In brief - Federal government releases exposure draft of Future of Financial Advice (FOFA) legislation
On 29 August 2011 the Federal government released an exposure draft of its Future of Financial Advice legislation. The exposure draft is the first tranche of an ongoing revamp of financial services regulation in Australia.
The key areas of change in the exposure draft are the "opt-in" fee disclosure requirements, a "best interests duty" and increased watchdog powers for the Australian Securities and Investments Commission (ASIC). The exposure draft remains subject to change and is yet to be tabled in Parliament.
The "opt-in" requirement — 12 and 24 month fee disclosure
The Federal government's Corporations Amendment (Future of Financial Advice) Bill 2011 (Cth) (FOFA), the first part of which was announced on Monday 29 August 2011, could potentially introduce a series of tighter regulations for the financial planning industry. The announcement sparked a flurry of media attention and commentary from various political and industry commentators.
Currently, many advisers have a standard practice of gleaning an ongoing or trail fee from clients' investment portfolios as a means of payment for their services. The Financial Ombudsman Service (FOS) held in December 2010 that there was no obligation for an adviser to provide ongoing services to a client even where he or she charged trail fees. This stance will perforce be changed once FOFA is enacted.
FOFA will insert sections 962-962M into the Corporations Act 2001 (Cth), the principal piece of legislation currently regulating the provision of financial services. The explanatory memorandum accompanying FOFA accepts that financial advice entails a particular type of benefit which accrues over the period of a client's investment. The ongoing or trail fee remuneration structure has not been abolished.
However, FOFA imposes two key obligations for advisers when seeking to impose an ongoing fee:
- firstly, where the adviser seeks to charge a fee for a period over 12 months, he or she must provide a fee disclosure statement to the client with information about their ongoing fee and their service, and
- secondly, where the adviser seeks to charge a fee for a period longer than 24 months, he or she must provide a renewal notice to the client in addition to another fee disclosure statement
Client consent to ongoing fees must be obtained every year
The opt-in requirement, as it is called, effectively requires an adviser to obtain a client's renewed consent to ongoing fees every year. The client can opt whether to continue accepting the adviser's proposed trail fee. A fee disclosure statement must be provided at least 30 days before the end of the first 12 month period, and set out details of:
- the fees already paid
- the ongoing anticipated amount for the next year, and
- details of the services the client has been entitled to, has received and will be entitled to receive in the next 12 months
Those requirements will be set out in some detail in a new section 962E of the Corporations Act. However, those will likely be elaborated further in delegated legislation or a body of rules once FOFA has inserted its new provisions into the Corporations Act.
Ongoing fees after 24 months
As to the 24-month reporting requirement, where the adviser intends to continue charging ongoing fees after two years, he or she must provide a renewal notice to the client at least 30 days before the end of that period. The notice will be in writing and include statements that:
- the client elects to renew the ongoing fee arrangement
- the ongoing fee arrangement will terminate should the client not elect to renew it
- the client will be taken to have elected not to continue should he or she remain silent after 30 days from receipt of the renewal notice and fee disclosure statement, and
- the renewal period is 30 days from receipt of the notice and statement
The client may also expressly elect not to continue with the agreement. If the client remains silent after 30 days or expressly elects not to continue with the agreement, it will terminate after a further 30 days. Once this occurs, there is no obligation to provide further services to the client. If the adviser continues to charge a fee, he or she may be liable for civil penalties under section 962L of the Corporations Act.
The maximum civil penalties for breach of the opt-in provisions will be $50,000 for an individual and $250,000 for a body corporate, as provided in section 1317G(1E) of the Corporations Act.
Acting in the client's best interests
The explanatory memorandum released with the exposure draft of FOFA explained that there is currently no obligation under the Corporations Act for advisers to act in the best interests of the client. Advisers already have a fiduciary duty to their clients, which imposes a strict duty on the adviser not to abuse his or her position of trust. This prevents the adviser from acting contrary to the interests of the client, obtaining a benefit to the client's detriment, or putting him or herself in a position of conflict.
Should FOFA be enacted, it will amend the Corporations Act to insert a statutory version of the fiduciary duty. This statutory duty will also go further by spelling out the steps an adviser must take to act in the best interests of his or her client. FOFA will insert section 961C into the Corporations Act, which will contain nine types of investigation that must be carried out by the adviser. However, "acting in the client's best interests" is not limited to those steps and will be subject to judicial interpretation if the legislation takes effect.
In brief, the nine steps that will be inserted in the Corporations Act as new section 961C will require an adviser to:
- identify the client's objectives, financial situation and needs
- identify the subject matter of the advice required by the client
- assess whether the client data is incomplete or inaccurate and make reasonable enquiries to obtain proper information
- assess whether the client's needs would be better achieved by way of different advice
- assess whether the adviser him or herself has the requisite expertise to give advice on the requested topic and if not, decline to give advice
- assess whether the client's objectives and needs may be met through means other than financial products
- conduct a reasonable investigation of financial products that might achieve the client's ends or assess information investigated by another individual
- where recommending product switching, assess and weigh the disadvantages and advantages of the products and only recommend the new product where it is reasonable to conclude that the new product may better achieve the client's ends, and
- base all "judgements in advising the client" on the client's objectives, financial situation and needs
Failure to comply with "best interests" duty
Failure to comply with the "best interests" duty under section 961C will result in both a civil penalty, enforceable by a court, and a civil action for damages. Where a client is held to have suffered loss as a result of an adviser's breach of the "best interests" duty, the client can recover their entire provable loss under the new section 961P.
These damages will also be in addition to any civil penalty that is imposed. The maximum penalty is $200,000 for an individual and $1M for a body corporate.
Given the significant monetary penalties available for breach of the "best interests" provisions, it is apparent that the Federal government has taken a strong stance against inappropriate financial advice to retail clients. Ostensibly, this was the result of the collapse of large failed investment vehicles during the GFC. The FOFA package of reforms is designed to tighten the regulatory system surrounding financial services in order to prevent such disasters in future.
Approved Product List — products must meet client's objectives
Importantly for Australian Financial Service License (AFSL) holders, FOFA will insert a new section 961G into the Corporations Act. The section relates to the Approved Product List (APL). That section will require that where an APL contains no product that would achieve the client's objectives and needs, an adviser may not recommend a product from that list.
It will be a matter for advisers and AFSL holders to determine whether the adviser will be authorised to recommend a product not on the list, should the APL not satisfy the client's needs and objectives.
Replacement of Section 945A with Section 961H — appropriateness of advice
Currently, and up until the enactment of FOFA, section 945A of the Corporations Act requires that licensees and authorised representatives "know the client" and "know the product" when providing advice. Those steps have now been absorbed into the "best interests duty" and reiterated in section 961H which reads:
961H Resulting advice must be appropriate to the client
The provider must only provide the advice to the client if it would be reasonable to conclude that the adviser is appropriate to the client, had the provider satisfied the duty under section 961C to act in the best interests of the client.
Extended powers of the Australian Securities and Investments Commission (ASIC)
In brief, the Australian Securities and Investments Commission will be granted a series of extended powers relating to financial services and advisers. Those changes will be inserted into Part 7.6 of the Corporations Act, relating to the licensing of financial services providers. They are summarised in the explanatory memorandum as:
- a power to cancel or suspend a licence where a person is likely merely to contravene its obligations, rather than breach them outright
- a power to ban persons "not of good fame and character" or persons who are not adequately trained or competent to provide financial services
- a power to ban persons if they are merely likely to contravene a financial services law, and
- a power to ban a person who is involved or likely to be involved in a contravention of obligations by another person
Effectively, the powers granted to ASIC will raise the bar for financial advisers. Their test of competency will be required to reflect a higher professional standard, to that of a "fit and proper person". It will be necessary to scrutinise an adviser's character and competency thoroughly to decide whether they are eligible to provide retail advice.
The future of FOFA
Should FOFA be approved and enacted by Parliament after further consultations, it will introduce significant regulatory changes to the financial planning industry. It also expressly prevents advisers and clients from contracting out of their statutory duties, and allows civil actions to be commenced for any breach up to 6 years after the cause of action arose. The scheduled provisions of FOFA are notionally proposed to commence on 1 July 2012, although this date may change, subject to events in the interim.
Presently, FOFA remains in draft form and commentary on the exposure draft is to be submitted by 16 September 2011. There may be further changes to the proposed legislation in due course. It is also likely that additional regulatory instruments will accompany the future tranches of the reform.
As it stands, the checks and balances provided in FOFA will add additional security to retail clients who seek financial advice. It will also mean increased reporting and investigative obligations for financial advisers and AFSL holders. Should FOFA be enacted, it will require serious consideration and an overhaul of advisers' current retail advice procedure. For the time being, it will be necessary to keep one finger on FOFA's pulse.
Article by Gavin Creighton, Partner, Kemsley Brennan, Special Counsel and James Stanton, Solicitor.