Another rotten apple

A month or so ago I found myself chatting to a consultant to some of the country's largest financial planning outfits. We talked for an hour or so, bemoaning the state of things in general – it's just something you do once you hit 50 - and financial planning in particular, a subject open to moaners of all ages.

As I was leaving, one final question popped out: 'If the biggest firms in the sector all operate on the same basis, as product pushers masquerading as planners, why is the Commonwealth the only major bank wrapped in scandal? Why haven't there been more?'

'Don't worry,' he replied, 'it's coming'.

And so it has. Naturally, Adele Ferguson of Fairfax has the story, uncovering wrongdoing at NAB, where 31 planners have been dispensed with in the past two years. Hers must be one busy mailbox.

This time, a bank whistleblower provided a copy of a board level report penned by Andrew Hagger, head of NAB Wealth. The story offers a few choice quotes, including this pearler:

'We have suspended, terminated or ensured resignations of 31 NAB FP and aligned advisor over the past two years due to conflicts of interest, inappropriate advice, inappropriate practices or serious repeat compliance breaches. Many of these recorded annual sales well in excess of the average advisor.'

Notice anything odd about that final sentence, like the fact that the words 'sales' and 'advisor' appear together?

Conflict of interest

NAB might be congratulated for dispensing with the services of advisors with conflicts of interest – although it appears breaches were not necessarily reported to ASIC – but all its advisors have a conflict of interest. You simply cannot be a sales person and an advisor at the same time.

Any suggestion that this conflict can be overcome through internal company procedures, a watchdog that barks rather than whimpers, or legislation that forbids commissions but implicitly allows others kinds of financial rewards, stands against the weight of history.

Ratings agencies like Moody's and Standard & Poor's are still, incredibly, paid to 'independently' assess and grade financial products. They played a key role in the Global Financial Crisis, essentially making stuff up for money.

Matt Taibbi in Rolling Stone quotes a few insider emails revealed in a court case covering the matter. One explained how the ratings agency employee 'had difficulties explaining 'HOW' we got to those numbers since there is no science behind it'. Another expresses his hope that 'we are all wealthy and retired by the time this house of card[s] falters'.

As Taibbi says, 'Moody's and S&P have for many years been shameless tools for the banks, willing to give just about anything a high rating in exchange for cash.' The ratings companies were not alone.

Despite their internal controls and strict risk management procedures, the banks were prepared to do just about anything in exchange for cash, too.

A London School of Economics research report titled Risk Culture in Financial Organisations says the UK Parliamentary Commission on Banking Standards found 'the presence of a centralised risk management function and apparently strong risk governance did nothing to prevent disaster.'

Weird, eh? All those compliance procedures, training courses and policies amount to nothing when a big fat bonus cheque or promotion is waved in front of someone's nose. Who woulda thought it?

You can forget the regulators, too. Many have either come from a big bank or want to end up at one. As Carmen Segarra's revelations revealed, regulators quickly turn to water when they have to actually regulate.

Revealing its simpering nature, ASIC even sent the media release on the NAB scandal to NAB for a final spit and polish. What kind of cop think's that is in any way okay? Only one completely in hock to those it regulates.

In its defence, ASIC recently secured its biggest ever fine - against two companies that no longer exist. This is an organisation that comes down like a tonne of bricks on a ghost but lets the big fish go free.

There's a reason why doctors aren't allowed to accept remuneration from drug companies (and why drug companies continually try to skirt these laws); financial incentives greatly affect human behaviour.

Incentive superpower

As Warren Buffett's business partner Charlie Munger once said, 'I think I've been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I've always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.'

Professor Uwe Dulleck of the Queensland University of Technology has studied the power of incentives on experts like doctors and financial advisors, finding that 'under experimental condition one third of participants were consistently driven by their own private benefit so they always chose the option that gave them the highest profit.' In a bank-driven sales culture like NAB or Commonwealth, you can bet the figure is a lot higher than that.

The renegade senators that blocked the Government's attempts to water down the Future of Financial Advice reforms, giving the big banks exactly what they wanted, should be commended.

But those seeking financial advice should not rest easy. Until the sales function is separated from the act of proffering advice, all sorts of conflicts exist that will lead to higher profits for the big banks and poorer retirements for everyone else.

If the rips offs are to end, so must vertical integration. The banks cannot be allowed to manufacture financial products and then shove them through a sales channel labeled 'advice'.

The best way to achieve that is through a Royal Commission into this rotten industry. Only this has a chance of creating the political will for change.

In the meantime, many investors are saddled with an unenviable task; of needing financial advice but not knowing how to find someone we can trust to deliver it. Six questions for your financial planner will help, but not as much as government legislation to break the banks' stranglehold on this sector.

Commonwealth, Macquarie Private Wealth and now NAB have revealed themselves as bad apples. We await more grubby stories from AMP, ANZ Bank and Westpac. Surely they're out there?