Conflicted selling fees are back, and it’s game on

These are all very interesting comments but what is the definition of "sophisticated"?
Surely the fact that I religiously read FirstLinks and Livewire does not make me sophisticated, even though I might meet the definition as regards assets and/or income.
Similarly there are very "wise" advisers who have made atrocious decisions on behalf of clients but would qualify on numerous grounds, were they to be included in the definition (eg have some financial qualification from a reputable body).
Personally I have entrusted investment decisions to an adviser who has performed well, and with whom I have good rapport.
The fees charged are reasonable IMHO, and I have no idea whether he collects "stamping fees", of which I had no idea until reading this article. (Maybe that disqualifies me from being "sophisticated"...)

Email from Judith Fox of Stockbrokers and Investment Advisers Association:

Dear Graham, I read your article this morning about conflicted selling fees which also canvasses wholesale investors and the wholesale investor test. We issued a discussion paper, 'Does the wholesale investor test need to change?' [https://www.stockbrokers.org.au/wp-content/uploads/FINAL_SAFAA-DiscussionPaper-WholesaleInvestorTest-280122.pdf] in February to inform the public discussion on the wholesale investor test.
When we published it we were Stockbrokers and Financial Advisers Association (SAFAA) ... We are now Stockbrokers and Investment Advisers Association (SIAA)...
The tagline accompanying our new name — ‘Serving the interests of investors’ — captures the fiduciary relationship our members have with investors. One of the comments after your article reflects the reality that there is a fiduciary relationship, whether a client is retail or wholesale.

Graham. Long time reader of your Firstlinks. Wanted to congratulate you on the recent well researched stamp fees article and outcome. Well done must be satisfying to see the impact your writing can have. Regards Craig

There seem to be a lot of points left out of this article in order to not detract from the view of the author:
1. I am pretty sure most dealer groups require that the family home is excluded from the wholesale investor assets' test
2. I am pretty sure that an assessment of the client must be made by the adviser to ensure the client has the required financial knowledge to be capable of being classified as a sophisticated investor. It is not based purely on financial capacity
3. there was no mention in the article that one of the primary reasons for no new LIC's / LITs coming to the market in 2020/21 was the market volatility that occurred during and after the Covid market dislocations
4. as I understand it there are many unlisted managed funds that pay a placement fee to advisers for clients investing who are wholesale. Why constantly pick on the LIC's which in the main are actually providing very good investment opportunities, and often an opportunity to purchase $1 worth of assets for sometimes 80c? We need the LIC sector to expand, not contract.
5. with adviser numbers dropping by a third over the last few years, and regulations for retail advice soaring, it is a completely logical decision for advisers to concentrate on those clients where they can add the most benefit and also be adequately remunerated for their advice. Advisers are not classifying clients as wholesale investors simply to be able to receive a stamping fee
6. whether stamping fees are rebated to clients or not, they should invariably result in a lower overall fee charged to an adviser's client base because they are paid by the manager, not out of the fund or by the client. This fee benefit will often be felt by the entire client base - both retail and wholesale through lower overall fixed fees
7. if an adviser is simply putting clients into a LIC because of the stamping fee and not because of the fundamentals of the fund, their performance will be adversely impacted and they will end up with no clients. I really don't believe that a wholesale client will leave an adviser if their performance is excellent and their overall fees are lower, simply because an adviser may place them into a LIC that pays a performance fee

It would be great if a balanced view could be presented in such articles.

Well, Peter, you are a hard marker. The article is over 2,500 words using original source documents and checking with many people, and I'm supposed to write a thesis covering every possible angle. I don't have a horse in this race. There's a fair bit of 'I'm pretty sure' and 'as I understand it' in your criticisms. Well, I'm absolutely sure the wholesale test is $2.5 million on all assets including the family home, so show me a reference on a dealer website which says they exclude the family home. And I can't see any logic in your claim that if a fund manager pays $1,000 to a dealer/broker to put a client's $100,000 into a fund, then somehow, that benefits the adviser's entire client base through lower fees.

On the Australian Government website (moneysmart.gov.au) it makes it quite clear there is no requirement for an accountant to assess one's financial or share knowledge to qualify. The family home is also included in the assets test. As an aside: I tried to join a well-known Australian fund which was, as it turned out, only offering its services to wholesale clients. It was an online application. All you had to do was click in the box that said you either have 2,500,000 in assets or you had earnt over 250,000 for the last two years. There was nothing else to do.

On October 11 2021 the AFR published an exclusive article titled: More than 3 million Aussies are now ‘sophisticated investors’ (see https://www.afr.com/policy/economy/more-than-3-million-aussies-are-now-sophisticated-investors-20211007-p58y13). If you read the article the reason more and more Australians are qualifying as sophisticated investors is because of the family home rising dramatically in price. The article goes on to note that by 2041 almost 44% of Australians will qualify as a sophisticated investor.

The reason the numbers are increasing rapidly is interesting. It is all to do with indexation or the absence of it. Professor Phillips, an expert in taxation, stated that “Meeting the requirements of the sophisticated investor definition is unlikely to guarantee that an investor is immune to poor investment choices or being misled by shady deals." He described the lack of indexation in the 20-year-old test as an “oversight” by policymakers. But some market sources said the decision not to update or amend the test was more deliberate and the result of vested interests in the wealth management industry." I leave the readers to decide whether they think it was an oversight or vested interests at play. The lack of indexation is the problem. You could win lotto, inherit a large sum, live in a home that is rapidly increasing in price or work as a periodontist, mining engineer or be a famous tennis player and have no clue about investments. It wouldn't matter. You would be classified as sophisticated. Is this really the best we can do?

This nanny state mentality does a poor job at attempting to protect everyone from themselves and financial predators. The only protection of the weak is to put fear into the strong.

Peter, I struggle to follow your logic - your first comment oozes the detrimental, outdated perspective with a vested interest in stamping fees. Your second comment elicits three paragraphs of waffle with no specific value that I can interpret in the statements. The PIMCO Global Income Opportunities Trust had management fees of 1.4% p.a.+ chasing low returns at significant risk to the client, before deducting their fees? The winners I can see are PIMCO and the Joint Lead Arrangers and Joint Lead Managers. Hence, the lack of conviction as soon as Graham pointed a ray of sunshine in their direction. In closing, keep up the great work, Graham - eventually, the Peters of the world will give up on the "glory days" that resulted in a lost decade of advice in Australia.

I wonder why the banks rolled over in the Royal commission, exited retail financial advice and focused solely on advice to wholesale investors. I think everyone knows the test for being treated as a wholesale investor is inadequate yet politicians are asleep at the wheel or maybe they don’t want to annoy their friends in the institutions. If Jane Hume focused on anything other then crypto and digital advice we could make get some proper changes made to the industry.

The fact that Pimco has pulled this offer shows that advisers being paid to raise money isn't the primary motivation of the advice process. As an adviser we view multiples of offers each year and make the decision to invest solely based on client needs and the merits of the offer. Most offers we view we pass on. And most of those offers pay stamping fees. We looked at the Pimco offer and made the decision that it was not appropriate for our clients and clearly the rest of the market has done the same.

While there have been many issues with conflicted remuneration in the past the negative press was warranted. It is time to move on and acknowledge that the industry has changed for the better. Constantly writing negative articles about poor behaviour or that the sole reason advisers recommend an investment is to get paid from it. If you want to remain as a trusted adviser to your clients it won't be long before they leave you as a client if you constantly put your own interests before the clients. Advisers are well aware of this and that is what drives the advice process not how much you will get paid by put clients into certain investments.

No matter how well we regulate the industry there will always be an element of bad apples. It is not different in any industry on the planet. As an adviser I am tired of constantly being bombarded with negative press because of a few bad apples.

Absolutely right.
I concur with your views.
Perhaps the spotlight needs to be turned on conflicted politicians and bureaucrats.
They leave parliament or the public service only to take up roles with those they were either monitoring and had a vested portfolio interest.

I only recently came across a retail investment fund that requires I see an adviser. As one who has never required an adviser in my nearly five decades of investing, this was a real 'huh' moment. An hour or so on the internet uncovered dozens of articles on the the Design and Distribution Obligations and Target Market Determinations requirements for product designers, distributors and advisers, but nothing for the investor. Am I mistaken in thinking that the designer and/or distributor have to produce a TMD, but it is their choice as to whether they require the investor to locate (and pay for) an adviser?

Graeme you are correct (sadly), All financial product providers must produce Target Market determinations for every product they produce. Some have let the compliance teams / risk management teams produce these. A number of providers have taken the step of requiring a advisor to give a sign off that the product is suitable for the client or not having the product at all available if you are not wholesale or are getting financial advice to invest. Effectively they are restricting the market for the product

Thanks Tony. This reminds me a bit of the days when equity trusts charged a 5% up front fee, 80% of which went to the adviser. If you had no adviser the trust manager kept the whole 5%. This was not negotiable. The trust was prepared to lose a customer for fear of upsetting the advisers. The way round this was to find someone in the industry who, for a few bucks, would sign the form rebating the 80% back to the investor. This, by the way, prompted the start of the nil advice discount broker industry, which I assume would have died out once up front fees disappeared.

I qualified as a sophisticated investor many years ago. If I roll-over a bank hybrid into a new issue, it seems to me the fee would be paid by the bank and would not affect my returns, as they are the BBSW plus the set margin. But in the case of the PIMMCO issue, it appears the fees would be paid out of the fund - and thus reduce my returns. A new issue would have to present a really very compelling case for me to consider such a proposition. I wonder if I could elect to be treated as a wholesale investor in some cases, and a retail investor in others? Or is it once a wholesale investor - always a wholesale investor?

Very well written. I think stockbrokers will be very keen to jump back into the LIT / LIC market this year as there will be far less corporate activity (given where markets are) so a big chunk of their income has been taken away until the IPO market opens again.

Hi Graham
Great article but there is a lot unsaid. The legislative settings around advice are a mess.
As a financial planner/ advisor, with the code of ethics there is a real requirement to the advisor to believe the clients are truly sophisticated in terms of ability to understand the offers/ products irrespective of wealth tests. The broader market which includes stockbrokers (who are not licensed advisors) only need to to look at the financial tests. Many businesses are setting themselves up so only deal with sophisticates so do not have to deal with any of the financial advisors code of ethics considerations, and its a lot cheaper to provide advice without all the extra disclaimers that need to be provided for retail clients.

while the code of ethics would not let you receive commissions for sale of investment products to clients, it only applies to retail clients. While I have heard many say you cant have two separate heads in terms of ethical decisions so you shouldn't accept commissions from sale of any investment products to sophisticates, that hasnt been tested and their is no FASEA/ ASIC guidance around it. Obviously the recent Pimco offer and bank hybrid offers being widely distributed suggests that the common thinking is you can receive the commissions on sales to sophisticates. I note, its a issue for sale of any investment product that has commissions , they are still commonplace on property syndications as well.

While if we want Financial advice to be a true profession, I would suggest it should be stopped for all clients -sophisticated or not. At the same time it should be stopped for any other providers so that there is a level playing field.

I had thought the Government would change the Sophisticated test, but I do think there are a number of vested interests to keeping it where it is. I did see that UK and US both reduced the financial tests to be met for people to be classified as sophisticates, so more people could invest in Venture Capital. So there are arguments to be globally competitive, the financial tests get reduced. UK is ~$175k AUD income or ~437k AUD assets excluding pension scheme or family home. They even have a way you self certify in if you join a business angle group or the like for 6 months.

Many years ago I was accepted as a Wholesale investor . I looked at quite a number of offered investments but in the absence of sufficient positive & reliable information I did not invest in any . When my Wholesale investor status last expired I did not renew & feel more comfortable with some degree of protection as a Retail investor .

Excellent article, Graham. The wholesale investor test is wholly inappropriate in 2022, when 16% of the population qualify. Surely it's time for it to be reviewed.

A broader question must be why have so many clients chosen to be treated as "wholesale" if it significantly reduces their consumer protection, and why have so many advisers and brokers retreated to "wholesale" if it significantly reduces their potential market size?

The answer is that the current financial services consumer protection environment has become an unwieldy mess. It is unnecessarily complex and costly. It has been created by a series of kneejerk reactions to sensationalised events, without any attempt to consider the unintended (but highly predictable) consequences, or to integrate/replace previous provisions. At a time when consumers have never been better protected as retail advice clients, most are unable to afford it, or are unwilling to put up with the insane bureaucracy it involves.

There has been a consumer shift not just to wholesale, but to far worse options such as directly advertised products like Mayfair and the hordes of unlicensed cryptospruikers and finfluencers. While the diminished number of advised retail clients might be better protected, consumers on the whole are less protected than they were when the well intentioned but badly implemented financial advice reforms started about 10 years ago.

Great follow up article on stamping fees Graham!

Our advisory collects anywhere from $10,000 - $50,000 in these stamping fees each year and we give 100% to charity or rebate to clients - I am praying this continues as love seeing the impact this money makes on the recipients. We would still have taken up the same investments irrespective of the payments (which pass through to beneficiaries so no incentive to us) and can guarantee that if removed, this 'payment' will just sit in hands of some institutional player - I recommend doing some homework on how many firms keep the monies versus giving to charity as I think too often journalist just make assumptions without any homework on coalface of which firms keep versus which gives away. People gravitate to skeptical but I like to be optimistic, and feel that many firms in Australia care and do the right thing and many do not keep these monies. But clearly no one has actually done the work here and so the article is useless without it

Great article Graham and it is so important we keep shining a light on these behaviours amongst what I hope is a minority in financial services. Honestly sometimes I despair at the ethics of some finance industry participants. The ongoing cost of the latest PIMCO "offer" at 1.44% per year is really double what it should be - how many unadvised yet supposedly sophisticated investors are aware of that fact? How much additional risk are the managers likely to take to offset the fee and still provide investors with an acceptable return that will keep them invested?
On a positive note I am encouraged by the interim report released in November from the Australian Law Reform Commission who are reviewing the abomination that is the Corporations Act, and in particular Chapter 7 that deals specifically with financial products and financial advice. The ALRC have identified the very substantial issues with the wholesale / sophisticated investor definition - unfortunately there final report is not due until Nov 2023 and then must be acted on by government. I don't think we can wait another 2 years plus to address this issue.

A few missing pieces in this article. For a start, advisers have a fiduciary duty to Wholesale Clients which is the traditional 'best interests duty'. It is harder to prosecute the fiduciary duty as it requires the judiciary to adjudicate. The Corps Act was amended in order to get the Regulator the power to move on the BID without (costly) court cases. Then the Code of Ethics rounded out the regime by applying an ethical behaviour requirement to act in a client's best interest. The Corps act and the Code apply only to Retail Clients but the fiduciary duty is not demarcated. The client has recourse if they considered the behaviour warranted it. Secondly, a person whose house increases in value to qualify them as a wholesale client would need investable assets as well as the bricks and mortar to be "at risk" of being classified as a wholesale client. The article is sensationalist in its presumption that all people intersecting with the financial services industry need 'protecting from themselves'. A standard retail investor often doesn't have big dollops to place in syndicates and managed schemes so auto deselect anyway. If the pandemic has taught (me) anything it is that Australians seem to need to be told what to do and it is always the governments fault if things aren't the way they want them to be. And, that we have become a country of whingers. Maybe we always were and that is why financial service legislation is so ridiculously coiled into the 'Damocles sword' that Jane Hume described it as when she took over the portfolio.

The family home is included in the assets test. see https://www.afr.com/policy/economy/more-than-3-million-aussies-are-now-sophisticated-investors-20211007-p58y13

I would be interested to read where you found that "a wholesale client would need investable assets as well as the bricks and mortar to be "at risk" of being classified as a wholesale client" Could you provide a one or more references please as this is not what the AFR or Australian Govt websites note.

For example, ASIC states (https://asic.gov.au/regulatory-resources/financial-services/financial-product-disclosure/certificates-issued-by-a-qualified-accountant/): "The terms ‘net asset’ and ‘gross income’ are not defined in the Corporations Act and will therefore have their ordinary or common meaning." In other words, net assets are all things that a person owns, minus what s/he owes to other organisations or people.

The example of two people who own a 5 million home is provided. "For example if a couple holds an asset worth $5million as joint tenants then they each own 100% of the asset. In this simplified example they would each satisfy the Assets test and would be capable of being sophisticated."

A few counter points and feedback for Richard Branelly. 1. We also apply an agreed fee as a retainer and do not keep the stamping fee on any IPOs; 2. We do accept and rebate stamping fees to the client where the issuer paid such a fee (i.e. not out of NTA) - usually this can be done via the issuer allocating bonus units or shares - resulting in our Wholesale clients being better off than our Retail clients! It seems to us in talking to lead managers that plenty of others also go down this path. 3. Providing Wholesale Advice is dramatically more time efficient and with our firm results in lower fees (agreed fees - as we do not apply a percentage) than would otherwise apply if they were classified as Personal Advice. To my mind that clearly goes to the debate on best interests. 4. We no longer accept new Personal Advice clients. We can help more people under the Wholesale definition than we can under Personal Advice regulations. 5. Keep in mind Wholesale Advice only relates to investment advice - it is much narrower than Personal Advice - and that suits a segment of the market - particularly those running diversified share portfolios. 6. There is not the adviser capacity to convert Wholesale Advice to Personal Advice. If adviser numbers have halved in 3 years and you then added a whole new cohort to the Personal Advice pool - who would be the real losers? Answer is obvious, the wealthy would still receive advice but a larger proportion of the well-off would miss out. 7. The greatest risk with the Wholesale classification is not stamping fees - it is those who do not seek advice and instead fall for the full page ads/spruikers. If ASIC were to investigate such groups at that point they would lower the risks of a Mayfair.

Hi Tony and thanks for your valuable comments. No one should infer that my thoughts imply that all advisers operating in the wholesale investor space are acting inappropriately. Your practices as described without doubt reflect the very high ethical standards investors should expect.
Overwhelming my despair is reserved for the product manufacturers who were stymied by the 2020 banning on stamping fees for retail clients and are now seeking to exploit another path.
Your point regarding the inefficiency of providing retail advice under the current compliance settings is also well made, but I think we should agitate for this to be fixed so more clients can access affordable advice whilst still retaining important consumer protections. Classifying unsophisticated investors into the wholesale space avoids rather than solves the problem.
Personally I think lifting the threshold to at least $5million of "investable: assets (excluding the family home) would be appropriate. Furthermore, banning vertical integration of any form would be a necessary first step in resetting the compliance framework to make advise quicker and cheaper but also serve the interests of investors.

I'm very pleased you have covered this matter in detail. I have written to ASIC with a copy to the Minister for Finance with my complaint, which is: as a "non-sophisticated" investor of long standing, who has not required the services of a financial adviser for many years, I am now excluded from reinvesting, without fee, from an the expiring CBA CBAPF hybrid security to the new CBA hybrid security. I would be required to engage the services of a financial councellor at (for me) unnecessary expense.

It is really annoying when banks and others in the industry who are asset gatherers participate in this conflicted remuneration and give genuine wholesale products and fund managers a bad name unfairly, as well as discriminate against them and their products. Good wholesale products and funds, of which there are many (many more than retail in my view and I'm one of the few people who deeply research both) aren't of any interest to most intermediaries and don't participate in such conflicted remuneration. These practices tarnish wholesale investing unfairly. The reality is if you want to invest optimally and can qualify as such, you must be a wholesale investor as being a retail investor relegates you to MUCH inferior product and returns than what is available to wholesale clients. My returns with wholesale investing are massively superior to my returns with retail investing in large part because of this (and I have done both for years). Wholesale investing enables managers such as myself to provide cost-effective solutions to clients and start businesses which offer vastly superior solutions and products to clients than what is generally available with the retail constraints. Retail products are too hamstrung by bureacracy, regulation, costs and risks to make them a realistic option for most new managers starting businesses and providing superior investment product and solutions. So my message is by all means avoid the charlatans and usual miscreants, but don't be under any illusion that retail investor protections are all good as they will ensure you will get suboptimal results compared with good wholesale investing. Good wholesale investing should vastly outperform retail investing, should not be conflicted, and you don't want to miss out on it if you qualify or your capital will suffer for it.

I think the issue is that by regulators ratcheting up the regulatory barrier (DDO, exams etc) and taking away means for advisers to get paid by regulating against selling fees (many brokers who are advisers are on a per transaction rather than a % of FUM fee model), they are doing the exact thing they didn’t want – creating an advice gap for the true retail investor. As Jerome lander says in his comments, regulation has forced the offering to retail to be vastly inferior to wholesale. This results in inferior choice and returns to retail investors. Nobody wants bad advice in the industry but I don’t think just because an adviser gets paid for doing some work that it means their advice is conflicted.

Hi Graham, I am so grateful for this article. It explains so clearly the investment landscape in front of me and points to so many aspects that I could not see or understand. Outside our SMSF the only asset we have is our home. Inside the SMSF we don't meet the $2.5M criteria. I am the investment advisor and manager of our SMSF. So, I believed I was a stranded 'retail' client cut off from the nirvana of 'wholesale' investing with its lower fees and superior products. What you wrote made real sense to me and I am grateful to you. Thanks Jim.

I agree 100% with this. I qualify as a 'wholesale investor', but fortunately I am moderately sophisticated so I have held off filling in the form that removes hard won rights. Even more insidious are the websites that will not allow you to enter and peruse the offer unless you agree that you are wholesale investor and thus don't need all the facts.

Slightly off-topic, I too will be watching the PIMCO launch with great interest. I invested a significant amount in their bond funds a few years back, only to see them slump and take longer to recover. I asked but was never given a reason why all of their different bond funds exhibited the same correction, despite them supposedly holding different bonds. Alas, even 'sophisticates' such as myself :) fail to learn. Anticipating the drop in bond prices and in a reach for 'safe' yield I put a chunk of money into their biggest fund, the PIMCO Income Fund. Which (I assume) will be the basis for their new LIT. The distributions were nice. Less nice was watching it fall. If the LIT had been launched a year ago I probably would have chosen it over the managed fund but not after your lifting of the opaqueness regarding fees.

I'm not holding my breath about any changes to the wholesale loophole. Whilst there is some sympathy for 'Mum & Dad' investors being misled by conflicted advice, the public and the government seem to think that those with a nest-egg are fair game.

I am with Steve on this i.e. would probably qualify as a "sophisticated investor" but have chosen not to as I concluded it would be adding another risk factor to investing which already has enough risks. Very annoying though that one has to now be a "sophisticated investor" or pay for advice to simply roll a bank hybrid into the next hydrid issue. Can always buy them on the asx once issued although there is often a cost penalty in doing so.

Fred: The cost penalty is the price you pay to know that you are not being done over. I think of it as a form of insurance. In the long run the cost would be immaterial. And I would suggest it would be far lower that the commissions and advice you would need to pay either directly or indirectly to go through a broker and to be declared sophisticated.