The interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was released on 28 September 2018. The final report is due by 1 February 2019. Financial institutions have plenty to do before February.
Make submissions on the “issues” raised by 26 October
The interim report does not recommend changes to the legal framework or the regulators. Instead it invites submissions on 100s of issues. Many of the issues are expressed in broad terms and the interim report also asks whether the regime should be simplified. It is possible that the recommendations in the final report will be as broad and this could lead to unintended consequences. There is also a risk that financial institutions or industry bodies will not be able to successfully influence the final form of any resulting law changes given the pressure on politicians and Treasury to implement recommendations.
There are several broadly expressed issues asked in relation to financial advice. For example the interim report asks should financial product manufacturers be permitted to provide financial advice. Given how broad the definition of “financial product advice” is, it is very difficult for a product manufacturer not to provide general advice and comply with its other legal obligations. Perhaps the question related to “personal financial advice”? Does this also mean that superannuation trustees would be obliged to outsource intra-fund advice?
Do you make a submission on relevant issues by 26 October 2018 or hope the recommendations in the final report or any resulting law changes will be more precise?
Respond to findings in the interim report?
One of the functions of the Commission is to inquire into whether any conduct might have amounted to misconduct and if so whether the question of proceedings should be referred to the relevant government agency. The interim report contains many findings in relation to the case studies in rounds 1 to 4. The interim report is clear that the Commission is not seeking information relating to individual disputes or instances of misconduct or conduct falling below community standards. It appears that the Commission is not seeking further submissions from financial institutions that were the subject of case studies.
However, there are still things to do in relation to the findings and other breaches disclosed to the Commission including:
- remediating errors
- defending any action that might be brought by regulators or others
- changing business and compliance models (noting comments in the interim report that remediation without addressing the root cause may not be enough).
Expect more prosecutions?
Absolutely. The Commission is clearly of the view that regulators should prosecute more and no doubt regulators will feel pressure to do so. Below are just some quotes from the interim report in relation to ASIC:
- the ASIC Capability Review found, in 2015, that ASIC’s litigation strategy is risk averse and that ASIC does not pursue strategically important litigation
- ASIC has almost always sought to negotiate …very often remediation of customers has taken centre stage
- I do not accept that the appropriate response to the problem of allocating scarce resources is for a regulator to avoid compulsory enforcement action and instead attempt to settle all delinquencies by agreement
- the regulator is not called on to choose between remediation and enforcement. Often, enforcement will induce an entity to set about remedying the consequences of its default, or committing to doing so, before the penalty is fixed.
Prepare for round 7 in November
The next round and final round of hearings (round 7) will focus on policy questions arising from the first 6 rounds. Round 7 will be held from 19-30 November 2018. Chief executive officers of several institutions are expected to appear and we also expect regulators and experts to be called. Entities are likely be receive notices to produce more documents most likely in relation to key issues that arose in rounds 1 to 6 that are most relevant to CEOs.
Details about topics and case studies to be heard will be published prior to the hearings commencing. Topics are likely to relate to the themes covered by the notices to produce.
Change business and compliance models?
The interim report acknowledges that entities and regulators have announced changes in response to what has been revealed or what is anticipated to come out of the Commission. These include announcements about new programs for refunds to and remediation for consumers affected by the entity’s conduct, about the abandonment of products or changes to practices, about the sale of whole divisions of the business, about new and more intense regulatory focus on particular activities, and even about the institution of enforcement proceedings of a kind seldom previously brought. There have been changes in industry structure and industry remuneration.
We expect the changes to continue, particularly in relation to superannuation and life insurance.
Breach reporting processes should be reviewed given the Commission’s and ASIC’s focus on failures to report significant breaches in the time required by section 912D and the Commission noting that ASIC has taken no step to prosecute any licensee for contravention of section 912D. We expect ASIC will be under pressure to prosecute licensees that breach section 912D.
Review insurance policies
Insurance premiums for directors and officers (D&O) policies were already on the increase before the Commission. Insurers have also sought to confine their exposure to the Commission by introducing exclusions, in particular for financial services institutions. Generally, these exclusions are broad. This breadth is partly due to the Commission’s terms of reference including conduct that fell below community standards and expectations.
Where insurers are seeking to introduce Commission exclusions to a company’s policies, the language of the exclusion should be carefully considered to limit the scope as much as possible. At first instance, companies should explore whether it would be possible to resist a Commission exclusion altogether, although this may be very difficult. If this cannot be achieved, requests could be made to limit the application of the Commission exclusion to particular sections of the policy.
It would be also prudent for financial institutions to notify circumstances which may give rise to a claim coming out of the Commission prior to renewal. Companies should weigh up the benefit of a broad notification against the risk of aggregating all claims to one policy period. The scope of the notification should be informed by the scope of the proposed the Commission exclusion.
Boards can get a head start on a governance review
There are a number of themes coming out of the interim report that are sure to drive the final recommendations. Boards of financial institutions will no doubt be considering a number of governance measures to respond to those themes.
- addressing the Commissioner’s observations about a culture of greed and dishonesty, (remarks which led the CEO of the ABA to describe the release of the interim report as a “day of shame” for Australia’s banks) by reviewing the culture and values of the organisation, and the means by which to inculcate a customer-focussed culture more effectively
- reviewing remuneration structures for employees, especially sales-based variable remuneration for front line staff, but also for managers and senior executives
- reviewing commission structures for intermediaries, especially trailing commissions for mortgage brokers and grandfathered commissions for financial advisers
- addressing business structures that lead to conflicts of interest. As noted above, the Commissioner has questioned whether an entity that manufactures or sells investment products can also provide personal financial advice. (The superannuation round, not covered by the interim report, also raised issues of structural conflicts for superannuation trustees.)
- improving reporting structures for compliance and risk management failures, to ensure that the Board and senior management are informed of failures and can take steps to rectify them. This will already be underway as a consequence of APRA’s requests for self-assessment of non-financial risk management, following its CBA report.
Prepare for the final report
The final report is due by 1 February 2019. In addition to covering rounds 5 to 7 (i.e. the superannuation, insurance and policy rounds) the final report might also include:
- recommendations in relation to sector wide law reform where there is a clearly defined advantage.
- changes to the recommendations of the ASIC Enforcement Review Taskforce. The Government proposed to consider the final report alongside the taskforce’s 20 recommendations that relate to self-reporting of breaches, industry codes and ASIC's directions powers.
- whether criminal or civil proceedings in relation to misconduct that might have occurred should be referred to a government agency.
It seems unlikely that the final report will recommend extensive reforms. The interim report states “given the existing breadth and complexity of the regulation of the financial services industry, adding any new layer of law or regulation will add a new layer of compliance cost and complexity. That should not be done unless there is a clearly identified advantage.”