Conflicts of interest are one of the pillars of all financial services regulation. They were at the heart of the FoFA regulation in 2012, and they have recently been brought sharply back into focus by recent events – most notably the infamous standard 3 of the FASEA Code of Ethics, and the heated debate and eventual banning of stamping fees for LICs and LITs. The issue of conflicts and how we regulate them is inherently subjective, and in many ways represents a barometer of how the regulator and society views the financial services industry.
As of late there has been increasing uncertainty around the rules in this area, with FASEA’s Code of Ethics appearing to move the bar well beyond where ASIC had set it. Whether this is justified or not is in many ways a policy issue, but it certainly means that conflicts of interest are more relevant than ever to every financial services provider. On that basis, let’s unpack some of the main conflicts in financial services in the context of some of the most recent developments.
The conflict on conflicts
Never have conflicts of interest been at the heart of so much conflict. The issue, like a few others, stems from the fact the FASEA Code of Ethics appears to be inconsistent with established law.
The now infamous standard 3 of the FASEA Code of Ethics states that an adviser ‘must not act’ where an adviser has a conflict of interest or duty.
This is (arguably) in direct conflict with the established regulatory view, most directly illustrated in RG 181 where ASIC states:
“The conflicts management obligation does not prohibit all conflicts of interest. It does not provide that a licensee can never provide financial services if a conflict of interest exists.”
The ability to manage conflicts rather than avoid them makes a huge difference – and if standard 3 was interpreted to require the avoidance of all conflicts, including potential or perceived conflicts, it would represent a very significant change to our regulatory framework. My view is that FASEA’s latest response to these concerns firmly indicates it does not intend for the code to go this far, but the concern is certainly warranted.
The story so far
Back in 2012, when FoFA (and conflicted remuneration) was implemented, ASIC drew a line in the sand basically banning any product-based commissions and payments – but made some notable exceptions. Most notably, stamping fees on corporate deals and brokerage were excluded.
This is what created the now also infamous ‘loophole’ for LICs and LITs, whereby product commissions remained legal for listed products and not for unlisted – a loophole that was very recently closed when, after heated public debate and a lightning fast six-day consultation period, stamping fees for LICs and LITs were banned.
This outcome was at least somewhat driven by political and commercial interests, and was in many ways arbitrary. In the end, the banning of these fees was not so much closing a loophole as it was adjusting an existing one. If the climate was different, arguments could just as easily have been made to allow unlisted funds to pay commissions or, on the other hand, to end stamping fees for all securities (including company issues and IPOs).
The point of this is not to express a particular opinion on what the right outcome was, but to illustrate that the line of what constitutes an ‘acceptable’ conflict is hazy at best, and is constantly changing based on publicly held beliefs around the moral integrity of financial services providers. In many ways, LICs fell victim to the aftermath of the royal commission.
Let’s examine this in the context of stamping fees.
Are stamping fees fundamentally conflicted?
A stamping fee is a volume-based commission paid to an advisor or stockbroker for selling a particular security. As an example, let’s assume ANZ does a capital raising and agrees to pay all advisers 1 per cent of all securities those advisers manage to place with their clients.
For an adviser, a potential conflict now exists. Why do I say ‘potential’? Because whether it’s an actual conflict depends on the circumstances of the client.
It is easily conceivable that ANZ is a good investment for certain clients – it may be that a client has a growth portfolio with a significant allocation to blue chip high dividend stocks. Perhaps they already hold some ANZ and the issue comes with an attractive discount. This is an example where the interests of the adviser and the client are aligned – both benefit from the client making this investment. So, while the stamping fee arrangement here causes a potential conflict, there is in fact no actual conflict.
This distinction becomes very relevant when considering the impact of FASEA’s standard 3. The initial assumption was that the standard in effect banned all potential conflicts – and under that approach a whole range of currently legal fee arrangements would breach the code including, most notably, stamping fees on securities (not just LICs and LITs) and even potentially brokerage.
In their response to submissions issue in December last year, however, FASEA walked this back. FASEA said the code didn’t have the effect of banning any particular forms of remuneration, and noted:
“Standard 3 of the code is concerned with an actual conflict between duties advisers owe their client and any personal interest they have or an actual conflict between duties they owe their client and duties they owe another individual or organisation … The code does not seek to ban particular forms of remuneration, nor does it determine that particular forms of remuneration would always be an actual conflict.” (emphasis added)
While this certainly doesn’t alleviate all ambiguity around how the code fits in with existing regulation, the difference between avoiding a potential conflict and an actual conflict is vast – and makes adherence with the code very much around doing the right thing on a case by case basis, rather than making wholesale changes to the way advisers operate.
Can advisers be trusted to manage conflicts?
Let’s take another stamping fee scenario: this time we have a raising for small-cap mining company. The relevant client is middle aged and has a moderate risk profile. Their portfolio does include a small allocation to small cap equities, but the relevant adviser considers the investments they currently hold in this bracket to be at least as good as this company. A temptation exists here to sell down an existing small-cap to participate in the offer. In this scenario the adviser has an actual conflict of interest – and you are trusting the adviser to manage that conflict by passing on the offer and thereby also missing out on the commission.
Whether the average adviser can be trusted in this scenario is at the core of the stamping fee and conflicted remuneration debates. The recent ban on LIC stamping fees implies that the prevailing political/social view is that they can’t – and the temptation should just be removed.
In general, your view on the second scenario is a good way to assess where you stand on the conflicts and stamping fee issue. As someone who has worked with many advisers, my experience has been that the average adviser is not only morally equipped to manage this conflict, but is in fact strongly incentivised to do so. In the end, an adviser who does the wrong thing by their client won’t have that client for very long – and that’s before we even start thinking about AFCA (see my last piece) or other regulatory consequences. In that sense, every adviser has a very natural alignment of interest with their client which can go a long way to balancing potential conflicts.
Many would disagree with me, and the challenge for the industry is to start winning this debate in the forum of public opinion.
Nik Albrecht, director, Albrecht + Associates
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