Expert Feed
An auditor's view of conflicted advice
BY BEN MOFFATT | FRIDAY, 2 AUG 2019   11:36AM

"But why should conflicts of interest be a problem? People should simply be able to declare their conflicts of interest and make their decisions in accord with their professional duties rather than their own personal and financial goals."

That's a quote from Paul Thagard's article 'What's wrong with conflicts of interests?' which was published in Psychology Today in January 2017.

Conflicts abound in financial services (and not just in the usual and predictable places).

In fact, let's start this article by calling out a conflict of the laws applicable to Financial Advisers in the provision of financial advice. Standard 3 of the new FASEA Code of Ethics advocates that you must not advise, refer or act in any other manner where you have a conflict of interest or duty.

In a previous article we discussed Conflicts of Interest and outlined that Financial advisers and Licensees are able and required to disclose conflicts and relationships formally within their advice documents (947B and 947C) and financial services guides (942B and 942C).

Well that puts us in a bit of a pickle doesn't it. Let's just ignore this tension and acknowledge that, in an imperfect world, conflicts are inevitable.

Conflicts in practice

All advice has the potential to be conflicted, SMSF advice especially.

The further you dive into the advice, the greater potential for it to be conflicted due to the ways to invest and structure the fund itself. A number of professional advisers can be involved at each step of the advice process and each can influence the advice or its execution.

Consider investing in real property within a Self-Managed Super Fund (accompanied by gearing through a Limited Recourse Borrowing Arrangement (LRBA)). For an average SMSF set-up involving an LRBA and property purchase, we have an adviser; accountant; mortgage broker; real estate agent; solicitor and a range of retail and wholesale providers (depending on the specifics). Then consider direct and indirect commissions, referral payments and arrangements, remuneration structures and associations.

Potential conflicts abound.

ASIC have frequently expressed their concern with 'one-stop shops' because of these conflicts and the real potential for members to be financially disadvantaged. Both ASIC and the ATO will be increasing their focus on these types of businesses but, if you ask the clients served by these businesses, they'll often confirm that they understood the conflicts and are unconcerned with these interdependent relationships. In fact, they'll often feel that they benefited from the convenient arrangements. We've previously written about the problems with disclosing conflicts so we won't labour the point beyond highlighting the difficulty an adviser or Licensee may have proving that the client fully understood the entire circumstances and that these conflicts were effectively managed or disclosed.

Conflicts and convenience

"It's a little club so you deal with all their people. I'd rather just stay with the main group because they're together. They can talk to each other."
- Bernart, Melbourne in ASIC Report 575 (p.47)

"Absolutely, they've done everything for us. We've just had to do everything that they tell us to do-come in and sign this or they'll send this out.'"
- Nancy, Melbourne in ASIC Report 575 (p.47)

There is a large amount of information available regarding ASIC's window shoppers and research of the SMSF sector, with some reports suggesting that the majority of Self-Managed Super advice does not meet the relevant standards. We don't necessarily think that the majority is flawed, but we do uncover instances where it is difficult to determine where the greater benefit lies.

Surprisingly Self-Managed Super Funds (SMSFs) emerged from the rubble of the Royal Commission largely unscathed. There may be a number of reasons for this. First, because the current restrictions minimise the potential impact on retail investors and, second, because the law already imposes obligations on advisers to act appropriately.

Under S961J, an adviser must give priority to the client's interests when giving advice and they must demonstrate this. It is vital that consumers receive quality advice before embarking on an SMSF journey and as we've previously addressed, one of the most important roles of the adviser is to educate. It is not easy to manage all conflicts (including actual, apparent and potential) and there are a number of ways in which this can be achieved. We suggest using them all to some degree.

Prepare

Proper Preparation Prevents Poor Performances.

The first step for effectively managing conflicts (if they can't be avoided) is to understand what conflicts exist, what may exist or what might be anticipated by an objective party.

Some poor decisions can be made when an unfamiliar set of circumstances arises and there is uncertainty as to how to deal with it. There may also be circumstances where relationships, affiliations and benefits are not entirely known to all those involved within the business.

Approaching unprepared and without guidance can yield dire outcomes. Understanding the situation and having the correct tools to deal with it is paramount in the decision-making process.

Tips:

  • Understand yours and your Licensee's relationships, affiliations and arrangements;
  • Understand your Licensee's process in dealing with conflicts;
  • Request training to familiarise yourself with different scenarios and gain external perspective;
  • Request additional guidance and assistance where necessary;
  • Request workshops and scenario analysis.  

Avoid

"So, what can be done about conflicts of interest? The best strategy by far is simply to avoid them, by having professionals completely steer clear of situations where they have to juggle their legal responsibilities against their personal goals. "
- Paul Thagard

In a perfect world, this would be the most popular and most frequently used method, however it is easier to say than do in some cases.

Conflicts exist and some of these may very well be out of your control. There may be relationships at a business level that you are not aware of, or benefiting from, and the fact that it exists means it must be dealt with accordingly. It may be tucked away in the FSG or advice document that nobody reads.

The most effective way to manage actual or potential conflicts of interests and duties is to avoid any situation that might give rise to these conflicts.

Whether this is through not using an associated professional adviser or service, certain providers or declining the advice altogether. I know this may seem counter-intuitive, but if you are unable to ensure that your client's interests are prioritised then you shouldn't give the advice.

If the situation arises whereby avoiding the advice may place your client in a position causing detriment, then perhaps identifying a way to avoid the benefit itself may be the answer.

Tips:

  • Understand your Licensee's relationships and affiliations and how these relate to you and keep track of any changes;
  • Confirm and quantify the exact benefits which may be received;
  • Establish clear boundaries and refer where necessary;
  • Remove the commissions, benefits, rewards or remuneration from the situation;
  • Review existing relationships and consider adjusting;
  • Request or source additional training;
  • Decline the advice altogether.

Manage

Situations may arise where a conflict is identified but you still feel that you can provide advice which is in the best interests of your client.

How this conflict is managed is vitally important. Part of your strategy for managing conflicts might involve disclosure but disclosure is neither a complete, nor even a particularly effective method of managing conflicts.

In an expansive, diverse and complex business, the need for documenting the process becomes critical. It is often very difficult to determine (with clarity) the related parties that may benefit from the advice (and the extent of the benefit). Accordingly, it's difficult to be able to demonstrate that you've prioritised your client's interests.

In some cases, SMSF members are financially worse off and high fees and undisclosed commissions are paid to accountants, real estate agents, developers, property advisers, mortgage brokers, advisers and Licensees.

Tips:

  • Understand and familiarise yourself with the arrangements and clarify specifics;
  • Document considerations and steps you have taken to identify and assess the potential or actual conflicts;
  • Remove the commissions, benefits, rewards or remuneration from the situation;
  • Obtain external opinions and professional advice;
  • Review existing relationships and consider adjusting; and
  • Avoid the conflict altogether.

Disclose

This may very well be the easiest of the options available in terms of effort , but as we've said before, disclosure is not enough. As with most things in life, the easiest option isn't always the best.

Advisers often point us in the direction of what they've disclosed in the advice document in defence of a process failure. Alternatively, we've had advisers respond to their ineffective disclosure by declaring that not all Statements of Advice are read anyway.

Advisers routinely make disclosure errors.

For example, during a recent review, we found disclosures relating to certain insurance providers paying additional commissions based on the number of policies and insurance premiums paid by the clients. The disclosure also stated that the adviser in questions would directly benefit from these additional payments. When we addressed this with the adviser and Principal of the business, neither of them knew anything about the benefit and neither had ever received any of the disclosed benefits.

We have also seen examples where multiple referrals take place within the same business for Self-Managed Super Fund advice and the benefits being received are numerous. Some of these are reimbursed, whereas others cannot be specifically calculated, and some are reduced to zero as part of the process.

All of these options have their own risks but ultimately, the more complex the arrangements, the more room there is for error.

Disclosure has its place and should form part of any advice process, but it is not sufficient in isolation.

Tips:

  • Understand your Licensee's arrangements and keep track of any changes;
  • Understand your templates and make necessary changes depending on Licensee and individual arrangements;
  • Ensure the accuracy of the information provided and don't over-disclose to create a better perceived defence;
  • Be as detailed as possible and clearly outline relevant information;
  • Don't be too reliant on disclosure in itself; and
  • Request or source additional training.
1 comment so far
  Every commercial transaction has a potential conflict of interest. In every commercial transaction there is a mix of loss and gain to both parties. All advice which is bought (not free) carries a gain and a loss to both parties. Only where altruism is the only motive can there not be a potential conflict of interest. If the professional adviser has no personal or financial goals then there is no potential conflict. To ignore this basic fact is a political pretence.
JOHN SCHOFIELD  |  12 AUG 2019   1.06PM
Link to something pDUR1qlF