OPINION: Tear it up, stick it with FoFA

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FoFA isn’t the only set of rules that’s getting financial planning professionals all riled up, explains Jonathan Hoyle, partner at financial advisory firm Stanford Brown.

APES 230 is paternalistic, prescriptive and uncommercial. It should be torn up.

The Accounting Professional & Ethical Standards Board (APES) is an independent standard setting body for the three major Australian professional accounting bodies (CPA Australia, the IPA and the ICA). The APESB project to replace APS12 began in 2007 and has ended in the production of a draft and an explanatory note, now called APES 230. APES 230 sets the standard for the provision of ‘quality and ethical’ financial planning services for its members.

APES 230 will provide a significant boon for financial planning firms, as it will mean accountants will operate under a much more restrictive environment for providing financial advice. It is likely to remove any potential or existing revenue stream from adviser firm to accounting firm as a referral incentive.

As a large financial planning firm ourselves we are cognisant of the obvious benefits to our business, however the sheer ineptitude and scaremongering engendered in APES 230 compels us to add to the growing chorus of dissenting voices.

Submissions in response to APES 230 closed on 7 September. The Institute of Public Accountants (IPA) left no doubt as to their disdain for this controversial proposal with a tersely-worded submission, ending with a warning that should APES 230 not be amended, then “the Institute retains the right to issue our own pronouncement on financial planning services per our Constitution”.
 
The controversial elements of APES 230 are Sections 8 and 9, dealing with fees and third party payments. In essence, there are three highly controversial aspects of APES 230 that go well beyond FoFA:

  • Fees linked to assets under management are to be banned.
  • All product commissions are to be banned, including insurance and mortgages.
  • These rules are to apply retrospectively (no grandfathering).

On 25 June 2012 the Future of Financial Advice (FoFA) legislation was passed by the Australian Parliament and will apply to advisers from 1 July 2013. FoFA mandates a ban on conflicted remuneration including investment product commissions and asset-linked fees on geared products.

FoFA, whilst far from perfect, adequately deals with conflicts of interest, enshrines consumer protection and places an obligation on financial advisers to best serve their clients in a conflict-free and transparent manner.  No more is needed.

However, the APESB is not impressed and argues that “asset based fees threaten the fundamental ethical principles of the code of integrity, objectivity and professional competence and due care”.

In a free country most reasonable people would consider the method of payment between a firm and its client to be a matter for the firm and their client, rather than the government. However, let us not debate this point now. 

There are two ways for a financial adviser to be paid: from the product manufacturer or from the client. FoFA will ban the former for investment products but not for mortgage and insurance products. This is a sensible compromise as product commissions do create an inherent conflict and are best avoided where possible.

Client fees are generally paid via an hourly rate, a monthly retainer (commonly called ‘fee for service’) or via a percentage of funds managed by the adviser (an ‘asset-linked fee’). We use all three methods depending on the wishes of the client and on the particular situation.  

For instance, a young family in the wealth accumulation stage of their lives may have few assets to manage and hence a fee for service would be more appropriate. Whereas a retired couple requiring help investing their superannuation are more likely to be best suited (and want) a fee schedule linked to the size of the retirement pot to be managed.

There is much confusion surrounding asset-linked fees, with many industry consultants believing them to be little better than product commissions. APES seems to agree, citing four areas of concern:

  1. A perceived conflict exists because the advisor is incentivised to increase the client’s assets that they manage. (This is true, but see below.)
  2. Downside revenue risk in having a member's remuneration linked to the performance of the market. (Good! some pain sharing will keep us on our toes.)
  3. A percentage of FUM may be transparent in a conceptual sense, but it may not be clear in an absolute dollar sense. (This is no longer the case.)
  4. Managing $2m is not twice as expensive as managing $1m. (Correct, but see below.)

Let's take a closer look at points 1 and 4.
 

Asset-linked fees undoubtedly create potential for conflict of interest. A planning firm would increase its revenues if they advised clients to gear up rather than repay mortgage debt. But in the long run, they would have no clients left, as firms that continually dispense poor advice eventually go broke.

But what method of charging clients is conflict free? Hourly billing rewards indolence, needless over-complication and obfuscation – is APESB proposing to ban accounting hourly fees in favour of fee for service? And don’t think for one minute that fee for service is a panacea either. Most financial planners who claim to charge fee for service merely equate their fee to the assets to be managed and then bill monthly anyway.

But, far more fundamentally, we see no ethical conflict with charging our clients a fee linked to the size of the assets under our management. Managing $2m in a truly diversified SMSF takes far more skill, time and responsibility than placing $250,000 in a platform. The potential for error is greater and the consequence of an error far more significant. And yes, those who argue that managing $2m is not twice as costly as managing $1m are quite right. Hence we, like most advisers, have a declining fee scale reflecting this non-linear relationship.

We find it somewhat ironic that the government (via ASIC) is so in favour of fee for service. Our family would love to switch its income tax payments from the current geometric income-linked fee (the percentage increases as earnings rise) to an annual fee for service!    
 
Interestingly, APES 230 does occasionally stray into the realms of common sense when it states that “the Exposure Draft does not prohibit taking into account the value of the client's assets as one of the factors for determining the fee”.

We’ll leave the last word with the IPA: “Issues of fee structures are commercial decisions to be made by members and should not be matters for consideration by the APESB”. Indeed.
 
Tear it up. Stick with FoFA.

  • Gus on 3/10/2012 10:38:01 AM

    Excellent article Jonathan. APESB were to consider the APES230 at their board meeting on Sept 14th. To date not a word as to their decision. Accountants involved in financial planning are left in limbo from APESB as they grapple with FOFA. Can they make it any harder to try and run a financial advice business!

  • Matthew Lock on 26/11/2012 12:02:51 PM

    I see (and with some sense of dissapointment) that the "money for nothing and the bps for free" mentality is still alive and well...asset based fees are and always have been disconnected from the work being done...time to align fees with advice provided...fee-for-service and APES 230 rock!

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