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Code Committee voices objections

The Code Committee has slammed the wording of a new client-first duty set to become law for financial advisers, and the lack of personal accountability proposed for financial advice representatives.

Thursday, March 16th 2017, 6:00AM 9 Comments

by Susan Edmunds

An exposure draft of the Financial Services Legislation Amendment Bill is out for consultation.

The committee has made public its submission.

In it, is says extending the code to all advisers is an improvement.  But it was a concern that financial advice representatives would not be personally accountable.

“We appreciate the logic behind not requiring financial advice representatives to separately register, and recognise that breaches by financial advice representatives are just as likely to be attributable to the financial advice provider as the representative, consistent with the current approach for QFE advisers," chairman David Ireland said.

“However, we are concerned that this may undermine public confidence in the regime, as there is no mechanism for preventing a financial advice representative who personally acts in breach of the New Code from moving from one financial advice provider to another with no public record of past misdemeanours.”

He said it could help to call financial advice representatives “provider representatives” instead.

But Ireland said the committee’s overarching concern was that the exposure draft had strayed from a principles-based approach into something more prescriptive that would negatively affect the new regime.

In particular, the committee is worried by the duty to put clients' interests first, as expressed in the draft.

“Client first, as expressed in the current code, is a paramount obligation. It is a philosophical statement as to how financial advisers subject to the code are expected to behave in any scenario. It is aspirational in nature. Treating it as a black letter law concept is not appropriate.”

He said code standard one never lent itself to being enforced in court. "It is an obligation that lends itself perfectly to being expressed in a code of conduct where a disciplinary committee might be expected to take a broader consideration of a financial adviser’s duties.”

Ireland said the committee felt that, if the objectives of the regulatory regime were to be achieved, all advisers should be required to put the consumer first. That was the basis for it supporting the elevation of code standard one into the legislation.

But in the draft it had been reduced to simply a conflict of interest question. The way it was worded might stop the committee including provisions in the future code to elaborate on what was meant by placing clients' interests first, he said.

The committee also did not support the formulation of a new duty to agree on the nature and scope of advice. This is something the committee has pondered in depth lately, as it rewrote the existing code to address limited advice.

It recommended changes to the regulatory exemptions for accountants and lawyers, including introducing conduct obligations for those offering exempt advice.

Ireland said it was disappointing the committee had not been given wider functions under the bill - it would have liked to have been able to liaise with the Minister, FMA and stakeholders in relation to the code's application and enforcement. 





Tags: Code Committee financial advisers Financial Advisers Act Financial Markets Conduct Act

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Comments from our readers

On 17 March 2017 at 3:42 pm Murray Weatherston said:
Code Standard 1 - Three confessions (par 24) that stand out to me in this submission

1. Code Standard 1 "never lent itself to to being strictly enforced in a court of law"

2. "It is aspirational in nature"

3. "It's a philosophical statement'

It would be interesting to hear scholarly legal opinions about that approach in the context of minimum standards.

Here's me thinking CS1 would be expected to apply in the quasi-judicial venue of the FADC. An advisor facing a charge of breach of CS1 would certainly expect so.

Second I don't think that mandatory standards with which all advisers must comply by State decree is a place where "aspirational" goals should be expressed.

It's a different kettle of fish for a voluntary associations (e.g. dare I say, Financial Advice New Zealand) where individuals make the choice to belong or not - aspirational goals not expressed as minimum standards might be entirely appropriate here.

PS I do agree with many of the other of the Code Committee's submissions.
On 17 March 2017 at 4:18 pm Brent Sheather said:
That is a good point Murray. One would have thought Code Standard 1 would be a starting point for any court of law. Have to disagree on your comment about the FADC though as it seems pretty clear, given their past rulings, that they have no idea what best practice or putting clients’ interests first looks like. Not surprising given most of the members lack of experience
On 18 March 2017 at 11:00 am gavin austin adviser business compliance said:
Really Brent - you have surpassed yourself -no experience. Hon Sir Bruce Robertson - one of NZ's preeminent legal minds, Tracy Berry is well known in our profession and highlights your ignorance yet again, Simon Hassen has had 25 + years of giving NZ people sound advice, Peter Houghton ex London professional with a Finance background, Geoff Clews - background in legal and tax and finally David Houghton ex Auditor General and life member of the NZIC. So if this means a lack of experience in your view then God help us if we ever had to rely on your opinion on anything. I suggest you check your facts before running off at the mouth as you do. Some would say your comments are libellous and I would hope that ALL or some of the FADC take to task for your comments. You would do well to remember code standard 2.
On 18 March 2017 at 12:17 pm Murray Weatherston said:
Hi Brent

I think your criticisms of the performance of the FADC are unfounded. They have only ruled in 5 cases - in two proceedings were discontinued - one was David Ross who went to jail for criminal offences, and the other I assume either the adviser was sick and/or he voluntarily handed in his badge. In two other cases, FMA and the adviser agreed what charges would be admitted and what the penalties would be so I think FADC just rubber stamped the agreed deal. In the last case (the mystery X case), CS1 was not at issue.

So while I share some of your views about some officials who need to stand up and be counted, I disagree totally with your comments on FADC based on their performance to date.

I do hope none of the Committee members had turned down other positions because of the expected FADC workload!
On 20 March 2017 at 9:19 am Brent Sheather said:
Hi Murray

There were a few FADC cases where I thought the rulings were strange. One related to an early 2014 case where the FADC decision stated that the advisor had breached Code Standards 8, 9 and 12 but then the FADC said that “the offending simply related to the AFA’s failure to keep the require records”. Hello….Code Standard 8 says that advice must be suitable. Further on in the decision the FADC confused matters further by saying that record keeping is particularly important “when the client is taking on more risk than was appropriate”. Confusing.

Another reason I’m sceptical about the FADC is because an advisor who is on the disciplinary committee for financial advisors, was quoted as being of the opinion that one key test of suitability was whether other financial advisors would think a plan was appropriate. This so called “peer test” is apparently particularly important and according to one commentator it was referred to in a recent court case involving a financial advisor. Whilst a “peer test” might make intuitive sense that presupposes that the industry, as a whole, is doing the right thing but that may not always be the case. For example, a few years back, just about every financial plan I saw recommended finance company debentures as the fixed interest portfolio. So on this basis no one was doing anything wrong because everybody was recommending finance company debentures. Ridiculous logic. Today many many financial advisors and stockbrokers recommend that investors attain their exposure to NZ and Australian stock by buying 5-10 stocks in each market. This sort of concentrated portfolio is a recipe for disaster and hugely different to what best practice looks like as evidenced by the portfolio of professional investors. A cynic might suggest the “peer test” provides useful information the extent that if other financial advisors think a plan is appropriate then it most likely isn’t. There are more examples of why the peer test is ridiculous than we have space for here but some others that have made this column include the following:

• In the Rodney Hartles case a while back we had one of the “experts” make the ridiculous comment that ”a reasonable financial advisor” would have invested 10% of a clients total funds in finance company debentures. That’s almost half the bond portfolio in junk. Heaven help us.
• An AFA wrote in the newspaper recently that his clients had no bonds in their portfolios because interest rates were low.
• A financial advisor when putting together financial plans assumed historic returns from the stockmarket would continue when research clearly shows that it wishful thinking.

Sue Brown, formerly from DLA Piper and before that the FMA, recently said “the FADC should be a tool to help advisors understand what is expected of them” and “although the FADC had been operating for six years … had been a total failure”.

The FADC has an opportunity with its decisions, providing they are sensible, to set out what is and what is not good practice.

Lots of room for improvement and in my view the Board needs a few more unconflicted experts.
On 21 March 2017 at 9:16 am Brent Sheather said:
Thanks for that Gavin. I agree the FADC members have lots of experience and I am sure they have the highest levels of integrity but I wonder in some cases whether they have relevant experience. You have set out their backgrounds but to what extent have they been involved in investment solutions for retail investors? If we were to put each one of them separately in a room and ask them to set out an investment portfolio for someone with $500,000, having regard to best practice, do you think they would put together a portfolio that the trustees of a pension fund would sanction? It would be an interesting experiment.

Furthermore my opinion is that some of their backgrounds may be unhelpful in the determination of best practice. For example an investment banking background and hanging out with the sell side particularly vertically integrated organisations whose wealth management solutions have relatively high fees could mean that their experience might be with outcomes dissimilar to those that would be acceptable to the average pension fund. For example recall that the forward looking risk premium is about 3% so a wealth management solution with a 3% fee structure (inclusive of annualised transaction costs) implies mum and dad get the risk of equities with the return of bonds. Is this putting clients’ interest first? Would the NZ Super Fund be happy with this deal? Obviously not but that’s what the sell side presents to mum and dad as “putting clients’ interests first”.

Of course my concerns could be unfounded but as we have seen with the MBIE, the FMA and the Code Committee perceptions of what putting clients’ interests first actually entails can depend on:
• Who you see the client as being i.e. is it retail investors or the sell side.
• Your next career move.
• Ones’ client base – remember we have seen Code Committee members, who ostensibly bat for mum and dad, lobby in favour of performance fees.

My concern is that a big part of the job of the FADC is, as Sue Brown alluded to, to set out what is good practice. Knowing what good practice looks like is essential.
On 21 March 2017 at 10:42 am Murray Weatherston said:
I find the following comments directly attributed to Sue Brown to be very puzzling “the FADC should be a tool to help advisors understand what is expected of them” and “although the FADC had been operating for six years … had been a total failure”.

The FADC is the quasi-judiciary body that hears charges against advisers for alleged breaches of the Code of Professional Conduct for AFAs, brought by or on behalf of the FMA.

The FMA has laid very few charges against individual advisers as I have pointed out several times before.

The FADC does not originate actions. Blaming it for not having done much would be like - if no murders had been committed for 5 years, blaming the High Court for not having determined any murder cases over that time period.

On 22 March 2017 at 10:53 am Tash said:
Hi Brent Sheather.
You often refer to investment practices of pension funds as the standard to aspire to. Could you please explain why a pension fund's investment strategy is relevant to an individual.
Most Defined Contribution funds now allow member involvement in the investment or their fund balances (as is the case with KiwiSaver) and I assume you are not referring to those pension funds as those fund trustees have little involvement in investment decisions other than selecting the relevant options. This must mean you are referring to large defined benefit pension funds, which have endless time horizons not limited to the relatively short times to retirement for individuals who age. These pension fund trustees can afford to engage in very long term strategies totally inappropriate to individuals.
On 22 March 2017 at 4:40 pm Brent Sheather said:
That’s a fair question. Pension funds around the world, not just NZ, benefit from independent trustees and expert advice on investment strategy from organisations like Frank Russell, Towers Watson etc. Given that they are generally uncompromised experts their investment strategies are what our firm believes is best practice. For example, when finance company debentures were very popular not so long ago we looked at the average exposure of pension funds to junk and decided that as junk typically represented less than 5% of the average bond portfolio we would focus on high quality bonds just as per the average pension fund. Similarly their strategies answered the question for us as to exposure to CDO’s, Feltex, small-cap pharmaceutical companies based in India etc etc and lots of other things. We don’t just look at defined benefit pension funds but we look at what the industry does in aggregate.

By the way, you can’t generalise that pension funds must exclusively engage in long term strategies because some have more people dependant on income than they do have people contributing. If you look at client portfolios through this lens then, using Murray Weatherston’s analogy, there have been heaps of murders and most people have got away with it. So I repeat the FADC have very much missed the boat just like Sue Brown said.


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