tag:theconversation.com,2011:/global/topics/commonwealth-financial-planning-10518/articlesCommonwealth Financial Planning – The Conversation2014-10-29T19:12:47Ztag:theconversation.com,2011:article/335482014-10-29T19:12:47Z2014-10-29T19:12:47ZDo the crime, do the time? Not if you’re a banker in Australia<p>Recently, the head of the Australian Securities and Investments Commission, Greg Medcraft, called Australia a “paradise” for <a href="http://www.theage.com.au/business/australia-paradise-for-whitecollar-criminals-says-asic-chairman-greg-medcraft-20141021-119d99.html">white-collar criminals</a>. Soon after <a href="http://www.watoday.com.au/business/asic-backflips-on-criminals-paradise-comments-20141022-119v22.html">he recanted</a>, claiming he didn’t want the country to become a haven for financial fraudsters. This rephrasing likely followed when Finance Minister Mathias Cormann <a href="http://www.abc.net.au/news/2014-10-22/red-faced-over-white-collar-criminals/5834540">leaned on Medcraft</a>.</p>
<p>The mass media has done an admirable job bringing the CBA financial planner scandal to light, forcing ASIC to finally investigate, the Senate to inquire and the CBA to apologise and provide compensation. Despite this, frauds like these are <a href="http://www.abc.net.au/news/2014-10-24/cba-whistleblower-jeff-morris-discusses-financial/5840536">universally downplayed</a> as isolated events, perpetrated by “bad apples” in an otherwise trustworthy FIRE (finance, insurance and real estate) sector. </p>
<p>Australia’s economic history shows otherwise. Our past is littered with a surprisingly large number of control frauds, which government and regulators have done next to nothing to prevent and rarely prosecute. The mounting frauds appear emboldened by deregulation and liberalisation of banking and finance. </p>
<p>The following table provides an overview of the major frauds committed by the FIRE sector in recent decades.</p>
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<p>The term “control fraud” refers to the systematic, highly damaging, institution-driven and directed nature of the fraud, in contrast to common low-level frauds. The weapon of choice is accounting.</p>
<p>William K. Black’s book <a href="http://www.amazon.com/The-Best-Way-Rob-Bank/dp/0292754183/ref=dp_ob_title_bk">The Best Way to Rob a Bank Is to Own One</a> provides an excellent account of regulatory public executives who, during the United States Savings and Loan crisis in the 1980s, actively protected the worst fraudsters in the industry, while damning “mum and dad” investors. Black later developed the <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1590447">concept of control fraud</a>, whereby executives use the institution they manage as the mechanism to commit fraud.</p>
<p>Control frauds typically involve a four-part strategy: exponential loan growth, lending to uncreditworthy borrowers, extreme leverage and minimal loss reserves (plus obnoxious pay packets for bank CEOs). The obvious presence of these four elements in Australia’s banking system demonstrates the risk to stability which lies at the centre of finance.</p>
<h2>Why fraud goes undetected</h2>
<p>Australian economist Phillip J. Anderson documented in his book on <a href="http://www.amazon.com/Secret-Life-Real-Estate-Banking/dp/0856832634">US real estate cycles</a> from 1800 to 2008 that fraud is never detected by the mainstream for two reasons. The first is that FIRE sector executives and managers are extremely powerful politically, financially and legally, so few will tangle with them. Secondly, during economic booms, the public is typically too self-centred to care, as long as the predations don’t affect the majority.</p>
<p>ASIC refuses to investigate the control frauds, instead choosing to offer up a number of excuses: lack of funding, jurisdictional boundaries, ineffective laws and so on. Thankfully, 20-year veteran financial consumer activist <a href="http://www.bfcsa.com.au/index.php/about-bfcsa/about-denise-brailey">Denise Brailey</a> does what ASIC declines to do on a A$400 million dollar budget. Brailey, a criminologist, has helped unearth and sue control frauds and recalcitrant state governments over the years.</p>
<p>According to Brailey, Australia has two major control frauds rapidly growing without restraint: a <a href="http://www.smh.com.au/business/watchdog-asleep-on-australias-subprime-scandal-20131024-2w323.html">subprime mortgage scandal</a> and debenture-funded pyramid business scams. The former is similar to the US subprime mortgage scandal. Brailey estimates these control frauds could each cause over A$100 billion in losses. Brailey has warned ASIC about these control frauds for over a decade. </p>
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<h2>Paradise untouched</h2>
<p>It has never been a better time to be a criminal, as long as you’re a white-collar criminal in the FIRE sector. Bankers involved with the CBA financial planning scandal have <a href="http://www.smh.com.au/business/comment-and-analysis/the-response-to-the-commonwealth-financial-planning-scandal-shows-banks-really-are-above-the-law-20141026-11c13d.html">still managed to advance their careers</a> and win bonuses.</p>
<p>History enlightens us, which is why the history of control frauds isn’t taught anywhere. Political and economic elites want the public kept blind to the plague of theft they’ve been engaged in. In Australia, this history is left to individuals like <a href="http://www.bfcsa.com.au/">Denise Brailey</a> and <a href="http://www.bankvictims.com.au/dr-evan-jones">Evan Jones</a> to tell, whose work was used in my recently published <a href="http://www.worldeconomicsassociation.org/files/Bubble_Economics_Egan_Soos.pdf">book</a>, co-authored with Paul D. Egan.</p>
<p>The disparity between white and blue-collar criminals has never been larger. If I defraud my neighbour of $10,000, I’ll be charged, prosecuted and sent to jail for years. In contrast, a <a href="http://www.bfcsa.com.au/index.php/scams/hall-of-shame">banking executive</a> who robs borrowers and loots or destroys untold billions of dollars is praised by politicians, business groups, the mass media and the economics profession for “wealth creation”.</p>
<p>Australia’s credit-based banking system, liberated from responsibility by deregulation, self-regulation, de-supervision and de facto decriminalisation, has and will inevitably continue to generate toxic and recurring control frauds. The FIRE sector cannot be allowed to profit from control fraud. Government has a civic obligation to prosecute those who perform criminal acts on innocent parties. We know this as the rule of law.</p>
<p>Academia could offer an independent voice against these control frauds, but the legal and economics professions are mute before the FIRE sector, which employs many directly and indirectly. As Black documented, mainstream economists have intentionally ignored the dangers of control frauds, proclaiming that “private market discipline” and “rational agents” can prevent frauds from even occurring: “the market knows best” line of fallacious reasoning.</p>
<p>The full extent of these control frauds is yet to be revealed as the government, regulators and external dispute resolution organisations (RBA, ASIC, APRA, ATO, AFP, Treasury, FOS and COSL) resolutely refuse to investigate. Meantime, control frauds are free to weave a trail of forced bankruptcies, homelessness, poverty, desperation, depression and suicide.</p>
<p>History shows government only acts when the predations of control frauds break in the mass media. The two largest control frauds, the debenture-funded pyramid business scams and <a href="http://fsi.gov.au/files/2014/09/Banking_and_Finance_Consumer_Support_Association.pdf">subprime mortgage scandal</a>, are running rampant. Unfortunately, government will only grudgingly do something when the number of victims climbs far enough that they become too visible to openly ignore – but, by then, it will be too late. </p>
<p>Nevertheless, a Royal Commission is necessary to shine a light on the transgressions of the FIRE sector.</p><img src="https://counter.theconversation.com/content/33548/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Philip Soos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Recently, the head of the Australian Securities and Investments Commission, Greg Medcraft, called Australia a “paradise” for white-collar criminals. Soon after he recanted, claiming he didn’t want the…Philip Soos, Researcher, School of International and Political Studies, Deakin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/268222014-05-19T20:23:22Z2014-05-19T20:23:22ZResist efforts to water down FOFA, to protect all Australians<p>As public hearings into the <a href="http://futureofadvice.treasury.gov.au/Content/Content.aspx?doc=home.htm">Future of Financial Advice’s</a> Senate inquiry begin on Thursday, it’s probably not overstating the case to say the financial planning industry is at a crossroads. </p>
<p>With the F0FA regime currently in place, the opportunity presents itself for a new generation of financial planners committed to serving the best interests of consumers, without the conflicting incentive of commissions.</p>
<p>Unfortunately the old generation of financial planners appears intent on rejecting this opportunity. It’s probably not surprising given that, according to 2011 figures from the Mortgage and Finance Association of Australia (MFAA), only 11% of planners are aged under 30, and around 80% of planners are either owned or affiliated with the major banks. Hence the sales culture of the older planners and their vertically integrated organisations, wishing to cross-sell as much product as possible, is well entrenched.</p>
<p>As a consequence we are seeing an ongoing campaign (<a href="http://futureofadvice.treasury.gov.au/Content/Content.aspx?doc=home.htm">notably by some of the big banks</a>) to water down the FOFA legislation, which has only been in place since July 2013.</p>
<p>The proposed reforms to FOFA include removing the “opt-in” requirement where clients of financial advisers must indicate annually that they wish to continue the service, removing the need for an annual fee disclosure for clients engaging before July 1, 2013, and a watering down of the “best interest” duty and provisions directed at removing conflicted remuneration; that is the payment of commissions, on general advice.</p>
<p>The process was postponed in March when assistant treasurer Arthur Sinodinos stepped aside and finance minister Mathias Cormann referred the legislative package to the Senate Economics Legislation Committee, but <a href="http://www.smh.com.au/business/fofa-reforms-sell-retirees-short-20140512-385tm.html">media reports</a> suggest the government may soon unveil its plans.</p>
<p>The banking industry claims much has changed since the impact of the global financial crisis revealed the extent of shameful practices in the advice industry. </p>
<p>The financial advice collapses in Australia between 2006 and 2010 - involving <a href="http://www.themonthly.com.au/issue/2011/february/1299634145/paul-barry/eye-storm">Storm Financial</a>, <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/Opes+Prime?openDocument">Opes Prime</a>, <a href="http://www.theglobalmail.org/feature/inside-the-offshore-fraud-the-villains-and-victims-of-australias-biggest-pension-scam/789/">Trio Capital</a> and <a href="http://www.smh.com.au/news/business/westpoint-could-have-been-wound-up-years-ago/2006/07/05/1151779013363.html?from=rss">Westpoint Property Group</a> - resulted in more than A$6 billion in losses and involved more than 120,000 people.</p>
<p>All involved conflicted remuneration structures and high commissions as fundamental issues.</p>
<p>But more recent cases involving Commonwealth Financial Planning have been brought to light <a href="http://www.smh.com.au/business/banking-and-finance/cba-told-to-reopen-compensation-for-advice-victims-20140516-38fd7.html">by reporting from Fairfax’s Adele Ferguson</a> and <a href="http://www.abc.net.au/4corners/stories/2014/05/05/3995954.htm">the ABC’s Four Corners</a>.</p>
<p>Advisers in these cases exploited their clients by offering advice that prioritised their own best interest over that of their clients.</p>
<p>It is difficult to understand the extent of this exploitation without reference to specifics. In one of the key cases surrounding the Storm Financial collapse, ASIC pursued Macquarie Bank and Bank of Queensland on behalf of two investors aged in their sixties, <a href="https://storm.asic.gov.au/storm/storm.nsf/byheadline/Doyle%20proceedings?opendocument">Barry and Deanna Doyle</a>. </p>
<p>Despite the fact that the Doyles had indicated to their advisers that they had a low risk appetite, they were “double-geared” into the stock market by borrowing against their home and using the cash to raise yet more money to invest. </p>
<p>With only part-time income of less than $20,000, some Centrelink payments, and assets which consisted of a house worth $450,000 and $640,000 in superannuation savings, the Doyles ended up owning a share portfolio costing $2.26 million, on which annual interest payments eventually rose to $191,800.</p>
<p>Following the fall in asset prices the Doyles’ highly leveraged share portfolio was sold, consuming all of their superannuation savings. They were left with a debt of $456,000 on their previously unencumbered home, with insufficient income to make the repayments. In return for this disastrous investment advice, which saw them increase their borrowings or exposure to the stock market no fewer than 11 times in 25 months, the Doyles paid Storm $152,000 in fees.</p>
<p>Not surprising then that at the heart of the FOFA legislation are two key “gatekeeper” requirements to address conflicted remuneration. First, planners must prioritise their clients interests over their own, and second, the advice must be appropriate to the client’s own situation.</p>
<p>It is important to note here that there are advisers who do routinely act in their client’s best interest. This is reflected in the Financial Planning Association of Australia’s <a href="http://fpa.asn.au/financial-system-inquiry-submission-recommends-consideration-fairness-co-regulation/">submission to the Financial System Inquiry</a>, which argues that rather than water down the FOFA legislation, there is a good case to extend this “gatekeeper standard” to other areas of financial services to protect the interests of investors more broadly.</p>
<p>As we have been reminded only too often over recent weeks, we have an ageing population, increasing demands on the welfare system, and a very real need to maximise our retirement savings to ensure greater self-reliance in retirement. Given the generally poor level of financial literacy in this country, this is most unlikely to happen unless individuals can access low cost and scalable advice to assist in their retirement planning. The opportunities for the financial advice industry, and the investment community more generally, is therefore enormous.</p>
<p>The willingness with which individuals seek such advice, however, will depend on their confidence in the financial planning industry. Research from Rice Warner indicates that as a result of collapses such as those listed above, consumers hold a low view of financial advisers, with only 25% regarding them as ethical and honest. This mistrust results in Australians not seeking financial advice when it could be beneficial for them to do so.</p>
<p>The FOFA legislation presents a great opportunity for the financial advice industry collectively to adopt a more ethical client focused approach, re-instilling confidence in the industry. Without that confidence, individuals will not seek the advice they need, retirement savings will not be maximised, and there is likely to be an even greater need to rely on the age pension.</p><img src="https://counter.theconversation.com/content/26822/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Deborah Ralston is affiliated with Mortgage Choice Financial Planning and provided expert advice to ASIC on the Storm Financial case.</span></em></p>As public hearings into the Future of Financial Advice’s Senate inquiry begin on Thursday, it’s probably not overstating the case to say the financial planning industry is at a crossroads. With the F0FA…Deborah Ralston, Professor of Finance and Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.