Note: SuperGuide originally published this article about two years ago, but the topic remains highly relevant for readers today. We have updated the original article with information on the legal definition of ‘independence’ and the IFAAA’s version of independence..
Every week I receive emails from readers searching for qualified and independent financial advisers, and many of these readers share with me the difficulties they face as consumers locating an adviser who can legally claim they are independent. In this article, the president of the Independent Financial Advisers Association of Australia Limited (IFAAA), Daniel Brammall, shares his tips on how to spot an independent adviser, and also how to spot an adviser who is NOT independent.
Before we share Brammall’s views, I have included an email extract from one of our readers, John, which highlights the frustration that some Australians feel when searching fruitlessly for a financial adviser who is able to provide, expert and independent financial advice. John says:
I gave up looking for independent financial advice long ago and just try to do the best I can by myself. After four financial advisors in 20 years I finally realised that I had better judgement about investing than they did (and I know zilch). Unfortunately I would like professional advice on other aspects of managing super but, after meeting a range of different financial advisors who claimed to be ‘independent’ and finding that they weren’t, I gave up.
I consider John’s views an indictment on the financial advisory industry really, because here’s an individual who believes in the merits of quality financial advice, an individual who has used four advisers in 20 years, and who is still trying to find an independent adviser, but has given up the search: a real pity.
Daniel Brammall, who, as well as being IFAAA president, sits on the Government’s Financial Advice Advisory Panel (for more information on the panel see article THE SOAPBOX: Financial advice – Can the Gang of 18 change your super world?) considers John’s experience with financial advisers “all too common, sadly”.
Brammall believes that ‘independence’ is a term that lacked definition before the IFAAA was established in 2010.
“We had run out of patience with the large professional associations. Not a single one of them represented the interests of independent financial advisers nor did they do anything to promote independence to the public. Furthermore the associations didn’t seem to understand what independence was, nor how to achieve it. We set up the IFAAA to educate the public on what a truly independent financial adviser looks like and to encourage financial planners to do what is necessary to become a conflict-free fiduciary, rather than some sort of salesperson masquerading as an adviser. There was nothing to do but get it started ourselves,” explains Brammall.
“There are a lot of ‘smoke and mirrors’ games played by the financial services industry, designed to hide the conflicts they only disclose in the fine print. The fact is that independence DOES have a clear definition and only members of the IFAAA uphold this ‘gold standard of independence.”
So, what is the definition of ‘independence’ when referring to financial advice? According to the IFAAA, a genuinely independent financial adviser is one that does:
- NOT have any ownership links or affiliations with product manufacturers
- NOT receive commission or incentive payments from product manufacturers
- NOT charge asset-based fees
It’s unfortunate that the definition for ‘independence’ is a negative definition, that is, independence is a default when an adviser is NOT something, rather than when they ARE something. Brammall agrees, but explains that the IFAAA approach is to identify impediments to impartiality, and remove them.
The good news for consumers though is that Brammall suggests that you need only ask two questions of any financial adviser to determine if the adviser is independent (more on these two questions later in the article).
The more significant issue however seems to be the obstacles in place that prevent independent financial advisers operating in Australia. According to Brammall, conflicts impair the quality of advice. He says: “If high quality advice is what’s necessary to safeguard the life savings of Australians then what’s the debate about? Are we placing the commercial interests of an already bloated industry ahead of the life savings of Australians?”
Note: ‘Independence’ as defined by section 923A of the Corporations Act 2001 is slightly broader than the definition used by the IFAA. Under the Corporations Act 2001, a financial adviser can still represent herself or himself as independent even when she or he charges asset-based fees. A financial adviser cannot represent herself or himself as independent however if she or he receives commissions (unless fully rebated to the client), receives remuneration calculated on the basis of volume of business placed with a financial product provider, or receives other benefits that may influence the advice they give to a client.
Obstacle 1: Ownership links or affiliations with product providers
Let’s share some of the bad news: it is estimated that around 80% of the 18,000 or so of financial advisers in Australia are affiliated with a product manufacturer, which means that 80% of financial advisers are NOT independent. Of the remaining 3600 or so of non-affiliated advisers, it is unclear how many of these advisers are NOT independent due to receiving commissions for recommending financial products, or for charging asset-based fees. Note that the legal definition of independence permits the charging of asset-based fees.
Brammall believes the conflict of interest problem arises in the following way: when an adviser is owned by a product manufacturer there is, at worst, a products list limited to only that manufacturer, and, at best, simply a culture to push that manufacturer’s product.
Brammall cites, as an example, an interview he conducted with a paraplanner from a bank: “Last week I interviewed a paraplanner who currently works for a bank. She told me that the ‘practice leader’ at the bank called all the paraplanners and financial planners into a meeting and expressed his concern that the bank’s insurance product wasn’t being sold much and he’d like to see that change. One adviser suggested ‘surely we should be recommending whatever’s in the clients’ interests?’. The reply to her was ‘of course, but we want to see more of our product in your recommendations, that’s all’”.
Obstacle 2: Commissions or incentive payments from manufacturers
Brammall warns that an adviser, or advising firm, that promotes being ‘independently owned’ is not necessarily INDEPENDENT for the purposes of providing financial advice.
He cites another example where a planner, who is employed by an ‘independently owned’ advisory firm, is only able to advise on products that pay a commission, namely those products that are on the firms ‘approved products’ list. The client is then missing out on a broader universe of products.
“The argument being run by the industry’s major players (who are themselves product manufacturers or lobby groups representing planners who are conflicted to greater or lesser degrees) is that disclosing the conflicts is enough. This doesn’t hold water. If a conflict exists then there is a problem. Whether the adviser acts on that conflict is not the point – acting in the client’s interests as a fiduciary should not be a matter of discretion. Why ‘cotton wool’ an ‘adviser’ who insists on retaining conflicts so as to be remunerated as a salesman? A large number of planners apparently want to be treated like professionals but want to continue behaving like incentivised product intermediaries,” says Brammall.
“The issue is this: what is the service you want? Do you want to appoint a sales agent or do you want to get advice that is not tied to a transaction at all? If the adviser’s remuneration is based on a transaction, then that’s where their advice is headed, even before they’ve met you to work out a solution to your problem.”
Obstacle 3: Asset-based fees
The third obstacle outlined by Brammall is the use of asset-based fees when charging for advice: for example, 1% of funds under advice (FUA).
“Asset-based fees are simply commissions by another name. They differ legally from commissions by one technicality. If you dig up the Corporations Act 2001 and flip through to section 923A, you’ll learn that there is a phrase sheltering asset-based fees from being classified ‘commissions’,” says Brammall.
He uses the following example: A planner is given $200,000 to invest on behalf of a client and the planner charges 1% of FUA, or $2,000. If the client gives the planner $400,000 instead, the planner’s fee immediately doubles to $4,000. Does the client get twice the value of service?
Brammall further argues that as the client’s investment grows over time, so does the planner’s business income, with no extra effort, that is, just for doing their job. Brammall challenges that this portfolio management is what they’re already charging for in the first instance.
Another disturbing consequence of charging asset-based fees for financial advice is where the best decision may be NOT to invest any money, or instead to sell an investment, or to pay off a debt.
Brammall believes that an asset-based fee, by its nature and by definition, is an incentive for the adviser to always invest a client’s money (even when that is not in the best interests of the client), while a conflict-free structure is where advice is NOT tied to a product transaction in any way.
“Incentives are a conflict. End of story. Whether the adviser actually acts in favour of the incentive or not is immaterial. The conflict already exists and – in the most harmless situation – it simply serves no useful purpose for the client, but in the most sinister situation it pre-empts the recommendations of the adviser and is not in the client’s best interests,” argues Brammall.
Two questions to test your adviser’s independence
So, how can you spot an independent financial adviser? According to Brammall, you just need to ask two questions:
- Who are your shareholders? If any of the shareholders of the adviser’s firm are product manufacturers, then the adviser is not independent.
- Do any of your fee options contain a percentage? Brammall says that if a payment structure is linked to a transaction, then you should cross the adviser off your list.
Note: The Corporations Act definition of ‘independence’ permits asset-based fees, which are percentage-based fees/
I have a final question for Daniel Brammall: where can SuperGuide readers find this rare species of independent financial adviser?
“Naturally, all members of the IFAAA have the Gold Standard of Independence (visit www.ifaaa.com.au for more details). For non-IFAAA financial advisers, you really need to determine for yourself whether the adviser passes the Gold Standard test, and is therefore truly conflict-free. Here’s how:
- Start by going to the financial adviser’s website: it should be pretty clear whether they’re owned by a bank, insurance company or fund manager. If you see any of their logos it’s usually an indication. If they pass this step (or, at least it’s not yet a fail), go to step two.
- Are they paid on an incentive scheme (percentages)? Download their Financial Services Guide (‘FSG’) or if it’s not available, phone them and ask them to email it to you. What you’re looking for is the section on how the adviser is remunerated. Most planners include an hourly rate fee option but it’s illegal not to disclose ALL possible forms of remuneration. If there are any other options that work on percentages (commissions or asset based fees) the adviser fails the Gold Standard test.”