How to make good SOAs even better?

[ March 6, 2015 ]

There have been no major matters this week, which is great. No news is often the best news. But we have been thinking hard about how we can improve adviser SOAs and how SOAs can work better as client advice documents. It’s all about making a good thing better. We want to maintain and expand Dover’s compliance culture. So it makes sense to provide all advisers with continuous feedback about the SOAs and how they can be made even better. We have identified five areas where improvement is needed. These are discussed in turn below. Please read these materials and the attached links and make sure the ideas and requirements are included and reflected in your SOAs going forward. Remember that Mina Andrawis, Dover’s Legal Counsel, will actually prepare SOAs for you at a competitive fee: the prices are much lower than the labour cost of engaging para-planners and have the advantage of being automatically compliant. So everything is quick at your end. And it’s a great second opinion. See www.simpleparaplanning.com.au for more details.

Classifying non-conservative clients

Classifying as client as not being conservative is an inherently risky strategy. You cannot get sued if the client is treated as conservative. You can get sued if the client is not treated as conservative. So once you move into the “not-conservative” zone you have to be very careful to make sure that your advice is advice that a reasonable financial planner would agree with (ie not negligent) and that you can prove this. In summary, its all about your SOA, and making sure it will stand up to FOS scrutiny and interrogation. If the market falls and your client suffers a loss the appropriateness of your advice will be called into question. You may even have to front FOS. If on the balance of probabilities your advice was not advice that a reasonable financial planner would have given then you will be liable to compensate your client for the loss and interest thereon. Technically the burden of proof lies with the client as the complainant; but, as a practical matter, it lies with you as the adviser. You must be able to prove that your advice was advice that a reasonable financial planner would have given. The vehicle for doing this is your SOA. The SOA is the record of your advice to your client, and allows your client to decide whether to accept your advice. Here, it is critical that your SOA explains in plain English the facts explaining why you have treated your client as not being conservative. Example paragraphs for a fictitious couple, John and Betty, may help:

“In our meeting you said you believed you should not be treated as a conservative investor and that you should be growth orientated. We discussed this and, in summary, I agree with you. I also believe a reasonable financial planner would be of the same mind. At age 43 and 44 you realistically have at least another 15 years in the workforce. Your incomes are above average, and reasonably secure. The fact that you have two separate incomes reduces risk. You own your home (value about $600,000), have about $200,000 in super and have no debt, and this means your wealth is above average for your age. You are both university educated, and while John has no business experience Betty has worked for small and medium sized businesses and understands that commercial activities involve some risk. You are in good health, and although you have not invested significantly in the past both of your parents are long-term share investors and through this connection you know that share prices sometimes fall in value and capital losses are suffered.

If you have any concerns about not being treated as a conservative investor you should not sign the consent to act form and should contact me immediately.” Paragraphs like these two, reflecting the client’s individual circumstances, are essential in every SOA where the client is not being treated conservatively. They are needed to properly explain the reasons for your advice, and place responsibility back on your clients to contact you immediately if they do not agree with your assessment of their circumstances. The facts to be considered will vary from client to client, as will the weight to be attached to any one fact. The list of facts to be considered will usually include:

  1. age, and generally speaking the younger the client the more growth orientated the client should be;
  2. income. Height of income is obviously relevant. But so are stability and longevity. For example, two years ago I argued with an adviser that a 57 year old over-weight truckie working on a 6 month contract at a coal mine on $150,000pa was not suited to gearing because his income was not secure: few 57 year olds have a secure and long income in front of them. I later learnt his six-month contract had not been renewed. He has not worked since. By way of contrast, a fit and active 50 year-old nurse on $90,000 a year may be suited to a negative gearing strategy. She is in the 40% tax bracket, has a relatively high income but its also stable and secure (huge shortage of experienced nurses). She can reasonably expect to work at least another ten years and possibly a lot more, scaling down the hours if she wishes to, or ramping them up if she is short of cash. She had heaps of accrued sick leave and long service leave too;
  3. the diversity of income. Situations where both partners work generally mean their future income streams are less risky compared to where there is only one income;
  4. the existing wealth level. Generally speaking the higher the existing wealth level the more appropriate a growth-orientated strategy will be. If a 43 year-old client owns a home worth $600,000 and has $200,000 in super, placing the super in high growth investments may make a lot of sense. Gearing it up may make a lot of sense too. Appreciate that this means overall only 25% of her assets will invested non-conservatively (we regard debt free homes as being conservative assets) and the overall mix is still reasonably conservative. Make sure your SOA stresses this point;
  5.  education levels. Generally speaking the higher the education the more the client should be investing for growth, given that they are more likely to understand the ramifications and implications of their decisions, particularly the possibility of capital loss and the role the uncontrollable general economy plays in investment outcomes;
  6. training. This is similar to education. For example, a client who has worked extensively as a manager in small businesses and has, say, a certificate IV in small business management cannot claim to not understand that share prices can fall and capital can be lost;
  7. previous investment experience. If a client has invested heavily in direct shares previously, and had profits and losses, this suggests suitability to growth orientated strategies; and
  8. health. Clients with health issues should normally only invest conservatively, as their health issues mean they may not be earn a living by working and may not be able to recoup any losses.

None of these eight criteria is determinative. In some cases some criteria will decide the day, and in other cases other criteria will decide the day. It’s a case-by-case analysis, and each time the individual client’s facts have to be detailed, and set out in the SOA, along with your thoughts and comments. Assume that FOS will read your SOA. So think about what you want to have on the record for FOS to read. You have to show that your advice is advice that could be provided by a reasonable financial planner and is in line with established norms. If in doubt, stay conservative. And say why in your SOA. What if your client says he thinks he should be a high growth investor? The client’s view of things is important, of course. But your view of things is more important. You are the adviser, and it’s your advice that will be reviewed by FOS and may be the object of a damages award. You have to form and write down your professional opinion. Its no answer to say: “the client said he was high growth” when a reasonable financial planner would not have agreed. Here it’s your job to say “no”. If a patient attends a doctor and says, “I have a sore arm could you please cut it off” this does not mean that the doctor can cut off the patient’s arm without further investigation. It does not work like that. The patient’s opinion of what is wrong and what the cure should be is of only minor relevance. The patient is not the doctor. The doctor’s duty of care requires her to go through an evidence based process including accessing further information and opinions if appropriate before drawing on her own training and experience to diagnose the condition and prescribe an appropriate cure. Every doctor knows they need to be healthily skeptic about what patients say. Patients often get it completely wrong and sometimes just say what they think the doctor wants them to say. Sometimes patients even tell lies. It’s no answer to FOS to say “…but the client said she was high growth…”. Your SOA has to set out clearly why you thought she was high growth, and why a reasonable financial planner would agree with you. What if your client does not accept your advice? What if your client wants to invest in high growth investments, and you do not think this is appropriate, but your client nevertheless insists…? Here I suggest you use a paragraph like this one;

“You said you wanted to invest aggressively, using debt, because you are getting older and it is “now or never” and you need to catch up fast. I explained that most financial planners would disagree, and that my advice, based on your age, your low level of wealth, concerns about the stability of your employment and your general circumstances was that you should be very conservative and definitely not invest aggressively using debt. You have not accepted my advice and you have instructed me to facilitate the investments set out below. I will accept these instructions on the strict understanding that I have not recommended these investments and I am not liable in any way for any losses or costs incurred in respect of them.”

In other words, your SOA has accurately recorded your advice.

Risk analysis questionnaires

Dover strongly discourages risk analysis questionnaires (“RAQs). RAQs are biased devices designed to induce clients to overstate their readiness to take on risk. ASIC does not like them and FOS does not like them. Most RAQs full of leading questions and misleading questions and historically they have been mis-used to help sell dodgy products. Most Westpoint “investors” completed RAQs saying they had a high propensity to risk…it was part of the sale pitch…It was cruel. If you use RAQs you still have to set the facts supporting your reasons for the client not being treated as conservative and, if these facts conflict with the RAQ, the facts have to win out. In other words, Dover does not care what the RAQ says if the facts do not agree. An RAQ is not a substitute for an informed and reasoned professional opinion. Dover requites informed and reasoned, and recorded, professional opinions carefully set out in every SOA.

Capital protected products and Dover’s minimum investment holding periods

Dover requires minimum holding periods of ten years for share-based investments and twenty years for property-based investments. These minimum holding periods are mandatory. There are no exceptions. These minimum holding periods are specifically included in every Dover SOA through the “Corporations Act disclosure requirements: incorporation by reference” materials and the related hypertext link.  This is discussed further at 4 below. These minimum holding periods are mandatory because:

  1. investment theory says this is how long such investments should be held to even out short term fluctuations and for long term trends to manifest; and
  2. the client obligations section of the incorporated materials says clients agree to not complain about the fall in value of share based investments for ten years and to not complain about the fall in value of property based investments for twenty years. We are completely candid about the risk minimization aspect of this rule: its only fair. You cannot tell which team will win the game at quarter time. You have to wait until the end of the fourth quarter to see who won. And if the advice is “hold the shares for ten years” then we have to wait until the end of the tenth year to see if the advice was reasonable or not.

An interesting article from Wednesday’s Age newspaper touches on similar themes: David Potts discusses Warren Buffet’s famous ten year bet. If a client invested just before the market fell in 2008, they are not yet at the end of the eighth year. The market has now recovered from a fall of nearly 50% in 2008…Ten years is a long time in equity markets. Hopefully you will see my point. If the minimum holding period is ten years the client does not need capital protection. Capital protection will not be in the client’s best interests and will not be appropriate to the client. Separately, our experiences with capital protection products have been all bad. I have never seen a pay out. Call it a Pavlovian response if you will, but paying for capital protection is a bet not worth making. The bookie will definitely win. So, that’s my view. You can have a different view. If you do, the only requirement is that your advice, the reasons for it and the costs connected to it be clearly set out in the SOA. For example, you might write:

“I recommend you use BT’s Wrap Capital Protection. You can read more about it here: Link to BT’s Wrap Capital Protection . You should be aware that Dover’s minimum holding period for equities is ten years, and capital losses over this period are unlikely, and that the protection costs about 1.2% per annum. But overall I believe this advice is appropriate to you and in your best interests.”

Mandatory part of every Dover SOA: The Corporations Act disclosure requirements: incorporation by reference

Every Dover SOA has to include these two paragraphs, and the related (even essential) hypertext link: The Corporations Act disclosure requirements: incorporation by reference The Corporations Act and “good practice principles” require us to disclose matters that may impact your decision to act on our advice and your understanding of our advice. Paragraph 163 of ASIC’s Regulatory Guide 175 (RG 175.163) allows us to incorporate these matters into this SOA by reference, in this case through this hypertext link: Additional materials incorporated into this SOA. These additional materials form part of this SOA and form part of our contract with you, and include our promises to you as your adviser and our ethical obligations as responsible financial planners. We recommend you read these materials and let us know in writing if anything is not clear. These two paragraphs are mandatory. And the hypertext link has to be included too. There are no exceptions. This is because the RG 175 says the content has to be in the SOA if it is to comply with the Corporations Act. Paragraph 163 allows these materials to be incorporated by reference, which in this case is done via a hypertext referring to materials that Dover maintains on its website. If you do not include the hypertext link then the materials have not been disclosed in the SOA and you have breached the Corporations Act. The purpose of incorporating these materials by reference is, obviously, quality control. It also avoids long pages of standard material in every SOA, which conflicts with RG 175’s requirement that SOAs be concise and ASIC’s directions to AFSLs that SOAs be short and not cluttered by unnecessary and standard materials.

Client obligations

Dover’s SOAs also set out the client’s obligations: you can read them here: Additional materials incorporated into this SOA. The client’s obligations are a critical part of the adviser-client relationship. You are not your client’s nanny. Your client is a grown up who has to take responsibility for his or her own decisions and actions. This is made clear in the client obligations section of the SOA. The client’s obligations are an essential part of the contract between you and the client, and therefore, since you are Dover’s agent, between Dover and the client. Therefore they have to be in every SOA. No exceptions. By way of example, if you advise a client and the client does not instruct you to implement the advice, preferring the DIY model, you will not be liable for any loss suffered. The client obligations clearly state there is no liability unless the adviser is instructed to implement the advice. By way of further example, if you advise a client and you are asked to implement the advice and you do so, but then never hear from them again. When 24 months later the recommended fund freezes, the client cannot complain. This is because they did not come in for their six-month review. Once again, you will not be held liable for any loss suffered. The client obligations clearly state that there is no liability if the client fails to arrange six monthly review meetings. By way of a final example, the client obligations clearly state that the client cannot complain of a loss in an equity-based product for ten years or a loss in a property-based product for twenty years. That is, the client has to wait until the advice has run its course, the minimum holding period has ended, ie until the siren has blown at the end of the fourth quarter and the final score is on the board. Clients are responsible for their own decisions. You are just their adviser. You are not their nanny or their loss underwriter. So these client obligations have to be in every SOA, by hypertext link. No exceptions. In the unlikely event the client does not use e-mail obviously the materials, including the annexures, have to be printed and physically passed to the client. But the SOA still has to have these clauses and hypertext links in it. And the reason we require the hypertext link is simple: to prove that the materials were in fact provided. You will be amazed at what some clients say to FOS if they think it will help get them a cheque. I hope these comments are of some interest and will help improve your SOAs and the quality of your advice generally. Any complaints, queries or uncertainties? Let me know and I will do my best to explain.

The Dover Group