Australia: Risk management for financial advisers

In brief - FOFA reforms increase importance of risk management for financial advisers

The Future of Financial Advice (FOFA) reforms developed by the Federal government aim to "improve the trust and confidence of Australian retail investors in the retail planning sector" and to "tackle conflicts of interest that have threatened the quality of financial advice" given to Australian investors.

Financial advisers should review their risk management strategies

The spotlight is on financial advisers in Australia. The Federal government's FOFA reforms are well underway, with many of the proposed reforms due to commence on 1 July 2012.

The reforms are targeted at ensuring that investors receive advice that is in their best interests, rather than advice that is based on the incentives or commissions to be gained by the adviser in return for recommending particular investment products.

In light of the imminent commencement of the FOFA reforms, it is highly advisable for financial advisers to take the opportunity to review their risk management strategies.

Key elements of FOFA

The key elements of the reform package include the following:

  • Potential bans on conflicted remuneration structures in relation to the distribution of retail investment products and related advice. This includes managed investments, superannuation and margin loans.
  • The introduction of "adviser charging" to increase transparency and flexibility of payments for financial advice and to assist in the alignment of interests between the client and adviser.
  • Restrictions on percentage based fees to ungeared products or investment amounts only.
  • Improving access to and affordability of low cost 'simple advice'.
  • Strengthening the powers of ASIC to act against unscrupulous advisers and examining the need for a statutory compensation scheme.

Statutory fiduciary duty and "best interests"

Perhaps the most important key reform is the introduction of a statutory fiduciary duty for financial advisers. (A fiduciary relationship exists when one person places utmost trust and confidence in an adviser to manage or protect money.)

Under this reform, advisers will have a duty to "act in the 'best interests' of their clients subject to a 'reasonable steps' qualification and to place the best interests of their clients ahead of their own when providing personal advice to retail clients".

It is anticipated that the FOFA reforms will change the financial advice landscape in Australia significantly.

Large increase in claims against financial advisers

In the 2010/2011 financial year the Financial Ombudsman Service (FOS) received 30,283 complaints, an increase of 27% on the previous year. "Financial difficulty" disputes rose from 2,648 in the 2009/2010 financial year to 6,102 in 2010/2011.

FOS says that the increase in the number of Australians in financial difficulty was possibly due to the Global Financial Crisis and to rises in interest rates. There seems little doubt that the GFC has brought the question of "appropriate advice" into sharp focus for financial advisers.

In relation to financial planners, in the 2009/2010 financial year FOS received 1,999 complaints about investments, 38% of which related to financial advisers and 58% of which related to financial advice about products or services.

In 2010/2011, complaints to FOS about investment products and services increased by 19% with one particular product, mixed asset funds, being the subject of 62% of complaints. The FOS 2010-2011 Annual Review states that "The most common complaint from investors was that a financial adviser/planner had given them inappropriate advice, given their financial situation, goals and risk tolerance."

Nine simple steps to managing risk and preventing claims

While risk management is a broad and complex discipline, following a few simple risk management protocols can make all the difference in preventing or defending claims.

  1. Keep detailed file notes
    Always take detailed file notes of all important conversations, telephone calls and conferences. These contemporaneous records are imperative in managing claims, disputes and litigation. Follow up on these discussions with a letter or email to further bolster the content of those discussions or conferences.

    Ensure that all original file notes and other documents, particularly those containing signatures, are placed onto the client's file.

  2. Know your client
    Know what your client's personal circumstances and financial objectives are and tailor your advice to meet them. A recent study of financial advisers in Australia found that the giving of inappropriate advice without a reasonable basis was one of the top ten forms of unethical conduct in Australia. (See Smith J, 2010 Professionalism and Ethics in Financial Planning, PhD dissertation, Victoria University.)

  3. Know your product
    Conduct thorough independent research of a financial product and its features before making any statements about its performance. Be aware of conflicts of interest when relying on research prepared by research houses. For more information about this point, please see our earlier article Research houses to be more tightly regulated under proposed ASIC reforms.

    According to the Victoria University study, "misleading statements as to performance, product features or security" were the most prevalent breach of ethical behaviour made by Australian financial advisers.

  4. Avoid template Statements of Advice
    To tailor advice to clients better, avoid using template Statements of Advice. The Victoria University study found that there was "an overreliance on the use of template Statements of Advice... this hinders the financial adviser's ability to fully disclose all matters relevant to an informed decision making process."

  5. Disclose any monetary benefits you are receiving
    Always disclose any monetary benefits you are receiving as a result of the advice given and any conflicts of interest that exist or may arise. Provide your clients with all information necessary to make informed decisions about investment choices.

  6. Vulnerable clients
    When dealing with elderly clients, clients with special needs (for example, hearing impaired clients) or clients from non-English speaking backgrounds, ensure that you use appropriate methods of communication to ensure that they are given all relevant information to enable them to make informed decisions about financial choices.

  7. Financial advertising
    In February this year, ASIC released Regulatory Guide 234 (Advertising financial products and advice services: good practice guidance) that relates to advertising through any medium or form. The Guide promotes the use of advertising that provides balanced information to consumers.

    The Guide cracks down on the use of terms such as 'low risk', 'stress free' or 'guaranteed' and promotes advertising that provides a balanced message about returns, benefits and risks. ASIC urges financial planners who are advertising on the internet to consider the overall impression created by their advertising.

  8. Adopt a risk management and compliance system
    A rigorous risk management and compliance system can help to prevent risky conduct or risky advice that could lead to complaints or claims.

  9. Make sure you have adequate insurance
    Ensure that you have professional indemnity insurance coverage that meets the minimum indemnity amounts required by ASIC Regulatory Guide 126. However, if you are concerned about having to buy higher limits or different cover because of the recent Bridgecorp decision, seek specialist advice from your broker.

For more information about professional indemnity please see the website of Colin Biggers & Paisley or contact Ava Bentley at

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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