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Chapter 2

Issues raised with ASIC

2.1        The committee discussed a number of issues with ASIC at its oversight hearing on 29 April 2010.[1] These included:

• transfer of market surveillance responsibilities from the Australian Securities Exchange (ASX) to ASIC, and development of competition for trading services;
• transition to Commonwealth regulation of consumer credit;
• scrutiny of contracts for difference;
• ASIC's response to the collapse of Storm Financial;
• project Mint; and
• reviewing and evaluating recent litigation.

Trading services reform and transfer of market supervision responsibility

2.2        Legislation paving the way for the transfer of real-time market supervision responsibility from the ASX to ASIC passed the Senate on 11 March 2010. The legislation contains three key measures:

i.      It removes the obligation on Australian market licensees to supervise their markets;

ii.     It provides ASIC with the function of supervising domestic Australian market licensees;

iii.     It provides ASIC with additional powers, including the power to make rules with respect to trading on such markets and to enforce such rules.[2]

2.3        One of the cited reasons for the new arrangements is to counter perceptions of conflict of interest faced by the ASX, both because it is simultaneously market operator and watchdog, and because it would oversight competitors when competition for domestic trading market services is opened up.[3] The transfer of responsibility for market supervision is planned to take effect in the third quarter of 2010.

2.4        ASIC has taken a number of steps in preparation for its new responsibilities. For example:

• on 26 February ASIC released a consultation paper proposing its new Market Integrity Rules, based on the existing ASX market rules and Sydney Futures Exchange (SFE) operating rules, for comment by the end of March;[4]
• ASIC has purchased an 'integrated market surveillance system' to monitor and identify suspicious trading activity;[5]
• ASIC is forming a new team to implement its new responsibilities.

2.5        The committee asked ASIC to talk in more detail about time frames for the transition to ASIC oversight. ASIC indicated that it remained on track for taking responsibility for market supervision between 1 July and 30 September 2010. The purchase of the market surveillance system, for maintaining real-time market supervision, has been completed, and arrangements have been made for 26 staff with the ASX to migrate across to ASIC's market supervision operations.[6] At the time of the hearing, ASIC had held discussions with ASX regarding the market supervision model and ASIC's disciplinary model, though it was not clear how close to finalisation these matters were.[7] Nevertheless, ASIC was emphatic that everything was on track for the transition. It indicated that there was considerable continuity between the technologies and rules that would be applied by ASIC and those currently being applied by ASX.[8]

2.6        At the Senate Estimates hearing on 1 June 2010, ASIC indicated that it expected its final Market Integrity Rules would be issued 'in the next few weeks'.[9] ASIC also anticipated announcing the initial appointments to its markets disciplinary panel by the end of June.[10]

2.7        ASIC's proposed Market Integrity Rules are for the ASX and SFE markets only. The Rules 'do not anticipate competition for market services'. ASIC states that, 'new rules will be developed and consulted on if competition is to occur'.[11]

2.8        ASIC indicated its intention to effectively start consultation on new market rules for competition only once the first phase – of transfer of powers from ASX to ASIC – had been implemented.[12] The implication appeared to be that trading on competitor platforms such as Chi-X would not take place earlier than the first half of 2011.[13] ASIC indicated it was alert to emerging analysis in Europe and the US about the regulation of competitive trading markets.[14] The committee is aware that the nature of inter-market competition and trading behaviours played a role in the so-called 'flash crash' of 6 May 2010 in the US.[15] This appears to have highlighted the importance of getting regulation and rules right in a competitive market trading environment.

2.9        ASIC has identified a large number of questions that will need to be tackled before market competition can be realised. It outlined these matters in more detail in its answer to a question on notice, attached at Appendix 2.

Transition to Commonwealth regulation of consumer credit

2.10      In 2008 the Council of Australian Governments agreed that there should be national regulation of consumer credit. In October 2009 the National Consumer Credit Protection Act was passed. It established a new single, federal regulatory framework for the regulation of consumer credit. ASIC's responsibilities under the new arrangements include licensing consumer credit providers and being the national regulator of the new code. Licensees will be required to adhere to responsible lending conduct requirements, prohibiting lending that is unsuitable to the consumer's needs and that the consumer does not have the capacity to repay. The first stage of the new regulatory regime is to take effect from 1 July 2010.[16]

2.11      Prior to the new regime taking effect, consumer credit providers have been required to register with ASIC. Registration commenced on 1 April 2010. Consumer credit providers will be required to have registered by 1 July 2010, otherwise they will not be able to engage in credit activities, including activity relating to credit contracts, consumer leases, related mortgages and guarantees, and credit services. Following registration, licensing applications will have to be submitted in the second half of 2010 in preparation for implementation of the license regime on 1 July 2011.

2.12      ASIC advised the committee that 700 industry participants registered on the first day, 4500 had registered by late April, and registration was proceeding smoothly; ASIC at that time expected about 10 000 registrations in all.[17] By 1 June 2010, ASIC indicated that it had already processed 10 000 registrations.[18] The committee is aware of reports that industry has been supportive of licensing, and expects that the sector will meet the new standards.[19]

2.13      ASIC has been communicating with the sector throughout the registration process. It advised the committee that it had held presentations around the country in preparation for registration and licensing. As of 29 April, there had been 54 presentations conducted, and ASIC has also conducted a live webcast, available as a podcast from their web page. ASIC indicated further presentations were going to be made.[20] ASIC advised the committee that registration is a very simple process that can be done online.[21]

Contracts for difference (CFDs)

2.14      Contracts for difference (CFDs) are a form of financial derivative that are causing concern because of their limited levels of retail investor protection.[22] Australia was the first country to allow exchange-trading of CFDs,[23] and their use has grown rapidly: 2009 saw a 23 per cent growth in the number of participants in the market for CFDs, to 35 000.[24]

2.15      ASIC expressed two concerns about the CFD market. First, it wants to ensure retail investors are appropriately protected, as ASIC is not convinced retail investors always recognise the risks involved with these instruments:

Basically, they do not understand what they are investing in. So often there is an issue that people believe they may be investing in the underlying security rather than in the derivative, for example. There are some issues around realising that the losses potentially are unlimited in relation to these instruments. Trading losses are potentially a concern.[25]

2.16      ASIC's second area of concern regards trade in CFDs that are not exchange-listed: the over-the-counter market. ASIC is concerned about the protection of investor money, which is paid to the unregulated traders at the time they make the investments. There is also counterparty risk: the possibility that an entity trading CFDs will be unable to meet its obligations to pay clients whose derivatives have delivered them a large profit. As ASIC explained it, "if you go to a bookie and you break the bookie, you do not collect your bet".[26]

2.17      ASIC have been active in surveillance of the marketing of CFDs. They have been monitoring advertising by companies offering CFDs, and have been shadow shopping the seminars being offered by such companies. They have also been examining product disclosure statements, looking at the adequacy of information about product features and counterparty risk. In all three areas of surveillance, ASIC reported seeking changes to the practices of some companies.[27]

2.18      The committee notes that ASIC's consumer advice web page, known as Fido, provides a blunt assessment of the hazards of dealing in CFDs:

Put simply, CFDs are like borrowing to gamble.

You take a punt, with borrowed money, on whether a share price or market index will go up or down. You may be able to borrow up to 95% or more of your bet.

Because of this borrowing, it's much riskier than a flutter on the horses or a night at the casino. Your losses are potentially unlimited and can far exceed the money you've wagered.

You could wipe yourself out in a single day. For example, just 0.5% or 1% change in the price can turn into a 10% or 20% loss. In today's markets, daily price changes like this happen quite frequently.

Don't imagine you can reliably bet on which way the market will move, especially in the short term. In fact, a few early successes may just set you up for a disastrous fall. Unlike shares, with CFDs if the market turns against you, you can end up with a debt and not an asset, however much reduced in value. Borrowing money to gamble can be a recipe for disaster.[28]

2.19      Mr D'Aloisio commented that these products have in the past been primarily traded in the wholesale market, but now that they are being traded in the retail sector, there are questions about whether the risks are sufficiently understood by customers. He said that over-the-counter CFDs are 'on pretty close watch for us because of the degree of risk that an unsophisticated player can get involved in'.[29]

2.20      At the hearing ASIC indicated that they expected to release a regulatory guide in relation to how the retailers of CFDs should handle client moneys. At the time of reporting, a guide was yet to be released.

Committee view

2.21      The committee shares ASIC's concerns about the growing market for CFDs and the risks to which these can expose investors. The committee's examination of the collapses of Storm Financial and Opes Prime highlighted potential problems with the engagement of retail investors in high-risk product markets. The committee encourages ASIC to remain extremely vigilant in this area, and will itself also continue to keep the derivatives market under active consideration.

ASIC response to the collapse of Storm Financial

2.22      In its 2009 report Inquiry into financial products and services in Australia, this committee looked extensively at the collapse of Storm Financial Ltd. It urged ASIC to advance its investigation into Storm as a top priority, and to make timely public announcements regarding the progress of its investigations.[30]

2.23      At the Senate Economics Committee Additional Estimates hearing in February 2010, Mr D'Aloisio indicated that ASIC hoped to make the findings of its investigation into Storm Financial public in early March.[31] In March 2010 ASIC announced that it had completed a 'major phase' of its investigation into Storm Financial. This included receiving a report from liquidators Ivor Worrell and Raj Khatri.[32] ASIC stated that from then until the end of May 2010 it would be undertaking confidential discussions to see if a commercial resolution could be reached which ASIC would 'be prepared to recommend to investors'.  If an acceptable resolution could not be reached, ASIC indicated it would consider compensation actions.[33] Separately, the Commonwealth Bank of Australia set up a resolution scheme for former Storm investors.[34] In April ASIC launched a new website to help keep Storm investors informed of the progress of ASIC’s investigations and the outcome of commercial resolution discussions.

2.24      The committee understands that ASIC is concerned to achieve the best possible result for Storm's investors. For this reason, ASIC was reluctant to go into detail at its hearing with the committee on 29 April, and pointed out that it has 'not made final decisions on commencing any proceedings at this point'.[35] On 1 June 2010 ASIC issued a statement indicating that complex and confidential negotiations were continuing and ASIC would issue a further update on discussions at the end of June.[36]

Committee view

2.25      The committee is aware of some criticism of the time it is taking to make progress on the Storm Financial case,[37] but also appreciates the careful balance that needs to be maintained between on the one hand public disclosure and deterrence, and on the other hand achieving the best possible outcome for investors who have lost moneys. The committee believes ASIC is attempting to strike that balance, however it also believes that delays beyond July may lead to further questions about the effectiveness of the strategy.

'Rumourtrage' and Project Mint

2.26      Effective financial markets rely on the timely communication of accurate information about the financial products that are being traded. 'Rumourtrage' is the spreading of rumours or false information in order to deliberately affect the price of a market product such as a company's shares. This emerged as an issue of public concern in 2008, particularly in respect of short-selling.

2.27      In response, ASIC warned market participants against starting false or misleading rumours,[38] and established Project Mint in March 2008 to investigate such conduct. ASIC has indicated that the project made some progress in 2008-09, including that it:

• conducted an extensive inquiry into numerous purported instances of rumourtrage, seeking trading records and email correspondence from many brokers
• initiated formal investigations of some conduct
• made detailed submission to the Government’s Corporations and Markets Advisory Committee (CAMAC) seeking law reform, many points of which have been adopted in the formal CAMAC Aspects of Market Integrity Report of June 2009, and
• discussed, with listed entities, the management of confidential information.[39]

2.28      In September 2009, ASIC indicated that it was developing guidelines for market participants with a view to issuing a consultation paper in the next financial year.[40] That month, it issued a Consultation Paper on the subject.[41] In April 2010, ASIC indicated to the committee that it was in the process of issuing a regulatory guide,[42] however in May it decided to defer that process in light of industry consultation.[43] The consultation process highlighted the complexity of this area and the difficulty in designing further regulatory tools. However, ASIC has also drawn attention to a number of recent successful prosecutions in areas covered by Project Mint, including in relation to insider trading, market manipulation and false and misleading conduct.[44] Mr D'Aloisio highlighted to the committee that the deterrence effects of activities such as Project Mint are important.[45] While there is not an explicit separate project team, the activities covered by Project Mint remain an ongoing part of surveillance team activity.[46]

2.29      The Corporations and Markets Advisory Committee, in its June 2009 report Aspects of Market Integrity, recommended some reforms to the Corporations Act to assist in addressing rumourtrage:

Sections 1041E, 1041F and 1041G as civil penalty provisions

The integrity of financial markets would be further strengthened by making ss 1041E (making false or misleading statements) and 1041F (inducing persons to deal) civil penalty provisions and, for that purpose, amending them to remove the fault elements (including any fault elements and standards of proof that might be implied by the Criminal Code), in line with ss 1041A–1041C, which are also civil penalty provisions.

The Committee would also favour making s 1041G (engaging in dishonest conduct) a civil penalty provision if it were possible to cast it in suitable terms, given that the criminal concept of dishonesty is a central element of the offence as it stands.[47]

2.30      ASIC endorsed CAMAC's approach.[48]

Recommendation 1

2.31      The committee recommends that the Minister actively consider CAMAC’s recommendation for amendment to section 1041 of the Corporations Act.

Committee view

2.32      The challenges confronted by ASIC in dealing with market rumours highlight how difficult this area can be to police. This is exemplified by ASIC having only banned one broker in the context of Project Mint.[49] Nevertheless, some media coverage critical of Project Mint, suggesting it had led to no prosecutions,[50] does not portray the full story, either in terms of the effectiveness of Project Mint, or of the importance of deterrence activities to maintaining market integrity. Ms Gibson indicated to the committee that the process had resulted in changes in the way broking houses released information to the market.[51]

2.33      The committee supports ASIC's decision to defer the issuing of a regulatory guide at this point and to focus on achieving a 'lift in standards in the management of information'.[52]

Recent litigation

2.34      In its previous oversight hearing and report, this committee discussed recent high-profile litigation in which ASIC was involved, particularly its failed attempts to pursue One.Tel, AWB and Fortescue Metals Group.[53] Shortly after this committee tabled its last report, ASIC won an appeal overturning an earlier decision in relation to Andrew Lindberg.[54] That same month ASIC decided to appeal against its initial loss against Fortescue Metals Group Ltd and CEO Andrew Forrest;[55] however, ASIC also decided not to appeal against the decision that had ended its case against One.Tel’s former joint Managing Director, Mr Jodee Rich and the company’s former Finance Director, Mr Mark Silbermann.[56]

2.35      These have been the most high profile court cases, but they by no means represent the bulk of ASIC's litigation. In 2008-09 ASIC concluded 186 separate pieces of litigation, with 90 per cent success, including the jailing of 19 convicted offenders.[57] The success rate was 80 per cent when measured by the number of defendants (as distinct from number of proceedings). The success rate in civil, rather than criminal, enforcement proceedings was 94 per cent.[58] In addition, ASIC also resolved some matters through settlements of claims, and through enforceable undertakings.[59]

2.36      While ASIC has lost some cases, it has also had notable success, in cases and in negotiated settlements such as James Hardie, Westpoint, Opes Prime and HIH.[60] ASIC was also emphatic that willingness to take on major litigation is critical to deterrence activities and preserving market integrity. Its litigation plans are based on the Attorney-General's Department's model litigation rules. Mr D'Aloisio outlined aspects of how ASIC decides whether to pursue litigation. It assesses the significance of wrongdoing, and then examines the prospects of success of litigation. ASIC then also considers resource constraints it may face and obtains legal advice – sometimes externally – before putting a recommendation to the commissioners. The commissioners then make a strategic decision about whether to pursue the litigation. ASIC argued that this represents a 'very considered and rigorous process in reaching a decision as to whether or not' they pursue litigation.[61]

Committee view

2.37      The committee accepts that it is inevitable that some litigation will be lost. It also accepts that lost litigation is not the same thing as failed litigation, particularly when court decisions provide greater legal certainty for all parties without undermining the objectives of the regulatory regime. The committee has even heard raised the question of whether ASIC's high success rate suggests an approach to litigation that is too conservative.

2.38      The committee does not express a view about the desirability of a particular success rate in the courts. It strongly endorses the need for rigorous review of cases, particularly those that are likely to be expensive to litigate. ASIC's chair mentioned in the hearing the need to use 'external counsel much more selectively'.[62] The committee believes that the most important consideration is that ASIC's commissioners have available to them dispassionate and expert legal opinion about the prospects of any proposed litigation. Only the Commission can take the strategic decisions about whether litigation is worthwhile, but the information to support that assessment should be as rigorous as possible. That assessment should be prepared by whoever is best able to provide it.

Mr Bernie Ripoll MP
Chairman

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