Recent surveys of the financial planning industry, conducted by organisations such as the Financial Planning Association and the Australian Consumers Association have given the industry reasonable marks on most things, such as quality of advice, fees and regulation. The area that financial planners get the most criticism for is their "independence". So what exactly is an independent adviser?

An independent adviser is an adviser that operates free from biases and conflicts of interest. An independent financial adviser does not work for an organisation responsible for manufacturing products, and has no special incentive to recommend one product over another.

Quoting from ASIC's definition, an independent adviser:

• does not have any actual or potential conflict of interest in relation to any investment products recommended; and
• is free to choose products appropriate for the personal investment needs and circumstances of the client. It suggests that the choice is from a wide range of products available in the market and the recommended products are selected objectively and without any product bias that may influence the advice.

The Australian Securities and Investments Commission (ASIC), in an olsolete policy statement number 116 (part IV) defined what constitutes an "independent" advisory service. The direct link to Policy Statement 116 is http://www.cpd.com.au/newcorp/asic/ps/ps116.pdf.

Are advisers independent?

Numerous articles have appeared in the press criticising financial planners for their lack of independence. This is the number one problem identified with the industry. Surveys have found that the training and competence of financial planners is generally ok, the supervision and regulation of financial planners generally works as intended, most advisers do provide decent customer service. On the other hand, only the smallest percentage of advisers even remotely resemble "independent" advisers.

For example, in a June 2002 speech to the Sydney chapter of the Financial Planning Association (FPA), chief executive of the Australian Consumer Association (ACA) Louise Sylvan criticised the financial planning industry for low levels of disclosure and for the falling levels of independent advice.

Sylvan said the levels of independent advice was a ‘dis-improving’ situation and that the ownership of advisers was a concern for the ACA as a consumer association.

Sylvan also said the main concern was the level of bank ownership but the level of trail commissions and equity incentives were described as “perverse in some cases and of concern to consumers”.

Responding to comments made in November 2002 by Charles Littrell, the executive general director of the Australian Prudential Regulation Authority (APRA) that financial planning commissions made this an industry "based on bribery", the ACA backed APRA's stance and called for a total ban on trail commissions. While I personally support this idea wholeheartedly, the industry, including Ken Breakspear the CEO of the Financial Planning Association itself have referred to APRA's remarks as "outlandish and sheer conjecture".

Although the ACA and APRA have great concerns about financial planners, the most stinging attack I've seen came from members of the Australian Investors Association (AIA), an alliance of some 1,100 mostly high net worth investors. In a survey of members, reported in the September 5, 2002 edition of Money Management magazine, 99% of those surveyed believed financial planners who were owned by a fund manager or bank were more likely to recommend that institution's products over all other investments.

Further more, 95% of respondents also believed that the advice they received from financial planners was heavily influenced by 'soft dollar' inducements paid by institutions to advisers.

Bob Andrews, President of the AIA said his members are experienced investors, with a strong history of contact with financial planners. "Our members have got a better and broader knowledge of investing than the average fellow on the street and this is what they are thinking."

Andrews said the growing link between financial planners and large financial institutions would make it increasingly difficult for high-net-worth investors to receive the financial advice they were looking for.

According to the AIA survey, up to 80% of investors view independence as the most important factor in choosing an adviser.

The most anger was directed at trail commissions. Of the members surveyed, almost 60% indicated that they were unhappy with their advisers receiving trailing commissions. "Our members are well aware of trailing commissions and their objection to them is not going to go away", Andrews says.

"People are having great difficulties finding an adviser who they think is being honest and professional with them."

Another quote appeared in the Australian Financial Review on 2 November 2002 'Money Managers Talk Tough' by Gerry van Wyngen: "I've always thought it was a little absurd that managers and advisers are paid on an ad valorum basis, rather than a fee for service, or a flat fee. As funds grow the manager's income grows commensurately but why should the same thing apply to somebody who is referring the business? He's just part of the distribution. An adviser takes a trailing commission, and in my view is a leech. He's hooked onto a vein, and in this case it's mine!" (Iain Thompson, director of Corporate Governance International, which has been engaged by APRA to assist in assessment of the industry.)

Obviously there are rather strong feelings out there that trail commissions are a sub-optimal remuneration method for advisers!

The majority of financial planners (90-something percent) work for banks or large dealer groups. Almost all dealer groups limit their advisers to operating off a "recommended products list" (RPL), which in some ways is a good thing (it stops shonky advisers recommending scams, assuming shonky advisers that want to recommend scams adhere to their dealer's RPL), but in many ways impedes the adviser's ability to offer good advice.

Only rarely is a recommended product list constructed solely on the basis of the quality of investments, more usually a recommended product list is stocked up with products manufactured by the dealer group or a related party. It probably isn't surprising that if you go to a bank's financial planner you may walk out of there with a portfolio consisting entirely of funds managed or distributed by the bank, but it does make you wonder how the advice would change if the adviser could choose any fund at all.

In my case, when I left my old dealer group my advice changed dramatically. As much as I disliked it, I had to stick to the recommended product list as long as I worked there, those were the rules and they had to be obeyed. Nevertheless, it really ought to say something that now I am with a small independent dealer I have not used a single product from my previous employer's recommended product list and don't intend to ever again (although those products are still available to me if I want them).

What was wrong with the recommended products from my old dealer? Not that much, none of them were terrible products, but I found them on average quite expensive, in particular there were no index funds available (more on these in the section on strategy). Now that I am unrestricted and can choose from a much broader range of products, I can shop around in a much wider universe of products looking for products with lower fees and a wider variety of investment options. Using the products I use now, compared to the products I had to use then, my clients now save between 0.5%pa and 1.5%pa on fees. If you don't think that sounds like much, read my article on the benefits of saving small costs in the section of this web site under fees.

Talking to other advisers, I notice that the majority of those I speak to, particularly the ones that take the investment side of the business seriously, dislike the concept of restrictive recommended product lists. Obviously if given a choice most advisers would like to have more flexibility, not less, but adherence to recommended product lists is a condition of employment. The adviser may well have a portfolio completely different to the one his/her clients are invested in, often advisers do.

Many dealer groups have their own master trust or wrap account, and they insist their advisers only recommend this product. (Even when the dealer doesn't insist on the advisers using that product, the commission is usually much better for recommending company products and so the advisers use it anyway). Clients pay for these higher commissions, and they may also pay if the company master trust only has a few affiliated fund managers on its menu. There are a few master trusts out there with very low fees, but only independent advisers use them.

Commissions aren't the only benefit that advisers get for recommending the company product, there are also cumulative bonuses of various sorts, equity incentives for advisers and "production" targets to meet. I elaborate on these in the part of this web site that talks about fees.

If you ever wondered what sort of advice a financial planner would give if he wasn't obliged to use any particular product, and charged a fixed fee for service, keep reading this site!