In light of changes introduced by recent legislation on fee renewal and disclosure, Stewart Chandler from AFSL Compliance discusses the benefits of an Annual engagement model and why it’s his recommended approach for financial advice practices.

Ongoing fee arrangements: new obligations

In 2013, FOFA reforms introduced a requirement for financial advice practices with ongoing fee arrangements to provide clients with an annual fee disclosure statement (FDS), and obtain a biennial opt-in for new post-FOFA clients.

As per the 2011 Explanatory Statement, this was intended … to protect disengaged clients from paying ongoing financial advice fees where they are receiving little or no service…

The Corporations Act s962A defines an ongoing fee arrangement as being one where “a fee (however described or structured) is to be paid during a period of more than 12 months.”

It has been evident for many years that the FDS disclosure has not been an effective solution for the fee for no service issue. The Hayne Royal Commission considered this and recommended that financial advice practices operating under the ongoing fee arrangement model be required to seek annual client consent from all clients.

Annual engagement model

An annual engagement is an agreement between a client and a financial advice practice. It sets out services to be provided and fees to be paid over a 12-month period.

The engagement expires at the end of the 12-month period. The practice and client may decide to enter into a new annual engagement, however there is no obligation on either party. If the client does not enter a new engagement, the practice ceases charging fees.

I do not consider an annual engagement to be an ongoing fee arrangement as the fee is to be paid for 12 months. It is not to be paid for a period of more than 12 months.

The obligation to provide an annual FDS only applies to ongoing fee arrangements. It does not apply to annual engagements. This has always seemed logical to me as the annual engagement by itself meets the intent of the FOFA reforms. It gives clients sight of the advice fees they are paying, empowering clients to stop paying advice fees where they do not receive value from the service. It clearly does a much better job of meeting the legislative intent than the FDS disclosure.

Efficient and client-focused

Since the introduction of FOFA, I have encouraged practices to adopt the annual engagement model. In my view, it is a better solution for clients and a more efficient solution for practices. It suits practices that are truly engaged with their clients and where clients understand and value the services they receive.

In the early days there was a widely held view that practices would hurt their valuations by adopting the annual engagement model as clients may choose to walk away. It provided less certainty in the future income stream and the preferred approach was an FDS which was less likely to disturb the existing income stream. Today, that view has turned 180 degrees. Practices with highly engaged clients are valued more highly and annual engagement is a compelling test of this.

I continue to view the annual engagement model as the significantly better option for financial advice practices and their clients. The enhanced FDS will be more costly for practices to produce. I believe it is less likely to be a clear and concise document which delivers better client understanding and it will be less effective in reducing the occurrence of fees for no service.

FASEA obligations

However, it is important to recognise that moving to an annual engagement model does not simply take financial advice practices outside of the regulatory regime.

Financial planners are also required to meet the FASEA Code of Ethics, the TPB Code of Professional Conduct and their applicable professional body standards (eg FPA, CAANZ, CPA). Each of these codes and standards set out extensive obligations in relation to client engagement. Standard 4 and Standard 7 of the FASEA Code of Ethics, for example, require a significant step up from the Corporations Act in how financial advisers engage with clients:

• A formal engagement is now required for initial and one-off engagements and not just ongoing/annual engagements.
• A formal engagement is now required for commission-based engagements and not just fee-based engagements.
• There is a specific obligation for the engagement to be fair and reasonable, and to provide value for money for the client.
• The engagement must set out the terms and conditions of the engagement including the privacy arrangements.
• The engagement must disclose the commissions and other benefits received by the financial adviser and their principal.

Annual engagement in practice

Under the annual engagement model, financial advice practices provide new clients with an initial client engagement. This must meet the FASEA standards and covers the preparation of the initial Statement of Advice.

As part of delivering the SoA, the practice agrees the services to be provided over the following 12 month period. This would be documented in the annual engagement and again, it must meet the FASEA standards. Consent can take different forms but it cannot be verbal.

The annual engagement will typically include an annual client review where the practice will update their understanding of the client situation, including goals and objectives and review and update recommended strategies and products. Importantly, practices should also consider what services their client will require from them for the next 12 month period and the fee to be charged. This then forms the new annual engagement.

The annual consideration of the services to be provided and the fees to be charged, is consistent with FASEA standard 7 and the need to provide clients with value for money. It may be that a client needs less or more or the same services for the coming year. This consideration is a FASEA obligation and applies to both the ongoing fee arrangement and annual engagement models.

The annual engagement model works on a strict 12 months. Fees must be turned off if the client no longer requires the services or does not sign a new annual engagement. This is consistent with the FASEA standard which requires client consent prior to services commencing. It means practices need to obtain the client consent to the new annual engagement before their current engagement expires.

For example, a client may have their annual review in April each year. At the completion of the review, they would receive an RoA and a proposed annual engagement for the period 1 July to 30 June. The same would apply each year. This approach provides some margin for error where the annual review is delayed or clients take some time to consider and respond to the annual engagement.

In deciding how to best implement the Royal Commission recommendations, I would have liked to see the government mandate an annual engagement model. This approach would both recognise the higher professional standards introduced in the FASEA Code and provide better alignment between the Code and Corporations Act. It would have moved all financial advice practices to transition to a simpler and cleaner solution with a number of key benefits:

• Reduce complexity and uncertainty in legislation
• A more efficient solution for practices
• Simpler documents for clients to understand with better client protection.

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Stewart Chandler is a Chartered Accountant with 20 years’ experience in financial planning compliance. He is the founder of AFSL Compliance, a business providing support to financial planning practices which hold their own Australian Financial Services licence or are looking to obtain their own licence. Stewart is an FPA member and works with many FPA Professional Practices and members.