Flawed financial advice laws rushed through the Senate

The Future of Financial Advice (FOFA) reforms, originally proposed by the government on 26 April 2010, were made law last week. The reforms take effect from 1 July 2012 but there will be a one year transition period before all financial planners must abide by them (i.e. from 1 July 2013).

Furthermore, the reforms were rushed through the Senate by the Gillard government before a comprehensive debate on 63 amendments proposed by the opposition could be had. Because of this, there are some regulations underpinning the reforms that have not yet been finalised. This is quite extraordinary and is no doubt one of the key reasons why there is a one year transitional period.

The reforms seek to protect consumers when obtaining financial advice and build confidence in the financial services sector after the GFC. Two key changes will be the introduction of a best interest duty requirement for financial planners and the stamping-out of conflicted remuneration structures.

Financial planners will need to satisfy a so-called ‘reasonableness test’ to satisfy the new best interest duty requirements. Essentially, advisers will need to demonstrate they have made ‘reasonable inquiries’ into their client’s situation and a ‘reasonable investigation’ has been made with respect to financial products. In other words, financial planners will need to spend more time understanding their clients and their needs and consider a range of financial product solutions.

The best interest duty requirements are supported by bans on (some) conflicted remuneration structures. Trailing commissions paid by fund managers and superannuation providers, volume-based shelf-space fees paid by product managers to platforms operators, volume-based rebates from platform operators to licensees and asset-based fees on borrowed amounts all have the scope to ‘influence’ the advice given. All will be banned from 1 July 2013.

However, once FOFA is implemented, some conflicted remuneration structures will remain, such as upfront and trailing commissions on life insurances outside a superannuation product and asset-based fees on non-borrowed funds under advice.

In simple terms, this means consumers will continue to pay life insurance premiums that are up to 30% pa higher in order to fund the commission payments back to advisers, and financial planners will still be permitted to charge fees based on how much money their client has (rather than a fee based on the advice they actually need).

Additionally, the government has also failed to address the conflicts of interest that arise where a financial planner is employed by a product provider, such as a bank, life insurance company, superannuation fund or fund manager. Approximately 85% of planners in the country are employed by a product provider. Banning of some commissions notwithstanding, financial planners employed by a product provider will always have an obligation to recommend their employer’s products which creates an additional (and immediate) conflict of interest.

With this in mind, the validity of the now-legislated best interest duty requirements are bought into question because on face value, it seems 85% of advisers could not satisfy the financial product requirement. We’ll be looking for further details to be announced over the next 12 months.

In the meantime, the only choice consumers have in order to do away with all commissions and conflicts of interest is to deal with an independent financial planner. The FOFA reforms have no impact on independent advisers. However, the issue for consumers will be finding an independent adviser. There are less than 1%.

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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