Wading in the shallows: Advice, ASIC and Accountability
On 26 June 2014, The Senate’s Economics References Committee published its report on the performance of the Australian Securities and Investments Commission.
The report has been widely covered in mainstream media. Although presented as simply an assessment of ASIC’s performance based on two distinct case studies, the report was highly critical of both ASIC and the Commonwealth Bank of Australia; criticisms relentlessly pursued and compellingly presented by Adele Ferguson in her articles for Fairfax and in her Four Corners’ story.
In the Executive Summary, the Committee observed that ASIC was “a timid, hesitant regulator, too ready and willing to accept uncritically the assurances of a large institution”. In addition, they found that:
- The conduct of a number of “rogue advisers” working in CFPL was “unethical, dishonest and well below professional standards”
- Both ASIC and CBA placed reports of fraud in the “too hard basket” concealing detection, prevention and accountability;
- There was an “inordinate delay” in CFPL recognising that advisers were providing bad advice or acting improperly;
- “CBA deliberately played down the seriousness and extent of the problems in CFPL in an attempt to avoid ASIC’s scrutiny, contain adverse publicity and minimise compensation payments”
- The CFPL scandal was a lesson for the entire industry. “Firms … cannot turn a blind eye to unprincipled employees who do whatever it takes to make profits at the expense of vulnerable investors.”
The Committee made 61 recommendations and a number of observations about both ASIC and CBA. A detailed analysis of the report, and each of the recommendations, can be found online. What follows, is a high level review of the more interesting aspects.
Culture and Leadership (but not structure).
Leadership, including the incentives put in place for and by leaders, is as important in driving behaviour as the formal values endorsed by the organisation. The Committee avoids the seductive explanation of rogue agency for a more pragmatic focus on the culture in which agents act and prosper. Importantly, they broaden their view from the distribution culture of CFPL to also consider ASIC’s culture and the environment within which they operated.
In some respects, it’s a study in contrasts; one organisation is painted as knowing and concealing, the other as knowing but not escalating or sharing that knowledge. In both cases the organisations’ prevailing cultures contributed to the failures identified by the Committee.
Thankfully, the Committee proposes a number of practical reforms to improve the Regulator’s efficiency. In addition to suggesting that ASIC needs to “develop an internal management system that fosters a receptive culture [that ensures that] misconduct reports or complaints … are elevated to the appropriate level and receive due attention” the regulator needs to “ensure that a culture of compliance results from the enforcement action.” The difficulty is that the report provides no real guidance or insight into how culture can be measured and defined and assessed.
While the recommendation that the Government establish an “independent inquiry, .. judicial inquiry or Royal Commission” attracted the most media attention it is perhaps the recommendation least likely to be effected. While it is not entirely inconceivable for such an Inquiry to be instituted, it is more likely that the Government will maintain their position that the Economics Reference Committee has already spent considerable time and exhausted considerable resources to “investigate CBA, their conduct and propose any required legislative or regulatory reforms”.
The counter-argument recognises that a week is a long time in politics and that CBA have poorly managed their response to this crisis. Announcing an Inquiry would reassure voters of the Government’s commitment to effective regulation of the financial advice industry (while they work to refine arrangements implemented by the previous Government to achieve the same aim).
Perhaps, in the interim, someone will ask why funding a Royal Commission to investigate CBA is more efficient than appropriately funding the organisation already charged with investigating CBA?
Importantly, the Senate’s regulatory reformism extends beyond malfeasance and mismanagement within CFPL to direct their gaze upon “other financial advice businesses that have recently been a source of concern”.
Oscar Wilde stated that the “only thing worse than being talked about is not being talked about”, but Macquarie Private Wealth might disagree. Notwithstanding that the publication of the report has had minimal impact on Macquarie’s share price, the prospect of being closely and publicly scrutinised by a regulator publicly rebuked for its timidity and toothlessness is worrisome; even without the possibility of increased penalties and more diverse regulatory actions.
A sleeping watchdog?
The Committee’s public rebuke of ASIC exposes a curious asymmetry between observers of, and participants in, the financial services industry. Few of those participants who have been actively and doggedly “regulated” by ASIC would accuse ASIC of either toothlessness or timidity – a point recently made by Commissioner Medcraft when he declared his willingness to pursue any “big institution”. Given the allegations that CBA deliberately sought to conceal relevant information, one might wonder how a more aggressive approach would have produced a different outcome.
ASIC’s performance should be seen in context of the scale and complexity of the CBA surveillance and the resources that ASIC were able to bring to bear. The relentless pursuit of these matters through, and by, the Media has had a profound and immediate impact; but, in fairness, the results achieved by ASIC were already significant. That more can be achieved should not dismiss what has already been achieved, or trivialise the efforts of those who assiduously and invisibly laboured to achieve these ends.
The “too easy” option
Despite the tone of the Executive Summary, most of the recommendations made by the Committee are constructive (although, because of, budgetary reductions a few might be more difficult to implement than the Committee recognises).
As part of the general enhancement of regulatory powers, the Committee recommended an important administrative check and balance; the Auditor General should review ASIC’s use of Enforceable Undertakings (and comment on both the consistency of their approach and respondent’s compliance).
Enforceable Undertakings may, in many respects, be an attractive alternative to court proceedings, but as a matter of “regulatory hygiene” the Committee has recommended that ASIC review their use. In particular, the Committee recommended that ASIC review their triage system, ensure they properly identify and escalate issues and be prepared to enforce “compliance with the undertaking in court if necessary.
There are some key limitations with this approach. The penalties for breaching an Enforceable Undertaking are significantly less than the penalties for breaching the financial services laws. Accordingly, if the Enforceable Undertaking is intended to be the regulatory instrument of choice, then increased transparency and a renewed commitment to litigate non-compliance with their terms are only partial solutions. Without more significant penalties applied to non-compliance with the terms of an Enforceable Undertaking, the EU will remain a negotiated outcome with only limited and consensual force.
The discussion around Enforceable Undertakings brings us back to Macquarie Private Wealth and “other financial advice businesses that have recently been a source of concern”. On one hand, the Committee’s focus suggests a proactive view and clear support for vigorous regulatory activity. On the other hand, identifying broader concerns without making any recommendations around industry structure, vertical integration and disintermediation appears to be a wasted opportunity.
Given that some critics have identified these issues (and the ensuing conflicts) as causative of the CBA’s cultural failings the Committee’s silence might reflect a willingness to consign difficult commercial and political issues to the “too hard basket”.
Activity and funding
Addressing the popular (but inaccurate) view that ASIC was co-opted by the industry participants it is required to regulate, the Committee recommended additional resources be allocated to enforcement.
This is a curious suggestion given the Federal Government’s decision to cut $120 million dollars of ASIC’s funding over the next 5 years.
While ASIC is confident that they will cope with reduced funding, theirs may be a false confidence. In addition to consumers being forced to assume an increased responsibility for consumer protection, there should be some concern about ASIC’s capability to implement the Committee’s recommendations without additional funding. A more data driven, risk based and strategic approach to regulation may be the right response, but without adequate funding it’s more likely to be a placebo than a panacea.
Listening to Cassandra
In Greek myth, Cassandra was given the gift of prophecy; but she was also cursed never to be believed. Whistleblowers might empathise.
Looking back, there were any number of warnings given to CBA and ASIC that were either never heard, never acknowledged or simply never believed.
The lesson that must be learnt by ASIC and Industry participants is that passivity, delay or inactivity are inappropriate responses to warnings and whistleblowing. For their part, the Committee has recommended that ASIC review their processes in this respect and establish an Office of the Whistleblower. This proposal is a significant and practical reform to ensure that intelligence provided to the Regulator is more effectively acknowledged, managed and escalated.
The proposal to establish an Independent Inquiry or Royal Commission is more problematic.
Some dismiss the idea of a Royal Commission as an overreaction and simply an emotional and populist response; vindication for the whistleblowers, a forum for the aggrieved and, in addition, public shaming of the people and organisations that allowed the tragedy to occur by virtue of their greed, recklessness, inaction or incompetence.
Others recognise the proposal as the dramatic conclusion of a significant failures but suggest, pragmatically, that it would be more productive to dedicate resources and energy to current and prospective regulation than to combing over past failures.
This argument has a certain appeal; post-mortems have their value, but obsessive retrospective scrutiny might blind us to current events and distract us from identifying and preventing potential failures. But, if we don't take the opportunity to learn from these historic events, aren’t we likely to simply repeat these failures?
The allegations of systematised misfeasance, entrenched conflicts and management complicity may have been heard, but they have not been satisfactorily addressed by the Committee.
CBA have publicly apologised and committed themselves to achieving significant internal reforms; revising incentives and remuneration models, driving cultural change and offering compensation. But despite the public show of contrition, their critics remain unconvinced that their contrition is genuine, their reforms adequate or their timing apt.
These criticisms can only be countered by explanation, accountability and transparency; but some doubt that CBA have the will or willingness to pursue these outcomes. This is what makes an independent inquiry an appealing solution. In the usual course of events, ASIC would embrace the responsibility but their reputation has been battered, their resources dispersed and their competency challenged (principally by those that don't properly appreciate the scale and complexity of these matters, the limited resources available to ASIC and the profound cultural and structural changes they’ve driven).
Compensation is perhaps the least of the issues with which CBA, and CEO Ian Narev, must deal. The forensic challenge notwithstanding, financial remediation is a simple process for a bank; but while offering appropriate compensation is necessary, it is not sufficient. The harder task is the restoration of trust in the bank and confidence in the financial services industry.
Those that dismiss the idea of a Royal Commission as a symptom of moral panic, the gratification of egos or as an expensive indulgence for an affected minority may fail to recognise the underlying issue; a burgeoning apprehension that this type of conduct is not limited to CBA.
 Recommendation 7 “12.28 The committee recommends that the government establish an independent inquiry, possibly in the form of a judicial inquiry or Royal Commission, to:
thoroughly examine the actions of the Commonwealth Bank of Australia (CBA) in relation to the misconduct of advisers and planners within the CBA's financial planning businesses and the allegations of a cover up;
identify any conduct that may amount to a breach of any law or professional standard;
review all files of clients affected or likely to be affected by the misconduct and assess the appropriateness of the compensation processes and amounts of compensation offered and provided by the CBA to these clients; and
make recommendations about ASIC and any regulatory or legislative reforms that may be required.
 Recommendation 9 “13.34 The committee recommends that the government consider increased penalties and alternatives to court action, such as infringement notices, for Australian financial services licensees that fail to lodge reports of significant breaches to ASIC within the required time.”
 One might also ask, given the appointment and ongoing involvement of an independent compliance expert in the process, how the CBA was able to conceal relevant information from the Regulator.
 For example Recommendation 8 “13.33 The committee recommends that ASIC establish a pool of approved independent experts (retired experienced and hardened business people with extensive knowledge of compliance) from which to draw when concerns emerge about a poor compliance culture in a particular company. The special expert would review and report to the company and ASIC on suspected compliance failings with the process funded by the company in question.; Recommendation 22 “17.49 The committee recommends that the balance of ASIC's enforcement special account be increased significantly.”
 Recommendation 26 “17.56 The committee requests that the Auditor-General consider conducting a performance audit of ASIC's use of enforceable undertakings, including:
the consistency of ASIC's approach to enforceable undertakings across its various stakeholder and enforcement teams; and
the arrangements in place for monitoring compliance with enforceable undertakings that ASIC has accepted.
 Recommendation 25 “17.55 The committee recommends that ASIC should more vigilantly monitor compliance with enforceable undertakings with a view to enforcing compliance with the undertaking in court if necessary.
 Recommendation 22 “17.49 The committee recommends that the balance of ASIC's enforcement special account be increased significantly”.
(c) 2014 Sean Graham. Assured Support Pty Ltd.