Fact check: Chris Bowen scaremongering on return of old-style commissions for financial advisers

Updated

Commentary around the Federal Government's proposed changes to financial advice laws suggests the financial planning and advice industry is about to return to the bad old days when retirees lost their life savings in dodgy investments that paid big commissions to their advisers. But is that really the case?

In 2011, the former Labor government introduced the "Future of Financial Advice" (FOFA) reforms after a series of financial collapses. It turned out that many investors were given inappropriate advice by financial advisers who were motivated by big hidden commissions.

Some in the industry suggested Labor's reforms went too far and in response, the Coalition promised during the election campaign to amend FOFA. In January 2014 the Abbott Government released draft legislation and regulations for consultation, and on March 19 it presented revised legislation to Parliament. The process has since been paused for further consultation.

Labor opposes the changes. On March 25, Opposition treasury spokesman Chris Bowen told Parliament that the original reforms had been introduced in response to collapses such as Westpoint, Trio and Storm Financial.

"The commissions being paid for the advice to invest in Westpoint amounted, on average, to 10 per cent of the amount invested," Mr Bowen said. "And this Government thinks that's just fine. This Government wants to bring back laws which would enable that to happen..."

Will the Government's proposals allow the reintroduction of the type of commissions that were paid to advisers who recommended Westpoint and Trio investments or advisers employed by Storm Financial?

The claim: Chris Bowen says the Government's changes to financial advice laws will bring back the type of commissions that encouraged financial advisers to recommend risky investments.

Chris Bowen says the Government's changes to financial advice laws will bring back the type of commissions that encouraged financial advisers to recommend risky investments. The verdict: The proposed changes will only apply to some forms of general advice. They do not bring back old-style commissions.

General and personal financial advice

There are two types of financial advice - general and personal. The difference between them is that general advice is given without taking into account the client's objectives, financial situation or needs.

A regulatory guide issued by the corporate regulator, the Australian Securities and Investments Commission (ASIC), requires that in the case of general advice, the adviser must warn the client at the outset that they are giving general advice and that "the advice has been prepared without taking into account their objectives, financial situation or needs". The guide says that the advice will automatically become personal advice if the adviser considers the client's relevant circumstances when preparing and giving that advice. ASIC says the adviser "cannot avoid this by giving a general advice warning".

Many situations fall under the general advice description, ranging from general discussions with bank customer service staff to product brochures and advertisements.

Phil Anderson, the chief operating officer of the Association of Financial Advisers (AFA), one of the two largest associations of financial advisers, says that general advice could be telling a customer that "typically younger superannuation fund members will invest in shares as they generate the highest long term returns".

A spokeswoman for AMP, which operates one of the largest financial advice networks in Australia and New Zealand, suggests that general advice could even "be Shane Oliver [AMP's chief economist] talking about market conditions".

The financial planning industry

The broad nature of the term "financial advice" means that nearly everyone working in financial services - ranging from large banks and insurers to small consulting firms - could potentially be providing some form of financial advice.

However, the FOFA reforms were focused on the practices of people known as "financial planners" or "financial advisers". According to the explanatory memorandum for Labor's legislation, the "underlying objective of the reforms is to improve the quality of financial advice while building trust and confidence in the financial planning industry through enhanced standards which align the interests of the adviser with the client and reduce conflicts of interest".

In 2010, ASIC estimated that there were over 8,000 financial advisory practices, employing over 18,000 people in Australia. Most financial advisers give advice under the banner of a "dealer group". Some of the more prominent dealer groups are AMP Financial Planning, ANZ (using the brand OnePath), Westpac (under brands including BT Financial Services, Securitor and St George) and the National Australia Bank (through the brand MLC).

Financial products are developed by large institutions, such as banks and fund managers, who place the products on a "platform" that can be accessed by dealer groups. The dealer group prepares a list of possible products for advisers to offer to their clients and also provides some administrative services.

The usual practice is for the dealer group to hold a financial services licence and allow independent companies employing financial advisers (or individual advisers themselves) to be "authorised representatives" of the dealer. Some of the big institutions also employ their own financial planners. This means that someone who is, for example, an AMP or Commonwealth Bank branded financial planner may not actually be employed by those institutions.

When a customer first sees a financial adviser, they usually go through a fact-finding process during which they tell the adviser about their personal financial circumstances and goals. The adviser will then come up with a financial plan in the form of a written statement of advice. If the client gives the go ahead, the adviser will implement the plan and there are supposed to be regular follow ups.

What is FOFA?

Financial advisers traditionally did not charge upfront fees to their clients, but instead used to get paid through ongoing commissions they received from product providers (calculated as a percentage of funds invested). Some product providers chose to compete with each other on the basis of the commissions they paid to advisers, and the commissions usually continued to be paid for as long as the funds were invested (known as a trailing commission). These commissions were ultimately paid for by consumers through fund administration fees.

This system had the advantage of allowing people to obtain professional financial advice without large upfront costs. However, it also had the downside of allowing what Labor MP Ed Husic dubbed "unscrupulous operators" to make big money recommending investments that were not in the client's best interests but paid large commissions.

The FOFA reforms were designed to tighten up regulation of the financial planning and advice industry. When they were being developed in 2011, then financial services minister, Bill Shorten, said: "The vast majority of financial advisers are dedicated professionals who give good advice to the best of their ability. But that doesn't change the fact that many consumers lack trust in the profession and there is a perception that advice is under-regulated and open to abuse... These reforms are designed to encourage [people] to perhaps in the future get financial advice... In this sense these reforms can in fact be a growth strategy for the financial planning industry."

The reforms were introduced into law as provisions in Part 7.7A of the Corporations Act. They started on July 1, 2012, but only became compulsory on July 1, 2013.

'Conflicted remuneration'

The salaries of people who work in financial services can be made up of several components, including base pay, individual bonuses and company-wide performance bonuses. Bonuses are based on criteria that can include sales and customer service and one-off payments for cross-selling particular products (such as credit cards and online accounts).

The FOFA legislation does not actually use the term "commissions". It outlaws "conflicted remuneration", defined as benefits given to the adviser that "could reasonably be expected to influence" the advice, for both personal and general advice.

The Government's proposed changes to the "conflicted remuneration" rules have been watered down since the initial draft was released in December 2013.

The Government initially planned to narrow the ban on conflicted remuneration so that the ban only applied to personal advice. Conflicted remuneration would have been allowed in relation to general advice. This change had been abandoned by the time the revised bill was presented to Parliament on March 19, although Fact Check has found that some commentary on the issue continues to be based around the initial proposal.

Instead, the Government's current proposed change will only allow conflicted remuneration relating to general advice that is:

Given by employees of a financial services licensee (for example, a bank) recommending a product issued or sold by that person's employer, and

Only if the employee has not given any personal advice to the client in the previous 12 months

Conflicted remuneration will still be banned for personal advice.

The Government's proposed changes also allow bonuses for employees of financial product providers if the bonus eligibility criteria are based on both volume (total value of products recommended) and non-volume measures, and the bonus amount is "low" in proportion to the employee's total pay (around 10 per cent or less).

The Government has suggested to Fact Check that the former government intended such bonuses to be available under FOFA. It points to Mr Shorten's second reading speech introducing FOFA where he said that "income related to volume of product sales" may be permissible "if the adviser can demonstrate that the receipt of the income does not conflict advice".

Fact Check asked Mr Bowen's office for the Opposition's current position on employee bonuses, but no reply on that point was provided.

Are commissions being brought back?

The limited changes proposed by the Government will not bring back the controversial type of percentage-based trailing commissions that were offered to advisers for signing up clients to Trio and Westpoint.

For one, these changes apply to general advice only. The notorious collapses that led to the FOFA changes related to the provision of poor and conflicted personal advice rather than the general advice that the amendments relate to.

That should not be surprising. Financial advisers specialise in providing personal advice based on responses given by their clients. AMP's spokeswoman says: "It would be extremely difficult to have a one-to-one interaction with a client on a general advice basis and give a product recommendation without it falling into personal advice territory."

Mr Anderson of the AFA tells Fact Check: "Licensees, who are responsible for the conduct of their representatives, will not let financial advisers sell products by the means of general advice. Licensees conduct audits on client files to ensure that the advice is appropriate, and they will seek to pick up cases where advice documentation has not been provided to the client."

It is unlikely that the proposed changes would allow payments to a financial adviser even if they were giving general advice. This is because the changes only apply to advice given by employees of a financial services licensee, such as a bank, that develop the products being recommended. Most financial advisers are not employed in this way. AMP says less than 1 per cent of its advisers are employed directly by the company.

The beneficiaries of these changes are more likely to be counter or call centre staff at banks and other financial institutions, who take applications and cross-sell more straightforward products where information about personal circumstances is not required or considered.

Dante De Gori, general manger of policy for the Financial Planning Association (FPA), the other large association of financial advisers, tells Fact Check "the Government's amendments do not bring back commissions for financial planners". He says the changes "may allow the big banks to provide cash incentives to their branch and call centre staff to sell complex investment and superannuation products to customers without taking into account their personal circumstances".

Mr Anderson agrees that the changes would "allow some form of one-off sales bonuses to be paid to employees of banks and call centres, who have not given any personal advice".

In its submission to the Senate Committee on the FOFA reforms, the AFA says "the use of the term commission in connection with the exemption [is] misleading" and that it expects "the form of conflicted remuneration paid under such an exemption to be a once off bonus payment, rather than a traditional commission with an ongoing element".

The verdict

Mr Bowen is scaremongering. The proposed changes to the conflicted remuneration provisions do not bring back the type of commissions that financial advisers could receive before FOFA was introduced.

Sources

Editor's note (June 2, 2014): Chris Bowen asked us to publish his response to this fact check. You can read it here. It does not change our verdict.

Editor's note (June 23, 2014): The headline of this article has been changed to more precisely reflect the content of the fact check.

Topics: law-crime-and-justice, business-economics-and-finance, consumer-finance, consumer-protection, superannuation, chris-bowen, regulation, political-parties, alp, government-and-politics, australia

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