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28 Feb 2013

Are you FOFA ready? The best interests duty - what is appropriate, Part 2

by Matthew Daley, Samantha Carroll

Financial advisers will need to look closely at their current arrangements in light of these heightened ASIC requirements.

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

One of the core changes is the obligation to act in the client's best interests. In our last article we looked at the main elements of this duty as set out in the Corporations Act's best interests duty and ASIC's guidance.

In the second part of this article we'll look at the safe harbour that's available in some circumstances, and what it means to provide "appropriate" advice.

Safe harbour and the best interests duty

Section 961B(2) sets out a "safe harbour" for complying with the best interests duty in section 961B(1). If an advice provider can show that they have taken steps in section 961B(2), they are considered to have complied with the best interests duty.

The safe harbour requires an advice provider to:

identify the objectives, financial situation and needs of the client that were disclosed by the client through instructions. We note that, in light of RG175.230, ASIC may also expect advice providers to consider such things as product features the client particularly values, to comply with the best interests duty;

identify:

  • the subject matter of the advice sought by the client (whether explicitly or implicitly); and
  • the objectives, financial situation and needs of the client that would reasonably be considered relevant to advice sought on that subject matter (client's relevant circumstances);

The above points are similar to the previous requirement in sections 945A(1)(a) and (b) (now repealed) for providing entities to determine the relevant personal circumstances in relation to giving the advice and to give consideration to, and conduct an investigation of, the subject matter of the advice.

if it is reasonably apparent that information relating to the client's relevant circumstances is incomplete or inaccurate, make reasonable inquiries to obtain complete and accurate information. Under the previous section 945B (now repealed), the providing entity was required to warn the client if advice was based on incomplete or inaccurate information, but was not specifically required to make further reasonable inquiries to obtain further information when the information initially provided by the client is incomplete (although this may arguably have been implicit in the previous requirement, it is now expressly required under the reforms);

assess whether the advice provider has expertise required to provide the client with advice on the subject matter sought and, if not, decline to provide the advice. While this requirement has previously been articulated by ASIC, this is the first time it has been elevated to a statutory provision;

if it would be reasonable to consider recommending a financial product:

  • conduct a reasonable investigation into the financial products that might achieve the objectives and meet the needs of the client that would reasonably be considered relevant to the advice on that subject matter; and
  • assess the information gathered in the investigation.

This point seems to suggest that a determination may need to be made by the advice provider that they should not recommend a particular product in certain circumstances. We also note the emphasis on the advice provider to conduct a "reasonable investigation", which raises the question of how to evidence an individual advisor's investigation for each client file in conjunction with a licensee's own investigations;

base all judgments in advising the client on the client's relevant circumstances. This is similar to the previous requirement under section 945A(1)(c) (now repealed) that the providing entity must only provide appropriate advice to the client, having regard to its consideration of and investigation into the client's relevant personal circumstances; and

take any other step that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances. This is a new all-encompassing and broad requirement. Licensees and advice providers may need to consider what further steps may be taken and when it will be appropriate.

Providing appropriate personal advice

Assuming the advice provider has complied with the best interests duty in section 961B, the resulting advice must only be given if it is reasonable to conclude that it is appropriate for the client (section 961G). The appropriate advice requirement is directly concerned with the quality of the advice resulting from the actions the advice provider has taken in light of the best interests duty.

ASIC considers that advice is appropriate if it would be reasonable to conclude, at the time the advice is provided, that (RG 175.346):

  • it is fit for its purpose – that is, following the advice is likely to satisfy the client's relevant circumstances; and
  • the client is likely to be in a better position if they follow the advice (again, this statement suggests that if the client is not left in a better position it must be due to a failure to satisfy the best interests obligation). In evidencing whether this limb has been fulfilled, licensees need to consider how this could be demonstrated on each client file. For example, including reasonable projections based on the client's current position versus what is reasonably likely to occur if they follow the advice. Given ASIC's comments in RG 175 that the results of the investment will not be considered retrospectively in considering this rule, this suggests a strong emphasis will need to be placed on the client's goals and objectives.

If the safe harbour for the best interests duty is being relied on, advice providers must also:

  • base all judgments in advising the client on the client's relevant circumstances; and
  • take any other steps that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client's relevant circumstances.

In administering the appropriate advice requirement, ASIC will take into account the circumstances existing at the time the advice is provided, including but not limited to:

  • what is required of the advice provider under section 961B, including whether a modified best interests duty applies; and
  • whether the advice, if followed by the client, would be reasonably likely to meet the client's relevant circumstances.

If none of the financial products the advice provider is authorised to advise on are appropriate for the client, the advice provider must not recommend that a client take any action in relation to a financial product.

While ASIC RG 175 provides much needed guidance, the concept of leaving the client in a "better position" according to the standard of a "reasonable advice provider" is arguably still broad and perhaps does not provide the degree of certainty required by industry.

Ultimately, it will be in the application and enforcement of these provisions that greater certainty will be revealed and licensees will need to ensure they have sufficient processes in place to demonstrate that they have been duly diligent in adapting to the new regime and evidencing that each individual advisor is compliant.

Clearly, both RG 175 and recent ASIC enforcement activity raise the bar for advisers record-keeping requirements. Financial advisers will need to look closely at their current arrangements in light of these heightened ASIC requirements.

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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.