In my column today I reflect on the explosion in fund managers raising money via LICs/LITs and how these vehicles allow them to legally circumvent the Future of Financial Advice laws that expressly ban payments of conflicted sales commissions to brokers/advisers selling funds to retail investors (click on this link to read the full column for free or AFR subs can click here). Excerpt enclosed:
Parliament originally introduced the FOFA reforms to stop product manufacturers, mainly fund managers, paying conflicted sales commissions to advisers and/or brokers - or anyone with a financial services licence - providing advice to retail investors.
FOFA does not apply to wholesale (as opposed to retail) investors, nor to any normal business issuing shares, senior bonds, subordinated bonds or hybrids (preferred equity) to raise money to fund their operations. In these cases, conflicted commissions are permitted.
When these laws were introduced in 2012, they applied to all investment entities, including both listed and unlisted funds and investment companies. In 2014, however, sustained industry lobbying convinced politicians to exempt listed investment companies and trusts from FOFA's all-important reach.
Fund managers are now simply shifting their capital raising efforts on to the ASX to allow them to side-step FOFA completely.
As a consequence, there has been a tsunami of new listed investment companies (LICs) and listed investment trusts (LITs) launched since 2017, raising more than $6 billion for fund managers who have paid brokers/advisers enormous sales commissions of up to 3 per cent of the value of the capital contributed by mums and dads. This includes big names like Wilson Asset Management, Magellan, Platinum, VGI, and many others.
In dollar terms, fund managers have paid over $150 million in conflicted commissions to get brokers/advisers to push their products to retail investors, often in incredibly short timeframes.
For the vast majority of fund managers rushing to exploit this huge loophole, there is zero chance they could secure this volume of capital as quickly as they can on the ASX through normal FOFA-compliant channels.
And there is a real risk that advisers and brokers incented by large sales commissions promote complex strategies on to retail investors that do not properly understand the products.
Justin Baiocchi
The article makes it sound like this 'nefarious' practice suddenly developed overnight in response to FOFA. Yet, for years companies listing on the ASX, be it a LIC or a LIT or a regular Limited company, have all paid brokers commissions to find buyers for their shares. In some cases, brokers then pass on a portion of their commission to advisers who deal with direct investment clients. So your criticism is mostly aimed at the stockbroking sector, which was granted a FOFA carve-out as FOFA would have basically ended stockbroking as a profession. I'm really not sure what the issue is here. Since time began brokers have been paid a commission to sell shares to their clients, be they individuals or advisers who then recommend the investment to their client. As far as the adviser is concerned, there is still the Best Interests Duty which would apply, which would cover any reckless recommendations to clients to invest in a LIC. Ending this 'loophole' would effectively end the ability of a listing entity to gain widespread distribution of its shares prior to listing, severely crimping the ASX as a means of raising capital. Is that what you want?
Christopher Joye
No Justin, that is totally incorrect. As I say in my article: "FOFA does not apply to wholesale (as opposed to retail) investors, nor to any normal business issuing shares, senior bonds, subordinated bonds or hybrids (preferred equity) to raise money to fund their operations. In these cases, conflicted commissions are permitted." Nobody is trying to get FOFA to apply to a company issuing debt or equity securities to raise funding for working capital. Where FOFA does apply normally is to all investment products---it prevents people paying conflicted commissions to brokers/advisers to sell investment strategies (ie, funds) to retail investors, though these commissions are allowed for wholesale investors. After FOFA became law, the industry lobbied to have LICs/LITs excluded, and they became exempt. We have since seen fund managers shift capital raising to the ASX so they can use conflicted commissions to raise money from retail investors. Without these commissions, these funds would not raise a fraction of this money through normal FOFA channels.
Justin Baiocchi
Thanks Christopher, I think I see your point - if I could paraphrase: what's the difference between a fund manager paying an adviser a commission to recommend an unlisted managed fund to a client (now banned under FOFA), and a fund manager paying an adviser a commission to recommend participating in a LIC/LIT IPO to a client (not banned under FOFA)? I guess the recommended 'product' is slightly different, but yes I see there is an anomaly there which needs further consideration. As an adviser myself, we have always refused to accept commission payments in such cases, or required it to be paid to the client. But then again, 99% of the 'product' being pushed by the brokers/lead arrangers/IPO managers is such rubbish that we're rarely ever troubled by this scenario.
Christopher Joye
agreed!