Compensation Arrangements for Financial Services Providers

Yesterday the Parliamentary Secretary to the Treasurer (Chris Pearce), announced that regulations to complement section 912B of the Corporations Act 2001 (the Act) are expected to be made by 1 July 2007. The Act requires financial services licensees that provide financial services to retail clients to have in place appropriate compensation arrangements. The arrangements must either be approved by ASIC, or satisfy the requirements specified in the regulations.

ASIC exempted financial services providers from the requirement to comply with section 912B in 2002, and this exemption is due to expire on 30 June 2007. The reason for the exemption included the difficult insurance market suffered globally in the wake of September 11 2001 and the collapse of HIH.

The proposed regulations will provide for certain licensees to be exempt and require other, non-exempt licensees, to have professional indemnity insurance. The proposed regulations will specify that section 912B is satisfied if licensees have professional indemnity insurance in place. Certain bodies which are regulated by the Australian Prudential Regulation Authority will be exempt from this requirement.

The regulations will also include transitional provisions and provisions relating to the return of the security bonds currently held by the Australian Securities and Investments Commission (ASIC) in respect of existing compensation arrangements.

The regulation will be supplemented by ASIC guidance which will assist licensees to put appropriate arrangements in place and will be released by ASIC for public consultation at the time the regulations are made.

Mandating professional indemnity insurance as proposed under the regulations is intended to reduce the possibility that affected licensees will not have adequate cover in place to compensate retail clients in the event of a successful claim, but investors need to be aware that there may be situations where claims cannot be met.

The regulations “will reduce the possibility that affected licensees will not have adequate cover in place to compensate retail clients in the event of a successful claim" Mr Pearce said. The media release suggests that the regulation is expected to have particular impact where inappropriate financial advice has been given and the retail client loses money as a consequence. The regulations will operate in tandem with existing provisions in the Act that provide avenues for retail clients who have suffered loss due, for example, to a defective advice document, to claim compensation from the licensee.

Disclosure in relation to these compensation arrangements will need to be made by financial services providers in their Financial Services Guides.