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Did your client understand your advice?

Jon-Paul Hale says complying with Code Standard 4 is going to be a problem for advisers. Here's why.

Wednesday, January 5th 2022, 5:43PM 5 Comments

by Jon-Paul Hale

We had some significant legislation passed last year, and one of the things that come through is a significant change in how our advice will be measured.

It used to be advice compared to your peers on what could be considered reasonable care, diligence, and skill. The changing market between 2010 and 2020 meant that the measure for this would move based on what the majority of the market's advisers were doing at the time.

For authorised financial advisers, they had the additional overlay of what was Code Standard 9 at the time, reasonable steps that the advice is suitable for the agreed nature and scope. We still essentially have in the new code, Code Standard 3, but with more commentary.

This translated to the back of a wet paper napkin back in 2010, which improved to reflect a six step advice process that the AFAs were required to use by the time the new rules came into play.

Today, that's changed significantly, as the measure of your financial advice is not only the use of a process similar to the six step advice process, it also has the overlay of Code Standard 4; ensure that the client understands the financial advice.

I don't know about you, but I have some challenges with this, as I don't have access to the client's brain to determine if they really do understand what I have advised them, and nor do you.

This code standard four has commentary:

"a person must not give financial advice unless the person has taken reasonable steps to ensure that the client understands the nature and scope of the advice being given, including any limitations on the nature and scope of the advice."

Ok, this seems to be straightforward, document what you have said and get clarity from the client on what they understand. Somewhat tick box so far.

"Understanding the financial advice includes the client having sufficient comprehension of the content, risks and consequences of the financial advice, and of the nature of any ongoing and other services related to the financial advice, to be able to make timely and informed decisions about the financial advice, such as:

* whether the financial advice is based on valid assumptions about the client's circumstances

* whether to follow the financial advice

* whether the fees and costs associated with following the financial advice, such as those of any financial advice product or platform, are acceptable

* whether and when to seek additional financial advice."

We can postulate what this second section means regarding our actions, but that does not necessarily mean the client understood what we advised.

It's somewhat straightforward to document what we do regarding the first point. The rest of the points are entirely subjective for the client.

The last one questions the adviser's knowledge and experience to identify if their advice has gaps and needs additional support. A classic don't know what you don't know scenario, which is somewhat impossible to manage. It has a specific application to us where there is a lack of knowledge on replacing a product.

And that is the rub; our advice is open to interpretation with hindsight on how the situation unfolded for the client. There are significant points in this that mean we have to be very diligent with implementation.

The last bit of this is: "What amounts to reasonable steps by the person who gives the financial advice will depend on the circumstances, such as the nature and scope of the financial advice, and the skills, experience and vulnerabilities of the client."

As an adviser, the piece that will be the most difficult to manage is "the skills, experience and vulnerabilities of the client."

We can take a reasonable approach to ensure that we have educated the client on possible knowledge gaps, but we know clients still don't get it.

Clients will still make decisions against their best interests, and potentially we are on the hook for that.

For example, a young male cancelling his income protection cover before surgery for a knee injury that ACC is paying for.

* From their perspective, they have ACC paying the bills, so what's the problem?

* What they don't know; if that results in a long term disability where they can do a different occupation but not their own one before disability, they have no choice about that; the income protection cover is no longer there.

* If they want to apply for cover in the future, they will now have exclusions, which will possibly put their financial position at risk in the future, which could have been avoided if they were advised at the time of cancellation. (Which I would expect all advisers would to protect the policy)

With your clients doing these things:
* Have you taken the time to advise on the risks of removing coverage?
* Did your client understand the implications of that?
* And have you documented this in a way that protects your arse as you go?

John van Winden at NZHL introduced me to a term way back in 2008, LRAC. Long Range Arse Covering.

Are you doing sufficient LRAC to ensure that a client doesn't claim they didn't understand your advice in your future?

Because that is where we do not have sufficient guidance on what is reasonable to achieve the requirements of Code Standard 4, and this is wide open to interpretation by both dispute resolution services and the Financial Markets Authority presently.

In my personal view, if you're not being somewhat paranoid about this piece, you're probably not doing enough.

Tags: Code Opinion

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Comments from our readers

On 15 January 2022 at 2:26 pm Matron said:
@JP right on the button. How many Advisers actually ask the customer what their level of financial literacy is? All those generic cookie-cutter SOA applications will be found wanting... lots of 'Doh!' moments on the horizon this year.
On 17 January 2022 at 9:58 am w k said:
i could see you giving ideas of adding the 7th and 8th step to the so-call 6-steps approach.

PLUS someone going to suggest that all advisers needing to take another compulsory "bridging" paper on top of current requirement.
On 18 January 2022 at 3:18 pm Murray Weatherston said:
@w k
Haven't you forgotten steps 9, 10 Jack Queen King and Ace.
And also the step whereby you determine whether your client is or is not a vulnerable client will a full written explanation of what you took into account in making your determination; and if yes, a full report on the actions you took to take account of that determination and the outcomes thereupon.......//sarc
On 18 January 2022 at 6:06 pm w k said:
@murray: i think there's also a joker somewhere in the pack too.
On 24 January 2022 at 2:17 pm JPHale said:
Nice comments, and yes I don't think we have this piece buttoned up yet.

The rest of the pack could be rolled out. I don't know where this is going to land, but I don't think we are anywhere near having the full picture...

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