The firm vs the client: conflicted decision making post-Royal Commission

The Financial Services Royal Commission has created a stir across the country; it’s not often that I overhear conversations about AMP at my local pub, or that my Mum sends me a text asking if her superannuation is ‘safe’.

Within the wealth industry there has also been widespread shock.  Some of the things that have come to light have been well understood to exist.  But I think in some cases we’re collectively surprised at just how bad those instances of failure look when they are made public; it’s been somewhat of an ethics refresher for all of us.

And some of the failures came as a surprise – for example I had honestly thought the process of remediation was more effective and timely than it’s been shown to be, and I’ve never personally witnessed a discussion about being anything other than truthful with the regulator.

Change will reverberate across the industry for years to come, but there is one specific adjustment that we have noted over the last week, and it relates to the test that we should use when making ‘conflicted decisions’, where the interests of consumers are at odds with the commercial interests of the firm.

How should a product provider decide between its own interests and that of its clients?

To date, the test that has been applied in many organisations has been that they must comply with the law, including meeting all their fiduciary obligations.  This sounds entirely reasonable, until you consider the situation of a product provider that has a range of products, the more contemporary of which are unambiguously known to be better and cheaper than the older, legacy products.  An adviser might be expected to shift the client into the better product, but as a product manufacturer many have declined the opportunity to carve up their own revenue line to ensure clients are shifted to the more contemporary product solution.

It’s unlikely there is any legal obligation on the product provider to shift members in a legacy product to a better one, as this type of responsibility (of understanding personal situations, of recommending the best product) is arguably an advice construct rather than the domain of product manufacturers.

Until now.

Counsel assisting the Commissioner have excelled in leading their witnesses to water.  It generally went something like this:

• C: You knew Product A was priced at 1.7% per annum?
• W: Yes
• C: And you knew that Product B was priced at 1.0% per annum?
• W: Yes
• C: And the products share similar features?
• W: Yes, broadly similar but not identical.
• C: And did you close Product A and move the investors to Product B?
• W: No
• C: And in deciding not to do that, did you preference the interests of the firm over those of its clients?
• W: Yes

You will note that the question as to whether the manufacturer was required by law to preference the interests of its clients over its own in this scenario is not asked – meeting legal obligations alone is potentially no longer sufficient.

Instead, there is a test of ‘community standard’ being applied to decisions made by for-profit institutions.  But, as an industry that relies on regulatory compulsion, where there is a material gap between the knowledge of clients vs providers, and whose products are care-taking clients’ financial livelihoods while being both intangible and opaque –the standard should rightly be high.  There are clear consequences of such an approach, however.  On the negative side, we’re not sure providers will launch newer, lower-cost products if they are required to move existing customers to them.  But, then again if they don’t, new entrants who don’t have such back-book considerations have a natural advantage – and this could drive innovation.

Regardless of where this all lands, it’s clear any attempt to walk-back the standard from the new high set by the commission will not help the industry’s reputation. The strength of Australia’s banking and superannuation industry is the envy of the world, but this strength is built on trust – trust borne out of a reputation that there is no better system to ensure the security of Australians’ savings and financial futures.

It’s clear that if the bulk of the commercial players exit or demand higher returns for participation, that will necessarily reduce the availability of advice in Australia.  And despite the horror stories of the past few weeks, on balance this would be a very negative outcome for Australian consumers.

The opportunity is to redefine the landscape, to think creatively about how advice can be sufficiently commercially attractive to be broadly available without significant social cost, rather than simply viewing the service as two points of polarity – commercial and conflicted or pure and unprofitable. There are other options, but more on that another time.

One thing is clear– change is coming.

Where to now?

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