Protection Against Bad Advice

Sydney Morning Herald

Wednesday November 15, 2006

JOHN COLLETT

It has taken the collapse of the property developer Westpoint to finally prompt the Federal Government into forcing financial planning firms to take out adequate professional indemnity insurance.

It might surprise readers to know that financial advisers are not required by law to have insurance. Originally the Government intended that the Financial Services Reform Act, which came into effect in 2001, would ensure licensees would have adequate insurance.

However, after the collapse of FAI and HIH, premiums rose so quickly that the Government gave a moratorium on the requirement.

At the time informed observers such as David Child, the chief executive of Adviser Ratings (a firm which rates financial advisers), warned that some small planning groups would not be able to pay compensation should anything go wrong.

The Westpoint collapse shows that Child wasn't crying wolf. Some smaller financial planning firms had several millions of dollars of their clients' money invested with the developer.

The commissions Westpoint paid to advisers were higher than usual. In many cases, the risks of the investments were not adequately explained. Now 3500 small investors have lost more than $300 million.

Up to $200 million of that was placed by planners working for member firms of the Financial Planning Association, which has always said that one of the reasons consumers should seek financial advice from a member is because of its professional indemnity insurance.

At the time of the insurance crisis, the association lowered the minimum insurance requirement from $3 million a firm to $2 million. Some firms started taking out policies with excesses of $150,000 a claim - meaning it would have to fund the first $150,000 on each claim out of its own pocket. Also, to help keep a lid on premiums, some firms took out policies that excluded advice on tax-effective investments and on direct share investing.

The planning firms owned by the big institutions, which avoided Westpoint, have the financial strength to be self-insured but some clients that were put into the developer by smaller firms have been left exposed.

Those who invested more than $100,000 on the advice of planners cannot claim through the Financial Industry Complaints Service because there is a cap on claims above that amount.

The litigation funder IMF Australia is about to start a class action on behalf of some of the investors against a handful of planning firms, although many more were involved.

It is pointless taking legal action against those, as they have inadequate insurance and next to nothing in assets, or otherwise have gone into voluntarily liquidation.

Prompted by the Westpoint failure - and after five years of inaction - the Government has acted. It wants all planning firms to have insurance by the start of next year.

There will, however, be a lot of argument between the Federal Treasury, which is charged with working out what is deemed adequate, and the financial planning industry.

The smaller firms will resist a high level of cover and argue that if the insurance is too expensive it will drive them out of business.

The Government says the firms must obtain cover that is adequate and "to the highest possible liability" of claims that could arise.

Whether that means that those giving financial advice will have adequate cover remains to be seen.

The minimum $2 million cover for Financial Planning Association members does appear to be inadequate in the face of Westpoint-style claims.

Most small planning firms are honest and ethical but consumers should nevertheless ask for details of their insurance cover - until the changes come in.

© 2006 Sydney Morning Herald

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