Government releases FOFA regulations

In brief

The Government's much anticipated FOFA regulations were registered today and provide significant relief for benefits provided to employees and representatives of product issuers who provide general advice. They also expressly allow bonuses to be linked to successful product sales providing the bonus is not a 'commission', and the best interests duty also has been amended. There are many other amendments and a long Explanatory Statement traversing many of the most significant FOFA issues. But like the notes inserted by the regulations, an Explanatory Statement cannot amend the law. Partner Michelle Levy, Senior Associate Simun Soljo and Lawyer Rosie Thomas report.

Best interests duty – what is all the fuss about?

The regulations substitute some of the prescribed steps with slightly narrower steps in order to make it clear that an adviser and their client can agree to limit the scope of the advice. This advice is called 'scaled advice'.

The regulations also say that an adviser does not have to take any other step that would reasonably be regarded as being in the best interests of the client in order to be able to prove they have satisfied the duty. Again relief is provided only until 31 December 2015. While this amendment has been the subject of enormous debate, we remain sceptical about the difference it will make – it was hard to see that it had much room to operate and, equally, it is hard to see that its omission will make any real difference to the quality of advice.

Performance bonuses – are they really conflicted remuneration?

The Government says that FOFA was not intended to prevent modest bonuses being paid to employees providing financial product advice. But the difference between a bonus and conflicted remuneration was difficult to identify and so the regulations provide an express exemption for benefits provided to an employee or other representative of a licensee that would otherwise be conflicted remuneration if the conditions in the regulations are met.

A benefit will not be conflicted remuneration so long as it is a 'low in proportion' to the representative's total remuneration and, in calculating the bonus, the weighting given to the financial products sold by the representative is 'outweighed or balanced by the weighting attributed to other matters'. The ES says that 10 per cent of the representative's remuneration might be low and suggests that compliance might provide a suitable counterweight to the numbers of products sold by the representative as a basis for calculating the bonus. It does not explain why the other 90 per cent of the representative's remuneration does not in fact influence their advice. Nevertheless, this is consistent with ASIC's view.

ASIC says that salary is not conflicted remuneration and, while this is clearly a welcome view for the industry, it does not appear to be based on any principled reasoning. It also leaves open the possibility that a representative provides a product recommendation because that is what they are told to do – it is part of their job – and that no part of their remuneration would in fact change what their advice would be.

General advice – conflicted remuneration is okay so long as it is not commission

The regulations will allow a licensee to provide a benefit to an employee or other representative of a licensee (or related body corporate) if they provide general advice 'under the name of the licensee' and the benefit is not a 'recurring payment made because the person has given general advice' or 'a payment solely because a financial product of a class in relation to which the general advice was given has been issued or sold to the client' (referred to as a commission). There are also other conditions.

This exception is significant. It is also going to make even more important the not terribly well understood or clear distinction between general advice and personal advice. It will be important, but not enough, for a person relying on this exemption to make it clear to their customers that they are not providing personal advice. They must not have considered one or more of their objectives, financial situation and needs.

Will it open the floodgates to conflicted remuneration? It is hard to say that it will, but it might go a long way to creating a two tier industry – with financial advisers on the one hand and sales people on the other.

This might be a good thing – consumers who are looking for independent advice should know if they are instead dealing with a product sales person.

Benefits calculated by reference to another benefit

The breadth of this regulation has been significantly narrowed from the draft – now it says that a benefit will not be conflicted remuneration to the extent the amount or value of the benefit is calculated by reference to another benefit that is not conflicted remuneration, but only because of the express exceptions in sections 963B, 963C or 963D.

So, a licensee who receives a benefit provided by their client under s963B(1) will be able to provide some or all of that benefit to an authorised representative. There is nothing preventing the licensee providing a multiple of that benefit, (or a fraction of it as might have been intended) and so it does open the way for some interesting decisions about when a benefit is calculated by reference to another benefit. This may well be an area for the anti-avoidance provision to do some work.

Client pays exemption – how wide is it?

The regulations insert two new notes (to add to an existing note) into the regulations. They purportedly 'clarify' s963B(1)(d) of the Act (although neither 'note' expressly refers to that section). This means anyone wanting to interpret s963B(1)(d) of the Act will need to remember to refer to the 'notes' in the Regulations which are relevant to the section. This is an interesting approach to regulation, not least because the authority of the notes to change the meaning of the plain meaning of a legislative provision is unclear.

Putting aside the statutory interpretation quirks, s963B(1)(d) exempts a benefit that is given to the licensee or representative by a retail client in relation to the issue or sale of a financial product, or financial product advice given, by the licensee or representative to the client. The breadth of the section has always been unclear – the Explanatory Memorandum to the Bill introducing the section said it applied where a benefit was given 'at the direction, or with the clear consent' of the client. The first of the new notes provides a reference to s52 of the Corporations Act 2001 (Cth) which says that 'a reference to doing an act or thing includes a reference to causing or authorising the act or thing to be done.'

If a client can authorise a payment by providing their 'clear consent' to the payment, what are the limits of the exemption? According to the ES, the first new note has been included to demonstrate that where a benefit is given by a third party with the client's authority, the client pays exemption applies 'as long as the benefit is given using the client‘s own monies, or funds the client is beneficially entitled to'. There is no basis in the terms of the legislation (or the new note about s52) for this interpretation. This does not mean that there are no limits to the scope of the exemption – the limits are contained in the words themselves – the benefit must be provided in relation to the issue or sale of a financial product or the advice provided to the client by the licensee or representative. The words of the client pays provision and section 52 are the correct place to identify the limits of the exception, not the notes or the ES.

What happens next?

The regulations commence tomorrow (1 July 2014). It is unfortunate the industry has not seen some of the changes until the day before commencement and this will make compliance tricky. While ASIC has not released a statement in relation to how it will administer the requirements in light of the changes, we might expect it to take a 'facilitative' approach.

The regulations must now be tabled before Parliament, which may disallow them (effectively repeal them). This can be done by a disallowance motion within 15 sitting days of the regulations being tabled. The earliest this could happen is next Monday when the Senate resumes. A motion would not succeed in the House of Representatives which is controlled by the Government, but it could succeed in the Senate if enough of the cross-bench Senators support the disallowance. Not for the first time or the last, the attitude of the Palmer United Party could decide the fate of the Government's amendments. The timing of the regulations – made in the aftermath of the release last week of the scathing Senate report on ASIC's performance and the scandals in the financial planning industry, could affect the outcome.