PJC releases financial services inquiry report
The Parliamentary Joint Committee (Committee) on Corporations and Financial Services or the Ripoll Committee as it is popularly known, released its
report (Report) on its inquiry into financial products and services in Australia (Inquiry) on 23 November 2009.
The Report sets out 11 specific recommendations which are discussed below. In broad terms, the recommendations relate to:
- raising standards of advice;
- making disclosure more effective;
- removing conflicted remuneration practices; ensuring better transparency, competency and accountability through the licensing system;
- reforming lending practices;
- limiting access to complex and/or risky investment products; and
- introducing a last resort statutory compensation scheme for investors.
The proposed changes will predominantly impact financial product issuers and distributors and financial advisers.
The most high profile issues raised in the Inquiry were:
- A ban on commissions for financial advisers.
The Committee recommended that government consult with and support industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers without coming up with suggestions as to how this could be done (see Recommendation 4 below for further information).
- The creation of separate licensing categories to distinguish between advisers operating in a sales capacity or those offering ‘independent’ advice.
The Committee does not support creating separate licensing categories on the basis that it would create an added layer of complexity to the licensing system, would require an extensive public education campaign, and would potentially be confusing. The Committee is of the view that bringing additional professionalism and transparency to the industry can be achieved more effectively through alternative recommendations contained in the Report.
- Prudential regulation
The Committee has not supported calls for greater prudential regulation of AFS licensees through capital adequacy rules. However, the Committee has suggested that agribusiness MIS licensees be required to demonstrate they have sufficient working capital to meet current obligations. (see Recommendation 7 below for further information).
Recommendation 1: The Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an AFSL, requiring them to place their clients’ interests ahead of their own.
It is arguable that such a duty already exists at common law (a position adopted by the Trustee Corporations Association of Australia at the Inquiry). However, the Committee seems to have adopted ASIC’s submission that an additional legislative requirement to put the interests of clients first where there is a conflict would lead to a higher quality of advice and the emergence of a professional advice industry.
The Committee is of the view that:
- there is no reason why advisers should not be required to meet this professional standard
- there is no justification for the current arrangement whereby advisers can provide advice not in their clients’ best interests, yet comply with section 945A of the Corporations Act and
- a legislative fiduciary duty would address this deficiency.
Recommendation 2: Government ensure that ASIC is appropriately resourced to perform effective risk-based surveillance of the advice provided by licensees and their authorised representatives. ASIC should also conduct financial advice on shadow shopping exercises annually.
The Committee is of the opinion that ASIC needs to undertake the enforcement of legislative standards of advice with a more rigorous and targeted approach. ASIC should perform effective risk-based surveillance on the advice provided by licensees and their authorised representatives, focusing particularly on licensees that:
- have come to the attention of ASIC previously
- recommend a high proportion of high risk products
- have limited products on their approved product list
- disproportionately recommend one type of product or
- have limited experience or qualifications.
The Committee considers it important that ASIC establishes robust audit processes to be undertaken by suitably qualified field staff. The Committee is of the view that more regular, preferably annual, shadow shopping exercises should be conducted to identify breaches of the legislative standard and provide an important deterrent for licensees.
Recommendation 3: The Corporations Act be amended to require advisers to disclose more prominently in marketing material restrictions on the advice they are able to provide consumers and any potential conflicts of interest.
During the Inquiry, ASIC proposed that advisers be required to disclose more prominently restrictions on the advice they are able to provide consumers and in particular, the limited range of products an adviser tied to a product issuer is able to advise on.
The Committee was of the view that this recommendation is particularly important in the case of advice from vertically integrated financial institutions, where conflicts of interest attributable to the ownership structure will exist even if commission payments to advisers are eliminated as a form of remuneration.
Recommendation 4: Government consult with and support industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers.
The Committee received considerable evidence suggesting that the most effective way to improve the quality of financial advice for consumers is to remove conflicts of interest altogether by banning commissions and other conflicted remunerative practices.
ASIC submitted that commissions create conflicts of interest that are inadequately managed by disclosure and suggested that the Committee consider recommending a ban on a range of remunerative practices. ASIC submitted that:
“While the reforms to clarify the fiduciary-style duty of advisers will have a significant impact on the ability to use commission remuneration, the Government should still assess changing the policy settings of the FSR regime so that advisers cannot be remunerated in a way that has the potential to distort the quality of advice given.
This would mean that the following forms of remuneration would not be permitted, particularly in relation to personal advice:
(a) up-front commissions;
(b) trail commissions;
(c) soft-dollar incentives;
(d) volume bonuses;
(e) rewards for achieving sales targets; and
(f) fees based on a percentage of funds under advice.”
ASIC proposed that people who do not hold themselves out to be advisers, or those providing execution-only services, be able to continue to receive commissions. ASIC also indicated that the government would need to consider whether to ban advisers receiving commission payments altogether, or permit them to return them to clients in full.
The Committee noted that remuneration structures that are incompatible with a financial adviser’s proposed fiduciary duty (Recommendation 1) should be removed. The Committee acknowledges that some in the industry have already indicated a willingness to move away from commission-based remuneration practices. The Committee welcomes this and recommends that government consult with and support industry in effecting this transition.
Recommendation 5: Government consider the implications of making the cost of financial advice tax deductible for consumers as part of its response to the Treasury review into the tax system.
Recommendation 6: Section 920A of the Corporations Act be amended to provide extended powers for ASIC to ban individuals from the financial services industry.
ASIC recommended that legislative changes be considered to empower ASIC to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee ‘may not comply’ with their obligations in the future. This is a lower threshold than the current ‘will not comply’ and would allow ASIC to take a more proactive approach to prevent likely breaches of licence conditions before they occur.
The Committee supports ASIC’s recommendation that it be easier for the regulator to ban individuals operating at the fringes of the financial services industry, by bolstering ASIC’s banning powers under section 920A of the Corporations Act.
Recommendation 7: As part of their licence conditions, ASIC require agribusiness MIS licensees to demonstrate they have sufficient working capital to meet current obligations.
The Committee is unconvinced that increased capital adequacy requirements for licensees generally would be of overall benefit to consumers, as it may lead to industry consolidation which would not necessarily be in the consumer’s best interests.
The Committee concluded that improving the regulation of financial advice is more effective than regulators attempting to ensure, through additional regulation, that products are ‘safe’ for investors. Notwithstanding this and the fact that ASIC is not a prudential regulator, the Committee is of the view that the unique nature of agribusiness MIS warrant some regulatory intervention to ensure that these schemes do not, over time, develop a ponzi-like character by relying on new product sales to prop up existing schemes. Accordingly, the Committee recommends that, as part of their licence conditions, ASIC require agribusiness MIS licensees to demonstrate they have sufficient working capital to meet current obligations.
Recommendation 8: Sections 913B and 915C of the Corporations Act be amended to allow ASIC to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee ‘may not comply’ with their obligations under the licence.
With respect to licensee standards, the Committee supports ASIC’s recommendation that it be able to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee ‘may not comply’ with their obligations in the future, rather than the current legislative standard of ‘will not comply’. The Committee is of the view that this is an important measure to allow ASIC to be more proactive in preventing likely breaches of licence conditions before they occur.
Recommendation 9: ASIC immediately begin consultation with the financial services industry on the establishment of an independent, industry-based professional standards board to oversee nomenclature, and competency and conduct standards for financial advisers.
The Committee is of the opinion that a professional standards board (PSB) overseeing conduct standards for financial advisers should be established. This reform would increase professionalism within the industry by ensuring that those wishing to call themselves ‘financial advisers’ or ‘financial planners’ would be required to obtain PSB membership and adhere to its standards. An industry-based, independent PSB, working in conjunction with ASIC, would establish, monitor and enforce competency and conduct standards amongst members and have the power to sanction or remove those who do not comply. The Committee considers that such an entity would be more effective at identifying and addressing problems early, receiving better intelligence at industry level and not being constrained by meeting high legislative thresholds before taking action. ASIC would need to work in conjunction with a PSB to avoid duplication and overlap of their respective oversight functions.
Recommendation 10: Government investigate the costs and benefits of different models of a statutory last resort compensation fund for investors.
It was noted in the submissions that compulsory professional indemnity (PI) insurance regime provides only limited protection, and evidence to the Inquiry suggested that it is not suitable, or indeed intended, for such a role.
ASIC confirmed that ‘there are significant limitations on the effectiveness of PI insurance as a compensation mechanism for retail investors’. Insurance policies may exclude certain circumstances, depending on the extent of cover the insurer is willing to provide. Fraud is generally not covered and contracts do not apply where the licensee has ceased business.
The Committee recognises that the deficiencies of PI insurance make a last resort statutory compensation fund covering licensee wrongdoing appealing. There are, however, a number of significant issues that would need to be overcome in any scheme’s design. Capping payments would largely address moral hazard issues, but of particular concern is the very difficult task of formulating an equitable levy system that does not compel licensees with a cautious approach to cross-subsidise riskier activity. There are also concerns about the cost that would ultimately be passed on to consumers, and whether it would be justified by the protection it offers.
The Committee is of the opinion that more work is needed to determine whether a tailored statutory compensation scheme would be desirable and cost effective in Australia. This should include consultation with industry about how levy arrangements might be designed to ensure they are fair and equitable across the industry.
Recommendation 11: ASIC develop and deliver more effective education activities targeted to groups in the community who are likely to be seeking financial advice for the first time.
The Committee notes that ASIC is presently delivering a number of financial literacy programs via initiatives such as school curriculum-based programs and their own consumer information website, FIDO. While these are certainly useful approaches, the Committee is of the view that ASIC could be doing more to target key, higher risk, older demographic groups by promoting sensible investment messages, including through the mainstream media.
The Report is now in with the federal government to determine which of the recommendations it will adopt. The federal government has indicated that it will consider the Report together with the report of Jeremy Cooper into superannuation (expected in June next year). A further article in this newsletter, ‘Major inquiries to impact the superannuation system’ takes a more specific look at the impact of these reports and the Henry review on the superannuation system.
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