Chapter 2 - Issues raised with ASIC


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Chapter 2 - Issues raised with ASIC

2.1        The committee's hearing with Australian Securities and Investments Commission (ASIC) officials on 12 June 2007 included discussion on a number of issues relating to ASIC's regulatory responsibilities. The main issues that were discussed are considered in this report. These include:

2.2        The committee notes that a number of these issues were discussed with ASIC officers at the Senate Economics Committee's budget estimates hearing on 30 May 2007. As the two hearings occurred within a two week timeframe, many committee members had taken the opportunity to follow up on some of these matters at the committee's ASIC oversight hearing shortly after. Consequently, this report has drawn on evidence taken during budget estimates where it has provided the basis for discussions at the hearing relevant to this report.

Property investment scheme collapses

Recent losses

2.3        Following the Westpoint collapse in late 2005, the committee has repeatedly expressed its concern that other similar schemes may encounter solvency problems.[1] Unfortunately, since the committee's last ASIC oversight hearing two further property investment schemes have collapsed, owing in excess of $500 million dollars.

2.4        In March 2007 the Fincorp group of companies collapsed owing 8000 investors $212 million. Fincorp raised monies through first ranking (secured) notes and unsecured notes. Of the money owed to investors $178 million is owed to secured note holders, who are expected to receive returns of 30 cents in the dollar. Unsecured note holders are not expected to receive any return. According to ASIC, Fincorp encountered trouble with its business model between August and November 2006, when it became apparent that without raising further money the companies would run out of cash. When property valuations did not support additional borrowing the group decided to go into voluntary administration. ASIC has indicated that it had previously placed a number of stop orders on Fincorp prospectuses for inadequate disclosure.[2]

2.5        Australian Capital Reserve (ACR) collapsed shortly after in May 2007. It had raised $327.7 million in unsecured 'Deposit Notes'. ASIC indicated that the business model was similar to that of Fincorp and that it had also issued a number of stop orders on ACR for inadequate or inaccurate disclosure.[3]

2.6        The committee notes that as this report was being finalised another high risk property investment scheme, New Zealand based Bridgecorp Holdings, collapsed in circumstances not unlike the other three cases. The collapse has left 18,000 investors facing losses of up to $450 million. The group raised money from investors in both Australia and New Zealand offering 'term investments' with returns reported to be between 9 and 11 per cent. It loaned the money raised from investors to property developers at a much higher rate.[4] Within days of the collapse nine companies in the Australian arms of the group, including Bridgecorp Finance which reportedly has $27 million of debentures and unsecured notes issued to Australian investors, were placed in receivership. The remittance of $3.7 million from the Australian arms of the group to the New Zealand entity, in possible breach of the Corporations Act, has been referred to ASIC for investigation.[5]

New preventative measures

2.7        At the Senate estimates hearing on 30 May 2007, ASIC indicated that the $8 billion unlisted and unrated debenture market, representing 1.5 per cent of the total debt securities market, will be given additional attention. The Westpoint, Fincorp and ACR schemes are part of this sector. A three point plan was outlined by new ASIC Chairman, Mr Tony D'Aloisio:

  1. Assess the business models of existing schemes.
  2. Intervene with/guide proposed new schemes to add protection to business models and improve disclosure.
  3. Improve investor education programs.[6]

2.8        ASIC also advised that it is using an external property expert and valuer to advise on changes the regulator can make to the way in which it reviews prospectuses for these sorts of companies.[7]

2.9        From the perspective of improving investor education, ASIC told the Senate Economics Committee that the attraction of such schemes reflected imperfect knowledge amongst investors:

There is probably not as great an understanding about how franked dividends work for yields on shares, compared with 9.5 per cent. If you have a five per cent yield on shares, you might say, ‘That is only five per cent.’ When you put your franking credits into that, it makes a difference. Then you have your capital gain and how you factor that in. They are the things that need to be reduced to very simple rules, and I think they will go a long way to dealing with these sorts of issues. You would expect in a market with perfect knowledge that the $8 billion debenture mark that we are talking about—if it were high risk, unlisted and unrated—would no longer be preferred by the market and they would move to other forms of investment. It is the imperfect knowledge at the moment that must be in part driving that sector.[8]

2.10      ASIC indicated that ascertaining the reasons why these unsecured products have attracted investors is a priority:

...we are looking very closely at what was the investor profile, but more importantly we are also looking at what motivated the decision, what were the decision points; the extent and role advertising played; advice, where they sought the advice, where they did not; how they characterised an unlisted, unrated debenture, unsecured note compared to a term deposit; was there confusion.[9]

2.11      ASIC also elaborated on its plan to establish whether the business models used in this sector are inherently flawed. It warned, however, of the precarious nature of the task:

...the business model itself has to be stress-tested, but what we do not want to do is to fall into making a mistake of overreacting and then there are a lot of probably very valid and proper investments and raising of capital out there that we then have an implication for and cause a run-on. We have to be quite careful about how we go forward on analysing this business model and trying to pinpoint if it has a flaw.[10]

2.12      Identifying the motivations for people entering into risky investment propositions and establishing whether or not the business model behind them are flawed are both welcome initiatives. The former will assist in tailoring educational programs to warn potential investors of the financial risks, while the latter is an essential step in determining how to avoid similar schemes also collapsing, or at least mitigating any inevitable losses.

2.13      However, the committee is of the view that the current strategy should have been triggered by the Westpoint collapse in 2005, rather than waiting until further predicted collapses occurred.

Adequacy of past action

2.14      As well as questioning the various aspects of ASIC's forward plan to address problems in the sector, the committee also pressed ASIC on its inability to prevent the recent property scheme losses, despite widespread speculation of schemes similar to Westpoint also collapsing. Although it was too early to speculate on ACR, ASIC responded that the regulator had been regularly intervening to improve Fincorp's disclosure material for some time. ASIC's written statement on Fincorp indicated that it had issued stop orders for inadequate disclosure on three of their four prospectuses, following which the deficits were rectified. This included ASIC taking action against Fincorp in the NSW Supreme Court for inadequacies relating to its second prospectus. Following the third prospectus, ASIC sought legally binding undertakings from Fincorp to correct misleading advertising. In addition:

For the 4th prospectus, ASIC required an independent expert’s report on the recoverability or impairment of loans from Fincorp to the group of companies. In other words, could Fincorp fully recover its loans (as I said earlier these loans were its main asset and subject to the floating charge for secured noteholders). This report was provided in May 2006 and confirmed ‘no impairment’ which, in effect, meant that the loans were (in the independent expert’s opinion) recoverable by Fincorp in full. Indeed, the Fincorp audited accounts filed on 9 October 2006 for the year ending 30 June 2006 were not qualified in relation to ‘no impairment’.

2.15      The extent of ASIC's intervention raised the question as to why Fincorp's collapse could not be prevented despite the many warning signs. In response ASIC emphasised that poor disclosure does not necessarily infer insolvency:

[Fincorp] had absolutely a pattern of poor disclosure. We were on them regarding their documents and their advertising, but to suggest that immediately translates to solvency, which is of course the shut-down power, it does not connect.[11]

2.16      ASIC also stressed that any decision to shut down a scheme on the basis of solvency necessitated making the delicate judgment that investors are going to be better off by doing so:

The difficulty is to let them run on, because you have rollovers and redemptions as people go; people could have got out and then do not because you have got an issue about ‘Do you let them run on or do you stop them?’ It is a difficult judgment to make. At the end of the day it is really for the directors of these companies to make those decisions. Indeed, in ACR it was the directors in the end who made the decision that they could not actually continue on with the company and put in voluntary administrators. In Fincorp they did the same. I think it would be difficult for ASIC to have to make that call because you are then being set up that you know how these investments work and that you have actually expertise, then you can predict the sale price of units in a development in two or three years time. It is really the people running these things, the directors who have to make those sorts of judgements.[12]

2.17      The committee acknowledges that ASIC faces a dilemma when attempting to regulate schemes that it may consider to be flawed and at risk of collapse. It is not a prudential regulator and, unless the entity is clearly insolvent, ASIC's role is limited to ensuring proper disclosure. If disclosure problems are rectified and auditors report no solvency problems, ASIC is left in a position where more regulatory action is unable to be taken in relation to specific entities.

Strengthening ASIC's powers

2.18      ASIC described its powers over these property investment schemes as follows:

We do not run these people’s businesses for them. We have powers on disclosure and then right at the end of the line we make ... a judgement about whether they are solvent or not. There is a lot in the middle.[13]

2.19      In response to questions over the adequacy of legislative framework within which ASIC operates, Chairman Tony D'Alosio indicated that:

I have looked at the issue of whether we need additional powers. I would like us to go with this three-point plan for the next 12 months before forming any view about whether additional powers are needed.[14]

2.20      He later added:

At the end of that period we would form a judgement as to whether in fact some change is needed. At this point we do not see any change required.[15]

2.21      The committee has previously recommended that ASIC press the government to amend the disclosure requirements in the Corporations Act to increase the $50,000 threshold applying to promissory notes.[16] At the Senate Economics Committee's May 2007 estimates hearing ASIC indicated that discussions over the issue with Treasury had taken place since August 2006, culminating in ASIC writing to the Treasurer on 24 May 2007 requesting that the promissory note threshold be lifted.[17] The committee welcomes ASIC's efforts but again believes a more forceful approach should have been adopted earlier.

Bank conduct and dispute resolution procedures

2.22      The committee's attention has been drawn to a number of cases involving non-provision of bank statements and alleged bank malpractice. These relate mainly to instances where business loans are held rather than consumer loans. The committee is concerned that a number of these disputes have been running for considerable periods of time and banks have not been able to resolve them through their internal dispute resolution processes.

2.23      One case raised by the committee relates to the apparent non-provision of bank statements to a client with a loan with Rabobank. ASIC told the committee that this dispute had been resolved and ASIC would not be investigating the matter as it was unlikely that any breach within its jurisdiction had occurred:

...Rabobank was signed up to the 1993 Code of Banking Practice but not a more recent version. The 1993 code required bank statements to be provided every six months but because this was a loan account and not a bank deposit account, the view is that a loan account is not covered by that provision. The Corporations Act 2001 deals with deposit accounts that are financial products but does not deal with the reverse. In other words, an account where you owe the bank money and not vice versa is not a financial product and therefore the statutory provision does not apply—the statutory provision being section 1017D(2), that requires a statement every 12 months. The situation in relation to Rabobank having breached anything was unclear.[18]

2.24      Two other cases of interest to the committee that were raised briefly with ASIC relate to alleged misconduct by banks in their dealings with business loan customers. The first case relates to alleged misconduct by the National Australia Bank (NAB) in its dealings with a customer with limited English skills, Mrs Fouzia Safetli. ASIC confirmed that it is currently investigating an assertion by Mrs Safetli that the nature, effect and risks of the guarantee provided for her son's business had not been properly explained by the bank. The second and long-running case involves allegations by Commonwealth Bank customer, Ms Lana McLean, that the bank has failed to provide bank statements showing a continuous record of all transactions and personal records dating back to 1996.

2.25      The committee understands that ASIC has jurisdiction to investigate misleading or deceptive conduct or unconscionable conduct under the Corporations Act. ASIC told the committee that while it was looking into the Safetli matter, it did not propose to take any further action in regard to the McLean dispute unless new evidence was brought to its attention.

2.26      Given the number of complaints about banking practices the committee has received, it is concerned that the banks' own internal dispute resolution (IDR) procedures do not appear to be working. ASIC told the committee that it had no indication that there was a systemic failure in this area:

When consumers are not getting what they want from internal dispute resolution, there is the external process and there is complaining to us, and our data is not showing over-the-odds levels of complaints about internal dispute resolution procedures, particularly with the majors. It is a key part of our surveillance, it is a key part of having a licence from us, but it is not flashing a red light, particularly because the next step from internal dispute resolution is generally to external.[19]

2.27      It also suggested that banks had a commercial interest in resolving disputes with customers:

...in financial services where you have a very large brand to protect there is a pretty strong correlation between having that brand and wanting to resolve complaints. That is a pretty broad generalisation, but I think the data bears that out.[20]

2.28      On several occasions, including the 12 June oversight hearing, ASIC was asked to provide an update on the efficacy and timeliness of banks' internal dispute resolution processes including when they were last examined. ASIC, having agreed to take the matter on notice, responded that over the last three years it has examined the operation of IDR processes in areas of three of the four major banks that fall within the financial services licensing regime, or where matters have come to its attention in the context of exercising the consumer protection powers set out in the ASIC Act:

In one case, that examination was as a result of a review in the bank's financial advice subsidiaries. We have found no significant issues with the IDR procedures in relation to financial advice in our most recent review. In another case, the bank self-reported an issue and identified some shortcomings in its complaint procedures which could have had implications for activity it undertook under its Australian Financial Services License. Remediation procedures in relation to those shortcomings have now been completed. The other matter is ongoing and largely involves a third party's offer of a bank product.[21]

2.29      From an external dispute resolution perspective, the committee queried whether the Banking and Financial Services Ombudsman's jurisdictional limit of $280,000 limit is too low. ASIC replied that, unlike the FICS limit, 'there is very, very little noise about that limit being too low'.[22] On the problem of enforcing adherence to banking codes of conduct, ASIC confirmed that banks are not legally required to sign the most recent banking code of conduct. It also informed the committee that the Uniform Consumer Credit Code, a uniform state-based system, does not apply to business loans.[23]

2.30      Given these regulatory dead ends for business loan customers seeking external resolution to their banking disputes, the role of ASIC in enforcing the unconscionability provisions of the Corporations Act seems to be an important one. However, ASIC indicated that it had decided to focus on system problems rather than individual cases: 'If ASIC got involved in every civil dispute that it was invited to get into, it simply would run out of resources'.[24]

2.31      In the light of ASIC's evidence and subsequent complaints to the committee alleging malpractice involving by the major banks, the committee has requested that ASIC further investigate and report to it on a number of these complaints. The committee has asked ASIC to give particular regard to the non-provision of bank statements and the internal dispute resolution processes banks follow. Any further action by the committee in this area, including an inquiry into possible systemic malpractice in the banking sector, will largely depend on the response it receives from ASIC.

Professional indemnity insurance for planners

2.32      A regulation to require financial services licensees to have appropriate compensation arrangements for clients' losses is expected to be made by 1 July 2007. This will specify that section 912B of the Corporations Act is satisfied if licensees take out professional indemnity (PI) insurance. The regulation will be accompanied by ASIC guidance, which will be released for consultation when the regulation is made.[25]

2.33      ASIC informed the committee that it had commissioned a report examining the state of the PI industry to complement the consultation process, which is expected to commence by the end of September 2007. When questioned as to whether the PI regime would be in place by the intended starting date of 1 January 2008, the ASIC Chairman said: 'We will do our best'.[26] ASIC had told the Senate Economics Committee that in the longer term it hoped that a standard industry wide PI policy could be used:

...if you could achieve some sort of industry based standard policy that the brokers were prepared to write and issue with insurers issuing, from ASIC’s point of view that would be quite desirable because it makes the ability to administer adequate arrangements much easier. We think that is a longer term plan but, nevertheless, we want to work with the industry to see if we can get to that point.[27]

2.34      The committee remains to be convinced that insurers will offer PI insurance to all existing financial planning firms. In response to speculation that a leading insurance company is refusing to provide PI insurance, ASIC commented:

Certainly PI insurance as a general rule is available; there is a market for it both here and overseas. We would need to look at where this example was a decision made for commercial reasons—if indeed it was made—because they wanted to focus on other business, as distinct from it being a reaction to a concern on a number of claims that may be coming forward.[28]

2.35      Although overdue, the committee welcomes the introduction of this regime. It will closely monitor its implementation, particularly with regard to the availability of PI insurance for smaller financial planning firms.

ASIC review of EFT Code

2.36      In February 2007 ASIC invited submissions on the Electronic Funds Transfer Code of Conduct (EFT Code).[29] Media reports suggested that some banks may seek to change the code to shift liability for internet banking scams on to consumers.[30] ASIC indicated that both it and the Australian Bankers Association did not support changing the code in this way.

Superannuation advice and shadow shopping survey

2.37      Following the AMP Financial Planning superannuation switching scandal,[31] ASIC has uncovered further instances of unacceptable superannuation switching advice. In May 2007 the NSW Supreme Court found that First Capital Financial Planning had engaged in misleading and deceptive conduct when advising 170 teachers to switch from their public sector funds into retail superannuation funds. It found that the company had not properly compared costs between the funds and had misleadingly compared past performance. First Capital agreed to write to the affected teachers offering a full review of their advice, as well as reimbursing teachers who choose to return to their old fund and for the cost of making the switch.[32]

2.38      In response to a query at a May 2007 Senate Economics Committee estimates hearing about why those who remained in the retail fund would not be compensated, ASIC explained that:

... to estimate what position a person would be in staying in the new product and to try and reimburse them or compensate them for doing that would involve an acutely hypothetical actuarial calculation about where they might be at some unknown end point. So what I am saying is that we just did not run the case against First Capital going into that territory. We decided to keep it fairly simple and say, ‘You can go back to your existing product, the one that you were misled out of, if you like, and the court order will say that you have to be compensated as if you never left that.’ But to go down the other route would simply be too hard.[33]

2.39      In the committee's August 2006 ASIC oversight report, it recommended that ASIC conduct another superannuation switching shadow shopping survey in 2007, publicly naming advisers and licensees found to have repeatedly and seriously breached the requirement to provide reasonable advice.[34]

2.40      The committee is disappointed that ASIC has not yet made a decision on whether another shadow shopping exercise of this kind is to be undertaken.[35] The previous survey highlighted widespread instances of unreasonable advice on superannuation switching and led to a major undertaking by AMP Financial Planning to conduct an overhaul of its procedures and offer 35,000 clients a full review of advice. Given the effectiveness of the exercise in uncovering inappropriate behaviour by financial planners the committee is surprised at ASIC's apparent reticence to repeat it. Such surveys not only identify shortcomings in the industry but act as a considerable deterrent to providing unreasonable advice.

2.41      The committee notes complaints from some sections of the industry that they have been unfairly targeted by ASIC's shadow shopping exercise. However, clients of financial planners are entitled to receive advice that meets the requirements of the law. Therefore if ASIC is serious about superannuation advice meeting the legislative standard then it will continue to monitor the financial planning industry through this very effective exercise. The committee reinforces its recommendation from the August 2006 report and believes that ASIC should undertake a follow-up shadow-shopping survey.

Recommendation 1

2.42      The committee recommends that ASIC conduct a shadow shopping survey on superannuation switching advice before the end of 2007.

ANAO report on ASIC's investigation procedures

2.43      In January 2007 the ANAO released a report on the effectiveness of ASIC's processes for receiving statutory reports of suspected breaches of the Corporations Act. It found that while the number of complaints referred to ASIC had been increasing the number investigations had fallen dramatically. Specifically, over the period 1997-98 to 2004-05 the number of reports received alleging offences increased by almost 90 per cent, while the number of reports that ASIC investigated or subjected to surveillance decreased by more than 90 per cent.[36]

2.44      The ANAO made five recommendations, including that ASIC:

2.45      All five recommendations were accepted by ASIC.[38]

2.46      The committee had previously considered the reporting and consequences of suspected breaches of the Corporations Act as part of its inquiry into the operation of insolvency and voluntary administration laws. In its 2004 report of that inquiry, the committee raised a number of concerns about ASIC's investigation of suspected breaches, including that ASIC was not giving sufficient priority to the assessment and investigation of reported breaches and that it may not have had sufficient resources for the task.[39]

2.47      At the oversight hearing on 12 June, ASIC addressed these concerns. It informed the committee that additional government funding had allowed ASIC to increase its rate of investigation:

Data in the 2006-07 year already shows that we are now doing a two per cent rate on reports as opposed to the one per cent which was mentioned in the ANAO report. It is pleasing to see that the effects of the assetless administration fund that the government introduced for us are really starting to come through. So far this year under that regime we have banned a total of 72 company officers coming directly out of the assetless administration system, which is more than twice the 30-odd bannings that happened in the previous year.[40]

2.48      ASIC also defended its previous performance in this area. Deputy Chairman Mr Jeremy Cooper explained that the low rate highlighted by the ANAO report was offset by increased surveillance to prevent insolvency losses:

...part of the explanation for a seemingly low response rate on liquidators’ reports was that in fact ASIC had moved into a more proactive mindset and not waiting around for liquidators’ reports to come in but actually visiting companies where they were giving off some signs that they might be having problems with solvency. In the 2005-06 year we did 536 surveillance visits to companies that were suspected of having these sorts of difficulties. This intervention resulted in some 95 of these companies having external administrators appointed. We would say looking at over 500 companies and appointing administrators in nearly 100 of those cases is effectively preventing the sort of later catastrophes that might occur if you had not done that and waited for the companies to go into liquidation and then again waited even further for liquidators’ reports to come in. In fact we have moved our activities from the graveyard to while these companies are still alive but exhibiting difficulties. We think that is much more profitable for protecting creditors. What this is really about is protecting creditors who deal with these companies and the investors who invest in them, and we think the early intervention is better rather than picking over the ruins and seeking to punish company directors.[41]

2.49      The committee reiterates that reporting obligations are one of the most important mechanisms in the law for identifying possible breaches of the Corporations Act that must be performed to the highest standard possible. The committee accepts that ASIC's priorities in this area appear to be heading in the right direction, demonstrated by its acceptance of ANAO recommendations. The committee encourages ASIC to act on these recommendations in a timely manner.

Senator Grant Chapman

Senator Grant Chapman
Chairman

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