02/03/2012

Following the recommendations of the Ripoll Enquiry the Federal Government determined to enshrine in legislation an obligation on financial advisers to act in the best interests of their client. 

The second tranche of the draft Future of Financial Advice (FOFA) legislation was released recently.  It contains the above description of what acting in the client’s best interest actually entails.

The concept of reasonableness is referred to twice in the 961E description and no fewer than seven times in the primary obligation section 961B.  My mind was taken back to the original standard of reasonableness: 'the man on the Clapham omnibus'.

It was 1903 when the phrase was first used by Sir Richard Henn Collins MR in the English Court of Appeal case of McQuire v Western Morning News.  But it only came to prominence thirty years later in 1933 when Lord Justice Greer used it in Hall vs Brooklands Auto-Racing Club to exemplify the standard of care that a man was obliged to afford his fellow men (and women); a standard that had only recently appeared in the then relatively new law of negligence. 

The man on the Clapham omnibus is a reasonably educated and intelligent but non-specialist person – the so-called reasonable person against whom a defendant's conduct might be judged.

Our FOFA 2 financial adviser has obligations that go much further than those expected of that chap on the London bus.

The financial adviser must act in the best interests of the client in relation to the advice (s.961B(1)).  He can meet that obligation by doing all the things set out in s.961B(2).  Those obligations draw heavily from the current law.

There are seven requirements, numbered (a) to (g) in s.961B.

(a)    identify the client’s objectives, financial situation and needs (current s.766B(3)).

(b)    identify the subject matter of the advice (whether explicit or implicit) and the objectives, financial situation and needs that would reasonably (there’s that word again) be considered as relevant to the advice sought (no exact current equivalent).

(c)    where it is reasonably (that word again) apparent the information relating to the client’s circumstances was incomplete or inaccurate, make reasonable (and again) inquiries to obtain complete and accurate information (even if the client doesn’t want you to?) (compare to current obligation to warn in s.945B).

(d)    assess whether you have the expertise to advise on the subject (query to what standard?) and if you don’t then decline the retainer (no current equivalent).

(e)    if in considering the subject matter of the advice it would be reasonable (yet again) to recommend a financial product, reasonably (that’s the 5th time the word is used in the section) investigate and assess products that might reasonably (and the 6th) be considered as relevant to advice on the subject (compare to s.945A(1)(b)) where investigation has to be of the subject matter of the advice).

(f)    base all judgements in advising the client on the client’s relevant circumstances (compare to the s.945A obligation to determine and inquire regarding the relevant circumstances).
 
(g)    take any other step that would reasonably (the 7th time the word is used in the section) be regarded as being in the best interests of the client given the client’s relevant circumstances.

The final over-arching obligation is the sting in the tail and the reason why there is a need for the s.961B description of what that final obligation requires. 

In assessing the behaviour of a financial adviser and ensuring their actions are in the best interest of clients ss. 961B(2)(g) and 961E apply the following four standards:

1. The planner must have acted with a reasonable level of expertise in the subject matter of the advice sought by the client.
2. They must have exercised care.
3. They must have objectively assessed the client's relevant circumstances.
4. They must have regarded taking the step as in the best interest of the client, given the client’s relevant circumstances.
   

There is a circularity to this obligation which will likely exercise some forensic minds more able than this author's.  S.961B(2)(g) requires the adviser to take any other step that would be in the client’s best interest.  But s.961E then says that if the adviser regards the step as in the best interest of the client then it is so (provided they meet the other three criteria).

There may be many further steps that might be in the best interest of the client, but are they necessary?  If the adviser does not take that "other step" are they then in breach of the provision?  Does that mean that financial advice will be regularly subjected to judicial examination at the request of clients (and their lawyers with 20-20 hindsight) who wish to prove that some "other step" should have been taken?

Such an outcome would be curious given the legislation's concession that an adviser is not required to consider 'every financial product available'; effectively nodding to the fact that the notion of a 'best interest' is not a theoretical ultimate standard that is entirely impractical in the real world.

So are we to interpret the legislation as obliging that 'other step' or simply saying that if the adviser takes that 'other step' it needs to be in the client’s best interest?

And having done all these things the adviser still needs to comply with s.961G – it must be reasonable (hmmm) to conclude that the advice is appropriate.  And who will decide that?  Perhaps we can ask the man on the Clapham omnibus. 

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.