Wed 10 2018
Royal Commissioner Kenneth Hayne’s interim report
Royal Commissioner Kenneth Hayne’s interim report contains no specific recommendations, and no draft recommendations, but rather postulates two main questions for further consideration:
- Why did it happen?
- What can be done to prevent the conduct happening again?
This long, but surprisingly readable interim report provides considerable insight into the Commissioner’s thinking so far on the topics considered: responsible lending, financial advice, SME, agricultural lending, remote communities, and regulation and the regulators. The interim report did not include material in relation to insurance and superannuation.
The Royal Commission case study process has shone disinfecting sunlight on the conduct of financial services entities which have not met community standards or expectations, and in some instances do not comply with the law. Many of the case studies considered by the Royal Commission re-examined conduct which was already known to the regulators and to others. Nevertheless, by considering case after case, focusing on the most egregious behaviours, and intensely and precisely questioning senior management, the Commissioner escalated such conduct into the public arena and onto front pages. There has been no opportunity for excuse making and prevarication; financial services providers have been exposed to public condemnation and opprobrium.
Commissioner Hayne clearly thinks financial service providers must do the right thing by consumers. They operate in this industry by virtue of a social licence and accordingly have a community ethical responsibility as well as a legal one. Personal consumer responsibility is not tackled by the Commissioner in this interim report. Rather he suggests that the imbalance of power between the financial services provider and the consumer properly imposes a higher conduct standard on the provider of the product or service.
Why did it happen?
The Commissioner has not hesitated in identifying greed – which he defines as the pursuit of short term profit at the expense of basic standards of honesty- as a key reason for the misconduct which has been brought to public attention and condemnation. He has posed questions relating to financial incentives to staff, questioning why such incentives are necessary, and challenging the premise that staff and intermediaries will not do their job properly and to the best of their ability without incentive payments.
He also sheets home responsibility to failures by ASIC and APRA to properly investigate, prosecute or punish misconduct.
“The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court. Much more often than not, when misconduct was revealed, little happened beyond apology from the entity, a drawn out remediation program and protracted negotiation with ASIC of a media release, an infringement notice, or an enforceable undertaking that acknowledged no more than that ASIC had ‘concerns’ about the entity’s conduct. Infringement notices imposed penalties that were immaterial for the large banks. “
It is likely, therefore, that ensuring that Regulators use the powers they already have to ensure proper conduct will be a focus for the Royal Commissioner. Statements from the new ASIC Chair James Shipton (to the Parliamentary Joint Committee on Corporations and Financial Services) in relation to the necessity for more powers, and for greater funding may also find fertile ground in the final recommendations of the RC.
What can be done to prevent the conduct happening again?
There is a recognition in the Interim Report that pre-emptive steps are already being taken to address poor conduct. Heads have rolled, remediation programs have been implemented, offending products and practices have been abandoned, businesses have been sold and remuneration practices changed. Commissioner Hayne would also be aware of the multiple class actions that have commenced against various firms, and other litigation has been initiated by ASIC.
Nevertheless, these changes are not enough.
The Commissioner was very critical that entities could not readily identify how, or to what extent, the entity as a whole was failing to comply with the law. As a consequence it was easy to explain particular events by reference to a pocket of poor culture, when in fact boards and management did not have a complete understanding of the nature or extent of compliance failures. Commissioner Hayne noted that poor conduct occurred in all the major entities, and could not be characterised in a way to contain that misconduct, and distance the entity from responsibility. Rather the root cause of poor conduct often lay with the systems, processes and culture cultivated by the entity.
So cultural change is likely to be an essential theme of the final report. This could be implemented by extending the Banking Executive Accountability Regime to financial services entities. (Currently, the BEAR is intended to hold banks and their senior directors and executives, holding positions of trust or responsibility, to a heightened standard of responsibility and accountability, overlaying, rather than replacing or changing the existing framework of corporate law. Extensive provisions apply to those described as accountable persons, and significant penalties apply.)
Treatment of conflicts of interest and duty were also seen to demonstrate
“the validity of a basic observation of the world: that the choice between interest and duty is resolved, more often than not, in favour of self-interest. And they are results that, on their face, deny a fundamental premise for the legislative scheme of the FOFA reforms: that conflicts of interest can be managed by saying to advisers ’prefer the client’s interest to your own’. Experience (too often, hard and bitter experience) shows that conflicts cannot be managed.”
Likely, therefore, will be the end of grandfathering of remuneration provisions, and perhaps also a legislative reframing of other remuneration provisions.
Also likely is a requirement for a stronger Regulator response, such as a requirement that Regulators prosecute misconduct, and enforce a more punitive approach. Unlikely are further detailed regulatory requirements. Commissioner Hayne is clearly of the view that the current requirements already oblige financial services entities to:
“apply basic standards of fairness and honesty: by obeying the law; not misleading or deceiving; acting fairly; providing services that are fit for purpose; delivering services with reasonable care and skill; and, when acting for another, acting in the best interests of that other…”
The existing law is ‘labyrinthine and overly detailed‘ and in the ‘blizzard’ of legislative requirements, it is too easy to lose sight of these simple ideas informing the conduct of financial services entities.
The Commissioner’s Interim Report postulates further significant issues, questions, and observations. We set some of them out here. Keen observers of social and economic history will want to read the whole 1,000 pages.
Heather advises on all regulatory, compliance, investment, tax and contractual issues, as well as acting in connection with disputes, regulator actions, product development, fund mergers and restructurings, and other transactions...More about Heather
Anne is a leading superannuation and financial services lawyer with deep knowledge and understanding of the superannuation and financial services industry...More about Anne
Mark specialises in corporate insolvency matters, commercial litigation and corporations law disputes, intellectual property and copyright litigation, and financial services disputes including securities enforcement...More about Mark
Jacob is a member of Hall & Wilcox’s commercial dispute resolution team, practising predominantly in general commercial litigation.More about Jacob
You might be also interested in...
Thinking | Thu 03 2007
The first tranche of draft regulations was released for public consultation on 26 March 2007 as part of the Corporations and Financial Services Regulation Review process. Some key issues dealt with in the first round of draft regulations are set out below: Keeping Financial Services Guides and Product Disclosure Statements up to date Where there […]
Thinking | Mon 05 2007
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 […]