Brace yourself – conflict of interest is coming!
Amendments to financial services legislation is often a drawn out affair. The Financial Services Board (FSB) notes, for example, that the process of enhancing the conflict of interest provision in the General Code of Conduct for Authorised Financial Services Providers and Representatives (the Code) kicked off in 2006. Although wide consultation has taken place since, the process only gained impetus after a 2008 amendment to the Financial Advisory and Intermediary Services (FAIS) Act, which allowed for the prohibition of financial incentives in the Code.
In mid-December 2009 the FSB published yet another consultation notice – circulated with a draft conflict of interest amendment – with a 1 February 2010 deadline for public participation. The consultation process is finally behind us and the conflict of interest amendments to the Code will come into effect any day now. Are financial services intermediaries ready for the change?
Reining in conflict of interest?
Product provider can’t do business without broker distribution channels. Fierce competition in the distribution space has contributed to conflict of interest abuses and to a culture of entitlement among financial advisers. Financial services brokers have become accustomed to certain ‘free’ services as local product providers pay training and compliance costs (among other incentives) in return for their loyalty. The attitude in this circle has long been: “I’ll sell my services to the highest bidder!”
The changing financial services landscape made it necessary to tackle the ‘conflict of interest’ issue. South Africa is following international best practice by adding conflict of interest amendments to the Code. In the past a product provider (or similar) could train a group of brokers at Sun City and play a round or two of golf without the brokers paying a cent for the privilege. The proposed legislation will put a stop to this. Some might complain that the legislation is draconian, but it needs to be to change entrenched attitudes and practices.
A look at the key changes
Amendments to the Code include new definitions to clarify and contextualise frequently used terms, including financial interest, immaterial financial interest, and ownership interest. Conflict of interest is defined as:
…Any situation in which a provider or representative has an actual or potential interest that may, in rendering financial service to a client, –
a. influence the objective exercise of his, her or its obligations to a client,
b. prevent a provider or representative from rendering an unbiased and fair financial service, or from acting in the interests of a client;
This interest includes, but is not limited to –
i. a financial interest;
ii. an ownership interest; or
iii. Any relationship with a third party.
The amendments enforce limitations on financial services providers with regard to what they may receive from third parties in respect of their financial services business, or give to other financial services providers and representatives of the latter – Section 3A(1)(a).
Subsections (i) and (ii) of the above refer to remuneration not regulated, subsections (iii) and (iv) to other fees that may be legally received or given with certain provisions, and subsections (iv) to immaterial financial interest that is limited to R1 000 per year per person from any third party. It is not clear at this stage whether the R1 000 applies to each broker in a particular broker firm, or to the firm itself. Section 3A(1)(b) introduces limitations on the way financial services providers pay incentives to their representatives. The section discourages giving undue preference to certain product suppliers or products created by product suppliers.
Adding to the compliance burden
The changes will add to brokers’ administrative and compliance lode. Section 3A (2) “introduces the obligation to have a robust conflict of interest management policy” while Section 3A (3) “introduces an obligation on the compliance officer to report to the Registrar on the compliance with these provisions in the annual compliance report.”
There are a number of ironies – or unintended consequences – to the conflict of interest amendments. The legislation will put a stop to a number of invaluable ‘free’ services, including compliance and practice management. The feeling is brokers who aren’t prepared to pay between R250 and R1 500 per month for compliance services will move the compliance function in-house, with a clear risk to industry-wide compliance standards. Another downside to the legislation is that product training will be severely curtailed. Product providers can still provide product training, but add-on training on unrelated financial topics will have to be curtailed. The product provider (or similar) won’t be able to offer estate planning or income tax legislation training unless it charges a fair market fee.
Implementation dates not set in stone
In the long run brokers are going to have to get used to the idea of paying for services they once received for free. Industry experts say the gazetting of the ‘conflict of interest’ amendments is likely to be 1 April 2010. Independent brokers will probably have three months from date of gazetting to get their ‘house’ in order. Brokers shouldn’t feel pressured to commit to service agreements with product providers, compliance companies etc until these deadlines are clarified. Be wary of signing up with product providers (or others) that are using fear-based selling tactics. There’s no pressure to get in on the ‘ground floor’ where the legislation is concerned, so make sure you understand the level of service you are signing up for.
Does the FSB have the resources to police conflict of interest? Whether or not they have the resources the legislation gives them far reaching powers. A service provider caught contravening the ‘conflict of interest’ legislation will probably get away with a stiff financial penalty – but a broker found guilt of accepting a ‘handout’ will in all likelihood lose their FAIS licence. All the FSB has to do is make an example of one broker – and the entire industry will quickly fall into line.
Editor’s thoughts: The conflict of interest amendments to the Code will change how financial services intermediaries relate to product suppliers. Many of the free benefits enjoyed in the past will fall away when the amendments are signed in to law. Are you aware of the changes to the Code – and do you believe these changes will significantly impact your business? Add your comment below, or send it to [email protected]
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