All NSW councils are governed by the NSW Local Government Act 1993 and its amendments (The Act). The Act requires NSW councils to formulate an investment policy and adhere to that policy regarding the management of their investments.
To help NSW councils formulate an appropriate investment policy, the Office of Local Government[1] (OLG) published a set of guidelines in May 2010 following recommendations made by Michael Cole after his review of the NSW local government sector in 2008. The OLG’s guidelines recommended the phraseology copied below be used in relation to the appointment of independent advisors. Many councils adopted this phraseology verbatim in the drafting of their subsequent investment policies.
“Council’s investment advisor must be approved by Council and licensed by the Australian Securities and Investment Commission. The advisor must be an independent person who has no actual or potential conflict of interest in relation to investment products being recommended and is free to choose the most appropriate product within the terms and conditions of the investment policy.
The independent advisor is required to provide written confirmation that they do not have any actual or potential conflicts of interest in relation to the investments they are recommending or reviewing, including that they are not receiving any commissions or other benefits in relation to the investments being recommended or reviewed.”
In the last few years, some NSW councils have started to utilise online reporting software that is linked to electronic trading platforms. The provision of an online reporting platform has been included in tenders or EOI’s for independent advisory services, and some platform providers have been successful in winning mandates as independent advisors with their reporting systems (and advisory services) being subsidised by commissions made from their trading systems.
The appointment of platform providers as independent advisors is in breach of the OLG May 2010 Guidelines as the platform providers were patently product manufacturers and distributors running a market place to distribute products via their platform and the Guidelines were issued in response to Michael Cole’s 2008 recommendations which included:
“Product manufacturers / distributors should be excluded from being appointed investment advisors to Councils.”[2]
This recommendation was made to address what Michael Cole believed to be inherent conflicts of interest between providing independent advice and earning separate fees or receiving other benefits for also providing the investment product recommended. Michael Cole’s review advocated a complete separation of duties and all his recommendations were adopted by both the OLG and the NSW Government[3].
NSW councils are in breach of their own investment policies if they have adopted the OLG’s Guidelines and use a platform provider as an independent advisor while also trading through the platform. The Act requires councils to adopt an investment policy and comply with that policy and therefore non-compliance with their investment policy is a breach of The Act[4].
The investment policy breaches are apparent both because of the “actual or potential conflicts of interest in relation to the investments recommended” which arise because the advisor also distributes (and in some cases also manufactures) the products being recommended and because some platform providers are now openly admitting receiving commissions for the distribution of product which they do not rebate to the council as per the disclaimer below.
“The information and recommendations constitute judgements as of the date of this report and take into account the information you provided to [The Platform Provider] about your investment objectives and investment policy. If the recommended product provider uses our market platform, [The Platform Provider] receives 1bp p.a. of the value of the investments they transact through the platform.”
Fortunately, there is a simple solution to this issue for NSW councils which is to separate the function of transacting and reporting via an online trading platform from the provision of independent advice; particularly when going to tender or EOI. This separation is entirely consistent with the OLG Guidelines of May 2010, Michael Cole’s Recommendations from his 2008 review and The Act.
The practice of completely separating advice from product provision is also reinforced as the best practice by the recent findings of the Hayne Financial Services Royal Commission that concluded the inherent conflicts of interest in vertically integrated businesses which provided both advice and product provision could not be effectively managed as there will always remain a bias towards recommending in-house product. Many banks have subsequently separated and sold their wealth management divisions and others are in the process of doing so.
The lessons above from the NSW Government are also an example of best practice for other industries as the findings of Michael Cole in 2008 regarding the management of conflicts of interest (they can’t be managed and need to be separated) and the OLG’s response in 2010 largely mirror the findings of Kenneth Hayne in 2019 and so serve as a template for other industries.
[1] The May 2010 Guidelines were published by the NSW Division of Local Government, Department of Premier and Cabinet (DLG) which was subsequently renamed the Office of Local Government (OLG)
[2] Recommendation 3 from the Cole Report
[3] The OLG May 2010 Guidelines state the NSW Government adopted all the Recommendations from the review completed by Michael Cole (page 5 in Section 1.1)
[4] Based on representations made by the OLG to Amicus rather than Amicus own interpretation of the Act
