New rules light dark corners

Financial planning in Australia has a colourful past. And right now, the advice industry is gearing up for a legislatively driven bright future.

Under a twin set of laws, dubbed the Corporations Amendment (Future of Financial Advice) Act and the Corporations Amendment (Further Future of Financial Advice Measures) Act, the Labor government has rewritten the rules governing the historically asymmetric adviser-client relationship.

Ostensibly designed to empower consumers, the Future of Financial Advice (FoFA) package, which passed into law on June 27, imposes hefty new responsibilities on advisers while also sweeping away a multitude of controversial practices defined by the label “conflicted remuneration”.

There is an important caveat in that many of the FoFA measures apply only to new clients and/or new business written by advisers after the regime came into force on July 1. The industry has also been given a one-year transition period before full compliance starts in July next year.

But many clients will soon feel the tangible effects of the FoFA revolution, according to a partner and financial services specialist at Sydney firm Argyle Lawyers, Peter Bobbin.

“They’re going to be getting lots of paper,” Bobbin says.

He says FoFA is “forcing advisers into new terms of engagement with clients”, whether either party wants it or not.

As a result, advisers and financial services firms are furiously rewriting client contracts and product materials to reflect the FoFA changes. “That’s what I’m spending a lot of time doing now,” Bobbin says.

A critical issue driving the paperwork, he says, is the requirement under the new law for advisers to always act in the best interests of their clients.

While the best interests clause falls short of the fiduciary standard some industry critics had been calling for, the clause nevertheless puts advisers on an unprecedented legal footing with their clients.

“Planners are saying, ‘OK, I will consider your best interests but you have to tell me everything I need to know’,” Bobbin says.

“They’re seeking to limit liabilities . . . which is not unreasonable.”

However, he says if history is any guide, most clients will ignore the new fine print.

“Unfortunately, most people won’t read the agreement but they really should, to understand the new terms,” Bobbin says.

The best interests requirement and an obligation to supply annual fee disclosure statements to clients will both become mandatory across the board from July 1, 2013.

Other important aspects of the legislation, though, may just apply to clients signed up by advisers after they begin to formally comply with FoFA (until July 1, 2013) – the ban on conflicted remuneration, such as commissions on investment products and the controversial “opt-in” clause, requiring clients to renew adviser agreements every two years if they are paying recurring fees.

The FoFA cut-off point could create the situation in which advisers in effect are servicing two classes of client, subject to different standards. But Bobbin says several factors may mitigate against the drift to duality.

First, he says many advisers may choose on ethical grounds to treat all clients equally. And if not on principle, Bobbin says others may prefer to apply the full FoFA rules to all clients for the banal reason of administrative simplicity.

“It just might be easier [for advisers] than running multiple systems,” he says.

Other natural forces could also convert a pre-FoFA client into post-FoFA mode. Bobbin says that if a client changes the nature of service leading to the creation of a new legal entity, such as the decision to set up a self-managed superannuation fund, that will trigger the full FoFA treatment.

As well, he says the new regime is likely to result in a number of advisers, mostly those approaching retirement, selling their clients, who will then be treated as new clients by the buyer and therefore subject to all FoFA rules.

Finally, Bobbin says clients can also ask their advisers to switch on the FoFA rules.

“There’s no reason why clients can’t say they want [FoFA] to apply to them,” he says.

The chair of consumer rights body Choice, Jenni Mack, encourages the clients of financial advisers to press for equal rights under FoFA.

“If a consumer is in an existing advice relationship, they should tell their adviser that they want to agree the terms of [their] relationship every year,” Mack says. “This should prevent consumers paying for services they don’t receive.”

Mack says that if current clients don’t ask, the benefits of FoFA will be limited to the annual disclosure notice “which is a shadow of the original proposal”.

“The disclosure notice is now only a forward estimate of fees and does not include commissions, so existing clients will find it harder to know what they have actually paid,” Mack says.

Choice also advocates that all clients negotiate flat or hourly-based fees with their financial planners rather than fees calculated as a percentage of assets.

“Consumers should tell their adviser that they do not want to pay asset fees,” Mack says. “Consumers should ask if they can pay by hourly rates or an agreed amount for advice.

“Consumers should ask if they can pay the amount over time rather than a lump sum.

“The biggest thing to be aware of in the FoFA world is ongoing fees. We do not want to be in a position in five or 10 years where we find that ‘ongoing fees’ have replaced commissions.

“Ongoing fees have many of the perverse effects of commissions. Importantly though, consumers can stop ongoing fees, and this is a huge advantage.”

The transition to a flat-fee world, however, won’t be that easy, as commissions on existing investment products will continue for the life of the product regardless of FoFA. And not even Choice is advising clients to switch blindly into new investments merely to avoid paying commissions.

“We have not yet done a comprehensive review of the costs to consumers of exiting such products but [we] do suggest consumers seek advice,” Mack says.

“Past research suggests that the longer-term costs of holding commission-paying products will outweigh the costs of exiting but the exit costs may be high in the short term.”

The principal of Sydney financial advisory firm Plaza Financial, Peter Hogan, says that switching investment products can be an expensive process for clients, given the inevitable tax consequences and also possible loss of product benefits.

Hogan, who also doubles as a senior technical consultant at MLC Technical Services, doesn’t expect that advisers will face a huge demand to switch products as the final FoFA deadline looms. However, he says advisers should be addressing the impact of the FoFA changes as part of regular client reviews in the year ahead.

“I don’t think clients should be calling up their advisers immediately and demanding to know what they’re going to do about fees,” Hogan says. “But [in reviews] advisers should be discussing how they intend to provide advice on an ongoing basis.

“Advisers have to start articulating their value proposition as they’ll have to lay it all on the table in two years [when the first ‘opt-in’ renewal is due].”

Bobbin says clients must understand the nature of the new deal. He says that while FoFA does demand a greater level of engagement between advisers and their clients, it also allows advisers to offer limited or one-off advice – “scaled advice” in FoFA jargon – under different terms.

“It’s part of the choice concept – that clients should only be paying for the services they want and are appropriate,” Bobbin says.

“Clients have to understand if the service they are receiving is what they need – is it enough, is it too much?”

• Tweet