In my Interim Report I asked many questions. As I said at that time, I sought to provoke informed and useful debate about the issues that have emerged in the course of the Commission’s inquiries.
Many of those questions were explored in the course of the final round of the Commission’s public hearings and in the many submissions made to the Commission. Submissions were received from financial services entities; the Australian Prudential Regulation Authority (APRA); the Australian Securities and Investments Commission (ASIC); Treasury; those who have been affected by the conduct that has been the subject of the Commission’s inquiries; other interested parties given leave to appear at some of the Commission’s hearings (including the Finance Sector Union and consumer bodies such as CHOICE and the Consumer Action Law Centre); industry associations (including the Australian Banking Association (ABA) bodies representing financial advisers, mortgage brokers and others); academics; and members of the public more generally.
The focus of this Report must be on issues, causes and responses. I will deal separately with the various sectors of the financial services industry. More particularly I will deal separately with:
- financial advice;
- superannuation; and
Some more general issues extend across all sectors of the financial services industry. They are issues about
- culture, governance and remuneration; and
The responses to the issues that are identified in each of those separate areas are informed by some underlying principles. It is useful, therefore, to begin by stating those principles.
1.5.1 Underlying principles
At their most basic, the underlying principles reflect the six norms of conduct I identified in the Interim Report:
- obey the law;
- do not mislead or deceive;
- act fairly;
- provide services that are fit for purpose;
- deliver services with reasonable care and skill; and
- when acting for another, act in the best interests of that other.
These norms of conduct are fundamental precepts. Each is well‑established, widely accepted, and easily understood.
Of course, when these norms are stated in the terms I have, it will be said that borderline cases can be identified. And applying the norms to some of those borderline cases may not be easy. But real or imagined cases testing the boundaries of a rule do not show that the rule has no content. Debate about whether the wire runs one side or the other of one or more fence posts must not obscure the size of the field the fence encloses.
The six norms of conduct I have identified are all reflected in existing law. But the reflection is piecemeal.
The general obligations of Australian financial services licence (AFSL) holders, stated in section 912A of the Corporations Act, and the general obligations of Australian Credit Licence (ACL) holders, stated in section 47 of the NCCP Act, stand out.
First, both provisions impose an overarching obligation to ‘do all things necessary to ensure’ that the financial services or credit activities authorised by the licence are provided ‘efficiently, honestly and fairly’. Understood properly, this requirement would embrace all six norms.
Second, both provisions oblige licence holders to comply with, in the case of AFSL holders, the financial services laws and, in the case of ACL holders, the credit legislation. That is, licence holders must obey the law.
Third, both provisions oblige licence holders to maintain their own competence to provide the licenced services and to ensure that their representatives are both adequately trained and competent to provide those services. That is, they are required to have the capacity to deliver services with reasonable care and skill.
As the law now stands, breach of these general obligations carries no penalty. They are licence conditions enforceable only indirectly, by threatening withdrawal of the licence.
That said, the requirement that an AFSL holder acts honestly is expressed further in section 1041G of the Corporations Act, which makes it an offence to engage in dishonest conduct in relation to a financial product or financial service. But the offence relates only to conduct in relation to a financial product or financial service, and Divisions 3 and 4 of Part 7.1 of the Corporations Act are given over to defining what is, and is not, a financial product, and when a person provides a financial service.
The more particular norms I state about not misleading or deceiving and acting fairly are reflected in the provisions of the Australian Securities and Investment Commission Act 2001 (Cth) (the ASIC Act) about misleading or deceptive conduct, false or misleading representations, unconscionable conduct and unfair contract terms. And the requirement to provide services that are fit for purpose and deliver services with reasonable care and skill are also reflected in the ASIC Act. But some of those provisions apply generally and some apply only to dealings with consumers. And the unconscionable conduct and consumer protection provisions use definitions of ‘financial product’ and ‘financial service’ that differ from those provided by Chapter 7 of the Corporations Act.
The sixth norm – when acting for another, act in the best interests of that other – is reflected in the financial advice sector by the best interests duty imposed by section 961B of the Corporations Act, together with the associated obligation provided by section 961J to give priority to the client’s interests over other interests.
The norms are dealt with differently in respect of superannuation and insurance. In superannuation, they find their most prominent reflection in the SIS Act, in the best interests covenant and associated covenants by registrable superannuation entity (RSE) licensees and directors of trustees. And those covenants also provide direct reflection of the norm that a person or entity acting for another, must act in the best interests of that other.
In insurance, all of the norms may be seen as embodied in the duty of utmost good faith imposed on each party to an insurance contract by section 13 of the Insurance Contracts Act 1984 (Cth) (the Insurance Contracts Act).
As I say, the six norms of conduct I have set out are reflected in existing law, but the reflection is piecemeal.
1.5.2 General rules
The six norms of conduct I have identified support, and in some cases entail, some general rules:
- the law must be applied and its application enforced;
- industry codes should be approved under statute and breach of key promises made to customers in the codes should be a breach of the statute;
- no financial product should be ‘hawked’ to retail clients;
- intermediaries should act only on behalf of, and in the interests of, the party who pays the intermediary;
- exceptions to the ban on conflicted remuneration should be eliminated;
- culture and governance practices (including remuneration arrangements) both in the industry generally and in individual entities, must focus on non-financial risk, as well as financial risk.
Why these general rules?
Apply and enforce the law
The first general rule, that the law must be applied and its application enforced, requires no development or explanation. It is a defining feature of a society governed by the rule of law.
The conduct identified and criticised in the Commission’s Interim Report and in this Report has been of a nature and extent that shows that the law has not been obeyed,and has not been enforced effectively. It also points to deficiencies of culture, governance and risk management within entities. Too often, entities have paid too little attention to issues of regulatory, compliance and conduct risks. And the risks of regulatory or other non‑compliance and of misconduct are the risks of departure from the first general rule of ‘obey the law’. What consequences follow, and whether this amounts to effective enforcement of the law, bears directly upon the nature and extent of the regulatory, compliance and conduct risks that entities must manage.
Industry codes are expressed as promises made by industry participants. If industry codes are to be more than public relations puffs, the promises made must be made seriously. If they are made seriously (and those bound by the codes say that they are), the promises that are set out in the code, and are intended to govern the particular relations between the provider and the acquirer of a financial product or financial service, must be kept. This must entail that the promises can be enforced by those to whom the promises are made: the customer who acquires the product or service, and the guarantors of loans to individuals and small businesses.
‘Hawking’ company securities, by making unsolicited approaches to potential buyers, has long been unlawful. The practice has long been unlawful because it too readily allows the fraudulent or unscrupulous to prey upon the unsuspecting. There is no real check on what is said to the target and often the target is not able to check the truth of what is said. The asymmetry of power and information between the provider of the product and service and the acquirer is very large. Even if the ‘hawker’ is not fraudulent or unscrupulous (and, too often, cases examined in evidence showed that the hawker was at least unscrupulous) the acquirer is nevertheless ‘unsuspecting’. The potential acquirer who has not sought out the product or service comes to the encounter unprepared to look critically at whatever is said. The potential acquirer often does not know what questions to ask.
Hawking financial products and managed investment products is now generally prohibited. But there are some exceptions. Other than the provisions relating to offers not made to retail clients and offers made under an eligible employee share scheme, however, there is no immediately apparent basis for thinking that the exceptions are areas where the fraudulent or unscrupulous may not yet prey upon the unsuspecting. And the evidence given to the Commission points firmly against maintaining exceptions to the general prohibition, at least in respect of superannuation and insurance products, other than the two exceptions mentioned: offers not made to retail clients and offers made under an eligible employee share scheme.
For the avoidance of doubt, it should also be made plain that a solicited meeting, or telephone call, to discuss one type of financial product must not be used for the unsolicited offering of some other type of product. (In that regard, common forms of banking products, like transaction accounts and credit card accounts should be treated as together forming the one kind of product. But each superannuation product and each insurance product is, and should be treated as, a distinct product type.)
In the Interim Report, I pointed out how difficult it may be to decide for whom intermediaries act and to whom a particular intermediary may owe duties and responsibilities. As I indicated then, the difficulties may be acute in the case of mortgage brokers. But the difficulties are not confined to home lending. Point-of-sale negotiation of credit arrangements (by car dealers, white goods retailers and the like) presents similar difficulties.
The point is much more important than a dry point of legal analysis. For whom the intermediary acts determines what duties the intermediary owes and to whom they owe them.
The general rule that should apply throughout the financial services industry is that an intermediary who is paid to act as intermediary:
- acts for the person who pays the intermediary;
- owes the person who pays a duty to act only in the interests of that person; and
- ordinarily owes the person who pays a duty to act in the best interests of that person.
The particular working out of these principles, especially with respect to mortgage brokers and the home lending market, is dealt with in the chapter about banking.
The definition of ‘conflicted remuneration’ in the Corporations Act shows why the practice should be prohibited.
Section 963A of the Corporations Act defines ‘conflicted remuneration’ as any benefit (whether monetary or non‑monetary) given to a financial services licensee or a representative of the licensee, who provides financial product advice to persons as retail clients, that, because of the nature of the benefit or the circumstances in which it is given, could have either or both of two effects:
- it could reasonably be expected to influence the choice of financial product recommended by the licensee or representative to retail clients; or
- it could reasonably be expected to influence the financial product advice given to retail clients by the licensee or representative.
That is, as I said in the Interim Report, ‘the very hinge about which the conflicted remuneration provisions turn is that the payment is one that “could reasonably be expected to influence the choice of financial product recommended to retail clients”’.
For grandfathered commissions, the time when the initial advice was given and the initial conflict arose has passed. The influence of the commission has already done its work once. But the problem remains. The influence continues. Advisers have an incentive to keep their clients in products with grandfathered commissions rather than advise them to move to better products. There can be, and is, no justification for maintaining the grandfathering provisions.
Culture and governance
After the Global Financial Crisis (GFC), financial services entities and regulators, in Australia and elsewhere, gave close attention to financial risk. Until recently, however, too little attention has been given in Australia to regulatory, compliance and conduct risks. Too little attention has been given to the evident connections between compensation, incentive and remuneration practices and regulatory, compliance and conduct risks. The very large reputational consequences that are now seen in the Australian financial services industry, especially in the banking industry, stand as the clearest demonstration of the pressing urgency for dealing with these issues. As the Group of Thirty (G30) said in November 2018, ‘getting culture and conduct right is not a supervisory requirement. It is necessary for banks’ and banking’s economic and social sustainability’.
1.5.3 Making change carefully and simply
Treasury, and many of the entities that made submissions, urged the need for caution before recommending change. This is undeniably right.
As I said in the Interim Report, adding a new layer of regulation will not assist. It will add to what is already a complex regulatory regime. No doubt the financial services industry is itself complicated. That may be said to explain why the regulatory regime is as complicated as it is. But closer attention will show that much of the complication comes from piling exception upon exception, from carving out special rules for special interests. And, in almost every case, these special rules qualify the application of a more general principle to entities or transactions that are not different in any material way from those to which the general rule is applied.
History shows, as Treasury submitted, that legislative simplification can be a long and difficult task. Programs to simplify the law relating to income taxation and to reform corporate law have extended over many years – well beyond the life of a single Parliament. And I do not doubt that simplifying the law that relates to the financial services industry would be a large task. But there are two parts of that task that can inform, and I consider should inform, what is done in response to this Report.
First, it is time to start reducing the number and the area of operation of special rules, exceptions and carve outs. Reducing their number and their area of operation is itself a large step towards simplificiation. Not only that, it leaves less room for ‘gaming’ the system by forcing events or transactions into exceptional boxes not intended to contain them.
Second, it is time to draw explicit connections in the legislation between the particular rules that are made and the fundamental norms to which those rules give effect. Drawing that connection will have three consequences. It will explain to the regulated community (and the regulator) why the rule is there and, at the same time, reinforce the importance of the relevant fundamental norm of conduct. Not only that, drawing this explicit connection will put beyond doubt the purpose that the relevant rule is intended to achieve. And, the further consequence will be to highlight the fact that exceptions and carve outs like grandfathered commissions constitute a departure from applying the relevant fundamental norm. Emphasising the fact of departure may assist in reducing both the number and the extent of these qualifications.
In their submissions, some entities used the undoubted need for care in recommending change as a basis for saying that there should be no change. The ‘Caution’ sign was read as if it said ‘Do Not Enter’.
An assertion was necessarily implicit in the submissions that sought to maintain some aspect of the present regime unchanged: that doing nothing about those matters would carry less cost than making any change to the rules under consideration. But rarely, if ever, was the submission developed beyond the point of bare assertion. Rarely, if ever, was there explicit examination of, or comparison between, the costs of doing nothing and the costs and consequences of changing the rules. The rules that govern grandfathered commissions provide a useful example.
Two grounds have often been given for maintaining the present rules about grandfathered commissions without modification: orderly transition and constitutional infirmity.
If the provisions were made to allow orderly transition within the industry, that time has now passed. How much longer is the transition to take? For all the suggestions that it will ‘wither on the vine’, the charging and receipt of grandfathered commissions remained alive and well until some of the larger participants in the industry (especially the banks) sensed the wind of change may be blowing and found it best to bend now by phasing it out rather than have the wind grow to such intensity that it snap off this branch of their activities.
Whenever change is mooted, someone will suggest that changing the permitted forms of remuneration would lead to constitutional difficulties because it would amount to an acquisition of property otherwise than on just terms. As I said in the Interim Report, two points must be made. First, where would be the acquisition? Who would acquire anything? What proprietary benefit or interest would accrue to any person? Second, if the point is good, it was good at the time when most forms of conflicted remuneration were prohibited. Yet no-one sought then to challenge the validity of the relevant provisions and the Future of Financial Advice (FoFA) ban on conflicted remuneration has now operated for more than five years without challenge.
It is time to ignore the ghostly apparition of constitutional challenge conjured forth by those who, for their own financial advantage, oppose change that will free advice about, or recommendation of, financial products from the influence of the adviser’s personal financial advantage.
A third point is sometimes made in attempting to justify preserving grandfathered commissions. It is said that prohibiting this form of remuneration once and for all will carry with it unintended consequences and the advice industry will be disrupted.
Generalised fears of this kind should not be heeded.
‘Disruption’ and similar terms can be used, and in some submissions to the Commission were used, as little more than pejorative synonyms for ‘change’. As the Treasury submissions show, however, it is always necessary to identify the nature and the extent of the consequences that will or may follow from the change under consideration before speaking of the change as ‘disruptive’. Without identifying those consequences, ‘disruption’ has no useful content.
If an exception to the rules prohibiting grandfathered commissions is to be preserved, the exception must be closely and cogently justified. Saying only that there may be ‘disruption’ or ‘unintended consequences’ is nothing but a naked appeal to fear of the future. And it seeks to graft some exception onto the body of law intended to give effect to a coherent set of policy objectives without any attempt to identify the competing policy objectives.
Creating exceptions that depart from underlying principles has consequences. Those consequences are amply demonstrated by the grandfathering arrangements made in respect of FoFA. ‘Temporary’ or ‘transitional’ carve outs departing from principle too often become (and in this case did become) entrenched. Carve outs and exceptions are too often exploited (and in this case have been exploited) for purposes having nothing to do with the stated purpose of their creation. Creating carve outs and exceptions impedes, and may even prevent (and in this case did prevent) achieving fully the intended policy objectives that inform the body of the law. Instead, the law is (and here it was) made more complex; it is (and here it was) made harder not only for regulators to administer but also for the regulated community, and the public more generally, to understand.
 Corporations Act s 912A(1)(a); NCCP Act s 47(1)(a).
 Corporations Act s 912A(1)(c); NCCP Act s 47(1)(d).
 Corporations Act s 912A(1)(e) and (f); NCCP Act s 47(1)(e) and (f).
 ASIC Act s 12DA.
 ASIC Act s 12DB.
 ASIC Act ss 12CA–12CC.
 ASIC Act ss 12BF–12BM.
 ASIC Act ss 12EA–12ED.
 ASIC Act ss 12BAA,12BAB.
 SIS Act ss 52, 52A.
 The 1926 Report of the UK Company Law Amendment Committee chaired by Mr Wilfrid Greene KC (Cmnd 2657) recommended that the offering from house to house of shares, stock, bonds, debentures or debenture stock or similar securities either for subscription or sale should be made an offence. Hawking company securities has long been an offence under Australian company law. See now Corporations Act s 736.
 United Kingdom, Report of the UK Company Law Amendment Committee (Cmnd 2657), 48 .
 Corporations Act ss 992A and 992AA.
 Corporations Act ss 992A(3A) and (3B).
 FSRC, Interim Report, vol 1, 56–9.
 FSRC, Interim Report, vol 1, 92.
 G30, Banking Conduct and Culture: A Permanent Mindset Change, November 2018, Foreword, v.
 Treasury, Interim Report Submission, 1 –.
 See, eg, AMP, Interim Report Submission, 7 ; ANZ, Interim Report Submission, 2 ; CBA, Interim Report Submission, 41 ; Westpac, Interim Report Submission, 2 ; NAB, Interim Report Submission, 17 ; Mortgage Choice, Interim Report Submission, 3 .
 For example, the preservation of grandfathered commissions during a successor fund transfer by potentially treating the succeeding RSE licensee as a ‘platform operator’: see the NULIS Nominees (Australia) Ltd case study discussed in vol 2 of this Report.
 FSRC, Interim Report, vol 1, 95.
 Cf JT International SA v The Commonwealth (2012) 250 CLR 1.