In recent months there has been considerable government, media and industry attention focused on margin loans.
The general hype of late has centred on the tattered affairs of margin lenders Opes Prime and Lift Capital, as well as the record margin calls made earlier this year in response to turbulent global financial markets.
In turn, this has triggered debate about the practices of financial planners when advising on such loans, including the receipt of discounts for planners on their own loans from some margin lenders, the ability to obtain loans for clients with very high loan to value ratios (LVR) and the ability to receive numerous fees from the recommendation to utilise a margin loan, such as trail commissions from the investments purchased with the loan, other fees/benefits from margin lenders and fees from clients when recommending loans.
Not surprisingly, the Australian Securities and Investments Commission (ASIC) has called for margin lending to be regulated in accordance with the financial services regime under Chapter 7 of the Corporations Act 2001 (Act).
So what will this mean for financial planners and licensees?
Will routine practices and procedures need to be revisited and changed if margin lending falls under the financial services regime? Such issues will be considered in further detail below.
Discounts and disclosure
The interest generated from discounts received by financial planners on their personal margin loans has received momentum over the past few months as a result of investors losing millions of dollars with the collapse of margin lending giants Opes Prime and Lift Capital.
There have been arguments that the discounted deals for planners have resulted in biased advice to investors; that the deals/discounts granted to financial planners by margin lenders are used to ‘induce’ planners into advising their clients to take out loans through a particular lender.
However, there are arguments raised on the other side of the spectrum, namely:
1. It is common practice for some margin lenders to give financial planners cheap loans;
2. Financial planners have a first-hand experience of the loan and therefore are in a better position to recommend such loans to their clients — the notion of try before you buy;
3. The majority of margin calls made back in January 2008 as a result of financial market turmoil were not made to clients who had invested through a financial planner; and
4. Anyone, not just financial planners, can negotiate a commercial discount on their loan.
However, the real issue seems to be whether or not such discounts should be disclosed given margin loans themselves are not regulated under the Act at this time.
Are these discounts effectively soft dollar? Is there a relationship that may influence the margin loan advice or the advice related to the overall investment strategy of which the margin loan is one element?
To disclose or not to disclose
Margin loans are not treated as a financial product under the Act and therefore not subject to the same rules and regulations as, say, shares and managed funds.
However, despite this, it is arguable that planners who provide advice/recommendations to their clients in relation to margin lending do so as part of a financial service to the client.
This is because the purpose of the loan is to grow the financial portfolio of the client. Accordingly, the relationships and benefits associated with any aspect of the overall investment strategy and advice given to the client should be disclosed.
In addition, financial planners owe a duty of care to their clients when providing financial advice, regardless of whether the actual product associated with the advice falls under the ‘financial product’ banner.
Accordingly, any potential conflict of interest arising from the planner/margin lender/client relationship should be managed and at a minimum disclosed. This would seem to be appropriate practice and in keeping with the financial planning industry’s push for greater transparency, whether a legal obligation or otherwise.
Tip: the client should be in a position to make an informed financial decision and therefore should be made aware of any issues that may be seen as having the potential to impact on the objectivity of the financial advice provided.
Regulating the credit industry
There have been calls to regulate the margin lending industry for some time.
The Federal Government’s Productivity Commission has been active in this regard by recently releasing its final report, Review of Australia’s Consumer Policy Framework on May 8, 2008.
The report recommends transferring the responsibility for regulating consumer credit to the Federal Government.
Prior to the release of the report, ASIC provided a submission to the commission calling for margin lending to be regulated in accordance with the financial services regime under Chapter 7 of the Act.
In particular, ASIC submitted that the margin loans were closely connected with the underlying investments that they fund and were therefore part of the investment ‘decision-making process’ regulated under Chapter 7 of the Act. This view is consistent with the argument previously posed in this article.
At the time of drafting this paper, no further submissions to the report have been invited and it is likely that some aspects of the report will be implemented in time.
In addition, on June 3, 2008, Superannuation and Corporate Law Minister Nick Sherry released the green paper, Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation, which, among other things, proposed regulating the margin lending industry.
In particular, the green paper put forward three options for reform of the margin lending industry:
1. maintain the status quo;
2. include margin loans as a financial product under the Chapter 7 of the Act; or
3. develop a separate Commonwealth regulatory regime for margin loans.
The Government has invited industry to submit comments to the green paper.
What does this mean for planners and licensees?
Although legislation has not yet been introduced, it is envisaged that if margin lending is brought within the scope of Chapter 7 of the Act, there will be specific provisions requiring:
> increased disclosure in both the Financial Services Guide and the Statement of Advice;
> procedures to manage, disclose and avoid conflicts of interest associated with margin loans;
> adequate risk management systems with respect to margin loans; and
> consumer access to alternative dispute resolution schemes for complaints arising from such loans.
While margin loans are not yet regulated under the Act, best practice would dictate that these bullet points already form part of a licensee’s compliance system.
At a minimum, it would seem that any discount on a margin loan received by a planner should be disclosed to the client if that same facility is recommended to them.
Planners should not disregard their duty of care to clients when advising/recommending on margin lending just because at a glance it appears to be an area that does not fall within Chapter 7.
Mary Nicole Ferizis is a solicitor with The Argyle Partnership.
