Be Wary Of Conflicts Of Interest When Seeking Financial Advice

Sydney Morning Herald

Saturday September 27, 2008

JOHN COLLETT

In the storm engulfing financial markets many are being blamed - greedy investment bankers, short-selling hedge funds and central banks. But while the markets will eventually recover, the systemic conflicts of interest in the financial services industry will continue to afflict small investors.

As well as receiving advice that is not always in their best interests, consumers end up paying for the commissions, kickbacks and non-monetary incentives that slosh around the system.

For consumers looking for independent advice the regulatory protections are minimal. Stockbrokers, especially when they are part of a business also doing corporate advisory work, have long been tainted by compromised research.

That was highlighted after the dotcom bubble in 2000 when some brokers' analysts published positive reports on technology companies they privately thought were no good. The reason was that corporate advisory arms of the investment bank that employed them were doing business with those companies.

Much of the research is independent and first rate, but it is well known that some brokers research only those companies for which their employers perform corporate services - and then produce only favourable research.

The Australian Securities and Investments Commission has brought in some changes to separate research from investment banking operations. But these tend to be only recommendations and guidelines, and are almost impossible to enforce.

Then there are the researchers of fund managers. Some researchers are paid by the managers to be rated. But no fund manager is going to write a cheque to a researcher if it believes it is not going to make "investment" grade. Financial planners cannot recommend any fund that does not make that grade.

Conflicts of interest exist in every industry, but while it is bad to make a small purchase - such as a mobile phone - where there is a conflict of interest, for those being advised on retirement savings the conflicts can be devastating.

Most financial advisers are still paid commissions which, no matter how they are dressed up, are really sales commissions. They are collected by fund managers from investors' capital and then paid to planners.

Apart from sales commissions there is a host of incentives and kickbacks, such as marketing programs and promotional subsidies, that drive up the costs for consumers and have the potential to compromise the quality of advice they receive. Not-for-profit industry superannuation funds do not pay commissions and, regardless of their investment merits, will not be recommended by commission-based planners.

Most mortgage brokers are paid in the same way as financial advisers. They get paid two commissions as a percentage of the value of the mortgage - one is upfront and the other is a "trail" or continuing commission.

Unlike planners, the commission is paid by the lender and not the consumer. But the problem is the same - will a lender pay a higher commission to be recommended even if it does not offer the best loan forthe consumer?

ASIC has been active in recent years on the issue of conflicts of interest. But the view of the regulator and the Federal Government is that these conflicts should be disclosed and managed.

The various industry bodies have codes of practice their members must adhere to. These codes do ban a few of the most pernicious conflicts of interest.

The solution, as far as the authorities are concerned, is to get the financial services industry to adhere to managing these conflicts of interest and to disclose them.

Consumers are asked to wade through reams of disclosure documentation, requiring the skills of a business analyst to navigate. The onus is on consumers to try to work out which of these conflicts may adversely affect them and which they can live with.

The best bet for investors is to follow the money. If commissions are involved, consumers should consider whether it might be better to pay for the advice on a fee-for-service basis rather than a commission structure. Paying directly will help ensure the advice is independent, and may even work out cheaper.

Another important consideration is the structure of the business employing the adviser. Holders of an Australian Financial Services licence must have a financial services guide. It states who owns the business and whether product recommendations are restricted in any way. It shows the services that can be offered and how the business's advisers are paid.

Consumers should be sceptical about the "almost anything goes, just disclose" approach to consumer protection and should not feel embarrassed to confront potential advisers about their concerns.

© 2008 Sydney Morning Herald

Back to News Index | Back to Home