'But for' compensation methodology unfair: FAAA

The methodology used to calculate compensation for victims of bad financial advice appears to factor in 'opportunity costs' and has drawn the ire of advisers, calling it "unfair" and "unsustainable" for the industry.

The "but for" methodology is how the Australian Financial Complaints Authority (AFCA) calculates compensation and how it interplays with the Compensation Scheme of Last Resort (CSLR) raised concerns at the Financial Advice Association Australia (FAAA) Congress.

By way of example, FAAA chief executive Sarah Abood pointed to a recent AFCA case whereby the victim made a profit and the balance size increased to $1.06 million.

According to the determination, the victim 'ought' to have achieved $1.33 million, resulting in compensation of $272,000.

"The AFCA methodology, in itself, is not a new thing. It's how it interacts with the CSLR, which is capped at $150,000. From our perspective, it seems completely unfair but also obviously unsustainable," she said.

"This Compensation Scheme of Last Resort should be paying, basically an income guarantee to those clients. The floor is not, 'you've lost money'. The floor is, 'well, maybe you could have done a bit better in the Vanguard Balanced fund, for example'. That's where the anger is."

At a separate session that touched on the topic, lead ombudsman for investments and advice at the Australian Financial Complaints Authority (AFCA) Shail Singh explained the reasoning behind the test.

"'But for' the failing of the adviser, where would the consumer have been invested?" he said.

"It's not about theoretical losses. It's not about opportunity costs. It's about direct loss that arose from the failings of the adviser."

Singh agreed that, from the outside, it looks like an opportunity cost calculation.

Taking the example of Commonwealth Bank, which some years ago took clients' investments out of term deposits, referred them to financial planners who invested the money in high-growth portfolios, and then lost their money.

Many people would agree that if the client remained in the term deposit, the money would not have been lost, he said, adding that AFCA wouldn't use the best-returning fund as a basis for the calculation.

"It's often one of the trickiest parts of what we do, but it's ultimately been endorsed by the courts," Singh said.

In effect, Abood sees it as the advisers "being forced to underwrite the minimum return guarantee for the clients of every failed adviser".

"The fact that client losses are defined not as money lost - as you'd expect - but the amount they would have earned had they been invested in, say, the Vanguard Balanced fund... there's a moral case and a practical case, and the moral case is it's not fair," she said.

It is impactable and unsustainable, she said, because compensation for Dixon Advisory victims has blown out to $154 million that advisers will likely pay, while the top 10 major companies will have to fork out $240 million.

"If that doesn't outrage you, I don't know what will," she said.

Abood believes forcing advisers to foot an ever-growing levy will drive them out of the profession and increase the cost of advice for those who are left.

"What we need, in terms of the methodology, is for it to be based on consumer loss and that a claim shouldn't get to the CSLR unless the clients actually lost money," she said.