Billion-dollar bad behaviour
The US bank that duped customers may be the tip of an iceberg of fraud in the sector.
Barely four years ago, the American multinational financial services company Wells Fargo was named the world’s most valuable bank brand for the second consecutive year. Today, the company’s reputation is in tatters and it is enmeshed in a US$142 million ($211 million) class-action lawsuit alleging acts of misconduct stretching back to at least 2002.
These included pushing its customers into retirement funds managed by Wells Fargo itself; creating bank and credit card accounts in customers’ names without their knowledge; modifying mortgage conditions so that customers ended up paying more than they owed; using what a judge called “deceptive” and complicated contracts to dupe small businesses into paying more than they needed to for credit-card transactions; fining mortgage clients for missing a deadline even though the delays were the company’s fault; selling risky investments it didn’t understand or which were “highly likely to lose value over time”; and forcing car-loan borrowers to buy unnecessary insurance policies. Some who defaulted on payments lost their cars.
In many of these cases, the practices were driven by employees’ need to reach tough sales targets, the Los Angeles
Times reported. The bank had an aggressive programme to “crosssell” different services to its customers, and chief executive John Stumpf, who has since resigned, encouraged employees to open as many as eight accounts for each customer. More than 5000 workers were fired over the creation of as many as 3.5 million fake accounts.
The Office of the Comptroller of the Currency (OCC), the US’s main bank regulator, has fined Wells Fargo more than US$1 billion. It has also found evidence of irregularities in sales practices at other large and mid-size banks but is so far refusing to name them.
The OCC, which wants to see less financial regulation, is headed by former Los Angeles banker Joseph Otting, one of several big industry names appointed by President Donald Trump. for New Zealanders to see they have the right product, delivered fairly. And we need to step up to the plate and make sure we are acting fairly.”
THE SELF-REGULATION PROBLEM
The self-regulating Financial Services Council is working on a code of conduct, which will be announced in September and come into force next January. Details are still under wraps, including whether it will be binding, who it will cover, how it will be enforced and what penalties there will be for companies that break the rules. But Klipin is optimistic it will bring change.
“In the end, a code of conduct binds an industry together to lift standards and build trust in the sector. If people step outside the code, there have to be consequences.
“We will meet what you expect in a code. In the end, the best-functioning market is where you have engaged and knowledgeable consumers, with engaged, informed and disclosing advisers and product providers.”
Faafoi is putting his faith in a bill brought in by the previous National Government – the Financial Services Legislation Amendment Bill (FSLAB), which is before a select committee. It has the worthy aim of ensuring that financial services are provided “in a way that promotes the confident and informed participation of businesses, investors and consumers”.
The bill will bring the rules for registered financial advisers (RFAs) in line with those for authorised financial advisers (AFAs), so everyone is expected to put their clients’ interests first.
But Faafoi wants to bring errant insurance salespeople into line with better disclosure requirements: salespeople will have to tell their clients about commission structures – hard and soft.
“A customer may be overinsured, or underinsured [or] have a policy with features that do not meet their needs.”
“I want to see FSLAB improving the disclosure obligations of those offering financial advice so that consumers can make informed decisions,” Faafoi told the Listener. “Part of the work on improving disclosure will look at addressing soft commissions.”
In fact, the bill is a bit vague on this point. All the industry has to go on so far is that those giving financial advice must “disclose certain information to retail and wholesale clients. The content, timing and manner of disclosure will be prescribed in regulations and may differ from the existing requirements,” the bill says.
Industry players have been quick to push for a light-handed regime.
“To avoid an undue compliance burden, the disclosure regime must be flexible and principles-based,” law firm Chapman Tripp said in its submission to the economic development, science and innovation select committee. “Ideally, it would prescribe the substantive matters that advisers need to disclose and leave the form of delivery to those best placed to make that assessment: the advisers themselves.”
The Insurance Council, the guiding body for the general insurance industry, though not the life insurance companies, goes further, saying it wouldn’t want the Government to limit how companies remunerate advisers.
“While … we fully support remuneration disclosure, we do not support restrictions on the types of remuneration that can be provided by financial advice providers.” The Financial Services Council agrees. “Ultimately, the way companies choose to structure their remuneration packages is a commercial decision,” the council said. “However, the FSC strongly supports the request from the FMA to consider the nature and value of the soft commissions they provide to ensure that their use of them is supporting good outcomes for consumers.
“The key issue with remuneration is clients’ right to know the who, what and why of the advice they’re receiving and if it’s linked to remuneration at all. In other words, ensuring that any potential conflicts are properly managed and disclosed, and that the adviser is up front about them.
“This hasn’t always been the case and all of us have had to lift our game.”
CONFLICT “UNAVOIDABLE”
Although the Insurance Council acknowledges any payment an adviser receives from any source except their client carries with it an inevitable potential for conflict, it argues that it can be managed.
“The question is simply one of nature and degree as to how likely the financial adviser would be to set aside the client’s interests for his or her own interests or the interests of his or her employer. But in our view, this misses the point.
“Conflicted remuneration is unavoidable in New Zealand’s financial services industry; it should be managed, not banned. Market innovation should not be constrained in terms of the types of remuneration that can be offered. What is critical, in our view, to protect consumers is:
first, the disclosure of that remuneration to consumers, so that consumers can make informed choices about the conflict(s) their financial adviser is under; second, for financial advice providers to have clear and effective policies, procedures and controls around conflicted remuneration in place.”
The message to Kris Faafoi: you can trust us. But consumer-protection bodies beg to differ. Both Consumer NZ and Citizens Advice Bureau New Zealand (CAB) have been lobbying for years to have commissions banned. They cite the example of the Netherlands, where commissions on all financial products, including life insurance, were outlawed in 2013.
In Australia, the Government stopped short of banning commissions, but capped upfront commissions at 80% from this year. That will fall to 60% by 2020.
Andrew Hubbard, deputy chief executive of the CAB, argues that telling advisers to disregard their own interests in favour of those of the clients is a great theory but isn’t going to happen in practice.
“In an ideal world, this might suffice. But that is not the world we live in. Faced with the possibility of a healthy commission or bonus, advisers may not always heed the impulse to do the right thing. Or they may convince themselves that their interests and the client’s align, when this is not the case.
“We are not confident that simply requiring advisers to manage their own conflicts of interest will significantly increase consumer protection.”
Hubbard argues that, in many cases, disclosure just gives people lots of information they don’t know how to interpret. In the worst cases, it can give someone a false sense of trust in the adviser selling the insurance product – a warm fuzzy feeling about that lovely person who’s being so open with me.
Ironically, the Government received the same warning from its own officials in 2015. An MBIE issues paper about the financial services sector highlighted a number of “disturbing” behavioural studies, both local and international, that found disclosure can sometimes be worse for consumers than non-disclosure in terms of resolving conflicts of interest.
It found that:
following disclosure, advisers feel comfortable giving more biased advice than they otherwise did; people receiving advice do not properly adjust for adviser bias and generally fail to sufficiently discount biased advice; following adviser disclosure, clients can feel uncomfortable turning down the advice they receive, as it may indicate a lack of trust in their adviser. In fact, upon receiving information disclosure, clients tend to trust their adviser more, on the basis that they perceive an adviser’s declaration of a conflict as a sign they are acting ethically.
The MBIE paper said that if advisers were
required to provide a written statement about their conflicts, clients would have time to study and absorb them. But who reads those long and often impenetrable disclosure documents? And even if people read them, MBIE argues it can be difficult to understand the impact of a conflict of interest on the advice being offered.
“In most cases, by the time a consumer is given an adviser’s secondary disclosure statement, they have already decided that their adviser is trustworthy and is acting in their best interests, effectively making the disclosure redundant.”
The industry argues that many consum- ers are unwilling to pay for financial advice, particularly in relation to insurance, and that commissions are a cost-effective way for people to access advice. Banning commissions will limit the availability of advice, leaving consumers worse off, it argues.
That’s rubbish, says Hubbard. Just as there’s no such thing as a free lunch, there’s definitely no such thing as free financial advice. And bad advice is potentially worse than no advice at all.
“We acknowledge that moving to a feefor-advice model may deter some consumers from seeking advice. The fact is, however, as the UK Financial Services Authority makes clear, financial advice is never free to the consumer.
“We believe it is better to have a system
There’s no such thing as a free lunch, or free financial advice. And bad advice may be worse than no advice at all.
where fees are transparent and advice is neutral than one where remuneration is conflicted and advice compromised as a result.”
Consumer NZ chief executive Sue Chetwin is also a fan of banning all commissions. At the very least, she says, New Zealand needs more education for financial advisers and tougher penalties for playing fast and loose.
“Direct civil liability would provide a strong incentive for advisers to meet their obligations to consumers and is essential to improve industry standards,” Chetwin says.
Watch this space, says Faafoi. Written submissions to the Financial Services Legislation Amendment Bill have closed and the select committee is due to report back at the end of this month. But cynical commentators say the only thing that’s certain is that the insurance sector will fight tooth and nail – as it has done in the past – against any changes it sees as detrimental to its own interests. It will battle subtly and unsubtly, in open submissions and behind the scenes.
DON’T HOLD YOUR BREATH
Andrew Hooker from Australian-based Shine Lawyers, which specialises in compensation law, has been working in the insurance sector for most of his career, starting in the industry itself and then spending two decades taking lawsuits against insurance companies.
He points to a Law Commission report in 2003 and a set of recommendations in 2004 covering pretty much the same stuff the FMA and Kris Faafoi are dealing with now.
He says he won’t be putting much money on Faafoi achieving the change the sector desperately needs.
“Best of luck to him against the insurance industry. It’s pretty powerful.”