In Australia, the most consistent news item in June and early July was to do with what? Rolf Harris, The World Cup, phone tapping by The News Of The World or Mum and Dad investors and the advisor industry?
Well for consistency rather than pure headlines I kid you not, it's the last one and for you and I, by far the most important. Touchy feely Rolf is now yesterday's shabby news. Germany 7-1 over Brazil in the World Cup? Unreal, but over.
Plundering our savings is not over. The continuous news coverage on this issue has applied the blowtorch to Australia's largest bank which is The Commonwealth Bank (CBA). It also owns the ASB here, so first of all some background.
Eighty percent of the industry advising Australian (and probably New Zealand) investors, where to put their savings, is controlled by five major institutions. These are the four banks, CBA, Westpac, NAB and ANZ and the insurance giant, AMP. In the decade 2000-2010, the financial advisory industry was hit by a number of failures some of which were accentuated by the Global Financial Crisis (GFC).
The financial advisory industry is huge. Taking just the public superannuation funds, the sum invested, known in banker speak as FUM (funds under management), is approaching A$1.8 trillion. This industry has a lot of people earning a substantial income from advising on investor savings. The number of commissions vary from advisor to advisor but can include any or all of the following:
Annual, Base, Entry, Management,Transfer, Upgrade, Closing and Trailing commissions.
No advisor wants to be precise on fees. It appears an average figure would be over two percent of FUM. In some cases there may be fees on fees. In all, these fees will have a major impact in degrading the return you get on your savings (a gross 9 percent return becomes a 6.8 percent return or worse with tax still to be deducted).
The average advisor would be keen to improve his fees and hence his annual income. Unfortunately, unless the overall investment performance can be lifted, this strategy will be at the expense of you, the investor. So much for commissions. Back to events at the CBA.
During 2005-08, the CBA had 700 planners servicing over 60,000 clients. As one financial commentator put it 'the planners over this period lost their moral compass.' What happened was akin to a Wall Street movie plot. Many of the planners got together and agreed to broaden the 'active' client base by contacting the many investors who had somewhat boring current and term deposits.
These deposits earned little or no commission, and clients were encouraged to switch funds into more aggressive plans that earned higher interest. The problem was that the proposed plans had much higher risk. For the planners, their benefit came from a large jump in commissions. In the industry this sort of frenzied activity promoting higher risk products is known as 'boiler room' tactics.
Not only were individual commissions higher, the planning group leaders offered bonuses for high 'performers' and super performers were idolised. At the peak of this CBA activity was Don Nguyen who, alone, controlled $300m in investor funds and during a 10 month period in 2007 wrote $36m in revised business. Many of his clients were elderly, unsophisticated investors charmed by his attention and accepting his recommendations.
To gain access to these conservative investors, lists were prepared based on bank records. These were often supplied by bank branch tellers who received 'tip' fees from the planners. Do you want me to repeat that? Even worse, incidents emerged of client signatures being forged to facilitate the transfer of funds.
A small group of CBA planners met at a Sydney Mosman pub to discuss what was happening. They decided it was time to whistle blow and make regulators aware of these practices. Contact was made with the Australian Securities and Investment Commission - the watchdog set up by the government years before to protect investors from shonky behaviour. Incredibly ASIC took no follow-up action for 18 months. No wonder one wag scathingly renamed it the 'watch puppy'.
This world of deceit and speculation came tumbling down with the arrival of the global financial crisis in 2008. With clients whose funds were in more dangerous investments (Collateralised Debt Obligations or CDOs) being one, up to 50 percent of savings went up in smoke. CBA management went into damage control. With ASIC sniffing around the fringes the bank sacked or transferred some planners, others left the bank and some investors were reimbursed for their losses.
Was it all enough? For a time it appeared the bank had covered up the mess and could move on. However, the failure of ASIC to act swiftly in a number of similar cases kept interest alive, particularly with financial journalists. New legislation was discussed by government. This became known as FoFA or the 'future of financial advice'. Many of the changes, particularly to commissions, were resisted by the big five institutions. They don't want much regulation at all.
Recently this led to a re-examination of advisor performance over recent years and a Senate enquiry into the performance of The Commonwealth Bank and ASIC. The 500 page report has just been released and is very critical in its attack on bank practices. It also highlighted that this was not an isolated incident and that the whole of the advisory industry had much to answer for.
So where does that leave us, the Mum and Dad investors? As Gordon Gecko famously said in the film 'Wall Street', 'greed is good', and that pretty well sums up where we sit in the scheme of things. Sucking the hind tit.
Advisors or financial planners work for very large and powerful organisations that have been built on conflicts of interest. The two major conflicts are between maximising your return against maximising their commissions or fees and to make matters worse, many of the investment products on offer by these big organisation are their own products. These conflicts, and what is called 'vertical integration', are an elephant in the room of investment.
Are the regulators keeping an eye on proceedings? In both Australia and New Zealand they have been deplorably weak in their proactive systems and in their response time to fixing problems. Can you and I be confident things will now improve and that the emphasis will be placed on our returns and not the returns for the advisor or finance organisation?
So where is the bottom line? In theory it's simple. Selling products that earn a commission and advising on them shouldn't go together. If they do, then the advisor must declare a conflict of interest. Is the boss going to be happy if advisors do just that?
Ah but yes, I forgot, 'greed is good'. So don't hold your breath on this one. By Ken Edwards