In the absence of compelling scientific evidence is the debate, in the media and in practice, concerning the legitimacy of the current authorised representative (AR) licensing model for individual Australian financial advisers. The lack of a theoretical framework within financial planning theory defining, modelling and measuring legitimacy is leading to a deficiency in scholarly attention on this matter. To rectify this deficiency, Suchman’s theoretical framework is qualitatively interpreted, applied and extended to inspect the legitimacy of appointing, authorising and regulating (licensing) individual advisers through third party licensees as specified in the Commonwealth Corporations Act 2001 (the Act) (Commonwealth of Australia, 2001). Applying legitimacy to financial planning theory, for the first time, in this way lays the theoretical foundation to (1) advance financial planning theory, (2) raise further questions for future empirical research and (3) provides policymakers a basis to obtain credible evidence required to make evidence-based decisions around licensing advisers. Our analysis begins with a brief historical background discussion on the legislative framework of licensing advisers in Australia, together with a simple description of the Australian AR licensing model. The significance of examining the legitimacy of the existing AR licensing model is then highlighted. Subsequently, the main section then attempts to interpret Suchman’s legitimacy theory by applying it to the AR licensing model. In the closing statements, we present some recommendations for future research direction and the way forward in applying our stated theoretical framework.
Since 1996 the current AR licensing model has been rooted in the implementation of Financial Services Reform (FSR) and the subsequent Corporate Law Economic Reform Program [CLERP] (Corbett, 1999; Overland, 2007). CLERP with Wallis’s Financial Systems Inquiry recommendations published in 1997 led to the Commonwealth Financial Services Reform Act 2001 (FSRA) on 11 March 2001 (Hutson and Vonnessen, 2003; Parliamentary Joint Committee on Corporations and Financial Services, 2014). FSRA repealed the old licencing system of multiple licenses regulating the activities of inter alia insurance agencies, brokers, securities dealers, accountants and solicitors (Pearson, 2006). Chapter 7 in the new Commonwealth Corporations Act 2001 replaced the old corporation’s legislation. From 11 March 2002 (Australian Securities and Investments Commission, 2016e), a single licensing system (Banister
FoFA reforms started with consumer credit legislation. Under this legislation, effective 1 January 2010 (Ap, 2011), the Australian government regulated conflicts of interests relating to loan products (Banister
In addition to the above changes, amendments were made to the previous accountants’ FSRA AFSL licensing exemptions (Banister
Notable during the Murray Review’s consultation phase was a brief dialogue in the Australian Senate about a single financial license for each individual financial adviser, rather than one license for an institution (licensee) contractually engaging a number of advisers (Commonwealth of Australia, 2014e). Surprisingly, the final Murray report made no recommendations regarding individual licensing (Commonwealth Government, 2014). Instead, his report concluded the existing regulatory framework of product design, product distribution, disclosure and financial advice is insufficient to deliver reasonable treatment to clients (Commonwealth Government, 2014).
Many (specifically Kingsford Smith, 2011; North, 2015) contended the legislation would be unsuccessful in bringing tangible benefits to the public. Pearson (2006) pointed at the licensing model as a risk to clients with expensive compliance costs and significant adviser turnovers. Superficially, FoFA reforms dealt with specific clauses in the Act, neglecting the overall manner in which advisers were licensed through third party licensees, specifically those advisers affiliated to product issuers.
Part 7 Division 5 is a key part in the Act relating to licensing financial institutions (licensees) and their ARs (financial advisers) (Banister
Along similar lines, prominent in the media and in practice (Power, 2016; Fox, 2014; Spits, 2014; Lester, 2016; Jacobson, 2016; Pokrajac, 2014; Commonwealth of Australia, 2001) yet insufficiently addressed in scholarly literature is the identification and definitions of the categories of licensees and their ARs. On these grounds we define advisers as: (I) independent providing independent advice. Therefore, legally they can use the terms ‘independent’, ‘impartial’ or ‘unbiased’ as specified in section 923A of the Act, because they either meet: (a) the Independent Financial Advisers Association of Australian’s (IFAAA) gold standard and strict independence conditions, with no direct or indirect ownership, affiliation or association (henceforth, affiliation) links to product issuers, and charge no commissions or asset-based fees (for example licensees Roskow Independent Advisory and Brocktons Independent Advisory); or (b) the requirements in section 923A, with no direct or indirect affiliation links to product issuers, charge no commissions, but charge asset-based fees (for examples licensees Pitcher Partners Wealth Management and Aspire Financial Consultants). (II) Aligned to product issuers providing aligned advice. Therefore, legally they cannot use the terms ‘independent’, ‘impartial’ or ‘unbiased’, because they do not meet the requirements in section 923A (for example AMP-owned licensees and the bank-licensees). (III) Non-aligned to product issuers providing non-aligned advice. Therefore, they cannot legally use the terms ‘independent’, ‘impartial’ or ‘unbiased’, because they only meet some of the independence principles as prescribed in section 923A (for example licensees, Professional Investment Services and Count).
Surprisingly, there are various allegations (see, for example, Vickovich (2015)) of mid-sized licensees and their ARs advertising themselves as ‘independent’ while under the misconception of following the independent advice principles when instead they are selling their own ‘white label’ products recommended from single platforms and/or allow commissions or asset-based fees. Thus potentially misinterpreting the requirements in section 923A of the Act. Therefore, it is apparent more research is required to understand how practitioners understand the definition of independence as defined by the Act. Also subject to deficits in academic works, yet apparent in media commentaries (Vickovich and Micallef, 2013), were discussions on the advantages and disadvantages of licensing advisers through third party licensees. Some advantages include inter alia third party licensees allowing advisers to focus their attention on the client while leaving back-office, compliance and regulatory burdens to the licensees. Licensees affiliated to large institutions are in a better position to pay compensation to clients for losses suffered if legal compliance breaches or unethical behaviour occurred (Pokrajac, 2014). Disadvantages include inter alia advisers unable to market themselves as independent to clients who consider independence important, as well as being restricted by the licensees’ approved product list when providing advice to clients (Santhebennur, 2014).
North (2015) contended the licensing regulations disseminated a range of business models covering different sizes. Debatably, leading to inconsistent standards between licensees (Vickovich, 2014c) for compliance audits, education, training, supervision, licensee licensing requirements and conduct (Bennett, 2000). Valentine (2008, p.283) critically reasoned not all advisers operate on a level playing field, nor carry uniform regulatory burdens under the existing licensing model. For example, S765A of the Act does not regard physical assets such as direct real estate (property), wine, art, stamp collections and credit facilities as financial products (Commonwealth of Australia, 2001). So inter alia mortgage brokers, real estate agents, art dealers, coin and stamp dealers do not require an AFSL or are only partially covered by the AFSL regime. Furthermore, Smith
Given our discussion so far, and for the interest of financial advisory industry stakeholders, we believe it is important to scrutinise the legitimacy of the current AR licensing model using a theoretical model to obtain some scientific validation and verification. Despite the legislation regulating advisers through third-party licensees to protect the public, the transgressions list continually grows (Coorey and Eyers, 2015; Mennen, 2014; Ferguson, 2016). In recent years, to reduce more wrongdoings, attention focussed on the inherent conflicted remuneration of financial services (Batten and Pearson, 2013). This focus on remuneration included consideration by scholarly researchers (Kingston and Weng, 2014; Serpell, 2008; Moutsopoulos, 2005), inconclusive parliamentary debates on public record (Commonwealth of Australia, 2014b; Commonwealth of Australia, 2014f) and government inquiries (Parliamentary Joint Committee on Corporations and Financial Services, 2009; Parliamentary Joint Committee on Corporations and Financial Services, 2014), media commentaries (Ferguson, 2015; Santhebennur, 2015) and public submissions during consultation phases of the Australian inquiries into financial advice (Kearney, 2014; Morris, 2014) leading to new remuneration legislation (Commonwealth of Australia, 2001).
Yet, Valentine (2008) claimed conflicts of interest from affiliation to product issuers is the reason for the contraventions. The regulator ASIC, the Ripoll Inquiry PJC and some Australian government officials (Banister
On the existing available evidence, it seems reasonable to suggest the legitimacy of licensing advisers through third-party licensees affiliated to product issuers is important politically, especially when the licensing model could be a potential source of the lack in public confidence and trust (Taylor
The difficulty with professionalising financial planning is, historically to this day, financial planning is rooted in product sales (Knutsen and Cameron, 2012). Cull (2009) was of the opinion this embedded sales culture is the reason accountants felt financial planning did not meet all the requirements of a true profession. Yet interestingly, the accounting profession incorporated ethical standards for accountants providing financial services into their APES 230 standards (Accounting Professional & Ethical Standards Board Limited, 2013). Then in 2015 Certified Practicing Accountants (CPA) formed CPA Australia Advice. In 2016 they successfully applied for their own AFSL and ACL. So CPA members who want to avoid the self-licensing responsibilities could become ARs and provide independent financial advice through CPA Advice (King
From early writings by Bamber and Iyer (2002), accountants were restructuring to provide other non-accounting services internationally. Some of the 200,000 professionally qualified accountants (Accounting Professional & Ethical Standards Board Limited, 2012) are repositioning and redefining financial planning within their self-regulatory model (Brown, 2008; Global Accounting Alliance
Against this backdrop, intellectual attention shifts to applying legitimacy theory in financial planning practice and profession. Díez-Martín
Theoretically speaking, understanding the legitimacy of the AR licensing model is dependent on examining Suchman’s (1995) three broad, yet specific, types of legitimacy: (1) pragmatic (regulative); (2) normative (moral); and (3) cultural-cognitive. Figure 1 visually represents these legitimacy types conceptualised within financial planning theory. Importantly, Scott (2014) highlights entities exhibiting regulative, normative and cultural cognitive legitimacy increases their survival rates.
In the case of pragmatic legitimacy, Suchman (1995) outlines this as the perception of the social support for an entity’s activities operating within some socially acceptable system. From existing literature, regulative legitimacy, derived from pragmatic legitimacy (see, Chen and Roberts, 2010; Rao, 2004), occurs when regulatory entities use laws to create a perception of trust and confidence in society (Kostova and Zaheer, 1999) by regulating behaviour (Scott, 2013, p59). Seemingly, the “tool of legitimation” (Chen and Roberts, 2010, p.654) ASIC uses to co-regulate individual advisers via licensees is the Act (Tyson-Chan, 2006, Australian Securities and Investments Commission, 2012a). ASIC’s social control (Santana, 2012; Yeung, 2009) over licensees and their ARs gives the licensing model its “right to exist” (Pellegrino and Lodhia, 2012, p.70), which is being tested by the loss in public confidence and trust. Theoretical (Scott, 2014) and empirical legitimacy studies (for example, Bitektine, 2011; Chelli
Legitimacy is not only about the “right to exist” (Pellegrino and Lodhia, 2012, p.70), but also what is judged as “the right thing to do” (Yeung, 2009, p. 286) morally. Therefore, normative (moral) legitimacy focusses on specific morals, values or ethics (Chua and Rahman, 2011; Chen and Roberts, 2010) of an entity’s goals, activities, structures, and/or outcomes, within a socially accepted (Johnson and Holub, 2003) and constructed value system (Bitektine, 2011). Australian financial planning professional associations and licensees shape the moral professional foundation for advisers. They interpret and implement the regulative rules using as their defence compliance (Carnegie and O’Connell, 2012) with the Act. Consequently, understanding the licensing model’s normative (moral) legitimacy requires scrutinizing the following sub-categories Suchman (1995) identified, and illustrated in Figure 1 above: (1) consequential; (2) procedural; (3) structural; and (4) personal.
Consequential moral legitimacy is the moral assessment of an entity’s socially valued outcomes (Suchman, 1995, p579). Data gathered during two ASIC reviews in 2011 and 2014 showed licensees’ main source of revenue were paid by fund managers or product issuers. In the literature, specifically aligned licensees are seen as “commercial businesses using advisers as a sales force” (Parliamentary Joint Committee on Corporations and Financial Services, 2014, p.24) to support shareholder theory (Kofman and Murawski, 2015, Lindorff and Peck, 2010, Griffiths, 2007, p.231) instead of stakeholders’ interests to develop social capital (Lindorff and Peck, 2010). Yet ASIC expects licensees and their ARs when managing conflicts of interests to put the client’s best interests first, even if not in the licensees’ or the licensees’ shareholders’ interests (Australian Securities and Investments Commission, 2016d). Conflicts of interest can be managed through disclosures (Serpell, 2008) and complying with the best interests duty, however Bruhn and Miller (2014) suggested this was not always done effectively.
Maclean and Behnam (2010) maintained financial institutions struggle to manage their regulatory compliance when the legal requirements conflict with or compromise their commercial activities. They indicated resolving this tension is critical to ensure legitimacy. In support, Lindorff and Peck (2010) wrote legitimacy requires managing these institutions for the benefit of all stakeholders, not just shareholders and employees. Therefore, whether (or not) licensing advisers through third-party aligned licensees creates tension between the licensees’ commercial interests and their clients’ best interests should determine the existence of consequential moral legitimacy. The premise is if aligned licensees’ commercial interests are consistent with the clients’ best interests, then licensing advisers through third-party aligned licensees is more difficult to challenge (Figure 1) and existing licensing retains consequential legitimacy. Establishing this is important, because Griffiths (2007) suggested focussing on immediate shareholders profits results in negative social costs to retail clients. Furthermore, Bearden (2002) pointed out financial interests can compromise advisers’ professional judgement, hence damaging the adviser-client professional relationship of trust notwithstanding the quality in the advisers’ work. Bearden (2002) contended a defining characteristic of any profession is conflicts of interests matters and should be avoided (Bearden, 2002). Any incompatibility between the institutions’ values and the professional values of the adviser manifests into institutional-professional conflicts, which requires compromise (Bamber and Iyer, 2002). In light of Australian policymakers’ push for professional standards (Parliamentary Joint Committee on Corporations and Financial Services, 2015), English (2008) indicated to decrease the likelihood of experiencing this conflict, professionals should work in institutions sharing the same values and goals as the profession.
Procedural moral legitimacy is the moral assessment of the entity’s socially acceptable practices, standards and procedures (Suchman, 1995, p. 579). In legitimacy theory, decoupling (Cole and Salimath, 2013) occurs where formal policies, processes and rules for legislative compliance differ from actual practice (Carruthers, 1995) and behaviour (Scott, 2014). Unconfirmed are allegations licensees implement legislated practices, standards and procedures reinforcing the advisers’ product distribution role (Parliamentary Joint Committee on Corporations and Financial Services, 2014, p.24), which Sampson (2010) contended is sometimes without detection. Secondary non-academic sources claimed Australian aligned licensees limited their ARs to recommendations of mainly products they select and assess for the approved product list (Australian Government, 2014, Sheehan, 2016). Additionally, Lee (2007) suggested licensees and their representatives are linked to a deceptive sales culture, where these representatives are used to cross- and up-sell specific products from the approved product lists (APL). West (2009) alleged there is no reason why aligned licensees would want their representatives to retain, recommend or include on their APLs a competitor’s financial products. ASIC found in a review the statutory fiduciary duty obligations failed to impact most institutions’ APLs, except for a few amendments such as a reduction in the number or types of products on the list (Australian Securities and Investments Commission, 2014). Newnham (2012) maintained licensees are adept at keeping in place distribution channels masquerading as sources of advice. Except for the inductive qualitative analysis by Maclean and Behnam (2010) of a US financial services organization where widespread deceptive sales practices occurred, there is a deficiency in Australian research empirically validating or verifying the above claims.
In this aspect, future research should empirically verify the licensing’s procedural moral legitimacy by examining the existence of perceptions that licensing advisers through third-party aligned licensees result (or not) in deceptive sales procedures, standards and practices to reinforce product distribution, while giving the appearance (window dressing) of satisfying regulatory requirements. Should this not be the case, then the licensing demonstrates procedural legitimacy (Figure 1). This information is significant, because Maclean and Behnam (2010) demonstrated decoupling the compliance program from practice results in the loss of external legitimacy, because internal legitimacy of the formal compliance program is damaged, which then culminates in unethical practices becoming institutionalized. An Australian study by Smith (2009) suggested an ethical culture promoting ethical behaviour within AFSL licensees is dependent on the presence of formal and informal systems and procedures.
Suchman (1995) defined structural moral legitimacy as the moral evaluation of adopting formal structures acceptable to society. Presently under the existing licensing regime a licensee appoints, authorises and regulates multiple representatives (Australian Government, 2014). Significantly, doctors may prescribe certain pharmaceutical products they favour (Everingham, 2014), but they are not licensed to practice their craft through these third-party pharmaceutical institutions. Lawyers, doctors and accountants work for corporate commercial institutions but they retain autonomy and control within their job role (Rubin, 2015). When lawyers (Arteta, 2016; Australian Bar Association, 2016) and doctors (Medical Board of Australia, 2012) leave their workplace they retain their professional status, their license to practice and ability to work without needing to transfer to other corporate institutions. Similarly, when accountants leave public practice they can retain their registration with their professional associations (Bamber and Iyer, 2002; Institute of Chartered Accountants of Australia, 2012). Bearden (2002), Cheetham and Chivers (2005) set out numerous characteristics of a profession, which is further supported by a substantial body of literature (see for example, Watts and Murphy, 2009; Frumento and Korenman, 2013). Through their independent bodies such as the Medical Board of Australia, Law Societies of each State, Australian Bar Association, Institute of Chartered Accountants Australian Board and the CPA Board, Tom (1995, p.3) noted each new entrant into the profession must meet their specific entrance and ongoing requirements. These characteristics, Cheetham and Chivers (2005) held, provides a profession its legitimacy. In contrast, Australian financial advisers are not self-regulatory, collegial, independent, structured, hierarchical and client-focussed (Riaz
The present debate in the media revolves around advisers being viewed as quasi-employees controlled by their licensees (Pokrajac, 2014). This may be a problem, because Smith
Personal moral legitimacy is achieved through the moral and social evaluations of charismatic individuals’ roles (Carnegie and O’Connell, 2012; Goretzki
Legitimacy is not only about the “right to exist” (Pellegrino and Lodhia, 2012, p.70) and the “the right thing to do” (Yeung, 2009, p. 286) to meet legal and moral obligations. Additionally, cultural-cognitive legitimacy is a perception of shared understanding, activities, norms and beliefs (Santana, 2012) with the aim to perpetuate an institutional order (Kury, 2007) based on cognition or awareness (Meyer, 2007). With assumedly shared common understandings, activities, norms and beliefs with their clients and the media, ARs under the their licensees’ control, operationally enact the rules (Kury, 2007) as specified in the Act. In other words, with cognitive legitimacy it is taken-for-granted (Carnegie and O’Connell, 2012) “this is how we do things” (Kury, 2007, p.373) (Figure 1). Namely, ASIC appoints, authorises and regulates individual advisers through third party licensees. Simply, with the legislation clients and their advisers should have as Scott (2014) notably theorises a shared understanding as to 1) who they are (identity), 2) what is expected of them (role) and 3) how effective they are (performance). With identity Arman and Shackman (2012) purported the Australian general public can distinguish between the different designations in the medical, legal and accounting professions, yet they cannot do the same for advisers. With adviser roles, some government officials contended, Bernie Ripoll’s FoFA reform recommendations provided a strong legal framework distinguishing advice from sales (Commonwealth of Australia, 2014c). As a refutation, North (2015) explained, because the definition of financial advice is narrowly tied to product, the Act does not assist in clearly distinguishing the delivery of independent professional advice from financial product sales advice. Accordingly, clients and their advisers should have a shared understanding of the advisers’ identity and role so the objectives of the Act can be achieved (performance). For purposes of this paper, the objectives include inter alia protecting the public, aligning the adviser-client interests, managing, controlling or avoiding conflicts of interests and encouraging competition between financial services providers (Corbett,1999, Ap, 2011). Perkins and Monahan (2011) wrote achieving these objectives is important for the sake of public support, trust and confidence in the financial advice industry.
In light of the previous discussion, personal moral legitimacy of the licensing model is evident, if the distinction between independent financial advice (independent adviser) and conflicted financial advice (aligned adviser) to achieve the objectives of the Act is clear to the Australian public (as depicted by Figure 1). This is important to establish, because Rubin (2015) argued confusion around titles and designations undermines the trust society requires to justify granting individuals professional autonomy, necessary to qualify as true professionals.
The existing literature seems to take a negative view on advisers being appointed, authorised and regulated through third party licensees. It seems, the difficulty in obtaining a balanced view, is due to the deficiency in financial planning theory and availability of empirical evidence that is supported by epistemologically sound conceptual frameworks to understand the legitimacy of the licensing model. Not only is the legitimacy of the current licensing model for individual advisers inconclusive and under-researched, but also whether licensing advisers through third party licensees is a significant problem is unclear. Consequently, in an area where no prior research is evident, we apply an established theoretical framework to examining the legitimacy of the current AR licensing model. The framework provides an opportunity to develop a standard instrument for further empirical analysis using dimensions such as regulative, consequential, structural, procedural, personal and cultural-cognitive as criteria to capture the perceptions, for example of ARs, regarding the desirability, proprietary, or appropriateness of the current AR licensing model. The application of Suchman (1995, p. 574) theory will not only advance financial planning theory, but also provide a scholarly platform for future empirical research to provide policymakers, domestically and internationally, with initial data and analysis tool to assist with policy decisions around the regulation of individual advisers.
Within the predominantly FoFA legislative framework, Australian financial advisers are appointed, authorised and regulated through third party licensees as specified in the Commonwealth Corporations Act 2001. Licensing advisers in this manner is apparently confronted by mainly negative mixed messages from various stakeholders without any compelling scientific-based evidence of what is appropriate for this emerging profession. Without enough peer reviewed financial planning literature supported by epistemologically sound definitions, principles, models, norms and decision rubrics, it is difficult to present a balanced view in the paper. No academic researchers have yet attempted to define, model and measure the legitimacy of the licensing model, because seemingly the conceptual construct is difficult to define and quantify. The proposed rectification is applying Suchman’s theoretical legitimacy framework as a theoretical foundation to obtain conclusive evidence to validate whether (or not) the licensing model is legitimate. Not only will this advance financial planning theory, but will also raise questions for further investigation. Furthermore, empirical data collected using this framework will provide policymakers concrete evidence to make decisions around licensing individual advisers without having to rely on unconfirmed claims. Until empirical research based on a theoretical construct is undertaken, a vacuum in financial planning scholarly theory, empirical research literature, as well as the myths and unsubstantiated arguments surrounding licensing advisers through third party licensees will remain. This study therefore proposes Suchman’s legitimacy theoretical framework as an important theoretical contribution to empirically evaluate and verify the legitimacy of the current licensing model for individual financial advisers.