Treating the symptoms and not the disease

The final report out of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry made a total of 76 recommendations; most of them sound and responsible, some of them philosophical in nature, a few of them questionable (or may I dare say commercially naïve) … but there’s one recommendation in particular that in my view does nothing to fix the problem it is seeking to address and in fact introduces an element of socialism into the financial advice industry.
I’m talking about the Compensation Scheme of Last Resort.


In order to provide financial advice, a financial adviser needs to have an Australian Financial Services License (AFSL) or be an Authorised Representative of an AFSL.  In order to obtain and maintain an AFSL, the financial adviser must be able to demonstrate capability to adhere to certain conditions of the AFSL, such as:
  • Responsible Manager/s that meet educational and operational requirements;
  • Organisational capability;
  • Financial resources;
  • Training of authorised representatives;
  • Monitoring and supervision of authorised representatives;
  • Adequate internal and external dispute resolution arrangements; and
  • Adequate client compensation arrangements (incl. appropriate professional indemnity insurance coverage).
*  for full details of licence conditions see ASIC Pro Forma 209 (now in bold font).
The failure to demonstrate capability of any licence condition will mean an application for an AFSL will be rejected; further, the failure to maintain adherence to any licence condition will mean a breach of the conditions of the AFSL and the possibility of the cancellation of the AFSL.

What Problem are We Trying to Fix?

FOS Circular Issue 34 from August 2018 provides details on ‘unpaid determinations’.  An unpaid determination will occur when a consumer is awarded compensation via the FOS dispute resolution process and the consumer receives no payment (or less than the full payment); this is
typically as a result of the failure of the business of the AFSL, with the proceeds of insolvency proceedings representing nil or a minimal return on the dollar.
FOS advise that from the start of its Terms of Reference (01/01/2010) to 30/06/2018 the total of unpaid determinations is $16,040,397.76. It’s important to note the $16m figure does not include any interest on the base award which once applied will see this figure grow substantially.
It’s entirely appropriate that a consumer should be confident that compensation will be paid, as such the problem that we’re trying to fix is the AFSL who is the subject of the determination having adequate client compensation arrangements (i.e. ensuring the AFSL is maintaining the obligations of its AFSL).


The culprits who have caused this problem are not the banks, financial institutions or the larger and well-resourced AFSLs/dealer groups. They are 44 separate, small, and under-resourced AFSLs who have been proven unable to comply with 177 FOS determinations which affects 246 consumers; these 44 AFSLs are no longer in business.
Each of these culprits was a small/self-licensed/boutique AFSL who, when a client complaint/compensation was awarded against them, found that their PI Insurance policy didn’t respond (i.e. inadequate client compensation arrangements, 1st breech of licence conditions) so the funding of the determination was subject to the strength of their balance sheet.  A lack of financial resources (i.e. inadequate financial resources, 2nd breech of licence conditions) then meant that the AFSL could not pay its debts/ bligations as and when due (insolvency test) which included the client compensation, receivers were then appointed and it’s all over.
Let’s look at precisely how this happens.

Professional Indemnity Insurance

Just having a PI Insurance policy doesn’t automatically mean that the licence condition of adequate client compensation is satisfied; you need to make sure that when you need to call on the policy it’s ready to respond.  A PI Insurance contract, like all insurance contracts, has conditions and definitions that need to be met to ensure coverage is available; I call this operating ‘inside the swim lanes’.
For some, one of the attractions of having your own AFSL is that there’s no ‘big brother’ professional standards officer looking over your shoulder checking your work; conversely one of the downsides of having your own AFSL is that there’s no ‘big brother’ professional standards officer looking over your shoulder (you only realise this when a material complaint arises).  The benefit of that professional standards officer is that someone is ensuring you stay in the swim lanes, not just so that you meet all of your compliance obligations, but also to ensure you’re operating within the conditions and definitions of the PI Insurance policy.  Without that professional standards officer in the first year, you may wander off course and get close to the lane rope but you’re still in the swim lane; in the second year you may wander a bit more off course and be swimming across the lane rope; in the third year … well you know what happens.
I don’t say this because I’m against self-licensing (I absolutely support self-licensing, in fact Infocus evolved from a self-licensed financial advice practice), I make these comments because this is exactly what I regularly see occurring in the industry.  Over the years we’ve had a number of advice businesses exit our AFSL to become self-licensed; the common exiting comment was ‘your compliance regime is too tough’.  We also rarely partner with firms that were formerly self-licensed as the challenge of getting them back inside the swim lanes can be too much.

Financial Resources

The current licence condition for financial resources is, in my opinion, too low; it’s better than the $20k bond required under the old Securities Dealers licence, but it’s still too low.
I find it almost laughable that in today’s regulatory and litigation fuelled environment that one can actually become self-licensed with the investment of minimal financial resources, and meet their licence conditions, and then go out and take on the responsibility of advice on many millions of dollars.

The Royal Commission Solution

The solution recommended by the Royal Commission, based on recommendations from the Ramsay Review, was all about addressing the symptoms of the problem (the unpaid determinations) and not the root cause of the problem itself (the cause of the unpaid determinations).  This is extremely disappointing as you cannot fix a problem unless you address the cause.
The solution recommended by the Royal Commission is that the structure which led to the unpaid determinations be allowed to continue completely unchanged, with the bill for the unpaid determinations left to the ~20,000 ethical and capable financial advisers (the rest of us) to pay. 
This is penalising the majority for the crimes of the few, the distribution of the costs to the financial advice community as a whole.
This sounds a lot like socialism and with the current level of unpaid determinations we can all expect to pay at least another $1,000 per annum in industry funding. Inevitably, these additional costs trickle down to advisers, and in turn clients, increasing the cost of accessing quality financial advice.
The flaws of this recommendation are numerous, and this article is already long enough. 
The Solution that will Actually Fix the Problem
There are many individual changes occurring within our industry that are leading us down the path towards professionalism, including those changes led by FASEA, LIF, and all of the other acronyms.
However, these individual changes don’t address the root causes of the problems that lead to unpaid determinations, which is the failure of AFSLs to adhere to licence conditions.
In my view the following would address the problem:
  1. ASIC – the regulator should bear the responsibility for unpaid determinations. This figure would come off their annual profit prior to distribution to their government shareholder (the revenue ASIC now rake in is more than 3.5 times their cost of operation, I believe it was ~$1.2b last year). This will ensure that they perform their job as corporate policeman effectively including:
    a) Being more robust at the time of the initial issuance of an AFSL, including the testing of ability of meeting licence conditions and adhering to the reference checking regime recommended by the Royal Commission; and
    b) ASIC ensuring that licence conditions are continually being met. This could be as simple as testing/evidencing the adherence to all licence conditions as a part of the annual audit.
The outcome of ASIC bearing responsibility for these unpaid determinations would be that they now have funds at risk. This will either encourage ASIC to become a more effective regulator (ASIC was savaged by the Royal Commission for failing to perform its key role of protecting the public) or have them suffer a financial consequence for their shortcomings.
  1. AFSL – the introduction of a minimum level of capital adequacy, somewhere around $1m. The outcome of a minimum level of capital adequacy would immediately address issues caused by under-resourced AFSLs and I would imagine having more capital at risk would have an immediate change in the attitude of the boards and management of these firms. Improved management would see advisers stay inside the swim lanes as the consequences for failing to do so would now be significant and, if they did stray outside the swim lanes, there would now be appropriate resourcing to help fund compensation arising from client complaints. 


This is an article that not only seeks to address the flaws in the Royal Commission recommendation of Compensation Scheme of Last Resort, but also challenges the subject of self-licensing as a panacea for the ills of the industry.
We all have opinions, none of which are wrong, but glossing over a subject or failing to identify/challenge its problems because it might not suit the philosophical argument you’re endeavouring to put forward is wrong.  The failure by the Royal Commission to point out the root cause of such an important subject as unpaid determinations is a cause for concern.
I’m all for meeting my personal and corporate responsibilities, I’m far from perfect, but I’m a responsible individual and our AFSL is a responsible corporate citizen.
I do not feel like lying down - nor should my peers or our collective good advisers - and accepting being forced to take on fiscal responsibility for those who do not take their responsibilities for both the provision of advice and the meeting of their licence conditions seriously.  

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Sensible discussion of the issues associated with this particular recommendation of the Royal Commission - 'privatise the profits; socialise the losses (Australian farmers).

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