14 Feb 2013

Are you FOFA ready? The best interests duty - what is appropriate?

by Matthew Daley, Samantha Carroll

The best interests duty and related obligations generally apply to the "individual providing the personal advice", not the "providing entity"– a significant change.

The Australian Government's Future of Financial Advice (FOFA) legislation commenced on 1 July 2012 and compliance will be mandatory from 1 July 2013.

The FOFA reforms focus on improving the quality of financial advice and expanding the availability of more affordable forms of advice, and represent a significant reform to the Australian financial services industry. One of the core changes is the obligation to act in the client's best interests.

In this article we'll look at the key aspects of this obligation.

The Corporations Act's best interests duty and ASIC's guidance

On 13 December 2012 the Australian Securities and Investments Commission (ASIC) released long-awaited final guidance on the best interests duty following extensive consultation with industry and other stakeholders, in an update to Regulatory Guide 175 Licensing: Financial product advisers- conduct and disclosure (RG 175). The best interests duty and related obligations are contained in Division 2 of Part 7.7A of the Corporations Act 2001 (Cth), and require advice providers when providing personal advice to retail clients to:

  • act in the best interests of their clients (section 961B);
  • provide appropriate advice (section 961G);
  • warn the client if advice is based on incomplete or inaccurate information (section 961H); and
  • prioritise the client's interests (section 961L).

The best interests duty and related obligations generally apply to the "individual providing the personal advice" (RG 175.204), in contrast with the previous obligations in Part 7.7, which applied to the "providing entity"– that is, the Australian Financial Services (AFS) licensee or authorised representative. This is a significant change, and ASIC expects that advice providers themselves have processes in place to ensure that they act in the best interests of their clients (RG 175.236).

Accordingly, organisations will need to further consider what consequential amendments are required to their compliance arrangements and systems. For example, it may be necessary to move towards a more principles-based approach as opposed to a prescriptive approach to documentation, policies and procedures. We will provide further information on FOFA and governance, risk and compliance arrangements later in our series of FOFA articles.

The best interests duty – what is it?

When providing personal advice to a client, an advice provider must act in the 'best interests' of the client in relation to that advice: section 961B(1). The expression "best interests" is not defined in the Corporations Act or RG 175, although ASIC considers the concept of leaving the client in a "better" position according to the standard of a "reasonable advice provider" as key in determining whether the best interests duty has been complied with (RG 175.229). This assessment would depend on the circumstances and includes the following factors (RG 175.230):

  • the position the client would have been if they did not follow the advice;
  • the facts at the time the advice is provided that the advice provider had, or should have had, if they followed their obligations;
  • the subject matter of the advice sought by the client;
  • the client's objectives, financial situations and needs;
  • where relevant, product features that the client particularly values, provided that the client understands the cost of, and is prepared to pay for, those features; and
  • if the client follows the advice, they receive a benefit that is more than trivial.

ASIC's interpretation of section 961B and the best interests duty was criticised in some submissions to ASIC as (according to the submissions) it seems to imply that if the best interests obligation is satisfied, the client will or is likely to enjoy a better result. Rather, it was submitted, there can be a favourable result even if the obligation is not satisfied and vice versa, and so the result should be irrelevant. Furthermore, the concept of a "better" result is in itself ambiguous, and could encompass both long- and short-term results and monetary and non-monetary factors.

In response to such concerns, ASIC has emphasised in its finalised Guidance that the "better position" standard is an objective standard for assessing the processes used when complying with section 961B and in considering whether the best interests duty has been complied with, and accordingly ASIC will not examine investment performance retrospectively.

Nor does the better position standard impose a "perfect advice" standard. In certain situations, advice that the client "do nothing" will satisfy the best interests duty, if a reasonable advice provider would believe that the client is likely to be in a better position if the client follows the advice. Ultimately, ASIC expects advisers to exercise judgment in acting in the best interests of the client, and a '"one-size-fits-all" advice model is unlikely to be sufficient.

In the next edition we'll look at the safe harbour that's available in some circumstances, and what it means to provide "appropriate" advice.

For more information on the new obligations or what steps you can take in moving towards the new regime, please contact us.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.