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Last Thursday the second tranche of the Future of Financial Advice ('FOFA') legislation was introduced into Parliament.
The Bill incorporates the much anticipated "best interests obligations". These obligations appeared in the tranche 1 exposure draft and have now been incorporated in a slightly revised form in tranche 2. Importantly, the Bill provides the framework for scaled advice. The Bill also outlines some transitional (grandfathering) provisions regarding the otherwise largely unchanged bans on conflicted remuneration, volume based shelf space fees and asset based fees on geared funds.
The Bill has been referred to the Parliamentary Joint Committee on Corporations and Financial Services.
The starting date of these reforms remains 1 July 2012. This is an ambitious implementation date given that the bill has been referred to committee. In addition, there has been no guidance on the release of the accompanying regulations.
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Executive Summary
In this client alert we outline how the key changes contained in the Bill will affect the way you will need to provide personal financial advice. Though only partially amended, we have set out the 7 steps for compliance with the best interests obligations.
We have divided our discussion into 2 sections:
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Best interests obligations; and
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Prohibition on conflicted remuneration, volume based shelf space fees and asset based fees on geared funds.
The bill, rightly or wrongly is premised on the belief that following a more rigorous advice process will lead to better advice. The bill also aims to tackle the misalignment of interests between advice providers and their clients.
There are improvements to the bill from the exposure draft. However, many in the industry are likely to feel that the bill will still significantly increase their cost of compliance.
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Best interests obligations
The best interests obligation is an obligation on the advice provider to act in the best interests of the client in relation to the advice. An advice provider can prove compliance by following a revised set of 7 steps contained in Section 961B(2) and giving priority to the client's interests where a conflict arises. Advice providers would be well advised to document their compliance with each of the 7 steps (only 3 steps are required for basic banking products and general insurance products). Whilst most of the obligations are on the individual advice provider, the civil penalty provisions resulting from any breach flow through to the licensee or authorised representative.
A provider satisfies the best interests obligations if it follows 7 steps:
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identifying the objectives, financial situation and needs of the client;
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identifying the subject matter of the advice that has been sought as well as the client's relevant circumstances;
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making reasonable inquiries to obtain complete and accurate information from the client;
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declining to give advice if the provider does not have the required expertise;
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Assess the information gathered from an investigation into the financial products that might achieve the client's objectives;
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Based on the judgements above, advising the client on their relevant circumstances; and
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Taking any other step that would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances.
It is likely that advice providers will have some discomfort about what exactly will be required to satisfy the last (7th) step. The explanatory memorandum indicates that this step is not satisfied by following the process through steps 1 – 6. Something additional will be required.
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No longer a requirement
In an improvement from the exposure draft, the advice provider no longer has to:
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conduct a reasonable investigation into appropriate financial products available;
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advise a client that their objectives could be better met if they obtained advice on another subject matter either in addition to or in substitution for the advise requested;
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assess whether the client's objectives and needs could be met other than by acquiring financial products; or
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maintain a list of approved products.
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Client's relevant circumstances
The inclusion of the requirement to obtain the client's relevant circumstances is described in the explanatory memorandum to the Bill, as "designed to accommodate the provision of limited advice (also referred to as 'scaled advice' that only looks at a specific issue". This is a very valuable change from the exposure draft and means that businesses can provide scaled advice, providing they act in the best interests of clients. Providing scaled advice still requires following the 7 steps outlined above, but only with respect to the objectives, financial situation and needs of the client that would reasonably be considered relevant to advice sought on that (limited) subject matter.
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The test for what is in the best interests of the client?
What is in the best interests of the client is at the heart of the best interests obligations. The test is: If a person with a reasonable level of expertise in the subject matter, exercising care and objectively assessing the client's relevant circumstances would regard it as in the best interests of the client to take that step. This is an objective test which means that an impartial person with the requisite experience would regard the advice as in the best interests of the client. You might wish to consider implementing a system of cross-checking advice provided by advice providers to ensure that the best interests of the client are given priority.
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Giving priority to client's interests
If an advice provider knows or reasonably ought to know, that there is a conflict between the interests of the client and the interests of the following list of people, or their associates: the provider, a financial services licensee of whom the provider is a representative or an authorised representative who has authorised the provider to provide a specified financial service, the provider must give priority to the client's interests when giving the advice. The rationale behind these changes is to prevent companies providing benefits to related body corporates in an effort to circumvent the Bill.
In order to comply with this provision, advice providers will need to be very aware of who might be considered to be an associate.
This obligation does not apply for basic banking products or advice on general insurance products.
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Where advice is based on incomplete or inaccurate information
Under these circumstances, the provider must warn the client that the advice is based on incomplete or inaccurate information relating to the client's relevant personal circumstances and that the client should consider the appropriateness of the advice. However, these warnings to do not affect the best interests duty. Specifically, an advice provider must assess whether they have sufficient information on which to base advice. If an advice provider does not have sufficient information, they should exercise caution in providing advice. On a practical level, this could be difficult where a client pays for an advice session but the advice provider is unable to adequately provide advice. In order to overcome this barrier, advice providers could supply customers with a checklist of information to bring to an advice session.
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Prohibition on conflicted remuneration, volume based shelf space fees and asset based fees on geared funds
The bans on conflicted remuneration, volume based shelf space fees and asset based fees on geared funds remain in place for both general and personal advice. The prohibition still includes monetary and soft-dollar benefits.
The most important change has been the revised definition of conflicted remuneration which has changed from "might influence the choice of financial product recommended..." to "could reasonably be expected to influence the choice of financial product recommended." Though subtle, this represents a higher level of influence requirement than under the previous test. However, the threshold for influence remains low, and therefore easy to trigger.
Though volume based benefits are still presumed to be conflicted remuneration, an advice provider can seek to prove the contrary is true. The explanatory memorandum indicates that this drafting was necessary to cater to the "wide range of remuneration arrangements". The explanatory memorandum goes onto state that the relevant section 963L is not an exhaustive definition of what constitutes conflicted remuneration. Advice providers will have to wait for the regulations before they learn whether the remuneration they wish to pay is prohibited. The regulations to this section will be closely followed as they will hopefully indicate some concrete exceptions.
There has been some clarification around the transitional (grandfathering) provisions including:
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The best interests obligations apply from the commencement of the legislation, whether or not the advice was sought before that day;
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The ban on conflicted remuneration does not apply where the benefit is given under an arrangement entered into before the ban commences and, importantly, the benefit is not given by a platform operator; and
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The ban on volume-based shelf-space fees does not apply to a benefit given to a financial services licensee or an RSW licensee under an arrangement entered into before the commencement day.
For more information about the prohibitions on conflicted remuneration, volume based shelf space fees and asset based fees on geared funds please click here to read our previous client alert.
For further information on anything in this Client Alert, please contact Astrid Raetze, Bill Fuggle, or the Baker & McKenzie lawyer with whom you usually work.
