Financial services take to the stand

19 October 2018

Harrison Ford’s words in Presumed Innocent, that “I need a good lawyer, a very, very good lawyer, an expensive lawyer,” were surely muttered in many a banking and financial services boardroom upon the Government’s announcement that a Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry would go ahead.

More than just lining the pockets of several corporate law firms, the Commission looks set to change the legal landscape of the industry permanently.

Consensus in the legal world is that while that may not be through widespread legislative reform, as hinted by Hayne in his recent Interim Report, both enforcement and interpretation of the law look set to tighten.

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So, what do those in the financial services industry need to prepare for?

“Getting back to basics”

Hayne’s position that extensive change shouldn’t be needed suggests that taking a more holistic approach to considering legal reform post-RC is beneficial.

“A useful place to start is not in the detail but stepping back from that,” managing partner at financial services law firm Holley Nethercote, Grant Holley, says, recommending the industry use the opportunity to “get back to the basics”.

Inherently, that comes back to the legal obligation to provide financial services efficiently, honestly and fairly.

Anne MacNamara, a partner at Hall & Wilcox and a member of the Association of Superannuation Funds of Australia, and Matthew Ellis, a partner in Norton Rose Fulbright’s insurance team, believe that this is both the cornerstone of the current legal landscape.

“AFS (Australian Financial Services) licensees are under an obligation to do all things necessary to provide financial services ‘efficiently, honestly and fairly’, and my expectation is that in order to further align the interests of companies with those of the customer, that this provision will become the legal battleground over which the parameters of conduct are set,” Ellis says.

Of course, the obligation to act efficiently, honestly and fairly is already imposed on licensees, although the contraventions uncovered by the Commission begs questions about enforcement.

MacNamara is optimistic that the Commission’s comments on regulators’ responsibilities to act more strongly will see an uptick in enforcements by the Australian Securities and Investments Commission (ASIC) and Australian Prudential Regulation Authority (APRA) of these three obligations, while Ellis believes the provision is set to become a penalty provision.

“ASIC will be keen to test the extent it [the obligation] can be relied upon to change conduct and culture in the industry,” Ellis predicts.

A focus on fees

Moving beyond the basics, it’s safe to say that the detail in Hayne’s recommendations will include a focus on fees.


Grandfathered commissions are clearly going, and indeed are already gone for many institutions. Westpac, ANZ, NAB, Macquarie and the Commonwealth Bank have all announced an end to the controversial fee structure since the Royal Commission began.

The most licensees can really hope for is a transition period, which chair of boutique financial services law firm The Fold Legal, Claire Wivell Plater, believes may be long enough to allow advisers time to rejig their pricing models.

This could be achievable through regulatory guidance rather than legislative change. The guidance would have to be strong in what it prohibits to be effective, however, Wivell Plater warns, as “even the early efforts of ANZ and Westpac [to remove grandfathering] were ineffective as almost every element of their new ‘balanced’ scorecards involved a sales metric of some kind”.

Even beyond regulatory change, consumers have become so aware of and against grandfathering that that public perception alone may spell the fee structure’s end.

“That’s very powerful for institutions that are built on trust,” MacNamara says.

Asset-based commissions

In an interim report focused on the client, Hayne suggested that value-based commissions are inconsistent with acting in clients’ best interests.

As such, Wivell Plater says, regulatory reform may be required to prohibit these payments. While there have been some signs that the industry is moving away from asset-based fees, she warns that these are “around the edges”, so timely and effective reform may require tangible regulatory change.

Alternatively, Wivell Plater believes that ASIC providing strong guidance to the effect that asset-based commissions present an unacceptable conflict of interest could be enough to end the practice.

Ongoing service arrangements

Hayne inferred in the Interim Report that ongoing service arrangements were a concern, suggesting that existing fee disclosure requirements for fees for the past year haven’t been effective in improving transparency for what services are gained.

“[Hayne] is concerned that advisers treat these as trail commission for advice that has already been given, that clients seldom complain about being charged for doing nothing, and that one of the reasons they don’t complain is because they are charged invisibly, being a line in a platform statement,” Wivell Plater says.

“He is clearly concerned that licensees have treated the provision of ongoing services as a matter of no concern to them, having no mechanism for determining whether they were provided.”

Wivell Plater again believes that legislative change won’t be needed here as ASIC guidance should also suffice.

In-house and replacement products

Hayne has suggested that recommending in-house products should only be allowed when the adviser can prove in writing that the product is better for the client than comparable third-party products, and Wivell Plater says that the same could be said to apply to replacement party recommendations.

The law is already on Hayne’s side here. Regulatory Guide 175 provides that advisers only recommend an in-house product if there’s additional benefit to the client and to consider whether a client’s existing product still meets their needs before recommending a replacement.

Of course, the fact RG 175 exists and breaches still occur adds validity to Hayne’s criticisms of enforcement agencies in the Interim Report.

Concerns regarding in-house products also come back to the Commission’s focus on conflicts of interest. The natural, and most extreme, response to this issue is to end vertical integration.

Ellis says, however, that while the focus on conflicts of interest between product manufacturers and licensees and advisers may see further recommendations, he thinks it unlikely that the Commissioner would recommend an end to the structure.

Hayne’s resoluteness that big change isn’t necessary or beneficial seems to prove this true.

Anyway, as MacNamara points out, many of those big businesses are already disintegrating as the big banks divest their wealth arms.

Extension of BEAR?

While members of some boards – AMP springs to mind – have fallen on their swords because of the Royal Commission’s discoveries, the question of directors’ legal liability remains somewhat unsolved despite the many obligations of the Corporations Act.

MacNamara suggests that extending the Banking Executive Accountability Regime (BEAR) to cover superannuation and insurance executives could improve this by expanding its current definition of ‘banking executive’ to include financial services executives.

“I think that would be a relatively easy extension of law,” she says, adding that superannuation and insurance are the obvious areas to focus on “as they’re more institutionalised services”.

Wait, is the law going to change?

Hayne clearly outlined in the interim report that the existing laws are too complex, labelling them as “a blizzard of provisions” and saying that many of the obligations that, if followed, would have prevented much of the behaviour uncovered by the Commission are already in force.

Requirements to be fair, to provide services fit for purpose, act in clients’ best interests, deliver services with reasonable care and skill, and not to mislead are already enshrined in law. What then, could their simplified form look like?

Again, Holley points to “getting back to the basics”.

He points to misleading and deceptive conduct provisions. While a simple phrase in itself, it’s repeated many times in the legislation for no additional effect. This is ripe for simplification.

So too, Holley says, is the licensing regime.

“You don’t just get the law,” he says. “You get layers and layers of requirements which can get to the point where it actually distracts the players from the main game.”

Wivell Plater flags the best interests duty as an area where the law has become too complicated.

“The focus [of the duty] has been more on breaching advisers for not demonstrating that they have followed the safe harbour steps, rather than looking at whether the advice provided was actually likely to put clients in a better position,” she says.

She suggests that simplification could include removing the safe harbour provisions.

It’s also worth remembering that there were already regulatory reforms in the pipeline before the Commission that, Ellis observes, “given the bipartisan political support being shown towards the Commission since the hearings began, the industry should expect that they will be adopted into law at some point”.

These include changes to the design and distribution obligations legislation, increasing the size of penalties and the range of provisions subjected to penalties, the imposition of broader banning powers for individuals, and the increase in ASIC’s licensing powers.

Where’s the enforcement?

A law is only as good as its enforcement, however, and the effect of any of the above reforms or simplifications depends on whether people feel compelled to follow them. After all, as Hayne and counsels assisting the Commission repeatedly proved, much of the misconduct occurring already breached the law.

It is little surprise then, that regulators got a hard wrap in both the Interim Report and the Commission fallout. So much so, that Ellis says that the one certainty coming from the Commission thus far is that regulators will be adopting a different approach to enforcement.

ASIC chair, James Shipton, noted the Interim Report’s “serious and important observations of ASIC’s role as a regulator” in a statement after its release. He acknowledged that the regulator needed to work “to build a stronger legislative, enforcement and regulatory framework with tougher penalties”.

Hayne suggests that stronger governance from regulators is needed to achieve this, saying that civil penalties should be pursued rather than just Enforceable Undertakings, an old favourite of ASIC’s. The Productivity Commission has previously said similar, slamming

ASIC’s 96 per cent prosecution success rate as showing regulatory timidity.

Hayne broaches that this could be by ASIC, if it has a “reasonable prospect” of proving a contravention, allowing a court to determine the consequences of that misconduct.

This means that more court time is a possible outcome of the Commission.

“I expect that ASIC will seek to run prosecutions under provisions which have not been fully tested by the courts in order to gain clarity over the scope of these provisions,” Ellis anticipates.

Of course, a tangible threat of court may also be enough to resolve some misconduct.

“Hayne points out that the prospect of a trial is a sharp spur to prompt [a] realistic discussion of whether and how issues about liability, final relief and compensation for those who have been affected by the conduct could be resolved,” Wivell Plater says.

Then, there’s again already changes underway regarding enforcement. The Government has already approved the recommendations of the ASIC Enforcement Review, and Ellis warns that the industry should be conscious of the size of penalties that will come into play once these become law.

Where to from here?

It’s hard to plan for the unknown and, of course, until Hayne’s final report comes down in February much of what will change is unknown.

It seems safe to say that Hayne’s wishes will be the Government’s command though, with an election inevitable and public fury over the revelations of the Commission palpable.

So then, what should advisers be doing to prepare?

“If financial services licensees want to be proactive, I would suggest taking a step back and looking at their business operations through a different lens,” Ellis says.

“If they were to review their practices on the presumption that treating customers fairly is a legal requirement and in the best long-term interests of the company, it is likely to start a process of rebalancing the commercial interests of the company and the interests of its customers.”

Wivell Plater recommends that financial advisers start to carefully rethink their business models in several areas.

This should include removing grandfathering; “it will go, and probably quickly once it’s announced, so [AFSLs] need to be prepared for that,” MacNamara warns.

Remuneration and inducements have also come under the microscope, particularly regarding in-house or recommended products and insurance. As such, MacNamara also cautions that AFSLs need to very clear on what behaviour they are remunerating and what their clients get from that.

AFSLs should already have risk management frameworks, and Holley says now is the time to enact them. He recommends reading the Interim Report then implementing that framework considering Hayne’s comments.

This includes working out whether they are following the law now and whether they have a documentary trail proving that they are.

“Again, that’s getting back to basics,” Holley says.

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