Chapter 06 – The Best Interests Duty

Introduction

The best interests duty lies at the heart of everything that a financial adviser does. It is a fundamental duty owed by financial advisers to their clients.

The best interests duty was introduced in 2013. It is fair to say that its introduction was accompanied by much angst within the financial planning profession. In many ways, this was a great pity. The best interests duty is not something that any respectable financial adviser should be worried about. Indeed, here at Dover we believe that the best interests duty actually makes compliance with all aspects of financial planning regulation simpler and more achievable.

In this chapter, we examine the best interests duty. In particular, we discuss Dover’s specific method of assisting our advisers to meet the best interests duty.

What is the best interests duty?

Section 961B(1) of the Corporations Act 2001 contains 16 deceptively simple words. These words are:

“the provider must act in the best interests of the client in relation to the advice.”

These 16 words provide an extremely comprehensive summary of the financial planning compliance framework.

There are a number of things to note about section 961B(1). The first is that this is a provision of an act of Parliament. Therefore, the best interests duty exists simply because Parliament wants it to. While many people are cynical about the Australian political system, Australia is generally a representative democracy. It is also one of the most stable democracies the world has ever seen. This means that Parliament expresses the will of the people. So, when the Parliament writes a requirement into law, Mr or Ms Australian voter agree with what Parliament is doing.

Put simply, the average Australian voter expects that a financial adviser works in their client’s best interests at all times. But the reputation of financial advisers did not meet that standard – so the Parliament legislated accordingly.

The second thing to note is that the provision is imperative. The act says that the provider must act in the best interests of the client. Therefore, the best interests requirement is a duty imposed by statute on financial advisers. This is why we refer to the ‘best interests duty.’

Perhaps unfortunately, the Corporations Act does not further define what it means by best interests. The legislation does contain some guidance, which we will discuss later. But it only provides guidance. There is no formal definition.

In the Australian legal system, we have what is known as a ‘separation of powers.’ This means that it is the task of the Parliament to enact statutes. These statutes must then be interpreted by the courts. Parliament can provide guidance to the courts about how statutes should be interpreted – but courts will decide whether or not a statutory requirement has been met. Parliament and the Courts are separate players in the legal system. So, legal power is separated. 

Therefore, it is usually courts that provide us with ‘working definitions’ of statutory provisions. They do this when they provide written explanations of their judgements. As of 2018, there has only been one court case on the best interests duty. Unfortunately, the facts in that case were so bad that the failure to act in the client’s best interests was patently obvious. This means that this case does not really assist advisers looking for a relevant definition of the best interests duty.  

In a sense, using this single case to try to define the best interests duty is like using Mount Everest to define a mountain. Knowing that Mount Everest is a mountain does not help us decide whether some smaller geographical feature is also a mountain (and every other geographical feature is smaller than Mount Everest). Similarly, knowing that the court concluded in this one case that the best interests duty had been breached does not help us decide whether some less horrible advice also breaches the best interests duty.

That said, here at Dover we have identified at least two further sources that we think to provide good guidance as to the best interests duty. Let’s look at these now.

The Parliament Itself

Whenever legislation is introduced to the Parliament, its introduction is accompanied by a ‘second reading speech.’ A second reading speech is a way for the relevant minister to explain to Parliament the purpose and desired effect of a piece of legislation.

The best interests duty was introduced via an amendment to the Corporations Act in November 2011. At the time, Bill Shorten was the Assistant Treasurer. He gave the second reading speech. His speech sought in part to reassure financial planners that the best interests duty would not represent cataclysmic change for the profession. His speech included the following statement:

“…the vast majority of financial planners do see their role as making their dealings with customers such that … the customer is better off than if the customer had never sought financial advice to begin with…”

You can read the full text of the second reading speech here.

Minister Shorten offered the concept of ‘better off’ as a guide to the best interests duty. The online Oxford dictionary defines better off as follows: “In a more desirable or advantageous position, especially in financial terms.” So, better off basically means being in a better financial situation than previously.

This provides good guidance regarding the advice – but may not be sufficient regarding ‘interests.’ For interests, we need to look at guidance provided by the main regulator of financial services.

ASIC’s Guidance

The main regulator of financial services is of course the Australian Securities and Investments Commission, or ASIC. Given its role, ASIC’s interpretation of the best interests duty is very important. The main document communicating ASIC’s interpretation is Regulatory Guide (RG) 175. However, the regulator has also provided some less formal statements which also let the industry know what the regulator is thinking. For example, in January 2017, the Deputy Commissioner of ASIC, Peter Kell, made the following statement to a Parliamentary Joint Committee on Corporations and Financial Services:

“In terms of vertical integration, the key issue is that, under the law you have to act in the best interests of clients. You have to put the clients’ interests first. You have to avoid conflicts of interest…”​

The Deputy Commissioner was actually discussing the perils of vertical integration. Vertical integration is where an adviser and the product being recommended by the adviser both come from the same source. So, the Deputy Commissioner was not talking initially about the best interests duty. But, he did introduce the importance of that concept. And in doing so, he added to what Mr Shorten had said to the Parliament five years previously.

Mr Shorten talked about a client being left better off. But the Deputy Commissioner went further and said that an adviser must avoid conflicts of interest. This means that the benefits of the advice must always flow to the client. This is important because it would be possible for a client to be made somewhat better off by advice that provides a much larger advantage to the adviser. The regulator was saying that it does not think that advice of that nature would meet the best interests duty.

Is the best interests duty a fiduciary duty?

The regulator’s comments bring to mind the concept of a ‘fiduciary duty.’ The FindLaw online Legal Dictionary defines fiduciary duty as follows:

a duty obligating a fiduciary (as an agent or trustee) to act with loyalty and honesty and in a manner consistent with the best interests of the beneficiary of the fiduciary relationship.”

Within the Australian legal system, a fiduciary duty is the highest standard of care that one person can owe to another. A fiduciary duty is not exactly the same as the best interests duty. However, the two concepts are very similar, as the definition above makes clear. One of the benefits of this similarity is that the concept of a fiduciary duty has been around for over a century. This means that we have a lot of guidance on how fiduciary duty is best defined.

This guidance can be ‘boiled down’ to two fundamental premises of a fiduciary duty: ‘no conflict’ and ‘no profit’ (see, for example, the High Court decision in Breen v Williams, which can be viewed here). That is, where a fiduciary duty exists, the person owing the fiduciary duty must avoid all conflicts of interest and must not personally profit from the existence of their duty.

Importantly, ‘no profit’ does not mean ‘no fee.’ A professional can be paid for providing services within a relationship in which they owe a fiduciary duty. But they cannot personally profit from their position. For example, a lawyer owes a fiduciary duty to his or her client. Lawyers obviously get paid – usually very well. But a lawyer cannot personally profit from a relationship. A leading example here was where a lawyer was not allowed to purchase shares in a company with which his client was involved because the lawyer became aware of the company through the professional relationship with their client. In that particular case, the client did not suffer any ill effect by virtue of their lawyer purchasing shares. But the lawyer was simply unable to make such an investment, because to do so was to profit personally from a fiduciary relationship.

In terms of the best interests duty, the no profit rule is perhaps the less important of the two established fiduciary duty rules. More important is the no conflict rule. If there is a fiduciary duty, there can simply be no conflict of interest. This is why, for example, a lawyer who has helped a married couple with any legal matter cannot then represent either member of the couple if they decide to divorce. The lawyer cannot owe a duty to both members of a separating couple: that is a conflict of interest.

There is a parallel between the prohibition on conflicts of interest within a fiduciary duty and ASIC’s statement that conflicts of interest must be avoided. This parallel leads Dover to see the fiduciary duty as a useful benchmark when putting the best interests duty into practice.

Do financial advisers owe a fiduciary duty?

A fiduciary duty arises in one or both of two ways. The first is through what is sometimes described as a ‘defined relationship.’ A defined relationship is one in which the courts have stated a fiduciary duty exists whenever that relationship exists. A director always owes a fiduciary duty to the company of which he or she is a director. A lawyer always owes a fiduciary duty to his or her client. The trustee of a trust always owes a fiduciary duty to the beneficiary or beneficiaries of that trust.

At the moment, the list of defined relationships does not include financial advisers. A financial adviser does not always owe a fiduciary duty to his or her client merely because they are a financial adviser.

The second way that a fiduciary duty can arise is sometimes described as the ‘specifics of a relationship.’ The specifics of a relationship can mean that a relationship will be deemed to involve a fiduciary duty. Whether that is the case is basically a matter of fact, but the client’s expectation is generally particularly relevant when deciding whether a fiduciary duty will be deemed to exist.

This means that if a client expects that they are owed a fiduciary duty by their financial adviser, a court may hold that such a duty does exist. So, while the adviser-client relationship does not always lead to a fiduciary duty, it will sometimes. Whether it does depends on the client’s expectation.

And when such a relationship is held to exist, that means that the best interests duty and the fiduciary duty both exist.

Interestingly, the code of ethics of the Financial Planning Association states the following:

“In keeping with the Member’s professional role, the Member understands and acts in accordance with the fiduciary duty – expressed as the twin ethical requirements of ‘loyalty to one’s client’ and ‘not to profit without informed consent of one’s client’ – by placing the client’s interest first.”

This means that members of the FPA effectively impose a fiduciary duty upon themselves.

We know that the best interests duty always exists for a financial adviser. We also know that a fiduciary duty may well exist for a financial adviser. Further, we know that a fiduciary duty is the highest possible standard of care. This means that if an adviser meets their potential fiduciary duty to a client, then he or she will also meet their best interests duty.

This is why it makes sense for all financial advisers to basically assume that they have a fiduciary duty – and then meet that duty. Doing so will automatically take care of the best interests duty that definitely exists. It will also take care of any potential fiduciary duty that may exist.

An adviser who aims to meet the highest standard of care will automatically meet all ‘lesser’ standards. As an analogy, think of a piece of road on which the speed limit is 60 km an hour. If a driver imposes a higher standard on themselves, and decides to drive at no faster than 55 km an hour, they will automatically meet the less restrictive standard of 60 km an hour.

So, the smart financial adviser acts as if they have a fiduciary duty – and then meets that duty! This means that they do not profit from the relationship with their client (other than to derive fees as a professional adviser). It also means that they avoid all conflicts of interest with their client.

Where an adviser avoids a conflict of interest, then the only interest remaining is the clients. This makes acting in the client’s best interests quite straightforward.

Corporations Act Guidance – The Safe Harbour Provisions

In the introduction, we referred to some guidance within the Corporations Act itself that may be useful in putting the best interests duty into practice.

Section 961B(2) of the Corporations Act contains what are known as ‘safe harbour’ provisions. Minister Shorten referred to these provisions in his second reading speech. He said:

“for the adviser that wants certainty around compliance above all else, the general obligation is supplemented by a provision setting out steps which, if satisfied, will be deemed sufficient for the adviser to have fulfilled the general obligation.”

According to Wikipedia, a safe harbour is “a provision of a statute or a regulation that specifies that certain conduct will be deemed not to violate a given rule. It is usually found in connection with a vaguer, overall standard.”

Section 961B(2) contains seven elements, all of which must be met if the adviser is to claim the safety of the safe harbour. The seven elements are useful, but there is a problem. The last two of the provisions are somewhat circular. Here is what the seven elements say collectively:

(2)  The provider satisfies the duty in subsection (1), if the provider proves that the provider has done each of the following:

  1. identified the objectives, financial situation and needs of the client that were disclosed to the provider by the client through instructions;
  2. identified:
    1. the subject matter of the advice that has been sought by the client (whether explicitly or implicitly); and
    2. the objectives, financial situation and needs of the client that would reasonably be considered as relevant to advice sought on that subject matter (the client’s relevant circumstances );
  3. where it was reasonably apparent that information relating to the client’s relevant circumstances was incomplete or inaccurate, made reasonable inquiries to obtain complete and accurate information;
  4. assessed whether the provider has the expertise required to provide the client advice on the subject matter sought and, if not, declined to provide the advice;
  5. if, in considering the subject matter of the advice sought, it would be reasonable to consider recommending a financial product:
    1. conducted a reasonable investigation into the financial products that might achieve those of the objectives and meet those of the needs of the client that would reasonably be considered as relevant to advice on that subject matter; and
    2. assessed the information gathered in the investigation;
  6. based all judgements in advising the client on the client’s relevant circumstances;
  7. taken any other step that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances.

As can be seen, the first five elements are quite specific and it will be quite easy to know whether or not these elements have been met. But the sixth element is where things start to become circular. It requires that ‘all judgements’ be based on the client’s relevant circumstances. But what does ‘all judgements’ mean? There is a lot of grey area and need for interpretation here.

The circularity is completed in the next element, where the adviser must have taken ‘any other step’ that would reasonably be regarded as being in the best interests of the client. So, to meet the best interests duty you must have taken all steps that would reasonably be regarded as being in the client’s best interests.

The concept of best interests appears on ‘both sides of the harbour.’ You will have acted in the client’s best interests if you have taken all steps that are in your client’s best interests.

The safe harbour provisions are also referred to in ASIC’s Regulatory Guide 175, paragraph 239, which states:

“Showing that all of the elements in s961B(2) have been met is one way for an advice provider to satisfy the duty in s961B(1).”

Essentially, the seventh element brings the adviser back to a ‘reasonable person test.’ The adviser must have taken any step that would reasonably be regarded as being in the best interests of the client. The word ‘reasonable’ is actually used five times within the safe harbour provisions. ASIC make this explicit in paragraph 225:

“When assessing whether an advice provider has complied with the best interests duty, we will consider whether a reasonable advice provider would believe that the client is likely to be in a better position if the client follows the advice.”

So, to meet the best interests duty means doing what a reasonable financial adviser would agree is in the clients’ best interests. Let’s look at this concept of a reasonable financial adviser.

The Reasonable Adviser Test

In a sense, all roads lead back to a reasonable person test. The reasonable person test has a long history in legal interpretation. The concept is attributed to an old English case (McQuire v Western Morning News), in which the judge referred to the opinion of “the reasonable man on the Clapham omnibus” as a point of reference when deciding whether a person has acted appropriately. The judge’s reference seems to hark back to Walter Bagehot’s description of the average Englishman as a “bald man sitting at the back of a bus.”

Conceptually, a reasonable person is not quite the same as an average person. It might better be described as an average of all competent people. Reasonable means someone who reasons, which implies a certain level of intelligence and capacity for critical thinking.

When applied to a professional, the reasonable person test becomes a ‘reasonable professional’ test. This is why ASIC refers to a ‘reasonable advice provider’ in paragraph 225 of RG 175.

The reasonable adviser test is one that is ultimately applied by a court. And, as we have seen, there has only been one case on the best interests duty. For now, we have to try to identify how a Court would apply the test.

The best way to do so is to think about the reasonable adviser test in the sense of whether an average competent financial adviser would agree that advice is likely to leave a client in a better position.

How to Meet the Reasonable Advisor Requirement

As we saw above, a reasonable adviser test is a very similar thing to an ‘average competent adviser’ test. The best way to test yourself for reasonableness is therefore to ask a competent financial adviser what he or she thinks of your advice. To make the test truly robust, you should ask several competent financial advisers what they think. This is because of the concept of ‘reversion to the mean.’ The larger a sample size becomes, the more likely that the average assessment within the sample size will reflect the broader population.

Make sure that the other adviser is independent of you. We mean ‘independent’ in the sense that it does not matter to them whether they agree with your advice or not. Basically, this means do not ask someone who will suffer financially if the advice does not proceed.

Invite the other adviser to play the devil’s advocate. That is, encourage them to try to find ways in which your advice might fail the best interests duty. Remember, a true professional acts as if as if one day they will find themselves in court been challenged by someone who does not like them.

If you prepare for that day in court, it will probably never come.

Dover’s Approach

The reasonable adviser test is the main reason that Dover reviews every statement or record of advice prepared by any of our advisers. Before advice can be presented to a client, it is reviewed at least twice by legally trained financial advisers within our head office. The reviewers approach the advice from the point of view of the client (actually, from the point of view of the client’s potential lawyer in any future legal challenge to the advice). Am I (the client) better off if I follow this advice?

The reviews are robust. They can be because Dover’s remuneration is not related to any specific piece of advice. Dover charges a flat fee and therefore there is no incentive to approve a particular piece of advice if that advice does not meet the best interests duty requirement. What’s more, with more than 390 advisers, no one adviser represents more than about 0.25% of Dover’s remuneration. This means that we can err very much on the side of caution when doing a review, as we are not dependent on the revenue provided by the adviser whose advice is being reviewed.

Put simply, the idea is that two heads are better than one. And three heads are better than two, especially when the second and third heads belong to lawyers! We get each of these people to play the role of devil’s advocate. They perform a robust assessment of the quality of a piece of advice. If they all agree that the advice is in the client’s best interests, it becomes highly unlikely that the advice would actually fail the best interests requirement.

Dover introduced this compulsory review system in 2012. Since then, only one complaint about bad advice has been upheld against any Dover adviser. In that case, the adviser did not present the SOA to the reviewers (a very serious matter within Dover). Therefore, we can happily say that since 2012 no reviewed SOA has been the subject of a valid complaint.

The system works.

To use an analogy, we see reviewing an SOA as rather like conducting a swimming test before people plunge into the ocean at Bondi. Checking that people can swim before they head into the surf is much better than trying to rescue them later.

Good advisers appreciate what Dover’s review system brings. After all, any decent professional welcomes a second opinion. They know that having other professionals agree that their advice is in their client’s best interests is the best way of ensuring that their advice actually is in the client’s best interests.

Summary

Dover believes that the best interests duty is a great way of ensuring broad-based compliance. After all, if an adviser’s systems all lead to the production of advice that leaves a client better off and which is free of conflicts, it is likely that those systems will meet all other compliance requirements as well.

That is why we can quite confidently say that, if you provide advice that:

  1. leaves your client better off;
  2. is free from conflicts of interest;
  3. would meet the standard demanded if a fiduciary duty exists; and that
  4. other advisers agree is in your clients’ best interests…

then the best interests duty should look after itself.

This is why we here at Dover think that having a best interests duty enshrined in legislation actually makes compliance easier.

The Dover Group