1. Christina Kalantzis, Principal - Alexis Compliance Premium Wealth Management Limited 22 November 2012 FOFA and Conflicted Remuneration

2. Overview FOFA Status update  Early adopters  Update on FOFA Regulations  Code of Conduct Best Interest Duty  The Advice Process (s961B), Advice Quality (s961G)  Conflicts of Interest (s961J) Conflicted Remuneration  Volume based benefits  Performance benefits for employees  Asset based fees on borrowed amounts  Anti avoidance

3. FOFA Status Update Race to become FOFA Compliant “.. In respect if this law, an amendment was moved and accepted in the House of Reps to allow for a voluntary commencement date of 1 July 2012. With an effective date of 1 July 2013. … This will allow providers in the industry to do what they do best:compete with each other to ensure that there is a race to become FOFA compliant… … I think that we will see such a race to ensure compliance with FOFA and that particular firms and advisers will then advertise their compliance to the market. It will be means of attracting customers..” Source: senator Matt Thistlewaite (ALP - NSW) made the statement in the Senate on Tuesday 19th June 2012.

4. FOFA Background 2009 PJC Report Government responded to PJC 13 October 2011 - the House referred the Corporations Amendment( Future of Financial Advice) Bill 2011 24 November 2011 the House referred the Corporations Amendment( Further Future of Financial Advice Measures) Bill 2011 21 June 2012 the Senate passed the package after introduction of Corporations Amendment (Further Future of Financial Advice Measures) Bill 2012 Received Royal assent on 27 June 2012

5. Status of Regulations 3 batches of Regulations  Batch 1 - released 23 May 2012 - responses due 5 June 2012  Batch 2 - released 23 May 2012 - responses due 5 June 2012  Batch 3 - released 14 June 2012 - responses due 28 June 2012 The regulations have provided information regarding;  Disclosure in FSGs and SOAs for soft dollar benefits below the prescribed amount  Product fees are no ongoing fee arrangements  Prescribed amount of soft dollar is $300  Ban on conflicted remuneration for inside super starts on 1 July 2013.

6. Status of Regulatory Guides ASIC Powers - released in June 2012 CP 182 Best Interest duty - released 9 August 2012 - responses due 20 Sept 2012 CP 183 Scaled Advice - released 9 August 2012 - responses due 20 Sept 2012 CP 189 Conflicted Remuneration - 28 due September 2012 - responses due 9 Nov 2012 CP Codes of conduct - ???

7. Best Interest Duty.. the best interests duty is a legislative requirement to ensure the processes and motivations of financial advisers are focused on what is best for their clients. It is true that this will ultimately lead to better advice in many cases, but first and foremost it is about regulating conflicts, not the intrinsic quality of the advice provided… Source: Hon Bill Shorten, Minister for Financial Services and Superannuation, second reading speech to the Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011.

8. Best Interest Duty s961B 1. Identity the objectives, financial situation and needs of the client “that were disclosed to the provider by the client through instructions” 2. Identified the subject matter of the advice sought s961B(2)(b)(i) 3. Identified the “reasonable relevant” objectives, needs and circumstances 4. Make reasonable inquiries where information is incomplete or inaccurate 5. Consider whether you have the expertise to provide the advice (and decline if you do not)

9. Best Interest Duty s961B 6. If “reasonable to consider recommending a financial product” investigate the products and assess the information you gather 7. Base all your judgements on the client’s relevant personal circumstances 8. Take any other step that “would reasonably be regarded as being in the best interests of the client” “meeting the objectives, financial situation and needs of the client must be the paramount consideration when going through the process of providing advice..”

10. CP 182 “Instructions” Instructions can be provided through a face-to-face meeting, by phone or email or by “entering information into an online form or program”, and instructions can be provided over a period of time and a series of communications.

11. CP 182 “Capacity to pay” CP182, ASIC notes that the client’s capacity to pay, or willingness to pay for advice is a mechanism by which advisers can determine the type of service they choose to provide. The adviser must act in the best interest of the client, an adviser can filter the service provided by cost and either decline to provide advice or offer the client alternative options such as factual information, general advice or a referral to anther adviser.

12. CP 182 “Switching and APLs” 175.A127 We consider that the advice will generally only be appropriate if it would be reasonable to conclude that the net benefits that are likely to result from the new product (or option) are better than under the existing product (or option). This applies where either the new product or the existing product is (or both products are) a financial product under Ch 7.

13. CP 182 “Switching and APLs” 175.A128 Advice will often be appropriate under s961G if there are overall cost savings for the client that are likely to override the loss of benefits that are of value to the client. 175.A129 The determination of whether there are overall cost savings for the client must take into account all the circumstances, including the cost of the replacement (i.e. making the switch) and the advice provider fees, if they are payable only if the switch is made.

14. CP 182 “Other Obligations” ASIC intend to administer the best interest duty “in light of other obligations that apply to AFSL and their reps” (CP183.30 - Giving information, general advice and scaled advice) including: Common law obligations (including the duty of care and fiduciary duties) Contractual obligations Industry standards and codes Regulatory requirements (Corps Act and ASIC Act) Trustee duties and obligations RE duties and obligations

15. CP 182 “Good Advice” ASIC (CP175.A23) consider that good advice processes (and quality advice) are based on: (a)a clearly defined scope and an investigation of the client’s relevant circumstances; (b)assistance given by the advice provider to the client, if required, to set prioritised, specific and measurable goals and objectives; (c)where relevant, consideration of potential strategies and options that are available to the client to meet their objectives and needs; (d)where relevant, consideration of all aspects of the impact of the advice or example, tax or social security consequences;

16. CP 182 “Good Advice” (CP175.A23) (e)good communication with the client. This includes: (i)providing a Statement of Advice (SOA) that is logically structured and easy to understand, if one is required; and (ii)if appropriate, depending on how the advice is provided, verbal interactions that aim to ensure that the advice and recommendations are understood; and (f)where relevant, strategic and product recommendations that are appropriate for the client’s relevant circumstances.

17. CP 182 “Other steps” ASIC recommends that the following steps help demonstrate compliance with the “good advice” requirement; Clearly explain what advice services are being provided (and what is executed); Provide strategic recommendations that benefit the client; Specify that the advice (and its continuing appropriateness) should be regularly reviewed; and Offer to provide advice on “any other key issues identified by the advice provider that are not part of the scope of the advice” (RG 175.A111).

18. CP 182 “Safe harbour” Other reasonable steps Section 961B(2)(g) of the safe harbour for the best interests duty provides that an advice provider needs to take 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. The words at the time the advice is provided mean that this provision does not consider what may have been in the client’s best interests in hindsight. The Revised Explanatory Memorandum states that:In satisfying this final step [s961b(2)(g)], [an advice] a provider will need to go further than in the previous more specific steps [s961b(2)(a)(f)], and will have to take any step necessary to demonstrate that it has acted in the best interests of the client (paragraph 1.43).

19. CP 182 “Client priority rule” The client priority rule is an active duty and is not simply a matter of disclosure. RG175.A142 Using information barriers to avoid becoming aware of a conflicting interest of a related party would breach s961J if the advice provider should reasonably have known about the conflict. RG175.A143 Section 961J(1) requires that an advice provider should not act to further their interests over those of the client when giving the client advice. In complying with this obligation, advice providers should be guided by what an advice provider without a conflict of interest would do.

20. CP 182 “Client priority rule” The client priority rule does not prohibit an adviser from accepting remuneration from sources other than the client but if the adviser priorities non-client sources over the interests of the client then the adviser has contravened this rule.

21. CP 182 “Client priority rule” RG175.A148 The conflicts priority rule means that: (a)an advice provider must not recommend a product or service of a related party to create extra revenue for themselves, their AFS licensee or the related party, where additional benefits for the client cannot be demonstrated; (b)an advice provider must not “over-service” the client to generate more remuneration for themselves or one of their related parties. This means that the advice provider must provide a level of service commensurate with the client’s needs. Eg you must not recommend an unduly complex strategy if the client is unlikely to seek ongoing advice; and (c)an advice provider must recommend non-financial product solutions relevant to the client’s situation, where appropriate, even if this means the client is less likely to need financial advice in the future (e.g. advice on debt reduction, estate planning and/or Centrelink benefits).

22. CP 183 “Information,General Advice and Scaled advice” All advice is scaled. CP183- Giving information, general advice and scaled advice (August 2012) ASIC distinguished between financial product advice and factual information by their qualitative nature. Financial product advice:generally involves a qualitative judgement about - or evaluation, assessment and comparison of - some or all of the features of a financial product. Factual information: is objectively ascertainable information, the truth or accuracy of which cannot be questioned”. CP183.25

23. The role of the client The advice relationship involves reciprocal duties and involves a partnership between the client and the adviser. The adviser relies on the client, after necessary enquiries, to provide them with accurate information on their financial and personal circumstances to enable them to act in the client’s best interests. Professional advice is to present consumers with choices that they understand and value.

24. CP 189 Conflicted Remuneration The Corporations Act prohibits: (a)AFS licensees and their representatives (including authorised representatives) from accepting conflicted remuneration (s963E, 963G and 963H); (b)product issuers and sellers from giving conflicted remuneration to AFS licensees and their representatives (s963K); and (c)employers from giving their AFS licensee or representative employees conflicted remuneration for work they carry out as an employee (s963J).

25. CP 189 Conflicted Remuneration Conflicted remuneration is any benefit given to an AFS licensee, or its representative, who provides financial product advice to retail clients that, because of the nature of the benefit or the circumstances in which it is given, could reasonably be expected to influence: (a)the choice of financial product recommended to clients by the AFS licensee or representative; or (b)the financial product advice given to clients by the AFS licensee or representative: s963A

26. CP 189 Examples of Conflicted Remuneration Examples: (a) upfront and trailing commissions paid by a product issuer to a licensed dealer group, whether the payment is made directly or through some other arrangement, such as through a non-cash payment facility; (b) volume-based payments from a platform operator to a licensed dealer group; and (c) volume-based bonuses and other payments, such as a commission or one-off payment, to a financial adviser, which is calculated by reference to the number or value of financial products acquired by clients based on the advice of the financial adviser. The payment could be made by: (i) the financial adviser’s dealer group; (ii) a platform operator; or (iii) a product issuer.

27. CP 189 Substance of the “benefit” ASIC in deciding whether a benefit is conflicted remuneration, will look at the substance of a benefit over its form, and consider the overall circumstances in which the benefit is given. In forming a view on whether a benefit is conflicted remuneration, ASIC will look at a range of factors, including: (a)how the AFS licensee or representative gains access to the benefit; (b)who is giving the benefit; (c)when the benefit is given; (d)what reasonably appears to be the likely reason why the benefit is being given; (e)how the value of the benefit is determined; and (f)what the benefit is and its features.

28. CP 189 “Benefit Value” We propose that a benefit is more likely to be conflicted remuneration if: (a)its value is greater than $300 for each AFS licensee or representative that receives the benefit; or (b)for benefits that are given on a frequent or regular basis, the combined value of all benefits given is greater than $300 for each AFS licensee or representative that receives the benefit:

29. CP 189 Other banned remuneration In addition to the ban on conflicted remuneration, the Corporations Act prohibits other forms of remuneration that have the potential to influence the financial product advice received by retail clients. The other forms of remuneration that are generally prohibited are: (a) a platform operator accepting a volume-based shelf-space fee from a funds manager; and (b) an AFS licensee, or its representative, who provides financial product advice to a retail client charging asset-based fees on borrowed amounts used to acquire financial products by, or on behalf of, the client

30. CP 189 Anti - avoidance Section 965 There is also a ban on entering into or carrying out a scheme that is designed to avoid the application of the provisions in Pt 7.7A of the Corporations Act, including the conflicted remuneration provisions

31. CP 189 Volume based benefits Volume-based benefits are presumed to be conflicted remuneration: s963L. ASIC consider that the size of a benefit, and the portion of the benefit that is volume based compared with the portion that is not, are relevant when looking to prove that a volume-based benefit is not conflicted remuneration ASIC propose that volume-based benefits that may be conflicted remuneration include:where a platform operator or other product issuer is also a licensed dealer group, benefits received in its capacity as platform operator or other product issuer and equity arrangements with representatives.

32. CP 189 Volume based benefits ASIC propose that, in some circumstances:a volume-based benefit may not be conflicted remuneration if it is passed on to the client and ASIC are less likely to scrutinise a benefit that is not passed on to the adviser, if certain controls are in place.

33. CP 189 Performance benefits for employees Not all performance benefits given to employees are conflicted remuneration. ASIC propose that employers should consider:  the eligibility criteria for the performance benefit;  how difficult it is for staff to meet these criteria;  the purpose of the performance benefit;  the proportion of the benefit that is volume based;  the link between the benefit and the financial product advice provided to clients; and  the proportion of the benefit to the overall remuneration of the employee.

34. CP 189 Performance benefits for employees Remuneration based on total profitability If an employee is remunerated based on the total profitability of their employer or the business unit in which they work, and not the employee’s individual sales, we consider this is less likely to be conflicted remuneration if the size of the business unit is large enough that the impact of the individual employee’s sales on the profitability of their employer or the relevant business unit could not reasonably be expected to influence the financial product advice.

35. CP 189 Volume base shelf space fees The Corporations Act prohibits a platform operator from accepting a benefit if it is a volume-based shelf-space fee: s964A(1). The purpose of the ban is to prevent: [t]he receipt by platform operators of volume-based benefits to the extent that such incentives are merely a means of product issuers or funds managers “purchasing” shelf space or preferential positions on administration platforms (paragraph 2.61 of the Revised Explanatory Memorandum).

36. CP 189 Volume base shelf space fees The presumption in s964A(2) does not apply if the platform operator can prove that one of the following applies to all or part of the benefit: (a)the benefit is a reasonable fee for a service provided to the funds manager by the platform operator or another person (fee-for-service exclusion); (b)the benefit is a discount on an amount payable, or a rebate of an amount paid, to the funds manager by the platform operator, the value of which does not exceed an amount that may reasonably be attributed to efficiencies gained by the funds manager because of the number or value of financial products in relation to which the funds manager provides services to the platform operator, or through the platform operator to another person (scale efficiencies exclusion): s964A(3).

37. CP 189 Asset based fees on borrowed amounts AFS licensees and authorised representatives that provide financial product advice to retail clients are generally prohibited from charging asset-based on borrowed amounts that are to be used to acquire financial products by or on behalf of a client: see s964D and 964F. If an AFS licensee or representative is found to have charged asset-based fees on borrowed amounts, they may be liable for a civil penalty.

38. CP 189 Asset based fees on borrowed amounts When does the ban not apply? The ban on charging asset-based fees will not apply to an AFS licensee or authorised representative if they do not know that an amount used to acquire financial products by or on behalf of a client has been borrowed, as long as this fact is not reasonably apparent.

39. CP 189 Asset based fees on borrowed amounts When a client has a portfolio of products purchased with a combination of borrowed and non-borrowed amounts, we consider that: (a)if the financial products purchased with borrowed amounts can be separately identified from the financial products purchased with non- borrowed amounts, asset-based fees can be charged on the proportion of the portfolio purchased with non-borrowed amounts; and (b)if the financial products purchased with borrowed amounts cannot be separately identified, asset-based fees should not be charged over the whole portfolio. This is because it is not clear which financial products the borrowed amounts have been used to acquire.

40. Any questions? Christina Kalantzis, Principal ALEXIS Compliance & Risk Solutions www.alexisrisk.com.au www.alexisinsurance.com.au COMPLIANCE - PI INSURANCE -RISK MANAGEMENT