Diversification is one of the “fundamentals of financial planning”, the Australian Financial Complaints Authority (AFCA) said, and putting the blame on advisers who fail to uphold this is reasonable.
A key part of the push to include managed investment schemes (MIS) in the Compensation Scheme of Last Resort (CSLR) has been related to financial advisers paying the bill for what are essentially product failures.
While far from the first time the Financial Advice Association Australia (FAAA) had made the argument, in a submission to the Treasury review of the CSLR, the association singled out the inclusion of MISs as particularly important.
“At the core of what has gone wrong, are issues directly related to the development and promotion of in-house investment products that were poorly managed, with unacceptable levels of conflicts of interest,” the FAAA submission said.
“This is compounded by insolvency laws that favour corporations over consumers, resulting in the CSLR creating a moral hazard for the profession, in that the consequences of poor behaviour are not borne by those who have perpetrated it, but by those who are innocent of wrongdoing.”
During AFCA’s member forum on Thursday, Alexandra Sidoti, senior ombudsman – investments and advice, said despite the issues with the products, what the complaints authority is “fundamentally observing are advice failures”.
“A product failure is never a good thing. It’s not good for the financial firm. It’s not good for the consumer,” Sidoti said.
“When there’s a product failure, though, and that’s maybe 5 per cent of a person’s portfolio, that’s not going to have a catastrophic impact on someone’s superannuation funds. The issue that we’re really seeing here is a complete lack of diversification, and that’s an advice issue.”
At the heart of the problem, she added, is that advisers are not taking into account the client circumstances when they walk in the door.
“At the time of providing advice, they’re not thinking, what’s this person’s attitude towards risk? What are their objectives? Are the recommendations that we’re making likely to meet the client’s objectives? Sidoti said.
“Fundamentally, we’re seeing at times 100 per cent, as I said, of someone’s investment funds going into a single product. If that product then fails, that’s 100 per cent gone. Sometimes it’s not as high as 100 per cent but still, 50 per cent, 60 per cent, 70 per cent – really high volumes.”
She likened the issue to another trend that saw self-managed super funds (SMSF) linked with direct property through “one-stop shops” that had an advice arm, a real estate arm and accountants.
“The financial advice was consistently for people to establish an SMSF and go into a direct property. A lot of the time, these people had maybe 200 grand combined in their superannuation. You then use that for one direct property investment, and you’ve got all of your risk in a single asset,” Sidoti said.
“It’s that fundamental lack of diversification, which is just one of the fundamentals of financial planning.”
Shail Singh, AFCA lead ombudsman for investments and advice, added that while there have been a total of 201 funds frozen this century, “not all of those are actionable against the adviser”.
“It’s a really important point. So, for example, if people put someone into a mortgage fund for 5 per cent, it was suitable to their portfolio, and there was no information to show that that fund was not going to perform – the adviser’s not responsible for that sort of conduct,” Singh said.
‘Don’t expect advisers to have a crystal ball’
According to the complaints authority, it is not singling out advisers for product failures if their advice process is sound but something unpredictable happens.
“One of the things we consistently say is we don’t expect advisers to have a crystal ball,” Sidoti said.
“I think one of the best examples of when we saw a lot of this was with the agribusiness post-GFC. There were a lot of people invested in agribusinesses, there were certain tax benefits associated with that. When the GFC hit, a lot of these agribusinesses failed.
“We saw a lot of complaint volume at that time, but quite often that didn’t result in a finding against the adviser, it would really depend on the proportion of someone’s portfolio that was exposed to that particular product and whether that level of exposure was problematic, rather than the fact that the product ultimately didn’t perform, because there’s always risk.”
This, Singh added, highlights the role that financial advisers play as a “gatekeeper” there to protect their clients.
“Most do a fantastic job at this,” he said.
“But as we’ve highlighted, there are business models that are problematic. Generally, they’re vertically integrated. Generally, it’s conflicted remuneration, and these continue to exist.”
Speaking at the FAAA Roadshow in Sydney on Thursday, chief executive Sarah Abood reiterated the association’s stance that these product failures are “at the heart of every case that has gone to the CSLR so far”.
“Product failure is being redefined as advice failure, because if it’s an advice failure, the client will get compensation. If it’s a product failure and the product provider has fallen over, the client gets nothing,” Abood said.
“So, we’re seeing a lot of work happening behind the scenes, many groups organising to redefine what they do as advice failure. We’re really concerned about that. We think it’s really important that MISs should come into the scheme.”
Also speaking at the roadshow on Thursday, FAAA general manager policy, advocacy and standards Phil Anderson stressed that the “real pain is being experienced” because of in-house or related party products that fail.
“Why are advisers paying for product failures? The reality is that the law allows for where there’s advice failings for the adviser to take the full pay,” Anderson said.
“The CSLR doesn’t even include managed investment schemes. So, there’s more than one reason why we end up paying for everything. We want the scheme to be genuinely last resort, not first resort.”
So going by the logic of AFCA regarding asset allocations, where does this leave the industry super funds who label their product as a balanced portfolio, yet the real asset allocation is high growth? Can every member of that fund now claim for any loss?
Let’s not blame the Adviser here…the problem lies deeper.
These firms lure the new Adviser in like a spider with a web of promises of better working conditions, perhaps the transition from paraplanner to Adviser or a pay rise and a change…..The Adviser once trapped, frequently has no choice but to hang around for the next 9-12 months until a new employment opportunity arises. In the interim, they sell XYZ inhouse product.
I agree with the earlier comments that the Licensess are in fact the gatekeepers. Having said that, it is very easy to obtain an AFSL and become self-licenced – that is part of the problem. I know everyone hated “vertical integration” and large licensees but the fact is that these institutions actually do protect consumers and, under their watch, yes, when a product failed, clients lost some money but the diversification that was in place stopped these sort of disasters occurring. I also have the view that SMSF’s should be banned and only APRA regulated funds should be approved – far to many gullible consumers get sucked into a SMSF because it is just too easy and the shonks and crooks know this.
How exactly did the vertically integrated advice/product licensee Dixons protect consumers from Dixons inhouse product failures?
The problem with AFSL licensing is not whether it’s easy or hard to obtain, it’s whether that licensing role is abused to sell inhouse products. Self licensed advisers are generally better for consumers because they are less likely to have inhouse products.
Advice conflict from investment/super commmissions and kickbacks have pretty well been eradicated by legislation. But the advice conflict of inhouse products has been enshrined in legislation.
Brilliant. So because some people don’t have the aptitude to have an SMSF, then ban the whole industry. Good grief.
Cool – so does this mean that some of those ‘index balanced’ options could be considered ‘undiversified’ given the concentration risk of capitalisation weighted indexing?
Advisers are NOT the gatekeepers. ADVICE LICENSEES are the gatekeepers. Advisers are beholden to their ADVICE LICENSEE. The fatal flaw in all of this is that advice licensees can also be product licensees. When that happens their role as gatekeeper is totally conflicted.
AFCA is trying to punish innocent advisers for the unbelievable stupidity of our advice regulations.
Correct. If it is advice failures hold the advisers that failed their duty to account. Clearly ASIC believe this is a licencee failure due to conflicted business model but that just leaves the beneficiaries of the advice failures not only whole but we (the advisers) making their current fee paying clients whole. Even better one of the key executives of the licencee sits inside treasury dept responsible for financial advisers. I want to see the people actually responsible held to account not just swept under the rug and all advisers carrying the can.
Not sure if I believe these comments from AFCA. If the majority of the advice failures involved advisers recommending 50-100% allocations to a single, high risk investment, which failed, then surely they would be referred to ASIC and we would be seeing mass bannings. But we are not seeing that. So something is a bit off with these comments
Here’s the problem with AFCA, CSLR and Dixon.
Only Dixon DASS licensed advisers had access to the failed Dixon URF product.
No other authorised representative of any other AFSL was able to access any Dixon products
So why are non-Dixon advisers forceed to pay a levy for a product failure that was vertically integrated.
And why should RISK ONLY advisers, who do not advise on investment or superannuation, have to pay the Dixon levy
This whole episode has a smell to high heaven as my mother would say. It stinks !!
Isn’t ASIC also charging and responsible for oversight of the ASFL’s?
Tell me why my thinking is wrong or maybe I’m young and naive: We can all get upset, why should we pay for the wrong of others, why should we all be punished? Personally, I think you will never ever change these people’s mind they’re power-hungry narcissistic government employees at the end of the day. Protesting and taking a stand is great, not backing down is great. Personally, I’m trying to control the things I can. I am waiting for a systemic problem to happen with an industry fund, or huge index provider for all the lies to become apparent. John 8:32 And you will know the truth, and the truth will set you free.
They are not government employees.
Government guaranteed Non Government organisation?
If they are not Government employees, then what a business model – no other business can establish itself to compete and Advisers have to pay – by law or regulation?
AFCA & CSLR prove a complete lack of PROPORTIONATE LIABILITY to dodgy MIS failed products.
AFCA prove they are a Kangaroo court, making up their own legal rules.
Proportionate liability is a legal principle that limits the amount of compensation a defendant pays if they contribute to a loss caused by multiple parties.
IT CANNOT BE ANY CLEARER THAT FAILED MIS PRODUCTS are a major contributor in these client losses.
Yet AFCA & CSLR apportion Zero liability to these failed MIS.
Morally wrong & LEGALLY WRONG TOO.
And ASIC should be stopping dodgy MISs before they are even allowed onto the market. But all those lawyers keep pretending that they understand investment products.
Just stick to plain vanilla large, diversified, preferably lower cost, fund options, when implementing strategies that are aligned to clients financial goals, and you will be fine. And you will still incur a CSLR levy for advisers / institutions who don’t do the “right thing”. Makes sense.
What if, a client wants more than “fine”.
There are any number of fine call-centre officers at the various super funds.
Maybe, we professionally qualified advisers should separate ourselves from these fine people.
I agree with you 100% but, damned if you do, and damned if you don’t. Heads or tails, we lose (pay levy, get gaslit, crucified, sent to re-education camps etc.) unfortunately.
Yes, there are a number of these funds – large exposure to unlisted property assets, great returns over loads of time frames and some have low fees – what could possibly go wrong? But it does seem like there is a biased from many regulators that anything but is risky and will be blamed on the Advice? Does these “plain vanilla large, diversified, preferably lower cost, fund options” come with a guarantee?
Not wanting to be seen as sucking up to the regulator here, but I do believe that there are advisers who do not diversify enough and find that when a particular investment fails, it damages the entire portfolio.
I was always fighting my former institutional employer around this by using core satellite investment approaches for my clients wanting to offset the downturns where active managers add value to the growth periods when passives add value.
If AFCA is not holding advisers with robust and sound reasoning to account for product failures good, but they should be noisy about it.
Also the CSLR is about BAD Advice, not bad products and if the product was part of a Well Diversified portfolio that is reasonable given the clients needs and objectives, advisers should have nothing to worry about.
But as you say, you had to fight your institutional employer. You may have won that fight, but many advisers don’t have the power to fight their employer or licensee. The employer determines whether you keep your job or not, and the licensee determines the compliance rules for the organisation. If that employer or licensee is also a product company, they have enormous financial and legal power over the adviser to influence product recommendations.
AFCA is punishing the powerless, not the real source of the problem.