When can advisers recommend a switch to an in-house product?

ASIC has determined that conflicts with in-house products do exist

In its Report 562, ASIC looked at the big five financial service institutions – CBA, Westpac, ANZ, NAB and AMP – and found that 68 per cent of their client’s funds were invested in in-house products. Looking at 200 files where clients switched from external to in-house products, ASIC found that 75 per cent failed to demonstrate compliance with the best interests duty (i.e. the safe harbour). Around 10 per cent of those files contained advice that left the customer significantly worse off.

In many cases ASIC found that the client’s original product was perfectly capable of meeting their needs and objectives, and so replacing them was ‘unnecessary’.

It would be naive to think that such conflicts only occur at the big end of town. The same conflict affects many small to medium-sized advice businesses (including those that use managed accounts). We know that ASIC’s managed account project is focusing on a number of issues including fees, suitability and – you guessed it – conflicts!

Can financial advisers still recommend in-house products?

The conflict priority rule is an important element of what ASIC calls the ‘best interests duty and related obligations’. It requires a financial adviser to prioritise the interests of their client above their own interests and the interests of their licensee or corporate group. The royal commission made it clear (if it wasn’t already) that a conflict arises whenever a financial adviser recommends an in-house (or related party) product.

While in-house product recommendations are not prohibited pursuant to the Corporations Act or the FASEA Code of Ethics, advisers need to take appropriate steps to prioritise their clients’ interests above their own. It’s not enough for an adviser to merely disclose the conflict. The adviser must explain why the in-house product is likely to leave the client in a better position and how it is more likely to satisfy the client’s needs and objectives (versus the client’s existing product).

This explanation should be captured and properly documented as part of the advice process. The message from ASIC is clear – if it’s not documented on file, it didn’t happen. In Report 562 and Report 515, ASIC pointed to the fact that often there was nothing on file to demonstrate that the adviser had complied with the best interests duty (and related obligations). So, even if the adviser hadn’t breached the law, there was no evidence that the adviser had complied with the law.

What if an in-house product isn’t appropriate?

An in-house product isn’t going to be appropriate for every client that walks in the door. When this occurs, the adviser has three options:

• Research other financial products that may be more appropriate for the client;
• Refer the client to another adviser who can help them; or
• Politely decline to advise the client.

When should an adviser consider switching a client to an in-house product?

If a client has an existing product, you may consider recommending a switch to a new product (including an in-house product) if it is in the client’s best interests to do so. A good time to consider a switch is if the client’s existing product is inappropriate for them, taking into account their needs and objectives.

However, if the client’s existing product is appropriate for them and capable of meeting their needs and objectives, it will be difficult to justify a switch.

Before you recommend a switch to an in-house product, you should:

• Properly research your client’s existing product;
• Conduct a comparative analysis of the existing product v the in-house product. You may consider including a third (external) product that is capable of meeting the client’s needs and objectives. This gives your client a better idea of the options available to them and the pros, cons, risks and costs of each option; and
• Capture your research on the client file and summarise it in the statement of advice.

Generally, it will be difficult for you to justify a product switch if:

• The benefits of your in-house product are lower than the client’s existing product; or
• The costs of your in-house product are higher than the client’s existing product.

The best recommendations are usually easy to explain. If you are struggling to justify or explain your recommendation to switch to an in-house product – stop and reconsider it.

Simon Carrodus, solicitor director, The Fold Legal

Adrian Flores

Adrian Flores is a deputy editor at Momentum Media, focusing mainly on banking, wealth management and financial services. He has also written for Public Accountant, Accountants Daily and The CEO Magazine.

You can contact him on [email protected].