Understanding the best interests duty and its obligations

Legal experts Samantha Hills and Grant Holley dissect the best interests duty and the obligations that come with it.

All over the country, financial services businesses are counting down to 1 July 2013.

From conflicted remuneration to fee disclosure statements there is more than enough for the average adviser to think about. One area that remains blurry for many advisers is the best interests duty and its related obligations. 

The best interests duty need not be as daunting as it first seems, but a good understanding of the requirements is essential. Some handy tips can take you much of the way to ensuring that you meet the new requirements. 

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The best interests duty, which now appears in section 961B of the Corporations Act 2001 and which becomes effective on 1 July this year, is just one among a variety of areas which regulate the relationship between you and your client.   

The services you provide to your client are also regulated by: 

• The law of negligence – the main element of which is the duty of care you owe to your client; 
• Equity – fiduciary obligations being a key element which may be relevant to you; 
• Contract law; and 
• Other parts of the Corporations Act 2001 and legislation beyond this. 

While this seems overwhelming, there are probably multiple things you do in your relationship with clients which help you to satisfy your obligations in all these areas.  

Also, the best interests duty, rather than being an entirely new creation, is the natural evolution of earlier requirements, with which you are probably well familiar. 

In the 1990s, the Corporations Law, in relation to securities advice, required you to know your client and know your product. The Life Insurance Code of Practice acted in a similar fashion in relation to life insurance. 

It set out the mechanics of giving advice in a manner to ensure that the advice was fit for its purpose. It set the standards expected of a reasonable adviser. 

These requirements signalled a shift from a sales-based industry to an advice-centric approach and a move to greater professionalism. 

Then the Financial Services Reform Act 2001 overhauled the financial services industry, with most major changes starting in 2004. It brought us the current requirements under section 945A of the Corporations Act 2001 that require licensees and their advisers to: 

• Determine the personal circumstances relevant to the advice being given to the client; 
• Make reasonable enquiries in relation to those; 
• Having regard to that information, consider and investigate the subject matter of the advice; and 
• Ensure that the advice given to the client is appropriate. 

The requirements in section 945A and those in the old Corporations Law and in the Life Insurance Code of Practice had three main elements in common. 

1. They documented the mechanics of how to give advice; 
2. They attempted to prescribe how a “reasonable adviser” should act; and 
3. They laid out a process commonly followed in other professions. 

Since the early 2000s, a series of dramas and collapses occurred – the GFC, Westpoint and Storm Financial – to name a few. These were followed by various government enquiries.

An overriding theme was that people perceive that two key factors were to blame for much of the investment fallout from these events: 

1. Funds were driven into high risk investments courtesy of high commissions and other remuneration structures benefiting advisers and their associates. 
2. The financial advice industry has significant inherent conflicts of interest which were not satisfactorily mitigated by existing legislation or industry self-regulation. 

The Government began considering the introduction of a statutory form of “fiduciary duty”. 

The common law requires you to provide advice to your clients to the standard of a reasonable adviser in your position.

If you fall short of this and the client suffers loss as a result, you could be sued for negligence. By setting out a process for you to follow, section 945A of the Corporations Act 2001 imposed a separate statutory duty that was similar to this. 

A fiduciary duty sits apart from these. It falls into an area of law known as “equity”. Equity originally developed separately from the law.

It developed in England from the 1500s when the Courts of Chancery were able to examine cases where the application of the law in a dispute between parties resulted in an outcome that was manifestly unfair. These Courts were able to decide such cases based on what was morally right, or fair. 

A fiduciary relationship arises when there is a position of trust between two people. The law presumes that many relationships are fiduciary – for example, parent and child, lawyer and client, employer and employee. 

However, adviser and client is not one of these relationships. Relationships falling outside the presumption can be fiduciary if there is a relationship of special trust and confidence between the parties. 

As a result, many adviser/client relationships may be fiduciary. It depends on the specific circumstances – particularly on whether the client depends on and is influenced by the adviser’s expertise. 

When you have a fiduciary duty towards someone, this means that you are not allowed to put your interests ahead of theirs. 

Whether you have met your fiduciary duty (should you have one) depends not so much on the mechanics of the process (as it does for a duty of care and in the old section 945A of the Corporations Act 2001) but rather on your motives for exercising your influence over the client. 

The new best interests duty is distinct from a fiduciary duty but has many of the hallmarks of a fiduciary duty – in particular, an emphasis on your motivation – for providing the particular advice to the client. 

The new best interests duty and associated obligations meld the two areas – mechanics and motivation – and prescribe how you should approach them: 

1. When providing the advice, you must act in the client’s best interests. 
2. There is a “safe harbour” – that is, a set of requirements that, once met, mean that you have met your duty to act in the client’s best interests. This introduces some mechanics to help prove the nobility of your motivation. 
3. Your advice must be appropriate. 
4. You must prioritise the client’s interests if there is a conflict between those and the interests of you or parties related to you (such as your employer or your licensee).
5. Conflicts cannot be managed simply by disclosing them. Nor can you contract out of these obligations. 

 From a technical legal perspective, the way the new legislation is drafted means that you actually have three separate new duties: 

• A duty to act in the client’s best interests; 
• A duty to provide advice that is appropriate; and 
• A duty to prioritise the client’s interests in the event of a conflict. 

The “how to” of fulfilling your duty to act in the client’s best interests is found in the “safe harbour” provisions. This “how to” is very similar to previous formulations but: 

• The emphasis is wholly, instead of only partly, on the client’s interests; and 
• There is greater emphasis on gathering more information about the client and, if relevant, the product. 

To find yourself in the safe harbour: 

• Identify the objectives, financial situation and needs of the client that were identified through instructions; 
• Identify the subject matter of the advice sought by the client (whether explicitly or implicitly); 
• Identify the objective, financial situation and needs of the client that would reasonably be considered relevant to the advice sought on that subject matter; 
• If it is reasonably apparent that information relating to the client’s relevant circumstances is incomplete or inaccurate, make reasonable enquiries to obtain complete and accurate information; 
• Assess whether you have the expertise to provide the advice sought and, if not, decline to give the advice; 
• If it would be reasonable to consider recommending a financial product, conduct a reasonable investigation into the financial products that might achieve the objectives and meet the needs of the client that would reasonably be considered relevant to advice on the subject matter and assess the information gathered in the investigation; 
• Base all judgments on the client’s relevant circumstances; and 
• 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.  

In relation to the duty to prioritise the client’s interests in the event of a conflict, the Australian Securities and Investments Commission (ASIC) has said in RG 175: 

• The recommendation of the product of a related party must be supported by extra benefits for the client; and 
• If your APL contains only products of a related party, you must not recommend one over a competitor’s product unless a reasonable adviser would be satisfied it was in the client’s interests to be recommended that product over a rival product with similar features and costs. 

Your overall approach to the three new duties should be informed by ASIC’s view that “a reasonable adviser should believe that the client is likely to be in a better position if the client follows the advice”. 

Case study 

Consider whether the adviser in the following situation has complied with his best interests duty. 

Anna Robic has a portfolio of managed funds with Acme platform. The reporting is “clunky but OK”. She is concerned about fees.

Her adviser recommends switching to Perfect Platform because the reporting will be much easier to follow. The fees are higher than her existing platform by 0.1 per cent of assets under administration. 

A different situation 

Cecil Poole comes to his adviser wanting to review his term life insurance. He has an existing death benefit of $500,000 and needs $600,000.

His adviser’s recommendation is to take out a new policy for $600,000, with terms that are otherwise very similar to the existing one. The adviser receives a commission on the $600,000 policy rather than commission on a $100,000 increase. 

Useful tips 

When considering situations such as these and ones arising in your own practice, use the following tips. 

• Avoid “cookie cutter” advice 
• Ask yourself:
  1. Did I get to know the client? 
  2. Did I clearly define the task I was asked to do? 
  3. Did I follow a process? 
  4. Did the advice address the goals and objectives of the client? 

These tips should be familiar to you after years of operating under the current regime. 

But there are two more questions you should ask yourself to ensure that your advice meets the requirements of the best interests duty and its associated obligations:  

1. Would a reasonable adviser believe that the client is likely to be in a better position by following my advice? 
2. If this client was my son or daughter being influenced by my advice and trusting me to act in their best interests, is this what I would recommend? 

Samantha Hills is a lawyer and Grant Holley is a founding partner of Holley Nethercote Commercial and Financial Services Lawyers.