Thanks to the royal commission, everybody is talking about vertical integration and in-house conflicts. We explain what this means and highlight four things you can do to manage conflicts effectively.
I’m a financial adviser. Am I conflicted?
Probably. Vertically integrated structures are pretty common in the wealth management industry. It’s not just the big banks that use them.
- Do you recommend financial products (including managed accounts) that are issued or operated by your licensee or corporate group?
- Do you recommend financial products that will give you, your licensee or your corporate group some type of financial benefit?
If you answered yes to either of these questions, congratulations! You’re conflicted.
So, is my business doomed?
No. Commissioner Hayne toyed with the idea of separating product and advice – known as ‘structural separation’ – but in the end he rejected the idea.
But don’t celebrate just yet.
While Hayne decided that it should be possible for advisers and licensees to manage in-house conflicts effectively, he was damning of the poor consumer outcomes caused by in-house conflicts in recent years.
We expect ASIC to scrutinise vertically integrated structures and in-house product recommendations this year. So advisers and licensees need to be able to demonstrate that they understand the conflict and can manage it effectively.
How do I do that?
You have to place your client’s interests above your own. In most cases, your client will have an existing product. So you should:
- Perform a comparative analysis of the pros, cons, fees, risks and benefits of their existing product v your in-house product; and
- Explain why your in-house product is better for your client than their existing product. It’s not enough to just tell the client you have a conflict.
In-house product recommendations will generally be inappropriate if:
- The benefits of the in-house product are lower; or
- The costs of the in-house product are higher.
The exception to this is if there is a clear justification for your recommendation. For example, if your in-house product addresses a specific client need or objective that the existing product doesn’t.
If you can’t easily explain why you’re recommending your in-house product, don’t do it.
Is that all?
No. You have to record all of this on the client file and explain it in the statement of advice. Most advisers don’t do this adequately.
If your advice is not properly documented and explained, you are effectively guilty until proven innocent.
So, what should I do?
You can demonstrate that you are managing your in-house conflicts by doing these four things:
- Properly research your client’s existing product;
- Link each recommendation to your client’s needs and objectives;
- Explain why your in-house product is better for your client than their existing product; and
- Record all of these things on the client file.
Simon Carrodus, senior associate, The Fold Legal
“you are effectively guilty until proven innocent.”
Absolutely true, but why is it so? How are financial advisers different to regular citizens? Why are we guilty first?
Also what is the standard of proof?
It seems as though, yes we are guilty until proven innocent and that the standard of poof is set as a moving target. An adviser could do all the things that Simon suggested, be absolutely convinced they are acting in the clients best interest – but some other ‘professional finds after the fact that there was a better option …. BOOM guilty. I’ve seen a remediation example where the adviser was deemed guilty (advice seemed reasonable and met the clients stated needs) but the ‘from’ fund subsequently performed better than the ‘To’ fund.Remediation calculated based on padt performance that the adviser had no foresight into at the time of the advice.
If I follow this, does this mean I can charge $5,000 for $100 of photocopying?
[quote]If your advice is not properly documented and explained, you are effectively guilty until proven innocent.[/quote]
What a great industry to be working in!
Enough is enough. Get off our backs. Journalists have been feeding off us for too long. What are you wishing for? The collapse of the industry? I received a telephone call from the Herald Sun asking me if I wanted to contribute towards an article to support my business and financial planners. The deal was that I would have had to pay for the privilege. What a joke. I have emailed a couple of journalists inviting them for a coffee in order for them to see what we actually do throughout a working day. No response because it would actually create a positive outcome for our profession.
Should have asked them to pay…
Any provider of professional services who charges a fee has an inherent and immutable conflict of interest. That does not matter how they charge or whether the service is legal, medical, or financial (or any other). Any that claim they don’t are, at best, ignorant; at worst, deceitful.
Close, but no cigar. In financial services, all services and products that have a cost are in conflict with the clients’ interest UNLESS the product or service used creates a greater benefit than its cost. Those who can’t understand that simple logical step are as you describe…
So if a solicitor takes on and charges for estate planning work when another solicitor is more experienced is that conflicted advice ? If a solicitor receives a success fee rather than fees for service is that commission ? Are both these examples of a double standard dressed up as professional practise ?
Philip that is much too simplistic. The example of insurance claim comes to mind.
I could charge a “no-win, no-fee” of 30% of an insurance claim payout.
The client benefits because they get 70% of something, rather than 100% of nothing.
It may very well be that it was an easy claim to win, but then the client didn’t know that did they?
The same example could apply to an extortionate flat fee too.
No, I agree with Phil. Your insurance claim is simplistic. If you charge $3K pa ongoing and only provide $1k benefit, then your have perhaps put yourself ahead of the client.
Price is only an issue in the absence of value. Only a client can determine the value to them. How do you put a price on what different clients value in terms of emotional comfort and peace of mind? Good luck calculating that – when it’s mainly what clients pay for
I agree, but not so sure that ASIC will.
You have a fundamental misunderstanding as to what a conflict of interest is. A conflict of interest is incredibly different to actively conflicting the clients interests.
A conflict of interest is unrelated to whether the client is put in a better or worse position, it is whether the service provider is in any way incentivised to provide a service that might not be appropriate to the client – the key difference being that you can be conflicted while still doing the right thing by your client.
Doctors can say you need to come for regular check ups when they are not necessary, lawyers can make mountains out of molehills and make recommendations knowing it will create more work for them.
Ah Simon, given your tips to so called managing conflicts of interest have been required Financial Advice Laws for a long time and the RC has not really added anything new that should always have been done.
What a complete load of waffle is your article and no matter how much extra Red Tape BS disclosure, regulation and rules are put in place – Vertically Integrated Advice simply can’t avoid conflicts of interest that prove far too great to provide unbiased Financial Advice.