The ethics of SMSF advice

BRYAN ASHENDEN is head of financial literacy and advocacy at BT Financial Group.

The newly imposed Financial Adviser Standards and Ethics Authority Code of Ethics has been the cause of much consternation in the advice industry. Bryan Ashenden highlights the standards to which SMSF advisers will need to pay close attention.

It’s been over seven months now since the Financial Adviser Standards and Ethics Authority (FASEA) Code of Ethics came into eff ect for financial advisers to consider when providing personal advice to a retail client. And to a large extent, the transition has been smooth, which is a great refl ection that in reality most advisers have always been acting ethically when providing advice.

In reality, many of the issues with the code have really centred on the question of how to document the actions, thought processes and considerations that arise and not actually the way the adviser has acted. However, when it comes to advice regarding SMSFs, things can be a little more complicated.

The first complication is actually determining who it is that you are advising. We oft en remind our clients if they have (or are contemplating having) an SMSF, one of the important aspects to always remember is keeping the assets of the fund separate and distinct from their personal assets. The ATO has a significant focus on this as well. So what does it mean when it comes to the Code of Ethics?

Difficulties are common in advising SMSF clients: Am I advising a person as an individual or as a trustee? Who do I address my advice to? Does it matter? Aren’t they the same, given all members need to be trustees anyway?

This conundrum immediately brings us to a consideration of Standard 1 of the FASEA code for SMSF advice, requiring practitioners to “act in accordance with all applicable laws, including this code, and not try to avoid or circumvent their intent”.

Identifying who the client is for SMSF advice can oft en be easily determined by asking the question of who needs to take the relevant action or, perhaps in even simpler terms, to whom would I be addressing the advice if the client was in a retail super fund.

As an example, advice on drawing on a retirement income stream would likely be directed at the member as you wouldn’t provide advice on drawing on a retirement income stream to the trustee of a retail fund. However, if this advice also includes advice on the underlying investments of that income stream, which would naturally have an impact on the investment strategy of the SMSF, to whom would you direct that advice? If it was advice concerning a retail fund, again you would direct it to the member on the basis of the fund allowing for member investment choice. So is it any diff erent for an SMSF?

Where FASEA Standard 1 could cause some issues, however, is where questions arise regarding whether the SMSF could or, perhaps more correctly, should be regarded if a wholesale investor. With comfort given by the Australian Securities and Investments Commission (ASIC) a few years back that no action would be taken where an SMSF is classified as a wholesale investor if the accountants certificate test requirements have been met, has this led to more SMSFs being advised on this basis?

While we don’t have any readily available data to show whether a change has occurred or not, perhaps the initial question is why should it change the advice approach? What is the reason for treating an SMSF, and its trustees, as a wholesale investor rather than a retail investor?

Many of the issues with the code have really centred on the question of how to document the actions, thought processes and considerations that arise and not actually the way the adviser has acted.

With retail investors receiving additional protections under the Corporations Act, could making a change to the status of the client, because it may make the advice process easier, be seen as avoiding the intent of the law? With virtually all other advice on super regarding a retail fund being required to be provided on a retail basis, how do you justify a diff erent position for a SMSF?

Unfortunately, as with many ethical dilemmas, there is no simple and easy answer, and I am not saying treating an SMSF as a wholesale client cannot be an appropriate solution. But there is a need to ensure the adviser can justify why you have undertaken a particular position.

Not surprisingly, one of the more common areas of ethical consideration for SMSF advice is where a multidisciplinary firm is in being used that off ers both the advice and administration services to the client. Clearly, the question here is whether Standard 3 dealing with conflicts of interest has an impact on this situation.

Now, let’s deal with a couple of headline issues upfront. Firstly, the FASEA code has not been designed to prevent firms operating multidisciplinary practices that can service many needs for clients under the one roof.

Secondly, Standard 3 does not actually prevent you from proceeding where a conflict has been identified. The intent of Standard 3, when you read through all the supporting documentation and guidance notes FASEA has issued, fundamentally comes back to a question of acting in the best interests of the client. To this end, a simple test can be to ask the question: “If the conflict we are focusing on didn’t exist, would my advice have been any diff erent?” If the answer is “no, it would have been the same advice”, then it is hard to see how the conflict has impacted the advice in any manner, and Standard 3 should not give rise to any concerns.

It is the nature of the business arrangement in place here that has caused the issue or concern to be raised for discussion in the first place. It should not automatically be assumed that because an adviser works within a practice that also off ers SMSF administration services, that any advice to a client to establish an SMSF is done because of the ability of the firm to generate additional revenue from those administration services. Similarly, if those administration fees are slightly cheaper because of the nature of the in-house referral, that again doesn’t mean it’s not appropriate, as it could be cheaper to service the client all under the one roof through the appropriate sharing of information.

However, it would also be reasonable to expect there would be a greater level of scrutiny and advisers in this position would likely need to have more proof points to demonstrate their compliance with the FASEA code requirements. The more hurdles that exist, the more hurdles there are that need to be overcome.

It is the same dilemma that faces advisers who work in vertically integrated businesses. There is an assumption (I would suggest erroneous) that advisers who operate in these business models are naturally conflicted. The tests (or the standards) aren’t any diff erent, it’s just the hurdles may be set a bit higher. And, of course, it’s where you need to identify the diff erence in requirements between corporations law and the FASEA code.

An increased focus on the standards and appropriately documenting considerations, thought processes and observations throughout the advice process can only be a good thing.

Under corporations law, advice to invest in a product that may be produced or managed in-house could meet the best interests requirements if it can be shown to help put the client in a better position. While this best interest requirement still applies under the FASEA code, albeit without a seven safe-harbour steps approach, Standard 3 would pose the question whether a diff erent product would have been recommended if the advice was being given in a non-vertically integrated environment.

One other FASEA standard that has particular application, or perhaps a greater emphasis, for SMSF advice is Standard 5, and in particular its emphasis on requiring an adviser to ensure a client understands not only the benefits of the advice and products being recommended, but also the risks and costs, and that the adviser has reasonable grounds for being satisfied the client has this understanding.

It is always important any recommendation to establish an SMSF is being done for the right reasons and not a reaction to a client’s request to have one simply because their mates do or because they aren’t happy with their existing retail fund arrangements. The need for trustees to understand their obligations in running an SMSF is a fundamental requirement exceeding them simply signing an ATO trustee declaration that they understand their duties and obligations.

Where a challenge could be faced for SMSF advice is where there appears to be a main decision-maker among the trustees. It is not uncommon one trustee plays a larger role than the other(s) and is oft en looked to as being the person who calls the shots. With many SMSFs being comprised of family members, this is perhaps not a surprising outcome. It is also doesn’t mean the SMSF is not appropriate as all the trustees may understand their duties and obligations, may understand the risks and be aware they are equally liable for the actions of any of the fund trustees.

The difficulty for advisers under Standard 5 is to distinguish between simply deferring to another trustee and disinterest in their obligations. And while it can sometimes be hard to identify the indiff erence, for SMSF advice this is perhaps one of the key focuses for Standard 5. Remember, this particular standard is really there to help support and protect the adviser.

If a client were to make a complaint, what would be the first statement in their complaint? “I didn’t understand the advice, I didn’t know what I was getting into.” A proper consideration by an adviser of the requirements of Standard 5 should mean this complaint should never be successful.

And remember, the testing of Standard 5 around understanding should never be set and forget. It needs to be tested, considered and assessed each and every time advice is given to any client as circumstances can change. While the use of an SMSF could have been appropriate at one point in time, this justification may not exist in the future.

There is no doubt the FASEA Code of Ethics has created some challenges for the advice industry since its introduction, but fundamentally it hasn’t changed the actions of the vast majority of the industry who have always done the right thing. But an increased focus on the standards and appropriately documenting considerations, thought processes and observations throughout the advice process can only be a good thing to give a solid basis for showing how the delivery of advice, and in this case SMSF advice, is moving from an industry to truly being regarded in the eyes of the consumer as being the delivery of a professional service by professionals.