Conflicts of interest aren’t unique to any single country. (Photo by Greg Sullavan/iStock by Getty Images.)
Last month, the SEC announced the results of its long-awaited deliberations over whether to pursue a fiduciary standard for brokers, potentially bringing them under the stricter regulatory umbrella covering registered investment advisers (RIAs). The verdict: keep separate rules for investment sales (brokers) and service (RIAs), but strengthen the sales rules and make the line between the two stronger. Predictably, opinions about the effectiveness of this are split. Right now, supporters and opponents are filing public comments, which the SEC will then review and perhaps use as the basis for revisions before a final vote on the new standard. But while the debate continues, we think the latest happenings in Australia show why investors shouldn’t rely on rules alone—no matter how well-intended or carefully crafted—when evaluating an investment professional.
Australia’s financial system is under the microscope after a string of recent scandals prompted an official public inquiry into banking and financial service practices. This is being conducted by a Royal Commission, which tells you the extent of the problem once you know a little about how Australia and other Commonwealth nations work. Ordinarily, when evidence of wrongdoing surfaces, you might expect lawmakers to deal with it. But in certain situations, the government might deem the problem beyond the its resources—in other words, cabinet ministries and regulatory agencies might not have the manpower or clout necessary to investigate, ferret out all problems and recommend solutions. The Royal Commission—a public inquiry called by the head of state—is Australia’s solution. Prime Minister Malcom Turnbull called the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Royal Commission, or BRC) last November, amid mounting public backlash over recent scandals and investigations into interest rate rigging and money laundering, as well as other alleged wrongdoing.
The BRC began in March, and it has spent the past few weeks focusing on the wealth management industry. Thus far, it has discovered advisers charging clients decades after their deaths, bankers forging loan documents and brokers knowingly selling unaffordable insurance add-ons to clients. While this seems like a lot in a short period, time is of the essence. Usually, Royal Commissions have no end date. But this one is set to end on February 1, 2019, forcing investigators to cram everything into a year. While the allegedly dirty deeds take many forms, at root are conflicts of interest. For example, when financial planners’ bonuses depend on meeting sales quotas, they aren’t exactly incentivized to think carefully about whether that insurance rider is a net benefit to their customer.
One main provision of Australia’s regulatory standard for financial advisers is known as the “Best Interests Duty.” It basically directs advisers to act in clients’ best interests, prioritize clients’ best interests ahead of their own when conflicts of interest arise, disclose all potential conflicts of interest, reduce those conflicts to the extent possible, and deliver advice that is “appropriate” for the client. While US RIAs have operated under a very similar standard since 1940, Australia’s 2012 Future of Financial Advice Act codified its fiduciary standard and took effect in mid-2013. Among other things, the new regulations banned “conflicted remuneration,” which is a fancy term for advisers steering clients into products that pay the adviser a commission—essentially, the practice the US Labor Department’s recent (and currently in limbo) attempt at a fiduciary-type standard for American brokers working with retirement accounts sought to end.
The BRC’s findings suggest some institutions weren’t adhering to Australia’s new rules. One firm hogging headlines now amid a scandal known as “fees for no service” provides a cautionary tale. As the name suggests, the firm charged clients for services never rendered—a practice described by one of the firm’s execs as putting shareholders’ interests ahead of clients’. Additionally, it apparently funneled clients into in-house products, causing them to incur hefty exit fees when switching out of their old funds—without a sound basis for believing the move would eventually be a net benefit, according to one employee’s testimony. As you might expect, clients paid the fund’s administration fees while the adviser selling the fund collected an “advice fee.” While this firm is in the headlines now thanks to its executives’ high-profile BRC testimonies, similar breaches apparently occurred elsewhere. In a sweeping review of vertically integrated financial firms, the Australian Securities and Investments Commission (ASIC) found the majority of client assets were in in-house funds and 75% of reviewed cases didn’t comply with the best interests duty. The spotty compliance record makes us wonder whether the Labor Department’s rule, which amounted to reams of paperwork and disclosures, would have been any more effective in deterring brokers from steering clients into suboptimal in-house funds.
Australia’s experience teaches another lesson. Most financial advice in Australia is rendered by professionals at vertically integrated financial firms—banks that offer investment services as well as traditional banking. ASIC’s report found conflicts of interest inherent in this business model, as it leads to the firm simultaneously serving in a sales and service capacity—or, as the report put it, “institutions engaging in both the provision of personal advice to retail clients and the manufacture of financial products … .” This strikes us as eerily similar to how the line between investment sales and service in America has blurred over the past several decades. We have long theorized that restoring this line, making it crystal-clear to investors whether they are working with a broker or RIA, might do more to improve transparency than adjusting brokers’ rules. Perhaps the SEC’s efforts to more strongly delineate between sales and service, including prohibiting brokers from calling themselves “financial advisors” (as opposed to “advisers,” which is a title unique to RIAs), might help. But only time will tell.
Regardless, we think the BRC saga shows the importance of doing your own due diligence on financial professionals and not relying on regulatory standards. Important questions to ask include: How are you paid? Will you charge me for advice and sell me products? What are the potential conflicts of interest, and what do you do to reduce them? What are all the costs and fees I might end up paying. Beyond that, always look into their experience, history, expertise, customer service and values, as these items can help you gauge whether they always strive to put investors first and deliver top-notch service.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.