SYDNEY: 31 May 2013 - The rear-view mirror is a wonderful thing.  If you are reversing.  But it is no way to go forward. 

Thank goodness ASIC agrees.  ASIC Regulatory Guide 175: Licensing: Financial product advisers lays to rest a concern that has unsettled the financial planning industry since the FOFA reforms were first touted.  Specifically it notes that when assessing whether financial advice has been provided in a manner complying with the so-called best interests duty (s961B of the Corporations Act) it will not ‘examine investment performance retrospectively, with the benefit of hindsight.’  

This position reflects the Minister’s position when introducing the requirement. In his second reading speech he stated:  ‘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.’   That is, best interests is about decision processes at the time of the recommendations, it is not about the outcomes flowing from those recommendation.

This perspective is consistent with s961E of the Corporations Act which provides that ‘It would reasonably be regarded as in the best interests of the client to take a step, if a person with a reasonable level of expertise in the subject matter of the advice that has been sought by the client, exercising care and objectively assessing the client's relevant circumstances, would regard it as in the best interests of the client, given the client's relevant circumstances, to take that step.’  Again the evaluation is an ex ante one: would the reasonable expert person recommend that step.

From the perspective of the legal heritage of the best interests duty, this make absolute sense. The best interests duty at common law has at its heart the pursuit of the interests of the beneficiaries, and the concept of pursuit is fundamentally concerned with the motivation or mindset of the holder of the duty.  That is, the relevant question is whether the adviser had the requisite orientation at the time the advice was given, not whether there was some other course of action, identifiable with the benefit of hindsight, that might have promoted the client’s interests even further.  The harsh reality is that there is almost always some potential course of action that, had it been followed, would have outperformed the strategy actually recommended.  It would be remarkable if that were not the case.

Of course there is always a degree of asymmetry in actions against an adviser for the advice they have provided.  Profitable strategies, however deficient in an ex ante objective sense they might be, are almost never going to be challenged.  Clients bless their good luck (or overlook the deficiencies in the advice) all the way to the bank.  It is only losing strategies that come under the scrutiny of ASIC and the courts.  But what RG 175 makes clear is that the realisation of a loss does not of itself prove that the advice was not, at the time it was given, in the best interests of the client.  Investment markets can be unkind and even the best advice will not be optimally profitable over every time period. 

That said, the FOFA duty was not of the same nature as the trustee duty articulated in Cowan v Scargill  that it resembles. Clearly, an adviser must act having regard to the interests of the individual client, not to a collectivity of clients. 

Regard must also be had to the expectations of the client.  In a trust situation, such as pertains in the superannuation context of the best interest duty, the trustee may have had no personal interaction with the party to whom the duty is owed.  Australian Super has 2 million members, REST 1.9 million. 

In contrast, an adviser is expected to have a very personalised relationship with its  client.  It for this reason that the legislation now formally provides a defence (in s961B(2)) to an alleged breach of s961B(1) for the adviser that can demonstrate (in summary terms) that it has identified the objectives, financial situation and needs of the client (or made reasonable attempts so to do), undertaken relevant research into the financial products recommended, and based his or her advice on those findings.  These characteristics of good quality advice cannot guarantee the ideal outcome for the client, but as the Regulatory Guide notes, ‘the provisions should lead to a higher quality of advice being provided compared to the general standard of advice being provided under [the provisions they replace] s945A and 945B.’  

Perhaps just as important for the industry, the distillation of the components of best interests start to provide a blueprint for financial planning firms seeking to establish an internal compliance regime to regulate the conduct of their advisers.  But it is just a start, because the defence requires the adviser to take any steps 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.’   As Lindgren and Stone have noted, just quite what opportunities for regulatory or curial creep lie resident in that provision are not clear.   So while the prospect of review by rear-view mirror might appear to have been put to bed, a few tremors remain.