Regulatory "Rinkles": Spotlight on conflicted remuneration

This edition of Regulatory Rinkles focuses on certain aspects of the conflicted remuneration regime under Part 7.7A of the Corporations Act 2001 (Cth) (Act), which are often ill understood.

This focus is timely following the Royal Commission and the proposed end of the grandfathering regime. While the grandfathering of conflicted remuneration is coming to an end through the advent of amendments to the Act made by the Treasury Laws Amendment (Ending Grandfathered Conflicted Remuneration) Act 2020 (Cth) (which comes into effect from 1 January 2021), the fundamental issues discussed here will continue to be relevant. This is because there will continue to be a need for licensees to work out whether payments are conflicted remuneration in the first place.

This analysis will take the form of "furphies" to be discussed and dismissed.

FURPHY 1: Benefits provided to a licensee, as opposed to a representative, will not be conflicted remuneration.

The typical thinking behind this furphy is that if a representative provides the financial advice, then a benefit provided to the relevant licensee (rather than the representative giving the advice) cannot be conflicted remuneration.

With respect, we disagree with this proposition and hold it to be incorrect for a number of reasons.

First, at the most simple level, a licensee can in fact be the provider of the advice, and is treated as such, where the relevant individual providing the advice is an employee of the licensee (ie a representative). In other words, where a representative of a licensee gives the advice, as opposed to an authorised representative, then the licensee is the provider of the advice. Here, the employee representative advising the client is the licensee for these purposes. The Act makes it clear that for most purposes, the provider of the advice in such a circumstance is, in fact, the licensee (see for example section 944A of the Act, relating to financial disclosure. The best interests obligation regime contained in Division 2 of Part 7.7A of the Act is a specific exception to this regime).

Second, the licensee can still be seen to be providing the advice even where it is provided by an authorised representative of the licensee. In this regard, the relevant text of the definition of "conflicted remuneration" in section 963A of the Act is instructive, viz:

"Conflicted remuneration means any benefit, whether monetary or non-monetary, given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice … "

So a threshold issue is who provides the advice. But even where the individual giving the advice is an authorised representative (rather than an employee representative), the licensee can still be seen to be providing the advice on the basis of the operation of section 52 of the Act, where:

"A reference to doing an act or thing includes a reference to causing or authorising the act or thing to be done."

In this context, the licensee causes or authorises the representative to provide the advice. Of course, the authorised representative is still also providing the advice (in conjunction with the licensee).

Third, even disregarding this last point, the fact is that payments to a licensee can still influence advice provided by a representative, such as an employee who is not an authorised representative. The payment to the licensee may result in the licensee inducing or influencing (either directly or indirectly) the representative to provide certain advice favouring certain products. For example, the licensee may receive amounts from a product issuer if the representative succeeds in the client acquiring financial products issued by the product issuer, which in turn may result in the licensee being able to give greater support, financial or non-financial, to the representative.

All this said, it is true that in ASIC Regulatory Guide RG 246 Conflicted and other banned remuneration (RG 246), ASIC states that where certain payments are made by a platform operator to a licensee but no payments are passed on to the individual adviser:

“…we are less likely to scrutinise the benefit under the ban on conflicted remuneration if there are controls in place to ensure that the benefit does not influence the advice given by representatives of the AFS licensee.”[1]

This position has, in our experience, been used by industry in the wider (but analogous) context of payments made by product issuers more generally and not just platform operators. Some industry participants have treated ASIC’s statement as a de facto exemption, but this is risky for several reasons, as follows:

• first, the formulation ASIC uses of it being “less likely to scrutinise” is of lesser force than other formulations used by ASIC for other factual scenarios (such as where fees are payable by product issuers if they are passed through to the client or where a product issuer provides general advice about its own products and accepts management or administration fees for those products);[2]
• second, ASIC does not anticipate that such payments would be made without controls in place, such as to ensure that the payments will not be passed on from the licensee to the adviser; and
• third, and most importantly, these payments will be conflicted remuneration if they have the requisite influencing effect on the advice (under section 963A of the Act). While these payments are not necessarily impacted by the impending removal of the grandfathering exemptions, ASIC’s statement of being "less likely to scrutinise" is not as emphatic or concrete than the formulations it uses for other “quasi-exemptions”, and noting also that ASIC is not bound legally to any of these pronouncements.

Certainly, maintaining strict controls around:

• ensuring the payments are not passed on to the individual providing the advice; and
• reducing, mitigating or (less easily) eliminating influence,

will be very central to this issue but at the end of the day, the strict legal position is that the payment controls must neutralise any influence.

FURPHY 2: When non-monetary financial benefits may constitute conflicted remuneration.

This is less of a furphy and more of a clarification of the concept of non-monetary benefits. Clearly, the Act includes non-monetary benefits in its prohibition on conflicted remuneration, but is a non-monetary benefit a straightforward concept?

It is certainly very broad, encompassing any benefit that is not money. So this will include the provision of goods but it goes much, much further. For example, a product issuer who gives advisers access to its clients at promotional events could be providing a non-financial benefit to those advisers.

The real issue is where to draw the line. For example, is the promise by a product issuer to indemnify the advice licensee under a distribution agreement a conflicted non-monetary benefit, particularly in circumstances where the distribution agreement has been negotiated at arm’s length?

In this context, it is suggested that one way to evaluate non-monetary benefits as conflicted remuneration is to ask if the relevant item is in fact a "benefit" in the true sense. It seems to us that an item which is paid for at market rates by the licensee or adviser, or for which the licensee or adviser provides commercial consideration, will not usually be a "benefit" that section 963A was designed to catch. In other words, the concept of "benefit" imports the notion that there is a favourable outcome bestowed by the provider on the recipient.

In contrast, the sale of something by the licensee to a representative for less than market consideration is clearly a benefit, as would be a loan at lower than commercial rates.

FURPHY 3: The client-paid exemption can operate where a product provider is giving a benefit to a licensee (or a representative), or a licensee is giving a benefit to a representative provided the benefit is sourced from client funds.

For this exemption (in section 963B(1)(d) of the Act) to operate successfully, the benefit must be given by the retail client.

In order for the client to give that benefit, as ASIC correctly notes in RG 246, the benefit must come from the client’s own funds.[3] Importantly, the Act contains a note to section 963B of the Act, which makes it clear that superannuation amounts that are caused or authorised to be paid by the client are to be treated, under section 52 of the Act (commented upon above), as given by the client. Superannuation amounts are not necessarily a benefit of a client.

The relevant text of the note to section 963B is:

“Under the governing rules of some regulated superannuation funds, a member may seek advice on the basis that the trustee of the fund will pay the licensee or representative for the advice and then recover the amount paid from the assets of the fund attributed to that member. In that case, the member has caused or authorised the amount to be paid to the licensee or representative and so, because of section 52 of the Act, paragraph (1)(d) would apply to this amount.”

With respect, this analysis seems correct. The relevant trustee may under the governing rules of the fund require the relevant member’s consent to the application of amounts in his or her account balance to pay for financial advice. As such, the application of trust money towards an expense must be appropriately incurred under usual trust law principles. Unless the amount is an unrestricted non-preserved amount (and hence, the member has a vested entitlement which it can direct payment of), the payment will be in the nature of an expense of the fund, albeit paid from the member’s account balance.

Note that generally, a member cannot direct a trustee to pay such an amount due to the restriction in section 58 of the Superannuation Industry (Supervision) Act 1993 (Cth), which precludes trustees being subject to direction under the governing rules. However, relevantly, an exception exists in relation to a benefit payable to the member (ie an unrestricted non-preserved benefit (see section 58(2)(c))).

In order for the client to give the benefit, he or she must determine not just to pay a benefit but also, the specific quantum of the benefit. If the client simply delegates that decision to another party, such as a product issuer (or a licensee), as to how much to pay to the adviser, it is hard to say that the client has given the amount to the adviser. So for example, if the client authorises the licensee to pay up to $1,000 to the adviser, a discretion resides in the licensee as to how much it actually pays the adviser. As the client has not determined the amount paid, it is difficult to establish that the client has given that benefit.

FURPHY 4: The client-paid exemption applies whenever a benefit is given by the client to the licensee or representative.

This interpretation would be far too wide.

Under the Act, only benefits given by the client in relation to the issue or sale of a financial product or for the provision of financial product advice to the client qualify under the Act (see section 963B(1)(d)).

Under the Corporations Regulations 2001 (Cth), a benefit given by a client to a "provider" dealing in a financial product on behalf of the client also qualifies (see Corporations Regulation 7.7A12E), noting in this regard that the dealing must be one made on behalf of the client. For example, an arranging by the licensee for the client to acquire the product would only qualify if the arranging was affected by the licensee acting on behalf of the client and not on behalf of the relevant product provider.

TRANSITIONAL ISSUES

Having discussed these Regulatory Rinkles, many organisations will be examining how to transition away from grandfathered remuneration, given the new legislation referred to above.

In that context, a frequently encountered issue is whether a product issuer can bring forward (ie accelerate) the payments that would otherwise be payable under a grandfathered arrangement with a licensee. We will deal with this issue and other transitional issues in our upcoming edition on "Transition of Grandfathered Remuneration", which will be published in the next few weeks.

[1] ASIC RG 246 at 246.120.

[2] ASIC RG 246 at 246.77 and 246.139.

[3] ASIC RG 246 at 246.72.