In his determination of our case the Financial Ombudsman
directed our Financial Adviser to pay many hundreds of thousands of dollars to
us but we received nothing as the company was in liquidation and the directors
were all bankrupt. The company's professional indemnity insurance was
pathetically inadequate and had long been exhausted.
Investors caught up in the collapse of the MIS found that they had few
if any available or affordable avenues to seek some form of restitution for bad
advice and/or irresponsible lending practices. In this chapter, the committee
examines the compensation mechanisms available to investors who, through poor
advice or misleading promotion, have suffered financial loss.
Avenues for recompense
ASIC maintained that:
Having efficient and effective dispute resolution and
compensation mechanisms is integral to promoting the confident and informed
participation of consumers in the Australian financial services system...
The experiences of numerous retail investors in agribusiness MIS,
however, exposed deficiencies in the mechanisms meant to provide redress for
breaches of the law. For example, one couple stated that there was no recourse
for the average investor, explaining:
Lawyers' fees are hundreds and thousands of dollars. ASIC
have done nothing. The Financial Ombudsman does nothing. What do we have left?
Our voice now is through the press and imploring you, who are a representative
of the people of Australia, to do something.
Along similar lines, Greig and Bridget Allan noted that there was no
compensation for small investors in the collapse of forestry MIS and other agricultural
schemes. In their view:
Litigation is fraught with expenses beyond the limits of
small investors. Banks have enormous resources to see that all loans are paid
in full for collapsed schemes.
An investment manager who has been attempting to assist a number of
clients with investments in early Timbercorp forestry projects, Mr Jeff Chin,
joined many other investors to highlight the difficulties investors have in
seeking recompense for perceived shortcomings:
The difficulties for growers in simply defending the claims
in court include inexperience and the extremely high cost of access to justice.
In some cases, it simply cannot be financed, whereas in others, the cost is
disproportionately large and many multiples of the amounts in question (which
is typical of the reason that the consumer protections were put in place in the
first instance)...The Liquidators appear to be gaming this with their preference for
the unduly legal approach and refusal to discuss.
In his assessment, the most serious allegations appeared to involve
breaches of existing regulations that centre on intermediaries who are bankrupt
or have been in bankruptcy. According to Mr Chin, 'the issue is not that
current regulations do not already prohibit such behaviour, it is that perpetrators
simply ignore the existing requirements and there does not appear to be
adequate compensatory arrangements in place'.
Advisers—professional indemnity insurance and bankruptcy
ASIC noted that AFS licensees must have adequate arrangements for
compensating retail clients and consumers for loss or damage due to breaches of
the financial services laws and explained the compensation arrangements. For
example, the Corporate Regulations 2001 mandate that an AFS licensee must have
an 'acceptable contract' of professional indemnity (PI) insurance as 'the key
form of compensation'.
According to ASIC, this PI insurance cover is required to:
adequate, having regard to the licensee's business (the volume of business, the
number and kinds of clients or consumers, the kind of business and the number
of representatives) and the maximum liability to compensation claims that
realistically might arise;
external dispute resolution (EDRs) scheme awards—currently, two ASIC-approved
EDR schemes operate—the Financial Ombudsman Service (FOS) and the Credit and
Investments Ombudsman (CIO);
fraud or dishonesty by directors, employees, other representatives and other
agents of the licensee; and
- have a
limit of at least $2 million for any one claim and in the aggregate for
licensees with total revenue from financial services or credit services
provided to retail clients and consumers of $2 million or less.
PI insurance, however, has its drawbacks. ASIC noted that this insurance
is designed to protect AFS licensees against business risk, but not to provide
compensation directly to investors and financial consumers, explaining further:
It is a means of reducing the risk that a licensee cannot pay
claims because of insufficient financial resources, but has some significant
limitations, including where there are insolvency issues, or multiple claims
against a single licensee. In addition, directors may access PI insurance to
defend legal proceedings, which may reduce the amount available for investors.
According to ASIC, the gaps in, and caps on, PI insurance cover will 'inevitably
remain a problem', given the limits on ASIC's capacity 'to compel commercial
providers of the product to adapt it to a purpose different from and beyond the
purpose for which it was designed'.
Evidence to this inquiry highlighted the inadequacy of PI insurance for
some of the financial advisers who recommended agribusiness MIS to their retail
clients. A number of investors referred to their financial adviser opting
to declare bankruptcy, thereby closing off any means for them to recoup losses
they believed resulted from inappropriate advice or their adviser's misconduct.
Indeed, by declaring bankruptcy, the adviser escaped litigation and left
clients unable to recover their losses.
Invariably, investors looking to receive compensation from their adviser
for poor financial advice were disappointed. One such investor stated:
The adviser had insurance but it was not enough to cover all
the people suing them and they declared bankruptcy leaving us with no avenue
for compensation. Our last resort is this class action against Bendigo/Adelaide
bank. We started off with an unencumbered home and now we are in over one million
dollars of debt with only one income and a young, growing family.
Their account is similar to many others, who referred to the inadequacy
of professional indemnity insurance.
A number of growers noted that the professional indemnity their financial
services provider had taken out was 'hopelessly inadequate'.
For example, one investor stated:
Our Financial Planner was massively under-insured and he
himself declared bankruptcy to avoid litigation to recover costs against him. We
are left with no financial recourse against the financial planner and the legal
avenues against the banks seem to be fruitless despite clear evidence of
knowledge of the non-viability of the schemes they were funding.
Another investor, referred to her adviser, Mr Holt, stating that it was
hard to believe that he was allowed to trade with only a $2 million PI insurance
policy for his business, which proved totally inadequate for his clients.
Effectively, the clients were denied the opportunity to take legal action to
recoup some of their losses brought about by his poor financial advice.
A financial adviser without financial backing means that even when an
investor has received a favourable award from the Financial Ombudsman Service
(FOS), the investor may not receive compensation. FOS is one of the two
ASIC-approved EDR schemes.
The experiences of clients of Mr Steve Navra demonstrated
clearly the limited opportunities for obtaining any form of restitution. One
such client explained that after the first successful FOS claim against Mr
Navra, Mr Navra immediately 'declared bankruptcy, relocated to Melbourne and is
now practicing "wealth education" seminars down there'. He noted
At the time of the Great Southern demise, we even received a letter
from ASIC advising us we had potentially been mis-sold Grapevine products by
Steve and to take [it] up with the Financial Ombudsman—but to what purpose?
Steve is bankrupt, had insufficient insurance to cover all our claims...and with
this 'settlement' we would no longer be able to pursue via FOS anyway.
Another couple had a similar experience. They had received a letter from
ASIC advising them that they may have been given inappropriate financial advice.
They subsequently lodged claims for compensation through FOS only, in their
words, 'to be let down'. They explained:
Just as our case was about to go to determination our financial
advisor declared bankruptcy. Subsequently we sought private legal advice, at
great expense, and are still awaiting an outcome as it appears our financial
advisor only had about $2 million insurance cover and the insurer is able to
employ delay tactics until the statute of limitations is up or we give up.
Noting that there was already a professional indemnity requirement, the
FPA asserted that it was 'effectively broken'. It suggested that ASIC has no
way to check PI cover: that there are no checks to make sure it is adequate.
ASIC recognised that the effectiveness of the existing mechanism
intended to compensate investors was limited where the ASF licensee 'is
insolvent and the PI insurance is not responding'. Put bluntly:
In these circumstances there is generally no realistic
prospect of investors obtaining any compensation.
One investor suggested the need for a special compensation scheme:
The amount of debt and financial hardship this has directly
caused hard working Australians, some sort of compensation package for
Timbercorp victims needs to be addressed and set up as it has affected so many
families and put them on the path to financial ruin.
Another couple also suggested that help was needed to introduce a
compensation package for victims of Timbercorp who received bad financial
advice and whose projects were managed poorly. They added:
We can't be fully compensated for our total loss, as there is
no amount of money that can restore our trust or health.
Clearly, the incidence of uncompensated loss for investors in
agribusiness MIS undermines public confidence in Australia's financial services
system and enlivens the debate about the merits of introducing a last resort
Report on compensation arrangements
Industry Super Australia acknowledged that many of those who had
suffered financial loss because of their investment in MIS had not received
compensation. It believed there was value in considering the recommendations
arising from Mr Richard St John's 2012 report. Although not specifically
addressing investors in failed MIS, Mr St John's recommendations have
relevance. They included:
require licensees to provide ASIC with additional assurance that
their professional indemnity insurance cover is current and is adequate to
their business needs;
more attention should be given, on a risk targeted basis and in
conjunction with the level of their insurance cover, to the adequacy of
licensees' financial resources to enable better management of risks and
unexpected costs such as compensation liabilities;
ASIC should take a more pro-active approach in monitoring
licensee compliance with the requirement to hold adequate professional
indemnity insurance cover and any new requirement in regard to financial
resources, and in targeting licensees who are most at risk;
to assist ASIC in playing a more pro-active role in administering
the licensing regime with respect to compensation arrangements, consideration
should be given to clearer powers to enforce standards and to sanction
licensees who do not comply;
in dealing with licensees who give up their licence or reduce the
scope of their licensed activities, ASIC should seek where possible to secure
ongoing protection for retail clients including by imposing appropriate
conditions in relation to the termination of a licence or the amalgamation or
takeover of a licensed business; and
given their role in the regime for the protection of consumers of
financial services, and marked increases in their jurisdiction, External
Dispute Resolution schemes and ASIC should give more attention to the adequacy
of the EDR scheme processes as those schemes grow beyond their origins as
forums for small claims.
With regard to introducing a last resort compensation scheme, Mr St.
John urged caution. In his view, such a move at this stage would not address
the underlying problems: that it would 'be inappropriate, and possibly
counter-productive'. He explained:
A last resort scheme would have the effect of imposing on
better capitalised and/or more responsibly managed licensees the cost of
bailing out the obligations of failed licensees. It would not work to improve
the standards of licensee behaviour or motivate a greater acceptance by
licensees of responsibility for the consequences of their own conduct. It could
well introduce an element of regulatory moral hazard by reducing incentive for
stringent regulation or rigorous administration of the compensation
According to Mr St John, deferring further consideration of a last
resort scheme would be preferable pending the implementation of the measures he
had proposed as well as other reforms now in train including FOFA.
The committee touched on the inadequacy of compensation mechanism in its
2014 report and has again received, and taken evidence on, this matter in its
scrutiny of financial advice inquiry (SOFA), particularly a proposal for a compensation
scheme of last resort. For example, consistent with the evidence relating to
agribusiness MIS, Mr Craig Meller, AMP told the SOFA inquiry that some providers
in the industry do not have adequate insurance arrangements. He recognised that
it would be appropriate to have some sort of underlying safety net for those
who have slipped through the system—'those who got a FOS determination and
then, for whatever reason, were unable to be remunerated from the provider of
Mr Meller suggested that in conjunction with any consideration of a
compensation scheme, consideration should be given to determining what the
minimum levels of indemnity insurance should be and ensuring they are
appropriate. He did note, however, that there are cases where insurance is not
available, for example, a business cannot get insurance for committing fraud. In
...there should certainly be consideration that minimum capital
requirements could be put in place, to ensure that the number of people who
slipped through the safety net and were not remunerated could become de minimis.
In that case, it would be much easier to build an industry coalition to find a
way to cover such a compensation scheme.
From her unique position as the independent hardship advocate (IHA),
Ms Lowe had no doubt that a significant number of the people she was
working with should receive compensation. She noted that at best the advice
they received to invest in Timbercorp appeared 'completely inappropriate, at
worst, deceitful', adding:
It is equally clear that the protection mechanisms in place
are not adequate to provide that compensation.
Ms Lowe considered the avenues open to the victims of bad financial
advice and concluded:
Whilst many victims of poor adviser conduct may well succeed
in a complaint to either the Financial Ombudsman Service or Credit and
Investments Ombudsman, a favourable determination must then be satisfied.
Neither adviser solvency nor professional indemnity insurance has proved
adequate to this task. In the case of PI, levels of cover are either woefully
inadequate to compensate loss or too narrow in scope to answer at all.
Experience in other insurance markets such as public liability and home
building insurance suggest that endeavours to mandate scope or depth of PI will
not succeed in the medium to long term.
In her view, a last resort compensation scheme should exist to provide
redress for consumers suffering loss as a result of inappropriate or negligent
Ms Lowe informed the committee that such a scheme has 'the capacity to provide
a real remedy to people whose lives have been blown apart'.
The difficulty then is to find the funding to ensure proper
compensation. A number of witnesses before the SOFA inquiry referred to
this problem. AMP observed:
The challenge we have, as a large corporate that naturally is
very well capitalised and essentially self-insures, is to ask ourselves if it
is appropriate that the shareholders and the customers of AMP end up paying for
the incompetence of others in the industry. While there is a good argument for
that broadly being for the better good of the industry, we also want to ensure
that it did not create those moral hazards and so we would be a very willing
participant in further consideration of this scheme.
In effect, according to AMP, such a scheme would never apply to its customers.
AMP suggested that it would be timely to revisit the findings of Mr St. John's
report on a statutory compensation scheme.
Mr Andrew Hagger, NAB, similarly recognised that some people, who have
dealt with a small firm, go all the way through a system to FOS, receive a
judgement in their favour, which is then not paid. Whereas, in his words, if NAB
do the wrong thing, customers can be compensated.
Mr Nicholas Moore, Macquarie Bank, also referred to people found to be
victims who, despite FOS determinations, have not received compensation. He
agreed that such people deserve justice but it has not been delivered to them. Mr
Moore understood the importance of the industry having professional standing,
A normal industry professional body does have some sort of
compensation scheme; we see it in the law profession with solicitors and with
other professional bodies. We would see that, with this part of the evolution
of the whole financial planning industry, it would not be an unexpected outcome
in terms of ending up here.
According to Mr Moore, moral hazard is an important concern to bear in
mind, but that Macquarie thought that a compensation scheme was an issue that
certainly needed examining. He referred to other industry bodies where similar
sorts of schemes were in place, so, in his view, there certainly were 'precedents
for it out there'.
Mr Graham Hodges, ANZ, agreed that there was a gap in respect
of a scheme of last resort or better arrangements around public indemnity
insurance to make sure people do not fall through the cracks. In his view:
...the problem is that you have myriad players, many of whom do
not have much financial means or much protection in terms of insurance. If
there is a systemic issue within that planner group then there is a likelihood
that that planner group will not have sufficient financial muscle to right the
Referring specifically to investors in the failed Timbercorp schemes, he
...the issue for many of these people is that the limited
amount of insurance or personal indemnity insurance these practices had was
gone very quickly and there were many, many clients affected. So there is
nowhere for these people to go other than, as a number did on several
occasions, to work through a class action. In the Timbercorp case they lost
comprehensively on two occasions, at further cost and with further delay and at
further cost to the individuals, because they were advised by the lawyers not
to pay their loans.
ANZ's preferred option would be for organisations that have sufficient
financial strength and can pay out as required for mistakes to be allowed to
effectively self-insure because they have the capital behind them.
Organisations that do not have sufficient financial strength, however, 'would
be required to take out some sort of insurance'.
He also recognised the issues of moral hazard but thought
they could be minimised and would probably be a lesser issue if planners'
insurance costs rose as a result of their mistakes. Mr Hodges elaborated:
When you meet with the people who have gone through the
extreme hardship that some have, where there is no-one to go to, you can see
why it is worthwhile putting in place a scheme, even if there is some reduced
risk of moral hazard, I believe.
ASIC supported 'consideration' of the introduction of a limited
statutory compensation scheme. It noted that it does not have the power to
award or compel an AFS licensee to pay compensation where the licensee has
caused direct financial loss to retail investors. ASIC suggested that an
independent 'statutory compensation scheme would supplement PI insurance and
the formal determination of claims by EDR schemes'.
As a final observation on the need for a compensation scheme of last
resort, Ms Lowe noted that the problem encountered by the victims of unsound
financial advice was significantly broader than Timbercorp. She referred
particularly to evidence submitted to the committee's inquiry into the scrutiny
of financial advice.
Clearly, the current system for compensating retail investors who have
suffered financial loss as a direct result of inappropriate financial advice is
failing the investors. Despite the work of FOS, many people who have received
favourable FOS determinations are unable to receive fair compensation because
their adviser had inadequate insurance and, in many cases, declared bankruptcy.
In light of the evidence, the committee recognises that some form of
compensation scheme for the victims of bad financial advice warrants much
closer consideration. The committee resolved that, rather than duplicate work
and examine this matter as part of its MIS inquiry, it would investigate a
compensation scheme of last resort as part of its SOFA inquiry. One of SOFA's
terms of reference goes directly to this matter—whether existing mechanisms are
appropriate in any compensation process relating to unethical or misleading
financial advice and instances where these mechanisms may have failed.
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