How to start in an area that is so little understood, even by those who set out to regulate or administer the laws of advice?
Let’s start in a place called Mar-a-Lago, a Donald Trump owned private club in the salubrious Palm Beach in the good ol’ US of A. The cream of the local socialite set are gathered for a fellow magnates’ 60th birthday party.
Seated at one of the elegant tables was Robert Jaffe, an investment executive linked to Bernie Madoff. Madoff’s global ponzi scheme had recently been exposed and one of his victims, Jerome Fisher, walked into the ballroom to attend the birthday party. He spotted Jaffe at a table and commenced vent ing some of his anger at losing large amounts of funds. All of this is from the brilliantly written Vanity Fair article, Madoff’s World by Mark Seal. Here is the part that we are interested in. It is too brilliant to paraphrase, so i’ve taken the following quote directly from the article…
“..Fisher had a “few bucks” – reportedly $150 million – invested with Madoff through his friend Jaffe. When Fisher spotted Jaffe that night at the party, he exploded. “I was sitting at the next table, and i will tell you Jerome Fisher went wild,” said one guest. “I mean this guy Jaffe got him into the deal to start off with, and on top of it he got a commission. And Fisher didn’t know about the commission. Fisher was screaming, ‘What the hell are you doing here! And you got a f**king commission – a point and a half-on me!’ And he let out a roar at this guy that was unbelievable.”
It is not hard to sympathise with the fellow in the story. He has lost a considerable sum of money in a scam, and finds out that the person who introduced him to the “opportunity” received a secret commission for doing so. The lack of disclosure of the existence of that bias is the additional hurt that is added to the financial loss.
Although this note starts in the United States, it is really only about the provision of advice system in Australia. Here we have very clear laws on disclosure and a strong enforcement regime. It includes the requirement to state any commissions or incentives that may be received either directly or indirectly, and specifically notes the limited conditions under which an advisor is able to call themselves “independent”.
However, it all falls down when we look at how the interplay of legislative intent, due process and commercial imperatives actually works in the real world.
Let’s start by making an assumption that independence does not guarantee lack of bias. This has been covered elsewhere but it is an important starting point.
Now we ask ourselves if the disclosure of bias will help us (i am using a version of the Royal “We” to make my article more comfy and inclusive) to make a valid decision in regards to some advice that we have received? The assumption we will go with is that it does help. We will assume that full disclosure of the bias will enable us to determine whether there is an influence outside of the confined definition of our best interests that should be taken into account when deciding whether or not to proceed with that advice.
Let’s say that you go to a financial advisor and you seek a direction on some investment. The advisor has recommended that you invest in The Great Big Fund (which i will refer to as “the GBF”), and points to the various benefits and advantages of doing so. As required, the advisor discloses that they will receive a commission or fee for directing you towards that fund. They point out that the GBF has an envious track record, winning various industry awards and topping the lists of performance charts put together by independent research houses. They record the characteristics of the GBF and how these relate to your personal finances, setting out the pro’s and con’s along with how the GBF will provide the answers to your identified investment objectives. All-up, a fairly compliant illustration of an advisor/client interaction.
There could be a piece of wording in amongst the D&D section (Disclosure and Disclaimer) of the confirmation correspondence that points out that the advisor’s licence provider may receive volume or marketing benefits from the placement of various types of business from various service and product providers.
It would be usual for the prospective investor to not even notice that wording in amongst the trailer-load of disclosures and disclaimers that are required to be made when confirming even a relatively basic financial plan.
So there is very little chance that the average investor would have time/be interested/ consider to even think about just what all this may mean.
It actually means quite a lot.
Perhaps it is best approached by looking at just who hands out the licences for the vast bulk of financial advisors in Australia. It is predominantly businesses associated with the major banks. You see, some time ago Australia introduced compulsory superannuation. Banks worried about losing some of their savings income to superannuation funds and businesses that operated these. They also looked at the profits likely to be made in this area. The result was a spending-spree in which banks or bank -associated businesses bought out the funds management firms considered most likely to benefit from the vast pool of superannuation money that was going to be accumulated.
There were a (very) few large players left outside the banks’ reach (such as AMP and National Mutual, which became AXA when the giant French funds management company bought a chunk of after the company had depleted its resources trying to gain AMP’s No. 1 status in the industry). To compete, these companies set up divisions that were run along different business models to the standard AMP/AXA/MLC/ large insurance company, “tied-agent” system. In other words, they allowed some of their advisors to operate on a wider framework than just selling the parent company products.
The competition for market exposure led to huge outlays as banks and the big insurance companies (now considered funds management companies) vied with each other to “tie-up” distribution networks for their products.
Now you might think that owning the company that hands out licences to financial advisors would not help much to provide an avenue for selling your particular form of investment, superannuation, savings or insurance products and services but it very much does. The reason for this is that the holder of the financial services licence, which allows you to appoint authorised representatives (ie, advisors), is the gatekeeper of the list of products that the advisor is able to select from when making investment recommendations.
Yes, the list of products that the advisor is able to choose from to meet client objectives is set out in what is called an “Approved Product List” or APL that is written by the financial services licence holder.
Now you may say that this is a conflict of interest that the legislators should have dealt with – but nothing in developed society is as obvious as it would appear and the legislators had based this particular requirement on sound principles. That is, that an advisor should only recommend products and services that had been adequately researched by an appropriately qualified researcher. This helps to limit the kind of investments that can be offered by advisors, who may be of quite varying levels of knowledge, experience or qualifications. As the financial services licence holder is responsible for the recommendations of their advisors, you can see why they would want to limit the range of options available. This was also, in part, an attempt to stop the sort of scams where advisors recommend investments that they may own or have a beneficial intitlement to. All-in-all, it should be a good thing.
Once upon a time, it would have been a good thing, as the average investor who placed money with an agent of (eg AMP/MLC/AXA/Prudential/Colonial Mutual/Legal & General/City Mutual etc, etc, etc) would have been quite aware that the agent represented this company solely, and was limited to recommending products that were run by them. This made disclosure and bias a bit less of an issue, as there was an obvious bias through the company that the agent was tied to.
There was also a difference between an “agent” who was an agent for a particular company versus a financial advisor who did not represent a particular company. They actually had quite specific obligations in that the agent was legislatively representing their company to the client whereas an advisor was representing the client to the particular company that was being recommended.
If we come back to the present, we are in a world of blurred boundaries. The holders of financial services licences do not obtain profits just from their products with their name on it. Simple nomenclature is so much more complicated. It is difficult for the average investor to know who is behind a particular product or service as the providers are tied in many different ways.
One was relates to the perception of a need to cater to the consumer calls for greater choice in relation to (predominantly) investments rather than being limited to the options available from only one company.
The result was a number of (initially) independently owned investment structures called “platforms”. These platforms were really just administrative companies that ran a superannuation, investment or pension fund, taking care of the various trustee, compliance and marketing requirements while contracting out the investment options to a number of different investment companies.
In other words, rather than having your superannuation with (say) AMP, you could have it with a platform that offered investment options from AMP, MLC, AXA, Perpetual and any number of boutique companies set up by investment professionals and teams that left the big institutions to set up their own funds management businesses (there are so many now but classic examples would be Platinum, Investors’ Mutual, 452 and any number of others).
As the platform managers were able to group exposures into larger parcels of money, they could obtain wholesale levels of investment fees, helping to reduce the impact of their own fees. Some platforms even offer access to direct shares and listed securities. From a portfolio point of view this is all very good stuff. It helps to increase the diversification available and to help an investor keep just the one account over their lifetimes, changing and altering their underlying investments as circumstances and wants change.
The negative that developed was that the platform operators have to obtain exposure to a distribution network to ensure that they reach and keep a critical mass of invested dollars to keep their business viable. Again, in stepped the big insurance and banking groups, to provide the start-up capital and expertise to make these platforms work even better.
And so we come to the point where the bias has moved away from particular fund managers and now into platforms. In other words, most financial services licence holders either own or receive a financial benefit from, a particular platform. Sometimes it is from a range of platforms but the end result remains a form of bias that can be disclosed but is particularly hard to understand.
Why is this important? It is important because the Approved Product List (remember the good ol’ APL mentioned above?) will usually be based around not just a particular list of products but a single or short list of approved platforms.
So the advisor has a selection to choose from in making recommendations but each of those recommendations contains a fundamental bias, as the investor has no way of knowing how those particular products or platforms relate to others available in the market.
You see, the advisor is not allowed to make recommendations on products that are not on the recommended listing. This is a gripe that the “Industry Funds” area of the superannuation industry is piqued about, as it does not provide them with a level playing field in the representation of their funds in the open market. As an example of this, AMP was chastised by the industry regulator for using the APL as a gateway to ensure that the bulk of money flowing from recommendations of their advisors ended up in AMP related products.
So let’s look at this in a fairly direct way.
If the approved product list that the advisor is required to operate from includes products, platforms or services that the group issuing their authorised representatives licence has a financial interest in then there is bias in the recommendations.
This applies whether the advisor is from an insurance company, a supposedly independent group or one of the Industry Super Funds.
This is a fundamental flaw in the transparency of the provision of financial advice in Australia and one that should be addressed to ensure that the various vested interests are adequately understood and disclosed.
However, those vested interests are very strong (both financially in the case of funds management as an industry and ideologically as in the case of Industry
Super Funds) and i see very little in the way of informed discussion or intelligent analysis of this area. Let’s just put it down to a bit of hypocrism on my part – hypocrisy (in that i am an advisor who also owns a share in a company with a financial services licence) tinged with a hint of cynicism (in that i have watched legislative change chase a much more flexible and adept financial sector over many, many years).
i would like to suggest that the financial services provider that i am associated with would never accept these “rebates” or kickbacks but there is a commercial imperative involved here, and the provision of advice without these additional sources of funding is becoming more difficult every day.
My objective will be to make sure that if we ever take that step, that it is clearly articulated to those who deal with us and, as far as possible, the ramifications are fully disclosed at every turn.[poll id=”4″]