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Chapter 2 - Issues raised during the hearing
2.1
The committee's hearing with Australian Securities and
Investments Commission (ASIC) officials on 13 June 2006 included discussion on
a number of issues relating to ASIC's regulatory responsibilities. These were primarily:
- ASIC's ongoing regulatory involvement with
respect to the Westpoint collapse;
-
superannuation advice and ASIC's shadow shopper
exercise;
-
ASIC's educative role;
-
conflicts of interest in the financial services
industry;
-
ASIC's new memorandum of understanding with the
Commonwealth Department of Public Prosecutions;
-
ASIC's assistance to the Victorian Police in the
Vizard matter;
-
increases to ASIC's budget funding;
-
prosecution rates for corporations law breaches;
-
the burden of financial services regulation
compliance; and
-
a proposal to incorporate a business judgment
rule into the Corporations Act.
2.2
The committee notes that a number of these issues were
also discussed with ASIC officers shortly prior to the 13 June hearing, at the
Senate Economics Committee's budget estimates hearing on 31 May 2006. As the two hearings occurred
within a two week timeframe, many committee members had taken the opportunity
to follow up on some of these matters at the committee's ASIC oversight hearing
shortly after. Consequently, this report has drawn on evidence taken during
budget estimates where it has provided the basis for discussions at the hearing
relevant to this report.
Westpoint
Backgound
2.3
The Westpoint Corporation is at the centre of a complex
mezzanine finance investment scheme that collapsed in late 2005, owing 3000 - 4000
investors up to $400 million in total. Most of the money raised for the various
property development schemes in the Westpoint group came from the issue of
promissory notes; unsecured and similar to an IOU. Westpoint offered investors
a 12 per cent p.a. return on their investment. Many were channelled into the
schemes on the advice of financial planners receiving commissions as high as
ten per cent.
2.4
Issuing promissory notes of over $50,000 to retail
investors allowed Westpoint to exploit a legal loophole, enabling them to raise
funds without meeting the usual disclosure requirements, ie registering a
prospectus or disclosure statement. Concerned they were deliberately attempting
to place their activities outside ASIC's jurisdiction, ASIC instigated
proceedings against two Westpoint mezzanine companies in the WA Supreme Court.
The court determined in favour of ASIC when it found that the notes constituted
managed investment schemes and therefore fell within the scope of the
Corporations Law. It also determined against ASIC when it ruled that the notes
were not debentures, as ASIC had argued, subject to more rigorous disclosure
requirements. They were deemed not to be a financial product and therefore ASIC
did not have jurisdiction over them, particularly with respect to acting on
Westpoint issuing misleading information to investors. Both sides appealed the
decision and the outcome is discussed at paragraph 2.15.
2.5
Although the decision technically gave ASIC the power
to wind up the scheme, ASIC Chairman Mr Jeffrey
Lucy has indicated that to seek to wind up
Westpoint in court would have required concerns over their insolvency. In the
absence of complaints that investors were not getting paid, combined with
Westpoint's auditors giving their 2004 accounts an unqualified pass, ASIC has
claimed it had little evidence to provide to the court that the appeal process
should be bypassed and the scheme wound up.[1]
Timeliness of ASIC's engagement
with Westpoint
2.6
ASIC has been subjected to criticism over the
timeliness of its response to warnings about the various Westpoint schemes well
before their ultimate collapse. Specifically, the Real Estate Consumers
Association in 2001, and the WA Department of Consumer and Employment
Protection in 2002, formally raised their concerns with ASIC.
2.7
At the Senate Economics Committee's estimates hearing
on 31 May 2006, ASIC
outlined the genesis of its later court action against Westpoint:
...in 2002 when there were discussions between the Department of
Consumer and Employment Protection in WA and staff of ASIC and consumer warnings
were issued, ASIC also started looking more closely at what could be done to
deal with the risk that seemed to exist. A matter was commenced in the
enforcement directorate of ASIC in January or February 2003 to look more
closely at this issue.[2]
2.8
ASIC explained its attempt to persuade Westpoint to
comply with their disclosure requirements; that they were not justified in
exploiting the existing legislative 'exclusion':
There was an express exclusion for promissory notes over $50,000
from the definition of ‘debentures’; that was the problem. We looked at what
could be done given that that is what the situation appeared to be, that these
were not covered by the legislation that we are tasked to regulate. We
developed an argument that we thought had some merit and we thought we needed
to raise directly with Westpoint to persuade them that what they were doing,
which purported to rely upon the exclusion, did not in fact do so.[3]
2.9
This continued until ASIC realised it was not making
progress, when court action was taken:
That occupied several months in 2003. It would be fair to say
there was a lot of toing-and-froing between ASIC and Westpoint and in particular
their lawyers, Freehills—they might say ‘toing-and-froing’; we might say ‘cat
and mousing’—over this issue. We eventually realised by the end of 2003 that we
were being stalled, we were being given the run around, and we delivered an
ultimatum to Westpoint to either comply with the argument that we had put
forward about the Corporations Act or we would take court action. We ended up taking
court action to force Westpoint to comply with the Corporations Act, based on a
very difficult technical argument that in part relied upon an interpretation of
the Bills of Exchange Act rather than the Corporations Act. Nonetheless, we had
to fight for our jurisdiction and that is what we did.[4]
2.10
The time consuming nature of achieving an outcome
through this process is obviously of concern now that Westpoint has cost
investors so much of their money. However, ASIC justified its approach on the
basis that it was the most appropriate one that could have been taken at that
time:
...the issue we were facing, as a practical pragmatic matter,
was that we were dealing with the here and now; we had to do something. It was
not a matter of waiting for law reform through the normal processes. I am not
sure how long that would have taken. We had to deal with something in the here and
now and that is what we did.[5]
2.11
In 2002, the then Parliamentary Secretary to the
Treasurer, Senator the Hon. Ian Campbell,
wrote to the WA Minister for Consumer Affairs regarding concerns over mezzanine
financing. Senator Campbell
indicated in correspondence that: 'If required, the government will consider
any recommendation ASIC makes to improve consumer protection in this area'.[6] In evidence to the committee, ASIC
defended the route it had taken through the courts, rather than seeking
legislative change:
...the decision to deliberately carve out promissory notes
greater than $50,000 was a deliberate decision taken by parliament. That
position existed. At that stage, as we have said in earlier forums, the
complaints which we received were to do with the jurisdictional issues; they
were not to do with business plan issue or business model issues. People were
not suffering financial hardship at that time through their investments.
Mr
Lucy added:
We took the matter to court. At that stage you do not know whether
or not the law needs changing until you test it in the court.
...
The legal advice was that we would be successful, and we were
not fully successful.[7]
2.12
The court's decision did, however, give ASIC the
opportunity to take action against Westpoint on the basis that its scheme had
been deemed to be a managed investment scheme. When questioned over why it did
not seek to do so, ASIC stressed that the requisite concerns about Westpoint's
solvency were not present:
...in order to take action at that point and, given that this
trial was still on foot—the proceedings were still on foot—and the relief that
we were seeking as a consequence of that finding was still before the court, we
needed to have some additional here and now urgency or some here and now risk
that meant the issue could not wait. We were very concerned about things like
financial vulnerability. We had sought further audited accounts to be lodged by
the Westpoint Group. They came back audited and unqualified, so we did not seem
to have any financial grounds on which to attack Westpoint at that point.
...
We had circulated to all the investors about the action that we had
taken in 2004. We did not hear any responses from them. In the meantime,
Westpoint was continuing to meet redemption requests. It was continuing to pay
monthly interest to investors. There did not seem, at that point, to be an
urgent issue that would require the court to take immediate action as opposed
to continuing to hear the matter in the normal course, which meant awaiting the
appeal.[8]
2.13
The committee believes that a more effective response
from ASIC may have been to seek the removal of the legislative exemption
Westpoint exploited, in order to ensure ASIC's jurisdiction over the mezzanine
schemes. However, the committee acknowledges that it is in a position to make
such an assessment with the benefit of hindsight. Once the understandable
decision to test the matter in court had been instigated, ASIC was left to
await the judgment of the court before agitating for legislative change. ASIC
contacted the relevant investors to invite them to join its action claiming
Westpoint's communications were false and misleading; none responded. Audited
accounts sought by ASIC were returned unqualified and there were no complaints
from investors regarding unpaid capital or interest.
2.14
The committee is of the view that ASIC cannot be blamed
for the deception and/or inept behaviour of the parties that contributed to
this corporate collapse. ASIC should now focus on improving investors'
financial literacy to avoid being trapped by such schemes (see later discussion
beginning at paragraph 2.47), investigating and prosecuting those that have
committed offences, and ensuring that losses through similar schemes are
prevented.
2.15
The committee notes that following ASIC's appearance
before the committee, the WA Court of Appeal upheld the original Supreme Court
judgment. Consequently, the legal loophole exploited by Westpoint may,
according to ASIC, continue to operate with respect to similar mezzanine
schemes. Following the judgment, an ASIC spokesperson was quoted as saying:
'The loophole should be plugged – that would have to be the conclusion...'.[9] Chairman Mr Jeffrey
Lucy was also quoted as suggesting the
loophole be closed by raising the exemption threshold from $50 000 to $500 000,
or more.[10]
Current investigation
2.16
ASIC informed the committee that it was in the process
of seeking intelligence from investors who lost money in the collapse:
We have sought communications from essentially all of the
investors. I cannot give you the number, but I can give you a statistic.
Investors who total $300 million in aggregate of investment out of about $350
million to $400 million have responded. We have a very high participation rate
and we are in the process of collating that intelligence.[11]
2.17
Mr Lucy
told the committee:
We are in a position where we have a very active investigation
on foot in relation to Westpoint ... we are investigating all circumstances
dealing with Westpoint, including the role of directors, officers and third
parties, including auditors. That is a matter that we are working on. We have
it in front of us, but it is not appropriate to go into any particular detail.[12]
2.18
Although ASIC has not been prepared to comment on the
specifics of the case, it has confirmed that the investigation will encompass
the role of Westpoint directors, financial services licensees, advisers
recommending the mezzanine schemes with high commissions, KPMG's role in
auditing Westpoint's accounts and advising (or otherwise) ASIC regarding
concerns over Westpoint's solvency, and other third parties. The committee also
notes ASIC's efforts to return persons of interest in their investigation to Australia.[13]
2.19
The committee also notes the possibility of investors
recovering a portion of their money through litigation if common law negligence
by the auditors can be proved.[14]
2.20
The committee urges ASIC to pursue this matter as
vigorously as possible and encourages people who invested money with Westpoint
to assist ASIC with its investigation.
Other potential investor losses
2.21
Aside from minimising the damage associated with the
Westpoint collapse and prosecuting those who have committed offences, the
committee is concerned that other, similar, high-risk mezzanine schemes could
be placing investors at risk of losing their savings.
2.22
ASIC has indicated that there are indeed other
mezzanine schemes operating that need to be monitored. At a budget estimates
hearing, Mr Lucy
stated:
...we are surveilling the Australian financial market landscape very
closely. We have dialogue with a small number of entities where we have varying
levels of concern and we think that those issues are being managed
satisfactorily.[15]
2.23
However, he told the committee that the pending court
decision prevented immediate action to unambiguously legislate these schemes
within ASIC's jurisdiction:
One of the difficulties which we all face is that we have an
open-ended appeal decision with the Western Australian Court of Appeal. Once
that decision is finalised, then we can recommend to the government that they
need to look at amendments; or, if the decision goes in our favour, then we do
not need to worry about that. We are all up in the air over that particular
issue.[16]
2.24
In a strictly regulatory sense, ASIC's principal
preventative measure has been to issue stop orders. These are utilised where
ASIC believes there has been inadequate disclosure about specific financial
products, either through the prospectus or product disclosure statement,
depending on the type of product. This prevents those subject to the order from
raising any further capital.[17]
2.25
From a consumer perspective, ASIC has also attempted to
persuade the media to take responsibility when choosing whether or not to carry
advertisements for similar high-risk mezzanine schemes.[18] However, ASIC stressed that the best way
to avoid such disasters is through literate investors seeking advice with
licensed planners:
There is a distinct advantage, in our view, in people dealing
with licensed advisers; they have very clear responsibilities. Also, we are
stressing to people that they need to take responsibility for their decisions.
They need to have regard to risk and what they can afford to lose. They need to
have regard to their own financial circumstances. They need to understand that
it is a bit like the bull’s eye in the centre. One can deposit money with an
APRA regulated bank and the risk is absolutely minimal. The further you move
out, the greater the level of risk. There is nothing wrong with undertaking
risk as long as it is properly balanced with what you can afford and what your
circumstances are as to whether or not you are employed or retired. It is a
matter of balancing. In the case of financial advisers, those are exactly the
responsibilities that they have—to know their client and to know their
products.[19]
2.26
The committee notes other similar schemes referred to
at the Senate Economics Committee's budget estimates hearing in May 2006.[20] This area is of considerable concern
to the committee and it will continue to monitor ASIC's efforts to prevent such
schemes from providing misleading information to investors.
Superannuation advice and ASIC's shadow shopper exercise
Survey results
2.27
In April 2006 ASIC released the results of its 'Shadow
Shopping Survey on Superannuation Advice', which surveyed 259 individual
advisers - representatives of 102 Australian Financial Services Licence (AFSL)
holders - to assess 306 examples of financial advice provided to real consumers.
2.28
In the committee's view, the survey results are of
major concern. ASIC found that superannuation advice did not, overall, meet its
expectations. The survey revealed that:
-
given the client's individual needs, 16 per cent
of advice was unreasonable;
-
one third of advice suggesting a switch in funds
lacked credible reasons;
-
unreasonable advice was between three and six times
more likely where a conflict of interest (eg high commissions) was present; and
-
advisers failed to give a requisite Statement of
Advice (SOA) on 46 per cent of cases (though one fifth of these were verbal
advice to stay in an existing fund).
2.29
ASIC identified the major problems as being advisers
not examining existing funds before recommending new ones, and SOAs not
adequately disclosing the reasons for recommended action and not disclosing the
consequences of switching super funds.[21]
Significantly, most clients that had received poor advice were not aware that
it was so.
2.30
ASIC stated that the breakdown of advice given on the
basis of commission or fee-for-service was 50 per cent each.[22]
Approved product lists
2.31
A major issue identified by the committee is the
relationship between super switching advice and financial services licensees'
approved product lists. When recommending a switch from one superannuation fund
to another, planners must be in a position to properly assess the relative
merits of the existing 'from' fund to the potential 'to' fund. That is, the
fund being switched to must be of greater benefit to the customer than the one
they are already in. ASIC Deputy Chairman Mr Jeremy
Cooper told the committee:
Where you are recommending a switch, you need to look at the
existing arrangements that the customer has and assess the plusses and minuses
of moving out of that product and into a new product. You need to explain those
to the client and then include them in the statement of advice. The report that
you were referring to, the super switching report, had some rather unhappy
outcomes. For example, people had existing funds, where they had quite
reasonable insurance, and through lack of care on the part of the adviser it
was recommended that they move into another product. They either lost that
insurance or ended up having to pay much more for it. We set all that out in
that report. That is really a summary of the legal obligation. It makes perfect
sense. If you are giving professional advice to someone about whether they
should move out of a fund, it is not rocket science to expect that you would
have a look at what fund they are already in and see how it stacks up with what
you are recommending. It is that simple.[23]
2.32
This requirement dictates that if a person's existing
'from' fund is not on their financial adviser's approved product list, then a
recommendation to switch cannot be made because advisers are not permitted to
provide advice about funds that are not on their licensee's list. ASIC
described this as a sensible risk management tool for licensees:
If I were a financial services licensee, I would want to know
which products my authorised representatives were advising on and which ones
they were not. If they want to advise people about moving out of a
superannuation fund into another one, they need to make sure that the list is
sufficiently broad. Otherwise, they are going to have a very small amount of
work to do in that area.[24]
2.33
The major difficulty with this situation arises when
the requirement for planners to provide advice about products only on approved
funds lists intersects with the highly commission-based structure of the
financial planning industry. In particular, industry funds do not pay commissions
to financial planners to market their product. Where a client's existing fund
is an industry-based one, ASIC admitted this can be problematic when seeking
superannuation advice:
...the remuneration model at the moment often means that many
financial advisers do not advise about industry funds. We are not making any
secret of that.[25]
2.34
Hence advisers are placed in a 'catch 22' situation
which may be factor in some of the superannuation switching advice shortcomings
detected in the ASIC survey.
2.35
However, ASIC advised the committee that this sort of
scenario was, in the context of the recently enacted Super Choice regime,
causing the industry to move towards a market-driven solution. Mr
Cooper told the committee:
I am saying to you that [the commission-based fee model] is a
difficulty, but already the industry is racing towards a solution in creating a
different fee model where people will be able to get that advice.[26]
2.36
When asked if ASIC was advocating that licensees move
to fee-for-service remuneration models, he stated:
That is for the industry. In our shadow shopping work, we show
that there is a fairly worrying correlation between commission models,
conflicts and so on and advice that does not have a reasonable basis. We will
leave it at that.[27]
2.37
The committee believes that superannuation advice
should ultimately be given on the basis of the product that is best for the
client. It welcomes any move by the industry towards providing services on a
fee-for-service basis. However, the committee recognises that this will become
a reality only when there is a change of attitude by consumers, who thus far
have shown a reticence to pay such fees. Further, for some consumers fee-based
advice would be unaffordable.
Commission-based remuneration
2.38
The role of commissions paid by the suppliers of
financial products to advisers appears to be an issue in relation to poor
advice. Some advisers are not recommending the most appropriate products for
their clients, instead preferring to encourage investment in those that offer
the greater commission-based reward. This presents a clear conflict of interest
that ASIC says needs to be managed through disclosure. ASIC has stated that
paying commissions for financial product sales is not going to be outlawed, but
the situation has to be managed when providing advice:
The people who pay commissions are the people who make the
products. The government has spoken in relation to whether or not those product
issuers can pay commissions. The landscape is that they can pay commissions.
Where we are coming from is how licensed advisers and their authorised
representatives handle that scenario where they are advising on products where
there are commissions being paid. That is an entirely different perspective. We
are not seeking to regulate whether or not product issuers can pay commissions.
We are looking at the conduct of people who give advice about those
products—that is, at how they disclose their commissions, at whether they get
bias from those commissions and at whether it makes them cut corners. That is
what we see in the shadow shopping work.[28]
2.39
Mr Lucy
has previously suggested that commissions in excess of two per cent should be
disclosed separately.[29]
2.40
When assessing the problem of poor super advice, the
committee recognises the complex interplay between the level of commission on
offer to advisers, the possible effect that has on the advice given, the
monitoring role of financial services licensees to ensure their advisers are
giving appropriate advice, and significantly, the financial literacy of the
general public when choosing how to invest their savings. Although the many
facets of this issue make it a difficult one for ASIC to address, the committee
expects this exercise to lead to a substantial overall improvement on the
disappointing standard reflected by the survey. This is discussed further from
paragraphs 2.44 – 2.46.
ASIC's strategy
2.41
ASIC indicated that 14 (undisclosed) licensees are the
subject of specific follow-up action resulting from the survey results.[30] While admitting that 'major players'
were surveyed, ASIC stated that the exercise was intended to provide 'data
capture', rather than publicly shaming individual planners or licensees:
We did not want this one to be yet another confrontation where
ASIC seemed to be beating up on either individual planners or licensees. Even
on the way the project was designed, we had to give undertakings of
confidentiality to each one of the participants. We had in this survey over 300
people who actually were our real life guinea pigs. In order for us to do that,
and also to get Roy Morgan’s
assistance, we had to assure each one of them that their affairs and the advice
they had been giving had been kept confidential. That in itself very much
pitched the way that this work was going to go forward. It was not going to be
a name and shame exercise and it was not going to be a big enforcement
exercise, where ASIC was getting out the big stick. Instead, it was going to be
much more of a data capture on what exactly was happening. I think the way that
the industry has actually responded to this work bears that out. It has had
perhaps a much more constructive outcome than some of the other ones we have
done.[31]
2.42
To allay committee concerns that such an approach would
not assist current, ordinary investors to identify the consistently worst
culprits for poor advice, Mr Lucy
indicated that:
...it is reasonable to assume that we are carrying out
surveillance on them. To the extent that there are outcomes as a result of that
surveillance regarding poor activities or inappropriate activities, we will be
making that very much a public outcome.[32]
2.43
In evidence, ASIC sought to impress that although only
a small fraction of investors were surveyed, the targeting of poor performers
through these sorts of activities and ongoing surveillance would protect
investors more broadly.
2.44
The committee acknowledges the dilemma faced by ASIC. Its
preferred strategy is to bring about cultural change through industry
cooperation by accurately highlighting current substandard industry practice in
a non-confrontational way. As noted above, if licensees feel targeted with a
'big stick' then the practice of notifying breaches and efforts to better
monitor advisers by licensees may diminish.
Nonetheless, the survey shows a level of performance that indicates
thousands of customers are receiving advice that will unknowingly cost them
enormous amounts of money, often tens or even hundreds of thousands of dollars
in additional fees and charges. This is unacceptable at a time when investors have
the opportunity to easily switch their superannuation fund.
2.45
The committee is of the view that the survey results
should serve as a warning to those offering unreasonable superannuation advice.
ASIC should undertake a similar exercise in 2007 and, if results have not
significantly improved, repeat offenders who have been found to have repeatedly
and seriously breached the requirement to provide reasonable advice should be
publicly named.
Recommendation 1
2.46
The committee recommends that ASIC conduct a shadow shopping
survey on superannuation switching advice in 2007 and publicly name advisers
and licensees identified as responsible for repeatedly and seriously breaching
the requirement to provide reasonable advice.
ASIC's educative role
2.47
Besides enforcing and regulating companies and
financial services laws, ASIC is responsible for consumer protection in
superannuation, insurance, deposit taking and credit.[33] A large component of this protective
role is in improving the financial literacy of the general community, often
referred to as 'mums and dads investors'. In view of investors' losses
associated with the Westpoint collapse and exposed by ASIC's shadow shopper
exercise, this is an area in which ASIC could become more effective.
2.48
ASIC told the committee that, in order to broaden the
education campaign audience, its communications through the press had been
extended beyond publications such as the Australian
Financial Review to include the Daily Telegraph and talkback radio.
According to ASIC though, the problem of over-exposure looms:
The balance is that we cannot oversell ASIC. We do not want ASIC
to get to the point where people say, ‘Goodness me, it’s ASIC again in the
press,’ which reaches a point where it is a turn-off. We need to continue our
currency and for people to continue to want to listen to our messages.[34]
2.49
The committee suggested that ASIC assist investors by
maintaining an 'offenders' register' of individuals who have been sanctioned by
ASIC. Although it may be difficult to administer, an easily accessible list
would help alert investors considering investing money with, or taking advice
from, those that were subject to an adverse finding by ASIC. The committee
believes that such a list would also have a deterrent effect on individuals who
may otherwise choose to engage in unethical behaviour within ASIC's
jurisdiction.
2.50
With respect to superannuation switching advice (dealt
with in detail at paragraph 2.27 onwards), ASIC told the committee that its
website contained fee information on nearly 1000 funds.[35]
Conflicts of interest in the financial services industry
2.51
In April 2006 ASIC released a discussion paper on
managing conflicts of interest in the financial services industry. Using
illustrative scenarios, the paper outlined a number of conflicts within the
industry that ought to be managed. In the report ASIC also identified two
conflicts of interest for financial advisers that should be avoided completely.
They are: shelf fees and payments for switching funds. Shelf fees are paid, in
addition to commission, by an issuer of financial products to get their fund on
the approved product lists of financial planning companies. The latter conflict
involves product issuers paying an adviser to switch all his/her clients from a
competitor's fund to theirs. Part of the fee may be rebated to clients.
2.52
Following feedback and consultation with the industry,
the discussion paper and the responses to it will inform ASIC's policy
statement (no. 181) on this issue. ASIC stressed it is not attempting to 'cover
the field' of conflicts of interest that may arise, instead seeking to provide
illustrative guidance to industry:
...we do not think handling conflicts is a situation where the
regulator issues endless prescriptive guidance so we end up with a book of 5,000
pages, you look up the conflict that you think you are involved with and, lo
and behold, ASIC has set out a rule on that conflict. We are definitely not
going to be doing that. We did think that there was a need to bring the
high-level policy work down to a more recognisable level and deal with various
little scenarios in each industry.[36]
2.53
ASIC was not able to inform the committee as to the
timeframe for its next publication, be that another discussion paper or a
policy statement, on this issue. However, officers indicated that ASIC would
seek to provide further clarity on the appropriate response to particular
conflicts:
The next time ... I think people are going to be looking for
perhaps more commentary. The main thing we wanted to do was to get the
scenarios out, get people engaged with them and get some feedback. I think the
ball is now back in our court to consider each conflict situation a bit more
fully and have a little bit more of a think about what the answer is. I will
not say that the document that went out was relatively superficial, but it did
not spend a lot of time actually addressing the real answer on each particular
conflict.[37]
2.54
The committee will seek an update on this process at
its next oversight hearing.
DPP memorandum of understanding
2.55
On 1 March 2006 ASIC signed a new memorandum of
understanding (MOU) with the Commonwealth Department of Public Prosecutions
(DPP). This replaced the earlier memorandum agreed in 1992. The main features
of the new MOU are:
-
ASIC will, in a timely manner, refer a brief to the
DPP where it believes an offence has been committed and sufficient evidence to
support that view has been gathered;
-
ASIC is permitted to prosecute summary
regulatory offences with agreement from the DPP;
-
ASIC will consult with the DPP before applying for
a civil penalty order; and
-
liaison arrangements between the agencies.[38]
2.56
In an article in the Australian Financial Review on 1 June 2006, Mr Peter Wood, a former
executive director with ASIC's enforcement division, criticised the MOU for not
addressing the critical issues of consent and delay in the approval of criminal
charges for breaches of the corporations law. He stated that 'ASIC has failed
to take responsibility for making its own criminal enforcement decisions and
has no guarantee of a more responsive service from the DPP'.[39]
2.57
Mr Lucy
told the committee that the requirement for DPP approval of criminal
prosecutions is appropriate, providing an important balance against ASIC's own
investigations powers:
The first issue is whether or not ASIC should have the right to
take on a criminal proceeding as a result of our own determination; that has
never been my view. My view is that the independence or the independent role of
the Commonwealth Director of Public Prosecutions is extremely important. It is
important for a number of reasons. One is that we have significant powers
available to us in our investigation area. I think that if we had both those
powers and also the power to undertake our own prosecution, then it may well be
that parliament would look to minimise those powers, and I do not think that
would be the right outcome.[40]
2.58
He further described tension between ASIC and the DPP
as inevitable:
As far as the working relationship with the Commonwealth
Director of Public Prosecutions, inevitably there is a level of tension. I
think if there was no tension on either side there would be a risk that either
we would not be providing enough referrals or they would not be providing their
own level of scrutiny. They have a role to play and we think that role is played
well.[41]
2.59
Mr Lucy
added that during his tenure there had not been an instance where the two
bodies disagreed over whether a particular matter should be prosecuted.[42]
2.60
The other significant issue raised by Mr
Wood was that of the timeliness of the DPP's
responses to ASIC briefs, and the absence of any targets for the DPP contained
in the MOU. ASIC indicated that this aspect of the relationship was improving:
...the MOU is a principle document. Like any MOU, it is a
non-binding document; it is there to set a level of principles. Underneath that
are some working targets.
It further stated:
...the time taken by the DPP to bring charges—and these are
dealing with years ended 2002, 2003, 2004 and 2005—has gone from 10 to nine to
seven to six months. The time taken by the DPP to formally bring a matter to a
conclusion over the same period was 14, 13, 11 and six months. The time taken
by the DPP to return the brief for no further action was 13, 18, 10 and six
months. That is consistent with our own experience that the DPP is receptive to
the need to treat us as a core client and to provide proper turnaround and
proper service.[43]
2.61
The committee accepts that the DPP's involvement in
prosecuting ASIC investigations may be sensible, ensuring that ASIC is not both
policeman and prosecutor. However, the effectiveness of ASIC's relationship
with the DPP, as directed by the new MOU, needs to be continually monitored.
The committee believes that should the new arrangements fail to ensure
effective collaboration between the two agencies, a new MOU should be agreed to
further clarify each organisation's obligations.
Recommendation 2
2.62
ASIC and the DPP should regularly update the committee
as to the effectiveness of the revised Memorandum of Understanding.
ASIC's assistance to the Victorian Police in the Vizard matter
2.63
The Vizard matter was discussed at some length in the
committee's previous oversight hearing and in the previous report of December
2005.[44] Since then, the media has
reported the prospect of perjury charges against Mr
Vizard relating to possible discrepancies in
evidence provided by him in separate cases. The first case was a March 2003
Magistrate's Court committal hearing of Mr
Vizard's former book keeper, Mr
Roy Hilliard.
On this occasion, Mr Vizard
denied on oath that he had engaged in insider trading. Later, in July 2005, an
agreed statement of facts between Mr Vizard
and ASIC was put before the Federal Court. In this Mr
Vizard agreed that he had used information
acquired as a Telstra Director to trade shares for a personal benefit.[45]
2.64
The committee was interested to know whether ASIC had given
consideration to the consistency of the statement of facts put before the
Federal Court and Mr Vizard's
previous sworn testimony. Mr Lucy
took the question on notice, indicating that he did not want to prejudice
Victorian Police investigations.[46]
2.65
ASIC's later response indicates that their focus was
not on the possible implications of Mr Vizard's
apparently inconsistent evidence:
In preparing the statement of agreed facts, ASIC considered all
the evidence it had obtained during the course of the investigation. This
evidence included sworn testimony given by Mr
Vizard and other parties. The statement of
agreed facts that ASIC filed with the Federal Court represents a version of
events that ASIC believes to be accurate and that, in ASIC's opinion, is
supported by the evidence. Mr Vizard
had agreed to that version of events.
As for the possibility that Mr
Vizard may have committed perjury in the
preceding committal hearing of Mr Hilliard,
that is a matter for the relevant state authorities, namely the Victoria
Police and the Victorian Director of Public
Prosecutions. ASIC has and will continue to provide whatever assistance it can
to any enquiries by the Victoria
Police.[47]
2.66
As to ASIC's assistance to the Victorian Police, Mr Lucy
stated:
The answer is, yes, we have provided assistance to the Victorian
police in their investigation and we provided, at their request, the agreed
statement of facts that was provided by us to the court in our proceedings.
Whether or not that assists in proving perjury is a matter for time to tell. We
have assisted the Victorian police in the manner that I have outlined.[48]
2.67
It is unclear from ASIC's response to the question
whether Mr Vizard's
evidence to the preceding committal hearing was considered in the preparation
of the statement of facts filed in the Federal Court.
2.68
It is also unclear what consideration ASIC gave to the
consequences of the Federal Court receiving differing facts to those considered
in the committal hearing, and any influence possible perjury may have had on
the sentence handed down by Justice Finkelstein.
2.69
The committee invites ASIC to clarify these issues.
2.70
In its December 2005 ASIC oversight report, the
committee noted that the 'missing link' in the evidentiary chain was the
potential evidence of Mr Vizard's
former accountant, Mr Greg
Lay. ASIC told the committee that Mr
Lay had refused to provide a signed
statement, leaving ASIC and the DPP with insufficient evidence to mount a
successful prosecution.[49]
2.71
In a statement published on crikey.com.au on 22 June 2006, Mr
Lay's lawyer, Mr
Graham Lederman,
stated that Mr Lay
had declined to sign a witness statement on legal advice, but had not refused
to testify against Mr Vizard
and had not been asked to provide sworn evidence.[50]
2.72
In response to correspondence from the committee
requesting ASIC's interpretation of the crikey.com.au report, ASIC Chairman Mr
Jeffrey Lucy indicated that Mr Lay continued to refuse to sign the witness
statement required for further action, or to discuss the matter further with
the regulator. He wrote:
In respect of the statement attributed to Mr
Lay's lawyer, we can only assume that:
- By stating that "at no stage did Mr Lay
refuse to testify against Mr Vizard", Mr Lay's lawyer is distinguishing
between a "refusal to testify" and Mr Lay not agreeing to sign a
witness statement and Mr Lay not willing to engage in any further discussions
with ASIC or the CDPP in relation to the prospect of giving evidence.
- By stating that "at no point in time was Mr
Lay asked to give sworn evidence against Mr Vizard", Mr Lay's lawyer is
distinguishing being asked to give "sworn evidence" and being asked
to sign a witness statement in a form required for a committal hearing which
carries an appropriate acknowledgement that a person giving a false statement
is liable to an action for perjury.[51]
2.73
The letter concluded:
In light of [Mr Lay's]
response, at this point in time there is no additional evidence to submit to
the CDPP that could warrant a reconsideration of its decision that there is insufficient
evidence to commence a criminal prosecution of Mr
Vizard.[52]
2.74
The committee notes Mr
Lay's apparent, continuing refusal to
provide further assistance to ASIC in this matter.
2.75
However, the committee reiterates its concern, raised
in its previous oversight report,[53]
that ASIC and the DPP have not appropriately communicated on the possibility of
utilising s.19 of the ASIC Act to compel Mr Lay to provide evidence under oath
before an ASIC officer.
Budget funding
2.76
The 2006-07 budget provided ASIC with additional
funding of $120 million over four years for 'litigation contingency' for
'exceptional matters of public interest'. Previously, funding to meet ASIC's
enforcement costs, ie significant legal matters, were met through special
one-off appropriations. Investigations were funded from ASIC's 'business as
usual' funding. A different funding model to meet such costs has been
implemented whereby both investigation and enforcement costs may be drawn from
this $30 million per year reserve where agency costs for a particular matter
exceed the stipulated $1.5 million threshold.
2.77
ASIC officers indicated that the 'exceptional matters
of public interest' test would be determined by ASIC. The Westpoint collapse
and potential future related prosecutions is an example of such a matter. Mr
Lucy stated that ASIC had yet to determine
whether the guidelines it will prepare for drawing on these funds will be made
public:
Clearly we are going to have some guidelines. To the extent that
we do not want the people who we are litigating against to be able to use those
guidelines against us, I am not sure that is particularly constructive.[54]
2.78
At the Senate Economics Committee's budget estimates
hearing ASIC stated that a staffing increase from 1476 to 1578 was primarily to
undertake increased surveillance. Mr Lucy
also indicated that the increase would assist in dealing with ASIC's increased
enforcement capacity as a consequence of the aforementioned litigation
contingency funding.[55]
Prosecution rates for corporations law breaches
2.79
ASIC has been the subject of criticism over the rate at
which it prosecutes breaches of the corporations law. An article in the Sydney Morning Herald on 22 April 2006 suggested that in
2004-05 'compliance action' was taken against less than one per cent of
breaches of the corporations law reported by receivers and trustees in
bankruptcy.[56] In response to this
assertion, Mr Lucy
stated that:
The difficulty with some of those statistics is that they are
fairly unreliable. What the government has sought with this assetless
administration is, where liquidators are currently not in a position to be able
to complete their role as far as providing a report to ASIC regarding the
background of what breaches might be, the opportunity for ASIC to fund those
people. Previously we had a situation where liquidators may have made
essentially uninformed observations; now they will be in a position to actually
do the work to find out whether or not their observations are real live situations
and real live problems. Firstly, we would expect the quality of referrals from
liquidators to increase significantly. I would like to think that the
liquidator will therefore, across Australia,
make sure that they meet their obligation so that if there is mischief out
there we hear about it. Part of the funding is that we are more robustly funded
to take on those additional referrals.[57]
2.80
He continued to say that ASIC's decisions on which
cases to litigate were appropriate:
...do I think that we could be more aggressive with our
litigation? No, I do not. There is litigation in two categories, civil and
criminal. Our dialogue with the DPP is effective. There is the right level of
attention as to whether or not matters should be taken on criminally, so I
think that is appropriately dealt with. Similarly, with the civil side of
things, we have a success rate in the courts of some 97 per cent. We are very
energetic with our investigations to make sure that if there are opportunities
for prosecutions we will follow them through.[58]
Compliance burden of financial services regulation
2.81
The committee raised several criticisms of the high
compliance cost of Financial Services Regulation (FSR). In particular,
reference was made to a submission from an unnamed financial adviser to the Corporate and Financial Services Regulation
Review of April 2006, who claimed that compliance under FSR has turned into
'a monster for small dealers'.[59] The
adviser's submission contends that:
Form has become the requirement rather than substance. This is
bad for consumers whose objective is good advice. Consumers want substance and
not form...The huge fundamental flaw in FSR compliance is that it is focused on
process and not output. FSR seeks to regulate for good advice or at least
regulate against bad advice. As FSR is constructed, the regulator could use FSR
to focus on that objective but instead ASIC seeks to focus its regulatory
activity on process and fails to focus on policing advice output.[60]
2.82
ASIC acknowledged that the adviser is correct in that
the legislation does not impose a high benchmark, stating:
When you look at the various elements of what an advisor has to
do: the advisor has to know the product, know the client...and has to have a
reasonable basis for giving advice that is appropriate for the client. That is
a pretty low hurdle, not exactly a pole vault bar, that you have to jump over.
However:
In a sense the industry is lucky that the legislation does not
say that you actually have to give good advice because I am not sure that we,
as a regulator, are actually qualified to judge whether advice is good or not.
I think that is a policy platform that obviously was not taken up by the
government.[61]
2.83
In the adviser's view the system is 'very anti
advice-focused advisers who tailor advice to individual clients and very pro
the product distribution model of the big financial planning subsidiaries or
the big product providers'.[62] In
response, ASIC admitted that the statement contained 'an element of truth', but
indicated that it had to work within the context of an industry that was 'borne
out of a product-producing and product-selling environment'.[63]
2.84
The committee also questioned ASIC officials about the
potential of substantially increased audit fees resulting from the recent
inclusion of audit standards under the Corporate
Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP
9). In response Mr Lucy
indicated that ASIC is undertaking ongoing surveillance of the auditing
profession. In particular he stated that ASIC:
...will respond to any suggestion of [inflated audit fees] being
played out in the marketplace, including through industry groups such as
company directors and so on, to make sure that people understand that it would
be quite mischievous for auditors to increase their fees on [the basis of
auditing standards becoming enforceable under CLERP 9].[64]
2.85
In its previous examination of FSR legislation the
committee has expressed concern over the effect of excessive regulation in this
area, particularly with regards to small business.
Proposed business judgment rule
2.86
In April 2006 the Parliamentary Secretary to the
Treasurer, the Hon. Chris Pearce
MP, released a consultation paper on a variety of
corporate and financial services regulatory issues, including a proposed
extension to the business judgment rule.
2.87
The business judgment rule is based on the well
established legal principle that the courts are reluctant to pass judgment on
the merits of business decisions taken in good faith.[65] The rule is codified in subsection
180(2) of the Corporations Act which provides that a director is presumed to
have met their statutory duty of care and diligence where:
-
the judgment is made in good faith and for a
proper purpose;
-
the director has no material personal interest
in the judgment;
-
the director informed themselves about the
subject matter; and
-
the director believes the judgment is in the
best interests of the corporation.[66]
2.88
The note to subsection 180(2) emphasises that the
business judgment rule only operates in relation to the duty of care and
diligence in section 180 and not to any other provisions of the Corporations
Act or under any other law. That is, the business judgment rule does not
currently apply, for example, to the duty of good faith (s181), the duty not to
misuse position or company information (ss182-183) and the duty to prevent
insolvent trading (s588G).
2.89
The Corporations
and Financial Services Regulation Review consultation paper sought comments
on whether the business judgment rule should be extended to provide 'a general
protection for directors, excusing them from liability under the Corporations
Act, subject to certain conditions'.[67]
If adopted, the proposal would excuse a director from liability for breaching any obligation under the Corporations Act
provided they act:
-
in a bona fide manner;
-
within the scope of the corporation's business;
-
reasonably and incidentally to the corporation's
business; and
-
for the corporation's benefit.[68]
2.90
According to the consultation paper the proposal is
broad in nature. It states:
This protection would extend to any obligation the director or
officer has under the Corporations Act such as the duties of good faith, use of
position and use of information, the duty not to trade while insolvent, the
duty to keep books and records and declarations relating to financial
statements.[69]
2.91
In August 2006, the Parliamentary Secretary to the
Treasurer announced progress on the topics outlined in the consultation paper.
According to his press release the proposed extension to the business judgment
rule is one of several topics that 'merit a more focused approach, because of
the scope and complexity of the policy issues they raise'.[70]
The attachment to the press release indicates that the proposed
extension of the business judgment rule 'will be progressed in conjunction with
other reviews by Treasury'.[71]
2.92
ASIC officials were asked their opinion of the proposed
extension to the business judgment rule. Mr
Cooper raised concerns about the practical
operation of the proposed changes stating:
We simply do not see how it would actually function. That is not
surprising in the sense that a proposal like that is a complex thing that needs
to be worked through. The consultation paper is nothing more than a series of
proposals, and we are looking forward to understanding how a proposal like that
might work.[72]
2.93
A recent editorial piece from the Australian Financial Review also questioned whether it is
sufficient for a major policy change such as this to be explained in such
little detail. It noted that the proposal is 'all dealt with in two paragraphs'
and '[c]hanges of this scale require more detailed study...'.[73]
2.94
Mr Cooper
went on to say that the proposed change could make it harder for ASIC to
enforce the law and that 'if there is a suggestion that the rule itself is
somehow different [from the existing business judgment rule], our position is
that we do not support that.'[74] He also
acknowledged that ASIC has not been asked for advice on this proposal.
2.95
Given the broad nature of the proposed extension to the
business judgment rule and the enforcement concerns raised by ASIC, the
committee is of the view that these concerns should be provided to the
government so that it fully understands the enforcement issues when it
considers the merits of the proposal. From Mr
Cooper's evidence relating to some of the 54
other proposed changes outlined in the consultation paper, it is clear that
ASIC has enforcement concerns that go beyond the proposed extension to the
business judgment rule. On this basis the committee recommends the following.
Recommendation 3
2.96
The committee recommends that ASIC provide advice to
the Australian Government on its concerns regarding the enforcement effects of:
-
the proposal to broaden the 'business judgment
rule' as set out in the Corporate and Financial Services Regulation Review of
April 2006; and
-
any other proposals in the Corporate and
Financial Services Regulation Review of April 2006 that would have significant
enforcement implications.
Senator Grant Chapman
Chairman
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