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JOINT COMMITTEE ON CORPORATIONS AND FINANCIAL SERVICES
04/09/2009
Financial products and services in Australia

CHAIRMAN —I reopen this public hearing of the Joint Parliamentary Committee on Corporations and Financial Services, part of a series of public hearings the committee will hold to inform its inquiry into financial products and services. The committee is inquiring into issues associated with recent financial services provider collapses such as Storm Financial Group, Opes Prime Group and other, similar collapses. In conducting its inquiry the committee has made a decision to focus specifically on non-superannuation products and services. Witnesses giving evidence to the committee are protected by parliamentary privilege. Any act which may disadvantage a witness on account of their evidence is a breach of privilege and may be treated by the parliament as a contempt. It is also a contempt to give false and misleading evidence to a committee. The committee prefers to hear evidence in public, but we may agree to take evidence confidentially. The committee may still publish confidential evidence at a later date, but we would consult the witnesses concerned before doing this.

I welcome all the representatives from the Commonwealth Bank of Australia. I note for the public record that we have also invited the CEO, Mr Ralph Norris. Mr Norris cannot be present today but has made a commitment to appear at a later date. We have accepted that, so we will be talking to Mr Norris at a later date. Is there anything any of you wish to add about the capacity in which you appear today?

Mr Narev —I am the group executive of Business and Private Banking, which is the division through which Colonial Geared Investments reports.

CHAIRMAN —Thank you. Do any of you wish to make opening remarks?

Mr Cohen —My colleagues and I welcome the opportunity to assist the committee in its deliberations today. I am the general counsel and I am responsible for legal affairs within the Commonwealth Bank Group. Most relevantly today, I have been closely involved in the review of the bank’s involvement with Storm Financial and in designing the resolutions scheme involving Storm Financial clients who borrowed money from the bank. I would like to reiterate a number of key points from the submission that we lodged with the committee. As one of Australia’s largest financial service institutions with one of the largest financial planning groups, we welcome the opportunity to participate in this inquiry into the provision of financial services and financial products, in particular issues associated with the recent collapse of high-profile financial service providers. Whether the regulatory framework is appropriate to ensure Australian investors can have confidence in financial products and services is very important to CBA.

CBA has a strong interest in a regulatory environment that ensures Australian investors have access to affordable, quality financial advice and have confidence in the financial products and services being recommended to them. As we have said in our submission, in our view the regulatory framework for financial advice does not require wholesale change. We consider that with appropriate application of the existing framework and effective enforcement poor outcomes for clients will be rare. We have recommended in our submission 11 areas where additional information provided by industry participants to ASIC should enable the development of a risk weighted strategic view of an advice business. This will assist ASIC to identify either a failing business or a business with a high potential for failure. We recognise that ASIC’s role in this respect is not easy, and it can be assisted by the financial planning industry providing relevant and useful information to ASIC to enable it to monitor licensed financial advisers in a more strategic way. Further, CBA supports the proposed legislative changes in relation to margin lending, advice and the disclosure work being done by the Financial Services Working Group.

I would like to address briefly the bank’s association with Storm Financial. As you know, CBA, amongst others, provided financial products via Storm to their clients in order to realise Storm’s financial advice. As the bank’s CEO, Ralph Norris, has stated publicly, ‘The position in which some Storm clients find themselves, though not caused directly by the bank, does involve the bank to some degree.’ Today my colleagues and I echo Mr Norris’s statement that we are not proud of the bank’s involvement in some of the issues faced by those customers. Our CEO has also publicly announced that customers can be assured that, where we have done wrong, we will put it right. Both before and since that announcement we have been taking action to put wrongs right. First, our customer assistance program established with customers on the ground in Townsville and, second, our innovative resolution scheme.

We recognise the very real financial hardship suffered by some of our customers and we are genuinely concerned to assist them reach fair solutions and outcomes. As a first step we did put in place a customer assistance, or hardship team, in Townsville in February this year. That team continues to work with affected clients. The team has met with over 1,000 customers to learn more about their circumstances and, wherever possible, to help form a longer term plan to address their hardship. Our offers of assistance have been tailored specifically to each individual client’s circumstances, and those offers have included loan reductions and loan write-offs, loan restructures, reduced interest or zero interest for the life of the loan, and permanent tenancies.

To further help our customers who face hardship and recognising that in some cases we have contributed to that hardship we have established an innovative resolution scheme with the aim of providing swift, fair and transparent outcomes for affected customers. Not only will the scheme produce quick outcomes but, as a result of early claims being determined by former High Court Justice Ian Callinan, it will give the banks sound guidance on the offers that we make to customers who face similar circumstances. As an example of one of the issues that will be determined early—and it is an issue that we are aware the committee is interested in and wants to learn more about—is the question of who was responsible for margin calls being made to customers who had margin loans and will be considered early in the resolution scheme. We would like to address that issue during the session today because we do believe we have valuable information that will be of interest to the committee.

The resolution scheme is underway, and we have sent letters to all eligible customers explaining the scheme and how it will operate. In addition, Matt Comyn and Brendan French, who are here today, have attended information evenings organised by Slater & Gordon and the Storm Investors Consumer Action Group. So far approximately 430 customers have registered to participate in the scheme, and we are in the process of establishing an electronic document platform that will facilitate the delivery of important documents to customers and their lawyers. We hope to be making offers to customers in the coming weeks with a view to an efficient and quick process. To ensure customers are fully advised throughout the process, the bank is funding the cost of independent legal and financial advice up to agreed levels. To further assist customers, the bank has frozen interest payments on loans to those customers who register for the scheme by the end of this month.

In terms of our learnings, the bank has learned from mistakes that we have made in relation to some of our lending to Storm customers. Amongst the steps we have taken to remedy the situation, we have improved our valuation decisioning tool, known as VAS, which I am sure the committee has heard about, we have tightened our loan approval processes, and we have augmented our compliance and audit checking processes. We will be doing everything possible, and I can assure the committee of this, to ensure that the mistakes we have made in the past do not occur again.

Finally, while CBA acknowledges and is willing to put right the wrongs that we may have committed, it needs to be recognised that there are other parties significantly involved in the hardship suffered by Storm clients. CBA is not responsible for either those parties or their contribution to the hardship being experienced. Chairman, thank you for the opportunity to address the committee and our team is available to answer the committee’s questions.

CHAIRMAN —Thank you, Mr Cohen. I would like to get a couple of things straight first so that we are all on the same platform and we understand what we are talking about. Colonial Geared Investments is a subsidiary of CBA. Can you describe that to me?

Mr Cohen —Certainly. Colonial Geared Investments is a business within the Commonwealth Bank. It sits within our business bank and is an operating business which specifically focuses on marginal lending.

CHAIRMAN —So it is wholly owned; it is a subsidiary; it is the Commonwealth Bank?

Mr Cohen —It is wholly owned; yes.

CHAIRMAN —We are not talking about some other third party?

Mr Cohen —No. That is correct; it is the Commonwealth Bank.

CHAIRMAN —You also talked briefly about, and you mentioned throughout your submission, Storm clients.

Mr Cohen —Yes.

CHAIRMAN —Do you make a distinction between Storm clients and your clients?

Mr Cohen —In essence Storm clients became CBA customers in some circumstances. So there is a commonality. Some Storm clients also became CBA customers.

CHAIRMAN —I understand that, but the Storm clients were also your clients.

Mr Cohen —Our customers.

CHAIRMAN —Yes; your customers. So they were your customers.

Mr Cohen —Yes.

CHAIRMAN —So there is no distinction. You are not just calling them Storm’s clients for convenience or anything like that?

Mr Cohen —No.

CHAIRMAN —It is clear that they were your customers; they were not somebody else’s customers even though they might have been Storm customers as well.

Mr Cohen —Exactly. Perhaps I can assist you to understand why that terminology was used in our submission. We usually use that terminology in circumstances where we are relating to the financial advice that may have been given by Storm. In that context we refer to them as Storm clients. Where we are talking about loans, for example, made to a person—and it is a loan made by CBA—then they are a CBA customer.

CHAIRMAN —That is fine. In your submission you say ‘What we are doing to help Storm clients,’ but really it should be, ‘What we are doing to help Commonwealth Bank of Australia clients.’

Mr Cohen —Customers; yes.

CHAIRMAN —Yes; customers or clients. I will use the word ‘clients’. You talked briefly about the Commonwealth Bank’s relationship with Storm, and you have mentioned that in your submission. Obviously it is of great interest to us to understand how that relationship operated. You have not really gone into any detail. You talked about there being some sort of a relationship, but my understanding is that the Commonwealth Bank set up a specific BSB number just for Storm Financial, that you had also set up a specific team to work just with Storm clients and that there was quite a bit of effort over a long period of time put into Storm as an organisation. Firstly, tell me why that is and then how that operated.

Mr Cohen —I might give you a general overview and then Ross McEwan can talk specifically to some of the issues that you have raised. The association with Storm commenced in 1994. It was an association that commenced with a business that was known as Legal and General, which was then acquired by Colonial. The Commonwealth Bank Group acquired Colonial in 2000-01, so the association originally began before the Commonwealth Bank owned Colonial. It might be useful for the committee to understand the context of the Storm business in reference to our overall business. Perhaps both Ross McEwan and Ian Narev can talk a little about where the Storm association and the volume of business fit in within the Commonwealth Bank Group and how it relates.

Mr McEwan —I will address the home loan side of the business. Many of the comments that you made relate to the home loan part of the business. It was a unique relationship as we look through the Storm business association with our business. It had been running since about 1999. There was a small unit of about three to four people who were located in our area office and who serviced the Storm clients in the last five years of operation, dating back to 2004-05. It was quite unique for the Commonwealth Bank to have a cell that looked after a group that was not a broker and was not a referral agent, so therefore no commissions were actually paid to Storm for the business that they tendered to us.

It was also the uniqueness of that—that is, that there were no commission flows—that made it quite difficult for us to identify true Storm clients as we looked at it at the beginning of this year. The reason a BSB number was set up—it was set up in 2008; very late in the piece—was actually to start identifying those clients, because you need a BSB number to process, and the BSB number, which is a branch number, was actually allocated out to a branch within the Townsville area for which we have a number of branches. So can you imagine, whilst the unit is serviced, the actual clients got allocated out because of the BSB number and it therefore made it quite difficult to assess how much business was actually running through the proper cell itself. So it was quite unique in the sense that it had no broker relationship or referral relationship, and it had its own unit there, which is not something that we run throughout the country.

CHAIRMAN —Was that very generous of you to set all that up and not receive anything back? There were no brokerage fees, no commissions?

Mr Comyn —No.

Mr Cohen —No, not paid to Storm. The business was actually tendered from Storm. We would get a tender document saying they had a client who was looking for a home loan, here were the basic details and then we would send—

CHAIRMAN —But, on the home line side of that, it was very small though, wasn’t it? I think in your submission you said 0.2 per cent of something.

Mr Cohen —It was 0.2 per cent. And actually it is 0.2 of our overall book and was pushed—

CHAIRMAN —But home loans are pretty well run-of-the-mill in terms of bank business. I mean that is what banks mostly do. I am more interested in the setup in terms of the margin loans or what was set up in terms of the team. I do not know how many people it must have involved. You would not have set up a whole specialist team, a BSB number, to identify Storm customers, go to all that trouble just for some home loans.

Mr Cohen —Sorry, just for clarity: the BSB number was for home loans only.

CHAIRMAN —Okay.

Mr Cohen —Okay. So it was solely for the home loan business and put up in 2008 to start identifying that business coming through.

Mr Comyn —It was set up relatively late, in August 2008—

CHAIRMAN —Can I just clarify. The home loans invariably all ended up—at some point, those same customers ended up getting margin loans. Storm was not a mortgage broker just trying to get home loans for people, were they?

Mr Cohen —No, they weren’t.

CHAIRMAN —Because in fact their business model was the opposite of that.

Mr Cohen —That is right. They were not set up as a broker. They actually tendered out their business to ourselves and to other banks. So, I think the area you are looking at is—then moving on—that is the home loan piece and how it was structured up. The next piece is around how the margin lending was set up.

Mr Comyn —Ian can talk about the margin lending arrangements.

Mr Narev —Mr Chairman, I will talk about the margin lending arrangements with Storm. In doing so, I might just set one extra note of context in addition to what Mr Cohen said about the organisational housing of Colonial Geared Investments. The Commonwealth Bank basically has two margin lending businesses. One is our CommSec margin lending business, and one is our Colonial Geared Investments margin lending business. The distinction between them is quite important for current purposes, because the CommSec margin lending business lends directly to end customers. The Colonial Geared Investments margin lending business deals through financial advisers through dealers with end customers. So all customers of Colonial Geared Investments or margin loan customers of Colonial Geared Investments have come through a financial adviser, whereas on the CommSec side they have not. So that is a quite important context.

CHAIRMAN —But the contract for the margin loan—

Mr Cohen —The contract is between the Commonwealth Bank and the customer.

CHAIRMAN —In both cases—in the CGI case and in the CommSec case?

Mr Cohen —Correct.

CHAIRMAN —They have just come through a different mechanism.

Mr Cohen —Correct. Through different channels and through different organisational teams. In terms of the relationship between Storm and the Colonial Geared Investments business, Storm was one of approximately 7,000 dealer groups who were being dealt with through Colonial Geared Investments at that time. It was the largest by revenue. It was roughly 10 per cent of the revenue of Colonial Geared Investments at the time. And just to give you an idea, I think the financial year of 2008 was the peak year of the relationship, from the Commonwealth Bank’s point of view. The overall revenue from Storm margin loans that year was $7.8 million out of a total revenue for the division of just over $4 billion. So, while it was a significant 10 per cent of the dealer group part of Colonial Geared Investments as part of the overall business, it was actually a relatively small number. There is a high-value team of relationship managers, who deal with all the main dealer groups, and Storm was dealt with through particularly a couple of individuals in that team primarily.

CHAIRMAN —Still on the relationship—I am just trying to establish that we get the framework and the context right. Obviously there was a relationship with Storm; the CBA had a relationship with Storm. Your submission tends to read as though there was not much of a relationship, that it was almost casual, that it was just a few staff—obviously because they had to deal with Storm. Is that what you contend is the case? Or was it deeper than that?

Mr Comyn —Chairman, if I could say that we are well aware of some of the suggestions, made both to the committee by other witnesses and in the media, that the relationship ran deep, ran to the highest levels et cetera.

CHAIRMAN —Yes. I know what is in the paper. What I am asking you is what you think or what you are telling us it is. I am aware of what is in the paper.

Mr Comyn —We would like to establish for you exactly the level of the relationship.

CHAIRMAN —Sure.

Mr Comyn —It was not a relationship that ran to the highest levels of CBA. It was an association whereby Storm did refer customers to the CBA, and we have been quite open about that. And we dealt with those customers. We also dealt extensively with Storm through CGI on the margin loans, and that is something that we acknowledge. The relationship was no more than a referral of business to us, and we in turn serviced the business. In some cases—that is, through CGI—that went via Storm. In other cases—that is, the home loans—it was directly with the customer.

CHAIRMAN —So you contend, if I interpret this rightly, that there really was not much of a relationship. You were just doing business and there was not a higher level relationship.

Mr Cohen —No.

Mr Narev —There is one other point of context which I might offer in terms of your question about the BSB in relation to the margin loan business. Storm helped its customers get home loans through a variety of different banks and then helped its customers get margin loans through us and other providers.

CHAIRMAN —Yes, I am aware of that.

Mr Narev —The staff, because of the structure of the Colonial Geared Investments business, were actually not aware which of the margin loans coming through to them were home loan customers of the Commonwealth Bank and which were not.

CHAIRMAN —Were these just ordinary home loans—somebody purchasing a home—or were these people refinancing?

Mr McEwan —A number of these were refinanced. As I said earlier on, they came to us via a tender. So that tender may have been existing customers through other relationships with the bank or they may have been coming from somebody else or they may have had no home loan at all—it was actually a new home loan. So each of those was a tender document and process that was set up, it came to us and we then made a decision as to whether we wanted that home loan and put in our pricing.

CHAIRMAN —Can you tell us whether there were any formal agreements, in writing or contractual, between the Commonwealth Bank and Storm Financial?

Mr Cohen —There was a formal agreement established in 2002 in relation to a particular product known as CALIA. That was an agreement whereby we and Storm agreed how Storm would monitor the affairs of customers who took up the CALIA product. That was in 2002. There was, in 2007, a letter between us and Storm which dealt with some aspects of how the two of us would conduct our affairs in relation to CGI margin loans.

CHAIRMAN —And what was the detail of that?

Mr Cohen —Of that particular letter?

CHAIRMAN —What is the nature of how that worked?

Mr Cohen —If I can perhaps go back to the 2002 agreement first. I should say that this is in relation to a product that was not extensively used by Storm clients.

CHAIRMAN —If you could be brief on that one and then move quickly to the other, that would be great.

Mr Cohen —Okay. That was a typical dealer agreement that CGI established with dealers who had an arrangement with CGI. It was an arrangement that set out whose responsibilities were what, and in that document it was clearly set out that it was Storm’s responsibility to monitor customers’ margin situations and their affairs and to pass on and make margin calls. As I said, however, that was not a product that was used extensively.

CHAIRMAN —To pass on margin calls from who?

Mr Cohen —From CGI.

CHAIRMAN —So CGI would need to make the margin call with Storm and then Storm would need to pass it on?

Mr Cohen —That is correct.

CHAIRMAN —And there was no variation upon that process? That was just the process. Was it adhered to?

Mr Cohen —That was the process between us and Storm at that point. I think it is important to understand also that from about 2003 onwards there was a change in process. Up until 2003—and I think the committee has heard witnesses give evidence to this effect—there were margin calls made directly by CGI to the customers, so not necessarily via the financial adviser.

Mr Narev —I should just provide one extra detail about that point. In 2002 and 2003, the process for margin calls was that the dealer—the adviser—would actually notify the client and that would be followed up by letter from Colonial Geared Investments, which would typically arrive four or five days later. As a part of ongoing business model reviews in the ensuing—

CHAIRMAN —That was 2002 and 2003?

Mr Narev —That was 2002-03.

CHAIRMAN —Fast forward to 2007-08. What is happening there? What agreements have got in place and how do they operate?

Mr Narev —The letter to which I think you are referring is the May 2007 letter between the Commonwealth Bank and Colonial Geared Investments. The primary reason for that letter was to clarify a loan-to-value ratio of 80 per cent for customers of Storm who were invested in a specified range of funds from Colonial First State, Challenger, MLC and Barclays. It said that customers who were invested in those specific funds would be entitled to a global loan-to-value ratio of 80 per cent. There were some details relating to the weighting of different funds and how that might go into the loan-to-value ratio. That was the primary reason for the letter.

CHAIRMAN —Who was that initiated by?

Mr Narev —That was the subject of discussions between Storm and the Commonwealth Bank.

Senator WILLIAMS —In relation to the situation back in 2003, did you say that you would contact Storm about a margin call and they would contact the client back then?

Mr Narev —That is my understanding, yes.

Senator WILLIAMS —I question that because I have a document here, dated back then:

Emmanuel Cassimatis, Ozdaq Securities Pty Ltd

The following letter has been sent to the above named borrower—

a marginal investor—

and also their guarantors if applicable. It is for your information only.

Mr Narev —My understanding of that is that, in addition, once Colonial Geared Investments had written to the customer, the definitely provided a cut copy of the letter they had given back to the customer.

Senator WILLIAMS —So you wrote directly to the customer in a margin call in those days?

Mr Narev —Yes, and a copy of that was provided to the dealer. At the same time, prior to the customer even having received the letter which was copied to the dealer, the customer would have heard directly from the dealer.

CHAIRMAN —What was the arrangement and agreement between Storm and CBA for the 2007-08 period—covering after 2003?

Mr Narev —The key parts that are addressed in the letter—and then I will come back to what is not in the letter, which might be equally important—is the 80 per cent loan-to-value ratio and then, as I think the committee has heard, at the end of that there is the comment: ‘In the unlikely event of a margin call, Colonial Geared Investments and Storm Financial will work in partnership to clear the margin call.’ I am aware that this is a topic of a lot of interest to the committee, and I wonder whether I might offer a couple of thoughts on that now.

CHAIRMAN —Please do.

Mr Narev —Our practise undoubtedly in the business at the time, with 7,000 dealers, was to make margin calls through the dealers. I can say that, in the October 2008 to December 2008 period, 15,000 margin calls were made to customers outside Storm from the Colonial Geared Investments business. To the best of my knowledge, having made inquiries of my team, every one of those was made through a dealer. So our understanding was certainly that the margin calls for Storm customers would be made through Storm, as the financial adviser, and three files a day of information were provided to Storm to this end. We are also aware that in 2004, 2006 and 2007, although market conditions were a lot better, some margin calls were made. I think around 40 in 2004—

CHAIRMAN —I would just like to take you back a bit. You said ‘three files a day’; three files of what?

Mr Narev —This is information relating to Storm clients and their positions, largely, at the end of the day, given the prices of the funds.

CHAIRMAN —Why were there three files? What is the three?

Mr Narev —They all contained different information. One is called a loan file, one is called the customer file, and one is called the transaction file.

CHAIRMAN —And they were sent every day?

Mr Narev —Yes, they were sent every day.

CHAIRMAN —And you have got documentary evidence that they were sent every day?

Mr Narev —As you can imagine, we have looked into this quite carefully. In January and February, we undertook significant internal reviews to establish what we could. You can imagine that, over the period, it is very difficult to check whether every document was sent every day. What we know at a minimum—and I am not saying this is all—is that, substantially, all of the information was sent by the Commonwealth Bank during that period.

Mr PEARCE —What was the purpose of sending three files a day to Storm?

Mr Narev —From the Colonial Geared Investment’s point of view, bearing in mind that the primary relationship in this part of the business is between the financial adviser and the client, it was to make sure that Storm was up to date on the positions of the unit prices of the clients’ positions and their loan-to-value ratios.

Mr PEARCE —So that they were then in a position to be able to contact their clients?

Mr Narev —Correct.

Mr Comyn —In fact, the data that was actually sent—the three files that Ian is talking about—is an automated process and was sent to a Storm Financial email address. My understanding is that it was then uploaded into Storm’s systems. On top of that, the Colonial Geared Investments website was updated daily, which Storm financial advisers would have access to.

Mr PEARCE —So I was a Storm client and I went above my LVR, Storm would have known that within a day?

Senator WILLIAMS —As long as your files were up to date. Were they kept up to date during that critical period?

Mr Narev —That is another question that we have looked at. Again, we are unable to verify, given the nature of the information, that every unit price for every customer over the period was up to date. We know that substantially all of them were. As part of the remediation process that we are talking about, one of the things that will clearly be critical here is if, in relation to any given client on any given day, information was wrong and that led or contributed to a client’s loss. That is something that we would expect to come out in the remediation scheme. So we do know that substantially all the information was provided and it was substantially correct, at a minimum. But that does not mean that in isolated cases there may have been problems.

Senator MASON —Mr Cohen, I think you said that the relationship between Storm and the CBA was no more than a referral of business? Is that right, or did I misunderstand that?

Mr Cohen —I did say that.

Senator MASON —You say in your submission under ‘Executive Summary’:

Although the intent was genuinely to assist customers, the local relationship with Storm was sometimes too close, and on occasion we lost objectivity.

Is that right?

Mr Cohen —Yes.

Senator MASON —Are you aware that yesterday the committee discussed Mr Jelich’s submission, where he details all sorts of examples of that relationship? Have you read Mr Jelich’s submission?

Mr Cohen —No, we have not. We have not heard his evidence from yesterday. We have summaries of it from our people who were attending.

Senator MASON —Is the submission up on the web?

Mr Cohen —We have read Mr Jelich’s submission.

Senator MASON —In one of his examples he describes what is ‘a cosy relationship’ between Storm and the CBA. Is there any aspect of that that you would question? There are seven different indicia there of ‘a cosy relationship’.

Mr Cohen —We might not look at the home lending side.

Senator MASON —Forget the home lending. What else?

Mr Cohen —Yes, we are aware of the indicia there that Mr Jelich refers to. I do not want the committee to think that it suggests that, therefore, it was a pure mail-only, email-only type business. Of course, we did have meetings with them and we did discuss business with them as part of what I would regard as a normal business referral arrangement. In relation to home loans specifically, Mr McEwan can comment on the extent of that relationship. As you have noted, in our submission we do say that in the context of home loans we did allow the relationship with Storm to cloud our view of who the ultimate customer really was. We acknowledge that. We do acknowledge that that is something that needs to be looked at. It will be looked at in the course of the resolution scheme.

Senator MASON —Did it make any difference in relation to margin lending? Did that close relationship change your behaviour in relation to margin lending?

Mr Cohen —In what sense?

Senator MASON —Because it was such an intimate relationship with Mr Cassimatis and Storm. Did you retain your objectivity in terms of lending money to clients?

Mr Cohen —We believe that in the context of margin lending, and the same with home loans—

Senator MASON —I am not interested in home loans; I am interested in the margin lending.

Mr Cohen —Okay. In the context of margin lending, the answer is: we do not believe that the arrangements between us and Storm clouded our view as to the making of margin loans. However, I would say—because I do not think that it the full story—

Senator MASON —No, I do not think it is either.

Mr Cohen —I would say that we acknowledge that there may have been deficiencies. If there were deficiencies, then that is something that we would definitely be picking up in the resolution scheme.

Senator MASON —Let me go to the process of margin calls. There is evidence—in a sense as a summation of Mr Paul Johnston’s evidence—that Storm Investors Consumer Action Group gave. They summarised some evidence from Mr Paul Johnston, who apparently was the head of Colonial Marginal Lending from early 1996 until his departure from the company in 2003. He says:

The loan agreement is and always has been between the client and the borrower, not the agent - in this case, Storm.

Is that right?

Mr Cohen —That is correct, absolutely correct.

Mr Narev —Yes, a contractual relationship.

Senator MASON —So you bear the risk? Is that right?

Mr Cohen —Correct.

Senator MASON —Also, Mr Johnston says that he:

…was instrumental in the writing of clause 4.2 of the terms and conditions which talks about ‘you’ receiving a margin call. My knowledge and practical application of that clause is that the bank contact the client in writing, then the client (in consultation with the adviser) rectifies the position. Again, I should stress that if the margin call wasn’t fixed in the five-day period, I immediately sold the client down to protect BOTH parties (unless evidence was supplied that positive action was being taken to get the call fixed).

Is that right?

Mr Narev —The margin call process, we believe, was done, as I said, through the financial adviser and then onto the customer. I say, in reference to your question, that our sense on looking back at the business and the conduct of business over that time in terms of the buffers, the margin calls et cetera was much more driven by the amount of confusion that can be caused through an unprecedented drop in equity values, rather than special treatment for Storm as a result of any particular relationship between Colonial Geared Investments and Storm—in other words, as assessments were being made. In essence, here, the interests of the margin lender and the interests of the customer should be aligned.

Senator MASON —I agree. Indeed. I accept that. Because in a sense you are protecting the borrower.

Mr Narev —If the customer loses, the bank loses and there is no hedging or anything the bank can do that means that somehow it might come out ahead if a customer loses, so the interests there are fairly well aligned.

Senator MASON —Okay, I accept that. You referred to the letter—and this has come up in evidence—of 18 May 2007 from CGI, under the pen of Craig Keary. It relates to two issues, and you have raised both here this afternoon, in relation to CGI allocating a global LVR of 80 per cent for about 10 different indexed funds; is that right?

Mr Narev —That is correct.

Senator MASON —Would that have been made known to the clients?

Mr Narev —I am not sure but I doubt it would have, because the other important part of the letter, if you look at the bottom of the next page of the letter, is that it says Storm Financial will not gear a client above 65 per cent. The way these two numbers should be reconciled is: generally, a client would have been geared into the fund at the time of investment at 50 per cent. In fact, even at the end of August 2008 when the markets were starting to come down, the average loan to valuation ratio on the book was 67 per cent. So, to the extent that there was an 80 per cent buffer agreed in this letter, the thinking behind it—and obviously I was not here at the time, so I am going from hearsay—was that in essence it was a buffer against a falling market. It was not expected that Storm would communicate to clients that they should come in at 80 per cent. It was assumed that they would communicate to clients that they should continue to come in at 50 per cent, maybe up to 65 per cent, in the knowledge that there was then effectively an extra 15 per cent buffer and on top of that there was another 10 per cent buffer in case markets fell.

Senator MASON —Why would Mr Cassimatis have sought that and you granted if it were irrelevant?

Mr Narev —I cannot speak for what was in his head at the time, but obviously to the extent of being able to withstand some market downturns et cetera it just gives a greater level of comfort. That is certainly our view on how he might have sought it. It is also possible that you could seek this kind of LVR so you could gear up clients more than you had in the past.

Senator MASON —This is a relationship between you and those clients. Given that the LVR has changed to 80 per cent, and that is both good and bad but it changes the risk to the client—

Mr Narev —Correct, and to the lender.

Senator MASON —And to the lender, to you; indeed, I accept that. Yet you are not communicating that to the borrower. Why is that? I do not understand that.

Mr Narev —It is a very understandable question. This really goes both to the heart of how this relationship was conducted and to the proposed changes to the Corporations Law about how margin lenders who work through dealers should deal with end customers. The discussion about the suitability of the product for a particular customer’s needs, what might happen, was a discussion that was had between a licensed financial adviser and the end customer, not between the margin lender and the end customer. The margin lender received only an application form—

Senator MASON —Do you think that is prudent?

Mr Narev —We support the changes to the Corporations Law that are going to require some changes to that. So in that sense, in terms of understanding the market risk of the product and the volatility of the product, this is something that we do not feel customers probably understood well enough. If you look at the differences, as we have, in the past few weeks, for example, in some of Storm’s literature, which I have seen over the last couple of weeks, the likelihood of a margin call is raised as very small. In some of the literature customers are told, ‘Actually a bigger risk, rather than taking on a margin loan, is to do nothing.’ If you look at the CommSec side of our business, which deals directly with—

Senator MASON —That is fine; I understand that. But the bottom line here is that the risk has changed and the clients—your clients, who have a contractual liability to you—have not been informed. That is a fact, isn’t it?

Mr Narev —I am not sure that the risk has actually changed.

Senator MASON —It has. The LVR has changed.

Mr Narev —There is a question here—and I expect this will be discussed extensively in the remediation process, because this is a bit of a vexed question—about whether or not in fact a margin call is intended as a stop loss for a customer.

Senator MASON —Mr Narev, come on; you can do better than that. Let’s be serious. Quite clearly the risk has changed. It is for and against both the lender and the client, the customer, but it has certainly changed and the client has not been advised. I am not sure that is responsible, Mr Narev.

Mr Cohen —Could I maybe make one point there. We do acknowledge that some of the issues around margin lending are not clear. It would be fair to say that that is exactly the reason why we are taking—

Senator MASON —Mr Cohen, the question is not whether they are clear; the question is whether you acted appropriately and prudently. You may have acted in accordance with the law. I am not making any suggestions there. The question is whether you acted ethically, appropriately, morally and prudently.

Mr Cohen —I think that is an issue that should be and will be dealt with in the resolution scheme.

Senator MASON —I am just touching the tip of the iceberg here. What we now know is that the risk of the investment has changed, both for you and for the client, and the client has not been informed. I am not sure that is prudent. Can I draw your attention to the second page of the letter, where you say:

Despite our allocation of a global LVR of 80% to your clients on the basis of our expectations being met, as set out above, nothing in this letter modifies or varies the obligation of any client borrower under clause 3.2 of the margin loan to pay us the amount owing under the margin loan if that client borrower is either in default or we send the client borrower a five day notice requiring payment of the amount owing.

So quite clearly you had premised the idea that you could well send a client borrower a five-day notice requiring payment of the amount owing, hadn’t you?

Mr Narev —Under the terms and conditions of the margin loans for the vast majority of customers it was provided that a margin call could come either from the advisor or directly from the margin lender. That is a right that is protected.

Senator MASON —On the next page you say:

In the unlikely event of a margin call, CGI and Storm Financial will work in partnership to clear the margin call. Note, however, that CGI reserves its rights under its margin lending terms and conditions.

I will get to the nature of the partnership we have just mentioned in a minute; I think this is part of this relationship that we have discussed. You do not think it is very much, Mr Cohen, but I am not convinced that there is not some sort of relationship—we will get to that. The margin lending terms and conditions include, as previously discussed, the possibility that the bank will make contact directly—that is right, isn’t it?

Mr Narev —The possibility, yes.

Mr Cohen —Senator, I might add that that is also for the benefit of the customer, as it turns out.

Senator MASON —I accept that. In the past, we have heard evidence that Colonial Margin Lending made calls directly, and Mr Jelich gave the following evidence:

  • 1997 - The South-East Asia Economic Crisis;
  • 2000 - The Tech Wreck;
  • 2001 - September 11; and
  • 2003 - The Iraq War.

All of the margin calls referred to above were handled in an efficient and timely manner. Colonial were efficient and provided timely notices both in writing and by phone during these difficult periods.

Not one of my clients ended in a position where they had negative equity in their investments, or even close to negative equity.

Would you accept that that was his evidence?

Mr Cohen —I am sure that is the case.

Senator MASON —So what changed?

Mr Narev —I should note the submission from another adviser, Mr Fuller, where he said

… no client would ever receive a margin call direct from their margin lender.

Senator MASON —So you have read Mr Fuller’s submission but you have not read Mr Jelich’s?

Mr Narev —I think Mr Cohen said he had read both submissions.

Senator MASON —Have you read Mr Jelich’s?

Mr Narev —I have not read Mr Jelich’s.

Senator MASON —But you have read Mr Fuller’s?

Mr Narev —I know that Mr Fuller said this.

Senator MASON —I see—you have read some submissions but not all.

Mr Narev —As explained before, during 2002-03 and, I suspect, prior to that, based on inquiries that I have made, a follow-up letter was sent from Colonial Geared Investments but a call was also made by the financial advisor. What changed was the decision on that. I might also note that in December—

Senator MASON —Sorry, just to go back, did you say a letter was sent?

Mr Narev —Yes. And I think I explained in response to the chairman’s question why that changed.

Senator MASON —You did, as well as in answer to Mr Pearce. Let’s go very slowly through what changed. Also, the committee would like to have any evidence you have that there has been a change—a letter, an email or even a note of a phone call. Start again slowly.

Mr Narev —I hope I explained why that change occurred in 2002-03.

Senator MASON —No, explain it again.

Mr Narev —The change occurred because in 2002-2003 and, I am assuming, prior to that, the practice as I understand it—again, I am relying on discussions I have had with the team—was that a notification was made from a financial advisor to the end customer and that was followed up by a letter four or five days later directly from the margin lender. As it happened—

Senator MASON —That is what you say. That is not necessarily the evidence that Mr Johnston gave. Mr Johnston gave different evidence. He says there were calls directly from Colonial, as then constituted, to investors. He does not say there was any waiting for a call from a financial adviser, does he? There is bit of conflict of evidence there.

Mr Narev —I agree. This is clearly in conflict with—

Senator MASON —Do you accept that?

Mr Narev —Yes, I do.

Senator MASON —All right. Carry on.

Mr Cohen —I would like to add to that. The calls that are referred to could well be the physical letter that was sent from CGI to the customer. That amounts to a call.

Senator MASON —You mean the letter was a call?

Mr Cohen —Correct.

Senator MASON —I accept that.

Mr Cohen —I just wanted to clarify that.

Mr Narev —The other thing that I know from the team anecdotally, from December last year, is that at that point—and you are aware that there was a time from December when some communications were handled directly from Colonial Geared Investments to the end customer—there were a large number of discussions between Storm and Colonial Geared Investments during October and November 2008 as the market downturn worsened. Certainly from the Colonial Geared Investments side, it was increasingly realised that the instructions to Storm were not being acted on. From early December—

Senator MASON —Just say that again slowly. This is critical.

Mr Narev —I have mentioned that from the point of view of how the business model worked—the understanding clearly in the margin—

Senator MASON —Why did it change? Why did the process for margin calls change?

Mr Cohen —Could I try and answer the question, Senator?

Senator MASON —Please, yes.

Mr Cohen —The process, prior to that, as you heard, involved the dealer being notified, but also the customer received a letter.

Senator MASON —That is contested. Mr Johnston’s evidence is different. But, all right, there was certainly a change. I accept that; we agree on that.

Mr Cohen —The logistical reason for the change was this: we found in the business that notifying the dealer would occur by email or by telephone. Notifying the customer would occur by mail—a letter, physically in the mail.

Senator MASON —From?

Mr Cohen —From CGI directly to the customer. What changed is that we stopped sending the letter directly to the customer.

Senator MASON —Why?

Mr Cohen —The reason was that, due to the mail delays, quite often that letter proved to be useless, because the dealer had already notified the customer. Having received a phone call from CGI—

Senator MASON —Why wouldn’t you spend 50c sending a letter in any case?

Mr Cohen —Because we found that the effectiveness of the dealer contacting the customer was high. Sending a letter did not add anything to the process. What we did then—

Senator MASON —I am sure the phone call to the dealer was a good idea. It is great if the phone call from the dealer goes to the client—I accept that; that is terrific—but you could send a letter, it costs 50c, or you could phone the customer. Why didn’t you?

Mr Cohen —Because we relied on the dealers to have that personal contact, given that the—

Senator MASON —So you subcontracted a critical commercial decision that affects the money of thousands of people. You subcontracted that responsibility to a third party.

Mr Cohen —No, we would disagree with that.

Senator MASON —You would might disagree with that, but that is what has happened, hasn’t it?

Mr Cohen —No—

Senator MASON —It is not your responsibility; it is Storm’s. You did not contact the clients. Why not?

Mr Cohen —We did.

Senator MASON —Later. I will get to the timing in a second.

Senator McLUCAS —So you are saying that, in October or November 2008, the response to margin call changed in that you notified the dealer by email or phone, but you decided at that point, or at some time—and I want to know when the decision was made to change—that the option of sending a letter to the customer directly from CGI was not, in your view, a sensible thing to do. So my question is: when did that policy change occur?

Mr Narev —We are unable to point to the specific time when the policy change occurred.

Senator McLUCAS —Why not?

Mr Narev —What we do know is that it was significantly in advance of 2008—years in advance of 2008 is the best hypothesis. The reason is that, given the people and the business had changed over that long period of time, we are unable to point to the specific time and place that decision was made.

Senator McLUCAS —So you do not have a policy handbook that tracks changes like that?

Mr Narev —Not that change. We would also note—

Senator McLUCAS —It is a fairly substantive change. I think you would agree with me.

Mr Narev —I understand the point but we would also note that the other 7,000 dealer relationships that were run through Colonial Geared Investments were run exactly the same way, and 15,000 margin calls were made through those 7,000 dealer groups in the October through December period by financial advisers.

Mr Cohen —If I could perhaps supplement that answer it may assist Senator Mason’s line of questioning as well. Rightly or wrongly I say this: the industry practice in this type of business was for the conduct of margin calls to be made firstly to the dealer group and then the dealer group or the financial adviser would in turn contact the customer. That was a process that was industry wide. It was a process that operated throughout the 7,000 dealers that CGI had a business with. As we have said, we cannot pinpoint the exact date when that change occurred but it was subsequent to 2003 and well before 2008. It was years before 2008.

If I could just add the last fact for you: in the lead-up to the big market falls occurring in October and November of 2008, margin calls were made through all of the dealer groups that were associated with CGI, including Storm. All of the dealer groups, including Storm, up through to September, and even through to early November in Storm’s case, were responding to those margin calls—were passing the margin calls on to their customers. In fact, Storm wrote a letter to its customers on 8 October 2008, pointing out that certain actions needed to be taken in order to avoid those customers’ falling into difficult positions. It was clear to us that not only were the other 7,000 dealer groups handling margin calls in exactly the way that conduct over the last several years had occurred, but that so were Storm. Things did start to go awry, and we have pointed that out, but certainly in September Storm was passing on margin calls. Certainly in October Storm was passing on margin calls.

In its 8 October letter Storm said to its customers, ‘We are monitoring the market and we are monitoring your situation.’ During October we received over $600 million worth, effectively, of action in response to margin calls from Storm. It was very, very clear that Storm was acting on margin calls. Storm was passing on margin calls to customers because that was the way the industry was operating and that was the way Storm had operated with us.

Later on when we raised the issue that there did not seem to be enough action occurring in response to margin calls, Storm, in emails to us—we are happy to show them to the committee if that would help—told us not to contact customers directly because customers were their property.

—That was as late as December 2008.

Mr Cohen —That was an email in early December from Mrs Cassimatis.

Senator McLUCAS —In early December you had been advised by Storm not to contact customers?

Mr Cohen —They were telling us not to contact those customers.

Senator McLUCAS —Do you think Mr or Mrs Cassimatis has a right to tell you, the lender, not to contact your customer?

—We do not believe they have a right. In that time, in these market conditions, regular contact was being made about the best way to strike the right balance between the needs of the customers and the needs of the financial institutions involved.

Senator McLUCAS —I have just one more question and then I will leave it for others. You would have heard of Mr Cassimatis’s evidence to the committee, where he said that he thought the policy was that it would be like 2003, where it was the banks’ responsibility to contact the customer. What do you make of that?

Mr Cohen —Senator, I am afraid to say that we simply cannot agree with that characterisation. We have documents from Storm that make it very clear that Storm was acting on margin calls by passing on the margin calls that CGI was making to Storm. For example, there were emails in September 2008 from a Storm employee saying that Storm had a proven track record of managing margin calls throughout the relationship with CGI.

Storm was highly active in responding to margin calls. There was $575 million worth of response to margin calls directly from Storm by way of redemptions in October. We have already mentioned Mr Fuller saying that no client would ever receive a margin call directly from a lender. We have the instruction from Storm on 16 October 2008, from Mrs Cassimatis, instructing that funds from clients’ holdings be put into cash deposit accounts.

We have the fact that in an email of 16 October there are seven staff from Storm claiming to be working full time on the processing of margin calls. It was very clear to us that Storm was active processing margin calls. There was no silence from Storm; there was action on Storm’s part. However, what concerned us was that the speed of response and the action taken in response to margin calls declined significantly through November. It was at that point that we decided that we had to take direct action.

Senator McLUCAS —You covered this area earlier, but I would like to hear more about it. It has been said by many witnesses that the information you were providing to Storm was wrong. It was full of errors. How can you convince me that that is not accurate?

Mr Narev —There are a couple of aspects of this that I think are important. First of all, in the immediate aftermath of the end of last year, one of the first things that was done in the Colonial Geared Investments business was to, as best as it could, retrace all the processes that were undertaken at that time. I think I mentioned this before, possibly in response to the Chairman’s question. That has suggested to us that we did provide substantially all information and it was substantially correct.

Senator McLUCAS —What does ‘substantially’ mean?

Mr Narev —Substantially means that—

Senator McLUCAS —Sixty per cent of it was right, or what?

Mr Narev —It is a fair question. The review was unable to say—because of the large number of files that were sent through it over a period of time, it was unable to recreate all of them all the time. The conclusion that was reached is that, at a minimum, it could say that substantially all of the information was provided.

Senator McLUCAS —That does not tell me much.

Mr Narev —What we are committed to is that to the extent that any misinformation may have caused loss to an individual customer, that is something that we would absolutely be committed to putting right as part of the remediation scheme. We know that our systems were substantially reliable. Substantially, as you have identified, does not equal completely, because we cannot at this point say they were completely reliable—although we do not know that they were not—but if that did contribute to any loss that an individual had, then that is something that will be dealt with in the remediation scheme.

Senator McLUCAS —But it is a broader question than that. Mr Cassimatis’s assertion is that because your files were so wrong, there were so many errors in them, he could not use them to act. It is not simply about you dealing one-on-one with customers who have been hurt, although that is important. His assertion is that he could not use the information.

Mr Narev —There was also an email as late as 15 October from his son that we received saying that Storm’s own systems were giving them the most accurate picture for the client, and in fact they could calculate unit prices as accurately as the fund manager could, to three decimal places, for all of their customers. So based on the feedback we had from Storm during that period as we have gone through it, we have not seen any signs of lack of information. There are two dates that we are aware of where Storm has said in some of the discussions that they did not receive files. I do not have them in front of me. I think there was one in October and one in November. They are two dates that we can verify in our own review that the information was indeed sent.

Mr Cohen —I should add that those are the only two dates that we know of where Storm has told us that they did not receive information. And as Ian has said, our own review has shown that in fact there was information on those dates.

Mr PEARCE —But they also said their own systems were giving them the same information.

Mr Narev —They also said that their systems were given the information.

Senator WILLIAMS —Mr Cohen, Mr Norris has signed the front of your submission. Who prepared your submission? Did Mr Norris prepare your submission?

Mr Cohen —No, there was a team of us involved in the submission, including people on this table.

Senator WILLIAMS —On page 15 of your submission you said:

In 2006-2007, several of our staff with inside knowledge of our operating processes, policies and procedures were recruited by Storm. Moreover, these individuals used their pre-existing relationships with staff in our Townsville area office to encourage loan approvals.

How do you define ‘several’ of your staff? How many is several?

Mr Cohen —We are aware that you have received evidence to the committee that in fact only one person joined in that particular period, and that is correct. Only one person did join in the 2006-07 period. We said several people had joined in that period. In fact it was both before and after 2006-07 that several people joined.

Senator WILLIAMS —But your statement says in 2006-07 ‘several of our staff left the bank and joined Storm’. Was there in fact only one?

Mr Cohen —There was one in that period who joined Storm.

Senator WILLIAMS —So what you have in your statement is incorrect?

Mr Cohen —That is not correct that particular statement.

Senator WILLIAMS —Why?

Mr Cohen —Why is it not correct? Because when we looked at the dates of those who had transferred—and I should say, Senator, there were about six to seven people; and I have the exact numbers here if you would like me to be absolutely precise—and joined Storm between 1999 and 2007.

Senator WILLIAMS —So between 2006 and 2007, when you say several, there was in fact just one?

Mr Cohen —There was one person who joined in that particular year.

Senator WILLIAMS —At the bottom of that same page 15 of your submission it says:

… while many Storm clients had relationships with many financial services organisations, when Storm advised its clients to enter into one of our margin loans, this involved staff from other divisions who had no knowledge of the source of investment funds (i.e. via home loans).

But former CBA staff in Townsville who was working for Storm, Kristy Devney says:

This is not true.

She goes on:

The CBA has stated that when Storm advised its clients to enter into one of the CBA’s margin loans, this involved staff from other divisions—

as I have just quoted. And she says this is not true. She says that the Commonwealth Bank and Colonial:

… were well aware of the Storm process.

She then quotes a product called CALIA from the CGI website. Who is correct, you or Ms Devney?

Mr Cohen —Senator, I think the reference to CALIA there is also a reference to that document that I said was signed in July 2002 between CGI and the Cassimatises or Storm. There is no dispute, I think, between us and that witness as to whether there was knowledge about that product. That product did involve people taking out loans and investing in securities. To go to your precise point—was there knowledge across the organisation about the way the Storm model operated? The way the CGI business takes applications—and Ian Narev can give you a bit more detail if you would like it—is that an application form is completed by the adviser and the customer. It arrives at CGI with a cheque attached that represents the equity. That equity can come from any source at all, and Ian might be able to give you a bit more detail about that.

Senator WILLIAMS —When people approached Storm, the evidence that the committee has heard this week is that Storm would get a broad outline of the potential client’s position, whether they owned their home, whether they had a job, et cetera, and then would forward it to someone like the CBA, and the CBA would proceed with an approval of the application of the loan, if I can put it that way, without even the signature of the client. Did that happen in your lending process?

Mr Cohen —Ross McEwan can give you the exact detail of how that happened, for example, on the home loan side. I think that is what this is referring to.

Mr McEwan —As I said earlier, we would receive a tender document from Storm saying that they had a client that had a certain position and was looking to borrow X dollars—would we please tender in for that business? That tender would go to us and other banks. We would then send back and say, yes, this is the pricing because it was mainly a pricing position they were after. They were trying to get the cheapest home loan rate in the marketplace. We would put in an offer for that and then we would receive a full application from the client via Storm. That would come to us and we would put it through our normal home loan application process.

Senator WILLIAMS —When you went through that process surely the people in the CBA were aware that this borrowing against their home loan was for a Storm investment?

Mr McEwan —Certainly people that were close to it, yes, I would say that in most cases that would be the case because it had come from Storm.

Senator WILLIAMS —When you look at the Townsville branches, you had up to 600 audits of those applications done, I believe, which is what your former area manager of the CBA up there, Andrew Jackson, told us just two days ago.

Mr McEwan —Yes.

Senator WILLIAMS —He was informed down the line from state manager, John Hoey I think his name was, that: ‘Congratulations, everything has been done by the book and we have audited a lot of those applications for home loans and there was no discrepancy whatsoever.’

Mr McEwan —When we had a look early in the year around the Storm situation we asked the question: ‘We have the margin loan—what has happened on the home loan situation?’ So we did request what we call a desktop audit where you actually pull up the file, have a look and see if it complies with policy. That was, I think, the situation in February of this year when looked at, on desktop, 600 files approximately, so you are correct.

Senator WILLIAMS —Obviously, you are happy with the way that those CBA staff had lodged those loan applications?

Mr McEwan —When we looked at those on the first run through they looked as though they were within policy. We look at a number of features within it. Remember, too, that we were looking at it from a desktop position as opposed to pulling all of the files and going through every piece of the detail.

That was in February. As the Storm situation evolved, and we started to see a lot more clients coming in and wanting to talk to us about this situation, it became quite obvious that there were some irregularities in individual cases so we dug a lot deeper than that. That is why we say in our submission there are some areas that were irregular and we are going to have to put those right. That came after we went into a far more detailed review of files. It was a sampling of files that came out of those clients coming in and talking to our people and us setting up that unit.

Senator WILLIAMS —Obviously, that is when you saw something wrong with regard to Mr Jackson, hence he was speared from his position.

Mr McEwan —We have not at any stage said who has gone or what is happening with our staff; we have left that very confidential. We do have a very thorough process of review that has been going now for a couple of months. It is looking not just at the Townsville staff but all staff who had association with the situation. We are going through a major process on that.

Senator WILLIAMS —We heard from a witness yesterday: Sean Mcardle. I do not know if you are familiar with Mr Mcardle, but he was quite surprised to find his $2½ million loan with CGI all of a sudden went to $3 million of debt to his name. He had never put an application in for it and he had never signed anything but found his borrowings from the Commonwealth Bank had blown out an extra ½ million dollars. Are you familiar with the situation, Mr Cohen?

Mr Cohen —I am not familiar with the absolute facts of that situation. In fairness, we have not gone through every single customer yet. That is exactly what the hardship team is doing, and now the resolution scheme as well. Mr Mcardle’s case will go before the resolution scheme if he wishes to participate. The actual facts will be dealt with and, as we have said, if we have done wrong in that respect it will be addressed.

Senator WILLIAMS —We have heard a lot of evidence of people’s debts going up and up and up, and they were not aware of it. They said that they were not even signing forms for extra money. We have had numerous witnesses say, ‘Our debts just went up and up and we were not aware of it.’ They obviously put their trust in Storm and in you. As Mr Mcardle pointed out, $500,000 was slammed onto his debt and he did not know a thing about it.

Mr McEwan —Just picking up from the home loan perspective, for us to have lent—

Senator WILLIAMS —No, sorry, I am referring to CGI in that case.

Mr McEwan —Yes. I am just clarifying with the home loan, where they would have to go through an application or a top up process. It would be fair to say that when we received applications, and I think that the committee has heard that our staff said they had made contact with those people, for about 12 per cent of the ones we sampled that had actually not heard from Storm about the additional borrowings we went back to Storm and said, ‘This application will not go ahead until we actually have the customer understanding what is going on.’ That is my understanding of that situation.

Senator WILLIAMS —Fair enough. I think that is why it is important the committee actually speaks to people like Mr Clothier as well during our investigation.

Ms OWENS —You said before that the responses to the calls by Storm clients slowed in November and at that point you started dealing directly. That is right?

Mr Narev —Yes.

Ms OWENS —You had 7,000 other advisers at that time, and they were very difficult times. Were there other advisers where those responses also slowed? What was your monitoring process for that? What is your process that rings the alarm bells?

Mr Narev —There is a system that we rely on, the Empire System, which helps us with daily unit pricing of the underlying securities and loan devaluations et cetera which trigger margin loan reports. Obviously, the volatility in these markets was unprecedented. In relation to the margin calls made through the other dealers, they were almost without exception executed as intended by the adviser directly to the customer.

Ms OWENS —I know that, but you noticed in November—and initially Storm was responding, as you said—there was a slowing with Storm. Did you notice slowing with other dealers as well?

Mr Narev —Not to the best of my knowledge, but I might ask Mr Comyn to comment on that.

Mr Comyn —To no significant degree at all.

Ms OWENS —But you have a monitoring system that picked that up?

Mr Comyn —That is right.

Ms OWENS —Within how many weeks or days of the slowing starting did it pick it up?

Mr Narev —Pretty much instantly. We are keeping track, with the clients, on the number of their clients and margin calls and on the status of those margin calls on a client-by-client basis. So it is generally a matter of hours and possibly days but certainly not weeks.

Ms OWENS  —So you started dealing directly with them in November?

Mr Narev  —Storm clients from the beginning of December.

Ms OWENS —Was it when you were meeting with them one-on-one because of the slowing that you started to identify some of the anomalies in the loan processes?

Mr Cohen —Not so much then, Ms Owens, no. What we did understand from Storm clients—our customers—from the time we made contact in early December was that they would not really want to talk about the margin loans or the margin calls with us until they had had an opportunity to consult with the Storm advisers. So there was a period when it was difficult, even with direct contact with the customer, to get action started, because, naturally—and I think it was understandable on their part—they wanted to get advice from their adviser.

Ms OWENS —When you started dealing with people and started noticing the anomalies in the loans, what caused you to start dealing directly with those people?

Mr McEwan —That was probably well into the February-March period, when a number of the customers were having major financial difficulties and starting to look for help from us. It was at that stage, when we started doing detailed analysis of what position those customers were in and pulling their files, that we started to find some irregularities that set off warning bells with us.

Ms OWENS —Do you have systems in place that monitor and flag irregularities on an ongoing basis?

Mr McEwan —Yes, we do. We have a very detailed process through which we put, for example, home loans, and an audit process that shows up certain things as well.

Ms OWENS —Would the irregularities that you found in the case of the Storm clients normally have shown up earlier?

Mr McEwan —It is quite hard to say in this situation. They came about because we delved into these in a lot of detail. As we have said, one of the issues that showed up there was around the valuation system. Those were not things that show up with regularity anywhere else around the country; we have actually got the data that shows the percentage, and it is a minor percentage. So we were looking for quite specific areas here.

Ms OWENS —Okay. Thank you.

Mr PEARCE —Thank you all for being here this afternoon. I want to ask you a number of questions, but can I start by thanking you for your willingness to acknowledge that, in some areas, you believe there has potentially been wrongdoing and for your willingness to make that right. I am sure that I speak on behalf of all the committee when I say that we really do want to see any wrongs made right. So I thank you for your willingness and your commitment to doing that. I am particularly interested in the relationship between the bank and Storm. Mr Cohen, you have made some comments this afternoon, and I want to get them on the record once again. Essentially, was your relationship with Storm any different to the relationship you had with any other agency or advisory firm that you dealt with?

Mr Cohen —I think it is fair to say that the association we had with Storm spanned a number of areas of our business. As you have heard, there was clearly strong involvement in our CGI business and our home loan business, and thirdly in our wealth management arm, which managed the index funds—these were specific, Storm-badged index funds. So the association with Storm spanned several areas of the organisation. I would say that that is not an absolutely standard arrangement. It is quite common for large organisations to have relationships with us in more than one area, but, in this particular case, Storm did have relationships across three areas. Fourthly—and, again, this is probably a little bit unusual—Storm was also a corporate borrower from the organisation.

Mr PEARCE —Focusing on how margin lending worked, I think you mentioned 7,000-odd people that dealt with you on margin lending. There was no difference between the way that process was being managed with Storm compared to any other advisory firm?

Mr Narev —No; that is correct.

Mr PEARCE —Why is it that the committee has not heard evidence from many other people that had margin loans with other entities? In your view, why is it that we have been inundated with evidence relating to Storm?

Mr Cohen —I will give you our view. We understand that the people who have most experienced difficulty are the Storm clients. That has been our experience as well. Our experience is that it has not been the clients of other dealer groups who have suffered the same hardship and misfortune. It has largely been confined to the clients of Storm. It is probably not appropriate for us to comment on why that is the case. We do not know why Storm may have done what it did, but it is very clear that the extent of problems faced by Storm clients was not a problem shared with clients of other financial advisory firms.

Senator WILLIAMS —Were Storm clients levered up into further debt than other clients?

Mr Narev —The loan-to-value ratio of 80 per cent was the highest among the dealer groups within Colonial Geared Investments, but based on the assessment we have done across the industry there are other margin lending facilities, at the Commonwealth Bank and at other banks, that were around about the same level.

Mr PEARCE —But, again, there was no difference in the way you did your business in relation to Storm compared to any other area?

Mr Cohen —In the margin lending business, that is exactly correct.

Mr PEARCE —On a couple of occasions in your submission you touch on the area of ‘Storm insisted that we contact it, not its customers’.

Mr Cohen —Yes.

Mr PEARCE —But I think you also made the point later in your submission that a request like that is not uncommon. But you seemed to be quite strong on the insistence. Was it a stronger insistence than normal, Mr Narev? I am trying to understand the way that the relationship worked.

Mr Narev —I think again it is endemic to the whole structure of the industry in margin lenders dealing through dealers. You will probably note that in the suggested amendments to the Corporations Law, an affirmative obligation is now mooted to be placed on margin lenders to look behind the margin lending form that they get through dealers into the individual circumstances of the client. That did not exist at the time, and that is endemic to the industry for that part of margin lending which is done through dealers, in contrast—as I said before—with what we do directly with CommSec.

Mr PEARCE —I understand.

Mr Narev —The nature of the relationship is very much one between a licensed financial adviser and his or her client, with the margin lender as a product provider. It is a little bit difficult to comment about whether it is greater or lesser, but for the dealer groups through which Colonial Geared Investments deals, to a greater or lesser extent all of them see themselves as the guardian of the customer.

Mr PEARCE —In summary what you have told us this afternoon—and correct me if this is not right—is that you had a relationship going back quite some years with Storm. Business continued as usual. It happened every day. You sent three lots of data files every day. They were doing what they did; you were doing what you did. That essentially went on for years, through the early 2000s—2002, 2003, 2004, 2005, 2006. But something changed somewhere along the line, and you cannot share with the committee what, in your view, changed with Storm?

Mr Narev —What changed in terms of our relationship with Storm or in terms of Storm itself?

Mr PEARCE —In terms of Storm itself, if there was a change.

Mr Narev —It is difficult from where we stand to affirmatively state what changed with Storm. What we would say—and this is known to the committee—is that the period from September to December that year was a time of unprecedented decline in the equity markets, and the whole margin lending industry, in addition to other industries, was facing changes that it simply had not seen occur in the history of the people working there. I can only assume that Storm found the same thing and that may have resulted in changes in how it dealt with its customers.

Mr PEARCE —But you are telling us that you did not change your behaviour?

Mr Narev —We did not change our behaviour.

Mr Cohen —That is correct. We cannot know for certain what happened within Storm, but on its face it would appear that Storm struggled to deal with the exceedingly volatile times the market was experiencing.

Mr PEARCE —Importantly, again, you are telling us that nothing changed from your perspective. You continued as you had been doing, is that correct?

Mr Cohen —That is correct.

CHAIRMAN —I would like to take you back to the loans approval process. The contract is obviously between yourselves, as the lender—be it a home loan or a margin loan—and the customer directly, as well as having the intermediary. In your submission you talk about the staff having authority and approving loans. Is an individual member of staff, at an area office or a regional office, the person who approves these loans or do loans go to a central body or a central team in Sydney for their approval?

Mr Cohen —Can we split that between home loans and margin loans, because the practices vary, and we can talk about the delegations, if you like? Mr Narev will talk about the home loan delegations.

CHAIRMAN —Sure.

Mr Narev —Firstly a loan comes in. Our staff have various levels of delegation of authority at the front line and, once they go beyond that, they have to send the loans into a centralised area. For example, the Queensland area goes to our Sydney office.

CHAIRMAN —Where is the final tick on a loan?

Mr Narev —The final tick for a stock standard loan that meets all the policy requirements and has all the information and everything there can be signed off—as long as it is within policy—either with a mortgage lender or, as in this case, at the area office where they have the authority to do so.

CHAIRMAN —That is for home loans?

Mr Narev —Yes, but the next stage is, if for some reason there is something that does not fit within policy, it can go to a different area where people have higher levels of authority to deal with it outside of policy.

CHAIRMAN —Have you found anything extraordinarily different or wrong historically with anything that happened in the northern area, or were they standard and straightforward?

Mr Narev —No; they went to Sydney.

CHAIRMAN —On the margin lending side?

Mr Narev —The margin lending side is different, given the nature of margin loans is that they are a market risk product where the focus is on the underlying security versus the capacity to repay. So, for the Colonial Geared Investments business, an application comes from the dealer—and, as I think has been said before, the dealer completes with the client—and, as long as that loan is for underlying stock which is on our approved list and at loan-to-value ratios which are within our approved list, that is approved.

CHAIRMAN —But that is done in Sydney or somewhere else, not at a local level.

Mr Narev —The Colonial Geared Investments business is all based in Sydney anyway, I think.

Mr Cohen —Again, there is a level up to which loans can be approved and above certain levels they go to another level for approval.

CHAIRMAN —We have heard evidence and had submissions to the effect that clients of Storm did not fill out any forms. They may have signed a whole range of papers, but they did not specifically fill out any information. The information was filled out by ‘someone else’. Would you have an idea as to who that someone else who filled out those forms would have been? Did the bank fill out the forms?

Mr Cohen —Again, this differs between the home lending and the margin lending—so we might get into the specifics a little bit with Ross and Ian—but, in general terms, on the home loans side, when applications were received they were often received completed, and we received them from Storm. Ross can go into a little more detail there. On the margin lending side, applications were also received completed. There were various documents that were signed by the actual borrowers. Ross might give you a bit more of a sense of the home loans.

Mr Narev —To kick off a home loan, you need an application, so that is what we would receive. Then we would make the contact with the client to make sure that what we had was—

CHAIRMAN —Did you always make contact with the client in terms of a home loan, in all cases?

Mr Narev —That is a standard policy and is also what we heard from our staff was the case.

CHAIRMAN —And for margin loans?

Mr Cohen —Not through the dealer channel, no.

CHAIRMAN —So you would not make contact. In the end you took it on faith; whatever was presented to you was it.

Mr Narev —Yes, the focus was on the underlying securities and the loan-to-value ratio.

Senator WILLIAMS —What about repayments?

Mr Narev —This is an important differential between the home loan and the margin loan. Typically for the margin loan, in 80-plus per cent of the Storm cases, the interest was prepaid and effectively capitalised into the loan. Again, the focus is on: what is the underlying security and what is the loan-to-value ratio on the security, because there is not the same regular monthly principal-plus-interest payments in the manner in which a home loan is serviced. That is standard throughout the industry.

CHAIRMAN —The Storm model obviously involved gearing and double gearing, step investment, recapitalising initiatives, and all of that is now known and well documented. The CBA and CGI provided finance and had a relationship, and I understand you also did some due diligence in terms of an agreement or an arrangement you had between yourselves and Storm. What was that due diligence? What did you do?

Mr Cohen —I believe you might be referring to evidence the committee received around some due diligence, in early 2002 I believe.

CHAIRMAN —There may have been another time also, I think, when there was some due diligence done in terms of an arrangement or an agreement. It is my understanding that Storm were making an attempt to have a deeper relationship—a formal agreement put in place—and the Commonwealth Bank was looking at this and did some due diligence in terms of how that arrangement might work.

Mr Cohen —I will tell you what we do know, and it may or may not align with what you have heard. We are aware that at some stage Storm did propose that the Commonwealth Bank get involved in some form or other in relation to its proposed float on the stock market. There was some due diligence done at that point. I believe there was an information memorandum that was provided by Storm to the Commonwealth Bank and I understand that the discussion was around the question of whether or not the Commonwealth Bank would play a role in some form or other in the float of Storm.

CHAIRMAN —And what did due diligence find?

Mr Cohen —We did not proceed. In the end, that discussion and due diligence was at quite a low level within the organisation. It did not proceed through the organisation and, as you know, the Storm float did not proceed either. Is that the due diligence that you are—

CHAIRMAN —That is fine. I just wanted to put on the record what you claimed to be the case.

Senator MASON —The chair has reminded me that we were to have the pleasure of him coming before us in Canberra shortly, so I will not start another round of questions that I was going to ask. I will leave that for next time. I just want to finish off where I was. I just want to make sure this is correct. Mr Cohen, I think you said in relation to margin calls that there was no letter from the Commonwealth Bank to your customer, and also there was no phone call. Is that correct?

Mr Cohen —Which period are we talking about?

Senator MASON —Post 2003.

Mr Cohen —Post 2003, when the process changed, we changed to a process whereby margin calls were made directly to the dealer. That is correct.

Senator MASON —So you did not contact the customer directly.

Mr Cohen —That is correct.

Senator MASON —No phone call and no letter. All right. I just want to get this right. This was the normal process with other financial dealers. It was quite the regular practice, in fact, the normal practice. Is that right?

Mr Cohen —In the period after 2003, 2004, yes, that was our practice with dealers.

Senator MASON —And it worked satisfactorily?

Mr Cohen —Yes.

Senator MASON —Mr Narev, after 2003 it worked quite satisfactorily?

Mr Narev —Yes.

Senator MASON —Assuming that is all right and the process is working well, you are telling financial advisers and they are telling your clients, it is slightly unusual. What this amounts to is this: by leaving the transmission of the margin calls to Storm—the financial planner—that is allowing Storm, which is a third party, to dictate the timing of the margin call—a critical call that might, and did, prejudice your customers. That is right, isn’t it?

Mr Narev —Well, that is correct. What I would say, though, is that I would not categorise lightly the relationship between a financial adviser and his or her client. That is the person to whom they are looking to for financial advice on a whole array of things to do with the specific investment that they have.

Senator MASON —Sure, Mr Narev, but they are your customers.

Mr Narev —They are our customers.

Senator MASON —And you are bearing the risk, and their contractual liability is to you. And you are allowing a third party—you are subcontracting that responsibility to them, by allowing them to do the transmission of the call. The timing in fact is not from you. The timing is from Storm. I think it is extraordinary.

Mr Narev —I would not describe the relationship as a subcontract. There is a tripartite relationship here between a financial adviser, a margin lender and a client. It is not the case that there was only a contractual obligation going between two of those parties and that it was subcontracted out. The core relationship here through the dealer channel is the critical relationship between a licensed financial adviser and the customer who turns to that financial adviser for advice on a whole array of their financial needs. We have said in our submission that we relied upon Storm to do the right thing and they did not do the right thing. But there is a—

Senator MASON —No-one is actually quibbling with that. The bottom line is, though, the contractual relationship is between you and the customer. As we now know after two weeks of hearings, the late transmission of the advice cost people their homes and their livelihoods. So I assume, Mr Narev—and I think your submission says this—that you agree with the new legislation coming through that demands that from now on you, the bank, tell your customer directly. Why do you think that is a good change?

Mr Narev —My reading of the new bill is that it actually preserves the option as the client’s option for that call to come.

Senator MASON —Fine.

Mr Narev —It does not impose an affirmative obligation only on the margin lender. It merely says that the client will have the option of having the call exercised by the dealer or through the margin lender. So it is perfectly conceivable that, even under the new regime, people will receive margin calls not from the margin lender but from their financial adviser.

Senator MASON —If they choose to. Why do you think that is a good change?

Mr Narev —The interesting experience we had is that in December, at the time at which some of the calls were being made directly from Colonial Geared Investments to customers, customers were asking our people: ‘Why are you calling us? We want to talk to our financial adviser.’ If this has resulted in loss to any individual, I have absolute faith that that will come out in the remediation process. But in the large number of cases the individual sees the primary relationship as being with the person who has said, ‘What are your goals? What are your financial needs? This is the product that you should have. Give us a seven per cent fee and we’ll look after that for you.’

Senator MASON —Sure, they may. I do not dispute that. Firstly, Storm clients did not have that choice. That is the evidence. Secondly, the contractual relationship is between you, the Commonwealth Bank, and your customer. I still find it extraordinary that you can leave the transmission of that advice—that is, the satisfaction of the debt to you—to someone else.

Mr Narev —The contractual relationship, in its terms and conditions, expressly provides that the margin call may come either from the margin lender or from the financial adviser.

Senator MASON —I understand that, but still the debt is to you and someone else is transmitting that advice. When it is late—as I think is the evidence that we have had—what happens? People lose their homes and their livelihoods because no-one knew that the margin calls had been made. Some may have known, but many did not. We certainly know that.

Mr Cohen —I think it is clear from what we have heard from customers ourselves that some customers did not know that margin calls had been made. What you are alluding to is that that was because Storm, as their financial adviser, had failed to pass on that information. But you are also suggesting, I think, that that was also because the bank itself did not directly go to those customers until we realised that Storm was not doing so. It is the fact that we contacted those clients when we realised that Storm was not doing that.

Senator MASON —I think you explained that this process happens automatically, but when did you first realise that a Storm client would become subject to a margin call? When did that happen? Was it October?

Mr Cohen —No, before then. There were a number of early calls in September.

Mr Comyn —To give you an idea, on 3 October there were 48 outstanding margin calls. So there were very few until late September and early October. Then, obviously, as the market fell substantially in October and November that number rose.

Senator MASON —So that was in late September. The evidence is that you did not contact those people directly until December. Is that right?

Mr Cohen —Early December.

Senator MASON —That is over two months.

Mr Cohen —Actually, it is not that long because the extent of noncompliance with margin calls only became apparent to any significant extent as we travelled through the early part of November.

Senator MASON —Let us go to that. In the past, pre-2003, margin calls had to be satisfied within five days. That is right, isn’t it?

Mr Cohen —That is correct.

Senator MASON —This took over two months. Were you convinced that the clients were taking appropriate action to meet those margin calls?

Mr Narev —When you refer again to the correspondence between Storm and its customers on, I think, 8 October, one of the primary mechanisms that was used was a significant redemption of funds—over half a billion dollars. But between the time margin calls were made and December, nothing happened. There was a high degree of activity and there was a large frequency of discussions between Colonial Geared Investments and Storm about how to get the best outcomes.

Senator MASON —But Mr Clothier says in the letter of 9 February that it was only in December 2008 that CGI became aware that Storm was not notifying clients. Colonial then contacted clients directly. So there was some action, but it was over two months after you first notified Storm. Nothing was happening. Storm did not in fact tell people. I am not blaming the Commonwealth Bank for this, but what concerns me is why there was not greater prudence on your behalf to assure that had been done—over 2½ months.

Mr Cohen —Over half a billion dollars of margin calls were satisfied in the very period you are talking about. That was not inaction.

Mr Narev —Through the redemption of the funds.

Senator MASON —Yes, I accept that—some were. But, as we have heard over the last two weeks, in many cases people did not receive margin calls at all and went into negative equity of 143 per cent, in some cases.

Mr Cohen —Yes.

Senator MASON —So are you convinced that you took sufficient action over the two months? There was some action, of course, from Storm. Are you convinced you did all you could to inform your clients of margin calls that they were liable for?

Mr Cohen —It is a fair issue and it is one that we addressed in my opening address, and it is an issue that needs to be determined—and it will be determined—in a resolution scheme.

CHAIRMAN —Are there automated triggers in terms of margin calls? People do not do this manually. There are not thousands of people individually flicking switches.

Mr Narev —Clients show up on the system as being in margin call—that is correct.

CHAIRMAN —It is automated. So when the trigger point is hit, what happens in a margin call?

Mr Narev —In the Colonial Geared Investments business, as opposed to the CommSec business, a notification is sent to the dealer that these clients of yours are in margin call.

CHAIRMAN —So you are certain that that took place?

Mr Narev —I have mentioned before that, as best as we can guess it—

CHAIRMAN —But that is what you are saying?

Mr Narev —We can estimate it happened most of the time. I cannot stand here and say to you that in absolutely every case it did. If it proved not to have been done and that caused a loss, that is something that will come out in the remediation scheme.

CHAIRMAN —Is it possible to manually override or change the margin call trigger?

Mr Narev —Technically, it would be possible to manually override it, yes.

CHAIRMAN —What I am getting at is: is it possible that there was an agreement in place between Colonial Geared Investments and Storm which meant the trigger point had shifted? Is that possible? I suppose it is just a matter of plugging in the data and saying, ‘The trigger point was x; now it is 2x.’ Is that possible?

Mr Cohen —We know nothing of any such arrangement. It is a hypothetical and we are not aware of—

CHAIRMAN —So you are saying that is not the case?

Mr Cohen —We are not aware of that at all.

CHAIRMAN —So, for the record, there is an automatic trigger point. It is computer generated. That sends out an email or some sort of notification to the dealer, who is then meant to follow through—

Mr Narev —By making the margin calls.

Mr Comyn —Can I add to that? Generally, what we will receive back is a list by client and the instructions that have been taken from Storm. I have an example here. There are 200 clients on the list and for each client they mention what action has been taken. We had assumed that, as part of that action, they were discussing those actions with the individual clients.

CHAIRMAN —I just want to draw your attention to the Sydney meeting. I think it was on 4 December—is that right? Yes. There was a Sydney meeting with Mr Cassimatis and also—

Mr Narev —Mr Tait.

CHAIRMAN —It was organised by Storm, I believe, to specifically meet with the CEO, Mr Ralph Norris, to discuss some very important matters, obviously, on 4 December. Those matters were the failing business and investments and a way to trade, borrow or cover the calls out of trouble. Are you aware of that meeting and what took place?

Mr Cohen —Mr Comyn can probably comment. But yes, we are aware of that meeting and we are aware that a high-level proposal was put by Storm for the bank to advance more funds to Storm.

CHAIRMAN —Was Storm, or the founders of Storm, trying to cover for every margin call of its clients?

Mr Narev —As best we understand it, the intention was that money would be borrowed by Storm from the Commonwealth Bank to meet the margin calls of its clients.

CHAIRMAN —Of the Commonwealth Bank?

Mr Narev —Of the Commonwealth Bank.

Mr PEARCE —How could Storm borrow money in its own right to meet the margin calls of individual clients?

Mr Cohen —We do not know what arrangements Storm had proposed between it and its customers. Storm, as I think I mentioned a little earlier, was a corporate borrower from the bank in its own right. We lent money to Storm in its own right for its own corporate purposes, not for its client purposes. The arrangement that was being proposed, as we understand, was that the bank lend further money to Storm and Storm in some fashion—frankly, this proposal did not go far, for fairly obvious reasons—would fund customers to meet their margin calls. I know some importance has been attached to this by various witnesses, but it was actually against the interests of the Commonwealth Bank and it was against the interests of our shareholders. In fact, the liquidator of Storm has reported that Storm was insolvent in early December; making a further loan to Storm in those circumstances had all sorts of legal and insolvency implications.

Senator WILLIAMS —Did you lend Storm $10 million in October just prior to that?

Mr Cohen —There was a drawdown of an existing facility in, I believe, September or October.

Senator WILLIAMS —To pay out a facility they had with Macquarie Bank?

Mr Cohen —I am not aware of the reason.

Senator WILLIAMS —Macquarie says in their submission that in October a facility was paid out to Macquarie. I believe it was a $10 million facility that you lent Storm in October 2008. You might be able to check on that for us.

Mr Cohen —We can certainly take that on notice.

Senator McLUCAS —I will go back in time a little bit. I want to know who makes the decision to sell down stocks and where that fits in terms of the advice of margin call. You are saying there was no action on the margin call. What is the next step and when did that all start happening?

Mr Cohen —If I understand the question correctly you are asking how the sale of the underlying fund investments occurred?

Senator McLUCAS —Yes.

Mr Cohen —In essence, once a margin call had been made, Storm, particularly in the October period, actioned that call. It would action the call by directly contacting the fund manager and ordering redemptions of the units held by individual customers in that fund. The fund manager, on receipt of a redemption request, would then seek to sell the underlying securities held by that fund and, in effect, redeem that customer out of the fund by liquidating the underlying securities.

Senator McLUCAS —So who makes the decision on the time to do it and who is advised of that decision?

Mr Cohen —That is a decision that is up to the relationship of the financial adviser and the client. As we saw from the letter of 8 October that Storm wrote to its customers, it was advising its customers to liquidate their holdings in the funds into cash. What we saw occur during October was the implementation of that advice by Storm by ordering redemptions of their clients’ units in those funds.

CHAIRMAN —So they ordered the redemptions?

Mr Cohen —Yes.

CHAIRMAN —In all cases?

Mr Cohen —Are you asking whether it was sometimes CGI and sometimes Storm?

CHAIRMAN —Yes.

Mr Cohen —The situation was that it was up to Storm to take the particular action in consultation with their customer. A margin call can be satisfied in several ways, of course. It can be satisfied by, for example, paying more cash in. It can be satisfied by selling down some securities. In this case, Storm’s advice on 8 October was to liquidate up to 100 per cent of the fund units in order to preserve against further losses as a result of a deteriorating market.

Mr PEARCE —They wrote to their client saying that and got their customers to sign a form?

Mr Cohen —Correct.

Mr PEARCE —They then presented those forms to you?

Mr Narev —As I understand it, there was authorisation to present them directly to the holders of the funds, Colonial First State and Challenger.

Mr PEARCE —So Storm provided those signed form and then the action took place.

Mr Cohen —That is correct. The purpose of allowing direct interaction between Storm and the fund manager was to facilitate those transactions. Because the market was moving rapidly, delays in implementation could result in swings in market value of a considerable amount.

CHAIRMAN —What was so wrong with the Storm badged fund that led to its complete closure, rather than just a selling down of position and allowing it to continue to exist?

Mr Cohen —There were a number of Storm badged funds that were administered by our wealth management arm. Those funds in turn invested in underlying securities. Most of these funds were indexed funds; they tracked the ASX index.

CHAIRMAN —Does that mean the fund was geared?

Mr Cohen —Was the fund itself geared? I would have to take that on notice.

Mr Narev —No, it was not geared. They were unleveraged index funds.

Mr Cohen —These were indexed funds, so they just tracked the ASX index. The process was that once redemptions started to be received, the underlying securities needed to be sold in order to fund the redemptions. These funds went from approximately $700 million down to $46 million in a matter of six weeks. The four indexed funds that I am talking about therefore ended up with roughly $11 million in each fund. The result of that was that those investors who still had their investments in that fund were effectively bearing all of the administrative, management and running costs of those funds amongst what was now a relatively small number of investors, as opposed to when a much larger number of investors were involved. The running costs are not insubstantial because those funds have derivatives and hedges in place.

The trustee of those funds, which is a member of the Commonwealth Bank Group, needed to look at the interests of investors who were remaining in those funds, not the investors who had got out of those funds. It was therefore essential that we take a view as to what was in the best interests of those remaining members. Also, it is probably relevant to know that because these funds were indexed funds—they were tracking the ASX index—with such a small amount left in each fund there was a serious risk that those funds would fail to comply with their mandate, which was to invest in the index in proportion to shares in the index. From a trustees perspective, it is obviously a major risk to fail to meet the mandate in accordance with the constitution of the fund. Taking into account the interests of the investors, the costs of the funds, the fact that those costs were now going to be met by an increasingly small number of investors, the trustee made a decision to close the fund in order to ensure that those investors did not suffer unduly. It was very much a case of intergenerational inequity potentially arriving as a result of leaving those funds open for too long.

Mr PEARCE —It was negative arbitrage because those customers that were left were having to pay the full cost of the funds. Because there were fewer customers, the per customer cost was significantly higher than when there was a lot of customers. Is that right?

Mr Cohen —That is correct.

Senator McLUCAS —When did that occur, Mr Cohen?

Mr Cohen —The closure of the funds occurred in early December.

CHAIRMAN —Mr Cohen, we have heard lots of evidence from really decent people who thought they were safe by investing with the Commonwealth Bank of Australia and its related entity, Colonial. They firmly believed that the bank would ride out the market fall with them and then come back out of it as the market recovered. Why did that not take place?

Mr Cohen —Are you asking why the bank proceeded with selling down and why the funds proceed with selling down, and why we did not just wait until the market corrected itself?

CHAIRMAN —Yes. The view of a lot of people was that, if there was sufficient agreement, relationship and business between Storm, Storm’s clients, and the Commonwealth Bank, there was an arrangement in place that meant you would possibly ride it out with them or the bank would stick with them. Why did that not happen?

Mr Cohen —With the benefit of hindsight it is relatively easy for people to say that if we had all just hung in there for a few months more we would have been fine. Nobody had the benefit of that hindsight in November and December. Markets were going through unprecedented volatility. We had not experienced volatility like that since the early 1930s. It was not a sensible decision to take a bet on the markets continuing to rise. In fact, with the benefit of hindsight, we all know that the markets fell substantially again between December 2008 and March 2009.

Many of those customers—and we do understand the reason people say this; I think it is an understandable human reaction—now say: ‘Look at the markets now. If we’d simply hung in there, we wouldn’t be in this position.’ It is a perfectly understandable human reaction. I am afraid, however, that there is a good likelihood that, if people had stayed in their positions through December 2008 and January and February 2009, as the markets continued to fall, they would be in a substantially worse position. I know that does not appeal to customers who face hardship at the moment, and that is why we are trying to deal with that hardship.

Senator WILLIAMS —I can see where you are coming from there, but have a look at the customers’ position. Let’s have a summary of what we have heard this week and here today. No doubt Storm Financial was a river of gold for the Commonwealth Bank and CGI to invest in. You would have invested hundreds of millions, perhaps even billions, of dollars in that program. We have heard from Andrew Jackson, a former area manager in North Queensland. The target levels of his branch were raised from $530 million or $540 million one year to $760 million the next year. His targets are set by your head office or hierarchy and your people in lending have to try and meet them—in other words, they have pressure on them to sell, sell, sell. You obviously had a lot of confidence in huge growth up in North Queensland.

We have had the situation where people, many of them elderly and on pensions, have mortgaged their houses because they trusted their Storm adviser and trusted your organisation. When 90 per cent LVR came, to save them from losing everything in their life the gate did not drop because of your relationship with Storm, or Storm did not carry the duties out properly, or you had a system where you trusted Storm to notify those very customers and they did not, where perhaps you should have been notifying them yourselves earlier. The one safety net they had did not capture them and they lost everything in their lives. Where do we go from here? Surely in future you will set up a situation in your organisation where you will contact the customer to let them know if they are in marginal calls so they can take action and do not rely on a third party to do that. Have we learnt that lesson in the whole episode?

Mr Narev —I have a couple of responses, certainly in relation to the Colonial Geared Investments side. First of all, in terms of our internal discussions about this reaction, the thing that weighs most heavily on us personally and as an organisation is the plight of the people.

Senator WILLIAMS —I can understand that because I have literally spent months trying to keep people alive.

Mr Narev —I understand that, and that has been the front and centre focus, which is why our first priority is to get our resolution scheme up and running and put significant organisational resources behind it. At no time since this has happened has the plight of people done anything else than weighed heavily on the organisation, and our primary responsibility at the moment is to put right where we did wrong, as our chief executive has said. In terms of the margin lending business specifically, we obviously are looking very carefully at the proposals in the corporations bill. We have said in our submission that we support those and we are already putting plans in place to implement those fully. What it is important to recognise, however, is that they do represent a fundamental change to how this part of the margin lending business was conducted inside the Commonwealth Bank and outside the Commonwealth Bank at the time. That helps these people very little, I understand, but those obligations are being taken very seriously.

Senator MASON —But in future, will you be contacting people in how take out a margin loan directly? That is the question: will you be contacting them directly after this shocking experience?

Mr Narev —We will first see where the law gets to, but I would say with a fairly high degree of certainty that that is something we will look at very carefully.

Senator MASON —Thank God for that. At least we have got that far.

CHAIRMAN —Gentlemen, thank you very much. Thanks to everybody in the room as well. Thank you for your submission.

Mr Cohen —Chairman, if I could just finish by reiterating a couple of key points. We acknowledge that people have suffered hardship, and we have said we are not proud of that. We want people and the committee in particular to understand that we are genuine about doing something for these customers. We do not enjoy seeing our customers in hardship. We see the need and we hope that our resolution scheme, once it goes through, will show the community, our shareholders, our customers and you that the scheme is worthwhile, that it is providing a swift and fair outcome and that the Commonwealth Bank actually does care about its customers. We care a lot about our customers. We certainly do not appreciate the fact that they are suffering hardship. We do want to do something about it.

CHAIRMAN —Thank you.

[3.00 pm]