17 September 2013
The best interests duty: A mandatory standard for financial advisers
Ever since the collapse of Storm Financial and Allco Finance Group, the Federal Government has been under pressure to introduce measures to help restore faith in financial services industry and better regulate the conduct of financial advisors. The result was the introduction of the Future of Financial Advice Reforms (FOFA) that has introduced new regulations enforced by strict penalties in the event of non-compliance.
In this bulletin, we explore one reform being the ‘best interest duty’ and consider how it affects the provision of financial advice, why financial advisers should be aware of this reform and what they must do in order to comply with the reform.
The introduction of the reform
The Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 amended the Corporations Act 2001 (Cth) on 1 July 2012 and introduced, amongst a number of other important measures, a statutory fiduciary duty on financial advisors to act in the best interests of their clients; a ‘best interests duty’. The duty is a codification of the existing common law fiduciary duty that is owed by all advisors, with additional penalties of banning and disqualification orders. Whilst the amendments were introduced on 1 July 2012, it only became binding on 1 July 2013.
How the law is applied
The duty contained in section 961 of the Corporations Act 2001 (Cth) requires advisors to act in the best interests of their retail clients and to place their clients' interests ahead of their own when developing and providing personal advice. The duty exists irrespective of whether the advisor is paid for the advice that is provided to the client. Failure to satisfy these rules may lead to civil penalties, such as a large fine, disqualification of a licence or disqualification from being a director.
The duty contained in the Act applies to advisors, (referred to as ‘providers’ in the Act) who give financial advice to a retail client. Generally, a client will be classified as a retail client unless they satisfy one of the requirements to be classified as a wholesale client under sections 761G (5) (6) and (7) or 761A of the Act. Broadly, a wholesale client is a ‘professional investor’ such as:
A person or entity with a financial services licence who controls assets of at least $10 million or who manages and invests funds for the public.
Or a ‘sophisticated investor’ being one or more of the following:
A person or entity with an accountant's certificate that invests in products of at least $500,000.
Have assets of at least $2.5 million or gross income of the last two financial years of at least $250,000.
Is a person or entity controlled by the abovementioned person or entity.
The duty is limited to the provision of personal advice, that is, advice on products tailored to an individual’s personal circumstances. It should be noted that the common law fiduciary duty continues to apply to all advisors in their dealings with clients, irrespective of whether the client is a retail client or not.
The Act lists steps which must be taken by an advisor in order to satisfy the 'best interests' standard. A summary of the key steps are as follows:
Identification of the financial situation and needs of the client.
Make inquires / further questions be asked if the information appears incorrect or incomplete.
Identify the specific advice being sought by the client and the circumstances of the client which are relevant to the provision of that advice.
Assess whether you have the required expertise to provide the client advice on the subject matter sought and, if not, decline to provide the advice.
Consider if it would be reasonable to recommend a financial product after conducting an investigation of the most appropriate products relevant to the client’s circumstances.
Take any other steps which would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances.
A reference to doing something ‘reasonably’ means undertaking a considered effort which takes into account all of the relevant circumstances of the client. It is expected that a prudent financial advisor will follow the steps and make file notes of having taken the steps. This will allow them to demonstrate to ASIC that they have met the standard if in the event ASIC investigates a client complaint.
It would be prudent for all advisors to follow these rules in providing advice to non-retail clients as it will assist with meeting their common law fiduciary duty.
So what is the effect of this Act
The statutory fiduciary duty will require financial advisors to develop and implement stringent processes when providing advice to retail clients which are in line with the requirements in the legislation. In the event a complaint is made and there has been a failure in meeting the standard, strong civil penalties may apply including significant financial penalties and a disqualification order - where the Court may disqualify a person from managing corporations for a period the Court considers appropriate, or disqualify someone from holding an AFSL.
If you have any questions regarding this duty, please do not hesitate to contact us for more information.
Author: Chris Tsovolos