The Best Interests Duty for Complex Financial Products
Meeting the best interests duty for complex or illiquid products requires more than a standard approach. Advisers must perform deep, client-specific due diligence that goes far beyond a product brochure and maintain meticulous records that show a clear, defensible reasoning process. This is the standard ASIC and AFCA expect.
From our experience, a robust and well-documented process is the best defence against regulatory scrutiny, especially when dealing with products that carry higher risks, such as unlisted schemes or hedge funds, particularly in superannuation rollovers and SMSF contexts.
Key Takeaways
- Go Beyond the Brochure: A Product Disclosure Statement (PDS) is a starting point, not the end of your research. True due diligence involves interrogating the product’s underlying assets, liquidity, governance, and fees.
- Personalisation is Paramount: The best interests duty forbids “one-size-fits-all” advice. Your recommendation must be tailored to each client’s specific objectives, financial situation, and needs, especially their tolerance for risk and need for liquidity.
- Your File Note is Your Defence: In a dispute, a detailed file note is your most important piece of evidence. It must show why a product is suitable, what alternatives were considered, and how the client is likely to be in a better position by following the advice.
- Heightened Scrutiny for SMSFs and Rollovers: Using complex products within an SMSF or as part of a superannuation rollover significantly increases the compliance burden. You must first justify the structure (the SMSF or rollover) and then the specific investment within it.
What Exactly is the Best Interests Duty for Complex Products?
The best interests duty is a legal obligation under the Corporations Act 2001. It requires financial advisers to act in the best interests of their clients when providing personal advice. For complex products, this duty is under a microscope.
Regulators like ASIC and complaint bodies like AFCA will look for clear, contemporaneous proof that you have met a series of related obligations:
- Act in the client’s best interests (s961B): This is the core duty. ASIC’s Regulatory Guide 175 (RG 175) explains that a good way to assess this is to ask: “Is the client likely to be in a better position if they follow the advice?”
- Provide appropriate advice (s961G): The advice must be suitable for the client based on their relevant personal circumstances.
- Prioritise the client’s interests (s961J): If a conflict of interest exists between you and your client, you must give priority to the client’s interests.
For complex products, meeting these duties means your files must demonstrate a considered, client-specific investigation, not just template advice.
Why is ‘One-Size-Fits-All’ Advice a Major Compliance Risk?
‘One-size-fits-all’ advice is a direct failure to meet the best interests duty because the law demands advice be tailored to each client’s unique circumstances. Treating a 30-year-old with a high tolerance for risk the same as a 60-year-old seeking capital preservation is a classic example of a breach. The latter client’s needs for liquidity and capital stability are fundamentally different.
The courts have taken a firm stance on this, particularly in cases involving superannuation rollovers. In ASIC v Westpac, the court criticised strategies that were pursued without genuine engagement with clients’ personal circumstances, highlighting that advice processes must not be used to simply funnel clients into a preferred product.
How Should Advisers Conduct Due Diligence Beyond the PDS?
A Product Disclosure Statement is a legally required document, but it’s not a substitute for your own investigation. For complex products, you must form an independent and well-researched view that is specific to your client’s situation.
In practice, this means interrogating the product beyond its marketing materials. Use ASIC’s guides for complex products, like RG 240 (Hedge funds) and RG 46 (Unlisted property schemes), as a checklist to prompt your research. Critically, you must document how the product’s specific risks intersect with your client’s goals, constraints, and time horizon. If you can’t verify or understand the material facts, that is a major red flag for its suitability.
What Key Questions Should You Ask About Complex Products?
- Underlying Assets: What are the precise assets? What is the fund’s structure and what leverage is being used? Are non-exchange-traded assets valued independently and regularly?
- Liquidity and Exits: How easy is it to get money out? You need to test redemption windows, withdrawal rights, and any triggers that could suspend access to funds. Check the product’s historical liquidity during times of market stress.
- Governance and Related Parties: What is the manager’s track record? Is there strong board oversight? Are there any related-party transactions or conflicts of interest disclosed?
- Fees and Costs: Map out all fees, both direct and performance-based. Understand how they are calculated and what the net-of-fee impact will be on returns compared to suitable, simpler alternatives.
How Do You Create a Compliant File Note?
A defensible file note is your best defence. It needs to show the process you took and the reasoning behind your recommendation, not just the conclusion. AFCA places significant weight on the quality of Statements of Advice (SOAs) and the logical chain connecting client circumstances to the final advice.
For complex products, your records should show targeted research, the alternative options you considered, and a clear explanation of why your final recommendation is likely to leave the client in a better position.
File Note Essentials with Examples
- Client Profile: Clearly document the client’s situation and objectives.
- Example: “Client is 58, has a balanced risk profile, and needs access to capital within 3 months for retirement. The primary objective is capital preservation with modest growth.”
- Key Risks Identified: Connect the product’s specific risks to the client.
- Example: “Product invests in unlisted, illiquid assets. Valuations are infrequent. It has a 12-month minimum redemption period and is classified as high-risk.”
- Clear Justification: Explain why the product is or is not suitable.
- Example: “Given the client’s stated need for liquidity within 3 months and their balanced risk profile, this illiquid product is not suitable. We recommend [Alternative Product], which has shorter redemption windows and lower volatility, consistent with their objectives.”
What are the Specific Risks for SMSFs and Complex Products?
When advising a Self-Managed Super Fund (SMSF) client on a complex product, the compliance burden doubles. Your advice must first justify the suitability of the SMSF structure itself for the client—considering the costs, risks, and responsibilities involved.
Only then can you justify the specific complex investment within the fund. Your advice must show a clear link to the SMSF’s documented investment strategy and its liquidity needs. ASIC’s updated guidance in INFO 274 (Tips for giving SMSF advice) makes it clear that advisers must address the suitability of the SMSF structure head-on.
What are the Red Flags to Watch For?
- You are unable to get clear, current information on the product’s leverage, liquidity, valuation methods, or counterparties.
- The fee structure is complex or opaque, with performance-based components that could materially alter the risk-return outcome.
- The recommendation relies heavily on the issuer’s marketing materials with little independent analysis, or the file notes use template rationales that don’t speak to the client’s unique needs.
The Bottom Line
The best interests test for complex products is met with disciplined due diligence, personalised reasoning, and meticulous records. A compliant file evidences a reasonable investigation and a suitability conclusion that is tied directly to the client’s real-world needs. This is what stands up to regulatory scrutiny—and it’s what separates a professional adviser from a product salesperson.
