An end to commissions?

15 minute read  13.05.2018

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has released submissions following the completion of round 2 hearings into financial advice.

Following the completion of the second round of hearings on the issue of financial advice, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Financial Services Royal Commission) has released written submissions. The Australian Securities and Investments Commission (ASIC) submission expresses the view, among other things, that 'the grandfathering of commissions [paid to financial advisers] should cease as soon as reasonably practicable' on the basis that they 'operate to incentivise advisers to keep clients in legacy products with a continuing commission structure, even where there may be better products available to meet client's needs'. Media reports suggest that some entities are already moving away from the practice.

Key Points

ASIC's submission, responding to the 28 questions put by Counsel Assisting in closing submissions, addresses a range of issues in addition to the question of the payment of commissions. What follows is a high level overview of some of the points put forward in ASIC's submission.

Client benefit from ongoing service arrangements does not justify the fees

ASIC states that it is 'concerned that many, perhaps even most, clients who are currently paying for ongoing advice may not receive benefit from that advice commensurate with its cost to them'. 

More particularly, ASIC questions whether the provision of an annual review is of value to clients 'whose personal financial circumstances are unlikely to be sufficiently volatile or investments sufficiently complex to justify them paying a significant fee'. ASIC adds that 'Certainly, in ASIC’s opinion, it is hard to see how an arrangement under which the client receives the mere "offer" of an annual review could sensibly, of itself, justify a significant ongoing service fee'.

ASIC goes on to comment that the current practice of fees being deducted from the customer's investment funds and remitted to the licensee 'may not suffice to bring the fact that they are being charged significant ongoing frees for service sufficiently to the attention of the customers' and that 'it would be more likely that any ongoing service would provide meaningful value to a customer if the fee for that service were required to be invoiced to the customer and that payment specifically authorised, as and when the service was provided'. 

Grandfathered commissions

 ASIC states that in its view 'it is plausible that a continuing culture among licensees and advisers of receiving ongoing commissions which bear no direct relationship to the provision by them of service to the customer (a culture condoned to at least some extent by the grandfathering of commissions) may have contributed to those licensees and advisers paying insufficient regard to the need to charge ongoing service fees only where the service was provided'. ASIC goes on to express the view that 'In principle, any exception to the ban on conflicted remuneration has the ability to create misaligned incentives, which can lead to inappropriate advice' and adds that it is concerned that 'almost five years after the implementation of the FOFA reforms, grandfathered commissions continue to form a significant proportion of licensee/adviser remuneration and grandfathered commissions operate to incentivise advisers to keep clients in legacy products with a continuing commission structure, even where there may be better products available to meet the client’s needs'. Accordingly, ASIC believes that the grandfathering of commissions should cease as 'soon as reasonably practicable'. ASIC states that it accepts that consideration may need to be given to a short transition period to allow licensees and advisers to adjust their businesses.

Commenting on the same point, The Financial Planners Association of Australia (FPA) submission to the Commission comments: 'Ongoing fee arrangements where the ongoing advice is not provided contravene reasonable community expectations, regardless of whether they are technically grandfathered. The FPA would support the removal of grandfathering for ongoing advice fees and all ongoing advice fees being subject to the Opt-in requirement. Grandfathered commissions has led to an environment where many clients are paying fees and yet receiving no services. Ceasing grandfathered commissions and making all ongoing fee arrangements subject to opt-in will result in grandfathered fee arrangements quickly coming to an end where no services are being provided to consumers'.

ASIC views on the vertical integration model

 Asked to comment on whether the vertical integration of platform operators with advice licensees serves the interests of clients, ASIC referred to the findings in ASIC Report 562: Financial advice: Vertically integrated institutions and conflicts of interest and reiterated that though vertical integration may provide some benefit to clients (in certain circumstances), this could not be assumed in every case and added that 'a vertically integrated business model gives rise to an inherent conflict of interest, which needs to be carefully managed by a licensee to ensure that advice given to the client complies with the best interests duty and related obligations and is not tainted by that conflict'.

Commenting on the viability of successfully managing conflicts of interest in the vertical integration model, ASIC reiterated the view expressed in report 562, that there remain 'significant challenges around effectively managing the conflicts of interest that are inherent in vertically integrated businesses' but that ASIC's present view is that it 'should be possible for licensees to effectively manage the conflicts of interest associated with providing personal advice to clients and manufacturing financial products and it should not be necessary to enforce the separation of products and advice'.

No justification for sales-based remuneration and incentives for financial advisers

 ASIC states that 'A remuneration or incentive arrangement which rewards a financial adviser for generating revenue from customers creates a conflict of interest' and added that 'In ASIC’s view, it is very far from clear why there is a need for this risk to be embedded, to any extent, in the remuneration or incentive arrangements for financial advisers…evidence [heard at the second round hearings]…tends to suggest that there is no good reason why the remuneration of employed financial advisers should be structured so as to incentivise them, to any degree, to maximise the revenue generated from their clients'.

How should the provision of good quality financial advice be incentivised?

 ASIC comments that 'If the financial advice industry had a true professional ethos then, in ASIC’s view, it ought not to be necessary to incentivise financial advisers to provide good quality advice' or to reward them for 'ethical conduct'.

[Note: ASIC Chair James Shipton has previously called for the finance sector to raise standards of professionalism and suggested that the industry currently has a 'window of opportunity' to raise standards without the 'imposition of a regulatory catalyst'.]

Having said this, ASIC goes on to suggest that incentivising the provision of good quality financial advice should be based on an objective review of the advice in question (which could be done in conjunction with a routine compliance audit) with the integration of 'customer satisfaction' as a measure of the quality of the advice to identify that the advice is of good quality. 'Once objectively good quality advice is identified, it can be rewarded by the licensee' ASIC writes.

ASIC adds that in its view 'there should be no difference in the remuneration for advice that is in the client’s best interests, whether it be to recommend change or no change to an existing investment strategy'.

Commenting on the need to reward ethical conduct, ASIC states that rewarding ethical conduct requires that licensees and advisers have appropriate systems and processes in place to enable them to identify ethical and unethical conduct. Once identified, ASIC suggests that ethical and unethical conduct should be rewarded or punished as appropriate via performance management and remuneration systems. ASIC suggests that his could mean aligning adviser remuneration to good quality client service rather than to revenue/product sales. Measures of this kind, ASIC notes are more likely to be effective, where the necessary systems and processes are supported by a strong culture.

Improving compliance and audit processes

 Referring to the recommendations in ASIC Report 515: Financial advice: Review of how large institutions oversee their advisers ASIC reiterated a number of ways in which the advice and audit process could be improved eg by improved use of key risk indicators to target audit work (among other measures). ASIC comments that 'Ultimately, however, the appropriate monitoring and supervision of advisers comes back to whether the licensee has the commitment to do so, has devoted sufficient and appropriate human, technological and financial resources to the task and is appropriately incentivising the auditors and managers involved in the task'.

Manual systems are no excuse for poor monitoring

 Asked whether it is possible for financial services licenses to adequately monitor the quality of advice provided by employees and authorised representatives in a manual environment ASIC said that it is possible. ASIC added that though improvements in technology could enhance the monitoring and supervision of advisers to detect poor advice and facilitate good advice, 'improvements in technology are neither a prerequisite for quality advice, nor a substitute for other forms of monitoring and supervision'.

Support for the establishment of a last resort compensation scheme

Asked to respond to the question: 'Taking into account that it may never be possible to reduce the risk to zero, what is an acceptable risk that customers will be provided with inappropriate advice?' ASIC expressed the view that 'Given that some level of non-compliant advice leading to client loss is inevitable, consumer protection would be enhanced in ASIC’s view by the creation of a last resort compensation scheme'.

Timeframes for informing and remediating clients (that they have or may have been provided with inappropriate financial advice) are too long

  • ASIC states that 'when a licensee becomes aware that a client has been, or may have been, provided with inappropriate advice it should immediately inform the client'. ASIC goes on to comment 'It is not acceptable in ASIC’s view for licensees to fail to undertake any investigation or otherwise to make a concerted effort to determine whether inappropriate advice has been or is likely to have been provided, so that clients are not informed for months or even years'.

  • Commenting on what it considers to be an acceptable timeframe for remediating clients 'where a licensee determines that a client has been provided with inappropriate advice' ASIC states that the client should be informed and remediated 'immediately' though ASIC acknowledges that this may not be feasible in practice. On this basis, ASIC states that 'remediation should occur as soon as is reasonably practicable' and adds that it expects licensees to devote sufficient resources to enable compensation to occur in an efficient an timely way. ASIC comments that 'In that regard, ASIC’s experience (which has been further illustrated by evidence in the current round of hearings) has been that remediation is often far too slow, reflecting a failure by licensees to discharge that onus'.

ASIC's views on ensuring customers are protected during investigations of poor adviser conduct

 In situations in which a licensee has identified a risk that an adviser has provided non compliant advice leading to client loss and is undertaking an investigation to establish if this is so, ASIC says that the licensee should 'immediately inform clients that inappropriate advice may have been, or has been, provided, take steps to review the advice provided and remediate clients as appropriate' and take appropriate measures, suitable to the circumstances of each case, to ensure that no further non-compliant advice is provided eg suspending the adviser pending the outcome of the investigation (in a serious case) to imposing pre-vetting and close management supervision of the adviser (in a less serious case).

Mandatory reference checks

Commenting on the adequacy of current reference checking and information sharing requirements that apply when financial advisers transfer between licensees, ASIC expresses the view that the current ABA reference checking and information sharing protocol, while a step in the right direction, is not 'sufficient to protect the public when financial advisers transfer between licensees' and that in ASIC's view, 'consideration should be given to law reform to introduce mandatory reference checking and information provision (including qualified privilege) when financial advisers transfer between licensees'.

Commenting on the current system for professional discipline of financial advisers ASIC states that if the current system is maintained, ASIC's ability to ensure that only appropriate persons are able to participate in the financial services and credit industry would be enhanced if the grounds for exercising ASIC's power to ban individuals were expanded.

Impact of limited resources

 ASIC states 'With limited resources, it is inevitable that ASIC’s regulatory choices will entail difficult decisions as to what matters to investigate and to take action on and in what manner, so as to most effectively change the behaviour of industry participants and improve consumer outcomes. Difficult choices and trade-offs are required to be made, not only in the context of the financial advice sector, but across the full range of ASIC’s jurisdiction and responsibilities' ASIC writes.

Regulatory culture

 Commenting on regulatory culture, ASIC states, that a 'fundamental element of the regulatory regime is the responsibility that licensees have to ensure compliance by their businesses and advisers with the financial services laws. However, it is apparent from ASIC's experience…that licensees have not consistently fulfilled that role' and that consequently ASIC has adopted a progressively more 'hand-on', and more resource intensive, approach. ASIC goes on to state that the case studies heard by the Commission served to both to illustrate the gap between the views expressed by banking and financial services institutions and the practices within those institutions and their lack of willingness to engage with ASIC, 'there are a range of circumstances in which ASIC has found that the large financial services entities too often engage with it in a manner which is less than constructive' ASIC writes.   

Commenting on what changes in the regulatory culture within licensees might assist in reducing the incidence of misconduct in the industry, ASIC writes that: 'changes must start at the top, with a firm commitment by the Boards and senior management of licensees to put compliance with their legal and ethical duties to customers at the forefront of the organisation’s priorities, and then permeate every aspect of the engagement of licensees with their financial advisers, including in their recruiting, training, monitoring and supervision, and remuneration. At the individual adviser level, what is required is the sincere adoption of proper professional standards, as contemplated by the pending reforms required by the Corporations Amendment (Professional Standards of Financial Advisers) Act 2017'.

Reform of the obligations set out in s912A is unnecessary, but reforms to further strengthen the impact of banning powers should be considered

 Asked to comment on whether the obligations set out in section 912A of the Corporations Act 2001 (Cth) are expressed at 'too high a level of generality to be capable of being effectively enforced', ASIC said that in its view they are not, and that the fact that the general obligations facilitate 'principles based' and 'outcome-based' regulation rather than regulation by strict rules is appropriate.

Referencing recent proposed changes to ASIC's regulatory powers eg making s912A a civil penalty provision (among other changes) ASIC suggests that 'further law reform measures which would enhance the transparency and denunciatory impact of the banning process' would be to provide for: 'an entry to be made in the Financial Advisers Register on the sending out by ASIC of notice to an adviser of a hearing to consider whether a banning order will be made; and/or the publication by ASIC of the ASIC delegate’s reasons for decision'. 

Is industry moving away from the practice?

ANZ has committed to remove all sales incentives for financial planning bonuses

Prior to the release of ASIC's submission, ANZ announced a that it plans to 'remove all sales incentives for financial planning bonuses, speed up customer remediation, quickly remove planners that provide inappropriate advice, and demand new professional standards'. More particularly, ANZ has committed to:

  • 'Remove all sales incentives for bonuses and only assess performance on customer satisfaction, ANZ values, and risk and compliance standards
  • Quickly identify and remove planners that provide inappropriate advice – two audit fails and their contract will be terminated.
  • Only employ new planners with a relevant under graduate degree and industry certification, and require existing planners to be enrolled in further necessary training by January 2019.
  • Commit to completing compensation on about 9000 current inappropriate advice cases by the end of the year.
  • Offer an advice review, at no expense, for any of our financial planning customers who may have concerns about their current financial position'.

The WSJ comments that ANZ is the 'first' of the banks to make changes of this kind.

Westpac: The SMH reports that Westpac has indicated it has no plans to end sales based incentives for financial planners. Reportedly, Westpac has said that doing so would only mean planners elect to work for organisations where the sales-based bonuses are in place, or to work for themselves: 'If we don't offer some element of incentive to the planners to stay on our books, it will beg the question as why they would continue to work for us' Westpac CEO Brian Hartzer is quoted as saying. The article goes on to comment that Westpac also remains committed to the 'vertical integration' business model on the basis that it provides a valuable service to customers, and on the basis that issues with conflicted pay have been addressed by the Future of Financial Advice Reforms. The SMH comments that the chairman of the 2014 financial system inquiry and former Commonwealth Bank CEO David Murray (who will chair AMP), has also defended the vertical integration model.

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