The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry interim report, released on September 28, addresses the critical issues of how the level and extent of misconduct across the industry arose in the first place, and what now can be done to prevent it from happening again.

It generalises the factors behind the misconduct as being dishonesty and greed. It says it is fundamentally dishonest to charge for doing what you do not do, and that it is equally dishonest to give advice that does not serve the client’s interest but profits the adviser.

And whether the motive for such behaviour is characterised as “greed”, “avarice” or “pursuit of profit”, the report says the conduct ignores basic standards of honesty, and that its “prevalence and persistence” mean a close look must be taken at industry culture, regulation and structure.

The interim report covers the inquiry’s hearings into consumer lending, financial advice, lending to small and medium-sized enterprises, agricultural lending and financial services delivered to remote communities.

The absence of definitive or even draft recommendations means the likely recommendations of the inquiry’s final report, to be delivered in February 2019, remain unclear. However, after less than 10 months of operation, the inquiry has highlighted a broad range of issues and its interim report provides a number of useful signposts as to its thinking – as well as a set of useful principles for all participants in the financial services industry.

Why did it happen, and how to stop it happening again

The report says all financial services entities over time allowed selling to become the focus of their activities, and too often the sole focus of attention. As products and services proliferated, and banks competed for “share of wallet”, success was measured in terms of sales and profits.

When the pursuit of sales and profits led to misconduct – in those cases where the misconduct was revealed – then behaviour either went unpunished or led to consequences that failed to reflect the severity of the misconduct.

Remediation programs, compensating consumers and accepting enforceable undertakings don’t change the fact that much of the misconduct identified by the inquiry amounted to breaking existing laws.

As things stand, the “punishment” for misconduct was imposed by a conduct regulator (ASIC) that “rarely went to court to seek public denunciation of and punishment for misconduct”, or by a prudential regulator (APRA) that “never went to court”.

The consequences were insufficient to moderate behaviour or to prevent the same misconduct from recurring – and so the industry continued with business as usual.

The report highlights the fact that existing law already requires financial services providers to “do all things necessary” to ensure the services they provide are delivered “efficiently, honestly and fairly”. Just adding more legislation to say, in effect, the same thing would be neither effective nor efficient.

Six principles for all to live by

The report says “different enforcement” may be what’s needed to ensure financial services providers apply basic standards of fairness and honesty in dealings with consumers. The basic ideas are very simple, the report says, and the law may in fact need to be simplified to ensure that financial services providers:

1. Obey the law;
2. Do not mislead or deceive;
3. Act fairly;
4. Provide services that are fit for purpose;
5. Deliver services with reasonable care and skill; and,
6. When acting for another, act in the best interests of that other.

Three key issues for financial planning

The report identifies three key issues for financial planning specifically:

• Culture and incentives

The report says culture and incentives in particular parts of the financial services industry – including mortgage brokers, financial advisers and point-of-sale agents for consumer lending – and how culture is created and maintained by particular entities, all sheet back to the central issue of how industry participants are paid (including how bonuses and other incentives are calculated).

• Conflicts of interest and duty, and confusion of roles

The report focuses specifically on the notion that under the Future of Financial Advice (FoFA) rules, conflicts can and should be “managed”, by advisers and licensees meeting the “best interests duty” and by giving the client’s interests priority over the interests of the adviser and licensee. But it also addresses the structural impediments to effectively managing these same conflicts that it says “appear to be related to, if not stem from”, some entities manufacturing and selling financial products while, at the same time, advising clients which products to use or buy – in other words, it questions whether the supposed consumer benefits of vertical integration are ever actually released.

The report highlights confusion in the roles and responsibilties of certain players in the industry, including mortgage brokers and aggregators, and financial planners and product manufacturers.

• Regulator effectiveness

The report directs considerable attention to what responses regulators can make, and what responses regulators should make, to the conduct the inquiry examined during its public hearings. It says in determining what responses regulators should make, the inquiry will consider whether the responses they actually did make proved (albeit with the benefit of hindsight) to be appropriate and to produce satisfactory results for those concerned.

Eight pointers for advisers and licensees

The report provides a broad overview of the implications for the industry arising from the issues of misconduct examined, including through the use of case studies. The issues the report raises are likewise broad, but a number can be distilled from it that directly affect licensees and advisers.

1. Promoting sound advice

• How do advice licensees encourage advisers aligned with the licensee to provide sound advice (including, where appropriate, telling the client to do nothing)?

The report says:“Charging for doing what you do not do is dishonest. No-one needs legal advice to tell them that. The root cause for what happened was greed; the greed of both licensees and advisers: Licensees treated the provision of ongoing services as a matter of no concern to them. Provision of the services was treated as a matter between only the client and the adviser.”

The industry’s history and development from a sales-based culture means the nexus between advice and product is strong, and does not always produce the best results for consumers. The report notes that “advisers often treated ongoing service arrangements as though they were nothing but trail commissions for the advice that had already been given”.

2. Separating advice and product

• Should an authorised representative be permitted to recommend a financial product manufactured or sold by the advice licensee (or a related entity of the licensee) with which the representative is associated?

The report says:“The vertical integration of the industry may harm clients by protecting platform entities associated with advice licensees from competitive pressures. Clients end up paying more for platform services than other providers would charge for the same service.”

The supposed benefits of vertical integration – namely, the more efficient delivery of products and services to consumers – has not materialised in all cases, and in some cases has led to poor outcomes for consumers, when advisers recommend products manufactured by associated entities that do not serve the client’s best interests.

3. Licensing advisers individually

• Should all financial advisers (including those who now act as authorised representatives of an advice licensee) be licensed by ASIC?

The report says:“As between the licensee and the client, the licensee is responsible for the conduct of an authorised representative, and that responsibility extends to loss or damage suffered by the client. What is gained by having this structure? Would there be advantage in providing for the licensing of authorised representatives, thus bringing them under the direct supervision of ASIC?”

Removing the licensing obligation from the licensee (as it currently exists) would prevent a scenario where it is the licensee that determines whether an individual is fit and proper to be an authorised representative. It would mean poor advisers could be removed from the industry, independently of a licensee’s desire to retain them. It may be more onerous to licence individual advisers than a much smaller number of licensees. But individual licensing will change the role of the licensee and force a rethink of the value proposition for some, focusing them more on factors that support quality of advice and business development.

4. Seeking client approval

• Should platform operators be permitted to deduct fees on behalf of licensees without the express authority of the client of the platform operator?

The report says:“Clients seldom complained about being charged for nothing. They did not complain because the fees they paid were charged invisibly.”

A key focus of the inquiry was the continued deduction of “adviser service fees” by platform operators from client accounts, and remitted to licensees, with no checks made to ensure the licensee’s authorised representatives were actually providing ongoing service. Explicit consent from the consumer would be a further step to help ensure no fees are deducted were no service is being provided.

5. Keeping clients informed

• When an employee or authorised representative is terminated for fraud or other misconduct, should a licensee inform their clients of the reason for termination?

The report says:“Investigation and punishment of breaches of law should not be outsourced to private bodies. Licensees and industry bodies should not try to resolve breaches of law by advisers internally but must notify ASIC or other appropriate authorities.”

The inquiry appears sceptical about the ability of code-monitoring bodies (which may or may not include key industry associations) to monitor and police the behaviour of advisers (who may also be members of the association). In addition, it believes that clients have the right to know if their adviser has been terminated, and the reasons for that termination.

6. Automatically reviewing files

• When an employee or authorised representative is terminated for fraud or other misconduct, should a licensee review all the files or clients of that employee or intermediary for incidents of misconduct?

The report says:“Some licensees did not develop and enforce effective monitoring and checking procedures to prevent systemic failures.”

Misconduct may be committed by an individual adviser, or misconduct may be symptomatic of a broader, systemic issue within a licensee or advice network. Requiring a licensee to conduct a broader review would signal to both the licensee and the clients of its advisers whether the misconduct is isolated or requires broader action.

7. Checking references

• Should ASIC make more use of its Section 916G power (ASIC may give licensee information about representatives) to give a licensee information about a person who is or will be a representative of the licensee?

The report says:“First, licensees are not doing enough to communicate between themselves about the backgrounds of prospective employees. Second, licensees and ASIC are not sufficiently sharing information about advisers. Third, neither ASIC nor licensees are sharing information with industry associations.”

The issue of poor advisers – some of whom have been terminated by a licensee – quickly and easily gaining authorisation by another licensee has been a perennial industry issue. The Australian Bankers Association (ABA) sought to address this issue by requiring its members (and others who voluntarily comply with its code) to conduct more comprehensive reference checks. A recommendation along these lines would extend a similar approach to the broader industry, and formally involve the regulator in the process.

8. Putting licensees in the firing line

• Should there be more focus on criminal proceedings against licensees rather than individual advisers?

The report says:“Whether the conduct is said to have been moved by ‘greed’, ‘avarice’, or ‘the pursuit of profit’, it is conduct that ignored the most basic standards of honesty. The licensees did nothing to stop it and they took the proceeds. The conduct of licensees and advisers was inexcusable, and no-one has since tried to excuse it.”

The role of licensees in monitoring and controlling the behaviour of their advisers formed a key part of the inquiry’s public hearings. Enabling action to be taken against a licensee over the conduct of its authorised representatives would provide additional incentives for licensees to monitor their representatives – as well as a clearer (and potentially better-resourced) target for consumers seeking compensation or remediation.