Where did financial services go wrong?

The banking and financial services Royal Commission final report identifies some of the poor behaviour and shortcomings in the delivery of financial services to customers, but does not identify all of the problems.

The Commission has already had a substantial financial impact on some of the financial institutions with large sums being taken out of their profits to compensate clients. However, clients, particularly retirees, who have been the subject of poor treatment or have received bad financial advice and have lost their savings have, relatively speaking, suffered far greater losses. 

Where did it all go wrong?

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Insofar as the financial institutions are concerned, the fault lies squarely with the boards of directors. 

Many of those directors had little or no financial services experience. They didn’t, therefore, have the knowledge or the experience to make the enquiries to establish what the problems were in the way in which the businesses were being conducted and what the customers were being exposed to. 

They did not, for example, generally establish board compliance committees which would have enabled the committee members to obtain hands on knowledge of what complaints were being made and what was happening in communications with the regulators. 

Most of those institutions have problems with the way in which they are structured which result in them being riddled with conflicts of interest. They, generally, are the trustee of the superannuation and investment funds that they offer, the administrator of the funds, the investment manager of the funds’ moneys and the life insurer of the members of the superannuation funds. If the directors recognised the conflicts of interest inherit in these structures, they mostly didn’t do anything about it.

Years ago, as a member of the Superannuation Complaints Tribunal (SCT) which dealt with superannuation cases, in a dispute over whether an insurer should have paid a disablement claim which should have been paid, I queried whether the employees of the financial institution who sat on the superannuation trustee board of directors and who agreed with the insurer’s decision to refuse the claim, had a conflict of interest given they were employees of the company that owned the insurer. The submission to the Tribunal by the trustee was that there was no conflict of interest.

There was, therefore, no recognition that there was a conflict problem.

The decisions of that Tribunal frequently identified shortcomings in the way in which some superannuation funds were administered but, in the 13 years I was a member of the Tribunal, I became aware that directors of the trustee of the fund which was the subject of a particular decision were often not told of the decision or the contents of it. Again, it appears that directors didn’t make enquiries about such decisions. Consequently, the issues identified in the decisions of the Tribunal   continued to occur. 

The failure of financial institutions to deal with the problems identified in the evidence to the Royal Commission was allowed to continue because of the weak regulation that became apparent from the evidence. That has been long standing. A long time ago, when the Australian Securities and Investments Commission (ASIC) took over the regulation of superannuation from the former Insurance and Superannuation Commission, I did some training sessions for ASIC employees on regulating superannuation funds. When I and my colleagues discussed the circumstances in which

ASIC would litigate or prosecute, the reaction of the ASIC officers was that litigation was to be avoided to avoid the embarrassment that would go with losing some cases. Finally, that appears to be changing.

Perhaps, consequently, financial institutions and trustees will treat the regulators more seriously than they have in the past.

The Commission’s final report raised the question of whether charging clients for advice when none was provided was dishonest and, thereby, in breach of the legislation. A recent decision of the SCT required a financial institution to refund fees charged to a superannuation fund member for advice, when no advice was provided, but whether a prosecution for dishonesty will succeed is uncertain. For a successful prosecution to occur it will have to be proven, that the accused knew that no services were being provided.

An issue that did not receive much attention in the evidence before the Commission and in its report, other than hosting employers, is the large amounts spent by industry not for profit superannuation funds on advertising and promotion.

In spending those amounts, the legislation requires that it must be in the members’ best interests. The argument often used to justify the expenditure, which of course reduces the earnings distributed to members’ accounts, is that it attracts new members which reduces the overall fees charged to members. The evidence that the members’ fees are reduced by advertising is scant. There will, of course, at some point, be a challenge by a member to this practice and the relevant trustee will have the opportunity to demonstrate that amounts spent on promotion is in the existing members’ best interests.

Performance fees and similar fees, where investment managers receive around 25 per cent of investment earnings above a minimum level, also did not receive attention by the Commission. It may, one day, be tested whether a particular investment arrangement which includes such fees is in the best interests of the affected members.  

The Royal Commission did not concentrate to any extent on the millions of dollars of life savings that have been lost by investors, including retirees who can never get the money back, as a result of bad or fraudulent investment advice by a minority of financial planners. However, it may well be that the financial institutions who licenced those advisers might ultimately be held responsible for some of the losses, thus adding to their own losses.  

Noel Davis is a Sydney barrister, a former director of financial services companies and a former member of the Superannuation Complaints Tribunal.




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