Equity may inflict planners with case of Enronitis

Financial planners’ love affair with master trust and wrap platforms could be the trigger to embroil Australia’s financial services industry in a scandal to rival that which engulfed energy giant Enron.

That is the ominous warning of consultant Leo Wassercug who says the conflicts of interest intertwined with the recommendations many advisers give in relation to master trusts and wraps leaves them open to accusations of impropriety similar to those being faced by executives at Enron in the US and even at HIH and One.Tel in Australia.

The controversial claim comes as master trusts and wraps continue to stake their claim as the fastest-growing segment of Australia’s financial services industry.

Figures released by Plan for Life in its latest Australian Retail Investments Market Share report show that wraps and master trusts grew by 12.4 per cent in a stilted market over the past 12 months to reach $152.9 billion. This represents almost 53 per cent of the total retail products market in Australia and 20 per cent of the local gross managed funds market.

The exponential flow of money into the sector has attracted a range of providers, financial planning dealer groups amongst them, who have stakes in their own master trust or wrap in order to grab a piece of the pie.

“Every man and his dog wants to get into the action and have their own master trusts and wraps. The big players have their own because they can afford the technology spend. But the smaller players can also get into the market by badging somebody else’s [master trust or wrap]. Everybody is in on it,” Wassercug says.

But Wassercug, the principle of Look Research, says the lines between master trust and wrap platforms and the financial planners who recommend them have now become so blurred that much of the advice given by planners has to be viewed as tainted.

“When dealers become both advisers and platform operators, a potential conflict of interest may arise. They serve two very different and sometimes competing functions. Their prime function and legal responsibility is to provide independent investment advice to investors, including recommending the best managed fund and master trust. The other element of their business is to operate a master trust and increase its funds under management as much as possible,” Wassercug says.

The most dangerous conflict for advisers according to Wassercug is the equity they are often offered in a master trust or wrap in order to use that platform for their clients’ investments.

The situation creates a “temptation” for advisers to steer clients towards an investment platform that may not be the most suitable for that particular individual, Wassercug says.

“The individual advisers’ compensation may be tied to their cross-selling of master trust services to a client, either through volume or performance bonuses or directly as dividends on the equity they hold,” Wassercug says.

“As well as this, other potential conflicts of interest exist. Many of these actions may be entirely innocent in themselves but, together, they form a pattern, one which should be watched carefully by the industry.”

According to Wassercug, while advisers taking an equity stake in a master trust or wrap may seem common place today, it will be viewed in an entirely different light if one of these platforms gets into trouble.

“Sooner or later, a master trust or wrap may stumble. Something will go wrong. It need not necessarily involve fraud. It may simply be mismanagement or software failure. When the investors scream for blood, the deal which established the [financial planning group’s] house brand platform may not look as good in hindsight as it did when it was set up,” he says.

The predicament leaves financial planners with two choices: either disentangle themselves from any stake in master trust or wrap platforms, or establish structures to manage the relationship and any potential conflicts. The alternative could be nothing less than disastrous.

“We are only talking of potential trouble now but we must be aware of potential conflicts and take pre-emptive preventative action now,” he says.

“Does our industry have to wait unil we have our own home-grown Enron?”