Abolish the SOA
The current disclosure regime governing financial advisers is misguided and does not solve underlying conflicts of interest. Fundamental reform is required.
The obligation to provide an SOA came into force more than 15 years ago. Since then, there has been a continuous debate about the extent to which conflicts of interest that arise from institutional ownership or alignment of financial advisers should be disclosed in SOAs.
Conflicts of interest are important because they lead to bad outcomes for clients. The present system allows institutionally-owned or aligned advisers to act as a distribution channel for product issuers. In my experience the conflicts of interest that underlie this arrangement lead to clients being improperly switched from one product to another or being advised to purchase too much of a product including being advised to borrow to make the investment.
Product switching imposes unwarranted transaction costs upon clients, but its adverse effects can be particularly severe where clients lose the benefits of their existing insurance coverage as a result of switching from one product to another. Similarly, buying too much of a product, particularly where borrowing is involved, can lead clients to have disastrous outcomes.
In this context, the current framework that applies to the management of conflicts of interest that derive from the institutional ownership or alignment of advisers is deficient in at least four respects.
First, disclosure of conflicts of interest does not solve the underlying problem about whether an adviser should be providing advice. An adviser that has a conflict of interest is either able to provide appropriate advice in the context of that conflict or they are not. This is a decision that an adviser should personally have to make each time that advice is provided. Instead, advisers are allowed to disclose actual conflicts of interest in an SOA and leave it up to the client as to whether the advice should be implemented. In this way, responsibility for resolving issues about conflicts of interest is improperly transferred from the adviser to the client.
Second, the disclosure of conflicts of interest is a sham process on multiple levels. Actual conflicts of interest are disclosed in an SOA in the full knowledge that it is most unlikely that a client will read the disclosure and if they do that they will understand the effect of what is being disclosed to them. Clients see advisers because they want financial advice. Clients view the SOA as being a document that sets out financial advice. Clients don’t realise that in some contexts an SOA’s primary purpose is to disclose actual conflicts of interest that the client must consider and then form their own view as to whether they will implement the advice in the light of those conflicts.
Third, the obligation to provide an SOA derived from the view that conflicts of interest resulted in poor financial advice being provided to clients and that the way to resolve this issue was for conflicts of interest to be disclosed to clients by way of an SOA. The SOA operates as a way of avoiding the real issue, which is that business models that create an actual conflict of interest between an adviser and their client should be prohibited. An extraordinary irony of the current system is that I can see doctor about literally matters of life or death and I do not have to receive written advice, but if I consult a financial planner about even the most mundane of topics I have to pay for an SOA to be provided to me. The result being that I have to pay for a document that I don’t want or need so that I can be informed about the conflicts of interest that underlie my adviser’s business model.
A second level of irony is that the costs associated with preparing SOAs is a major reason why people do not obtain financial advice, with the result being that many people who would benefit from receiving financial advice do not obtain that advice. A third level of irony is that the costs associated with the production of SOAs create a commercial advantage for advisers who can subsidise these costs from fees generated from the sale of financial products. It is a perverse outcome of the current system that independent advisers are placed at a financial disadvantage because they have to comply with regulatory obligations that relate to a different business model that has inherent conflicts of interest.
Fourth, the purpose of the SOA has become distorted. The SOA is meant to benefit clients by disclosing to them matters that it is assumed that they need to know about before implementing advice. Instead, it has become a means whereby advisers at the clients cost can set out disclosures and disclaimers that are designed to make it more difficult for clients to recover compensation from their adviser for the consequences of bad advice.
The combined effect of these factors being that clients pay for an SOA that they are unlikely to read or understand, the purpose of which is to disclose the existence of conflicts of interest that should have been avoided. In addition, clients pay for an SOA that can be used as weapon against them should they get into a dispute with their adviser.
The solution to these problems lies with the abolition of the SOA.
An adviser should be free to document their advice in whatever way that they and their client think is appropriate in the circumstances and in a manner that the client is willing to pay to have done. With respect to conflicts of interests, the solution lies in the abolition of the use of disclosures as a mean of managing actual conflicts of interest. Each adviser should be under an obligation to form their own view, given the conflicts of interest that are inherent in their business model, as to whether they can provide advice to a client and comply with their regulatory obligations.
If the adviser gets that decision wrong, the adviser and their licensee will bear the consequences in terms of litigation and regulatory risk. Advisers and their licensees should not, on the basis that the conflict of interest has been disclosed in a SOA or some other document, be able to operate under a business structure that creates an actual conflict of interest between an adviser and their client.
David Huggins is principal of Huggins Legal and is a lawyer specialising in financial services litigation.
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