Should financial advisers be involved in the recovery of funds? Where can they get information and assistance on this issue? What are their responsibilities to the affected clients?
Currently more than $25 billion of investors' funds are locked up in managed funds that are frozen. To put this figure into context, the total funds under management in retail products is about $642 billion.
This represents no less than 72 funds that currently have a frozen status. It means clients in these funds are unable to access their money; that they have effectively illiquid investments.
Mortgage funds account for about $15 billion of this total frozen amount. Most of these funds have had their frozen status since 2008 when mortgage assets became illiquid and there was a flight to safety following the introduction of the government guarantee on bank deposits.
Recent reports indicate many mortgage funds are now offering investors partial withdrawal, however, it is still a situation where two years on investors do not have all their money back.
Further, for the investors with an estimated $8 billion in frozen property funds and a further $2 billion in fixed interest credit funds, no such progress is being made.
Add to this environment the steady stream of corporate collapses and failed investments - including Timbercorp, Great Southern, Storm Financial, Westpoint, Sonray Capital Markets and Trio Capital - and the number of investors now affected by frozen or lost funds is alarming.
Mind the information gap
The failure to effectively manage such investors could lead to further reputation damage for the financial planning industry, a point duly noted by ASIC.
"If an adviser does not actively manage the client relationship following a corporate collapse or freezing of a fund, it is likely that the client will decide not to retain the adviser's services," ASIC senior executive leader for financial literacy, consumers, advisers and retail investors Delia Rickard says.
"A dissatisfied and disillusioned client is dangerous for an industry that is trying to regain consumer confidence."
The FPA does not currently have an existing comprehensive policy on the issue.
When IFA requested an interview on the topic, a three-page policy document titled "Responding to Corporate Collapses - how planners can help" was created. FPA chief executive officer Mark Rantall says there is "room for this sort of education in what tends to be [a] reactive rather than proactive [area]".
Many industry participants pointed to ASIC as the main source of assistance for planners managing affected clients.
However, like the FPA, ASIC did not point IFA to any pre-existing information on the topic, but rather to a prepared written response. This response identified ASIC's consumer website, Fido, as a possible source of guidance for financial advisers as well as industry associations such as the FPA and the Financial Services Council (FSC).
And while the FSC was tremendously enthusiastic about the topic, it could not direct IFA to any information on the topic or to meet our interview deadline.
The legal fraternity and administrators were obvious ports of call for this story, but their input was limited.
Litigation firms highlighted they were currently acting on behalf of individuals and class actions taken against financial planners. They therefore did not want to be seen to be offering planners advice on how to better handle the situation.
Finally, the educators - surely this was a topic covered off by any number of education providers?
Not so, says Pinnacle Financial Services Academy managing director John Prowse.
"I don't think many people have comprehensive text on this because, firstly, there are so many variations as to why companies collapse. It is hard to draw up every possible scenario. Secondly, a lot of best practice involves legal matters and it is not good to run scenarios because it might be seen to be giving legal advice," Prowse says. He says while educators make planners aware of fund freezes and the role of research houses and approved product lists (APL), the level of detail varies and it is not a topic covered specifically by ASIC Regulatory Guideline 146.
Meanwhile, the Association of Independently Owned Financial Planners (AIOFP) is so concerned about the issue that last year it established its Filtered Research Centre using the services of Mercer and McGregor Asset Consulting in an attempt to deliver non-conflicted research to members.
"Research is the most important thing," AIOFP executive director Peter Johnston says.
"If you have a corrupted APL, you're an accident waiting to happen."
Reasons for freezes and collapses
Fund freezes, investment failures and corporate collapses have become more common incidences over the past two years.
"Things have stepped up," Slater & Gordon Lawyers commercial litigation and public liability practice group leader in Brisbane Damian Scattini says.
"The financial industry including the banks was pretty much drunk at the wheel in 2006, 2007 and 2008 and we're still reaping what was sowed back then."
According to Morningstar Australasia fund analysis manager Chris Douglas, fund freezes are not usually a common occurrence.
"Up until 2007 they were a very rare occurrence and when they happened there was a good reason for it and there still is, but the more it goes on and on, it isn't good for anyone," Douglas says.
Every fund manager has a mandate to elect to freeze a fund. Douglas says the typical reason they would choose to exercise this mandate is to protect the existing investors within a fund and to make sure everyone is treated fairly.
Certainly investment conditions experienced during the global financial crisis (GFC) fuelled the need for managed funds to be frozen. While many of the mortgage funds are now thawing out with partial redemptions available, in the case of the property and fixed interest credit funds, the large amount of unlisted assets in these investments makes it difficult to sell off these assets quickly.
But there are, of course, more sinister reasons behind fund freezes. For example, the Basis Capital Yield Fund was frozen in 2007 due to underlying leverage within the fund and the fact valuations were 10 per cent less than what the market perceived them to be.
The fund also had structural issues with the pricing of assets. Douglas says here the fund had to be frozen to keep the situation under control. Financial planners were implicated in the situation through misrepresentation of what the hedge fund actually was.
In the case of corporate failures - such as ABC Learning, Storm Financial, Strathfield, Allco Finance Group, MFS and Opes Prime - debt-laden balance sheets, unsustainable business models, poor management and indeed a dramatic change in the business cycle exposed these companies' true colours.
According to the FPA, fund freezes and collapses will continue to occur.
"Corporate collapses are a fact of life in the modern economy," FPA compliance manager for professionalism John Bacon says.
"Thankfully they don't happen too often. But they do happen, and even the best planners can expect to have to deal with this issue at least once or twice during the course of their professional career."
Information flow
Fund managers or research houses are the first to inform unit holders that a fund they are invested in has been frozen. Planners are also part of this information loop.
"I think in most cases fund managers try and keep advisers aware of what's going on and what's happening," Douglas says. "We see a lot of the documentation that fund managers give to financial advisers. In some cases the mortgage sector has not been as upfront about the withdrawal process but the performance has been better than expected."
Goodman Private Wealth Advisers chief executive and senior adviser Brad Church says wrap facilities such as BT have been very good at keeping advisers updated on the status of frozen funds, usually by email. His business has also registered its business with the fund managers of the affected funds, even if it does not use these funds.
It is in a fund manager's best interests to keep everyone informed on the situation of a frozen fund. But as Douglas says, they are unlikely to see the money return to them when the fund is reopened.
In the case of corporate collapses, Morningstar Australasia head of equities Andrew Doherty says the Australian Securities Exchange makes company announcements regarding such events and, being listed entities, there are rules that companies in this situation must follow.
Company briefings also play a big part in the communication of such events.
But IMF investment manager Charlie Gollow says the onus is on financial planners to make sure they have adequate information from a range of sources - dealer groups, industry associations and ASIC.
"If a financial adviser is doing their job, they should know anyway. Usually ones that know first are advising people to go into them or are managing them," Gollow says.
"The bottom line, however, is that a financial adviser must know the law and keep up to date with it so the obligation is on them to seek this information out if it is not delivered to them."
Adviser experience
"The most frustrating part of frozen funds is there is not much you can do other than sit and wait for everything to be resolved," Douglas says.
According to the AIOFP, when a fund is frozen or indeed an investment or company fails, the association sends out an email to find out if any of its members have been involved.
It then sends out a recommendation strategy to those affected primarily based on keeping in contact with affected clients and keeping them up to date. It also advises planners to be involved in the process of recovering funds.
"Advice applies in the good times as well as the bad," Johnston says.
Brisbane-based Goodman Private Wealth Advisers is currently working with some clients with frozen funds.
Church says these clients have come to the business during or since the GFC and for his business the starting point when managing clients with frozen funds is clear - to sell the asset. This is because a frozen fund would never have met its investment criteria in the first place based on its illiquidity or its potential to become illiquid.
If the client agrees to this strategy, the practice then turns its attention to managing the exit from the fund while overseeing the rest of the portfolio.
"We'll continue to report on investments but we will then make changes to the rest of the portfolio," Church says.
As the funds are released from the frozen fund, the business will then invest them back into the liquid part of a client's portfolio.
The business also has an in-house process that establishes a task list to remind planners to check on the status of funds.
"Often there are only windows of opportunity that allow redemptions," Church says.
"We submit requests but sometimes there are only partial sales." Melbourne-based Hewison Private Wealth also has experience working with affected clients. It had clients invested in Allco Finance hybrids and ABC Learning convertible notes as well as listed property funds.
Chief executive and private client adviser John Hewison says speed of response is the essence of the business's best practice in managing this situation.
"The faster we could communicate with clients and communicate the overall situation, they [clients] were fine even though the result was disappointing. Where there were concerns, we brought them in for a meeting and explained their exposure was very small," he says.
And there was never any concern over improper advice. "The failure of the investments wasn't a fault of ours. Our recommendations were sound, we hadn't over-exposed people and there were no legal ramifications," Hewison says.
The business's procedure has been developed through experience - the 1987 crash, the estate mortgage crisis in the 1990s - which he says on the most part, has guided the business well. For example, the business did not advise clients on mortgage funds because "mortgage funds have been in trouble that many times", he says.
What is regarded as best practice?
Taking stock of the situation, understanding how clients are affected and to what extent are the crucial first steps when managing a client faced with a frozen fund, corporate collapse or failed investment.
Doherty says if a financial adviser has a client involved in a corporate collapse, they must first have all the information they need so they can act in the best interests of their clients.
He says they should also switch out of the stock to try and achieve better returns and if the collapsed company does go into liquidation, explore the possibility of recovering lost funds.
Finally, on a regular basis, an adviser should review their client's portfolio and make sure it is weighted effectively across sectors and business risk. Doherty says in most cases, this will mean a 60 per cent exposure to blue-chip stocks, a 30 per cent exposure to second liners and then possibly some exposure to higher risk stocks.
In some cases, a client may choose to formalise a complaint against the investment or the adviser.
The FPA says it is a requirement that clients must be guided through the company's internal dispute procedure first before moving to an external dispute resolution (EDR) scheme. The Financial Ombudsman Service (FOS) or another service will then get involved if the matter is referred to an EDR scheme, but it is up to the financial planner to inform the client of their EDR rights.
The FPA warns the promptness of the lodgement of the complaint is important.
"Claims brought after a company has gone into external administration may be barred from recovery," Bacon says.
"The financial planner can play a critical role in ensuring his or her client's claims are brought in time, and have the benefit of free dispute resolution."
ASIC will get involved if the complaint involves fund managers. Planners may also be called upon to give evidence if an administrator is appointed or an ASIC investigation is called.
Bacon says because the primary role for a financial planner is around gathering accurate information, communicating to clients and reviewing the impacts on individual clients, a comprehensive communication strategy is a must, particularly in the case of clients with an ongoing service agreement who will require regular updates and possibly an early review of the impacts. The scope of this communication will be limited by the terms of a planner's licensee's professional indemnity insurance policy, so they should check this with their licensee.
"It may be better to take the initiative and contact a client that received one-off investment advice on the collapsed fund even though you don't have an ongoing service agreement with that client," Bacon says.
Rickard says in some cases planners do directly get involved in legal action on behalf of their clients. This was the case with the Great Southern and Timbercorp collapses.
"In most cases, however, the adviser's role will be limited to keeping the client informed, passing on relevant and useful information and keeping a watching brief on the status of the frozen fund or collapsed company," Rickard says.
A mutually difficult situation
Nothing can be taken away from the experience of an investor who cannot access or recover their own money, but it is also a highly challenging situation for advisers.
"This is one of the most difficult challenges a financial planner faces in the course of their professional life," Bacon says. "The financial planner has recommended the investment to their clients and the investment just doesn't underperform, the product fails altogether due to adverse market conditions for that investment or worse still because of gatekeeper failure up the line."
Johnston concurs: "Product failure is the most debilitating event that can happen to a practice and the adviser. Advisers can become almost a second 'child' to clients and to tell them their savings are under threat or lost is an adviser's worst nightmare."
It is important to highlight the circumstances behind a fund freeze or indeed a corporate collapse or investment failure will dramatically impact on the role an adviser has in assisting and managing a client's investments.
"It depends on what their relationship is," Gollow says.
IMF is a publicly listed funder of legal claims and acted against Professional Investment Services over its Westpoint actions.
"Did they place the money in this or are you managing my portfolio? Then in my view you have an obligation to deal with the situation," Gollow says.
Scattini describes a possible change in attitude a planner may have. "If you put someone into a Storm badged fund, its remarkable how someone feels the need for covering their own tail," he says.
He says this is exacerbated further because the financial planning industry is conflicted by high fees and high commission products, so the interests of the client can be skewed.
"The responsible ones deal with their clients," he says.
"But put it this way, no-one ever rings me to tell me they are happy with a financial planner."
From a practitioner's point of view, one of the most disappointing aspects of how clients with frozen or lost funds are currently managed is the lack of ongoing service provided by a client's previous financial planner.
"Our responsibility is pretty clear. Our job is to look after the clients and do what is best for them. But as an industry we are not very good at providing ongoing service. For us it is pretty straightforward to stay on top of these funds, but other groups might struggle with being proactive," Church says.
This is particularly the case, he says, for practices that only conduct annual reviews with their clients.
"At the core of this discussion is what we are doing for clients. Placing investments and moving onto the next client does not work in this situation," he says.
Gollow agrees: "One of the things they don't do well is stay close to their clients. From their perspective it might be a difficult balance because they advised clients in the first place and they might want to stick their head in the sand. They've got a fine line and there is a conflict in where they should lie with it."
A convergence of responsibilities
Why was a fund frozen or why did an investment fail in the first place? The question must be asked and Douglas says in such a situation, all relevant parties, including fund managers, research houses, dealer groups, ASIC and advisers, should work together.
But this is not always the case and often advisers feel like they are the ones who bear the brunt of the fault, irrespective of the reasons behind the collapse.
"Blame is always levelled at advisers and we would love it if product manufacturers were under the same scrutiny," Johnston says.
"Where there is a product failure, we believe the Financial Ombudsman Service should set up a committee of fund managers to put them under the same scrutiny." Bacon says if advisers have followed the FPA code of conduct, some wider questions should be asked.
"In these circumstances, the planner can rightly point to the investment gatekeepers, and ask were all the product disclosures accurate? Was the investment true to name? Did it do what it said it would do? Did the research houses express confidence in these elements on an ongoing basis? Did the trustees do their job? Did the auditors do theirs?"
From a planners' perspective, the FPA says planners can be confident in their recommendation as long as they follow the FPA code and have understood the clients circumstances, analysed the client's needs, developed suitable strategies based on a sound research process and selected investments to match a strategy.
"Moreover, in most circumstances the code requires that the investment represents a limited exposure for the client within a well-diversified investment portfolio," Bacon says.
ASIC says the percentage of the client's portfolio invested in the frozen fund or collapsed company will also be important.
"Where more than say 10 per cent is invested the client may not have been properly diversified and there may be an issue with the quality of advice," Rickard says.
Finally, also important is whether the client was geared into the investment and whether that was appropriate for the client.
