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Fraud, failure and financial crime
As part of an ongoing commitment to seek expert critiques in support of
its oversight functions, the committee invited Dr George Gilligan as an expert
witness to give evidence. Dr Gilligan is a senior research fellow in the
Department of Business Law and Taxation at Monash University. He is a
sociologist with research interests in regulation of the financial markets,
white collar crime and organised crime.
In his presentation to the committee Dr Gilligan covered four areas:
the sociology of how regulations are understood and acted upon,
including some history of the financial sector's status;
the strategic importance of the contemporary financial sector and
limits on its regulation;
- the nature of regulation and the competition of national
regulatory regimes to attract capital; and
- financial crime.
These issues are closely interrelated. A major theme underpinning all
four was balancing the promotion of markets and encouragement of
entrepreneurialism with market protection and discouragement of crime and
As he told the committee:
There is always this dilemma and this tension between
promoting efficient, open and flexible markets to attract capital, to create
wealth, to stimulate growth and to promote Australia as a global financial
centre with competitive products in an international sense, but at the same
time there is the context of protecting investors, and particularly the retail
investors. It is always on that seesaw, that fulcrum, and there are always
going to be people falling off who are going to get hurt.
In view of its inquiry into the collapse of Trio Capital, the committee
was particularly interested in the matter of fraud and financial crime and the
degree to which regulations can minimise and expose misconduct. Dr Gilligan's
explanation of the financial landscape gave a context for recommendations which
would assist transparency and the identification of risk.
According to the OECD Policy Framework, which Dr Gilligan provided to
Financial system transparency is essential for [the development
of sound policy and regulatory framework]...as it makes the operations of the system
more visible and supports the identification of risks...and possible problems
Dr Gilligan advised that, in the four core interrelated areas there are
some significant breakdowns in such transparency, which he suggested may be
addressed by ASIC.
The social and historical context of financial regulation
The financial sector has a long history of self-regulation over
centuries. This reflects the confluence of two trends: the defence of its
independence (which has facilitated its growth in power), and the consequent
dependence of rulers on the finance sector.
Originally, this was a dependence of the Crown for funding of military
campaigns; in the contemporary context it is a dependence of governments on the
sector for economic prosperity.
Dr Gilligan noted that because of this nexus, the financial industry was
alone in being able to defy governments or ignore government regulation. He
gave historical examples from the growth of the City of London of patterns of
quite open defiance which set the context for contemporary assumptions within
the financial sector.
Dr Gilligan emphasised two important social ideas underpinning the operation
of the financial sector. The first is the importance of trust:
[T]he traditions of the financial services are a personal
relationship...sociologies of trust that underpin the establishment of the
markets are still core when people invest in markets. People still trust what
they read about in a product disclosure statement. They still have that sense
that, if there is a major institution or there are instruments and services
that they are familiar with, they can somehow trust they will be there and that
they will deliver as they are saying on paper.
This point is evident from the testimonies of witnesses to the
committee's inquiry into the collapse of Trio Capital.
Dr Gilligan pointed out that the habit of trust indicates a moral dimension which
may be violated and gave instances from his research on white collar crime.
Dr Gilligan noted that the Global Financial Crisis can be considered in terms
of the abuse of sociologies of trust.
The second idea is the concept of 'routinisation' or habit. Dr Gilligan explained
that human agency interacts with social structures so that routines are
perpetuated, regardless of their effectiveness.
These two concepts—trust and routinisation—are central to Dr Gilligan's
analysis of the interaction between financiers and government. Although modern
financial organisations have responded to new regulatory structures,
they remain attached to past attitudes. For instance, he argued that those
involved with the raising, organisation and marketing of capital have great
influence in what is seen as the natural social and economic order. Whether
consciously or not, they usually equate their own interests with the public
interest. Dr Gilligan thereby claimed that regulation is used by the financial
services sector to support the attitudes of self-regulation and autonomy
inherited from the past.
According to Dr Gilligan, therefore, practices based on trust in the personal
honour of the financial provider are reinforced.
Dr Gilligan applied the idea of routinisation to the definitions of
financial crime. He suggested, for instance, that the classification of fraud is
subject to long-standing habits and suggested that this could be an area for
action by ASIC. In terms of distinguishing between fraud and market failure—an
issue of interest to the committee—he argued that habits in categorisation make
it difficult to define particular instances.
Influence and control in the contemporary financial sector
Dr Gilligan presented various data indicating Australia's significant
role in the global financial sector:
- The financial sector is the largest contributor to Australia's
national output and is estimated to contribute 11 per cent or A$135 billion of
Australia's Real Gross Value Added by Industry in year to June 2011 (Australian
Bureau of Statistics 2011).
- Almost 420,000 people are employed in Australia's finance sector (Australian
Bureau of Statistics 2011).
- Australia is ranked 6th globally for good corporate
governance by Governance Metrics International (2010).
- The Australian stock market was ranked in July 2011 as the 6th
largest in the world at US$1,136 billion (Standard & Poor 2011).
- Australia's Funds Under Management at US$1,500 billion, ranked in
2011 as the 4th largest in the world (Investment Companies Institute
- Australia ranks 4th in the world in terms of
superannuation (pension funds) assets at US$1,261 billion (Towers Watson 2011).
- Australia's financial markets turnover in 2009–2010 was almost
A$102 trillion, more than 250 per cent higher than 1999–2000 (Austrade
Dr Gilligan argued that with the rapid growth in financial market
turnover, governments have needed to develop a more effective and efficient
system of financial regulation.
Dr Gilligan notes that a key challenge in this regard has been to strike a
balance between 'due process' versus 'crime control'. Too much focus on crime
control could lead to 'flight of capital'; too much emphasis on due process
could leave the market exposed to unscrupulous operators.
Dr Gilligan submitted that the right balance is a matter of judgment and
negotiation between key stakeholders. The committee was told that regulatory
enforcement is 'more art than science' and that the level of intervention is
determined by what is judged as legitimate in the circumstances.
Dr Gilligan told the committee that in terms of the 'due process crime
control model', on a scale of 1 to 10:
I imagine Australia would be sitting somewhere about 6 or 7.
So it has an emphasis on efficient markets but also very substantive and
largely effective, in my view, regulatory infrastructures to protect investors
both retail and wholesale.
He argued that the financial sector in Australia has 'an enormous amount
of relative autonomy as we have seen through the global financial crisis' but
also operates within a context of 'very substantive and largely effective
regulatory infrastructures protect[ing] investors.'
The 'beauty parade' of competition for capital
Dr Gilligan felt that most national regulators would follow the three
core objectives defined by the International Organzition of Securities
1. The protection of investors;
2. Ensuring that markets are
fair, efficient and transparent; and
3. The reduction of systemic
The issue then becomes one of how well any national financial regime
complies with IOSCO standards and how well it both encourages market innovation
and also deters financial fraud or incompetence.
Dr Gilligan referred to the OECD Policy Framework for
Effective and Efficient Financial Regulation, which gives five areas in
which a regulator's effectiveness should be evaluated: the financial landscape,
policy objectives, policy instruments, system design and implementation review.
According to Dr Gilligan, Australian regulators, including ASIC, do well on the
OECD criteria. He noted that ASIC's reports have concentrated on deterrence and
investigation issues, and have not given as much information about ASIC's
activities in the 'educative-normative area'. Dr Gilligan felt that ASIC
reports could better employ empirical data to show how ASIC's resources are
allocated according to its six strategic priorities, and to emphasise the value
of its educative activities. This would enable better publicity about its
Dr Gilligan also noted that, in his experience, the Australian
regulatory system is well-regarded internationally.
Every time I am at an international conference I note that
the Australian regulatory actors are held in high regard not just because of
their positions within IOSCO but also more generally because they are seen as
proactive in developing regulatory models. They are seen as being balanced in
the way that they seek to promote Australia as a financial sector yet still
provide a context which provides reasonable—and, of course, that is a variable
term but an important term—protection to the investors both wholesale and
In other words, Australia is well placed to continue to build its
financial sector in the competitive market.
The committee supports Dr Gilligan's commendation of ASIC and his
assessment of the Commission's fine reputation internationally. The committee acknowledges
Dr Gilligan's analysis of the importance of maintaining a balance between
due process and crime control in order to enhance the Australian financial
sector in a globally competitive market. In this context, the committee agrees
that ASIC reports could better employ empirical data.
The committee recommends that ASIC acquire empirical evidence of its resource
allocation to its educative activities and outcomes of these activities. This
information should be more fully publicised in ASIC's regular reports and other
media accessed by investors especially retail investors.
Problems of defining financial crime
Dr Gilligan's evidence considered the definition of financial crime in
some detail. He noted that gaining empirical data on fraud and other financial
crimes is greatly handicapped by a plethora of varied definitions with the
result that meaningful statistics are hard to obtain:
It is not just apples and oranges; it is apples, oranges,
cherries, bananas and grapefruit—and that is just in an Australian context. It
is not standardised across state courts or advisory councils, for example. I do
not know whether this committee could somehow push that sort of line in a COAG
type context to get greater standardisation of data recording and reporting.
Dr Gilligan explained that different states aggregate data
according to different criteria in apparently ad hoc ways. International
jurisdictions also differ. The committee was presented with results of a survey
Dr Gilligan had undertaken in which twenty one agencies in the United Kingdom
and fourteen in Australia had responded to four questions about financial
Many of the agencies surveyed had no operational definition, and of those
that did, there was no consistency. Dr Gilligan drew the conclusion that there
was no shared approach or common definitions. There was inconsistent use of
terminology and regular failure, even by police agencies, to have a working
definition of financial crime.
One outstanding example demonstrates this incoherence. The UK Financial
Services Authority itself used the term 'financial crime' to cover 'fraud or
dishonesty, misconduct or misuse of information relating to financial management
or handling the proceeds of crime', even though identifying financial crime is
one of its four statutory objectives.
Examples from the Australian agencies demonstrated similar inconsistencies and
Dr Gilligan told the committee that:
... the lack of delineation, categorisation and
classification...makes it difficult to say what the extent of the problem is.
It is always more difficult to deal with a problem if you do not know the
extent of the problem.
He suggested that clarifying and systematically defining financial crime
would be a worthy project for ASIC to pursue given that ASIC regulates across industrial
sectors, has the resources and has access to relevant data.
Fraud and failure
The committee's discussions focussed on the distinction between fraud as
a criminal activity and failure of the market. In terms of fraud, Dr Gilligan claimed
that there are some instances that are unquestionably fraudulent because of people's
clear criminal activity. These cases require a higher level regulatory
response. Beyond this, he felt that the main priority is to uniformly classify
activities associated with fraud across Australian jurisdictions so that it can
be identified, tabulated and addressed.
On the question of market failure, Dr Gilligan focused attention on what
level of harm can be considered acceptable before intervention should occur.
The nexus between financial services and the national economy is of importance
in making such judgments.
Dr Gilligan did not feel that offering risky investments to
unsophisticated investors could be described as a crime. He introduced the idea
of abuse as an alternative way of thinking about them. He did stress that the
greater the depth of empirical data on such matters, the greater the reliability
of judgements made as to appropriate sanctions. Moreover, he suggested that
collection of valid empirical data on outcomes of educative programs on
financial product awareness would facilitate effective allocation of resources to
help inform potential buyers of financial products. Better informed clients
would be less susceptible to such abuse. 
The committee is particularly interested in the matter of defining and
dealing with financial crime and determining clear and consistent guidelines as
to whether activities are fraudulent. It would also encourage further efforts
to quantify the extent of criminal activity and acknowledges the difficulty of
doing this when terminology is fluid and categories are variable. Here, the
committee believes that there is an important role for ASIC in developing standard
definitions and classifications that could be proposed for use across the
The committee recommends that ASIC take steps to use available
information to collate and analyse definitions of, and approaches to, financial
crime, with a view to developing standard definitions and classifications that
can be used across the Commonwealth.
The committee further recommends that ASIC give particular attention to
ways of distinguishing between criminal fraud and market failure, and the
interventions available to ASIC in each case.
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