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Chapter 4

Updates on Storm Financial, Trio Capital, the Future of Financial Advice reforms, and the Fortescue and James Hardie cases

4.1        The final chapter of this report covers a number of issues of particular interest to the committee relating to topical and significant matters before the Australian Securities and Investments Commission (ASIC).

Storm Financial

4.2        In November 2009, the committee tabled its report into financial products and services in Australia. Chapter 3 of that report focused on the collapse of the Queensland-based company Storm Financial. The committee considered Storm's business model and the role of the Commonwealth Bank of Australia (CBA). The CBA was widely criticised for its management of margin calls on Storm Financial clients.[1] At a public hearing in September 2009, a representative of the CBA told the committee:

we are not proud of the bank's involvement in some of the issues faced by those customers ... customers can be assured that, where we have done wrong, we will put it right ... Both before and since that announcement we have been taking action to put wrongs right. First, our customer assistance program established with customers on the ground in Townsville and, second, our innovative resolution scheme.[2]

4.3        ASIC had planned to take action in the Federal Court against the Commonwealth Bank, Macquarie Bank and the Bank of Queensland (BOQ) for unconscionable conduct in lending money to clients to invest in Storm Financial. Shortly before the trial was set to proceed, the CBA agreed to settle with ASIC through a compensation package providing an extra $136 million to Storm Financial investors. This payment is to be made in addition to the $132 million that the CBA had provided to Storm investors through its resolution scheme. ASIC noted in a media release following the announcement:

CBA's $136 million of additional compensation is intended to ensure that each CBA investor (or investor group) who takes part in the settlement will get compensation of approximately 55% of that part of their total loss allocated to CBA under the ASIC compensation model. This calculation takes into account the compensation CBA already provided to investors under its Resolution Scheme. In determining the aggregate amount of compensation, allowance has also been made for the period that has elapsed between the time that Storm investors suffered loss and the time of receipt of compensation.[3]

4.4        In evidence to the committee at the December 2012 hearing, ASIC Chairman Mr Greg Medcraft summarised the regulator's actions against the CBA, Macquarie Bank and the BOQ in the Storm Financial collapse. He explained that the September 2012 settlement:

...ends our court action against CBA. We believe that that was a timely, fair and certain outcome from the investors who borrowed from CBA. We welcome the initiative of CBA to come to that agreement with us to actually not put investors through a long, costly and legal process. Many of these people who have lost money are elderly, and a long and costly court case was not a particularly good outcome for many of them.

The proceedings are still moving ahead against Macquarie Bank and Bank of Queensland and they are moving towards completion early in the new year as are those against the Storm founders, the Emanuel Cassimatis. We also have our court action on behalf of Storm investors on behalf of the Dawe family—that is ongoing. As I said, the compensation is on top of the $132 million already provided by CBA to the Storm investors. I just remind you that the forensic accountants that we are working with estimates the aggregate losses suffered by Storm investors were about $830 million. We believe already the recovery is quite significant.[4]

4.5        The committee asked ASIC about the role of class actions in pursuing compensations for Storm Financial investors on the one hand and Trio Capital investors on the other. Mr Medcraft replied that in relation to Storm Financial, 'the class action people thought they could do a better job than ASIC'.[5] He described class action as an 'efficient market mechanism'. In terms of ASIC's current position on Storm, however, the Chairman told the committee: 'We are very open to settling with Macquarie Bank and the Bank of Queensland'. When asked of the prospect of this occurring, he added: 'I would hope that the fact that CBA have settled would be reasonably persuasive'.[6]

4.6        The committee asked ASIC on notice to provide the costs of the Storm case, including the cost of the forensic accountant. On notice, ASIC responded:

In view of the pending litigation in which ASIC is involved arising from the collapse of Storm Financial, ASIC does not consider it appropriate to comment on the cost of the Storm case at this point in time.[7]

Committee view

4.7        The committee commends ASIC for its work to reach a settlement with the CBA on compensation costs for the victims of Storm Financial. It notes ASIC's hope that Macquarie Bank and the BOQ will do the same and that the outcome is both timely and fair for investors. The committee will continue to seek data from ASIC on its costs in the Storm case, and hopes to receive this information once court proceedings are finalised.

Trio Capital

4.8        Chapter 3 of this report detailed aspects of the role of auditors in the collapse of Trio Capital. At the December oversight hearing, the committee raised a number of other matters in relation to the collapse of Trio that deserve scrutiny.[8]

4.9        One of the committee's key concerns in its May 2012 report into Trio's collapse was that investors in self-managed superannuation funds (SMSFs) do not have sufficient warning that they are not covered under section 23 of the Superannuation Industry (Supervision) Act 1993 in the event of theft and fraud. The committee recommended that:

...the guidance material provided by the Australian Taxation Office for Self Managed Superannuation Fund investors clearly state the difference between the protections and compensation arrangements for investors in funds regulated by Australian Prudential Regulation Authority as distinct from the limited protections available to Self Managed Superannuation Fund investors.[9]

4.10      The committee asked ASIC whether it has made efforts to warn SMSF investors about the risks of fraud and theft. ASIC Commissioner Mr Greg Tanzer replied:

In relation to self-managed super fund investors there are a range of materials that we make available through the MoneySmart website. In particular, we have adopted the view that was taken by this committee about wanting to be very clear about the fact that investors in self-managed super funds do not get the backstop protection of the availability of compensation in the event that the minister certifies it should be payable if there is fraud, and losses occasioned as a result of fraud. This is the Trio situation...

In addition to that, ASIC has been quite active in the past in working out the appropriateness of advice to switch into self-managed super funds. In particular, we are currently refreshing some research that we have done in the past about what we think is an indicative balance that a person might need in order to make a purely economic decision just based on the costs of running a self-managed super fund.[10]

4.11      The committee also emphasised the need for criminal investigations into the perpetrators of the Trio fraud. It recommended that:

...the Australian Federal Police, in cooperation with the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority, pursue criminal investigations into—and, where applicable, criminal sanctions against—the key figures responsible for defrauding investors in Trio as a matter of high priority.[11]

4.12      At the December 2012 hearing, the committee asked ASIC for an update on how its investigations into Mr Jack Flader and his associates were progressing. ASIC noted that it had received a number of international requests, was 'in the process of reviewing those materials' and had spoken to 'a number of persons both onshore and offshore'.[12] Further, it told the committee that it is liaising with both the Australian Federal Police (AFP) and the Australian Crime Commission (ACC) in its investigations:

...we have referred information to the AFP and are awaiting their response. We have been in a regular dialogue since we referred the matter to the AFP and we understand that they will shortly respond to us in relation to whether they propose to undertake any investigation of their own or what they propose to do. We have also been in a dialogue with the ACC in relation to Mr Flader, but despite a substantial amount of further work and we are committing substantial time and resources to this matter, by no means has our investigation come to an end but there is nothing at this stage which alters our view despite the further evidence that we have as expressed in June this year, which is based on the evidence we currently have we currently see there being insufficient evidence to prove a breach by Mr Flader of Australian law.[13]

4.13      ASIC told the committee that while the AFP had not yet commenced an investigation, it is currently assessing a referral to decide whether to investigate. From ASIC's viewpoint, it has provided 'all the information that we think is appropriate and that they [the AFP] have requested'.[14] In an answer to a question on notice, ASIC noted that it had referred material concerning Trio and Mr Flader to the AFP on 22 June 2012. A meeting was held between ASIC and the ACC on 20 June 2012.[15]

4.14      On the prospects of returning money to affected investors, ASIC asserted that it had committed significant public funds to the Trio investigation and to claims on behalf of others to recover compensation. However, it had formed the view that those claims are not 'financially viable' given that there is no one with the resources that is likely to be found liable. As the Chairman put it:

I expect that if there had been some money somewhere, the class-action litigators probably would be on to it, frankly, given that they are pretty efficient at tracking down deep pockets. In a way we have been looking, but another point you might want to emphasise is that the class-action lawyers would probably have gone after, as a group, if they thought there was some money somewhere. You have not seen any class action taking foot.[16]

4.15      The committee asked ASIC whether it still believed that the moneys lost from the ARP Growth Fund—as opposed to those lost from the Astarra Strategic Fund— were as a result of negligence, rather than deliberate wrongdoing. ASIC responded:

I think what we said is that the causes of the losses in relation to the ARP Growth Fund are different to those for the Astarra Strategic Fund and that our view is that, in relation to the ARP Growth Fund, the cause of the failure was product failure resulting from the financial crisis. That is not to say, however, that we have not identified along the way conduct-related issues. But, as to whether those conduct issues caused the loss, we remain of the view that the fundamental cause of the ARP growth investors' loss is product failure as a result of the financial crisis. Our inquiries in relation to the ARP Growth Fund are ongoing. I can state publicly now, given that court proceedings are on foot, that the liquidators of Trio propose to examine Mr Gresham on 10, 11 and 12 December, and ASIC proposes to participate in those proceedings. Our investigations are ongoing in relation to both ARP and Astarra, and we have received and continue to receive a considerable volume of information from overseas regulators. We also continue to speak with a number of witnesses both onshore and offshore.[17]

Committee view

4.16      The committee urges ASIC, the AFP and the ACC to continue their lines of inquiry into the perpetrators of the Trio Capital fraud. At the next oversight hearing, in March 2013, the committee will seek an update from ASIC on the December 2012 examination of Mr Tony Maher (formerly Mr Paul Gresham). It is also interested to inquire into correspondence that ASIC may have had with the AFP and the ACC on matters relating to the Astarra Strategic Fund.

4.17      The committee is also interested in ASIC's view on a bill (into which the committee recently tabled a report) that would increase capital holding requirements for dual-regulated entities.[18] Trio was a dual-regulated entity: it was both a licensed superannuation fund trustee and the responsible entity for several managed investment schemes. These entities are subject to oversight by both ASIC and APRA. If the bill is passed, dual regulated entities will be required to meet the Corporations Act's adequate resources and risk management systems requirements, although risks that relate solely to the operation of a regulated superannuation fund by the entity will be excluded.[19] The committee is keen to seek ASIC's views on the need for, and possible effect of these amendments.

Future of Financial Advice

4.18      The committee's 2009 inquiry into financial products and services led to the introduction and passing of legislation last year to reform the financial services industry in Australia. In the Future of Financial Advice (FOFA) legislation, the government adopted five of the committee's recommendations directly, with four recommendations supported in principle and only two not supported. In its February 2012 report into the provisions of the FOFA bills, the committee stated:

As in the 2009 inquiry, the committee's principal interest in examining the FOFA legislation is to ensure better outcomes and protections for consumers of financial products and services. It believes that the legislation will achieve that aim. The FOFA Bills will not only enhance consumer protections, but promote the professionalism of the financial advice industry. For too long, the industry's standards have suffered from lax regulation and an inadequate focus on the needs and interests of clients. The FOFA reforms will significantly address these inadequacies, principally through the annual fee disclosure, opt-in and conflicted remuneration provisions. The costs of implementation and compliance for the industry will be far outweighed by the benefits to consumers from high quality advice and transparency in charging fees.[20]

4.19      The FOFA bills contained four key issues that were carefully considered in the committee's report. These required financial advisers to:

• provide a fee disclosure statement to a client when charging advice fees for longer than 12 months, and a fee disclosure statement and a renewal notice to a client when charging advice fees for longer than 24 months (the 'opt-in' requirement); and
• act in the best interests of their clients and put their client's interests ahead of their own when providing advice;
• provide scaled advice—or advice about one issue, or a limited range of issues—where the adviser must act reasonably and base the decision to narrow the advice on the interests of the client; and
• ban the payment and receipt of certain remuneration which has the potential to influence the financial product advice given to retail clients (conflicted remuneration).

4.20      Since its report last year, and particularly since the parliament passed the legislation on 25 June 2012, the committee has used the oversight process to gain regular updates from ASIC on its progress in providing stakeholders with guidance on FOFA. At the December 2012 hearing, the committee asked ASIC to comment on the draft paper on the approval of conduct that obviates the need for the opt-in requirement. ASIC Commissioner Mr Peter Kell told the committee:

We have been having some fairly intensive discussions with some of the organisations that have indicated they will either definitely or potentially submit codes, so the nature of the consultation there is tending to be more intensively focused on those organisations. I will give you an example: the Financial Planning Association, who have very clearly signalled that they intend to put their code forward for approval.

So our discussion with them has included ensuring that, as they develop their own code, they adequately consult with their members and other stakeholders on what sort of requirements should be in place around the 'obviate the need' issue[21] and how they engage with their clients on an ongoing basis to make sure that those clients know what they are getting and that they are paying for a service that they find valuable.

Beyond that, we have also signalled a couple of other issues in that paper that represent a variation to what has been our traditional policy, if you like. One is whether we ought to be open to a narrowly focused code that deals primarily just with the opt-in issue or whether we should stand by our normal approach of requiring a broader code that covers behavioural standards across the range of an adviser's activities, and the other issue in this area was whether we would consider an entity specific code. Again, we have signalled that it would be a significant break from our traditional approach in this area and that there would be some significant challenges, but we thought that, given that it has been raised with us, we might as well consult on it.[22]

4.21      The committee also asked ASIC to comment on the consultation process on its draft paper on conflicted remuneration.[23] Mr Kell responded:

There is no doubt that this paper has generated more response than our other consultation papers so far, which in some ways is not surprising—it does go to the heart of remuneration structures. There are some issues that have generated particularly strong interest in the paper so far. One is the way in which employee remuneration under FOFA is dealt with and the way in which conflicts under these sorts of arrangements are dealt with. We are currently giving consideration to the feedback we have got there.[24]

...

Some stakeholders, some industry participants, have indicated that they would like to see that opportunity for conflicted remuneration in that space limited as far as possible; others have said that they need to accommodate different ways of remunerating their employees within their current business model.

We have received around 30 submissions so far. We have held a series of roundtables with industry groups, consumer groups and others, and a range of individual one-on-one meetings.[25]

4.22      The committee also raised concerns that the conflicted remuneration provisions in FOFA may apply to investment firms which operate for non-retail clients as well as retail clients. These services typically operate on the basis of a bonus structure over and above a base remuneration structure for their portfolio managers.[26] ASIC allayed these concerns in a written answer on notice:

Under the Corporations Act, a benefit is only conflicted remuneration if:

• it is given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients; and
• it could reasonably be expected to influence the choice of financial product recommended to retail clients or the financial product advice given to retail clients.

The conflicted remuneration provisions do not apply in relation to services provided to wholesale clients. This position is reflected in our proposed regulatory guidance on the conflicted remuneration provisions.

From our consultations with industry, we consider that industry understand this.[27]

4.23      ASIC told the committee that it intends to release a final guide on conflicted remuneration and the approval of Codes of Conduct for exemption from opt-in requirement 'early in 2013'. The committee understands that these final guidances will be released in February 2013. The final guidance on the 'best interests' duty (Regulatory Guide 175) and giving general advice and scaled advice (Regulation Guide 244) was released on 13 December 2012.[28] The final guidance on fee disclosure (Regulatory Guide 245) was released on 25 January 2013.[29]

Committee view

4.24      The committee welcomes the progress that ASIC has made in releasing and finalising guidance material on the key aspects on the FOFA reforms. It awaits final guidance material on the key issues of conflicted remuneration and the codes approval exempting advisers from the opt-in duty. The committee is keenly aware of the sector's interest in this phase of the consultation process.

4.25      The committee will monitor with interest the progress of ASIC's FOFA workshops in February and March 2013.[30] It looks forwarding to discussing with ASIC the outcomes of this consultation process at the next oversight hearing.

Directors' duties and continuous disclosure requirements

4.26      There have been two important recent legal judgments relating to actions taken by ASIC against company directors for allegedly failing in their duties of accurate market disclosure.

• In October 2012, the High Court found that Fortescue Metals Group founder Mr Andrew Forrest had not misled investors when he claimed to have 'framework agreements' with Chinese entities to build an iron ore project in the Pilbara.
• In May 2012, ASIC won a case on appeal in the High Court with a finding that seven former non-executive Directors and the company secretary of James Hardie had breached their duties in approving a misleading Australian Securities Exchange announcement.

4.27      ASIC raised both the Fortescue and James Hardie cases in its opening statement to the committee.

The Fortescue case

4.28      ASIC commenced proceedings against Fortescue in the Federal Court in March 2006, alleging that because the framework agreements with Chinese companies would not be enforceable under Australian law, Fortescue had engaged in misleading or deceptive conduct. ASIC also alleged that Fortescue and Mr Forrest had contravened the continuous disclosure requirements of the Corporations Act by not correcting the false or misleading information. Mr Forrest had thereby allegedly failed to discharge his duties as a director of Fortescue with the degree of care and diligence required by subsection 180(1).[31]

4.29      In October 2012, the High Court upheld the appeals of Fortescue Metals and Mr Forrest against the 2011 decision of the Full Court of the Federal Court. The High Court found that Fortescue's statements about framework agreements were not misleading or deceptive to investors. It found that there was no evidential basis for assuming that a person hearing or reading the statements would understand that the parties had entered into agreements that would be enforced according to Australian law. Accordingly, the High Court further found that Fortescue and Mr Forrest had not failed to meet their obligations under the Corporations Act.[32]

4.30      The High Court's finding was based on the facts of the case itself, rather than a changed interpretation of the existing law. As ASIC's Chairman told the committee:

The Fortescue decision was a decision on fact, not a decision on law. It basically said, 'Well, it wasn't misleading.' The reason that the ASX delayed their guidance on continuous disclosure was that they expected that there could be a decision on law. But it was not a decision on law, it was just on facts, so it really has not changed the law.[33]

4.31      The committee asked ASIC to comment on how the High Court's decision would affect the Commissions' approach to litigation in the future. Deputy Chairperson, Ms Belinda Gibson, responded by noting that ASIC had been advised of a strong prospect of success throughout the preparation of its case:

As with any litigation we bring there is a series of litigal rules which require a decision where, broadly speaking, we have reasonable prospects of success. In the Fortescue case we had external counsel briefed at each point in the proceedings, and had advice that gave us that affirmation. We also had an external law firm give that advice.

In the case of the Court of Appeal we spoke to other counsel as to whether we were on the right track in going to the Court of Appeal. We take our responsibilities there very seriously. We have lawyers examine it. I suppose it is fair to say that with a case that runs all the way to trial, it is unlikely that one side thinks they are destined to lose. Otherwise, they are not contested. We had relatively strong advice at all points in the process.[34]

4.32      Mr Medcraft expanded that by going to court, there is a chance you are going to lose but parties think they are going to win. He told the committee:

In relation to cases, we have now set out publicly in our enforcement guide why we take on cases and why we do not. We look at the cost versus the public benefit. We look at the amount of harm or loss or the significance of the matter. We also look at the availability of evidence. Often it is lack of evidence that is the reason we do not take on a case, even if a lot of people have lost a lot of money. If the evidence is not there, you do not take the action, unfortunately. You might not even do an investigation.[35]

Finally, you look at whether there is any alternative course of action. Clearly, if we can get an outcome that does not mean going to court then we will try to get that outcome. We do enforceable undertakings, for example. What we end up with is an out of court settlement, like in the CBA case. We always look at alternate courses. But at the end of the day we have made it really clear that no-one is too big for us to take on. The government gives us $30 million a year for our enforcement special account. We have accumulated reserves and built a war chest so that we are in a strong position to take action. It is important to talk softly and carry a large stick. Basically, Australians would not expect anything less. If going to court is the way to solve an issue and we cannot do it any other way, we are not frightened to go to court. It is important to send that message, frankly: 'It doesn't matter who you are, we will take you on if that's the only way we can sort out a problem.' That is what is expected now.[36]

4.33      ASIC again emphasised to the committee at the December hearing that it views disclosure by listed companies as 'the bedrock of market integrity and fundamental to fair and efficient markets'.[37] It has emphasised the importance of companies being prepared to act quickly to respond to continuous disclosure issues, by having established policies and practices.[38] The committee welcomes ASIC's and the ASX's ongoing emphasis on continuous disclosure and the release of a substantially rewritten draft Guidance Note 8 Continuous disclosure: Listing Rules 3.1–3.1B (GN 8).[39]   

The James Hardie case

4.34      The James Hardie case dates back to February 2001 when the company released an ASX announcement stating that it had established a foundation to compensate sufferers of asbestos-related diseases who had claims against two of James Hardie's former subsidiaries. The announcement claimed that the 'Foundation has sufficient funds to meet all legitimate compensation claims anticipated'.[40]

4.35      ASIC commenced proceedings in 2007 against seven former non-executive Directors and the company secretary and general counsel Mr Shafron. It argued that the Directors approved the ASX Announcement at a board meeting in February 2001 when they knew or ought to have known that the Foundation did not have sufficient funds. In terms of Mr Shafron, ASIC alleged he attended the board meeting and should have advised the board that the announcement 'was expressed in too emphatic terms' in terms of the funding.[41]

4.36      ASIC's evidence focussed on board minutes approved by the Directors to establish that they had approved the misleading ASX Announcement. The Directors argued that the board minutes were incorrect and that they never approved the ASX Announcement. The Supreme Court of New South Wales found that the Directors had approved the ASX Announcement, that it was false or materially misleading, and that the Directors and Mr Shafron had failed to discharge their duties with the degree of care and diligence that a reasonable person would exercise in their circumstances. This decision was overturned by the NSW Court of Appeal on grounds that ASIC had failed to prove that the ASX Announcement had been approved at the Board Meeting. However, the High Court overturned this decision, finding that the board minutes were sufficient proof that the ASX announcement was approved at the Board Meeting.[42]

4.37      ASIC's Chairman reflected on the High Court's decision by emphasising the clear message it sends on the need to provide the market with accurate information. He told the committee:

The matter reinforces the importance of companies providing the market with correct and accurate information and that directors must engage with the most important announcements. There has been widespread public analysis of the James Hardie matter that has already resulted in an improved board process in relation to announcements.

Since the original decision in 2009, we have clearly seen a very significant engagement more broadly by directors with disclosure in terms of announcements, so we believe it is a timely reminder in terms of accuracy of statements that are made. Again, I have always emphasised I believe the general level of corporate governance in this country is actually very, very good, but these are timely reminders.[43]

4.38      In contrasting the High Court's James Hardie and Fortescue decisions, Mr Medcraft explained that the James Hardie finding was important 'because it was a decision on law'. He identified its significance in terms of clarifying that company directors are expected to check, and are responsible for the accuracy of significant statements made to the stock exchange.[44]

Concluding comment

4.39      The committee recognises the breadth and the complexity of the issues that ASIC must deal with on both a day-to-day basis and as part of its medium to long-term strategy. The various matters discussed in this report attest to the challenging and diverse roles of Australia's corporate regulator, and the importance of it providing stakeholders with clear guidance based on sound principles.

4.40      There are various issues of continuing interest to the committee that were not canvassed at the December 2012 oversight hearing. There are other issues of committee interest—notably ASIC's investigation into the hoax ANZ press release relating to the funding of Whitehaven's Maules Creek and the enforceable undertaking given to ASIC by Macquarie Private Wealth—that have occurred since the hearing. Future oversight hearings will examine these matters.

4.41      The committee is satisfied with ASIC's focus, activity and judgment on issues of market integrity, the role of gatekeepers, financial literacy, the explanation of the FOFA laws, the supervision of exchange-traded markets and matters of corporate governance and continuous disclosure. Clearly, there are ongoing challenges in each of these areas that will require the careful attention of ASIC and market participants. The committee does highlight the significant efforts that ASIC has made to date in each of these areas. It looks forward to further updates on how its forward work program is progressing.

 

Ms Deborah O'Neill MP
Chair

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