Through our discussions with the industry, we have discovered that many financial advisers are concerned about the detrimental effect the Federal Government's Future of Financial Advice (FOFA) reforms are going to have on their ongoing remuneration arrangements, and the value of their client books. Relevant factors that would have an impact on the value of existing financial services businesses include the opt-in requirement, annual disclosure requirement and banning of conflicted remuneration. In response to the industry's concerns, the Government indicated that it would introduce certain "grandfathering" provisions that would seek to mitigate the detrimental impact on some of the existing benefits and assets of financial advisers.
FOFA has a mandatory start date of 1 July 2013, or earlier if the AFS licensee chooses to comply before the mandatory start date. The date the licensee begins to comply with FOFA is termed as the Application Day.
Some grandfathering provisions have been provided under the amended legislation that introduced FOFA, which received Royal Assent on 27 June 2012. However, aspects of the legislation also raise some practical questions as to how grandfathering provisions apply in certain circumstances – e.g. when a client register is sold. This article looks at the grandfathering provisions relating to opt-in requirement and conflicted remuneration.
The opt-in requirement is applicable to a licensee or representative that has entered into an ongoing fee arrangement with a retail client. An ongoing fee arrangement is when a licensee or representative provides personal advice to a retail client and under the terms of the arrangement, a fee is to be paid during a period of more than 12 months. The FOFA reforms require the licensee or representative to obtain their client’s written agreement every 2 years in order to continue charging ongoing fees for financial advice.
Where the licensee or representative has entered into an ongoing fee arrangement with a client or provided the client with personal advice prior to 1 July 2013, there are grandfathering provisions that exempt the licensee or representative from requiring the client’s written agreement every 2 years in order to charge them ongoing fees. This can be termed the grandfathering of existing arrangements.
According to Treasury’s Explanatory Memorandum to the Corporations Amendment (Future of Financial Advice) Bill 2012 (paragraph 1.62), if a licensee or representative transfers their "grandfathered" rights under an ongoing fee arrangement to another licensee or representative after the Application Day it is "unlikely" to trigger the application of Subdivision B (opt-in requirement) if the "character" of the arrangement does not change. However, the Explanatory Memorandum does not delve into the definition or factors to be considered when assessing the "character" of the arrangement, so there are still some significant unanswered questions in this regard.
Annual disclosure requirement
Whilst there are grandfathering provisions for the opt-in requirement, licensees or representatives are still obliged to provide clients with an annual disclosure statement. Where the disclosure statement is not provided or not provided in a timely manner, the licensee or representative is not obliged to refund fees charged to the client after the due date of the annual disclosure statement in full. However, the client or ASIC may apply to the Courts for a refund where the fee recipient has knowingly or recklessly charged "ongoing fees" after the termination of the arrangement due to non-compliance with the fee recipient’s obligations (s 1317GA of the Corporations Act 2001). Civil penalties may also apply against the fee recipient in such circumstances.
It is also critical that when buying a client register or a financial advice business, the due diligence process should include investigations as to whether the seller has complied with their opt-in obligations, and that annual disclosure statements have been provided to clients. Otherwise, the buyer may be paying to acquire contractual rights to continue charging an ongoing fee, where the rights do not exist due to a fundamental failure of the seller.
Banning of conflicted remuneration
Licensees and representatives will not be able to accept conflicted remuneration on or after the Application Day. The definition of "conflicted remuneration" encompasses traditional product commissions, volume payments from platform operators, soft-dollar (i.e. non-monetary) benefits and asset-based fees on borrowed amounts.
However, the grandfathering provisions relating to conflicted remuneration allow a licensee or representative to continue receiving conflicted remuneration under an arrangement that was entered into before the Application Day.
Unlike the grandfathering provisions as they relate to the opt-in obligations, there do not appear to be any specific grandfathering provisions in relation to transferring existing grandfathered rights of conflicted remuneration to a third party.
In cases where either a body corporate licensee or a corporate authorised representative is the seller of a client register, it may be possible to indirectly transfer "grandfathered" pre-FOFA entitlements by selling the shares in the company. The method is fraught with danger as the buyer will also inherit the liabilities of the seller.
This area is extremely complex and you should seek legal advice prior to negotiating a sale or purchase.