You can't stop the gravy train

A recent article in Money Management (Planner bonuses defy FOFA) highlights the difficulties the Future of Financial Advice (FOFA) reforms face in trying to reduce the conflicts of interests inherent in our financial planning industry. As has, and always will be, the way, a shift in the goal posts simply results in the kicker changing target.

Our banks (and other large dealer groups) want their salesforce generating revenue and, one way or another, they will achieve it as best as possible within the regulatory framework they are presented with. That's the way the world works, particularly the gravy train that is the finance industry.

The FOFA initiatives wrongly target commissions (or, more precisely, 'conflicted remuneration') as being 'the' conflict of interest which needs to be eliminated to rid the financial planning industry of its ills. Commissions certainly create conflicts of interest and are responsible for the loss of plenty of Australian savings. Investors relying on the advice of someone being paid on commission should always tread very carefully. But too much focus on commissions draws attention away from the real problem and, quite possibly, exacerbates it.

The real structural problem in our financial planning industry (from investors perspective at least) is the association (through ownership or otherwise) between 'product manufacturers' and 'advisers'. Recent consolidation in the sector would suggest FOFA is having little impact on this issue (or, possibly, the opposite). Commissions are a manifestation of this problem, not the cause of it, and the article shows that organizations such as NAB will simply restructure their remuneration arrangements to ensure that everyone can best profit from the association without falling foul of the regulators.

This is not a comment on the integrity of NAB. It is natural for them to seek to maximise their profit in whatever legal way they see fit. But, as an advocate for investors, my concern is the financial industry working to benefit them, not the big banks or dealer groups.

If FOFA is to generate real change it should be targeted at breaking down the relationship between product and advice. Free market advocates (of which I am generally one of the strongest) like to argue that banks, for instance, should be free to set up financial planning businesses. But this is to ignore (either deliberately or subconsciously) that both the banking and financial planning industries are creatures of statute. APRA, ASIC, banking licenses and AFSLs don't exist in a free market. Arguing for the 'free market' in this case is, in reality, an argument for the further entrenchment of vested interests.

Regulation has contributed to consolidation in each of these industries (and the consequences thereof). It is only fair then that the regulations also work to eliminate these consequences. Separating the manufacture and management of financial products from licensed financial advice would be a good place to start.

The financial planning industry says it wants to be a profession. Lets consider another recognised profession - accounting. A common complaint of those working for the Big Four accounting firms is that there is hardly a share they are allowed to invest in due to 'auditor independence' rules. An auditor can't own shares in BHP because they would have a conflict of interest when it came to signing off on BHP's accounts.

But the financial planning 'profession' and the FOFA regulations, if applied in the accounting context, would not only allow the auditors to buy shares in BHP, they'd allow BHP to own the auditor! The auditor may well try their best, but they'd be so hopelessly conflicted, it would be a very difficult task.

This is the real problem with conflicts of interest. It is not so much that they cause a loss of integrity (although they can in some cases) but their subtle impacts. An advisor with a conflict of interest might, for instance, fall prey to confirmation bias. Rather than analysing a situation from the ground up, to arrive at a view, they may have a (subconscious) tendency to gather evidence to support a view. The difference is subtle but the difference in outcomes can be dramatic.

Even in an egregious situation, like Storm Financial, you would be likely to find many people thought they were doing the right thing (and had the analysis to prove it). Yet if they were coming from a more skeptical perspective they might have questioned the leverage, fees and timing.

I don't expect the politicians to tackle this task anytime soon. It's a tough task to turn up to major donors to tell them you're going to force them to offload a big chunk of their business, especially when it's the product distribution channel on which much of their profit growth is predicated.

In the meantime, commissions may fall by the wayside, but new forms of conflicted remuneration will rise to replace them. Until the time comes when the wheels are removed, or the tracks ripped up, the Gravy Train will keep on steaming along, crushing the returns of any investors who get in its path.

 

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