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Drawdown: When do you declare a conflict of interest?

If you advise a client into drawdown against annuitising (ongoing fee against no fee) do you declare a conflict of interest and at what point? ABR editor Rob Kingsbury talks to Andrew Brook-Dobson (pictured), Chairman of the Ethics, Disciplinary and Practice Standards Committee at the Institute of Financial Planning

The new pension freedoms available from April 2015 are likely to increase the popularity of drawdown as opposed to annuities as investors look to keep more control of their money in retirement. The danger for financial planners is that advising on this area is often likely to give rise to a conflict of interest.

This is particularly so where the financial planner is remunerated by ongoing charges based on percentage of assets under management, and where there is a clear advantage for the planner to keep the client’s assets invested rather than placing them into an annuity, on which the planner will receive no ongoing remuneration.

Dealing with the conflict of interests

Conflict of interest is an area where financial planners need to be more vigilant and to think ahead when they are meeting with clients, says Andrew Brook-Dobson, Chairman of the Ethics, Disciplinary and Practice Standards Committee at the Institute of Financial Planning.

“There may be planners who wouldn’t realise that the drawdown situation presented them with a conflict of interest,” he says. “They may feel they always act in a principled way and always have their clients’ best interests in mind and that because the issue had been discussed with the client and agreed as the right course of action there is no need to declare the conflict.”

But the IFP Code of Ethics is not ambiguous on this subject, Brook-Dobson points out. “What the Code requires is that: ‘Any potential conflict of interest must always be disclosed at the earliest opportunity’.

“Planners cannot decide on whether to declare a conflict of interest based on the outcome of the advice. The conflict of interest has to be declared at the start of the advice process. So if a client is being advised on whether to go into drawdown, where the planner will receive a fee based on invested assets, or an annuity, where the planner will lose that ongoing remuneration, that conflict must be declared up front so the client is always fully in the picture.

“It gives the client the opportunity to be forewarned, and forewarned is forearmed. It’s about disclosing the conflict and taking the conversation from there. If the planner has disclosed the conflict in a measured manner, then the client has all the facts and can ask the right questions and be assured of the value of the service.”

The right business culture

Another example, says Brook-Dobson, is where a client wants to buy a holiday property and comes to their planner to ask if they can afford to do so. “If a planner is working on an asset-based charging structure then he or she is going to see a reduction in their fee income if the client transfers assets out. Therefore they face a conflict of interest.”

The conflict of interest arises in attempting to answer the question, Brook-Dobson adds. “It is not dependent upon what the answer is. The conflict exists before you can answer the question. So if you get into the habit of only disclosing the conflict where you know the answer is a problematical one, then you’re not ingraining the right habits as a work ethic and into a firm’s business culture.”

Simply, from a business perspective, Brook-Dobson believes planners are better off disclosing the conflict to the client as soon as it’s been identified. “I don’t see the downside to having the conversation where the planner identifies and declares the conflict and then says to the client, ‘I’m never going to let the conflict get in the way of what’s truly right for you but I do need to flag it up’. I can’t think of any of my clients who would then turn around and not use us as a result. It’s only going to be a positive thing for trust and the relationship with the client.”

Offsetting through a minimum fee

There are going to be instances where a piece of planning advice will result in a loss of revenue for the planning firm. This is where firms need to have a clearly defined and transparent charging structure, Brook-Dobson says. “Having a minimum annual fee can ensure the firm has a means of income from each client. For example, if a client had all their investable assets in pensions and the right thing to do was to annuitise, then when they did so the planning firm’s revenue would drop but it wouldn’t drop to zero. That’s where it helps to be clear what service is being provided for the fee being paid.”

Brook-Dobson’s own financial planning firm, Brook-Dobson Brear, charges a minimum annual fee to clients and a percentage of invested assets.

“We use percentage of assets as a means of charging as we consider it a proxy for the value that we can deliver. It’s not a perfect proxy and if we are doing a lot of work and delivering substantial value for people with large amounts of non-invested assets, then we will negotiate and agree a fee structure that is higher than that minimum for the work we undertake,” he says.

Hindsight complaint

The danger for the financial planning firm is that not declaring the conflict of interest could result in a hindsight complaint, warns Brook-Dobson. “By not declaring the conflict, planners leave themselves open to being accused of taking a certain course because it was in their interests rather than the client’s, even if they have talked through all the options and agreed the course of action with the client. But if the conflict is declared up front, and the planner can say ‘we discussed it and agreed that this was still the right thing with all the facts in front of you’, then it’s much harder for that argument to hold substance.

“And importantly, it has to be pointed out that where a financial planner fails to comply with their professional body’s Code of Ethics disciplinary proceedings could ensue, which, in extreme circumstances, could lead to a removal of their SPS and their ability to earn a livelihood.”

Contact Andrew Brook-Dobson at: andrew@bdbfinancial.com

Click here to view IFP Code of Ethics

 

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