Payments Under Scrutiny

Inquiry in Australia could propose new rules

Summer is fast approaching in Australia, but a chill from Down Under is sweeping around the globe and is being felt by Canadian advisors. Potential regulatory changes in Australia have put commissions-based financial advice under scrutiny, and could set a new regulatory benchmark globally.

“Advisors in Canada need to be aware of this,” says Bruce Cumming, an advisor who owns Oakville, Ont.-based Cumming & Cumming Wealth Management Inc., which operates under the DundeeWealth Inc. umbrella. “There’s an event in another British Commonwealth country that could be earth-shaking.”

The role of financial advisors, the structure of payment for financial advice and commissions on the sale of financial products are at the centre of a parliamentary inquiry in Australia following the collapse of some high-profile companies, which affected thousands of consumers.

Among the hundreds of submissions to the parliamentary review is one from the Australian Securities & Investments Commission.

“The vast majority [of advisors] receive commissions from product manufacturers and so have incentives to sell products,” reads ASIC’s submission. “This structure creates potential conflicts of interest that may be inconsistent with providing quality advice and these conflicts may not be evident to consumers.”

The review panel will make its report to government at the end of November. No doubt more consultations will follow, but change seems so unavoidable that the submission by the Financial Planners Association in Australia says the association will require that members eliminate commissions-based selling by 2012.

The review in Australia follows a move in Britain by the Financial Services Authority to set a deadline of 2012 for imposing a new model for advice that also would eliminate embedded and up-front payments such as trailers and sales commissions.

Britain’s financial services industry regulator is well along the way to change, and aims to take comments from the industry and the public until the first quarter of 2010.

The upshot for Canadian advisors is clear, according to veteran industry participants who have worked both with regulators and as industry participants: Canadian sales practices are likely to come under the microscope again.

“We should assume that some of what’s going on may eventually come here,” says Paul Bates, dean of the DeGroote School of Business at McMaster University in Hamilton, Ont. “It’s entirely possible that it could.”

Bates, the former CEO of Charles Schwab Canada Co. who started his own brokerage house and was also a long-time commissioner with the Ontario Securities Commission until he stepped down this autumn, notes that the regulators frequently conduct peer reviews of each other’s systems.

The parliamentary joint committee on corporations and financial services in Australia had established the Inquiry into Financial Products and Services in Australia after the collapse last year of several small and medium-sized firms, most notably the unfortunately named Storm Financial Ltd., which affected thousands of Australian consumers, and Opes Prime Stockbroking Ltd.

According to the member of Parliament who leads the Australian parliamentary review, the losses in the case under review approach about $3 billion.

Storm Financial had built its client base to more than 14,500. It is alleged that about 4,000 clients were encouraged to borrow to buy funds, some of which were indexed to global equities markets near the top of their valuations in 2008.

Storm Financial is at the centre of the inquiry partly because of the spectacular nature of its demise and because of the role played by a couple of Australia’s largest banks — The Commonwealth Bank of Australia Ltd. and the Bank of Queensland — in lending to Storm Financial’s clients to make investments in securities markets.

After ASIC’s initial investigation, at the end of March, 2009, the regulator asked the country’s federal court to force Storm Financial into liquidation. Court proceedings against the firm’s owners and directors are ongoing. Storm Financial’s directors have launched suits against the Commonwealth and Queensland banks, which provided the loans.

Because of the role of margin lending in the Storm Financial case and others, the parliamentary committee is specifically investigating, according to a note from the Senate committee that struck the inquiry: “The involvement of the banking and finance industry in providing finance for investors in and through Storm and other similar businesses, and the practices of banks and other financial institutions in relation to margin lending associated with those businesses.”

The terms of reference for the inquiry are broader than that, however. The inquiry is looking at the role of the advisor, the regulations surrounding products and services, marketing and ads, licensing, consumer education and the adequacy of indemnity insurance held by firms that employ advisors.

The most focused of the terms refers to “the role played by commission arrangements relating to product sales and advice, including the potential for conflicts of interest, the need for appropriate disclosure, and remuneration models for financial advisers.” The mandate also brings up “the need for any legislative or regulatory change.”

The parliamentary review has received submissions from more than 400 organizations, corporations and individuals, many of them complaints from clients. Some of these focus on the potential for conflict of interest in the commission-based sales structure.

The ASIC submission, in particular, sheds light on major regulatory ideas that are surfacing globally, and says that the two biggest steps toward protecting consumers would be to eliminate commissionsbased advisor compensation and, notes Kelley McKinnon, a partner with Gowling, Lafleur Henderson LLP, who heads up the securities litigation practice in Toronto, that “investment advisors be subject to a fiduciary duty standard.

“What it means, as a practical matter for advisors, for instance,” says McKinnon, who was the deputy director of enforcement at the OSC, “is that there would be a much greater onus to ensure that there were no conflicts of interest, and that any conflicts of interest are exposed.”

The term “fiduciary duty” generally acknowledges that there’s an imbalance of power and information in favour of the advisor, and that an advisor must be highly loyal to his or her client, she explains. It’s the same duty by which a lawyer or accountant must abide.

The term is making the rounds in securities regulation. In July, the U.S. Treasury published draft legislation to give the U.S. Securities and Exchange Commission the authority to impose a fiduciary duty on any firm (broker, dealer or investment advisor) that gives advice about securities.

Most advisors do not work under this standard in Canada; but the term is especially relevant to Canadian advisors, because regulatory changes, notes McKinnon, “tend to wash over the border” from the south.

In the U.S. proposal, the SEC would gain power to set standards of conduct, including disclosure requirements. Notably, the proposal also calls on the SEC to examine and possibly outlaw sales practices, conflicts of interest and compensation structures that can hurt investors.

Lenore Davis, a registered financial planner and president of the Delta, B.C.-based Institute of Advanced Financial Planners, notes that commissions and trailers are disclosed in Canadian sales documentation, but there is no onus for full disclosure. “If a client doesn’t ask you about compensation, is there an obligation to disclose?” she asks. “There is for an accountant or a lawyer. In my opinion, it’s the difference between a professional and a non-professional.”

Davis says that the IAFP, which accredits RFPs, favours this sort of further specific disclosure, including compensation details, because it is a hallmark of financial planning as a profession.

Advocis says it was not prepared to discuss the Australian review at this time.

Dan Richards, a longtime financial services industry consultant who owns Strategic Imperatives Corp. in Toronto, says that advisors — particularly those in the insurance industry — would do best to be mindful of the changes abroad. “This is the way things are going,” he says. “Advisors cannot be in favour of less disclosure.”

In the meantime, it’s clear that the self-regulatory organizations are watching events globally. In a speech at the end of September, Susan Wolburgh Jenah, president and CEO of the Investment Industry Regulatory Organization of Canada, described regulatory winds in Australia, Britain and the U.S. and noted: “Investors’ expectations and needs will also continue to evolve.”

Used By Permission, (c) 2009 Investment Executive