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The view of the regulators
on the collapse of Trio Capital
This chapter presents the view of the three main regulatory agencies—the
Australian Securities and Investments Commission (ASIC) and the Australian
Prudential Regulatory Authority (APRA)—on the collapse of Trio Capital. It
details the regulators':
- key responsibilities in the oversight of the financial system;
involvement in the Trio Capital case;
- apportionment of blame for the collapse of Trio;
- evidence that they communicated in their oversight of Trio; and
- suggestions to tighten the regulatory framework.
The chapter also presents the views of the Australian Taxation Office (ATO).
The key regulatory and oversight
The following section outlines the responsibilities of APRA, ASIC and
Australian Securities and
As chapter 1 noted, the regulatory framework for managed investment
schemes and responsible entities was introduced in 1998 under Chapter 5C of the
Corporations Act. It is a requirement that the Responsible Entity holds an
Australian Financial Services Licence (AFSL) in operating the scheme, as part
of providing a financial service under Chapter 7 of the Act. It is ASIC's regulatory
responsibility to grant and monitor AFSLs, oversee the registration of managed
investment schemes, as well as risk based monitoring of conduct obligations
under the Corporations Act 2001.
Under the Corporations Act, responsible entities must meet minimum
financial requirements to operate a managed investments scheme. ASIC's
Regulatory Guide 166 states these requirements. They include that responsible
- be solvent at all times;
- have total assets that exceed total liabilities;
have sufficient cash resources to cover the next three months’
expenses with adequate;
- cover for contingencies;
- provide an audit report for each financial year, including
information about compliance with ASIC’s financial requirements; and
- hold at all times minimum net tangible assets calculated on a sliding
scale with a minimum requirement of $50,000 and a maximum of $5 million.
The regulation of financial services providers has been designed to
maximise market efficiency, with minimal regulatory intervention to protect
As ASIC told the committee:
The fundamental policy settings of the FSR [Financial
Services Regulatory] regime were developed following the principles set out in
the Financial System Inquiry Report 1997 (the Wallis Report). These principles
are based on ‘efficient markets theory’, a belief that markets drive efficiency
and that regulatory intervention should be kept to a minimum to allow markets
to achieve maximum efficiency. The ‘efficient markets theory’ has shaped both
the FSR regime and ASIC’s role and powers.
In describing the approach to regulation, ASIC stated:
underlying philosophy accepts that regulation is necessary to deal with factors
that prevent the market operating efficiently (e.g. fraudulent conduct by
market participants, information asymmetries and anticompetitive conduct).
However, that regulation should be the minimum necessary to respond to market
Further, ASIC's submission noted that it 'seeks to balance investor
protection with market efficiency', that consumer protection is afforded
through conduct regulation and disclosure regulation and that:
Efficiency, flexibility and innovation in the financial
services industry are promoted by ensuring that these rules are at the bare
ASIC sees its role as 'an oversight and enforcement body', adding:
The FSR regime is largely self-executing: Australian Financial
Services licensees and other participants are expected to comply with the conduct
and disclosure obligations in the law. ASIC oversees compliance with these
obligations and then takes appropriate enforcement action when there is
non-compliance. ASIC’s power to take action ahead of non-compliance is limited. 
In support of its role in relation to financial services regulation,
ASIC uses a number of regulatory tools including: engagement with industry and
stakeholders, surveillance, guidance, education, deterrence and policy advice.
ASIC also has a role beyond the FSR regime.
It also has responsibilities outside financial products and
services regulation. ASIC is the corporate regulator, overseeing approximately
1.85 million Australian companies and their directors and officers. ASIC also
regulates auditors, registered liquidators and credit providers.
ASIC's role in relation to the collapse of Trio Capital was around the
supervision of aspects that fall under the Corporations Act regime. These
include amongst other things regulation of the responsible entity, supervision
and regulation of the AFSL regime, supervision of the managed investment scheme
environment, and regulation of compliance plan and risk management
Australian Prudential Regulation
Trio was a trustee holding a registrable superannuation entity licence
under the Superannuation Industry (Supervision) Act 1993. As such, some
of Trio's operations came under APRA's regulation.
APRA is the other key regulator involved in financial regulatory
framework in Australia, and is 'the national regulator of prudential
institutions—deposit takers, insurance companies and superannuation funds'. In its
submission to the inquiry, described its role and approach to supervision as
APRA's role is to promote prudent behaviour by superannuation
funds through a robust prudential framework of legislation and prudential
guidance which aims to ensure that risk-taking is conducted within reasonable
bounds and that risks are clearly identified and well managed. Unlike the
banking and insurance sector, APRA does not have the power to issue prudential
standards for superannuation funds.
In supervising its financial institutions, including superannuation
funds, APRA has developed a risk-based approach under which institutions facing
greater risks receive closer supervisory attention. This enables APRA to deploy
its resources in a targeted and cost-effective manner. The risk-based approach
- licensing only those institutions that are likely to be able to
meet their financial promises under all reasonable circumstances;
- regularly analysing the financial condition of institutions and
reviewing their risk management to assess their relative risk of failure and
whether they meet prudential requirements;
- responding to these assessments by tailoring APRA's supervisory
activities to the risk profile of the institutions; and
- if necessary, taking enforcement action to protect the interests
of beneficiaries or to make it clear that illegal or materially imprudent
behaviour will not be tolerated.
APRA's role in relation to Trio was as the regulator of registrable
superannuation entities under the Superannuation Industry (Supervision) Act
1993 (SIS Act).
Australian Taxation Office
As chapter 1 discussed, the ATO also has a role as a regulator in
relation to self-managed superannuation funds (SMSFs).
The ATO administers the relevant superannuation laws for
SMSFs, works with trustees to help them meet their obligations and verifies
compliance. The ATO does not provide financial or investment advice, and does
not undertake a prudential role similar to that undertaken by the Australian
Prudential Regulation Authority (APRA).
The Reserve Bank of Australia described the roles of the three
regulators in relation to the SIS Act succinctly as follows:
APRA regulates the superannuation funds’ compliance with the
prudential regulation and retirement income provisions of the Superannuation
Industry (Supervision) Act 1993, while ASIC has responsibility for the
other provisions. The Australian Taxation Office has responsibility for the
regulation of excluded funds (i.e. funds that have less than five members).
These three regulators, in addition to the gatekeepers described in
detail in chapter 5 of this report, play an important role in shaping the
events around the collapse of Trio Capital.
The regulators' view of the Trio
The remainder of this chapter presents the regulators' view of the
collapse. Two points are clear. The first is both ASIC and APRA apportion
significant blame for the collapse of Trio Capital on the gatekeepers, in
particular the auditors. The second point is that, notwithstanding the role of
these gatekeepers, there are lessons for both regulators including their
communication with each other.
APRA gave verbal evidence to the committee on 30 August 2011 and 4 April
2012. At the first of these hearings, the Deputy Chairman, Mr Ross Jones, told
the committee that before suspending Trio in December 2009, APRA had been seeking
improvements in the management of superannuation funds by this trustee 'for a
number of years'.
Indeed, APRA conducted no fewer than five prudential reviews of Astarra
Capital between April 2004 and June 2009. Mr Greg Brunner, General Manager of Actuarial
Market and Insurance Risk Services at APRA, gave the committee an overview of
We undertook a prudential review in April 2004 with the
management and the board to set off some of the discussions about the trustees'
application for a variation of instrument of approval. In November 2005 we held
a prudential review which involved meetings with management and the trustee
directors. This review covered a broad range of risk areas and involved
discussion of the trustees' preparation for licensing. This was in the period
in the run-up to the beginning of licensing for our registrable superannuation
entities, the new licensing regime that had been put in place for
superannuation funds. We had some preliminary discussions with the trustees about
That was in November 2005. Then we conducted a prudential
review in several stages between November 2006 and December 2006. This involved
a review of the administration systems, an investment review and meetings,
again, with board and management. The flavour of those was that they were
fairly comprehensive reviews. Our prudential reviews involve detailed
discussions not only with the trustees but usually with management as well, and
sometimes other staff, within the fund. The next prudential review was held in
August 2008. That one examined strategy, risk management, governance,
investments and liquidity. Again it was quite a broad-ranging review at that
time. Finally, a prudential review was held in June 2009 which examined
governance, strategy and investments, including valuations and liquidity. They
were the reviews.
APRA's Deputy Chairman Mr Ross Jones told the committee that it was at
APRA's request that the trustee directors 'had begun to address deficiencies in
the valuation processes'. He noted that 'APRA had no reason to believe that the
trustee directors were untrustworthy'.
APRA pointed out that in 2007 and 2008, the relevant Trio funds had
received audit signoffs. In 2008 and 2009, APRA sought further information from
Trio regarding the valuations of certain investments. However, Trio's response
was that as some of these assets were in unlisted overseas trusts, there would
be delays in getting valuations.
APRA told the committee that when the relevant information was not received by
mid-2009, it conducted a further prudential review to seek more information. In
October 2009, when the trustee had not supplied APRA with all the information
requested, 'an investigation was commenced'. In December 2009, APRA issued a
'show cause' letter asking why Trio Capital should not be suspended or removed
as a trustee. An acting trustee, ACT Super, advised APRA that it would be
submitting an application for compensation under Part 23 of the SIS Act.
On 30 August 2011, APRA told the committee that it was currently
supervising the trustee ACT Super and was also examining former directors of
Trio. It noted that in addition to the enforceable undertaking (EU) against Ms
Natasha Beck, it expected further EUs 'over the next weeks and months'.
As of late March 2012, APRA had obtained a further five EUs from Trio
directors: Mr Rex Phillpott (15 years), Mr David Andrews (10 years), Mr Keith
Finkelde (six years), Mr David O'Bryen (five and a half years) and Mr John
Godfrey (no expiry date).
APRA's focus on trustees and
APRA told the committee that its main focus is on the conduct of
trustees, not verification by auditors. It is APRA's responsibility under the
superannuation legislation to ensure that superannuation trustees conduct their
affairs with the appropriate level of fitness and propriety.
APRA also noted that as a prudential regulator, its supervisory
activities and processes are not based on the expectation that fund operators
have engaged in fraudulent activity.
APRA does not look for fraud, nor does it routinely value underlying assets.
Instead, up to a point, it relies on auditors for that function. APRA's
oversight of the Trio funds was in relation to the valuation of the underlying assets
in which the investments were made. Again, asset valuation is not APRA's core
Mr Jones described APRA's supervision of Trio Capital as 'active
supervision' involving 'the standard collection of information but, more
importantly, it involves on-site visits to the fund, an examination of the
fund's investment policies and so on'.
He described APRA's regulatory approach in the case of Trio as follows:
For a number of years we had had concerns—certainly not
concerns about fraud, but we had concerns about the quality of the trusteeship
of this fund—and for a number of years we had been trying to get the fund to
improve the quality of its governance processes. That was what I would loosely
describe as active supervision. You tend to find that, if you have
circumstances with particular funds where you have some reservations about
their activities, you tend to engage in a more intrusive and more intensive
supervisory process than you might do with funds that you have a greater degree
of confidence in. That was probably the case with this fund for a number of
APRA and the auditors
The main theme of APRA's evidence to the committee was that, in a case
like Trio, it is reliant on auditors to check the accuracy of the information
that is supplied to it. APRA told the committee that 'in all probability', the
Trio fraud may have occurred 'well before 2009'. It also stressed that in 2007
and 2008, the fund received 'an unqualified audit sign-off'.
The strong implication is that the auditors should have detected the fraud and
that APRA was reliant on the accuracy of the auditors' information and
findings. As Mr Keith Chapman, Executive General Manager of APRA's Supervisory
Support Division, told the committee:
...at the end of the day, what can anybody do to determine
that the bit of paper/unit certificate/share script you have been given is
actually a real document? We certainly do not get down to that level of detail.
We tend to work our way down, as Mr Jones has indicated, from the trustee board
to governance processes to, 'What are you doing underneath that?' and 'How do
you verify?' The closest the system would get in that regard would probably be
the external audit sign-off, but even then, as you know, the external audit
does not go through and verify every single item of the accounts. It is done on
a reasonableness basis.
...in a normal situation when we talk to people we would get
something like a spreadsheet. We say, 'What have you got your assets invested
in?' It would be something like a spreadsheet which shows the sectors. Usually
in the normal circumstance we would not go down to the individual holdings. We
would do that where we had concerns that it was not a reasonable spread of
exposure or diversification. To actually get to a situation where we are
validating the assets I would suggest is when we have got to the end of the
line which is what happened here...
The only process in the system where assets are validated at
the specific level you are referring to is when the auditor does it and even
then as I said the audit is still helicopter like rather than getting down to
The committee put to APRA that its prudential supervision role will not
be effective if the information supplied to it by trustees is false. Mr Jones
Particularly, say, in the case of offshore investments, if
the information that is supplied to APRA is false and, further, if it has been
signed off and approved by auditors, it would be very unlikely that APRA would
have an independent ability to detect—
In the case of Trio, however, APRA emphasised that the trustee was
unable to supply the information on the nature of the investments: it had not
falsified this information.
In this context, significantly, APRA queried whether it had given 'too much
forbearance to the trustees' and gave the following response:
In retrospect you can always reach a different conclusion but
what I would say is that in all the other instances of our supervision over all
the years—and I am not trying to hide away from the fact that this one went
wrong—this process we have gone through that we have been describing has
actually got the right result. We have had changes in trustee behaviour and
changes in asset allocation.
Crucially, APRA told the committee that it will take a closer look at
the audit relationship:
Looking back in retrospect, if you ask the trustees for
valuations and details and they say, 'We're having difficulty getting to it,'
and the auditor has signed off, you probably should haul the auditor in and
have a serious heart-to-heart with the auditor about how they are doing that
process. But that is certainly one of the areas that we have taken out of this,
looking back: when do we make those sorts of calls?
APRA also noted in its evidence that the government's Stronger Super
reforms will impose additional duties on the directors of a trustee to act
honestly and in the best interests of beneficiaries. It noted that APRA will be
given a general prudential standards making power in relation to
Further, as part of the Stronger Super reforms, APRA anticipated that it will
have greater capacity to collect statistical data. While it doubted that this
capacity would enable an assessment of stock by stock holdings, APRA did expect
that the level of statistical detail would be looking at an investment option
The committee highlights the fact that, despite having suspicions about
the conduct of the trustees in 2005, it was not until 2009 that APRA issued a
'show cause' letter and eventually suspended the trustee. The committee makes the
following two observations that may explain this significant delay.
First, as a prudential regulator, APRA does not look for fraud. By its
own admission, in the case of Trio, its concern was not fraud but the quality
of the trusteeship which, on a risk-based assessment, appeared not to be of
great urgency. In this context, the committee also draws attention to APRA's
statement that it has got 'the right result' in terms of changing trustee
behaviour and asset allocation. This comment seems highly peculiar, even
insensitive, given the significant losses suffered by investors and APRA's role
as a prudential regulator.
Second, the committee recognises that the Trio case did require APRA to
undertake tasks it did not normally undertake. APRA does not routinely value
underlying assets but instead relies on auditors to examine individual holdings.
The committee accepts that ultimately, APRA must rely on the auditors for
accurate and reliable information on the presence of assets and their value. It
also notes APRA's point that in 2007 and 2008, the relevant Trio funds did
receive audit signoffs.
However, APRA should not be exonerated for its lack of action in the
oversight of Trio Capital. The committee is concerned that APRA did not pick up
key events that shaped the Trio fraud. These were the purchase of Tolhurst in
November 2003 and the replacement of the Trust Company as the trustee of
Professional Pensions Pooled Superannuation Trust in June 2004. The fact that
these events roughly coincided with APRA's first prudential review of Astarra
in April 2004, and were not identified as problematic, does raise serious
questions about the quality of APRA's prudential reviews.
The committee also believes that questions must be raised as to why APRA
delayed suspending Trio Capital when Trio could not value its assets in 2008.
It does seem strange that a trustee can be subject to 'active supervision' over
a period of six years and yet, when essential information was not forthcoming at
the end of this period, the regulator did not act quickly.
To the committee's mind, the trustee's tardiness in responding to fairly
basic information should have raised fundamental concerns. APRA should have
acted more decisively, sooner. For a risk based supervisor—as APRA is—the
inability of a trustee to provide basic valuation information should have
raised strong concerns.
Trio investors' criticisms of APRA's role are discussed further in
In its submission to the inquiry, ASIC stated that it had conducted a
review of its interactions with Trio Capital. The review 'confirmed that ASIC
performed its role under the current financial services regulatory regime in
relation to these events'.
The specific detail of ASIC's involvement with the Trio Capital collapse
is currently confidential.
Significantly, given APRA's view (paragraph 4.29), ASIC believes that it was
not until December 2009 that the directors of the Astarra Strategic Fund ran
the fund for fraudulent purposes. ASIC explained:
...I had examined Mr Richard very early in the piece and,
basically, for ASIC to go away all he had to do was provide indisputable
evidence of the veracity and worth of these investments. As time went by, the
longer it took and nothing was forthcoming, the more confident I became, but
there was never any situation where someone put on the table to me that this
was a blatant fraud upfront. It took about three months, I would estimate. I
had travelled to Hong Kong and interviewed people over in Hong Kong and it was
after that, and that was in December 2009, that I became confident that the investments
were not there. This is in the context of the Astarra Strategic Fund.
In its submission to this inquiry, ASIC set out its enforcement action
since commencing its investigation of Trio in 2009. This included:
action taken against Mr Shawn Richard leading to his sentence of
three years and nine months' imprisonment (with a minimum of two years and six
- an EU from Kilara Financial Solutions, which had recommended that
retail clients switch their superannuation holding into the fund My Retirement
Plan, for which Trio was the responsible entity;
EUs with former Trio directors Mr Phillpott and Ms Beck;
the suspension of the AFSL held by Seagrims Pty Ltd for three
- EU with former Trio Chairman and director Mr Andrews preventing
him from acting in any role in the financial services industry for nine years;
- EUs with former Trio directors Mr Finkelde and Mr O'Bryen
preventing them from acting in any role in the financial services industry for
Mr David McGuinness, Senior Executive Leader at ASIC, gave the committee
a brief chronology of ASIC's investigation into Trio Capital:
In mid-2009, in the course of work we were doing in relation
to hedge funds—in particular what we call the 'red flags project'—we identified
some potential issues with Astarra and Trio. That was in about mid-2009.
Shortly thereafter, in September 2009, we received a credible complaint that
was directed to the former chairman.
The day after that complaint was received, members of ASIC met with Shawn
Richard and compliance staff of Trio, and 10 days thereafter, I think—on
approximately 2 October 2009—ASIC commenced using its formal powers and
commenced a formal investigation. That then led to a collaborative approach
with APRA in relation to investigating and taking action. Within a month or
thereabouts, I think, we issued stop orders in relation to PDSs issued by Trio,
and when it was appropriate to do so—I think it was in December 2009—we took
steps, again in collaboration with APRA, to cancel the AFSL, or Australian
financial services licence, of Trio. In between October and December 2009, we
established, under the current chair, a task force of various parts of ASIC
representing those from our stakeholder team areas that deal with investment
fund managers, superannuation and investment banks, for example, and those that
were conducting the hedge fund review, along with people from our financial
adviser team and our deterrence teams.
ASIC's Chairman, Mr Greg Medcraft, told the committee that by the time
it had received a formal complaint about Mr Richard, the Commission already had
narrowed down Trio as one of a number of hedge funds that it considered of high
risk. ASIC's 'proactive surveillance' of the hedge fund sector began in
response to the Bernie Madoff case in the United States. Mr Medcraft explained
that in identifying the high risk hedge funds:
We excluded those that were domestically managed, for
example. We were really honing in—given the fact that the Madoff experience was
through a series of overseas entities—on those which we considered to indicate
higher risk...We were not focused on fraud. We were focused on verifying
existence and value of assets. If you remember, the existence and value of
assets was the issue with Madoff.
In terms of ASIC's key interest in Trio Capital, the Chairman told the
committee it was in the first instance concerned with whether the assets
existed and secondly, whether the valuations were correct.
ASIC's criticism of gatekeepers
ASIC's Chairman, Mr Greg Medcraft identified the role of gatekeepers as
the main problem in the oversight of Trio. He told the committee:
...what happened in Trio and ARP—is a good example of what I
think is gatekeeper failure. It does start with the responsible entities: the
directors and the executors of the responsible entities, the investment
manager, the compliance committee, the compliance plan audit, the research
houses, the custodians, the advisers. What we had here was that, if you want,
chain of gatekeepers. Many of those gatekeepers clearly came up short...
Gatekeepers provide a key role in our regulatory system and
when they fail in their role this can have serious consequences for investors,
such as we have seen with what happened with Trio and Astarra. One of the most
challenging tasks for a regulator is to identify so-called bad apples in
industry, particularly when they are engaged in outright dishonest conduct.
Gatekeepers are often the first in line in terms of defending against bad
behaviour by perpetrators of issues in the system. Therefore, improving the
regulation of gatekeepers is the key to ensuring the integrity of our system,
and I think you will see that reflected in our forward work program...for
example our work around research houses and custodians. 
Mr Medcraft added that this focus on the role of gatekeepers does not abrogate
ASIC of its responsibilities as an oversight body. He told the committee that
ASIC engages with industry and conducts surveillance, guidance, education,
enforcement action and policy advice to government to serve the interests of
retail investors. These activities were also emphasised in ASIC's submission.
ASIC told the committee that it was not aware that Trio's correspondence
with APRA on 23 October 2008 had been passed on to ASIC. The Trio letter
noted that it did not have available valuations for the Exploration Fund
Limited. A search of ASIC's internal systems 'could not come up with
information about such a referral'.
Improving compliance plans and the
role of auditors
Underpinning ASIC's criticism of gatekeepers in the Trio case is its broader
concern with managed investment scheme compliance plans, auditors and
committees. Its concerns with the current system of compliance plans are threefold:
the requirements in section 601HA of the Corporations Act
relating to the content of compliance plans are set at a high level rather than
requiring detail on specific matters. As a result, ASIC argued that the plans
are 'not being as effective as may have been intended'
and 'if someone has conducted the audit of the particular compliance plan, that
is almost enough to get you over the line. There is no sort of detail about the
work that needs to be done';
- the liability for the responsible entity and its directors
attaches to any contravention of the compliance plan, rather than material contraventions.
ASIC claims that this can result in generic compliance plans with low
standards, while still meeting the requirements of section 601HA; and
the Corporations Act requires a compliance plan audit to be done,
but does not impose any qualitative standards by which a compliance plan
auditor must conduct their audits.
In terms of compliance committees, ASIC highlighted that:
- there are no current legislative requirements as to experience, competence
or qualifications for compliance committee members;
there is also no regulatory or member oversight of the
appointment of compliance committee members; and
- the Corporations Act does not specify many governance
arrangements in relation to the proceedings of the compliance committee.
ASIC told the committee that currently, the law 'seeks to treat all
contraventions of compliance plans by officers of a responsible entity equally'.
Minor breaches are treated the same as more serious breaches. ASIC argued that:
...it would be more sensible for the law to focus on material
breaches rather than those minor breaches, because the way the law is
constructed at the moment it almost drives people to go back to compliance
plans at a very high level. They are concerned, and I can understand why they
are concerned, about their own liability, but the way the regime works as a
whole is that it is not operating in an optimal fashion to make sure that there
is a strong compliance culture within responsible entities and there is a good
system of checking around responsible entities.
ASIC suggested several areas of possible reform to the role of auditors
and compliance committees. It noted that in cases where an auditor fails to
conduct a compliance plan audit in accordance with the assurance standards,
'there would appear to be a prima facie case for ASIC to pursue the auditor in
One of the striking features about the Companies, Auditors and Liquidators
Disciplinary Board (CALDB), however, is how few matters ASIC does in fact refer
to the Board. APRA has not referred one. Chapter 5 discusses the views of the
Board about its role and workload.
Indeed, ASIC recognised in its submission that the assurance standards
that are relevant to a compliance plan audit do not have the force of law. As
such, there is no precedent for a successful action against a compliance plan
auditor. ASIC suggested that the government could consider:
(a) an approval process for compliance plan auditors so that
ASIC has the powers to remove or impose conditions on such approval; and
(b) civil liability provisions for compliance plan audits.
ASIC also identified possible reforms to improve compliance arrangements
to increase the effectiveness of compliance plans, auditors and committees. In
terms of compliance plans, it suggested:
- reviewing the effectiveness of the role of the compliance plan in
the compliance framework;
- setting more detailed requirements for compliance plans; and
introducing an approval process for compliance plan auditors and
civil liability provision for compliance plan audits.
In terms of compliance committees, ASIC noted that government could consider
minimum requirements for these committees and their membership.
The committee encourages ASIC to pursue its forward program of
activities in relation to compliance arrangements (see chapter 7). The
committee will monitor the implementation of these changes as part of its
statutory parliamentary responsibility to oversee ASIC's work.
Granting AFS licences
Chapter 6 of this report canvasses various criticisms of ASIC by Trio
Capital investors, not the least of which is that ASIC was responsible for
granting Mr Richard an AFSL. In this context, perhaps the most significant
aspect of ASIC's evidence was its criticism of the AFSL regime. In particular:
ASIC's ability to protect
investors by restricting entry into, or removing participants from, the
financial services industry who might cause or contribute to investor loss is
limited under the current FSR regime. This is because the current FSR regime:
- sets the threshold for obtaining
an AFS licence relatively low and the threshold for cancelling an AFS licence
relatively high; and
- focuses on the licensed entity
rather than the directors, employees or other representatives.
In terms of the threshold for obtaining and retaining a licence, ASIC noted
that it 'must' grant an applicant a licence unless it can prove that certain
statutory criteria are not met. Mr Price added:
Perhaps unsurprisingly it is very difficult to prove that
someone will not comply with their legal obligations in the future, because
quite simply people do not go round sending emails saying, 'It is my intention
not to comply with the obligations in the future.' The PJC recommendation from
the Storm and Opes Prime inquiry was to change that particular provision
broadly speaking to one that would say: 'ASIC may ban a person or it may not
grant a licence if the person is not likely to comply with its obligations in
In the Future of Financial Advice (FoFA) legislation, currently before
the Parliament, the government essentially adopted the Parliamentary Joint
Committee on Corporations and Financial Service's 2009 recommendations.
The Act amends the relevant sections of the Corporations Act to give ASIC
greater discretion in granting and cancelling AFSLs.
The Explanatory Memorandum to the Corporations Amendment (Future of
Financial Advice) Bill 2011 stated that these amendments clarify that ASIC
is not required to believe as a matter of certainty that the person will
contravene the obligations in future. It added:
In the 10 years since the introduction of the Financial Services
Reform Act, interpretation of this provision has tended to a view that ASIC is
required to believe, as a matter of certainty, that the person will contravene
the obligations in future. Such a standard would be so onerous that it could
result, in practice, in ASIC never being able to refuse a licence using this
part of the test. This new formulation is designed to ensure that ASIC can more
appropriately account for the likelihood or probability of a future
ASIC's submission supported the amendments, noting that the change:
...would overcome some of the difficulty ASIC currently experiences
when trying to assess whether an applicant will comply with its obligations and
meet its licence conditions before it has commenced business. The proposed
slightly lower standard (i.e. ‘may not comply’ or ‘is not likely to comply’)
would enable ASIC to consider a wider range of matters than currently permitted
and minimise this difficulty.
In terms of how these amendments may have influenced the Trio case,
Mr Price commented:
Were those sorts of additional protections in place when the
Trio matter was happening, or in another hypothetical matter, it may well have
enabled ASIC to act at an earlier stage. But would that have prevented investor
loss? I cannot tell you the answer to that. Even if ASIC makes a decision not
to grant a licence or to remove someone from the industry there are appeal
rights to the Administrative Appeals Tribunal and they do not always agree with
the position that we adopt on these matters. Quite rightly, they put high
regard on the fact that, if ASIC decides to exclude someone from an industry,
that deprives them of their livelihood.
The second point in paragraph 4.58 (above) notes ASIC's concern that the
current licensing system is based on the entity, rather than individual
directors, employees or other representatives. In its submission to this
inquiry and to the committee's inquiry into the FoFA legislation, ASIC drew
attention to the fact that:
Under the Corporations Act, a person or entity that carries
on a financial services business in Australia must obtain an AFS licence from
ASIC covering the provision of the relevant financial services, unless an
exemption applies. A key exemption is for those who provide services as a representative
of a licensee. Essentially, representatives are employees, directors,
authorised representatives (including corporate authorised representatives) of
the licensee. ASIC does not approve representatives. In addition, a person
acting as an employee or agent is not themselves treated as providing the
financial service of operating a registered management investment scheme.
This means that the AFS licensing regime generally focuses on
the AFS licensee, rather than the directors, employees or agents in relation to
operating a registered management investment scheme or other representatives of
that entity. However, officers involved in the decision making of a licensee
are subject to tests of good fame and character (e.g. police checks) when a
licence is granted. Also on grant of a licence, and at other times in
surveillance, there is assessment of key persons nominated by the licensee for
the relevant financial service business.
In terms of Trio Capital, therefore, ASIC emphasised:
...we did not register Mr Richard. The relevant person being
licensed here was Trio, not Mr Richard...
The history is that the body that would become Trio already
had a licence at the start of the financial services reform. Under the laws
that were in place of the financial services reforms, which were around 2002 to
2004, anyone who had formerly had a licence basically got a licence under the
new regime. Mr Richard became a director of that entity that already had a
licence. As to your question about Mr Richard and what was known about Mr
Richard, certainly I have read in a number of other submissions some concern
perhaps about Mr Richard and what he may have done in the past. The critical
question for us is: what concrete evidence do we have in respect of a
particular person? That is question 1. Question 2 is: even if we have concrete
evidence against a particular person, of what relevance is that ultimately to
the fact that someone already has a licence and is in our regime and so forth?
ASIC noted in jurisdictions such as Hong Kong, Singapore and the United
Kingdom, there is more focus on the individual during the licensing process. However,
it did not support a requirement to approve all individuals involved in the
financial services industry, believing the costs would outweigh the benefits.
ASIC did suggest that a more complete register of advisers providing financial
advice on Tier 1 financial products would enhance its efficiency conducting
Suitability of managed investment schemes
A further issue raised by ASIC in both its submission and in verbal evidence
to the committee is whether there should be regulations and restrictions on
investments in registered managed investment schemes. Currently, neither the Australian
Securities and Investments Commission Act 2001 nor the Corporations Act
imposes any restrictions on the investment strategy of registered managed
investment schemes. ASIC noted that in some international areas, there are
discussions about whether those who manufacture financial products should have
an obligation to ensure that the investment is not going to be unsuitable for
the final investor.
It also stated that in Australia, restrictions had previously been in place:
Before June 2007, registered managed investment schemes were
prohibited from investing in managed investment schemes that were not
registered under Ch 5C of the Corporations Act. The restrictions were intended
to prevent a responsible entity from establishing or investing in unregistered
managed investment schemes, including foreign collective investment structures,
to avoid the protections for scheme assets that normally apply to registered managed
investment schemes. ASIC provided limited exemptions to allow certain
investments in managed investment schemes to be held, even though the managed
investment scheme receiving the investment was not a registered managed
investment scheme in a number of circumstances.
The restrictions were removed by legislative amendment in
recognition of registered managed investment schemes increasingly seeking to
diversify their investments and that such investments are not generally made
for the purpose of avoiding regulation. The restriction on what a registered
managed investment scheme may invest in proved difficult to maintain in light
of commercial pressures to allow many legitimate foreign investments.
The committee notes the various points that ASIC has made in relation to
the limitations and restrictions on its role and believes that these are
legitimate concerns. It therefore welcomes the recent FoFA reforms to sections
913, 915 and 920 of the Corporation Act lowering the threshold for ASIC to
refuse and to revoke an AFSL. On the matter of ASIC's power to register an
entity rather than an individual director, there does appear to be a strong
case to establish a register of employee representatives in the financial
As with APRA, the committee has concerns at the length of time it took for
ASIC to detect fraudulent activity in Trio. It is particularly concerned that communication
between ASIC and APRA was lacking in the months from late 2008 to mid 2009.
ASIC's Chairman has emphasised that given the goal of 'efficient markets' and
rectifying asymmetries of information, it is important for investors to have
clear disclosure of the assets in a portfolio.
Yet, it seemed that APRA had not communicated to ASIC its requests for Trio to
provide information. As a result, when ASIC commenced its active surveillance
of hedge funds in June 2009, it did not seem aware that Trio was not providing
the prudential regulator with basic facts about the existence of assets and
their value. This information should have been communicated.
The committee is aware that the Memorandum of Understanding between ASIC
and APRA contains sections on mutual assistance and coordination, information
sharing and unsolicited assistance. The committee encourages the regulators to
continuing sharing information, even where a request for the information has
not been received.
The Australian Taxation Office's
The third regulator is the ATO, which has responsibility for ensuring
that investors in SMSFs comply with the SIS Act. The role of the ATO is to
register SMSFs, to ensure they have an investment strategy and that they meet
the basic prudential requirements set out in the SIS Act. In this context, the
Commissioner of the ATO, Mr Michael D'Ascenzo, described the ATO's
regulatory role as:
to provide some assistance to trustees and approved auditors
in relation to their obligations under the SIS Act and help them to comply with
a range of obligations under the SIS Act and the Income Tax Assessment Act.
What is I think critically different between what we do and what a regulator
like APRA does is that APRA looks at the prudential requirements – in other words,
the level of risk-taking that trustees of larger funds would undertake –
whereas, for self-managed super funds, the ATO's obligation is to ensure that
they have an investment strategy but the nature, effectiveness and risk of
their investment is really a matter for the trustees, subject to certain rules
in the law which say that certain investments are not able to be entered into.
The ATO monitors SMSFs compliance mainly through the receipt of
self-managed super fund annual returns. These returns include an income tax
return, a regulatory return with details of fund assets and fund management
issues, and a member contribution statement. In addition, the ATO noted that
each SMSF is required to obtain an independent annual audit of the fund. Where
there is a contravention, the auditor lodges an auditor contravention report
with the ATO. The ATO told the committee that through this process, it also
'audits the auditors'.
One of the key criticisms of the ATO from many SMSF investors in Trio
Capital was that they were unaware they were investing in an SMSF. Of those who
were aware, many were not familiar with their obligations and the regulatory
protections (see chapter 6). Mr Brett Peterson, Acting Deputy Commissioner
Superannuation at the ATO, told the committee: 'we send every trustee (of an
SMSF) a letter welcoming them and outlining their responsibilities and pointing
them to the range of support material we have'. He added that before a trustee
or a fund can be registered, the ATO required the trustee to sign a declaration
to certify that they understand the range of rules that apply to the management
of an SMSF. Mr Peterson told the committee: 'I have never had anybody say to me
that they were not even aware they had a fund. That is quite surprising'.
The ATO told the committee that it is aware that the vast majority of
SMSF investors lodge their registration 'through some kind of agent'. This is
potentially a problem. Notwithstanding their name, SMSFs are often not managed
by the trustee but by financial advisers and other intermediaries. In the case
of a significant number of witnesses who gave evidence to this inquiry, it does
appear that the key messages about trustees' obligations and exposures to risk—and
even their participation in an SMSF—are not being properly communicated to
trustees, either through the declaration form or through ATO guidance material.
The committee is concerned at the lack of knowledge of 'mum and dad'
SMSF investors (see chapter 6). The ATO Commissioner recognised that while
there is a 'vast difference' in the understanding and capabilities of trustees,
the ATO provides 'a lot of information' and educational material to help SMSFs
understand their obligations. This information was in response to ATO research
conducted 'a number of years back' which showed there were 'quite a number of
trustees who did not understand their obligations'.
The ATO's submission to this inquiry contained only one passing
reference to Trio. The committee did ask the ATO, in relation to Trio, whether
the ATO requires documentary evidence from managed investment schemes to verify
that the tax it is receiving from entities is the correct amount. The
We would not have any specific information other than what is
provided in the particular taxpayer’s return or the fund return. It then
becomes a question of whether our analytics and risk assessment procedures
identify that group or that company as requiring further attention. So really
unless there is some indicator that enables us to discern that what they have
said in their return is incorrect, we would not know until we did an
investigation. And we would not necessarily do an investigation until we had
some indication that this was a high-risk company.
In an answer to a question on notice, the ATO provided a breakdown of
asset allocations in SMSFs. In June 2011, overseas managed investment schemes
accounted for only 0.08 per cent of total Australian and overseas assets in
SMSFs ($341 million of $418.5 billion).
Is some fraud inevitable?
The regulators contended that even with the best regulatory system, it
will be difficult to detect and intercept all fraud. Mr John Price, Senior
Executive Leader at ASIC, told the committee that:
...if someone is minded to commit a fraud, whatever
regulatory system you have in place may find it difficult if that person is
determined and wilful to commit that fraud.
APRA also noted that in cases where those committing fraud have
established complex and elaborate systems to conceal and deceive, the role of
the gatekeepers is difficult. It put this argument as follows:
I think the real issue here is that, in a broad sense—without
getting into details about Trio—if two or three people deliberately set up a
very obscure process to commit a fraud, what are the chances that a lot of
well-meaning but not necessarily inquiring people, be it the auditors, the
board or other gatekeepers, can detect that problem? What we try to do is get
the trustees to take a proper look at what it is they are doing... [I]t comes
back in the real sense to whether there is a process that can be adopted to
stop the couple of people deliberately setting up a fraudulent process and/or
catch that soon thereafter with the gatekeepers. That is the significant
challenge in this whole process.
In a similar vein, APRA commented that its anticipated new power to set
prudential standards for superannuation funds was not a protection against all
fraud. The Deputy Chair, Mr Ross Jones, told the committee:
I certainly would never dare say that standards-making powers
would eliminate fraud. If you have a set of individuals who are actively
engaged in fraudulent activity, I do not believe that standards-making powers
would make enough difference. We have seen examples of fraud in other industries
here and overseas where you have quite substantial regulatory strengths and
powers. It must reduce the likelihood of fraud, but I do not believe it can
ever reduce fraud to zero.
APRA made the broader point that there have been very few superannuation
frauds in the past 20 years, with Trio Capital 'only the second major fraud'.
Mr Jones commented that to minimise their tax liability, many funds make
overseas investments. He noted that often, these investments are in
infrastructure assets which are 'not easily identifiable and quantified'.
The committee takes no exception to the general comment that no
regulatory system can deter all fraud. That said, where fraudulent activity
does occur, it is incumbent on the regulators to inquire what went wrong and
what could be done to close any loopholes. This also applies to governments and
their consideration of whether there is a need to amend the law.
The committee also believes that ASIC and APRA must exercise particular
vigilance in their responsibilities to regulate and oversee superannuation
investments and overseas managed investment schemes. The Australian
superannuation pot is one of the largest in the world and, given the camouflage
provided by the long-term nature of these investments, is potentially a ripe
target for unscrupulous operators. In terms of overseas managed investment
schemes, while they account for only a fraction of total Australian and
overseas investments in SMSFs, they demand the regulators' full attention given
their complexity and cross-jurisdictional component.
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