Who knows where the money goes?

PORTFOLIO POINT: The system that is supposed to track soft dollar payments in the financial services industry is flawed and needs urgent attention.

Trawling through the alternative remuneration registers of the country’s leading wealth management companies – after last week’s feature, Why is your adviser smiling? – only strengthens our belief that the current set of arrangements are deficient.

For the past six years members of the Financial Services Council (FSC) and the Financial Planning Association (FPA) have been required to maintain official “registers of alternative remuneration”. These registers are meant to record payments of all soft dollar benefits provided by fund managers and other product manufacturers to financial advisers.

Under a special code, adopted in 2004 by the FSC and the FPA, the payers of benefits are required to keep records of all hospitality, conference sponsorships and other gifts. The beneficiaries of these payments – mainly financial advisers – are also required to maintain reciprocal records.

Before furnishing a few more details on the muddied reporting of fund managers who dole out lavish gifts to the sellers of their products, I feel obliged to report what I see are fundamental flaws of the existing disclosure arrangements.

The current system of reporting is not transparent at the organisational and planner levels. Payment disclosures cited on the registers of the providers of soft dollars are not necessarily reported by organisations that receive the payments.

In the past 12 months MLC says it made more than 20 soft dollar payments, worth about $77,000, to ANZ’s advisory arm, Millennium 3. MLC names Millennium 3 as the receiver of the payments but Millennium 3 makes no reciprocal disclosure on its corporate register of receiving the soft dollars.

A spokesman for Millennium 3 says there was no disclosure of the payments to Millennium 3 because the beneficiaries of those payments were individual advisers. The spokesman said that each of the advisers in receipt of the MLC gifts disclosed the benefits in their own individual registers.

The FSC argues that this arrangement is effective and ultimately serves the code’s aim of enabling consumers to get information about soft dollars received by their adviser or prospective adviser.

However, the reporting system, as currently structured, makes it almost impossible to gain a clear-cut view of the total payments received by licensees, such as Millennium 3, because there is no requirement for licensees to maintain a central register of all benefits enjoyed by their adviser representatives.

On this basis, MLC excludes from its register all soft dollar payments it makes to representatives of its proprietary adviser companies such as Godfrey Pembroke.

Data on the aggregate flow of payments at the organisational level is meaningful information for consumers because it can help establish an understanding of the soft dollar culture of dealer and adviser groups.

Such information would be especially helpful in providing an insight into the ties between licensees and their parent companies, which also own product providers.

There are important reasons for requiring product manufacturers to name the beneficiaries of soft dollar payments on their registers. Such a requirement would go some way to help investors determine whether an adviser has actually disclosed everything on their register.

The present reporting system denies investors the opportunity to cross-check the quality of the adviser’s disclosure.

The disclosure system operates from a premise that all advisers behave in a competent and honest manner.

This is absurd. Only last week one Townsville adviser was jailed for eight years after pleading guilty to 13 counts of fraud. Other advisers have been forced to exit the industry this year following ASIC investigations into their activities.

The system thwarts attempts by a person unrelated to the disclosing parties to subject their records to a falsifiability test. The ability to cross-check an adviser’s disclosure against beneficiary details on a payer’s register would constitute such a test.

Without such a test, the system could never be described as transparent.

The code suffers from other defects. One is the ability of financial media and consumer advocates to efficiently collate information to establish which dealers, adviser groups and advisers are receiving the most and least amounts of soft dollars in the industry.

Knowing that an adviser enjoyed $5000 worth of soft dollars in the past year could only have meaning if there was an efficient method to determine whether this figure was above or below the median average received by other advisers in the market.

At present the only way to determine this is to inspect the registers of almost 12,000 members of the Financial Planning Association.

It is unreasonable to expect independent investors to undertake such a task.

And as we are discovering, securing registers can also be time-consuming, even though the code stipulates that they be furnished within seven days of a request. We’ve been waiting since October 25 for Victorian-based independent adviser group, Capstone, to supply a copy of its register.

Another problem with the system is that fund managers and advisers are making disclosures in different formats. This undermines one of the aims of the code, which is to “standardise the practices and procedures of FSA and FPA members who offer or receive alternative forms of remuneration’’.

FPA chief executive Mark Rantall this week recognised the important role the media plays in advancing the cause of disclosure under the industry-managed code. “The code is doing its job because you can report on it,” he told Eureka Report. “In no other profession is this done.”

Rantall said the industry code and associated disclosure requirements had been designed with the aim of facilitating media scrutiny of alternative remuneration activity.

If this is one of the measures that the FPA is using to gauge the code’s effectiveness, then it is failing.

Our article last week (see Why is your adviser smiling?) elicited messages of support from investors and mixed reactions from fund managers and advisers (see Letters of the Week).

IPAC chief executive Neil Swindells acknowledged that a refusal by a staff member to send us a copy of his firm’s register constituted a breach of the industry code.

In an email, Swindells wrote: “This does not forgive someone in IPAC refusing to supply it to anyone who asks. We are making sure all people are reminded this is not only our policy, it is law.”

Most advisers who contacted us described the article as a “beat up” or '’misleading”.

I’d like to address some of the concerns raised by those advisers.

One Queensland adviser accused me of deliberately “doing a half-baked job” with the aim of damaging the reputation of his profession. He went on to say that soft dollar payments rarely went to the planners themselves.

But as detailed out earlier in this article, there is plenty of evidence to show that payments made to licensees do find their way to advisers. For example, the majority of MLC’s soft dollar payments to Millennium 3 in the past 12 months went directly to that firm’s adviser representatives.

Simon Barlow, the principal of Albury-based Barlow Financial Planning, observed that journalists and doctors did not maintain soft dollar registers:

“Where is your soft dollar and conflicts of interest register for me to look at? How many 'free lunches' do you attend each year?”

The argument in relation to other professions not keeping soft dollar registers is a forceful one. While I am of the view that the FSC/FPA code is not working, the financial services industry should be given credit for at least establishing a disclosure system. Peak industry bodies for the medical and journalism professions should be making similar efforts.

A representative of Westpac’s BT Financial Group also alerted us to two errors in last week’s article. It was reported that the customer service centre of another Westpac-controlled company, BT Investment Management, had sent me an edited version of its soft dollar register. The incomplete register actually came from customer service at BT Financial Group.

I also asserted that the register sent from the customer service centre arrived 15 days after it was requested. I overstated the delay: it actually arrived 11 days after it was requested, possibly due to it being incorrectly addressed. The code stipulates seven days.

BT Financial Group made internal inquiries to determine why all references to the value of soft dollar payments had been omitted from the register supplied by its customer service centre.

“We understand the register received by the contact centre and sent to the caller was printed to A4 instead of A3, which resulted in the second half of the document being cut off,”’ a BT Financial Group spokesperson said. “We have since implemented a new procedure”.