While RDR focuses on retail consumers, its impact will most probably be most profound on group arrangements.
Following a number of audit failures in the United States and Europe, the European Commission published rules for audit companies on 27 May 2014 that banned the auditors of companies from providing non-audit services (such as consulting) to their clients. These rules also require companies to rotate their auditors every 10 years, or 20 years if they put these services to out for bid. While US lawmakers did not make rotation of audit firms compulsory they did ban auditors from providing non-audit services to their clients.
Collective wisdom of lawmakers on either side of the Atlantic was informed by the prosecution of the auditors in the Enron case. While the ultimate cause of Enron’s failure was the unethical behaviour of its executives, the failure by its auditors, Arthur Andersen to raise the alarm in its audit of the company added to the rot and the loss, including the harm to employees’ pensions.
One of the reasons advanced for the behaviour of Arthur Andersen was that it did not want to lose non-audit income. Arthur Andersen received almost half of its income from Enron from non-audit services, revenue it did not want to lose by expressing an adverse audit opinion. The primarily role of the auditor – to provide an unbiased opinion – was compromised by a lack of independence.
When this example is extrapolated to the South African financial services industry, it becomes clearer that independence matters. When you are looking for untainted, unbiased advice, independence matters. It is fair to say that advisers who are not independent find themselves in a position similar to that experienced by Arthur Andersen – the requirement to earn additional income or satisfy a shareholder’s interest may outweigh the interest in giving the best advice to a client.
How does this affect your retirement fund?
The original RDR documents specified retail consumers as its focus. I was discussing this topic with a former colleague employed at large corporate recently who expressed the opinion that these principles should not apply to companies that provide financial services to employers and trustees. His view was that employers were educated enough and could afford to wade through the potential conflicts that they faced. His view is quite understandable given that he works for the largest consultancy in the country which is also the country’s largest pension fund administrator and largest multi-manager of investments. My view is very different – there is no reason why the proposals regarding advisers should not apply to advisers of employers and retirement funds dealing with retirement savings and group insurance arrangements. Employers and trustees aren’t professionals in financial services and should not unnecessarily spend time and money on governance tasks that can be resolved through disclosure.
It is acknowledged that for most South Africans retirement funding is the only savings that they will ever have. At the same time, it is noted that with the exception of funeral policies, insurance is often beyond the reach of low income earners except through group schemes. So, while RDR focuses on retail consumers, its impact will most probably be most profound on group arrangements (if applied there).
The retirement fund offerings of most insurers are composite products consisting of their own administration offerings, own insurance products and their own investments which are almost always on their own investment platforms. Given that these components are already provided by product suppliers that are linked, there is already very little independence in the umbrella fund system. All the large umbrella fund providers also employ their own agents who market these funds. While these agents title themselves as advisers, their advice is limited to what is permitted by their principals. One of the umbrella fund providers styles its agents as consultants but one must question the independence of advice that limits choice to the products of the employer of the consultant.
What does this all mean?
I acknowledge that independence is not the holy grail. There is no substitute for competence and skill. Having said this, consumers should never have to doubt the bona fides of their advisers. The good news is that there are advisers who meet all the criteria of being competent, skilled and independent. There are also some steps you can take to manage conflicts of interests and independence to a level to which you are comfortable:
- Insist that your advisers disclose the following minimum information:
- All remuneration that they receive directly or indirectly from the products that they recommend;
- All non-financial incentives that they receive from the products that they recommend, e.g. do they get any incentives such as overseas conferences, incentive trips, production credits, etc.;
- In the case of advisers not linked to a product provider:
- the ownership structure of the adviser (i.e. do any product suppliers/other FSPs own shares in the adviser)
- whether any of its shareholders are directors of a product supplier or its subsidiaries;
- whether any of its family members are directly employed in providing the product recommended.
- Request that your consultant compare your existing umbrella fund or risk products to similar products in the market at least every 3 years. These comparisons are important in allowing you to keep abreast of developments in the market, in ensuring that you keep your costs down and in keeping your existing provider on his toes.
- Seek a second opinion. If your consultant gave you good advice, the second opinion should support that. If not, it might be time for a change.