty would give rise to in an adviser context.

The duty will depend on the circumstances of each case and will be scaleable. This may address the question as to how a bank planner can be subject to the same duty as a non-aligned adviser.

The Minister will consider a proposal that the role of financial planner receive explicit statutory recognition. As the duties and other requirements which will be imposed on advisers are quite specific, this appears a distinct possibility. However, given the breadth of the would-be profession, definitional difficulties will obviously arise.

The best interests duty will not require an adviser to broke the market. However, it will require an adviser to decline to provide advice if the adviser does not believe that he or she can do so in a client's best interests. At what point would such a realisation dawn on the adviser? Presumably not at the strategic, product neutral stage of the advice process. However, if an adviser's operating model combines strategic planning with advice implementation, and the range of products available to the adviser are not representative, then this may impact the adviser's ability to act from the outset.

Interestingly, the 2011 Paper says that financial liability for breach of duty rests with the 'providing entity'. Where the providing entity is a corporate authorised representative, does this preclude action for breach of duty against the licensee? If so, this appears to be a departure from the original proposal that licensees should also be liable for breach of the new duty by their authorised representatives. It is clear that statutory liability will not be borne by individual advisers, but they may be subject to administrative penalties such as banning and will remain subject to action at common law (eg negligence and breach of contract).

The Government is considering a range of issues when finalising its approach to the duty, including the relevance of the scope of the advice, how an adviser will know the client’s interests, whether licensees should be subject to a separate duty, and whether advisers should consider a range of products before making a recommendation. The focus of the duty is intended to be the process by which advice is given rather than the outcome, ie the advice given.

Other issues

Accountants exemption

The Government is engaging in continuing dialogue on the replacement for the exemption permitting accountants to give advice in connection with the establishment of self-managed superannuation funds. The idea is to ensure a level playing field while assisting accountants to obtain a licence to improve access to advice. This may involve facilitating accountants providing non-product specific advice.

Retail client definition

The Government is considering submissions on the options raised in its paper:

  • Increase product threshold to $1 million (a 100% increase above current dollar levels applying since 1990)?

  • in the future, index wealth and product value thresholds?

  • Exclude the home or superannuation from the wealth test?

  • Require a client's agreement to be treated as wholesale?

  • Require a composite test where two of the three product, income and wealth tests must be met?

  • Apply higher thresholds for complex products?

  • Repeal the experienced investor test or make it the only test?

  • Remove the wholesale/retail distinction?

  • Review the professional investor test?

  • Review the application of the superannuation trustee test?

  • Do nothing?

Financial services guides (FSGs)

Consultations are underway on the simplifications of FSGs.

Statutory compensation scheme

Richard St John has released a consultation paper relating to the Government-commissioned review of the need for a statutory compensation scheme. Options considered include:

  • Annual audited certification of compliance with professional indemnity requirements

  • Closer supervision by ASIC of higher risk firms

  • Development of standard professional indemnity policies

  • Group insurance for run-off cover

  • Additional disclosure of the level of cover

  • Last resort statutory compensation scheme

What next?

The 2011 Paper provides some further information about the FOFA reforms and addresses some concerns raised on the original paper.

However, there are key omissions - in particular, precise details of the nature of the statutory duty that will apply to personal advice.

The release of draft legislation is therefore critical. It seems this will not occur before July at the earliest, and the risk is that time lines slip, reducing the opportunity for effective consultation on the detailed provisions before the scheduled commencement dates.

The release of the 2011 Paper indicates there remains much for industry to achieve in ongoing consultation. It will therefore be important for industry participants to analyse the proposals carefully, identify the likely business impacts and stay close to their industry associations and Government contacts to participate fully in these discussions as they occur.