Get an A+ for your next licensee compliance audit – Part 2

Money Management recently published part one of Paul Derham’s 16 tips to help planner practices sail through their next licensee compliance audit. In part 2, Derham touches on issues such as planner recruitment and compensation arrangements. 

Related: Get an A+ for your next licensee compliance audit - part 1

9. Follow your recruitment process 

In September 2011, the Australian Securities and Investments Commission (ASIC) released a report (Report 251) that summarised its findings from surveying the 20 largest licensees that provide financial product advice to retail clients. 

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You may recall that ASIC asked the licensees a huge list of questions which caused a bit of a stir at the time in terms of the resources required to answer them. ASIC then released another report, Report 362, in July 2013, following responses from the second phase of questions targeted at the top 21-50 licensees. 

Both reports should be compulsory reading for anyone wanting to achieve an A+ in their next licensee review. Both reports also make comment about ASIC’s concern that a poor appointment process may result in a firm taking on a “bad apple” adviser, which may in turn cause a world of grief. 

ASIC has also released a guide called HB 322-2007 ‘Reference Checking in the Financial Services Industry’, in conjunction with Standards Australia. It includes loads of useful checklists and procedures that you can implement straight into your business.  

We often tell licensees that it’s not enough to rely on your external recruiter conducting the reference checks – you should have records on file that also show full RG 146 qualifications (including a skills module), as well as ongoing high-level monitoring of initial advice for an initial period. 

Other observations we made related to inconsistencies in employment contracts, and a lack of discipline in following the appointment protocol (this was often tied to rapid business growth or a lack of resources in HR).  

10. Your monitoring and supervision framework 

Your monitoring and supervision framework should be risk-based and fully resourced. 

Are your reviewers ensuring that personal advice to retail clients meets the Best Interest obligations? No doubt you have just updated your monitoring and supervision framework to take into account the Future of Financial Advice (FOFA) changes in all their glory. 

Monitoring and supervision is more than just an annual review. In our experience, it includes peer review, new adviser-file reviews, “anti-fraud audits”, interactive training, “circular folders” that include the week’s advice documents, and mentoring systems. 

ASIC noted in Report 362 that the average number of advisers for each file reviewer was 53. In our view, that ratio can be higher and still successful if there are good compliance systems that are asking the right questions and addressing them.    

11. Have an IT resources procedure 

Your procedures should make sure the business maintains adequate IT resources. You also need a backup procedure and disaster recovery plan. In our experience, the biggest failure in this area is the lack of testing that takes place. 

Many licensees don’t really truly test their IT backup plans. We’ve seen reports of IT systems tests that took three attempts before they successfully allowed the business to continue operating off-site. Have you made even one attempt? 

In an effort to be true to our word, we commissioned a test of our law firm backup processes. We discovered that they were completely inadequate, and put in place simple steps to address those shortfalls.   

In addition to testing their own backup processes, dealer groups should be seeing evidence of tests being done by their software providers. This is particularly relevant to advisers, given that most advice is stored in the cloud by third-party software vendors.   

12. Keep your compensation arrangements updated 

If you’re required to have PI (personal indemnity) insurance, then make sure you get legal sign-off if you renew your policy but change the terms. 

Alternatively, you can ask your broker to answer the following question, in writing: ‘Can you please confirm that our PI policy complies with the requirements of RG 126 and, can you please explain any conditions or exceptions to your answer?’  

The worst answer we’ve seen from a broker is “yes, the policy complies with RG 126, subject to the terms of the policy.”  That answer is useless. 

13. Check your disclosure documents 

This area is commonly less than perfect. We routinely find that FSGs do not comply with the various legal requirements. Also, SOA (Statement of Advice) templates are often too long and complicated. 

Who conducted your last SOA review? Sometimes an SOA is prepared by someone who has so much time invested in it, they will be reluctant to hack it into one third the size, which is exactly what it may need. Try getting an external party to have a go at simplifying your advice document.   

14. Update your research process 

If you service retail clients, and research your products, then you need to have a procedure that sets out why you’ve chosen the products you have, and how advisers can deal with non-approved products. ASIC and the tribunals and courts have made it clear that adopting someone else’s rating system, per se, is not good enough. 

Make sure your procedure is followed, and that it explains what a representative must do if he or she wants to recommend a product not on the list.

With the onset of FOFA, a big challenge for licensees with related party products on their list is showing that the related party product will result in the client being ‘better off’ by switching to it. How does your business address this issue? 

15. Use your conflicts of interest register 

When the requirement to have a conflicts of interest procedure and register came into force in 2005, most people scratched something together and put it in their compliance manual. But, does it actually contain identified conflicts?

Does it show that conflicts are being managed? 

If you’re stumped for any conflicts, ASIC released a discussion paper in April 2006, which is packed full of examples. Also, the introduction of “conflicted remuneration” under FOFA should result in you updating your conflicts of interest procedures. 

It is no longer enough to manage some conflicts by “disclosing” them – they must simply be avoided. That said, disclosure is generally done quite well. 

We made 74 recommendations in our sample reviews, and they related to updating conflicts registers, better managing related-party products, capturing meaningful disclaimers from advisers who may have relationships with external parties, and training staff on what actually constitutes a conflict.

In our view, with the onset of FOFA this is one of the most topical issues facing the industry.   

16. Be prepared for changes 

A good compliance audit will invariably suggest changes. Amongst other things, a compliance audit stocktakes and reviews your compliance framework as a whole and assesses whether the framework is really addressing the key issues and risks. 

We find that new compliance managers who commission a review are open to the recommendations. Entrenched compliance managers will, understandably, tend to defend their programs. 

According to ASIC’s Enforceable Undertaking with City Index Australia Pty Ltd, entered into on 8 April 2013, City Index took 11 months to fully implement certain recommendations. We suggest that you devote as many resources as you need to have a speedy implementation in a shorter timeframe. 

As you can see, preparing for a compliance audit is not a walk in the park. But, if you are constantly working on developing a positive culture of compliance, it won’t be impossible.

Think of compliance audits as a tool for positive change and a roadmap for navigating through the numerous regulatory obligations faced by licensees.

You don’t know what you don’t know. Accordingly, any breaches, findings and recommendations in the report will ultimately make your business a better business, if you act on them in the right way, quickly.   

Paul Derham is a partner at Holley Nethercote Commercial & Financial Services Lawyers.

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