Advice on managed accounts: A legal perspective

By Jayson Forrest - Managing Editor  - IMAP Perspectives

Simon Carrodus considers the legal and regulatory obligations for advisers when advising on managed accounts. This IMAP presentation was moderated by Jenny Mulders, Chair of the IMAP Regulatory Group

In a post-Royal Commission world, advisers and licensees have had to adapt to a much tougher regulatory environment, with a greater focus by the corporate regulator on advisers adhering to the Best Interests Duty.

Speaking at an IMAP webinar on ‘Giving advice on managed accounts - Best interest and other considerations’, Simon Carrodus - a partner at The Fold Legal - explored a range of key issues advisers need to consider when advising on managed accounts.

And at the top of his list are in-house products.

According to Simon, ASIC classifies most managed accounts as in-house products. ASIC defines an in-house product as being where the licensee or related party receives an additional benefit, such as a fee, when the adviser recommends the managed account.

“This could be a fee, like an investment management fee, that the licensee receives for managing the money,” says Simon. “We’re talking about an in-house product where the licensee receives an additional fee that they wouldn’t receive if the adviser recommended an external managed account.”

And while there is no ban by ASIC on advisers recommending in-house products, or licensees receiving an investment management fee on an in-house managed account, it must be remembered that with all in-house products, there is a conflict that must be acknowledged and managed by the adviser.

“The worst thing any adviser can do with an in-house product is to deny there is any conflict in using it,” Simon says. “If a product has your branding on it and you are receiving an additional fee for recommending it, then of course, there is a conflict.

“To manage this situation, you must first acknowledge the conflict and then ensure you have the proper measures and processes in place, like regular client file audits, to ensure that any potential conflict doesn’t result in any detriment to the client and that the advice provided is in the client’s best interest.”

Additional requirements advisers need to be aware of when considering recommending in-house managed accounts is s961J of the Corporations Act, which requires advisers to prioritise the client’s interests above their own or licensee’s interests, and Standard 3 of the FASEA Code: ‘You must not advise, refer or act in any other manner where you have a conflict of interest or duty.’

“Remember, ASIC has shifted its focus to in-house products, which encompasses the management of conflicts. Therefore, when advising on an in-house managed account, advisers need to understand that ASIC will look at this with a greater level of scrutiny,” warns Simon. 

However, what if no fees are attached to an in-house product? Is there still a conflict?

 Simon concedes, it’s an interesting question. He states that when no fees are charged for an in-house product, then there is definitely no financial conflict.

 “If the adviser is in a position where they can recommend a third-party managed account or an in-house product, and there is zero financial difference for the adviser or their licensee, then ASIC’s view is that the financial conflict has gone, as there is no financial incentive for the adviser to recommend their in-house financial product,” says Simon.

However, even though the financial conflict might be gone, he adds that ASIC will still be concerned about the incentive to achieve an operational benefit from any in-house product.

Are no fees a conflict?

“For example, if it’s going to be operationally easier for an adviser or licensee to have all or most of their clients in a specific managed account, then although there might not be a financial benefit, there may be an operational efficiency benefit. Also, there might be a marketing benefit by branding a white-label product and then claiming to offer an integrated advice and product solution.”

 While Simon believes there is seldom zero conflict when dealing with products, he urges advisers and licensees to be careful with their advice process, which includes understanding that managed accounts are not suitable for every type of client.

 However, he qualifies this by saying: “When no fees are charged for an in-house product, then you’ve probably eliminated 97 per cent of the conflict and you probably won’t come under the same level of scrutiny by ASIC, as you would if you were charging product fees.”

Appropriate advice’ is a key element of the Best Interests Duty and Simon believes it’s an essential area that advisers cannot overlook, particularly when providing advice on managed accounts. In terms of ‘appropriate advice’, the law requires advisers to be able to demonstrate a clear client benefit for every recommendation they make.

“If you are struggling to articulate a clear client benefit, you need to go back and rethink the advice or recommendation,” says Simon. “Specifically, the law requires you to explain how the recommended managed account addresses the client’s needs and objectives; and why the recommended managed account is likely to leave the client in a better position.”

Simon adds advisers need to have a clear vision as to why they think their advice recommendation will leave the client in a better position, and if this is clearly documented in the SOA, “then you’re in a very strong position moving forward, particularly if ASIC looks at your client files”.  

And while he emphasises that any recommendation needs to be linked to the client’s needs and objectives, he also adds that it doesn’t necessarily have to be the cheapest option available for the client.

“ASIC is clear that the recommendation doesn’t have to be the cheapest option available for the client. While price is a consideration, it’s not the only consideration. Other product features and benefits are also relevant, especially if the client says they are.”

Simon points to an example in RG175, where a client is willing to pay a little more for better reporting and the ability to follow their investments online. And while this scenario is more expensive for the client, ASIC maintains it is still consistent with the client’s best interest because the client specifically wanted this kind of online access to their investments.

Based on ASIC reports 515 (Financial advice: Review of how large institutions oversee their advisers) and 562 (Financial advice: Vertically integrated institutions and conflicts of interest), as well as findings from the Hayne Royal Commission, the three main areas where advisers consistently fall over in are: failure to do adequate product research; failure to tailor the advice to each individual client; and failure to keep proper documentation.

To these three points, Simon believes you could also add: failure to properly explain the advice.

“If you know your client’s circumstances, you’ve done your research, and you’ve got really good reasons to recommend a particular managed account, then you need to explain that and write it down in the SOA. Your chief reasons for recommending the managed account need to be front and centre for ASIC or an auditor to read,” he says. “Your documentation needs to tell a clear story to the reader.”

Interestingly, under the Safe Harbour provisions, which are a key component of the Best Interests Duty, advisers must demonstrate they have completed seven steps throughout the advice process:

1. Identify the client’s needs and objectives;
2. Identify the subject matter of advice sought by the client;
3. Make reasonable enquiries to obtain complete and accurate information;
4. Assess whether the adviser has the expertise to provide the advice;
5. Research products that might meet the needs and objectives of the client;
6. Base all judgements on the client’s needs and objectives; and
7. Take any other step that would reasonably be regarded as being in the best interests of the client.

However, of these seven steps, Simon believes steps one and five are particularly important when advising on managed accounts. But he adds, as also identified by ASIC, they are two areas that many advisers often fail on.

“Step one - Identify the client’s needs and objectives - is incredibly important. If you don’t know what the client’s needs, objectives and preferences are, then you can’t tailor your advice to the client. Instead, the advice is likely to be generic and templated. Advice needs to be tailored to each client, but this can’t happen if you don’t know your client,” he says.

“And step five - Research products that might meet the needs and objectives of the client - is not just about doing the research, it’s also about interpreting that research, applying that research to the client’s circumstances, and capturing that research in your file notes.”

Just as all clients are not the same, so too, not all investment structures are the same. It’s for this reason that Simon believes it is important that advisers need to have a thorough understanding of the key features and benefits of managed accounts, in order to be able to match this structure to a client’s needs, objectives and preferences - if appropriate to do so.

“If an adviser has properly understood their client’s needs and objectives, they will be able to quickly determine which type of investment structure will satisfy the specific requirements of the client. If the client tells you they want transparency of holdings, tax-efficiency, beneficial ownership, and trading efficiency, it will quickly become evident that the best structure for the client is a managed account, as opposed to a managed fund. But to determine that, you first need to ask the right questions.”

There’s no avoiding the fact that advising on in-house products, like managed accounts, does raise the issue of conflicts of interest. However, Simon is confident that any potential conflicts can be effectively managed though a robust advice process.

“Essentially, any potential conflict can be managed through a ‘robust advice process’. This can be done by ensuing the advice is appropriate for the client, that you are complying with the Best Interests Duty, and that the advice process is not detrimental to the client,” he says.

He points to the importance of researching the client’s existing investment structure and product, and determining whether it satisfies the client’s requirements. If not, then the Best Interests Duty requires the adviser to research other products/structures that may better satisfy the client’s requirements.

Once a suitable investment strategy (in this case, a managed account) has been determined for the client, the product research doesn’t need to consider other structures, like managed funds. In addition, the adviser does not have to research every managed account available in the market. Instead, the adviser can rely on research from their licensee or external research houses.

According to Simon, ASIC strongly encourages advisers to capture a summary of the alternative strategies that were considered for the client, with an explanation as to why those strategies were less advantageous than the recommended strategy.

“The adviser needs to be able to interpret the research and apply it for the client’s circumstances. That’s because only the adviser knows the client’s individual circumstances,” says Simon.

As part of the research process, the SOA should include a comparison of the client’s current product with the recommended managed account, and if the managed account is an in-house product, then the adviser should also include at least one external managed account that could also satisfy the client’s investment needs. The adviser also needs to include in the SOA any other product the client specifically requested the adviser to consider.

Simon believes licensees can assist their advisers in the product research process by benchmarking the features of their in-house managed account with other products in the market. In fact, the Design and Distribution Obligations (DDO) require product providers to undertake a periodic review of their products, including the ability of the product to meet the goals and objectives of clients.

From there, the adviser needs to justify their recommendation, which means clearly explaining and documenting in the SOA:

• How the managed account structure will satisfy the client’s needs, objectives and preferences;
• Why a managed account is likely to leave the client in a better position;
• Are there any trade-offs to the recommendation and if so, what are they, and why the recommendation is still appropriate; and
• What were the alternatives the adviser considered and why were those less advantageous for the client?

From a legal perspective, the key message Simon emphasis for advisers and licensees who use managed accounts is to remember that “good questions generally lead to good advice”.

He explains: “By asking the right questions to determine the needs, objectives and product preferences of the client, and then matching these with the most appropriate investment structure for the client, is one of the keys to providing good advice. But to do so, you need to know managed accounts and you need to know your client.

“And importantly, you need to clearly explain why the recommended managed account will satisfy the client’s needs, objectives and preferences, and will likely leave them in a better position. This includes providing a summary of alternative strategies that have been considered, as well as documented evidence of the product research conducted.”

Simon Carrodus is a partner at The Fold Legal. He spoke in an IMAP webinar on ‘Giving advice on managed accounts - Best interest and other considerations’.

The session was moderated by the Director and Founder of QRC Consulting and Chair of the IMAP Regulatory Group, Jenny Mulders.