Unravelled: ASIC's enforcement powers may receive a boost
5 February 2015
Other articles in this edition of Unravelled:
- The best interests duties – process or outcome?
- What do smoked fish have to do with retirement incomes?
- Will Australia serve up a Chilean-style super system?
- A new dawn for crowd sourced equity funding?
Written by Partner Belinda Thompson and Managing Associate Susie Stone
As previously reported (Unravelled: ASIC's enforcement decisions – Is litigation the most effective deterrent?), the Senate Economics References Committee's Report into ASIC's performance looked carefully at the enforcement powers available to ASIC, and whether – as ASIC submitted – it requires a broader range of powers and more onerous financial penalties in order to punish and deter corporate wrongdoing. The Senate Committee recommended that the penalties currently available to ASIC should be reviewed, but was also highly critical of ASIC's enforcement record, and particularly its reliance on enforceable undertakings. In this regard, the Senate Committee clearly took the view that ASIC's enforcement actions should serve not only to punish misconduct but also to deter others, and for this reason, ASIC must be 'respected and feared'. The Interim Report of the Financial Services Inquiry (the FSI) acknowledged the Senate Committee's inquiry, and undertook to examine carefully its findings in the lead-up to its Final Report.
It is clear from the its Final Report that the FSI has paid heed to the call to provide ASIC with an enhanced enforcement toolkit. The Final Report notes that several of its recommendations are consistent with those of the Senate Committee, and this is certainly the case in relation to ASIC's enforcement powers. The most striking of the FSI's recommendations from an enforcement perspective are:
- the introduction of a 'targeted and principles-based' product design and distribution obligation, requiring product issuers and distributors to consider a range of factors when designing products and distribution strategies;
- the introduction of a product intervention power for ASIC;
- strengthening the Australian Credit Licence and Australian Financial Services Licence regimes to allow ASIC to deal more effectively with poor behaviour or misconduct; and
- increasing both criminal and civil penalties.
Interestingly, the Final Report itself states that '[f]ew submissions comment on ASIC enforcement powers or the adequacy of the current penalty regime' (p252), although it recognises that there was some support for a substantial increase in maximum penalties. Indeed, there is limited discussion in the Final Report of whether there is a need for ASIC to have additional enforcement powers, or whether existing regulatory tools are sufficient to allow ASIC to deliver on its mandate. With this in mind, it is worth considering the FSI's recommendations in more detail.
Product design and distribution obligation
The introduction of a universal product design and distribution obligation would, according to the Final Report, require product issuers and distributors to consider various factors when designing products and distribution strategies. At the product design stage, issuers would be required to identify their target and non-target markets, and 'consumer test' products to make their key features clear. Similarly, issuers should agree with distributors on how the product should be distributed. After sale, both issuers and distributors should periodically review whether the product meets the needs of the target market and whether its risk profile is consistent with its distribution. A serious breach of the obligation would lead to a significant penalty.
In explaining the basis for this recommendation, the Final Report states that it is intended to support the fair treatment of consumers and strengthen consumer confidence in the system (one of the key themes underpinning the Final Report). In the FSI's view, the current reliance on disclosure, financial advice and financial literacy is insufficient: disclosure can be ineffective, while many consumers do not seek financial advice or obtain poor quality advice. The Final Report acknowledged that some submissions raised concerns that a product design and distribution obligation would increase product costs or decrease offerings for consumers, create difficulty in determining the suitability of products and result in additional compliance cost for industry. In response, the FSI states that the proposed obligation would likely have substantial benefits for consumers and those firms with existing good practices should suffer minimal additional costs – in other words, in the FSI's view, the benefits outweigh the costs.
The proposed obligation may be stated somewhat simply in principle. However, if implemented, it would take some time to develop an understanding of the factors that issuers and distributors must consider when designing and distributing new products. Indeed, clear guidance may not be achieved until these obligations are tested in the courts. All of which makes for fertile ground for consumer claims.
Product intervention power
Next, the FSI recommends that ASIC should be given a temporary product intervention power, to be used as a last resort or as a pre-emptive measure where there is a risk of significant detriment to a particular class of consumers (and importantly, without a demonstrated or suspected breach of any laws). The power would allow ASIC to impose amendments to marketing or disclosure materials, warnings to consumers, labelling or terminology changes, restrictions on distribution or even product bans. The FSI acknowledges that the recommendation takes into account the Senate Committee's Report, and expresses concern that ASIC has previously 'lacked a broad toolkit to respond effectively and in a timely way to an emerging risk of significant consumer detriment'. However, whether ASIC may actually already possess the necessary tools is not meaningfully considered (see further: Unravelled: Some facts (and myths) about ASIC and product intervention powers).
The power would be subject to several safeguards. First, ASIC would be required to consult with APRA prior to using the power when it may affect an APRA-regulated body. Second, ASIC's intervention would be for 12 months only, with an extension of time to be granted if more time is needed (either by the industry to change its practices or by the Government to implement permanent reform). Third, a decision by ASIC to intervene pursuant to this power would be subject to judicial review. Further, the proposed Financial Regulator Assessment Board should assess the use of the power as part of its assessment of ASIC's performance against its mandate.
In spite of these safeguards, this proposed power raises some serious concerns. While the FSI emphasises that it will be used infrequently, as a last resort or pre-emptive measure, there is nonetheless a risk of 'moral hazard' – that is, consumers may perceive that a lack of intervention by the regulator implies that a product is 'low risk'. Many consumers may fail to appreciate that the power is intended to be a last resort only, and assume that ASIC would exercise it if a product involved a risk of consumer detriment. The FSI says this is not an issue because the power is to be used infrequently and as a last resort – it is not a pre-approval power - however, query if consumers would appreciate this.
The FSI also recommends that the maximum civil and criminal penalties for contravening ASIC legislation should be 'substantially' increased to act as a credible deterrent for large firms – an issue that received significant attention in submissions. While the Final Report does not suggest particular figures, it does recommend that ASIC should be able to seek disgorgement of profits. The FSI does note that Australia should not introduce the 'extremely high' penalties for financial firms seen in some overseas jurisdictions, as this risks creating 'inappropriate incentives for government and regulators' unless the revenue is separated and used for social or public purposes.
Strengthening ASIC's powers
From an enforcement perspective, the FSI recommends that the Australian Credit Licence and Australian Financial Services Licence regimes should be strengthened to allow ASIC to 'deal more effectively with poor behaviour and misconduct'. These are interesting recommendations, bearing in mind that this issue was not a focus of the Interim Report or submissions generally. Again, there is a real question as to whether ASIC already possesses the power to do this.
Several of the FSI's other recommendations are not directly relevant to enforcement but are nonetheless likely to impact on ASIC's enforcement decisions. Those recommendations include:
- The establishment of a Financial Regulator Assessment Board to undertake annual reviews of the overall performance of the regulators against their mandate. The Board would report to Government on how the regulators have used the powers and discretions available to them, including in ASIC's case, the use of the temporary product intervention power.
- The strengthening of ASIC and APRA through increased budget stability built on periodic funding reviews and greater operational flexibility. The FSI recommends moving to a three-year funding model to give greater year-to-year certainty in funding profiles, as well as flexibility in how the regulators spend their budgets. In the case of ASIC, the FSI recommends an industry funding model whereby ASIC recovers the cost of regulatory activities directly from industry participants, through fees and levies calibrated to reflect the cost of regulating different industry sectors.
In preparing its Final Report, the FSI has clearly paid close attention to the report of the Senate Committee. The recommendations discussed above are designed to strengthen ASIC through a combination of better funding, an enhanced regulatory toolkit and higher penalties, enabling it to be the 'respected and feared' leader desired by the Senate Committee – with a potentially significant impact for both the financial industry and its customers. That impact is now likely to be the subject of further submissions to the Government before any decisions are taken.
Other articles in this edition of Unravelled
- Belinda ThompsonPartner,
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