April 16, 1995

Article at Sunday Age

BUSINESS | Crackdown on nest-egg industry

By Wilson da Silva

“IT’S just a bloody dog’s breakfast,”“says Mr Jock Rankin. “You’ve got differing standards and different authorities. You’ve got to get a single regime, a single regulator. Get tough on the industry. Legislate.”

Mr Rankin, chief executive of the Financial Planners Association of Australia, is more than a little anxious. He has been fielding calls all week, fighting to keep the reputation of his industry above that of the disreputable financial planners that give his members a bad name. But it was the undesirable flotsam that was highlighted by the Australian Consumers Association, publishers of ‘Choice’’magazine, in its detailed study of the industry released last week.

The association selected 23 of its members throughout the country who planned to seek financial advice and agreed to the study to visit three different financial planners each.

The planners, including banks and institutions, large chains and small independent operators, produced 58 financial plans that were assessed by a group of accountants, and even by a representative from the Australian Securities Commission and Mr Rankin’s FPA. 

And what hair-raising stories there were to tell. One couple were advised to negatively gear their property and borrow $45,000, investing it in the sharemarket. A fairly risky strategy indeed.

Another urged a client to sell his shares, all of which had seemingly good prospects, and invest the money in managed trusts. That would have brought benefits to the adviser who gains incentives for new business brought to trusts but would have been of questionable value to the client.

Worst of all, there was the Sydney financial planner (so identified in the telephone book) who, on first meeting his client, advised her to use her $90,000 as collateral for a loan of $65,000, and to sink the whole lot into Gold Coast property. This would leave her with a repayment of $600 a month based on a small income.

No problem, said the planner who, armed with a gaggle of graphs and charts, said her property would double in value within seven years thanks to the amazing one-in-seven”principle. And, if she could not get a loan, the planner could take care of it.

It is this kind of self-styled adviser that most troubles the FPA.

If they deal in property and do not advise on shares, bonds or unit trusts and other securities, they fall outside the powers of the ASC.

A review of the licensing of securities, started last year by the ASC, has been receiving submissions, and officials say there is a need to review the rules.

Mr Rankin says: “These people who specialise in property negative- gearing schemes, which are a giant bloody rort and are not based on the needs of the client at all but on flogging a dubious product at best, these people aren’t regulated.” “They go touring through the country towns and regional centres, hold big seminars and promise people the world from negative gearing in property.

They’re just charlatans skirting around the edges of the law. We wish to God these fast-buck merchants could be wiped out.”

It wasn’t just the charlatans who failed to pass the ‘Choice’’ quality filter. The study found that one in five of the plans violated corporations laws, was deceptive practice, dismissed a client’s preferences or seriously miscalculated a client’s financial position.

Less than 10 per cent of the plans got a gold star from ‘Choice’and 65 per cent of the advice ranged from “acceptable”‘to “poor”.

The magazine likened consulting financial planners to a game of Russian roulette.

The FPA did not concur with the interpretation ‘Choice’’put on the results but agreed that the worst 20 per cent of plans assessed were unacceptable.

Mr Rankin said his group which covers the bulk of financial planners in the 30,000-member industry (although there is some resistance from some of the big banks, most notably Westpac) abides by a strict code of ethics and a separate code of professional conduct.

There is an independent complaints-resolution scheme, administered by consumer advocate Ms Moira Rayner, which can offer up to $50,000 in compensation from money set aside by the association’s members.

Mr Rankin said that, because of this, planners who were members had great credibility credibility that the FPA would not stand to see damaged by an errant member.

“I’m not silly enough to think that all of our members are perfect and they all abide by the code of ethics and code of professional conduct,” he says.

But when you have that sort of a set-up - a disciplinary system and complaints resolution scheme to make our members accountable that’s much more assurance than given by non-members.”

The ASC review, the first since laws covering the industry were enacted in 1985, may help.

Submissions to the review, which was initiated last July, closed last week, and draft recommendations are due out this June. They will be up for public discussion for eight weeks, and the ASC will adopt a public view on them after that.

If legislative changes are required to encompass, for example, advisers dealing exclusively in real estate, these will be recommended to government.

“The legal requirements are quite flexible,”“ says one ASC official, a member of the licensing review taskforce.

“Perhaps once we have identified the real problem pockets, we might be able to administer the industry in a more meaningful manner.

“But we have also advocated that, maybe, the ASC should have discretionary power, similar to that over prospectuses, so that we can tailor the legislative requirements to suit the situation.”

Financial planning is an industry that emerged in the early 1980s, when making a fast buck was considered a virtue. Since the stockmarket crash of 1987 the industry has gone through a shakeout. Much financial advice made under the intoxication of the boom went decidedly awry, and many investors got their fingers burned.

This led to the creation of the FPA and the establishment of the codes of practice.

Now, rather than chasing quick profits, consumers are approaching financial planners to secure their nest-eggs or maximise existing investments.

So, the industry today is not what it was when laws were drawn up 10 years ago, and some have found ways to exploit loopholes in the regulations.

Although regulators see the FPA as beneficial, they say more needs to be done.

Says one official: “The problem right now is that they don’t have industry-wide coverage. Also, the industry is so diverse and different that one industry body may not be enough.

“We are arguing for tougher regulation and higher standards instead of the mishmash situation at the moment,”“says Mr Rankin. “Consumers want it and so do legitimate financial planners.”

Questions to ask your adviser

  • Are you a licensed securities dealer, investment adviser of authorised representative of a licence holder?
  • What does your licence allow you to advise on?
  • What are your areas of expertise?
  • How are you paid?
  • What benefits will you receive from my investment?
  • Are you a member of the Financial Palnning Association?
  • What is your source of research?
  • Have you any tertiary of professional qualifications?
  • What practical experience do you have in giving investment advice?
  • What did you do before you were an adviser?
  • Do you have enough professional indemnity insurance?
  • What association do you have with the providers of investment products you recommend?

What wort of advice would Paul Keating get on his financial affairs?

The Sunday Age approached three financial planners to give an investment strategy based on publicly known financial details of the Prime Minister.

  • Annual Salary: $190,361
  • Other annual income: $29,325
  • Estimated annual pension: $117,139 (on retirement in 1996)

Residential property: Terrace house in Elizabeth Bay, Sydney (estimated value: $1 million), Real Estate Investments: House in Woollahra, Sydney (estimated value: $2.5 million, Joint Shareholdings: Pleuron Pty Lrd (7500 shares held in private company), Noted valuables: Collection of period furniture, especially clocks.

Assumptions for planners: Client may retire around March 1996 and move to Woollahra, Sydney. He anticipates earning an annual income of $200,000 a year and to receive $1000 annually in dividends from his investments. He has a $2 million mortgage on the Woollahra property, and will need an annual income of $100,000 after tax.

John McInerney, Totall Independent Financial Planning

First there is the need to set up a company structure. A discretionary family trust maximizes income distribution and tax minimisation. I don’t think the client will want for much in the future being the recipient of a superannuation pension, of approx $117,000 pa, at the age of 52 when most have to wait till at least age of 55 or later.

To meet this requirement of $100,000 after tax, he could draw income from the company to supplement his superannuation pension. It would be appropriate that the $200,000 income generated by him in the future, be paid to the company wh3re the tax rate is 33%. This is more advantageous than the marginal tax rates most other workers find themselves paying.

On the surface it appears that the client has a bias towards property and consideration may need to be given to the investment of some of the available resources into equities, both in Australia and overseas.

Their proposal to live in the Woollahra property, on which there is a $2 million debt, does not appear to be the wisest choice. On doing this they would loose the advantage of claiming the interest as a tax deduction. It may be better to live in the smaller house in Elizabeth Bay and retain the gearing to reduce tax liability.

Regardless of the eventual strategy and structure, the regular monitoring of all aspects of the plan is of paramount importance.

Geoffrey Green, Sedgwick Noble Lowndes Financial Planning Limited Melbourne.

What happens next year? If the client and family move into Woollahra, perhaps the tenant might move into Elizabeth Bay? The rent would be less and the interest payments on the Woollahra property would no longer be tax deductable. Obviously some restructuring is required.

The principal family residence in Elizabeth Bay is exempt from Capital Gains Tax (CGT), but the Woollahra property is subject to CGT. The client could sell Elizabeth Bay and reduce his debt by $1m. When Woollahra becomes the principal residence it gains CGT exemption from that date. Or he could sell Woollahra and clear his debt! Otherwise he has an interest bill of $100,000, but no tax deduction and a prospective income of about $318,000. Perhaps the client’s wife could work for one of his private companies and reduce the tax burden by splitting the family income?

A discretionary family trust is another option for tax planning.

In summary then: He must find a way to fund the interest payments and ultimately repay the debt.

On the information given, it would not appear feasible to retain both properties, his future would be more secure if he sold Woollahra and retained Elizabeth Bay!

Some strategies may provied tax advantages but it is difficult to split his income.

He must cover his risks with adequate insurance and prepare an appropriate will.

Kevin Bailey, Monitor Money Corp.

The first thing he needs to realise is how tax inefficient it will be to move into the Woollahra house with a $2-million mortgage. The interest on this mortgage will be $200,000 pa on a 10% loan which is not tax deductible if it is his principal residence. The recent rise in interest rates will also have hurt. He requires $100,000 in annual income after tax. His pension and anticipated gross earnings of $200,000 will not cover his mortgage and living expenses. Assuming the pension is fully taxable (it may not be), he will face a tax liability of $144,505.68. This can be substantially reduced, however, with some detailed tax planning.

One solution may have been not to live in the Woollahra property but rent it out. This would enable him to claim the interest expense as a tax deduction. The interest expense would still be too high and he may have to sell the Elizabeth Bay property to reduce the debt on Woollahra.

Assuming the pension is fully taxable and the debt against Woollahra is in hin name, it would leave $18,139 taxable income if he had a 10% mortgage on the remaining $1-million debt. Hopefully he could involve his wife in the business he hopes will generate $200,000 pa. They could form a company, the company could contribute $62,000 pa to her super and salary and franked dividends could be paid to him to reduce the tax to approximately $44,000 pa. This would leave them with net income of a little over $100,000 pa.