Are we heading in the right direction?

While financial planners have requested changes to FSR rules, will the new proposals really make a difference? Lucille Bennetto takes a closer look.

At the public face of the industry there has been a positive response to the recently released draft regulations to amend the FSR legislation. Yes, improvement is always welcome - but is this really all that we can expect after at least 18 months of FSR?

The context of the proposed reforms made me wonder how much the Government has really been apprised of the details of the issues confronting planners. At the same time, in the light of recent public statements, one could have similar questions about Australian Securities and Investments Commission (ASIC).

The Government release stated: “Financial advisers will no longer have to give clients mountains of paperwork under plans unveiled by the Federal Government”. It also stated: “The draft regulations will also reduce compliance costs and provided the industry with greater certainty in complying with the law.”

Product offer documents

That these are completely optimistic statements can be demonstrated by understanding the practical application of the current regulatory requirements. One of the biggest problems in the industry is not the Statements of Advice (SOA), but the length of the Product Disclosure Statements (PDS). At present, the average appears to be between 40 pages, up to around 70 pages.

Place this in a typical advice example, where an adviser may recommend investing in a wrap platform. The client will receive a Statement of Advice of around 15 pages, plus the Product Disclosure Statement for the wrap. If you assumed 45 pages for the PDS, then the client is receiving a document to explain a product which is 3 times the length of the actual comprehensive financial advice the client will be given!

And if that is not enough, the client will, when investing into a wrap, have to receive the PDS for the underlying products into which investment is made. A client making, say 6 different investments through a wrap would, assuming the underlying product disclosure details ran to only 10 pages each, receive a further 60 pages of documents. In this example a client would be given a total of 120 pages of information!

The fact is that planners have been trying to deal with a problem imposed upon them within this industry, the problem being the length of the product offer documents. To that extent, they have endeavored to manage the client’s interests by reducing the volume of paperwork.

The solution has been taken to be that appearing as Proposal 3 of the proposed reforms, and which will allow product issuers to provide a short form PDS.

Fund manager responsibilities

The fund managers need to re-evaluate their own responsibility for producing client focused documents. Yet they need not have waited until this proposed Regulation to do so, for the law itself has never required the degree of repetitive information and level of detail that the “legal sign off” process has imparted into the size of product brochures. The current law is not prescriptive, so there is no current underlying requirement that the document should be so long.

In actual fact, the length of offer documents has increased over the years, mainly for two reasons. The first reason is that the risk fear in due diligence and legal sign off processes have overridden the most important factor (which both the legislation and ASIC require), namely that the document is likely to be read by the ordinary investor - and understood.

The second, and less important reason is that major fund managers have, for reasons of cost, combined a number of products into the one offer document.

Accordingly, the funds management industry must start to take responsibility for the part it has to play both in consumer issues, and in the problems of financial planners. The Government has proposed, by Proposal 3 to Schedule 3 of the proposed changes, to allow a “short form” PDS to be issued.

It is up to the funds management industry to take a practical and a more proactive approach to the content of all consumer documents, if this proposed amendment is to have any practical benefit.

SOA proposals

The second major proposal of the reforms will enable financial planners to avoid providing advice in the format of a Statement of Advice where the advice given is subsequent to previous advice given in the SOA format.

However, this exemption will only be available if:

• the client’s personal circumstances are not “ significantly different”;
• where the advice isn’t based on the client’s personal circumstances; or
• the basis of the advice has not changed significantly in the interim period.

What does this all mean? Firstly, what does “significantly different” mean in relation to a particular client? The natural meaning would be that there are no important changes in the client’s circumstances. This leaves us with subjective words, without any guidance. Who determines whether there have been any important changes? The client or the adviser?

And if it is the adviser, on what basis should he or she determine that there have been no significant changes? All that the adviser has to provide some form of guidance is an entirely subjective test, requiring a value judgment to be made by the adviser.

Basically this relief would therefore appear only to obviate the need for an SOA for standard ongoing review situations - where basically it is a portfolio review. However, even in these circumstances the relief may not help.

Basis of advice

If the advice now given is based on something other than the client’s relevant personal circumstances, the basis of the advice also must not have changed significantly. What if the advice being given relates to an existing investment portfolio, and the particular markets, into which the asset allocation of investments were addressed in the original SOA, have suffered negative performance? One can say that the basis of the advice originally was about asset allocation. It is then probable that a full SOA will still be required, because it could be argued that the decline in particular sectors of the asset allocation is “significant”.

The Release said: “there is no intention to define in the legislation what constitutes a ‘significant’ change…what constitutes a significant change in circumstances may vary from one client to another…it will therefore be up to advisers to determine”.

It is a sign of a mature industry when we can rely on “principles” based legislation to work for us, rather than suffering a prescriptive approach being applied. Yet how can it be said that is it working for us, when what has just been released creates more confusion for the financial planning industry? It is contrary to the stated aim of “providing industry with greater certainty”.

Administering the law

ASIC will no doubt in due course release an indication setting out how it intends to apply the proposed changes. But why can’t we just have law that enables each of those who have to apply it, to be able readily understand it, and to know when and how it applies? Otherwise we remain an industry entirely dependant upon ASIC’s view of the advice industry, and dependant upon an organisation which is only meant to apply the law, not to make it in a de facto sense.

Not only is that a quasi delegation of de facto law making powers, but in practical terms it leads to inappropriate outcomes. A recurring issue of late has been that ASIC has demonstrated a negative view of the way in which FSR has been applied by the financial planning industry.

Not only must one wonder how fully the Government, through the limitations of its reform proposals, understands the way in which financial planners operate, but the same concerns arise in relation to the organisation responsible for administering the law.

Of course it is natural that the staff in ASIC dealing with financial services compliance suffers from the same “occupational hazard” which we all encounter in our professions. A doctor only sees people who are ill, a lawyer may only see people in trouble. This tends to influence our views of the world. To put it simply, there aren’t any clients of planners out there who are contacting ASIC to say what a good job a particular financial planner has done. Under these circumstances, it is understandable that the collective view of staff at ASIC may unfortunately demonstrate a negative, but incomplete, view of compliance by the financial planning industry.

And ASIC, in determining where to apply its scarce resources, is naturally only going to focus on planners whom it has segmented as likely to have compliance issues.

What the public has had from ASIC in comment has been construed and repeated as negative comment for the industry. Even just recently Prof. Berna Collier gave a presentation to IFSA members on 5th October2005 “Wealth Management and Advice - the way ahead.” A rather broad statement was made during that address:

“In 2005…there is considerable unmet need for quality advice”.

This then becomes what gets reported out of her address? On the following day in the Financial Review the article by Barrie Dunstan bore the large heading “ASIC seeks planners help to iron out problems.”

Professor Collier then went on to define quality advice, as “advice provided by a skilled professional in a disinterested manner in the interests of a client”.

Let us focus on her words “considerable unmet need”. We should not accept this without requiring further explanation from ASIC. In the context of the thousands of persons operating as Authorised Representatives throughout Australia, what percentage of failure in giving advice becomes the threshold for saying that there are continuing failures within the industry? The reality is that in any profession there will always be a certain number who do not meet the required standards. But if it is going to be alleged that there is “considerable” failure within an industry, then the criteria for saying that the incidence of examples of failure has crossed the threshold beyond an expected level needs to be explained.

And as to the test of quality advice - the “skilled professional” test should not be in doubt since the PS 146 requirements ASIC has imposed means that higher entry standards have been required to become an Authorised Representative.

And where are the statistics that support the assertion made in the speech? In its recently released 2005 Annual Report ASIC indicated that it banned only 25 people from offering financial services. Maybe the answer is that these statistics don’t tell the true picture of what ASIC has seen and done.

The best indicator of how the industry is performing is in the Financial Industry Complaints Resolution Scheme, it placing no time or cost barriers against people complaining, and being so well publicised. Yet if we look there to see if this supports the view of the industry held by ASIC, the figures show that the number of actionable complaints fell almost by 50% since 2004. Indeed, FICS reported earlier this year that the number of complaints against planners had significantly declined over the past 2 years.

ASIC has invited IFSA and FPA to work collaboratively with it in order to address the problems which it sees exist. One would hope that as part of that process ASIC provides hard data and objective analysis in order that we may understand why it perceives the problems to exist. Of equal importance too will be the dialogue which must take place regarding the proposed reforms.