Code an 'opportunity to get it right'

Financial advisers have been portrayed as both collaborators and fall guys in the finance company collapses. Catherine Harris asks whether the Securities Commission-driven code of conduct will make any difference.

It's a fair bet that a ripple of bittersweet pleasure will be felt by every burned finance company investor when new regulations governing financial advisers come into force at the end of next year.

Whether that sentiment is justified is another matter. Even Gray Eatwell of Exposing Unacceptable Financial Activities agrees that many advisers were just as duped as their investors as finance companies fell like dominoes.

"I think a lot of them were sucked in just as badly as anyone else, but that doesn't forgive them on a professional standard though, does it? If we take on a profession of any sort, we all have to fess up to our competence."

The biggest criticisms of advisers who backed the wrong horses has been either that they were hiding conflicts of interests or at the very least lacked the competence to discern when a product was too risky to recommend.

The intention of the new Securities Commission-driven code of conduct is to register financial advisers and make them accountable for the advice they give.

David Hutton, chief executive of the Institute of Financial Advisers (IFA), says it is accepted that minimum standards for the industry are needed. But it would be unfair to blame advisers for too much.

"The people who made the finance companies fail were the directors and the managers of the finance companies. Where you can get concerned about advisers is if they put too high a proportion of members' funds into a small number of finance companies; in other words, they didn't do diversification and they didn't spread it, not only over different companies, but different types of investments."

One spectacular example of that was Vestar, which lost an unknown portion of the $1 billion funds it governed in failed finance companies such as Bridgecorp, Capital+Merchant and related party MFS Boston. Debate still rages over whether Vestar's concentration in such companies was due to bad judgment or the lure of high commissions. Vestar's owner, MFS NZ, has denied that Vestar encouraged finance companies to pay higher than normal commissions.

However, the controversy was enough to prompt Donal Curtin, a member of the Commerce Commission, to step down from the deputy commissioner role last year after questions were raised about his history as chairman of Vestar's investment committee.

Bridgecorp and Capital+Merchant Finance are believed to have paid double the usual brokerage.

New Plymouth lawyer Dennis King, whose firm is representing one of the Vestar litigation groups, says he would like to see commissions banned.

"In my view, the financial planners, at the moment, tend, although not in every case, to be commission-driven salesmen, whereas I think they should become a true profession and charge for their time and not by commission.

"We had the same problem back in the 1987 crash. It turned out that the finance companies which fell over were the ones that had been paying the biggest commissions to financial advisers, and the same thing has repeated itself."

But Mr Hutton and Kapiti financial adviser Chris Lee say doing away with commissions could make financial advice more costly.

"If my business moved to the financial planning model of charging 1 per cent per annum to everybody on their portfolios and giving back the commission that we're paid, my business would earn about five times as much income per year as it gets now," Mr Lee says.

"My own firm has handled [excessive commissions] for the last 20 years by saying if someone's paying us a greater rate of brokerage than is normal we give it to a client. We just hand it back and we've returned more than a million dollars of excess brokerage over that time...

"I'm not saying that makes that the only solution. I think disclosure is the main solution, but maybe there should be standardisation of commissions. But how the sharebroking industry would work without brokerage, I have no idea."

Whether the code will address commissions is not clear. The first part of the draft code, on competence, was released for public feedback last month and the second part on ethical conduct has just come out. Advisers who breach the code could be suspended or even banned.

The code was thrown back into the public spotlight recently when a "mystery shopper" survey by Consumer magazine deemed only three of 17 financial plans satisfactory.

Soon after, two members of the code committee resigned because they were connected to Moneymax and Westpac, which fared particularly badly in the investigation.

Financial Advisers commissioner Annabel Cotton said she accepted the resignations to preserve public confidence in the code.

Consumer was criticised for its lack of expertise in the area, but chief executive Sue Chetwin says the analysis was robust. Her organisation is also against commissions and has residual concerns about the standard of adviser education and adherence to disclosure rules.

"We thought the quality of disclosure about costs and provider-adviser relationships was really low among most of the advisers we went to, and that consumers weren't really getting the information they needed."

But she is supportive of the code. "We've been asking for this industry to be licensed since 1988, so it's been a long time coming."

Mr Lee agrees that the code is "a once in a lifetime opportunity to get it right" and does some things well.

"There are much stronger rules coming in about dispute resolution, about complaints and it gives much more power for the commissioner to deal with idiotic advisers by way of forcing them to compensate or suspending or expelling them from the industry." But he says it is "superficial" and doomed to fail if the only qualification requirement is a certificate.

That fails to acknowledge the experience, product knowledge and integrity of an adviser, he says, noting that qualifications and membership of the IFA have not prevented some from facing legal action.

Mr Lee's suggestion, even though it will take more resources, is to have the Securities Commission audit every adviser case by case, getting industry references and talking to clients.

In fact, there is already a way for advisers to get certified without the study. Just one organisation in Auckland offers the service, but Mr Hutton says it will certify experienced advisers who pass a rigorous interview and case studies.

Mr Hutton hopes this might avert a possible exodus of experienced but unqualified advisers.

Of equal risk is that those who don't wish to go through the certification process as individuals might join "qualifying financial entities", such as fund managers or banks, which still have to meet the same requirements, but carry the responsibility. He says dominance by insurance companies and banks would be a step backwards for consumer choice.

"What we wouldn't like to see is a move away from the non-aligned advisers who are free to recommend a variety of product from different companies."

Ms Cotton is unrepentant about the possibility that advisers will leave because of the certificate requirement. "I think this will go a long way to giving the public confidence that financial advice in New Zealand is to a very high standard."

No-one is quite sure how many financial advisers will be affected by the new rules. One estimate is 7000, including 1300 institute members, but Mr Hutton says the new code will cover thousands more people in banks, selling travel insurance, or even doing hire purchase.

Mr Lee says a move 20 years ago among insurance companies to license their agents as financial advisers unleashed "hundreds of advisers" who were making recommendations about companies they had no knowledge of.

He believes a tangible punishment for bad advisers is long overdue, but that trustees, auditors, credit ratings agencies, directors and regulators are even more culpable.

Mr Eatwell, of Exposing Unacceptable Financial Activities, says he's met a few advisers and finds it hard to believe most of them would deliberately misdirect client funds. But as moratoriums and legal action grind on, many investors are "facing dire straits". Some are ashamed.

What's worse, he believes, is that it could all happen again. He notes a recent Reserve Bank comment that there may be more finance company failures to come. He is critical of the Securities Commission and Companies Office for not using their powers of investigation and statutory management.

Meanwhile, he and others will continue to press for any compensation they can get. "There are still a lot of people carrying a lot of money that doesn't belong to them just now."

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