Standard 3 of the FASEA Code of Ethics (Standard 3) purports to eliminate conflicts. But for advisers who use managed accounts, it creates a whole new conflict – a conflict between Standard 3 and established law and regulatory policy.
Standard 3 and managed accounts
Standard 3 is drafted in absolute terms, which is where the trouble starts. It reads: “You must not advise, refer or act in any other manner where you have a conflict of interest or duty.”
The majority of managed accounts are white-labelled by, or associated with, financial advice licensees. This means they are in-house products, because advisers who recommend them to clients will generally receive a direct or indirect benefit. This creates a conflict of interest.
Despite the potential conflict, managed accounts do benefit clients in several ways by offering:
Can AFS licensees manage the conflict?
Conflicts can and do arise between the interests of financial services providers and their clients, but the law and regulatory guidance does not require licensees to avoid all conflicts. Under the Corporations Act, licensees have an obligation to have adequate arrangements in place to manage conflicts of interest.
ASIC Regulatory Guide 181 “Managing Conflicts of Interest” states that adequate conflict management arrangements help to minimise the potential impact on clients. It clearly indicates that not all conflicts need to be avoided, and it lays out three mechanisms for managing them:
Depending on the circumstances, financial services providers will generally use a combination of all the three mechanisms.
What’s an adviser to do?
It’s possible that FASEA may actually be in broad agreement with ASIC and the Corporations Act without realising it.
In consultation sessions last year, FASEA stressed that Standard 3 only prohibits advisers acting in the face of actual conflicts. This means that it doesn’t apply to potential or perceived conflicts. The rationale is that by managing a potential conflict so that it does not influence your advice, you ensure that it does not become an actual conflict.
FASEA’s guidance also puts forward a ‘disinterested person test’ – would a disinterested person reasonably conclude that the potential conflict could induce the adviser to act other than in the client’s best interests? An arrangement that passes this test should be permitted – irrespective of the form and features of the arrangement.
The problem is that the Code itself contains no such language or qualification. Hence the confusion remains.
What is a conflict?
A conflict is a divergence of interests between an adviser and their client. If a client pays a fee to an adviser and the adviser provides appropriate advice that is in the client’s best interests, is there really a conflict? Without attempting to speak for FASEA, I believe the answer in this situation would be ‘no’.
RG 181 provides two examples of actual conflicts:
While this is not articulated in the Code, it is consistent with FAESA’s guidance and commentary. It stresses the importance of advisers managing any potential conflicts by ensuring that the advice they provide is in the client’s best interests.
Acting in the client’s best interests
When recommending a managed account, advisers need to look at each client individually in order to determine whether a managed account is appropriate for that client. This involves considering the relative costs, taxation implications and the client’s preference for certain product features.
If an adviser is thinking about recommending a managed account to a client, they should consider:
Many advisers have some form of ownership interest in the business that operates the managed accounts they recommend. According to FASEA, sharing in profits generated by the provision of ancillary products and services (like managed accounts) doesn’t breach Standard 3 provided that the ancillary products and services are:
An adviser will breach Standard 3 if the dominant purpose for providing advice is to derive profits from ancillary products and services.
A robust advice process
Based on current law, guidance and the Code, financial advisers can still recommend managed accounts provided they follow a robust advice process.
A robust advice process looks like this:
We expect that advisers who recommend related-party managed accounts will attract more regulatory scrutiny in future. But Standard 3 isn’t a death knell for managed accounts. There will always be a place for advice and investment solutions that are appropriate and in the client’s best interests.
If you need advice on managed accounts and managing conflicts – get in touch. We’d be happy to help.