tag:theconversation.com,2011:/id/topics/storm-financial-2332/articlesStorm Financial – The Conversation2015-11-24T02:17:58Ztag:theconversation.com,2011:article/511182015-11-24T02:17:58Z2015-11-24T02:17:58ZMany wrongs can make a right: how mass redress schemes can replace court action<figure><img src="https://images.theconversation.com/files/102919/original/image-20151124-18227-1puwrus.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Class actions are often expensive and long-running.</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>Modern society is characterised by mass manufacturing, mass investment and mass consumption which give rise to “mass wrongs” - and the need for a system of mass redress.</p>
<p>Reports of harm to underpaid employees, users of pay-day lending and financial advice, shareholders and consumers has seen the rise of the redress or resolution scheme which diverts disputes from the courts into a quasi-administrative/ alternative dispute resolution mechanism.</p>
<p>Resolution schemes were previously ad hoc – created to deal with a particular crisis. Well-known examples include the World Trade Centre Victims’ Compensation Fund in response to 9/11 and the Gulf Coast Claims Facility in response to the BP oil spill in the Gulf of Mexico. </p>
<p>In Australia redress schemes were set up by banks in response to claims arising from Storm Financial’s collapse and in relation to financial advisers, and 7-Eleven has funded the Independent Franchisee Review and Staff Claims Panel chaired by Allan Fels.</p>
<p>However, the resolution scheme is becoming entrenched as a response to mass harm. In the UK the Consumer Rights Act 2015 permits a business to submit a voluntary redress scheme to the Competition and Markets Authority for approval as a mechanism to compensate customers. </p>
<p>In Australia the Australian Securities and Investments Commission (ASIC) has announced that it will develop a regulatory guide on review and remediation programs conducted by Australian financial services licensees that provide financial advice.</p>
<p>Why are the US, UK and Australia converging on resolution schemes as a solution to mass redress?</p>
<p>Potential defendants have an incentive to develop such schemes as they can avoid the high costs and risks of litigation. Corporations can deal with disputes that may adversely impact reputation and customer perceptions proactively. The resolution scheme can give real meaning to a corporate apology – it is the company putting its money where its mouth is. They can also incorporate flexible remedies beyond just financial payments.</p>
<p>The problem with resolution schemes is that the rule of law is replaced with consent and due process replaced with administrative steps. The public resolution of a dispute by an independent judiciary considering evidence, applying the law and giving reasons for a decision is lost.</p>
<p>Yet consumers are also attracted to schemes because they don’t have to incur the costs of litigation. The court system has tried to deal with mass harm through the class action. The class action can reduce the costs an individual would face compared to bringing litigation alone and, when coupled with litigation funding, provide protection against costs orders if a claim is unsuccessful. However, class actions are expensive. </p>
<p>For example the <a href="http://www.supremecourt.vic.gov.au/home/law+and+practice/class+actions/kilmore+east+kinglake+bushfire+class+action+settlement/">Kilmore East-Kinglake bush fire class action</a>, launched following the devastation of Victoria’s 2009 Black Saturday fires, recovered $494 million but $60 million went on legal fees. </p>
<p>In the <a href="http://www.smh.com.au/business/court-approves-centros-200m-classaction-settlement-20120619-20m2m.html">Centro shareholder class action</a>, $30 million from a $200 million settlement went on legal fees and then the litigation funders took about another 40%. But it can be worse. In the <a href="http://asic.gov.au/about-asic/media-centre/key-matters/information-for-great-southern-growers/">Great Southern financial product class action</a> a settlement of $23.8 million was reached - but $20 million went in legal fees.</p>
<p>Further, most class actions settle. There is no application of the law, reasons or precedent. After a settlement is reached a class action looks a lot like a confidential resolution scheme. Group members seek to substantiate their claims to an administrator, who applies some sort of formula to allocate the available funds.</p>
<p>The resolution scheme is a natural response to a court system, even with class actions, that is too expensive. The class action seemed to offer great hope through sharing of costs and economies of scale. However, class actions seem unable to deliver compensation as cheaply as resolution schemes.</p>
<p>However, the least cost option will be less attractive if it fails to fairly and equitably compensate consumers. Care needs to be taken that resolution schemes, especially those designed by corporations, are not tilted in the stronger parties’ favour or lack transparency. </p>
<p>This is why regulators are taking such interest in how a redress scheme will operate and want to see appropriate governance structures and procedures for independent review. Regulatory oversight will be used to promote just compensation.</p>
<p>Litigation will be the bogeyman that awaits disputants who cannot devise fair and effective resolution schemes for mass harm.</p><img src="https://counter.theconversation.com/content/51118/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael Legg is affiliated with Jones Day, Law Council of Australia Class Actions Committee and the Australia Pro Bono Centre.</span></em></p>Mass redress systems, rather than class actions, may be the least costly and most effective way to deliver compensation to large groups.Michael Legg, Associate Professor of Law, UNSW SydneyLicensed 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.tag:theconversation.com,2011:article/233652014-02-20T03:47:52Z2014-02-20T03:47:52ZLow penalties, high costs: ASIC needs legislative reform<p>In 2005, the Federal Court faced the difficult task of arriving at a penalty for Steve Vizard after he was found in breach of his duties as a director of Telstra. </p>
<p>In his judgment, Raymond Finkelstein <a href="http://www.smh.com.au/federal-politics/political-news/law-too-soft-on-whitecollar-criminals-says-former-judge-finkelstein-20120322-1vmxb.html">criticised the level of penalty</a> allowed under the Corporations Act and recommended that the upper limit of A$200,000 be reconsidered. </p>
<p>This week the Senate Economic References Committee is <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC">considering the performance of ASIC with public hearings in Sydney and Canberra</a>. Regrettably, nearly a decade after the Vizard case, nothing has changed.</p>
<p>ASIC is often subject to <a href="http://www.smh.com.au/business/scrutinising-asic-is-it-a-watchdog-or-a-dog-with-no-teeth-20131122-2y1s0.html">pointed criticism</a> for its perceived failures in policing the “big end of town” and its lack of timely, or sometimes any, intervention in matters that have attracted considerable media and public attention. </p>
<p>Some of these criticisms are well founded. But it should also be remembered that ASIC’s powers and functions are determined by its legislative framework. And that framework is overdue for reform.</p>
<h2>Insignificant penalties</h2>
<p>The upper limit of the penalty for directors and officers who breach their duties under the civil penalty scheme is still $200,000. This is without doubt a considerable sum. </p>
<p>But it does not lead to significant fines for individual directors who breach their duties. </p>
<p>In recent key cases the courts levied fines at the lower end of the spectrum. <a href="https://theconversation.com/the-hardie-judgement-muscling-up-asic-6840">In the James Hardie litigation</a>, for example, the Court of Appeal reduced the penalties imposed by the trial judge from $30,000 to $25,000 for the Australian directors and to $20,000 for the US directors. </p>
<p>These directors had breached their duties of care by approving a false and misleading announcement. </p>
<p>The non-executive directors in the <a href="https://theconversation.com/will-centros-mistakes-prompt-action-across-the-board-2048">Centro case</a> also breached their duties of care by approving the financial statements of the company despite a significant misclassification of the company’s debt. There was no fine imposed, in part due to the significant reputational damage they suffered. </p>
<p>It is perfectly clear from these and other cases that without legislative intervention to raise the upper limit of the penalty, we will continue to see relatively insignificant penalties handed out to directors. </p>
<p>While ASIC doesn’t suggest specific figures, it does make a submission based on the range currently available and within the parameters established by the legislation and the courts in previous cases. </p>
<p>It is proper that the courts weigh up a number of factors when arriving at an appropriate penalty. It is also fair that attention be paid to the reputational damage and embarrassment suffered by those who come before the courts. </p>
<p>However, it is notable that in the James Hardie case the fines for the Australian directors represented less than 40% of their directors’ fees in the year that they breached their duties. </p>
<p>In the Centro matter, the non-executive directors’ fees for the year in question ranged from $104,000 to $389,000. </p>
<p>The influence of the parity principle – that similar breaches should attract similar penalties – means that it is unlikely the courts will feel free to depart from the approaches in these cases without a circuit breaker. </p>
<p>Amending the legislation is the only way to change this pattern.</p>
<h2>Sky-high court costs</h2>
<p>The level of penalty is not the only area of the legislative framework ripe for reform. Other obstacles faced by ASIC include a cumbersome and costly civil penalty scheme where cases can cost many millions. </p>
<p>To ensure defendants aren’t exposed to penalty during proceedings, they aren’t obliged to specify their defences until ASIC’s case has closed. </p>
<p>As a consequence, ASIC is forced to plead all possible alternatives, increasing the complexity of its case and the time required to present it in court. Unsurprisingly, court time is wasted and costs escalate alarmingly. </p>
<p>For example, the costs incurred in the recent <a href="http://www.austlii.edu.au/au/cases/cth/HCA/2012/39.html">Fortescue case</a> have been estimated at A$30 million. Even before heading to the High Court, the total cost of the James Hardie litigation was said to be over $35 million.</p>
<p>In the Senate Committee hearings ASIC Chairman Greg Medcraft gave evidence that the <a href="http://www.abc.net.au/news/2013-08-12/asic-wins-storm-appeal/4881380">Storm Financial debacle</a> had so far cost ASIC $50 million. </p>
<p>Unless ASIC has accessible, efficient and powerful options that can be pursued through the courts, its position as the key regulator of companies and markets is undermined. This has inevitable consequences for all of us, as we are all now compulsorily investing through our superannuation schemes.</p>
<p>As the Senate Economic References continues to examine the performance of ASIC, it has an opportunity to recommend some real practical changes that can improve that performance. It’s an opportunity to act in the public interest that should not be missed.</p><img src="https://counter.theconversation.com/content/23365/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Suzanne Le Mire 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>In 2005, the Federal Court faced the difficult task of arriving at a penalty for Steve Vizard after he was found in breach of his duties as a director of Telstra. In his judgment, Raymond Finkelstein criticised…Suzanne Le Mire, Senior Lecturer, Law, University of AdelaideLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/109122012-11-22T19:39:18Z2012-11-22T19:39:18ZToo many lawsuits might break the banking sector<figure><img src="https://images.theconversation.com/files/17899/original/yyp97mnk-1353557312.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Rampant litigation in the financial sector will only create more risk for Australia's banks.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>This week, the National Australia Bank published its <a href="http://www.nab.com.au/wps/wcm/connect/nab/nab/home/about_us/20/3/8">2012 annual report</a>, confirming that its net profit for the year had fallen by about 21%, mainly from higher bad and doubtful debt charges. </p>
<p>Buried deep in the annual report on page 75 was an expense line item of $141 million related to “litigation expenses”. This not insubstantial amount had already been announced a few weeks prior as the result of the <a href="http://www.theaustralian.com.au/business/nab-pays-115m-to-settle-shareholders-gfc-claim/story-e6frg8zx-1226514026750">settlement</a> of a long-running class action by investors, who claimed to have lost money on the bank’s exposure to “toxic” CDOs.</p>
<p>The class action arose from events that occurred at the height of the global financial crisis (GFC) when, in May 2008, NAB announced that they were taking a charge of $181 million against its exposure to CDOs, while assuring the market that their investment in these products was “very conservative”. However, just two months later, the bank announced that it was taking a further charge of $830 million against its CDO exposure as a result of a write-down of similar securities by <a href="http://www.crikey.com.au/2008/07/29/how-merrills-dragged-nab-into-an-830m-writedown">Merrill Lynch</a>. Investors who had believed NAB’s assurances were justifiably ropeable when NAB’s shares tanked on the day of the announcement.</p>
<p>While NAB struggled back from the GFC abyss, some of the aggrieved investors joined a class action, run by the legal firm of Maurice Blackburn. After two years of litigation, this culminated in this month’s settlement of some $115 million, inclusive of costs and interest.</p>
<p>As has become customary in such settlements, there was no admission of liability by NAB.</p>
<p>Announcing <a href="http://www.nab.com.au/wps/wcm/connect/nab/nab/home/about_us/20">the terms of the settlement</a>, NAB’s company secretary, Michaela Healey stated: “The settlement of the class action is a purely commercial decision made in the interests of our shareholders. We are pleased to put this matter behind us so that we can continue to focus on improving returns for our shareholders without the distraction and significant expense of a lengthy trial”.</p>
<p>But hold on — who is actually paying for the settlement? Shareholders. NAB is slugging one set of shareholders this year for (allegedly) misleading another set of shareholders in the past.</p>
<p>But it is not only shareholders being stiffed. Another line item in the annual report shows that NAB has claimed $40 million income tax benefit against “litigation expense”, which, of course, ends up being picked up by the taxpayer.</p>
<p>The only people in the debacle who appear not to have felt the pain — aside from the lawyers — are the 11 non-executive directors of NAB, who collectively pulled down some $4 million in 2012, up slightly on 2011. Note that most of these directors were in place prior to the events that precipitated the class action and thus would (and should) be expected to bear some of the responsibility for the shareholder (and taxpayer) losses. But “no admission of liability” lets them off the hook, even though in the 2011 annual report the Board restated that the proceeding was being “vigorously defended”.</p>
<p>So what caused the climb down?</p>
<p>In its 2012 performance review, the bank lauded its “reputation-building initiatives, like doing more for our customers, investing in our own people and addressing our broader role in society”. Being found culpable in a class action for “misleading and deceptive conduct and [breaking] continuous disclosure provisions of the Corporations Act” would blow a hole in such fine sentiments. Best to settle and move on — especially if no one takes the blame and someone else is paying for it.</p>
<p>In a similar case, beset by a number of class actions following the failure of Storm Financial, Commonwealth Bank was <a href="http://www.abc.net.au/news/2012-09-14/cba-settles-storm-case-with-asic/4262298">forced to settle</a> with ASIC for a sum totalling $270 million to its customers who had lost in Storm’s collapse. Again there was no admission of liability by Commbank. Nor, as it turns out, did the Commbank Board take any responsibility. In the mean time, other class actions related to Storm continue for Commbank. </p>
<p>ANZ has also being caught in a similar no-win situation with the <a href="http://www.smh.com.au/business/asic-reveals-case-on-opes-prime-collapse-20110228-1bbtq.html">collapse of Opes Prime in 2008</a>. Having successfully asserted their rights, in court, to sell securities used as collateral to loans to Opes Prime, ANZ were nonetheless targeted by Opes investors as heartless bankers for selling their nest eggs (which they had foolishly handed over to Opes in the first place) over their heads. <a href="http://www.smh.com.au/business/anz-agrees-to-opes-settlement-20090306-8qjd.html">A class action</a>, run by Slater & Gordon, resulted in mediation by the corporate regulator ASIC, which eventually involved a settlement in which ANZ and Merrill Lynch paid around $253 million to Opes investors.</p>
<p>To recap: ANZ did nothing wrong in law, but being the last (and largest) man standing when Opes collapsed was fair game for litigation. ANZ settled and ANZ shareholders paid. No action was taken against the ANZ Board or management.</p>
<p>In each case, the banks have fallen foul of what the successful lawyer in the NAB case, Mr Jacob Varghese, called the “mechanism of private enforcement”. In other circumstances, such a mechanism would be called ‘vigilantism’.</p>
<p>Australia is not the only place that NAB is having legal problems. In its annual report, the bank foreshadows a payment of some $168 million for claims against its UK subsidiary, Clydesdale Bank. This provision is part of an industry settlement in the so-called PPI (Payment Protection Insurance) <a href="http://www.risk.net/journal-of-operational-risk/technical-paper/2164352/systemic-operational-risk-uk-payment-protection-insurance-scandal">scandal</a>. It is interesting to note that <a href="http://uk.news.yahoo.com/barclays-sets-aside-further-700m-over-ppi-scandal-135616736--finance.html">in the last month</a>, some UK banks have increased their estimates of their exposures to PPI, with the overall cost to the industry currently running at over $15 billion dollars. </p>
<p>One of the reasons for the seemingly out-of-control increase in the costs of the PPI debacle is the emergence of so-called claims management companies (CMCs). For a fee, these companies will do all of the paperwork for a PPI claimant and deduct a fee from any claim settled by a bank, before paying the claimant the remainder. Initially seen as white knights fighting the good fight for wronged consumers, these firms have become a self-sustaining industry, using the the <a href="http://www.ppiclaimback.co.uk/">internet</a> to trawl for potential claimants.</p>
<p>The genie is out of the bottle. The litigation and claims infrastructure has been built and is just waiting for the <a href="http://www.guardian.co.uk/money/2012/oct/29/claims-firms-mortgage-mis-selling">next big thing</a>. Having already spent considerable money on building the necessary legal and technical infrastructures, the cost to litigation firms of promoting new scandals is greatly reduced.</p>
<p>The arc of these scandals is as follows: (1) a financial company is perceived to wrong a customer; (2) the customer complains to the company and then to the Financial Ombudsman; (3) when sufficient customers make the same complaint and the issue is not addressed, they approach a specialist litigator; (4) the litigation firm convinces several hundred of the aggrieved to join a class action; (5) if not settled immediately, the action goes to court and the meter is running; (6) as each court appearance is scheduled, the dirty linen is washed in public, getting dirtier by the month; (7) all the while, the defendants in the action make loud noises about vigorously defending the case; (8) at some point, the clamour goes too loud; and (9) the defendant settles, while never admitting liability.</p>
<p>NAB reports just such an action “in relation to the payment of exception fees”, which appears to be at stage six in the arc above. We await the remaining stages, which, if past experience is anything to go by, will take two or three years to play out, all the while racking up costs for shareholders (and probably taxpayers).</p>
<p>While bank bashing can be a very satisfying blood sport, rampant litigation is not a very sensible way to run a financial system. Such legal actions inevitable push up costs for everyone in the industry, as potential legal settlements have to be factored into product prices. Out of court settlements also promote ‘moral hazard’ as bankers feel they can make risky decisions, safe in the knowledge that the shareholder (and/or taxpayer) will pick up the tab if it goes wrong. And such litigation, whether justified or not, also generates uncertainty as to the viability of legal contracts. It is all very well to have a watertight legal contract, but if that contract can be overridden by an out-of-court settlement, its effectiveness is debatable.</p>
<p>Such legal uncertainty, if it were to become prevalent throughout the industry, may even undermine Australia’s hopes to be a regional financial hub in the Asian Century. Perhaps it is time for the peak regulator, the Council of Financial Regulators, to address this potentially significant systemic risk.</p><img src="https://counter.theconversation.com/content/10912/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell 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>This week, the National Australia Bank published its 2012 annual report, confirming that its net profit for the year had fallen by about 21%, mainly from higher bad and doubtful debt charges. Buried deep…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/97612012-09-24T20:20:44Z2012-09-24T20:20:44ZToo late for Storm, but bank liability the lesson from Wingecarribee<figure><img src="https://images.theconversation.com/files/15784/original/vffj5yz3-1348452666.jpg?ixlib=rb-1.1.0&rect=20%2C35%2C1958%2C1260&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A rare win for investors: Litigation funder IMF (Australia) helped fund a class action case against Grange Securities, which was found to have misled unsophisticated investors.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Justice Steven J. Rares was blunt when he handed down <a href="http://www.austlii.edu.au/au/cases/cth/FCA/2012/1028.html">his judgement</a> in the long-running class action, Wingecarribee Shire Council vs. Lehman Brothers Australia, last week.</p>
<p>Grange Securities, a subsidiary of Lehman Brothers, had engaged in “misleading and deceptive behaviour” in promoting sub-prime derivatives known as Synthetic Collateralized Debt Obligations to three local authorities in NSW and WA, Justice Rares said. </p>
<p>Led by Wingecarribee Council, a regional council in Bowral in NSW’s Southern Highlands, 72 plaintiffs including councils, charities and churches were found to be entitled to millions of dollars after having been misled into buying toxic investments.</p>
<p>Much already has been, and will be, <a href="http://www.theaustralian.com.au/business/legal-affairs/lehman-found-to-be-liable-for-losses/story-e6frg97x-1226479146991">written</a> about the Wingecarribee case and the judgement. </p>
<p>But of interest here is the fact that the matter went through the full legal process with a hearing in open court and a final judgement made by a senior judge (although there may still be an appeal to a higher court). After considering the evidence, the judge ruled that Lehman was “liable to compensate the councils for [ALL of] their losses incurred as a result of their investments”.</p>
<p>Compare this with the latest settlement in the Storm Financial case. On 14 September, Commonwealth Bank <a href="http://www.abc.net.au/news/2012-09-14/cba-settles-storm-case-with-asic/4262298">agreed</a> to provide $136 million (on top of an earlier payment of $132 million) in compensation to customers who lost money when Storm Financial collapsed in March 2009. The case, brought by the Australian Securities and Investments Commission (ASIC), continues against other banks and Storm itself. Other class actions related to Storm also continue for Commbank.</p>
<p>The timing of the settlement is interesting. On 20 August, CBA released its 2012 annual report, which contained a section on Storm Financial in which the bank noted that it was “close to finalising its resolution scheme for clients of Storm Financial who borrowed money from the Group”. Less than four weeks later, the case with ASIC was wrapped up “without any admission of liability by the Group”.</p>
<p>This is yet another example of banks successfully burying bad news. Doubtless at some time in the future, an enterprising journalist will publish a book on the Storm Financial fiasco when names will be named. But for now, no one has fallen on their sword or been sacked at Commbank over payments totalling some $270 million (not including legal costs) underwritten by the bank’s shareholders. In fact, the Annual Report shows that all Board members received a nice pay rise.</p>
<p>Overseas, it is very different. Earlier this year, the UK banking regulator, the FSA, undertook a “thematic review” of complaints from numerous small companies concerning mis-selling of interest rate hedging products by banks. </p>
<p>When the review was completed, the UK regulator <a href="http://www.fsa.gov.uk/library/communication/pr/2012/071.shtml">ordered</a> the major UK banks to provide redress to any companies affected by mis-selling. The banks complied immediately and apologised. Now that’s regulation.</p>
<p>Thematic review is the new buzzword in regulatory circles. It means looking across the financial system at abuses that may be occurring in more than one institution and is a tool of so-called macro-prudential regulation. In a long overdue <a href="http://www.apra.gov.au/AboutAPRA/Publications/Documents/2012-09-map-aus-fsf.pdf">report</a> into macro-prudential regulation in Australia, jointly published by RBA and APRA, the banking regulator has jumped on the bandwagon and announced its commitment to such cross-industry reviews. </p>
<p>However, APRA has not yet provided details of any areas in which such a review will be undertaken. But the many complaints aired in the recent <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=economics_ctte/post_gfc_banking/hearings/index.htm">Senate Inquiry</a> on the banking system after the GFC might provide a useful starting point.</p>
<p>The form of words “without admission of liability” has become a cliché whenever cases of bank wrongdoing around the world are settled, usually with a large payment by the banks concerned. So much so that last November, Judge Jed Rakoff of the US District Court in Manhattan had had enough, <a href="http://www.huffingtonpost.com/2012/08/14/jed-rakoff-sec_n_1776300.html">throwing out</a> a settlement between Citigroup and its regulator, the SEC.</p>
<p>Judge Rakoff said that the regulator’s policy of settling cases by allowing a company to neither admit nor deny allegations “did not satisfy the law”. He added that the settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest” because it does not provide the court with sufficient evidence on which to judge the settlement.</p>
<p>The judge’s point is that the regulator is not only the prosecutor, but also the judge and the jury in these settlements. Nor is there independent oversight or appeal. And, as with the Storm case, it is the shareholders, not the wrongdoers, who pick up the tab.</p>
<p>One can sympathise with regulators, especially the SEC, which is inundated with a huge number of cases of bank wrongdoing resulting from the GFC. Banks (correction: shareholders) have deep pockets and can keep litigation going for a long time. On the other hand, regulators must consider the public purse when pursuing cases.</p>
<p>But a case that is judged in court creates case law and legal precedent. For example, as a result of Justice Rares’ judgement, we now know that some of the practices used by Grange were illegal and any banks involved in the same practices, now and in future, can be held to account without a long and expensive trial. Hopefully, regulators will make this point to any banks that may be tempted to follow Grange’s example.</p>
<p>One of the embarrassing facts that emerged from the Lehman trial was that Grange Securities sold these complex and, as it turned out, very risky products to councils and charities with misleading marketing material that praised local banking regulators whose “regulatory requirements make the Australian banking system amongst the safest in the world”. This implied that government would somehow protect the investments sold by Grange. The “safest banking system in the world” is a very powerful meme.</p>
<p>Following the GFC and other scandals, such as the <a href="http://www.guardian.co.uk/money/2012/sep/11/ppi-complaints-1500-a-day-fos">mis-selling of Payment Protection Insurance (PPI)</a> in the UK, governments around the world have beefed up their regulatory environments. One of the key areas that governments have focused on is “financial conduct” especially as regards ordinary consumers.</p>
<p>In the UK, the Financial Conduct Authority (FCA) has been carved out of the banking regulator, the FSA, to focus specifically on the “conduct” of financial services firms not only as regards retail customers but also commercial firms. </p>
<p>In the USA, the Consumer Financial Protection Bureau (CFPB) has been created with a similar mandate, to protect <a href="http://www.consumerfinance.gov/the-bureau/">consumers</a> from “unfair, deceptive, or abusive acts or practices”.</p>
<p>The lesson from these regulatory innovations is that a large single regulator may be too stretched to handle the myriad of issues that can arise in a modern financial system and that smaller and more focussed regulators would do a better job. [This, of course, is a hypothesis that remains to be proven or otherwise]</p>
<p>The new financial conduct regulators in the US and UK have also been given a mandate to improve financial literacy to help protect against financial fraud. In Australia, financial literacy is just one of the regulatory roles assigned to ASIC, along with regulation of financial markets and company registrations.</p>
<p>The ASIC <a href="https://www.moneysmart.gov.au/">Moneysmart</a> web site is primarily aimed at ordinary consumers, giving advice on investing, superannuation and retail credit, such as credit cards. However, as the Lehman case shows, with complex modern investments even finance professionals can have the wool pulled over their eyes.</p>
<p>If one believes that mis-selling of complex financial products could not happen in Australia, there is little need to consider changes to regulatory structures here. However, evidence to the Senate Inquiry would suggest that financial mis-selling was not limited to local councils but was widespread during the property boom of the early 2000s. If so, government should consider whether and how regulatory structures should be changed to meet such challenges.</p>
<p>There is also a need for case law to be clarified surrounding the practices of selling complex financial products. If necessary, the government should, where the law is unclear, be prepared to underwrite legal action by regulators against financial institutions, all the way through the courts until the matter is adjudicated. With the legal certainty of case law, both financial institutions and regulators will be able to move forward on firmer ground. And taxpayers will sleep happier at night.</p>
<p>In those cases where a settlement is agreed, it should be standard practice as part of, and paid for by, the settlement for an independent inquiry to be automatically set up. Since the actions of both regulated and regulator would be considered, such inquiries would be best administered by a truly independent body such as the Australian National Audit Office. To address any open legal concerns, the terms of reference of a particular inquiry would include recommendations from the judge in the settlement.</p>
<p>Wingecarribee shone a light onto dubious financial practices in the Australian marketplace. Such shoddy practices can only be tackled by strong and intrusive regulation, funded and supported by government. There is a need for government to learn all of the lessons from this case.</p><img src="https://counter.theconversation.com/content/9761/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell 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>Justice Steven J. Rares was blunt when he handed down his judgement in the long-running class action, Wingecarribee Shire Council vs. Lehman Brothers Australia, last week. Grange Securities, a subsidiary…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/52992012-02-21T19:39:37Z2012-02-21T19:39:37ZFinancial advice reform: have we learned enough from Storm?<figure><img src="https://images.theconversation.com/files/7789/original/jfq47ghx-1329451844.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Founder of Storm Financial, Emmanuel Cassimatis, speaks before a parliamentary inquiry.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>When <a href="http://news.theage.com.au/breaking-news-business/storm-financial-collapse-plan-outlined-20090810-ef9y.html">financial planning firm Storm Financial</a> collapsed with $3 billion in investment losses, many of its investors were left destitute.
A parliamentary joint committee inquiry into the company’s demise was conducted in response and, in 2010, then Financial Services Minister Chris Bowen announced a series of sweeping reforms aimed at giving greater protection to retail investors.</p>
<p>The Future of Financial Advice (FOFA) reforms are due to come into force on July 1, 2012. The proposals are intended to minimise conflicts of interest and restore confidence in the financial advisory sector. The proposals include: a ban on commissions and rebates on a prospective basis; a requirement for clients to opt in for advice every two years; a duty for financial advisers to act in their client’s best interests; a ban on percentage-based fees on geared products and portfolios; allowing superannuation funds to provide simple intra-fund advice at minimal or no cost to members; and further powers for the Australian Securities and Investments Commission (ASIC) to act against unscrupulous advisers. </p>
<p>The fundamental purpose of the proposals is to prevent consumers from suffering investment loss arising from inappropriate advice. The most devastating example is attributed to Storm, where about 4000 clients suffered losses estimated to be $3 billion. The advice was based around “double gearing” - by borrowing against the client’s house and then using margin lending to invest heavily in the sharemarket. The undoing of this strategy was the global financial crisis when share values fell heavily and the lenders called in loans – both against the shares and against the client’s house. Yet Storm had complied with procedural requirements of the law at the time. The model used by Storm could exist in the future for some clients, except for a modification to the remuneration method. </p>
<p>Where Storm’s advice model came unstuck was when they applied a similar strategy to a large number of clients, where it was argued that the advice was not appropriate in many sets of circumstances. The proposed “best interests” provision is a change from the current law as the adviser will be required to put the client’s interests first and above the adviser’s own interests. This is a laudable and ethical move, but can this be enforced? Under the best interest duty, an adviser is required to only give advice that is appropriate for the client. This will replace the current rule, which states that an adviser must provide a “reasonable basis for the advice”. In describing the best interest provision, the term “reasonable” is used a number of times, which indicates that subjectivity of what is reasonable will be the order of the day.</p>
<p>The current rules would have ruled out the Storm advice for a number of clients as the advice would have been deemed not to have been reasonable given the circumstances of each client. This matter is currently before the court under existing legislation. However, it may have been appropriate for some clients and under the new rules the same strategy could be appropriate for some particular clients as well. The Storm disaster is seen as the reason behind the changes to the laws governing investment advice. </p>
<p>Under the proposals, a financial adviser that charges fees for ongoing advice will be required to send a notice to the client requesting the client to agree to renewal of the service contract, otherwise the adviser must cease invoicing the client. Such a proposal adds costs to the operations of a financial planning practice, yet is designed to ensure that clients do not pay for any services that they do not receive. It is a worthy addition to the objective of consumer protection. </p>
<p>However, the FOFA reforms reinforce an inconsistency in the intent of the proposals. The proposal to allow intra-fund advice by institutions and superannuation funds reflects a conflict of interest, as the advice can hardly be seen as independent. When a member of a fund seeks advice from the fund in which they are a member, it is extremely unlikely that the member will be advised to invest elsewhere, other than in the same fund. With intra-fund advice encouraged by the proposals, this is likely to result in limited advice provided to consumers, which is not focused on the whole of the client’s needs but solely on their superannuation fund interest pertinent to that particular superannuation fund. This proposal is likely to push consumers more towards limited and conflict-ridden advice than that which existed before. </p>
<p>Furthermore, the advice offered by intra-fund means is generally paid for by the fund out of charges levied for the administration of the fund. Yet the banning of an alternate form of remuneration for advice in the form of commission is also seen as inconsistent. The allocation of payment for advice offered by superannuation funds is not declaredm yet the commission paid by retail investors is declared to the consumer. So, on the one hand, the proposals are aimed at seeking independence and objectivity; on the other, the institutions – banks and industry superannuation funds - control much of the product manufacture, distribution and the associated advice offered to consumers. </p>
<p>The enhancement of ASIC’s powers will capture all financial advisers (including those who are salaried employees), whereas at present, only those who are known as “authorised representatives” are known to ASIC. This will enable ASIC to ban employed advisers who can move from employer to employer under the current arrangements. </p>
<p>It might be said that the government has missed an opportunity to break the nexus between the manufacturers, distributors and advisers, but instead has provided a means of reinforcing the integration of product and advice and conflict of interest. It may be argued that this reinforcement of a conflict of interest scenario is a trade-off with the breaking of the up-front and trail commission element of the current situation, eliminating many independent advisers under the argument that a reduction of costs to retail consumers will benefit their superannuation balances in the long run. Overall, it is seen as a win for the institutions and the industry superannuation funds.</p><img src="https://counter.theconversation.com/content/5299/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Warren McKeown is a Certified Financial Planner who advises clients on investment and superannuation matters. The licensee is not associated with any bank or industry superannuation fund.</span></em></p>When financial planning firm Storm Financial collapsed with $3 billion in investment losses, many of its investors were left destitute. A parliamentary joint committee inquiry into the company’s demise…Warren McKeown, Teaching fellow , The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.