“Governance, competence and conflicts are bigger problems for licensees than adviser fraud and misappropriation”
— Sean Graham
Not all publicity is good
Unless we include “Fee for no service” (FFNS) issues, it’s clear that despite the recent coverage, there’s no fraud epidemic in financial services; but it’s inarguable that the increased reporting contributes to undermining public confidence in the advice profession.
Clearly, Licensees (and advisers) need to do more to detect, prevent and mitigate misconduct.
Both ASIC and Commissioner Hayne identified, and continue to identify, misconduct, misrepresentations and adviser fraud.
Unsurprisingly, given Report 515, Licensees’ Compliance Teams have been spectacularly ineffective in either detecting or preventing fraud.
We don’t concede that Licensees “can never detect fraud” or criminal activity, but it’s perhaps undeniable that they’re often impassive, slow to act and keen to avoid legal entanglements.
In recognition of these characteristics, and the industry’s failure to self-regulate, the industry faces a wave of new regulation designed to address these deficiencies – a new misconduct regime, mandatory reference checking and a new breach regime that mandates increased, and increasingly public, regulatory reporting.
These steps may not, explicitly, reduce the risk of deliberate fraud which is, in our view, less consequential than systemic cultural and conflict issues. In reality, the literature suggests that most adviser fraud is relatively unsophisticated and, despite fraudsters best efforts to conceal their contraventions, most Licensees could significantly improve their capacity to detect misconduct by making small, but critical, refinements to their compliance arrangements.
It’s important to be clear about definitions and differentiate between fraud and other conduct failures. Without being legalistic, in contextual usage, fraud is the deliberate and wrongful intention to deceive others for personal or financial gain. We appreciate that charging fees for services that were not provided seems to satisfy this definition but, in our view, these failures (like mistakes and innocent misrepresentations) don’t demonstrate the deliberate and wrongful intent to deceive required of fraud.
Deceit, misrepresentation and misappropriation of funds can be difficult to identify but, even in the absence of specialist compliance systems, a Licensee can increase the likelihood of detecting adviser fraud by ensuring that:
- their Compliance arrangements consider those lead and lag indicators that correlate with fraud; and
- staff and advisers understand that fraud is not a “victimless” crime; and
- internal resources have the courage and capacity to identify, escalate or pursue these matters.
The impact of fraud (and remediation)
“Surveys have shown Australians are reluctant to seek financial advice either because it’s too expensive or because they don’t trust the advice industry.
The distrust is understandable given AMP, ANZ, CBA, Macquarie, NAB and Westpac were forced to pay a total of $1.24 billion in compensation – as of December 31, 2020 – to customers who suffered losses or detriment because of fees-for-no-service misconduct or non-compliant advice.”
— Chanticleer, “Don’t let fraud kill financial advice”, AFR March 6, 2021
The costs of running a compliant advice business have, in recent years, significantly increased but not, in our opinion, as a direct result of adviser fraud.
Incidents of adviser fraud may not be increasing, but they are being increasingly reported. Interestingly, the direct costs of fraud are often significantly less than the rectification costs (and significantly less than the remediation costs for poor advice or no service.
We’re aware that one Licensee found that the amount misappropriated as a result of an adviser’s fraud was ultimately less than 30% of the total amount paid by the Licensee to remediate the fraud and manage the restitution program.
Unfortunately, too many Licensees are both unmotivated and ill-equipped to detect, mitigate and prevent adviser fraud.
In our experience, Licensees confuse their willingness to detect and prevent fraud with their capability of doing so; compliance arrangements are generally designed to detect systemic, evident and procedural failures. They are often inadequate, where, as is the case in most frauds, the misconduct is deliberate, subtle and actively concealed.
Identifying Misconduct
“Caddick’s failure to grasp the importance of compliance and ethics .. would prove to be her undoing.”
— “The early victims of fraudster Melissa Caddick”, Kate McClymont, SMH 24 April 2021
In fact, few Licensees have the measures, processes and integrated data systems that are capable of flagging issues, highlighting concerns and identifying root causes. Still fewer Licensees complement well-structured monitoring and supervision arrangements with formal, consistent and predictable consequence management policies.
The reasons for these significant gaps vary; cost, ignorance, a misunderstanding of their importance or a fear that these may prove a commercial impediment to recruiting and retaining advisers.
In fact, the reverse is generally true; better data and clearly documented policies reassure advisers that their Licensee will act rationally, consistently and predictably. They also help to protect the advisers, their clients and their businesses and help staff and representative to identify, and appropriately escalate, questionable conduct.
Implementing better compliance arrangements doesn’t require additional or significant expenses. Instead, small procedural changes (and cultural nudges) are, in our experience, the cheapest and most effective ways to reduce the increasing costs of fraud, misconduct and non-compliance.
Increasing Vigilance
“On average, fraud occurred over two years. The most common fraud control weaknesses were perpetrators overriding internal controls and lack of knowledge about fraud.”
— Judy Skatsoon, “Potential cost of fraud against govt $1.7 billion”, Government News , 18 June 2020
So what tweaks could a responsible Licensee make to its compliance arrangements to increase their likelihood of detecting fraud?
An initial step might be to ensure that the Monitoring and Supervision framework (however represented) requires and assist staff to to identify, consider and, where appropriate, escalate concerns where
- a common address is frequently used on client application forms (look for patterns in the submission of applications too);
- there are material discrepancies between the adviser’s marketing collateral (including their FSG) and the Financial Adviser Register maintained by ASIC;
“What this does teach you is dishonest people are cunning enough to realise exactly what consumers are seeking in an adviser & to mimic that with their falsehoods. ”
— Tim Mackay, Private wealth advisor. Linkedin 24 April 2021
- the Adviser seems to “living beyond their means” based on the reported remuneration;
- their are repeated (and incremental) administration errors;
- the adviser receives, and on-forwards, statements and correspondence;
- the adviser enjoys long, and frequent, vacations without any service issues arising;
- files scheduled to be reviewed are offsite or unavailable;
- the adviser is reviewed by the same reviewer each year;
- there is an unusually high turnover of the adviser’s support staff (or office relocations);
- the adviser has close relationships with vulnerable or disadvantaged clients;
- there is a sudden increase in “new business” with a similar lapse rate after 1 year;
- the adviser pays clients’ premiums (or claims to do so);
- the adviser’s conduct (or questions) seems inconsistent with their stated qualifications or experience;
“Lying about qualifications aside, these types of frauds are all premised on an (underserved) reputation, too-close personal relationships and a willingness of others to avoid the trouble of enforcing standards. The conduct you accept defines the industry. Hopefully, FASEA will change this.”
— Sean Graham, Linkedin, 25 April 2021
- the adviser holds Powers of Attorney, discretionary authorities (contrary to your policies) or offers a custodial service for clients;
- previous licensees (or employers) decline to provide references;
- the adviser is identified as being bankrupt or banned (or previously bankrupted or banned); and
- the adviser routinely collects client payments from product manufacturers or “deposits” cheques on clients’ behalf; and
- the adviser emphasises their experience, reputation or relationships when questioned about compliance issues.
