Lifting the lid: the Ripoll report

By Vishal Teckchandani
 — 1 minute read
The Ripoll inquiry has released its much-anticipated report into financial services and products in Australia. Vishal Teckchandani examines the parliamentary committee's recommendations, the industry's reaction and the report's findings on the collapse of Storm Financial.
After a gruelling nine-month schedule, including public hearings and sifting through nearly 400 submissions from investors and the financial planning industry, the Parliamentary Joint Committee (PJC) on Corporations and Financial Services Inquiry into Financial Products and Services in Australia has tabled its much-anticipated report in parliament.

The PJC, chaired by Labor MP Bernie Ripoll, resolved to inquire into and report on issues associated with the collapse of financial services firms including Storm Financial and Opes Prime.

"The collapse of Storm has had a catastrophic effect on thousands of people and has been a major focus of the inquiry, with over 200 submissions coming from former Storm investors," Ripoll says.


"Although the committee cannot make judgments about unlawful conduct, there were clearly multiple failures by Storm Financial and some lending institutions. 

"By recommending aggressive leveraged lending strategies to elderly people on low incomes, Storm's advisers were not providing advice that was appropriate to their clients' needs."

Both Storm Financial and the margin lenders who provided credit to their clients, particularly Commonwealth Bank of Australia (CBA), mishandled issuing margin calls when the market was in decline, he says.

"The committee also found that some banks were lax in their lending practices, providing excessive credit to investors with little capacity to repay when the value of their investments declined," he says.

Beyond the events surrounding Storm, consistent evidence to the committee supported the view that the required quality of advice Australians receive from their financial adviser needs to improve, he says.

"The remuneration incentives offered by financial product providers to financial advisers can lead to consumers getting advice that is not necessarily in their best interests," he says.

"The committee has therefore recommended that the Corporations Act be amended to explicitly state that advisers hold a fiduciary duty to put the interests of their clients first.

"We have also recommended that the government consult with the industry on the best way to cease payments from product manufacturers to financial advisers, such as commissions and volume bonuses. The conflicts of interest created by these payments are not always managed properly and should be removed to improve trust and confidence in the industry."


The 11 recommendations:

A fiduciary duty for advisers
The PJC recommended that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an Australian financial services licence (AFSL), hence requiring them to place their clients' interests ahead of their own.

Appropriately resource ASIC
The committee recommended that the government ensure ASIC is appropriately resourced to perform effective risk-based surveillance of the advice provided by licensees and their authorised representatives. ASIC should also conduct financial advice shadow shopping exercises annually.

Advisers boost disclosure
The PJC recommended that the Corporations Act be amended to require advisers to disclose more prominently in marketing material restrictions on the advice they are able to provide consumers and any potential conflicts of interest.

Cease payments from product makers to advisers
The committee recommended that the government consult with and support industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers.

Tax-deductible advice
The PJC recommended that the government consider the implications of making the cost of financial advice tax deductible for consumers as part of its response to the Treasury review into the tax system.

Extend regulator's powers
The committee recommended that section 920A of the Corporations Act be amended to provide extended powers for ASIC to ban individuals from the financial services industry.

Require agribusiness MIS licensees to demonstrate enough working capital
The PJC recommended that, as part of their licence conditions, ASIC require agribusiness managed investment scheme (MIS) licensees to demonstrate they have sufficient working capital to meet current obligations.

Allow ASIC to deny, suspend or cancel a licence
The committee recommended that sections 913B and 915C of the Corporations Act be amended to allow ASIC to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee 'may not comply' with its obligations under the licence.

Create a professional standards board
The PJC recommended that ASIC immediately begin consultation with the financial services industry on the establishment of an independent, industry-based professional standards board to oversee nomenclature, and competency and conduct standards for financial advisers.

Last resort compensation fund
The committee recommended that the government investigate the costs and benefits of different models of a statutory last resort compensation fund for investors.

Target community with effective education activities
The PJC recommended that ASIC develop and deliver more effective education activities targeted to groups in the community that are likely to be seeking financial advice for the first time.


Bipartisan support

All the recommendations gained support from both sides of politics.

Financial Services, Superannuation and Corporate Law Minister Chris Bowen says the PJC's report is a welcome contribution to the discussion about the future direction of the financial advice industry and investor protection. 

"Recent controversies, such as the Storm Financial collapse, have dented confidence in the financial advice industry," Bowen says.

"The government will respond to the committee's report in conjunction with the Cooper review, which will also be looking at commissions and fee structures in superannuation.

"Importantly, the government has already moved to put in place a national regulatory [regime]  and consumer protections surrounding margin lending."

Any regulatory changes by the government will be guided by key principles, including that the financial advice people receive must be in their best interests and ensuring that advice is not out of reach of those who would benefit from it, he says.

"We'll be working through the recommendations of the Ripoll report and will judge its recommendations against those two policy principles, to help ensure that financial advice is in the best interests of the client, while keeping this advice within the reach of those who may need it most," he says.

"The move away from commissions will improve transparency for consumers and will help to ensure that your clients receive advice which is free from any conflict of interest, whether real or perceived.

"It is worthwhile noting that this is a report with the support of both sides of politics.

"The shadow treasurer's (Joe Hockey) announcement last week that the coalition will oppose the removal of commissions sought to pre-empt this unanimous report."

Opposition financial services, superannuation and corporate law spokesman Chris Pearce says each recommendation offers the government substantial opportunity to further improve and enhance the regulatory framework introduced under the coalition.

"There is no one silver bullet, but the committee's recommendations are far reaching and substantial. I strongly support the recommendation that the government amend the Corporations Act to explicitly include a fiduciary duty for financial advisers operating under an AFSL," Pearce says.

Any changes to the remuneration structure of financial advisers must be clearly compatible with the introduction of a fiduciary duty, he says.

'The recommendation that ASIC immediately begin consultation with the financial services industry on the establishment of an independent, industry-based professional standards board to oversee competency and conduct standards for financial advisers should be adopted by the government with all haste. 

"Such an initiative would without question increase professionalism within the Australian financial services sector.

'The adoption of the report will provide better outcomes for Australians. I await the government's response."


Association concerns

The Investment and Financial Services Association (IFSA) welcomed the Ripoll inquiry's recommendation for a fiduciary standard between financial planners and clients, but signalled its opposition to the recommendation that payments from product makers to advisers cease.

The ceasing of remuneration to advisers from product makers is not needed should a fiduciary standard for planners be adopted following the inquiry, IFSA chief executive John Brogden says.

"A fiduciary duty is superior in all ways to any payments between product manufacturers and financial advisers," Brogden says.

"If a fiduciary standard for financial advisers is adopted, we do not believe ceasing remuneration paid to financial advisers from product manufacturers is required."

However, IFSA is ready to work with the government should it move to ban payments, such as commissions and volume bonuses, from product manufacturers to advisers, he says.

"However, if the government adopts this recommendation, we will work with them to ensure that the outcome is in the best interests of consumers," he says.

FPA chief executive Jo-Anne Bloch says the FPA is pleased with most of the recommendations outlined in the report.

While FPA members are already required to put their clients first as part of the FPA's code of professional practice, a fiduciary responsibility will require all financial planners to do so as a matter of law, Bloch says.

"Consumers can feel more secure, knowing that the financial advice provided is protected by a legal or regulated mandate," she says.

The FPA also welcomes the PJC's recommendations including making fee-based advice tax deductible and improving professional standards through an industry-based professional standards body to enforce fiduciary and ethical responsibilities for all those who wish to be genuine financial planners.

The association agrees there is no one silver bullet that will prevent another Storm Financial and it welcomes the PJC approach as sensible and practical, Bloch says.

"The FPA has led the reform process through the release of our code of professional practice, remuneration policy and education proposals. Our members have indicated that they are up for the challenge and want to restore confidence in the profession of financial planning," she says.

"The FPA would still like to see the term financial planner defined in the law. We still believe that this would be the best way to achieve all of the above and help consumers understand the real differences between the various 'advisers' that exist."

The association is also calling for a wide-ranging review of retail client compensation, which includes professional indemnity insurance and the Financial Ombudsman Service, she says.

"This issue has long been a source of anxiety for the FPA. If we are now to grapple with a compensation scheme, we want to work with the PJC and other stakeholders to ensure a reasonable outcome that does not simply raise the costs for financial planners who are doing the right thing," she says.

Association of Financial Advisers (AFA) chief executive Richard Klipin says overall the association is pleased with the recommendations. 

"The recommendation to impose a fiduciary duty on financial advisers to place their clients' interests ahead of their own is formal recognition of a responsibility we at the AFA have already enshrined in our code of ethics," Klipin says.

"We are pleased the committee has endorsed the action we have already taken with our members."

He says he is also pleased the committee stopped short of recommending a ban on commissions.

"Remuneration is a complex issue and the AFA is pleased the committee chose to recommend the government take a consultative approach to the issue," he says.

"We believe consumers should always have a choice in the way they remunerate their advisers."

He also praised the committee for recommending that financial advice become tax deductible. "If adopted, tax deductibility will make advice more accessible and affordable to everyday consumers, which is a win for middle Australia," he says. 

However, he expressed some concerns about increasing the surveillance of advisers via annual ASIC shadow shopping exercises.

"If done well, shadow shopping is a litmus test on the health of a financial advice business and therefore the financial advice profession as a whole," he says. 

"However, the AFA has some concerns that, if done poorly, it has the potential to become a witch-hunt of financial advisers."

The establishment of a professional standards board is a great opportunity for the industry to unite and collaborate on the key issues of professional standards and education, he says.

"We look forward to working with ASIC and the industry on this important, ground-breaking initiative," he says.

He called on all sectors of the financial services industry to now work together for the common good. "If all industry players can work together in the best interests of the consumer, we believe the future is bright," he says.

"The AFA looks forward to taking a consultative approach in working with ASIC, the government and the industry to improve the financial services landscape," he says.

"We believe that their hard work will be rewarded and expect that, like the Wallis report, the Ripoll report will have an important place in the history of financial services."

MLC chief executive Steve Tucker describes the recommendations as a positive framework to improve trust in the financial advice industry.

"The introduction of a fiduciary duty for financial advisers, combined with the positive steps the industry has already taken to move away from commissions under the IFSA Super Charter and the FPA's Financial Planner Remuneration principles, will create a more trusted and transparent advice industry," Tucker says.

"We have to move to a system where clients pay their adviser for advice and they pay administration and investment management fees to product manufacturers. 

"Money flowing in the opposite direction between product manufacturers and financial advisers has to stop if we want to counter allegations that financial planners are a sales force, rather than a profession."

MLC is also pleased the recommendations call for the Henry tax review to consider the implications of making the cost of financial advice tax deductible, he says.

"We want to see more Australians benefiting from quality financial advice and one of the ways to do this is to make advice more affordable," he says.

"If you can claim the fees your accountant charges to complete your tax return, you should be able to claim the fees your financial planner charges to help you self-fund your retirement.

"We also welcome the establishment of a professional standards board which can consider important issues such as lifting education standards for new financial planners and establishing clear definitions for the different types of financial planners that operate in the market, such as aligned versus independent."

These are important issues to resolve to increase professionalism and improve transparency for clients, he says.

"There has been a lot of speculation around what the PJC would recommend but what the committee has delivered is a sensible range of recommendations for the government to consider, all of which will have a positive impact on the future of the advice industry," he says.

MLC is the wealth management arm of the National Australia Bank, the country's third biggest lender by market value.

As the report has just been made available, it will be interesting to see more of the industry's reaction to the recommendations.

While the report did not contain a specific recommendation that qualifications to enter the industry be lifted - which arguably was widely expected - many firms have said they will require more from people who wish to join the industry.

It will also be interesting to see whether the recommendation of a last resort compensation fund would be supported by Australian taxpayers or from within the advice industry.


The collapse of Storm Financial: Ripoll report's findings

The causes of Storm Financial's failure are complex and contested, according to the findings of the Ripoll report.

"The committee's sources disagree in many details, including the true nature of the relationship between Storm and the banks (particularly but not solely the Commonwealth Bank); the processes for filling out loan documentation; the obligation (if any) of the banks to contact customers directly regarding margin calls; key meetings and events between September 2008 and January 2009; and the sophistication and understanding of risk by clients who entered into double-geared investment strategies under Storm's advice," the report said.

"The committee's overall role, having regard to what it has learnt through the examination of this corporate collapse and others, is to make any necessary recommendations for legislative change or regulatory improvement to help guard against, or mitigate the effects of, similar collapses in the future." 

Events surrounding Storm's collapse 
As the world's financial markets were thrown into turmoil in 2008, the value of Storm clients' investment portfolios diminished. It is this decline in value and investor equity, compared with the static value of the loans held, that took the clients' accounts into margin call territory. In evidence to the committee, long-time Storm group accountant David McCulloch reflected that: "In retrospect, the telling period for Storm clients appears to be around early October 2008 .What appeared to be the strength in the Storm modelling now became its Achilles heel, that is, the margin call at 90 per cent . Under normal margin lending arrangements, as existed with most or all other planners around the country, that is, 75 per cent to 80 per cent margin call ratios, at this time clients would have been margin called and at the very worst would have had about 20 per cent equity left in their portfolios - enough in most cases to clear home loan debts - but of course leaving Storm alone to account for lost values and client dissatisfaction."

One-size-fits-all advice
The committee found the big issue appeared to be that Storm gave the same advice, irrespective of the client's circumstances, to each of its clients. 

"It would appear Storm were doing a one-size-fits-all approach to advice. Everyone was doing the same, getting the same advice and clearly, whilst they might have been doing the right thing around disclosure and so on, that is not in line with section 945A of the Corporations Act where there has to be a sound basis for the advice," the report said.

"The committee cannot reconcile the practice of financial advisers giving all their clients the same advice, regardless of their life stage and circumstances, with the existing section 945A obligation to give advice that is appropriate to individual personal circumstances. In particular, the committee is not persuaded by [Storm founder Emmanuel] Cassimatis's explanation that Storm clients 'self-selected' after being told what the investment model was."

For at least a subset of Storm's investment clients - namely, clients on average incomes at or near the end of their working lives - the advice to engage in an aggressive leveraged investment strategy was clearly inappropriate, the committee found.

Storm's relationship with lenders
The committee found it surprising and highly concerning that there was such a lack of clarity around this critical facet of the Storm model. 

"The leveraged investment strategy was sold to clients on the basis that there were sufficient buffers and triggers in place, as well as cash reserve funds, to ensure that any margin call situation could be appropriately managed," the report said. 

"It seems remarkably careless, from Storm's point of view, to leave any room for doubt around this process."

While the committee acknowledges the banks' contention that their legal obligation was to inform the intermediary financial adviser, who in turn was obliged to consult with the client about how to resolve a margin call, the committee nevertheless believes the banks had a moral obligation to attempt to make direct contact with the loan account holders once it became clear that, for whatever reason, Storm was not functioning successfully as an intermediary to clear the margin calls.

"The committee heard in evidence that the CBA first made margin calls on Storm clients on 18 September yet did not make direct contact with clients until December - an elapsed time of approximately 11 weeks," the report said.

"Even noting the CBA's evidence that it received some 'action' from Storm during October, the committee views the length of the delay on the CBA's part as inexcusable, and it contrasts poorly with evidence from Macquarie Bank that it moved to make direct contact with clients within two weeks of realising that Storm was not notifying their clients.

"The committee therefore welcomes the commitment made by the CBA that, following an internal policy revision, it will now notify all clients of margin calls directly, rather than through an intermediary financial adviser."

Lesson learned as a result of Storm
There has been significant investor criticism of ASIC for not identifying the risks posed by Storm's one-size-fits-all financial advice model before the collapse occurred. 

"ASIC does not have a role in assessing business models for risk per se, but it does have a role in ensuring compliance with current Corporations Act 2001 requirements in relation to standards of advice, including the section 945A requirement that advice takes account of the personal circumstances of each client and is appropriate for that client," the report said.

This regulatory gap has now been closed, following the October 2009 passage through parliament of the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009, the committee said.

"The committee welcomes the passage of this legislation and, through such mechanisms as its regular oversight hearings with ASIC, will monitor its implementation and impact in the marketplace, particularly its ability to further protect investors from inappropriate advice or inappropriate product sales," the report said.

"The banks have indicated to the committee that they followed standard industry practice of notifying the intermediary financial adviser of margin calls and assuming that they would take responsibility for notifying the client and actioning a response to the call.

"The new legislation requires that, unless a client specifically elects to have the bank deal only with their adviser, the lender is required to notify both the adviser and the ultimate customer when their account falls into margin. This is an improvement on the current (unregulated) situation but the CBA, among others, has suggested that it would prefer to see a situation where banks must contact the client in all circumstances. The committee agrees that this may need to be the subject of future legislative amendment, to further strengthen client protection."

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Lifting the lid: the Ripoll report
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