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JOINT COMMITTEE ON CORPORATIONS AND FINANCIAL SERVICES
16/09/2009
Financial products and services in Australia

CHAIRMAN —I welcome witnesses from the Australian Securities and Investments Commission. Mr D’Aloisio, if you like to make some opening remarks, that would be welcome.

Mr D’Aloisio —We are appearing as a group that has appeared before you once before and has been responsible for the submission that we put to this committee. I would just make one brief comment and then update you on Storm Financial. The preliminary comment is that what we would like to do is to amplify and be clearer on the suggested changes in table 2 of the executive summary of our submission that we lodged with you on 14 August. What we have done and will now hand up is to provide more detail on each of the suggested reforms and changes in table 2 simply to assist the committee. We felt on reflection, looking back, that we were quite short in describing some of the changes we had suggested. We felt it may assist the committee to see how those changes would work in the context of the Corporations Act. That has been handed up so hopefully you will find it useful.

If I can then move to update the committee on our investigations on Storm Financial, the committee will recall that on 17 June I said to the committee that our investigations in relation to the collapse of Storm were continuing and that those investigations extended to the possible actions under section 50 of the Australian Securities and Investments Commission Act against all involved, including financiers, and that we had set an internal objective to be able to make decisions on those matters by the end of August—but we emphasise that that was very much an internal objective.

We say, first of all, that our investigation on the collapse of Storm and the conduct of all involved, including the financiers, is one of the largest investigations that ASIC has undertaken. Naturally we have a full-time team on it. We have supplemented that team with external resources as well. The investigation is being coordinated by a small group of senior executive leaders with a commissioner and I as part of the strategic team. We are satisfied that we have put in place the resources that are required for this sort of matter. The work on it is progressing quickly given the number of potential parties involved and the number of investors, and at the commission level we are pleased with the quality of the work and the hard work and commitment of our team.

On 4 September at the commission level we assessed the progress of the investigation and were satisfied that considerable progress was being made, including in relation to the scoping and the nature of potential causes of actions and possible legal proceedings. But we felt that additional investigative work and legal analysis was needed before the commission would be in a position to make decisions. So we set the next six weeks for that additional work to be completed and will again review the matter to determine if the matter has advanced sufficiently at that time for commission decision. That is likely to take us to around the end of October. We are not in a position today to outline the potential causes of action or other legal proceedings that we are assessing and our reasons for that are, first of all, that it could affect the effectiveness of our investigations and we do not see it as being in the interests of the investors if we were to outline our thinking at this point. Secondly, the public hearings of this committee are not complete and the liquidator examinations will commence on 24 September. Additional relevant material or evidence may emerge which we may want to evaluate.

While we would have liked to have been able to say more this evening, for the reasons that I outlined we are not in a position to. Let me reassure the committee, and in particular let me reassure investors, that we have their interests as our primary concern. As we have said before, for those investors who may wish to participate in the CBA settlement scheme that is a matter for them. They will still benefit from any ASIC actions that we may bring as there is a carve-out to that effect in documentation that the CBA is using. That is all I wanted to say in my opening remarks. I am happy to answer questions on that, and on any things you may wish to raise.

CHAIRMAN —I would like to begin by again thanking you for the work that ASIC has done and the submissions that you have provided. I just want to explore a couple of issues with you in terms of licensing. You make some comments in your submission about essentially raising the bar for the entry-level of licensing or giving ASIC more power to prevent someone getting a licence. Could you just go into a bit more detail to explain the licensing procedure? I have a few other questions around that but I am interested in your view in terms of how you make that a higher standard and set a higher bar.

Ms Bird —In our submission we suggest something which we would do—which would be to review the financial resource requirements that are imposed on licensees. So that is a project that we have now and we are looking at ways that we can do that. We are very conscious that there are limits to what we can do in terms of financial resource requirements because we are not a prudential regulator and we cannot set the sort of capital and liquidity requirements that a prudential regulator would. In terms of regulatory reform we actually only suggest fairly minor reform around the licensing regime. So, as we have said before, we are required to grant a licence if the conditions in the legislation are met. The two substantive conditions are that the key people are of good fame and character and the other one is that we have no reason to believe that they will not comply with their licence conditions. The test of having a state of mind that somebody will not comply before they have even started business is extremely difficult, and so we have asked that we have a slightly lower threshold in terms of ‘may not comply’ or we think that there is a possibility that they may not comply so that we do not have to reach that very high level of conviction before we can refuse a licence. The reforms that we have asked for are mirrored in the existing credit reform legislation.

CHAIRMAN —You also make mention of wanting increased powers in terms of making it easier for ASIC to be able to remove someone’s licence.

Ms Bird —Yes, there we have asked for the same thing—that we can remove a licence if we think that somebody may breach their obligations in the future. Because it is exactly the same problem: we have difficulty acting before a breach with the current test. Where we have asked for more powers that extend beyond that sort of thing is on the banning of individuals. We have asked for additional powers there.

CHAIRMAN —How realistic is that view though in practical terms? What is it that you would like you be able to do in the future that you could not do in the past? I would make particular reference to Storm, for example, given that ASIC did an audit and a compliance check. My understanding is that they passed shortly before they collapsed. So what is the importance of that in terms of had you had had those powers given that they passed the audit and compliance test? What difference would it make?

Ms Bird —I do not think I can talk about Storm so I will talk about it more in a general sense.

CHAIRMAN —I am just using that as a reference point. I am not asking you for details. I am just using it as a case study.

Ms Bird —It will not be easy to take away a licence, and it probably should not be easy to take away a licence. Taking away a licence brings to an end a business which may have many employees. We have in the past tried to take away licences and made decisions to take away a licence and been overturned by the Administrative Appeals Tribunal. So I guess we would think that with this change in the test we might have been more successful in those cases. So I guess we think it would have a practical impact, but I am not suggesting to you that suddenly we would be taking away hundreds of licences every year. When you look at the numbers of licences that are taken away, you see that it is a small number. This would enhance our ability to act before a breach. I think the changes in banning would be more significant.

Mr D’Aloisio —I think also that in our submission we have not put these changes to the licence conditions as the things that we think are right at the centre of improving quality of advice and so on in this industry. What we have said is that the key things are the clarifying of the actual duty itself on financial planners and advisers and the remuneration structure. They are things that we are saying that, if the changes are made, could make a real difference. The licensing conditions, as Jo indicated, are there. We think we can improve them. But we have not used the licensing regime as the thing to really try to get to the nub of this. We think it is to do with quality, remuneration structure and training. They are the things that we feel are going to see a lift in the standard.

Short-term that may well mean that a lot of people will go out of this industry, and we think there is a short-term issue there; but longer term we believe that if that basic framework of quality, training and the remuneration structure—and not creating the wrong sort of incentives—is at the centre of the reforms. And then there are a number of other changes that we think are important such as the licensing changes that we are talking about and education. We see all of that adding to it. We are not putting those up as ‘the thing’ that is going to fix the problems that are in the back of your mind and that are clearly in the back of my mind and which have occurred over more recent times.

CHAIRMAN —Still on the licensing issue, there are certainly some concerns about the number of licences that exist. The vast majority of those are at a corporate level. They are, let us say, high-end users or holders of an AFSL. And it is exactly the same licence as would be held by somebody who is a single operator—an owner-operator of some sort of firm. So there does not seem to be any way of distinguishing, through the licence itself, the capacity or the ability of the service provider. It just seems to be a catch-all licence, where the same conditions are applied.

And if you were to double the requirements—just for argument’s sake—I do not suspect that the large corporations in Australia would have any problems in complying. They would complain but in the end they would just comply, meet whatever requirements were set and get on with business. But the lifting of the standard could have a dramatic impact on single operators or small operators. I am just wondering how you distinguish between the levels within this giant grab bag of all those who hold a licence.

Ms Bird —The obligations are quite flexible so the way they apply—what is expected of you, your financial resource et cetera—will vary depending on the nature of the business you are conducting. As a general point, compliance costs are more expensive for smaller entities.

Mr D’Aloisio —It is a matter, also, of what condition you are talking about. Clearly, in your example of the big players and the small players, if you apply a financial resource condition that you have to have certain capital adequacy in the millions, then that licence condition can only be complied with by the big end of town. But if you put a quality condition in there—to do with the standards and quality—then that could be used to lift the lower end up. And the big end could probably comply with that as well. So in order to deal with the concerns you have—and we are happy to—we would probably have to talk a little bit about the types of condition you have in mind.

CHAIRMAN —The reason I raise that is to do with the link between the AFSL holder and the responsibilities they have, particularly for their authorised representatives, and the work that they carry out. In a larger organisation there are obviously many more people and if something goes wrong we can assume, from past experience, that it is not going to be the holder of the AFSL—the actual licensee—that is dealt with directly. It is more of an operational corporate issue which is dealt with down the line and past practice indicates that it is really an individual low-end employee or authorised representative who ends up carrying the responsibility for whatever took place in the organisation, whether it was policy or not. I am concerned. I just want your view on how that operates in practice and ASIC’s experience in terms of who is held directly responsible for issues that arise out of conditions from the licence.

Ms Bird —The licensee is responsible for the conduct of its authorised representatives and other representatives. So the licensee will be held liable. There is quite a complicated liability regime.

CHAIRMAN —Okay.

Ms Bird —That is the way the system works. The licensee is ultimately responsible for the breaches and the acts of its representatives.

Mr D’Aloisio —But the question you are getting to is: if you have 3,000 authorised reps and one or two of them do the wrong thing, do you take the licence of the main entity away? That is a tough call for ASIC.

CHAIRMAN —I am not suggesting anything at all, Mr D’Aloisio. I am asking the questions rather than making suggestions.

Mr D’Aloisio —No, I am saying that that is where the existing regime take you, and that is why we have wanted more direct power to be able to intervene at the authorised rep level, rather than just dealing with the licensee.

CHAIRMAN —I was just looking at the responsibility taken. There seems to be a disconnect between the responsibility of the person who holds the licence and the people physically giving the advice and the responsibility they take on, either personally or through their organisation. There just seems to be a long way that separates them.

Mr D’Aloisio —That is a fair observation.

CHAIRMAN —I think you have made the point for me: how much control can an organisation with 3,000 authorised reps really have in the end? How much responsibility does the individual carry in terms of the processes, procedures and all the myriad vagaries that might exist within that organisation, particularly given that of late a range of them have admitted to a whole range of mistakes?

Mr D’Aloisio —It is a matter for you and the committee. There are other possibilities. You can license individuals, you can license everybody—they have to apply for a licence—or you can go with the current structure. We have not expressed a view on whether you would register or license everybody and apply standards against those. But they are clearly matters for the committee.

Mr PEARCE —Thank you very much for being here and for your submission. I want to ask a number of questions about some comments that you have made in your submission, but before I get to those I want to talk more broadly. It seems to me that in your submission you are making a call for quite a lot of additional powers, for want of a better term. You provided us with this update this morning, but I think it is on page 13 and 14 of your submission that you essentially summarise what it is that you are after. You say down the bottom of page 13:

In ASIC’s view, the following two reforms are likely to have the most significant impact …

You talk about imposing a statutory fiduciary duty and preventing rem structures. Then you go on to more far reaching changes. You talk there about prudential regulation of a greater range of financial products and product design prohibitions or limitations. You are also talking about getting extra powers to influence the content and the material in advertising campaigns et cetera.

My very simple question is this: if ASIC were given more powers to approve products and to control advertising—what is in the advertising and what is not in the advertising—what would be the situation if and when something goes wrong in the future? Who is going to have the liability? Let’s just say you sign off on a product, you say, ‘That looks okay,’ you sign off on an ad, the company goes ahead and advertises and it gets a stream of customers coming in the door to buy this newfangled product that ASIC has approved and the product falls over. Who has the liability?

Mr D’Aloisio —Let me put that in context. We are actually not advocating the more far reaching changes that are listed in paragraphs 29 and 30. What we are saying is that, to assist the committee, these are things that are being debated and being used internationally. Then there is the later chapter that elaborates on that. We have not gone that far, and we have not gone that far for the reason that is behind your question.

It is a very simple answer to say that somebody says this product is okay, that they give it a rating of A or AAA and that investors are safe. Not only could that be wrong—and we have seen enough of credit rating agencies to know that that could be wrong—but it could have a perverse effect on competition or on buying power. People will think that the product is safe and then when it turns out not to be safe there is no option for government to step in as a guarantor of last resort. So we are very concerned about those issues. In the public statements we have made—indeed, in the opinion piece that was published under my name more recently—we draw attention to these issues. We are saying that these things are happening internationally, but we need to be careful in the way we regulate.

But what we are also saying is that when you look at the Wallis inquiry underpinning of the current regime, we are also querying whether it has gone far enough in protecting retail investors, given the important role, which was not foreseen by the Wallis inquiry, that retail investors would play in the market. They had not foreseen and could not have foreseen the impact that the superannuation levy has had on investment in our markets. In that situation, you have a much broader range of retail investors and retirees. You have groups of people who lose money at the wrong time in their life and it is no answer to them to say: ‘Well, it was a risk, you know. There was disclosure. You should have read the disclosure statement.’ The fact is that they cannot easily come back into the workforce.

So the changes we are pushing are to say: ‘Look, this is a real issue. We’ve got to re-examine this underpinning and there is probably a case for some more-targeted and better regulation to protect retail investors, without losing sight of the efficiency of the markets and not moving to moral hazard or guarantor of last resort.’

The changes that we were advocating in the previous paragraphs, which you have just referred to, fit in with what I have just said. When we look at the advice industry and the way that it has unfolded—and with the benefit of hindsight at the movement of retail investors—we think we need to focus a bit more on the quality of that advice, the training of those that give the advice and the commission structures. We think that that would protect these people—the retail investors—that I am talking about. So that is where ASIC is, as an organisation, in terms of providing assistance to this committee. We do not want to be the guarantor of last resort. Indeed, I have spoken about that publicly on a number of occasions. For ASIC to be a guarantor of last resort—if the government wanted it to do that, that is okay; it is a matter for the government—you would need resources that would be exponentially different from those that ASIC has today. And we would need all the skills of the investment bankers and so on. Indeed, the investment bankers had all those skills and they did not avoid problems.

Mr PEARCE —Let’s take, as an example, your suggestion about the role of marketing and advertising campaigns. You say that there should be mandatory content in advertising. You are making a recommendation that the act be amended to give particular power to require issuers to include specific content et cetera. Just talk me through, very briefly, how that would work practically. Let’s say that when I leave the parliament, which I intend to do at the next election—

Senator MASON —A great loss!

Mr PEARCE —and I decide to hang up my shingle, if I am clever enough to qualify, and I want to advertise something, how is it going to work? I preface this, Mr D’Aloisio, by saying that I know you already do some of this. Talk me through how, if you got some extra powers in this, a practitioner would go about this.

Ms Rickard —I think the first thing to clarify here is that ASIC is not talking about pre-vetting or approving ads. There is no suggestion that we would pre-approve ads or give them our tick of approval. What we are saying is that in certain situations there may be additional information which we believe investors who are viewing or listening to an ad should have in order to be in a position to work out how to respond to that ad. So it might be something about who that sort of product is suitable for. If it is a complex product the ad might say, ‘This product is only suitable for experienced investors.’ That is just an example off the top of my head. Or it might be that we require all advertisers of unlisted and unrated debentures, for instance, to disclose the ratings or to say, if they do not have a rating, why they do not have a rating.

Mr PEARCE —But you are asking for a consideration that you be given power to require the product issuers to do this. My question is: how are you going to implement that power?

—Well, if you take the example of the unrated and unlisted, where we trialled this on a voluntary basis, there is no point putting out an ad saying to mums and dads, ‘Go into this debenture; you’ll get nine per cent or 10 per cent. You can sleep well at night because you know you’re going to get nine or 10 per cent,’ if you do not have in that ad that the repayment of the principal is at risk. The fact that it is not rated by a credit rating agency will tell you that it is probably not capable of being rated. So in the unrated and unlisted area, we pushed the industry to say, when they did the ads, what the risk was for the repayment of the principal. We did that without legislative power. We did that through our powers.

What we are saying is that we ought to have that power more formally in order to be able to do that in other cases. It does not mean that we would do it for every advertisement, but we would consider it for those areas where you have particularly vulnerable groups. The unlisted and unrated area, the mortgage trusts and the unlisted property trusts have relied typically on having large numbers of retirees who would come in and take those products because they are yield products. They are products where people feel, ‘Well, I’ve got my money effectively invested in real estate. I have X per cent coming in; I can live off that and our principal is safe.’ We are tackling that through the advertisement and we are tackling it through education—asset diversification and understanding of risk reward premium. We do that through the work Delia and the group does on the FIDO web site. There are a number of ways that we are tackling it, but we also think that—coming back to your question—we should have the power in relation to some of the ads.

Mr PEARCE —In relation to remuneration structures, it says here that the act should be amended to prevent the use of particular structures. You said that would mean that some forms of remuneration would not be permitted, such as upfront commissions, trail commissions, soft dollar incentives, bonuses and everything else that we know goes on in the industry. I set my next question in the context that a lot of the industry, as you know, is already moving to a fee-for-service basis. We acknowledge that. If that power was written into the act, if the act was amended to do that, how would you envisage implementing such a thing?

Mr D’Aloisio —We are saying it ought to be prohibited by legislation. So it should be a self-executing power in the sense that that is the law.

Mr PEARCE —But would you imagine that, if it got passed in the parliament at eight o’clock tonight, it would start at five past eight tonight and just happen automatically? That is my point. As the regulator, you would be given the responsibility to implement—

Mr D’Aloisio —That is quite right.

Mr PEARCE —I want you to talk us through how you think that would happen, because it would be quite a significant shift.

Mr D’Aloisio —It would be, but really at the end of the day the industry has had plenty of time. We have known this issue has been there. A number of firms and entities have moved away from the wrong incentive that is created by selling commissions as distinct from giving advice. The FPA has done a lot of good work in the area, as you say. IFSA has been doing work in the area. So certainly there is a much greater level of consciousness of it and they are moving in what we think is the right direction. But, again, given what we have seen and how things have unfolded with the more recent collapses, our feeling is that these things should be banned either directly or through the standard of advice that you give.

Coming to your question of how ASIC would implement it, once the law is clear ASIC’s role in surveillance, compliance and enforcement would be no different to other things that you may have banned. Certain types of share offers are prohibited—what does ASIC do? They might have been allowed before. ASIC through surveillance and enforcement will ensure that the law is complied with. I do not think we are looking for a power for ASIC to be able to say which commissions in which companies are banned and which are not, because that takes us into competition and an unlevel playing field. We are simply looking at it as being a legislative change, and we will just use our powers in the normal way.

Senator MASON —Can I just ask a typical legal question. We have heard different answers from different witnesses we have taken evidence from over the last few weeks. If the committee was minded to recommend the imposition of a fiduciary duty, would that necessarily be inconsistent with the receipt of commissions by financial advisers? Is it necessarily inconsistent?

Mr D’Aloisio —I will preface my answer by saying that it is a legal question. Even though I have a legal background—

Senator MASON —What is your best advice?

Mr D’Aloisio —The position we have taken and clearly will continue to take as the regulator is that the law at the moment is uncertain as to whether the fiduciary duty exists or not. We take the view that it may well exist, but it is unclear. What we are asking the committee to look at is making it clear, and making it clear by saying, ‘The duty applies but you have to ask advisers to act in the best interests of clients, and it could be fiduciary.’

What difference does it make? The difference it makes is that, once you are in a fiduciary relationship, if you are going to take commissions or some other benefit, that benefit belongs to your client. It is not yours; it is your client’s, unless your client through disclosure but more importantly through informed consent allows you to keep it. The standard and the way you discharge that duty is that, if you are running a large organisation, for practical purposes you would be hard pressed to say, ‘Yes, you can still have commissions,’ because in each individual case you run a risk. So the change we would see to industry practice would be that a lot of the front-end, trail and ongoing commissions would probably not sit well with a clarification of that duty.

It does not of itself bring about that the commission has been banned. That is why we have asked you to consider the second limb of our recommendations which is to actually put it beyond doubt. But even if you did not do the second limb and only did the first limb, we would still feel that a significant number of the existing commission arrangements would go, and that would be in line with where the industry itself is moving and indeed, to be fair, where quite a number of companies have already moved.

Senator MASON —That was excellent evidence, thank you.

Mr PEARCE —I would like to clarify one thing about your submission. On page 5, point 10 you say that:

Recent events in the Australian and global financial system have lead to the Inquiry and with that the possible reassessment of the policy settings of the FSR regime and the economic philosophy that supports it.

I have not seen, in our terms of reference, any suggestion that the FSR regime or the economic philosophy that supports that regime is being reviewed. It is rather that we are looking at what has caused some of the problems in relation to some of the collapses and what can be done from a legislative point of view. I contrast that with the following paragraph where you then say that Australia has fared better in the global financial crisis than any other country, and part of that was the regulatory framework. So on the one hand you are questioning the regime and the economic philosophy and then on the other hand you are saying that it is part of the reason why we have fared better—which I would certainly concur with. I do not think there is any evidence to say that the committee is necessarily looking at the economic philosophy that underpins it. We are looking more at the practical implementation of the regime. Can you share with us—

Mr D’Aloisio —I am happy to clarify paragraphs 10 and 11 to make it clear that it is, I think, quite consistent with what we have said before. We do believe, and clearly, that Australia has fared better, and one of the reasons we have fared better is that we have had a better system and that in the RBA and APRA we have had excellent regulators. And it has been underpinned by a lot of other factors of macroeconomic policy of successive governments and by the resources boom. We have been lucky, it is great and we have got good systems. There is no doubt about that, at least in my mind for what that is worth.

At the same time, though, we are saying that the recent collapses are not divorced from the economic crisis in terms of the financial crisis that occurred and the impact it had upon the markets. In turn, it had an impact on leverage models and so on. There were investor losses in Australia. What we are saying is that that is sufficient for us to say, ‘Okay, can we improve the system and build on its success?’ And what we are saying is that when you look at the underlying philosophy of the FSR regime under Wallis, which had left it to the market but regulated conduct and relied on disclosure, we are just saying that probably those things, as I said earlier in the evening, need to be re-examined and looked at again.

Further, we think that that is also likely to happen internationally because you have got a situation where a number of changes are now coming in in various regulatory regimes, and there is a retesting and a rethinking about whether the market efficiency theory that a lot of this is based on needs to be tweaked. No one is suggesting that it has not worked; it just needs to be improved.

Mr PEARCE —That does not change the underlying philosophy, does it.

Mr D’Aloisio —No, it probably does not in that sense. I think you can re-examine that philosophy but I agree with you, it is not likely that you will see a change to it in the broad sense. Sorry, I was probably not as clear as you wanted me to be.

Mr PEARCE —That’s all right. You are a lawyer; I understand!

Mr D’Aloisio —Before, I wasn’t!

Mr PEARCE —You referred just now to what is happening internationally. How much time has ASIC been spending in looking at what has been happening internationally? What is your view of what is being proposed in the US and in the UK, and what is your view of how our regime will compare internationally?

Mr D’Aloisio —Clearly, as you would well know, initially the international work was very much around the toxic assets. That then moved very quickly into the prudential requirements for the financial institutions—the banks and so on—and more recently it has moved into our space, into the securities and investment space. In the securities and investment space three or four key issues have emerged internationally. One is short selling, which we have discussed with this committee, as well as where IOSCO has got to and the change that has been brought about in Australia as part of that. Another issue is hedge funds and the principles that are now emerging around greater control over and knowledge of what hedge funds are doing as part of the international work that is going on there. There is work on securitisation and credit default swaps, and Greg Medcraft is one of the people who have been heading that and looking at how we bring confidence back into the securitisation market, for example. On the accounting side, there are a number of changes going on around impairment, fair value—those principles.

What impact they will have in Australia and whether they will be taken up is a matter for government, as you would know. At the moment the government has responded on short selling. It has responded on credit rating agencies with ASIC, and in terms of how and whether the government responds to the other issues will be a matter for it.

You also raised a question about how we are faring against the US and Europe. There is no question that our system—the system they want to move to—already has a lot of those underpinnings. I think that is a fair comment. I think the twin peaks approach that Canada and Australia have is looked at very favourably. The work that APRA and the RBA do has been looked at very favourably. When you look at where the US is trying to move to, my limited experience tells me they are probably moving closer to where we are rather than us having to move further. But, again, these are matters for government, for Treasury.

Our role is really to work through IOSCO, to use the positions that we have, including co-chairing the task force on securitisation, to get those issues to a stage where each individual jurisdiction and each individual government can make an assessment as to which bits they will go with and which they will not. On that, we are in the hands of government. In terms of the issues we are concerned with here this evening, there is not as yet any international move at the IOSCO level on financial advisers, disclosure and so on. I think that is probably down the track. I think it is coming—we are seeing signs—but it is probably down the track.

Senator McLUCAS —Thank you for your submission. I want to go to questions of consumer protection or what I prefer to call consumer empowerment. In the relationship between a person who is probably in their early 60s and a financial planner there is an absolute imbalance of knowledge. I note that you recommend that we change the school curriculum, which really troubles me. I suggest to you that a person who is 17 will not remember when they are 65 what a margin loan is. I don’t think that is where we need to do our education, to be frank—but let’s put that to one side. What can we do? What tools can we provide to a consumer? You say in your submission that you recognise there is a fairly low level of literacy in our country. I don’t think we are any different to anyone else, but what tools can we provide a consumer who for the first time in their life has an amount of money—probably their superannuation—and is about to make some fairly major decisions?

Ms Rickard —I think there are a number of things that we can do there. We are in the process of producing a range of materials which we have been out testing which are designed to teach people investing basics. We do not want to teach people to understand all the intricacies of what a CFD is, but we want to teach them the importance of things like diversification, the relationship between risk and return and the importance of asset allocation.

We are refining those core messages and then we have to look at delivering them in a way that actually gets them into the hands of people who need them, which means using multiple channels. Whilst FIDO is our core communications network we are very conscious that not everybody has access to the net or uses the net, so we need to look at other ways. One of the things we have trialled is delivering seminars through Centrelink’s financial information service to try to reach those preretirees—the people you are talking about—and help them with those messages. You also use the media and messages and radio and all of those forums that reach people and you look at ways of distributing paper based publications through phone, through libraries and through working with adult education units. There are a raft of channels we can use to get those core messages out.

One of the things we know too is that, once you can give people some basic questions and some basic understandings, should they go and deal with an adviser, the more they are empowered to know the questions to ask, the better the advice is that they are likely to get. There are a range of things we can also do online in terms of tools that will help people to test advice and to understand risks of things that they are getting involved with. It is one of ASIC’s two key priorities in terms of our financial literacy work because we realise that this is a place where, if you suffer a loss, it is really very difficult to recover.

Senator McLUCAS —I will go back to my term ‘consumer protection’. Some of the evidence that particularly troubled me during our hearings was the repeated evidence from people who have lost their total life savings. They had informed the financial adviser that they were people who wanted very low risk, yet they ended up with what we now know was an extremely high-risk product. I am trying to think of a way you can insert something between advice that in my mind was not accurate and protection of an individual who, for very good reasons, has taken that advice and believed it. Can you insert in there a requirement, before you sign on the dotted line, that the planner has to provide almost an external tool to the consumer so that they can basically confirm the advice that has been given?

Mr D’Aloisio —I understand. I think the problem you have is the unknown, and the unknown is that in every investment there is a risk. There is the risk/reward that you need to assess and, as Delia says, the asset diversification: do not put all your eggs in one basket and understand the risk. There will always be a risk in investment. The only way you can ultimately remove it is if the government takes that risk so that it is the guarantor of last resort. Given that is not going to happen, and should not in my view, you are looking at protection. So the tools that we would use are clearly to improve the education, the way that people ask these questions and understand it themselves. We are looking at improving the financial advice industry so they provide better advice and do not get distorted by commissions. I would disagree with you: I think taking it right back to the schools and bringing it right through as part of someone’s education and whole development in life in understanding financial risks and so on will last and stay with them long beyond school. You cannot remove it altogether. Really, for someone to come in and vet it—let’s say it is an ASIC or an organisation that sits between the financial adviser—and the customer says, ‘Yes, you can go into that,’ all it is doing is transferring the risk to someone else.

We could look at it but it is going to be very difficult given that the heart of our system will always be, ‘If you are going to go into investments, there will be a risk. In your stage of life, you have to assess whether you are better off with a term deposit in a bank even though inflation is going to eat into the principal overtime. That is kind of at the lower end of the spectrum. How far up the spectrum do you not want to go in taking risks?’ You will have situations where retirees will lose. We can minimise it. Some of the experiences we have had more recently have troubled us. We are making suggestions, but I think we are talking about minimisation and not eradication of that risk.

Senator McLUCAS —Sure. I am trying to find a tool you can give a consumer so that the power imbalance is somewhat levelled out. It will never be equal, but—

Ms Rickard —There are things we are looking at. We are looking at the moment, for instance, at whether or not you could have a risk indicator tool in relation to superannuation and examining closely what a front end of that would look like so that it was simple enough for people to use and what the back end would look like so that the information underlying it was accurate and reliable. That work is still in progress and at a relatively early stage, but from that work it is possible to say, ‘If we can get that right there, can we apply it in other areas?’ When I talk about the basic messages we are trying to get out there on investing, there will be basic messages about borrowing to invest that become core messages. Yes, I think there is more that can be done, and there are things we are actively looking at.

Mr D’Aloisio —Let us take the term deposit as the simplest of products to illustrate this point. You say to an investor, ‘If you put your money in the bank you will get three, four or five per cent.’ If you then go further and say, ‘You have to factor in inflation over the life of that,’ do you then rate that investment for the investor as low risk, medium risk or high risk? The label you give it will be telegraphing something to that investor. Where would you put that product when you try to factor in movement in interest rates over a long period of time? Would you put it in low risk, middle risk or high risk? There are two factors here. We are talking about movement in interest rates and inflation. It is money, so it is clear. We are not talking about complexity. So, even when you strip this down to the simplest of products, it is difficult to help the investor or the consumer. It is difficult for organisations to come in and say that they can remove the risk from the investment. All we can actually do is help, assist, educate and make as clear as possible what the risk is. But, in the end, each investor has to take the risk and has to wear the consequences of the risk.

Ms GRIERSON —I think Senator McLucas has raised a very good point, and I do not find the answers very satisfactory. She has alluded to vulnerable groups. Those are groups who get a lump sum for their superannuation. I am sure people who get a lot of cash in hand at a redundancy are also a vulnerable group. I would think that ASIC should be thinking of tools. For example, when I look up something on Google, a pop-up comes up from another advertiser who I have not looked up. Surely when people look up their superannuation a pop-up could come up that is mandated and says, ‘This is your ASIC protector here. We are warning you.’ I think there are ways that you can do that. Senator McLucas has identified vulnerable groups in the community, and you are not telling them whether it is a risky product or not a risky product; you are just informing them at a moment when they have that need that there is something else they should be considering. I think that is a really good point and I think there are ways you could be doing it better. What we have seen in our inquiry is that there are vulnerable groups. There is a point of vulnerability when they start thinking about investing their money.

Mr D’Aloisio —Let us be clear. We know we have to do more to ensure people know about the risks in investments they make. If you can come up with simple tools and find out how to warn people, that is fine—

Ms GRIERSON —Be creative.

Mr D’Aloisio —but it is not the panacea that is going to fix this because in the end—

Ms GRIERSON —But it will let you sleep more soundly in your bed, I am sure.

Mr D’Aloisio —you have got to take the risk.

Ms Rickard —I suggest that you know that we do use it.

Mr PEARCE —This point has come up.

Mr D’Aloisio —ASIC is here.

Ms GRIERSON —I like it.

CHAIR —You can go to sleep now, because ASIC is here.

Ms Rickard —I was just going to let you know that we do use Google pop-ups—

Ms GRIERSON —Good.

Ms Rickard —and we do have things that go in so that, if people type in ‘get rich quick’ or any of a whole lot of other keywords, then one of the things that will come up is a link to FIDO—

Ms GRIERSON —That is excellent.

Ms Rickard —So it is something we are doing and we are working with Google about how we can refine it and do it better.

Ms GRIERSON —Wonderful.

Senator McLUCAS —I understand your comments about whether or not we should be having trail commissions et cetera. Putting that to one side, it has been put in front of the committee that what might assist is one page in the statement of advice which, in clear, understandable and very plain language explained all of the fees that a consumer is paying, in all the various ways, around all the various products. It has also been put to me that you have been trying to do this for some time and that it is very hard. Why can’t we do it?

Ms Koromilas —The legislation does require you to disclose all of the information—

Senator McLUCAS —We know that. We also know that most of the people we have spoken to had no idea that that disclosure was in there.

Ms Koromilas —I think that comes from the complexity of the remuneration structures that actually exist within the industry. So, when you have multiple types of remuneration that are predominantly paid by the product manufacturer to the adviser and to the licensee for the sale of that product, on top of volume bonuses and potential conferences that you can go to, that complexity leads to the consumer’s lack of understanding of how much it is costing them at the end of the day. So you do come across people who believe to a large degree that, because they have not written a cheque, they have not had to pay for the advice that they have received. A lot of that has to do with the structure of the remuneration itself. I think also on top of that—although remuneration is disclosed in the statement of advice—when a document is rather lengthy, it often can be lost on the consumer by the time they have actually got to that page. So I think that, when you add together the complexity of the remuneration structure and the complexity of the document in its entirety, it gets lost on people, and something that is relatively obvious to people who work in the industry—the way they get paid—is not something that the consumer pays attention to, because they are not asked to actually write a cheque.

Senator McLUCAS —It is more than that. For those planners who do not feel encouraged to disclose, the way the SOA is constructed at the moment almost facilitates that.

Mr D’Aloisio —Your point of trying to get it to one simple page and distil the essence—clearly we are with you on that, and we are working to do it. But there is a second issue embedded in it. The investor not only has to understand the fee structure; they also have to turn their mind to whether or not that fee structure could have distorted the advice they have been given.

Senator McLUCAS —You have got to have the first before the second.

Mr D’Aloisio —That is quite a different analysis. In a sense, yes, you can have a short-form disclosure and it has a—Deborah, in running this area, they have been working to achieve the one- or two-page disclosure documents that we all would want to see. But you then have to go to the next step, which is when someone reads that, and this is where disclosure has a limit. Yes, I have disclosed it, but is it an informed consent? Or is it really that, as the investor, when I have seen these fees, I have turned my mind to the fact and said, ‘Could this guy have distorted his advice because of these fees?’ And that is extremely difficult for an investor to do unless they are really experienced, because the person you are with is a trusted adviser. But you have gone to the person in the first place.

Senator McLUCAS —That is right. Thank you.

Mr ROBERT —Mr D’Aloisio, in your recommendations 3, 4 and 5, you are looking for a power to literally take away the livelihood of organisations and the people in them because you believe the person ‘may not comply’ or is ‘likely to contravene’ or where you believe a person ‘is involved’. There are a fair few qualifications there and a fair few verbs like ‘may not’ and ‘likely to believe’. How do you reconcile that with the concept of natural justice?

Ms Bird —The decision still has to be made by ASIC in accordance with natural justice. It is reviewable by the Administrative Appeals Tribunal. The changes we are asking for there are the changes that are before the parliament now in the credit bill. So you are right. Taking away a licence is a significant step and it is not a step that ASIC takes lightly. When you look at the figures, we have taken away 20 or so each year for the last few years. ASIC will take a whole lot of other regulatory actions before it would do that. So it might get an enforceable undertaking or take an individual banning or bring some other action. I agree with you that it is a significant step; we are just saying that at the moment it is an extremely difficult threshold to get over and it means we cannot act before a breach. We have to find the breach before we can take it away. We cannot act in a preventative way. If we had this change, which will probably come through in the credit legislation, we could possibly, in the appropriate case, where the other regulatory tools are inadequate, act in a preventative way.

Mr ROBERT —Why didn’t you propose this earlier? For example, we had a bull market running like mad, we were approaching 7,000 and ASIC knew that people were being pushed into high areas. You knew from your shadow work that when you went out there advisers were pushing people into areas where they had high fees. You knew that following a bull market comes a bear market. There are always corrections. This could on the surface look like a knee-jerk.

Ms Bird —Are you talking about the whole package or the particular—

Mr ROBERT —No, I am talking about those specific recommendations.

Ms Bird —I suppose the licensing regime has been in full force since 2002. It is an experience thing. We have had appeals to the AAT where we have lost. It is a matter of experience. The reforms in the credit legislation are based on ASIC’s experience in administering the financial services legislation and so we have already communicated our concerns. We are pleased to see that they have been taken account of in the new regime.

Mr ROBERT —You have to admit the timing of this looks like a knee-jerk considering this has not been flagged previously.

Mr D’Aloisio —How these things are characterised is a matter for you. I do not think any of this submission is knee-jerk. We have considered this very carefully. As you would know, we are the regulator. We apply the law to the fullest. Our job is to do that and to be able to demonstrate to government when we think a change is needed because the law is deficient. We do not ordinarily jump in and ask for changes. We will only ask for those changes where we feel we really need them. Here we are not actually asking for the changes. We are suggesting that these are the changes that the committee might want to put to government.

Mr ROBERT —If I could move to recommendation 6 on the fiduciary standard, cognisant that you are referring obviously to a legal relationship of confidence and trust for advisers investing money in an orderly and wise way. It would appear that you are looking to define that fiduciary arrangement regarding good faith where it says: ‘Amend the Corporations Act (s945A) to expressly require that a person who provides personal financial product advice must act in good faith.’ Are you intending to define ‘good faith’ as a term or are you intending to rely on what the Federal Court is defining as good faith?

—I think the concept of good faith has been subject to a lot of judicial and other case law, so we would not be seeking to redefine it. We would leave that to the courts.

Mr ROBERT —Cognisant that good faith is being defined in different ways across the courts?

Mr D’Aloisio —Yes, I think so. I think there is a basic concept of honesty and integrity around good faith. Even though you might get slightly different definitions there is a central concept to it.

Mr ROBERT —With respect to training and minimum qualifications, you have made no reference to the minimum qualifications required of people nor with respect to what is required for someone to be called a financial advisor or a financial planner or a product adviser or all of these terms. I am cognisant we have taken advice that people are doing courses for as little as a week to nine days and are out popping product advice, advising people to put millions of dollars into different products, which in my humble opinion is sheer nonsense. Do you have any advice for the committee with respect to minimum training requirements or minimum accreditation?

Mr D’Aloisio —We think that minimum standards need to be lifted. We ourselves set the training regime and we have think we need to reassess that. Clearly, we are not at this point in a position to say to you that we are at point A on the graph and we have to go to point C. What we are saying is that the way forward is that we have to consult. If the committee’s approach is consistent with that and the government takes that on, what we would see happening is that we would consult quite widely with industry again on training and we would float and discuss key ideas about whether it will be a course that will run for a week or six months, whether it will be a diploma course, whether it will be equivalent to a degree course and so on. There are a lot of issues. Then there is of course the important issue of transition. What you do with the groups that are already out there giving advice, and how do you transition to this higher standard? Again, we do not apologise for the fact that we have not given you all the detail. We saw this very much as giving you direction in terms of where we think we need to go.

Mr ROBERT —I would have thought that one of the most significant outcomes we have seen in the last 18 months is that there is no accreditation process. If you were a chartered accountant, you would have sat the chartered accountant exam. But there seems to be nothing that accredits someone as a financial planner, financial adviser or product advisor.

Ms Bird —The document we handed up related to the table 2 reforms that we suggested. In our submission, we also put forward a forward program that ASIC felt that it should take on in light of its experience. We said that one of the key things in that forward program would be a review of the training standards, taking into account the sorts of issues that you have raised.

Mr D’Aloisio —They are good points. You may have a situation where, as there is to call yourself a solicitor, there is a training requirement and accreditation to call yourself a financial planner, authorised representative, financial adviser, product distributor or product salesmen. There are a whole lot of categories in this industry already and we really have to look at those categories and the training around them because we accept and the industry accepts that the training standards need to be lifted. In the process that Jo has outlined, we will consult widely and see what changes we need to make to one of our regulatory guides.

Mr ROBERT —What is your time line for that?

Mr D’Aloisio —It is in the forward program. This is certainly ongoing now.

Ms Koromilas —We have set standards. There are some minimum standards that are set, and those standards do apply depending on the type of advice that you are providing and the different products. That is one thing. Certain products that are deemed to be more of a risk or more complex require a higher level of training, which is to a diploma level. Those that are left, such as bank deposits and general insurance that are at a lower level, such as tier one, would probably be to a certificate III level. There are standards. I think the question you are raising is whether or not they should be higher. In that regard, we have a project in my team looking at the way in which training can potentially affect the quality of the advice. Fundamentally, what you want is advice that is provided to retail investors that is of a good standard. Where that standard sits is obviously really a question for what the legislation then puts forward. Because there are already close to 19,000 people in this country out there providing personal advice to retail clients, a lot of the work in that project needs to be considering and consulting. That project is underway and is considering potential changes that could be made to the training standards and all of the things we have discussed today. It will look to get out there and start consulting with the industry once we can set some ideas around where those training standards should actually—

Mr ROBERT —I think we can all violently agree that they are, at present, far too low. I will move on to recommendation 8, which is looking at remuneration models. I am cognisant from paragraph 177 and surrounding paragraphs in your submission that the market is moving towards shaking itself out on how it is going to remunerate itself. You have quite rightly pointed that out. You are looking for a recommendation here to legislate and to regulate exactly how commissions are paid. How would you reconcile that with the overarching belief in efficient market theory?

Mr D’Aloisio —These are the balances that need to be made. I think efficient markets work well if there is information symmetry and if indeed the disclosure regime on remuneration is not distorting investor behaviour or the behaviour of the financial planner or adviser. Our feeling is that we are not achieving the necessary level of disclosure and informed consent and, as such, sometimes you have to intervene and regulate. My understanding of market efficiency theory is not that there is no regulation; it is that there is limited regulation.

Mr ROBERT —Minimal regulation.

Mr D’Aloisio —In certain areas you do need to regulate. Every market is regulated.

Mr ROBERT —Granted, but I would not call this minimum regulation: knocking out upfront commissions, trail commissions and soft dollar incentives—some of these should go, you are quite right—volume bonuses, rewards and fees based on percentage. That is significant regulation.

Mr D’Aloisio —If we go back to the last 10 or 15 years, the existing model has been in operation and there are strong arguments that it has not worked. So you have left it to market efficiency to regulate these trail commissions and so on, and there is dissatisfaction with some of the outcomes. So I think as a regulator we need to point those things out to the committee. In the end it is a policy matter for government whether it seeks to intervene and ban these commissions or not. We are simply saying that, when we look at it and the way it has unfolded, this is an area that has to be or should be re-examined. We are not putting it any higher than that.

Ms GRIERSON —I would like to say firstly that the fact that you have recommended across such a wide range of areas is terrific and I think it reflects the work of this committee, in that it is obvious that it takes every measure to make an impact. So I think that is wonderful. In terms of your recommendation about a statutory compensation scheme, I think the industry would want to know a little bit more about what impositions that would require of them and whether that would then flow on to clients through fees or whatever.

Ms Bird —We have not recommended a statutory compensation scheme—I should say that to start with. What we have suggested is—

Ms GRIERSON —You have drawn attention to the problems with professional indemnity insurance.

Ms Bird —We have drawn attention to the existing compensation regime and we have pointed out that it is not a perfect form of compensation. But we agree it is an incredibly difficult question how you get that backstop and what the imposition on industry would be. We have just pointed the committee in the direction of a scheme that operates in another jurisdiction and pointed out the sorts of issues that need to be considered in the design of such a scheme.

Ms GRIERSON —It certainly should be considered. This is not really your area of responsibility, but besides the vulnerable people who were taking lump sum super or had redundancies or some sort of cash in their hands we also saw people who have access to reverse mortgages or to lines of credit that allowed them to put their homes at risk et cetera. Have you made recommendations to the lenders or to APRA regarding the tightening of that sort of leniency in terms of their loans regime?

Mr D’Aloisio —APRA regulates mortgages and so on, and it does that very well in terms of what it requires. We have worked through Delia Rickard’s area to improve disclosure around products like reverse mortgages and the unlisted, unrated debenture area—those areas that we think relate to the vulnerable groups that you are thinking about. Certainly the work that we did on reverse mortgages has been picked up in the credit reforms that are coming through. So they are there.

But, again, reverse mortgages are another example of these products we were talking about earlier that are attractive in the sense that they release some equity at a particular point of life, but they have the unpredictability of asset prices and interest rates—two components that can go in different directions. That puts a higher risk around that product, because it is a product aimed at a vulnerable group in the sense that at 60, 70 or 80 you do not have the ability to go back into the workforce. So that is an area that we have been concerned about. I think government has picked it up and we will continue with our efforts to make sure that the investors are really careful and understand what the outcomes of these sorts of products are.

Ms GRIERSON —If there is a tighter regulatory regime, and if people breach that regime, what do you envisage would be the action, enforcement measure or penalty that might flow from that?

Ms Rickard —In terms of reverse mortgages—

Ms GRIERSON —I just mean generally in terms of the recommendations before us. I am talking about if they do not meet the provisions for mandatory advertising, if they do not have a disclaimer on their advice or if they do not meet the disclosure provisions.

Ms Bird —The details I will have to take on notice. The new credit bill which is before the parliament involves licensing and special obligations such as responsible lending. It is a licensing regime so it would give ASIC all the administrative powers that come with a licensing regime as well as other enforcement remedies. I am not familiar enough with the bill to be able to tell you what all the remedies are for the various forms of breaches of the legislation.

Ms GRIERSON —The stick is not often the way we do things, but I think that down the track it probably needs some more consideration. Finally, and do humour me, but when I look up my superannuation in regard to making retirement decisions in the future I do hope that there is a pop up box that says, ‘You could lose the lot. Read this,’ or whatever with ASIC’s badge on it.

Mr D’Aloisio —That is a fair point.

Senator WILLIAMS —I thank the witnesses from ASIC for being here. Following on from Ms Grierson’s point about the risks of investing, you have, as I see it, stringent regulations for debenture-issuing companies where they have to say, ‘If you invest with us, you may lose some or all of your principal.’ I think the situation is that they cannot use the words ‘invest’, ‘deposit’ or those sorts of terms. Is that correct?

Mr D’Aloisio —They cannot use the words ‘term deposit’ or like a bank deposit et cetera.

Senator WILLIAMS —I guess what I am saying is that you have really strict regulations on debenture-issuing companies and obviously banks can go broke as well—we have seen that around the world, unfortunately; and hopefully that is not the case in Australia. The point I am getting at is that we see these products out there in the market. We have referred to ones that are heavily geared such as the Storm products—where people had their houses mortgaged to the hilt, were leveraged very high and had high LVR. Yet what we have heard through the submissions and in evidence given at public hearings—and we have travel extensively—is that they asked, ‘Is my house at risk,’ and they were told, ‘No, your house is safe as can be.’ So they never had those stringent warnings that you have on debenture-issuing companies, which may or may not go broke—I know some that are very sound. Should we have the same message and regulations on some of these investment products that you have on the debenture-issuing companies?

Mr D’Aloisio —I think, in the way that we are approaching some of these recommendations, you will see that we are moving in that direction. We talked earlier about advertising and what needs to be disclosed and not disclosed. So that is moving in that direction. The other thing to bear in mind is that, even though you might have out there some Storm models and we have had those issues, there has been a lot of financial advice and planners who have advised not to put the house at risk and have advised not to take margin loans beyond 30 or 40 per cent debt as opposed to 70 or 80 per cent debt. So there is evidence that people out there are acting responsibility in the way they are advising, and we have also had the ‘excesses’ or alleged excesses.

I think what this period is doing to us is causing us to really try and assess it—to sort out the chaff from the wheat, so to speak—and to focus these changes on those areas where people are most vulnerable and get ‘sucked in’ by some of these investments. So I guess to put it simply we are trying to target these changes that we are talking about to those areas that are going to need them, concentrating on the more vulnerable and the more risky products but still allowing the market to operate and allowing the operators who have been working well in this industry to continue to work well. While we can get it out of context, there was something in the order of $1 trillion under management in Australia before the recent issues arose. There is still a significant amount under management now. Yes, there was the impact from the stock market. But it is coming back now. It is a well-run, efficient and global industry.

Senator WILLIAMS —At some stage did ASIC give advice to the effect of ‘when investing, retail investors should swim between the flags’ or something like that? Did someone say that?

Mr D’Aloisio —Delia will talk about that. She is a good swimmer.

Ms Rickard —We have been looking at ways to engage people with basic investing messages. A lot of people think it is too hard, too complicated or too boring. So we have been looking for frameworks in which we can grab their interest and get them within their comfort zone. One of the ones we have been trialling is investing between the flags to look at what are safe investing behaviours.

Senator WILLIAMS —Who decides where the flags are put? That is what I am getting at.

Mr PEARCE —And where the sharks are.

Mr D’Aloisio —The fact that it is eliciting these comments is good because it is getting people to think about investment and to think about risk.

Senator WILLIAMS —The point I am making is that that is good of advice but, as I said, who decides where the flags are put, because obviously with many investments—such as Opes Prime and Storm—the flags were put very wide apart or maybe people swam outside the flags.

Ms Rickard —The way in which we have been using the metaphor has been around behaviours rather than trying to place products inside or out. We have a lot of separate information that we provide on FIDO and elsewhere about types of products, what the risks are and what the benefits are. We really take people through the pros and cons in detail, and we do that work outside of the use of the metaphor.

Mr D’Aloisio —To come back and speak generally for a moment, when you analyse it you say, ‘Well, what are the things that you would like to change to prevent some of the issues that have occurred?’ If investors thought in terms of understanding the risk-reward premium and understanding asset diversification then I think that would have gone a long way with some of the examples we heard earlier about people taking the whole of their super fund and putting it into a debenture or not understanding that a nine or 10 per cent return could actually mean that your principle could be at risk. So I think that, when you try to distil what happened in the market and bring it back to commercial concepts and investment concepts. a lot of our effort is going to go into getting people to understand those two basic issues: how does risk-reward work with investments and what does asset diversification mean. In the Storm model asset diversification included the house, for example. Is that a sensible asset diversification that you want given the way that Australians protect their home?

Senator WILLIAMS —The last thing I would like say is that we have heard about, and you would have been following this case of course, some outrageous actions carried out during the Storm product application. For example, figures were filled in on applications for loans where Storm clients did not know who filled them in. They never spoke to the bank. There were all these sorts of things going on. They were not speaking personally with the loans officers; they simply trusted their financial adviser. Do you have any comment to make on those sorts of activities, which have obviously been brought to the attention of this committee?

Mr D’Aloisio —You will know from my previous answers that I will not be drawn into the issue of Storm right now.

Senator WILLIAMS —Yes, but what about just as a general issue.

Mr D’Aloisio —As a general concept, the first line of defence in a loan application is the bank—the bank and its systems and its compliance systems have to be such that these things are carried out in accordance with the law and, more importantly, in accordance with the proper business practices that they operate under. There is no reason to think that banks in Australia do not do that. So that is the first line defence that you would see. If indeed that line is crossed then it is fraud; and we will get involved and we will investigate and we will take action.

Senator MASON —I would like to raise an issue that does not relate to your statutory responsibility, but given your expertise in the area and your experience I would welcome your comments. We have had a bank assert that it was standard industry practice to leave the transmission of margin calls to agents such as Storm Financial rather than contact their contractual clients directly. That is the evidence that we have heard. In the case of the Commonwealth Bank in Sydney we heard evidence that they first made margin calls directly to Storm in late September and then only started contacting clients directly in early December. That is about nine weeks later. Do you think that is prudent, principled and responsible banking?

Mr D’Aloisio —I think if I can say this, as I said in answer to Senator Williams, I will not get drawn into the specifics.

Senator MASON —But what about the principle?

Mr D’Aloisio —If the loan document provides that the lender will notify the margin borrower three days before they exercise their right to sell the shares, for example—as some margin loan agreements provide—I expect that they would comply with that. If they do not, they will breach their contract. If they have breached the contract, it does not require ASIC to take action.

Senator MASON —This is not about ASIC.

Mr D’Aloisio —If indeed the agreement, on the other hand, provided that the lender could exercise the right to sell the stock at any time for any reason at whatever time of day on whatever view it formed, the lender would say, ‘I have a term in a contract that enables me to do that.’ In that situation, under existing law, unless you can show unconscionable conduct or some other type of misleading conduct, the lender would have been entitled to do what they did.

Senator MASON —That was not my question. My question was whether it was principled, responsible and prudent.

Mr D’Aloisio —Again, the first line of defence on those sorts of issues is the chief executive and management of a lending institution and their customer relationships. I would expect that they turn their minds to those things every day and look at customer relationships and making sure they look after their customers. As a customer of a bank, if I was treated in that way, I would exercise whatever rights I had, and probably the best one I would have would be to move.

Senator MASON —Ms Bird, you mentioned in response to Mr Roberts’ question the amendments to the Corporations Act. Of course, margin lending has been brought within the Corporations Act.

Ms Bird —Yes.

Mr D’Aloisio —Yes, it has.

Senator MASON —Do you endorse what has happened in relation to the margin lending regulations? Do you think it is a good idea? Is that an improvement?

Ms Bird —Yes. ASIC made submissions to the Productivity Commission when it was looking at consumer law pointing out that margin lending was unregulated and suggesting it be brought into the Corporations Act.

Senator MASON —In relation to making that submission, were the events surrounding Storm at the top of your mind?

Ms Bird —No. I think it was prior to the events surrounding Storm that we made the submission.

Mr D’Aloisio —I think it was 2002—

Ms Bird —No. It was 2007.

Mr D’Aloisio —It was not even with the benefit of hindsight.

Senator MASON —Does that vindicate your submission?

Ms Bird —We think the regulation of margin lending will make a difference. There will be a responsible lending obligation, which should make a significant difference. The regulations suggest that one of the things that the lender will have to look at is making inquiries about whether someone’s home is at risk and whether the borrower has borrowed the capital to get the security for the margin loan. So, yes, we do think it will make a difference.

Mr D’Aloisio —What we did not anticipate—or the market did not—was the growth in margin lending that occurred in a very short space of time.

Mr PEARCE —While the market was going up.

Mr D’Aloisio —The market was going up at the same time. As you saw in many other things, the risk/reward got lost sight of.

CHAIR —Mr D’Aloisio, in your submission on page 35 you say there is a perception amongst some consumers that being an AFSL holder means that the licensee has been approved by ASIC or that it signifies the high quality of the financial services provided by the licensee. I am wondering whether you have any evidence of that. If you could take that on notice, that would be good. What I am interested in is: could that perception—particularly in relation to Storm—have come out the fact that people have said to us, ‘ASIC came in and did an audit and a compliance test and it came out clean, which is probably a good indication that there is nothing wrong with the business or the model or anything else. There was nothing of concern to ASIC.’ It just puzzles me. Either there is a deficiency in law in what was happening at Storm or there was a deficiency in the audit process or compliance checking. Without going into the investigations that you are carrying out, no-one today could possibly look at Storm and say everything was okay and that they met all their obligations. No-one could possibly imagine that was the case. What did ASIC miss?

Mr D’Aloisio —We have gone through in some detail, in the confidential parts of our submission, just what we did and did not do. I am happy to go into a private session and go through that. I have said publicly that we do not believe we missed the issues, and we have answered those questions in the public part of the submission as well. So I do not accept the premise that we are behind what has been missed here.

CHAIRMAN —I am challenging what you have put in your submission. You are saying there is a perception amongst consumers that, because they have a licence, they have suddenly gained credibility. Of course they have—they have been granted a licence. This was part of the point of asking you very early on about the licensing. If by the very fact of granting the licence you give them credibility, then that credibility does exist, but then that is divorced from the process of going in, auditing and checking a company and giving it a tick of approval, which is what happens. It is no longer a perception; it is reality.

Mr D’Aloisio —You are licensed to drive a vehicle and the RTA gives you that licence. If you are involved in an accident, is it the licence that is at fault? Is it the licence condition? Is it the fact that the RTA did not check you?

CHAIRMAN —But if I am checked or audited, re-checked and tested?

Mr D’Aloisio —All that licensing does is to set the minimum requirements which must be met. At the end of the day, under our system the boards and management have to run these things and make money for their investors.

CHAIRMAN —So there is a big gap in law. If you go in and audit a company and you cannot find anything wrong, you tick it off. There is a big problem in law.

Mr D’Aloisio —I do not accept that we ticked it off. That is where we disagree. If you would like to go into a private session, we can go through all that.

Mr ROBERT —I have one very quick question which I am sure you will be able to give a yes or no answer to.

Mr D’Aloisio —I will try!

Mr ROBERT —To flesh out how you would view a fiduciary arrangement based on good faith, let me give you a quick scenario that ASIC should be able to answer. If there were an organisation that was leveraging people to 90 per cent LVR, that was then leveraging unrealised gains to 90 per cent LVR, that had the same price and the same plan for everyone, that did not diversify at all but just shoved everyone into the same high leverage and that kept clients from speaking with their banks, do you believe that in that scenario there might be a threat that perhaps that organisation may not be fulfilling its fiduciary duty of good faith?

Mr D’Aloisio —I would have thought yes.

Senator McLUCAS —I have a quick question that goes to page 53 of your submission, paragraph 186. I know you are talking about a fiduciary style duty of advisers and a range of things that would not be permitted, including ‘rewards for achieving sales targets’. You are making that comment about financial planners and advisers, I imagine. Do you see, though, that the reward for achieving sales targets in the banking sector is also skewing the behaviour of players?

Ms Bird —You are right—the recommendations that we have made have been limited to providers of personal financial product advice, and obviously in other situations those sorts of targets could have the same distorting effect. But we are not making any suggestion in relation to that; we just suggest that the committee might want to look at whether there are other distorting effects of remuneration arrangements in other circumstances.

Senator McLUCAS —You may have seen the evidence given in Townsville around the changing lending targets that were applied to the Commonwealth Bank in that particular agency.

Ms Koromilas —The submission in relation to the reforms suggests that potentially you may want to consider where there is an execution only service or where there is general advice provided as well. So it is not limited to personal advice but relates to the situations you are describing, which would typically be either a general advice situation or potentially just execution only, where someone comes in and says, ‘This is what I want,’ and there is merely the execution.’ Those things are put into the submission for further consideration.

Ms GRIERSON —I am looking at an article in the Sydney Morning Herald today: ‘ASIC plans call for “super-regulator”‘. It is apparently an exclusive. It does say that you seek these extra powers so that you would be able to address business models that are seen as risky. Are you confident that the set of recommendations that you are putting forward for a new regime would always support the clear identification of risky business models?

Mr D’Aloisio —First off, the journalist has taken licence with the submission that you have been given. ASIC has not called for a super-regulator and ASIC has not called for a Wallis-style inquiry. What I think the journalist picked up is what is in the submission before you, and the earlier discussion we were having about a re-examination of the balance between market efficiency and regulation. On the second part of your question, I would say that, clearly, we have given a lot of thought to these risks and how to deal with them as part of what this committee’s work is doing, concentrating heavily on the retail investors, financial consumers, the mums and dads and the retirees. With the benefit of the experience we have had with the market, we think the reforms that we are talking about are things you should consider and governments should consider. Beyond that, we are doing a lot of other work and there are other areas we are concentrating on, but we are not purporting to have a panacea to deal with all the issues that are out there at the moment.

Mr PEARCE —Mr D’Aloisio, Can I just quickly ask you one question about paragraph 15 of your submission. Before I ask you a question about that, I do note what you say in paragraph 16, the following paragraph. But, you say in paragraph 15:

The primary causes of these collapses—

that is, the ones listed above this paragraph: Storm, Opes, Great Southern, Timbercorp, ABC Learning, Allco, and Babcock and Brown—

and corporate failures were the market downturn and flawed business models …

Can you confirm to the committee that it was not a result of the law?

Mr D’Aloisio —No. Let me explain. There is no question at all that, with the market downturns and everything else, the business models that relied heavily on rising asset prices and leverage were flawed and proved to be flawed. The prime responsibility for those flawed business models is what I talked about earlier—the first and second line of defence, boards and executives. We have gone on to say: that does not mean that as part of those collapses—

Mr PEARCE —I know that.

Mr D’Aloisio —there has not been wrongdoing.

Mr PEARCE —I know that. But you are saying to the committee that the primary reason is that it was not the law’s fault, that it wasn’t a bad law?

Mr D’Aloisio —No; we are saying that within the existing law there could have been wrongdoing and we are investigating and taking action. Then we are going further and saying that, with the benefit of knowing what has occurred, and in trying to look at how to avert similar issues in the future, we think the committee should look at some basic changes to the law in the areas we have talked about. So we are saying: yes, the flawed business models and the economic times we are in—

Mr PEARCE —The primary—

Mr D’Aloisio —broad issues. There were failures. There was possible wrongdoing, which we are investigating. Industries responded and want us to make some changes. We are saying, ‘We think you have to go further or should think about going further.’

Mr PEARCE —Okay. Thank you.

CHAIR —Thank you very much for appearing before the committee tonight.

[8.10 pm]