Standard 3 (FASEA Code of Ethics) & Referral Fees – what’s the actually story?

Question from Financial Advisers (23rd May 2020):

“The Corporations Act requires a Financial Adviser to disclose any referral fee arrangement for referring a client (let’s say to an accountant and vice versa), however under Standard 3 of the FASEA Code of Ethics its states ‘you should not act if you have a conflict of interest’.  Does this mean a referral for benefit creates a conflict and so the Code of Ethics overrides the Corporations Act?”

Answer:

A good resource regarding this can be found at https://www.tpb.gov.au/code-comparison-corporations-act-fasea-standards

Referral Fees are not expressly permitted under the Corporations Act, nor are they expressly excluded.  For example, in the Corporations Act referral fees are not expressly included under s963 regarding exclusions to Conflicted Remuneration, although any “benefits” received, or likely to be received, need to be disclosed.

This means that under the Corporations Act a Financial Adviser can receive from or pay to a third party any benefit, being either monetary or non-monetary, provided the necessary disclosures are made in the relevant documents such as the Financial Service Guide (FSG) or Statement of Advice (SOA).

The Corporations Act is structured to ensure any potential conflicts are disclosed and that any actual conflicts are dealt with in accordance with the relevant sections.  These sections include section 912 (AFSL holder obligations), 961 (Financial Adviser conduct and disclosure obligations), and 963 (conflicted remuneration obligations).   

How does FASEA view Referral Fees?

The Financial Adviser Standards and Ethics Authority (FASEA) will review any referral arrangement between financial advisers and other service providers involving fees, such as those with accountants or mortgage brokers, as to how they are treated under the industry’s code of ethics. They key aspect that needs to be considered is whether any referral arrangement is in the interest of the client.[1]

During a recent SMSF Association panel discussion, FASEA chief executive Stephen Glenfield said: “This is one that we will think through a bit more as part of the guidance. In the first set of guidance we were really thinking about you getting paid a referral fee as an adviser. So it was about whether it was in the interest of the client that that referral fee was being paid.”

Stephen Glenfield continued, “You have to ask yourself a number of questions. If the person giving you the referral is doing so because you’re just paying for it, but you’re not the right person to give that advice, is that the right thing in an ethical environment to do – to keep taking clients when you’re not the right person to give advice to [allow you] to build a business?”

FASEA takes the position that clients should be referred to professionals where it is in the client’s best interest and not simply because a referral arrangement is in place.  This means any existing referral arrangements needs to be reviewed in light of this position.

How come Referrals Fees do not create a conflict?

The ‘referral fee’ is not the issue.  The issue is whether the benefit associated with the referral induces the Adviser to act in a way that creates a conflict.  That is, referral fees are not conflicted remuneration unless they induce the Adviser to act in a certain way.

There was some initial confusion about this point when the FASEA Code of Ethics first came out, however it is clear now that “referral fees” are permissible under Standard 3, although there are some clarifying points to consider:

  • Advisers need to “professionally assess” whether a conflict exists (whether it be a monetary or non-monetary benefit). 

 

  • The standard of Professional Judgement is a “Common Sense” Test approach based on the responses to the questions “would a disinterested or unbiased & reasonable person, in possession of all the facts, reasonably conclude that an arrangement or benefit could induce the Adviser to act other than in their client’s best interest.”  

IF YES, then a conflict would exist for the purpose of Standard 3 and, in this event, if personal advice was given to a retail client (that is, the Adviser “acted”), then the Standard would be breached.

To help Advisers assess any potential conflict, the test under Standard 3 should ask if the remuneration/benefit received will, or would likely, impact the Adviser’s ability to provide advice in line with the following:

  • in the best interests of the client (Std 2, 5)

 

  • the fees & charges (regardless of type) are fair & reasonable, & represent value for the client (Std 7)

 

  • client understands fees/charges, benefits, costs and risks of the recommendations made (Std 5, 7)

 

  • the advice & fee structure are appropriate for the client (Std 5, 7)

 

  • Standard 7 does not allow Referral fees (RF) to be paid directly to an individual, human Adviser.  This “direct” payment is not permissible given the wording of Standard 7 which states “Except where expressly permitted by the Corporations Act 2001, you (the Adviser) may not receive any benefits, in connection with acting for a client, that derive from a third party other than your principal (Licensee).”

 

  • Under Standard 7, Advisers cannot accept referral fees from third parties, although these fees can be paid through the Licensee to the Adviser.  If the referral fee goes through the Licensee and still induces the Advisers to act in a certain way (prioritise their own interest) then this would breach Standard 3, as a conflict would exist.

 

  • Standard 7 also required clients to “give free and informed consent to all benefits…” and so Referral Fees (even if paid via the Licensee/CAR) must be disclosed to the Client under the requirements of this Standard.

What if Referral Fees are paid to the Licensee and then passed to the Adviser, would this be okay?

The answer is “it depends”.  It’s not the pathway or method of payment, it’s the purpose or intent behind the payment.   If the payment exclusively influenced the Adviser’s advice – that is the definition of “conflicted remuneration”. 

Does this arrangement breach Standard 7 if Referral Fees goes via Licensee, and is not disclosed to the Client? 

Standard 7 has two limbs:

  • Adviser cannot receive benefits directly from 3rd party; and

 

  • Benefits received by Adviser are “fair and reasonable” and the client provides “free, prior and informed consent to all benefits”.

If the fee is not disclosed to the client, you may argue the second limb of Standard 7 has been breached.  You may also contend that Standard 3 has been breached if the Adviser has acted (provided advice) with a direct and present conflict in place.

If the referral fee is paid to the licensee and not directly to the adviser, and the client is aware and consents to all benefits, then Standard 7 has not been breached.  Interestingly this arrangement does not breach Standard 1[2] because although it appears the referral fee payment via the licensee is designed to circumvent Standard 7, it is in fact adhering to Standard 7 by not accepting direct benefits from a third party.

The key to understand if a referral fee arrangement breaches the Code of Ethics lies in Standard 3 and looking at the “dominant purpose” behind the advice being given relative to any benefit received.

[1] Source: https://smsmagazine.com.au/news/2020/04/20/fasea-to-review-referral-arrangement-fees/

[2] Standard 1 states, “You must act in accordance with all applicable laws, including the Code, and not try to avoid or circumvent their intent.”