FoFA stands for the Future of Financial Advice, although I think a better term should be Failure of Financial Advice.
For starters keep in mind that financial loss is nothing new. In fact, Edinburgh in Scotland has a Library of Mistakes which contains more than 6000 volumes that chronicle a whole litany of financial misfortunes. There is even a copy of the front page of a Chicago newspaper dated July 14, 1928 announcing that “Ponzi will not reveal his secrets”.
Whether it be the alchemist making gold, or the sellers of tulips in Holland, there is always someone with an angle and someone who is going to be ripped off.
What is new is the growing tendency for governments to believe you can protect consumers by simply increasing layers of red tape. At best, it gives investors false feelings of confidence – at worst it creates mountains of non-productive paperwork.
The current goings on in Canberra, which revolve around the much publicised FoFA rules are a case in point. Following the collapse of institutions like Trio, Westpoint, Opes Prime, Storm and a range of agricultural schemes, there were cries that “something needed to be done” to prevent such losses happening in the future.
Labor took up the challenge and after appropriate investigation, introduced the FoFA rules in April 2010.
Following representations from the financial planning industry, and as part of their program of eliminating red tape, the Coalition attempted to wind back part of the FOFA ‘reforms’. The changes appeared to be on track until a last minute change of heart by Senators Lambie and Muir took us back to square one.
A major stumbling block has been the requirement that the financial adviser must act in the ‘best interest’ of their clients. At first glance it would seem to be stating the obvious, because one could reasonably expect that your lawyer, doctor, dentist and every other person you deal with would have an obligation to act in your best interests. But, my legal advisers tell me this is not strictly the case. People who contract with you owe a ‘duty of care’ – if they fail to fulfil this duty, an action can be taken for negligence.
The problem with ‘best interest’ is that it is so vague that it opens up a whole new area of law. The FoFA laws already require the adviser to provide appropriate advice, warn the client if the advice is based on incomplete or inaccurate information, and to prioritise the client’s interests. Surely that is enough.
In an attempt to get around the inherent problems of defining ‘best interest’, the laws allow compliance with this duty to be demonstrated by a seven stage process to be known as the ‘safe harbour’ provisions.
To be protected by the safe harbour provisions, the adviser must tick a string of boxes which include identifying the objectives of the client, making additional enquiries if the information provided by the client appears incomplete, conducting a reasonable investigation into the financial products that might achieve the client’s objectives, and basing all judgements on the client’s relevant circumstances.
But that was not enough. They added another provision requiring the adviser to act in the client’s best interest. Yes, we are back to square one. For an adviser to prove they acted in the client’s best interest they have to prove they acted in their best interest!! As a barrister friend said “you could drive a truck through it”.
Every time lawyers try to simplify legislation, they create uncertainty. One of the simplest phrases in the Queensland Criminal Code reads “a person is not liable for an event that occurs by accident”. This is the phrase that has probably been the subject of most legal cases, where the courts have been required to interpret what accident means.
A classic case happened in New Guinea, where a couple were having an argument and she walked outside carrying a newborn baby to allow things to cool off. The argument continued and he finally, in desperation, threw a small stick at her. The impact of the stick killed the baby. Was that an accident? The case went to the Australian High Court, but I must confess I forget what the decision was. The point is that simplifying legal terminology can cause more trouble than it is designed to prevent.
As a legal friend said to me “if a person came to you when they were poor, it would surely be in their best interest for you not to charge them at all”.
Now let’s get back to the real world. The two most recent large financial disasters have been the failure of Banksia in Victoria, and Wickham Securities in Queensland. The new FoFA rules would not have done a thing to save their investors – the institutions were raising funds direct from the public.
The reality is that all the red tape in the world can’t offer investors protection from loss. Financial education coupled with an understanding of risk and reward remain the key ingredients.
We are now left with a system where it costs at least $2500 to consult an adviser, and that adviser is required to produce nearly 100 pages of documentation, which the average client is never going to read or understand.
Long time followers of mine will know that I’ve always regarded my principal constituency as being those who are battling to get ahead. The new laws have priced them out of the advice market.