By Karen Maley

28 Jan 2019 — 11:00 PM

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Will Commissioner Kenneth Hayne drive the final nail into AMP's coffin? Or will he offer the financial services giant a more hopeful future, where it can aspire to capture an even bigger share of the lucrative wealth management space, particularly now that most of the major banks are vacating the industry?

That's the question AMP shareholders — still reeling from the group's decision to slash the company's final dividend for the 2018 financial year — are wrestling with as they count the days until the release of the final report of the banking royal commission.

Conflicts of interest

With the AMP share price now languishing near a 20-year low, shareholders know the company's future hinges on Hayne's decision on the vexed issue of vertically integrated financial firms, whereby financial institutions design and create financial products which are then distributed to customers through financial advice or sales.

Commissioner Kenneth Hayne holds AMP's fate in his hands Internet

Now, there's little doubt that Hayne recognises the business model involves insuperable conflicts of interest. It's clearly in the interest of clients to get good financial advice, but that doesn't quite mesh with that of their financial advisers, whose interest lies in advancing their own careers and earning as much money as they can. Meanwhile, the interest of a licensee is to maximise profit.

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Or, as Hayne argues in his interim report, "the conflict may be better seen as a conflict between the financial interests of the adviser or the licensee and the duty that each owes to the client. (The adviser owes the client a best-interests duty and the licensee must ensure compliance with that duty.)"

Unfortunately, as the Australian Securities and Investments Commission's January 2018 report on vertically integrated businesses shows, there's an alarming tendency for the personal financial interests of advisers to trump their duty to act in the best interests of their clients.

ASIC went through the files of 10 advice licensees associated with AMP and the four big banks and found that in 75 per cent of the files reviewed, the adviser appeared to have prioritised his or her own interests rather than advancing the interests of clients. Even more worrying, in 10 per cent of the files reviewed, ASIC was concerned that the advice might have resulted in financial harm to the client.

As Hayne noted, these results "demonstrate the validity of a basic observation of the world: that the choice between interest and duty is resolved, more often than not, in favour of self-interest".

He added that the results also seemed to invalidate the argument that these conflicts of interests could be "managed" by telling advisers to prefer their clients' interests to their own.

The royal commission's own case studies, such as financial planner Sam Henderson, demonstrate that clients who go to non-vertically integrated financial advisers don't necessarily end up with better advice. supplied

As he observed: "Experience (too often, hard and bitter experience) shows that conflicts cannot be 'managed' by saying, 'Be good. Do the right thing'. People rapidly persuade themselves that what suits them is what is right. And people can and will do that even when doing so harms the person for whom they are acting."

Given the commissioner's lucid exposition of the ineluctable conflict of interest in vertically integrated firms, surely his final report will recommend that manufacturers of financial products should be banned from providing personal financial advice?

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Not necessarily, argue some leading financial figures.

The case for vertical integration

In the first place, they argue, banning "vertical integration" won't necessarily leave people better off. Clients, for instance, may have to pay more for financial advice and, if they do get dud advice, they will no longer have the comfort of knowing that they'll be able to seek compensation from a large, deep-pocketed financial institution.

What's more, they point out, the royal commission's own case studies — particularly those of the former financial planner Sam Henderson and the now-defunct Dover Financial — clearly demonstrate that clients who go to non-vertically integrated financial advisers don't necessarily end up with better advice.

Secondly — and this could well cause opposition shadow treasurer Chris Bowen to rue his precipitate pledge to carry out all the recommendations of the royal commission without actually knowing what he was signing up for — some of the biggest industry super funds themselves have also embraced a vertically integrated model, and are providing financial advice through either staff or licensed financial advisers. Industry fund heavyweights argue there's no inherent problem with vertical integration, and that conflicts of interest can be avoided by providing an explicit instruction that the top priority for financial advisers is to look after their clients' best interests.

There's also a third factor that might give Commissioner Hayne pause: if he does decide to ban vertically integrated financial firms, should the restriction apply to stockbrokers as well?

The answer he arrives at will have a huge influence on the ability of small- and medium-sized Australian firms — spread across industries ranging from tech, biotech, fintech to mining — to access the capital they need to expand their operations.

That's because in the past few years, almost all the initial public offerings and share placements that have been done for these types of firms have been carried out by medium-sized stockbroking firms, most of which are also vertically integrated.

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Indeed, the entire business model of these stockbroking firms depends upon their underwriting the IPO or private placement of, say, a small tech firm and then selling the shares to their enthusiastic clients, many of whom do business with the broker to get access to these capital raisings.

Industry veterans argue that it's difficult to see how these capital raisings — which have helped attract foreign capital to the Australian Securities Exchange and which have provided much-needed capital for small firms — could get done on any other basis.

They argue that if Commissioner Hayne were to recommend a ban on vertically integrated firms in wealth management, it most likely would also apply to stockbrokers with retail clients who also have an integrated business model.

And that inevitably would have a deleterious effect on future economic growth, by depriving many innovative small firms of a critical source of equity funding.

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