Personal finance and investing columnist at the NZ Herald

Brent Sheather: Anything goes so long as you disclose

David Ross. Hi exploits were a hard act to follow. Photo / Mark Mitchell
David Ross. Hi exploits were a hard act to follow. Photo / Mark Mitchell

It has been a couple of years since the revelation that most of the hundreds of millions that David Ross managed existed only in his head. Since then there hasn't been much in the way of new naughty behaviour by financial advisors. Even allowing for the fact that Mr Ross's exploits were a hard act to follow things have been quiet, in the public domain anyway, until now.

However, last month the Financial Advisors Disciplinary Committee (FADC) released details of new naughtiness by an Auckland based financial adviser who worked for one of the biggest firms and had some 28 years' experience. The good news is that no money was lost, stolen or spent on cars, drugs or prostitutes, which is a nice change. In fact no clients even complained about the adviser and the first they will know about his transgressions will be when he discloses it to them in his disclosure statement.
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Because the offending was minor the FADC has suppressed the name of the adviser and the firm for whom he worked which is fair enough, although the identity of the firm appears widely known.

Apparently the Financial Markets Authority (FMA), who referred the misbehaviour to the FADC, were alerted to the "issues" by the adviser's employer, a Qualifying Financial Entity (QFE). By the way if you are getting a little sick of these acronyms spare a thought for the daughter of former Treasury Secretary, Tim Geithner.

According to the London Financial Times, at the height of the GFC (sorry), Mr G was in hospital and his daughter had his phone. A call came through saying that POTUSA wanted to speak to her dad. She, being protective of her father's privacy, is reported to have said "who the f__k is POTUSA". It was explained to her that POTUSA stood for President of the United States of America.

Anyway back to the topic. What was the nature of the offending? That's a good question because it isn't all that obvious. The "decision" published by the FADC is confused to put it mildly. Firstly it stated that the adviser had admitted to breaching Code Standards 8, 9 and 12 as follows:

• Code Standard 8 - advice must be suitable for the client.

• Code Standard 9 - advice must be made via a written explanation and the AFA must ensure that the client is aware of the benefits and risks of the advice.

• Code Standard 12 - the AFA must record in writing adequate information about the advice.

But then the FADC contradicts itself by stating that "the offending simply related to the AFA's failure to keep the required records". Another acronym comes to mind .... WTF? The FADC then went on to say that record keeping is important because "of the influence it can have in determining whether an AFA has an up to date understanding of a client's situation, needs, goals and tolerance for risk" and thus ensuring that the advice is suitable.

In this case if the advice wasn't suitable (a breach of Code Standard 8) that would be a big issue but given that "the offending related to the failure to keep records" surely that's not the case. However further on in the decision the FADC states that the adviser acknowledged that record keeping is particularly important "when the client was taking on more risk than may have been appropriate for their risk profile". Hello ... was the advice suitable or not? If it wasn't that is a material transgression and how on earth does record keeping fix a mis-specified asset allocation? It clearly doesn't but the implication from the FADC's comments are that anything goes provided you disclose.

Publishing a FADC decision is an opportunity to reiterate to all financial advisers what is and what is not best practice but half of the decision is taken up by deliberations as to whether or not to suppress the adviser's name. If asset allocation was the issue in this case then that should have been highlighted.

If it was done badly the FADC should have set out the details, the context and told the industry what best practice looks like. Alternatively if the adviser's advice was suitable and he just didn't record it properly then this looks like a huge over-reaction by the FADC and really is a worry for the industry going forward. It is not at all clear what is happening here.

So all things considered something of a lost opportunity here but reading the decision is not a complete waste of time. The "agreed summary of facts" contained some specifics. The FMA looked at (only) four of the AFA's client files and found that they didn't contain documents recording his up to date understanding of their risk tolerances etc and he hadn't recorded conversations explaining the rationale for recommendations. The big lesson here for advisers is perhaps that whilst meetings are nice the bottom line is that you need to write to clients telling them what you recommend and why, i.e. less meetings and more emails.

Another aspect of the decision that might be of concern to practitioners is the emphasis that "needs and goals should be restated regularly and confirmed by the client to ensure they are accurate".

I have been in this industry since 1984 investing for retired mums and dads and my experience is that objectives, needs and goals don't change much once you are retired. Why would they? Retired people want to maximise income and maintain the real value of their capital if possible. These comments from the FADC suggest little experience at the coalface. Maybe this comment alludes to times past when bonds yielded more than shares and you "bought bonds for income and shares for growth".

Post the 30 year bull market in bonds those days are long gone and the FADC and the FMA need to appreciate that once a client retires the asset allocation does not need to change too much, particularly if the retired clients are investing with their children's future in mind as much as their own. Just last week, despite advice to the contrary, I had an 80 year old client instruct me to sell bonds and buy shares because she was of the view that 50 per cent in bonds was much too conservative for her, she needed growth and thus the portfolio should be reweighted to 35 per cent in bonds.

There is also some irony in this case. Recall that it was the QFE that alerted the FMA to the problem (whatever it was!) but it may well be that the adviser wasn't totally to blame for recommending a higher than appropriate level of risk in the portfolios. This column has argued for years that high annual fee structures compel advisers to overweight risky assets in order to "beat the bank". Today 10 year local government bonds yield about 4 per cent.

The organisation (QFE) involved here has an annual fee structure implicit in its recommendations of almost 3 per cent pa so buying genuinely low risk investments isn't an option and thus portfolios have to be overweight shares to achieve a worthwhile return. Maybe this case highlights a systemic risk in this company and others with a similar fee structure ... i.e. most of the industry. That is perhaps another thing that the FMA needs to think about.

- NZ Herald

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request.

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Personal finance and investing columnist at the NZ Herald

Brent Sheather is an Authorised Financial Adviser and personal finance and investments writer

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