Morbid fascination, peppered with dismay and cautious optimism.
That’s how I describe my feelings about Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
The commission recently published its interim report. It’s well-written and it’s straight-shooting.
Below are some of the themes and comments I found especially interesting.
Although the findings are specific to Australia, I think many of the comments, and lessons that can be learned, are applicable to New Zealand.
Dishonesty and greed
The report doesn’t mince words. Based on the evidence, it appears that there’s an enormous amount of dishonesty and greed in the financial services industry:
- “Two themes recurred: dishonesty and greed.”
- “Too often, the answer [for why bad conduct occurred] seems to be greed – the pursuit of short term profit at the expense of basic standards of honesty.”
- “Much if not all of the conduct identified in the first round of hearings can be traced to entities preferring pursuit of profit to pursuit of any other purpose.”
- “Whether the conduct is said to have been moved by ‘greed’, ‘avarice’, or ‘the pursuit of profit’, it is conduct that ignored the most basic standards of honesty.”
The issue isn’t “bad apples”
“That generally similar conduct occurred in all of the major entities suggests that the conduct cannot be explained as ‘a few bad apples’. That characterisation serves to contain allegations of misconduct and distance the entity from responsibility. It ignores the root causes of conduct, which often lie with the systems, processes and culture cultivated by an entity.”
The law doesn’t need to change. Enforcement needs to change.
This is a practical point that New Zealand’s Financial Markets Authority (FMA) and our representatives in parliament can take away from the interim report’s findings.
There are a variety of instances where the report says the law doesn’t need to change (or if it does, it should be simplified):
- “Much more often than not, the conduct now condemned was contrary to law. Passing some new law to say, again, ‘Do not do that’, would add an extra layer of legal complexity to an already complex regulatory regime. What would that gain?”
- “adding a new layer of law and regulation would serve only to distract attention from the very simple ideas that must inform the conduct of financial services entities”
- “no new layer of law or regulation should be added unless there is clearly identified advantage to be gained by doing that.”
The following comment should strike the heart of any senior person of a regulator, whether that be ASIC or the FMA:
- “The law sets the bounds of permissible behaviour. If competitive pressures are absent, if there is little or no threat of enterprise failure, and if banks can and do mitigate the consequences of customers failing to meet obligations, only the regulator can mark and enforce those bounds. But… the Australian Securities and Investments Commission (ASIC) [has not] done that in a way that has prevented the conduct described in this report. // Why not?”
The report basically says that ASIC should reconsider how it enforces the laws it is responsible for regulating:
- “When deciding what to do in response to misconduct, ASIC’s starting point appears to have been: How can this be resolved by agreement? // This cannot be the starting point for a conduct regulator. When contravening conduct comes to its attention, the regulator must always ask whether it can make a case that there has been a breach and, if it can, then ask why it would not be in the public interest to bring proceedings to penalise the breach. Laws are to be obeyed. Penalties are prescribed for failure to obey the law because society expects and requires obedience to the law.”
- “if ASIC has a reasonable prospect of proving contravention, the starting point must be that the consequences of contravention should be determined by a court.“
- “In some cases, there may be real and lively debate between ASIC and an entity about the breadth and operation of the applicable provisions. But if there is, it may be all the more important to commence litigation than attempt to settle it. Only the courts can give binding interpretations of applicable law and, if there is doubt about the reach of particular provisions, it will often be better that the doubt is resolved once for all than allowed to linger. Resolution of the doubt will guide future conduct by all regulated entities.”
- “I do not accept that the appropriate response to the problem of allocating scarce resources is for a regulator to avoid compulsory enforcement action and instead attempt to settle all delinquencies by agreement.”
In other words: ASIC should be much more actively litigating breaches of the financial services laws.
I think the FMA should be doing the same. What’s the point of having laws if they’re not enforced?
Asset-based fees and on-going service arrangements
On my reading, the report is critical of the traditional business model for financial advisers providing investment-related advice – where adviser lock clients into ongoing service arrangements and charge clients asset-based fees.
(Full disclosure: I may be reading into this, because it vindicates Fairhaven Wealth’s business model, which is fiercely independent, charges fixed fees, is advice-only, and doesn’t lock clients into ongoing arrangements.)
- “it is general industry practice for platform operators to charge fees calculated by reference to the amount of funds under administration and not as a fixed fee. This method of charging appears to owe much more to history than any other reason and its persistence suggests that there are not strong competitive pressures at work.” (This comment relates to platform operators, but I’d argue the same is true with financial advisers.)
- “making an ongoing service arrangement gives the adviser a financial advantage. The adviser stands to earn, and to continue to earn, annual amounts from the client. The less the adviser does before the fee is paid, the greater the financial advantage”
- “If done properly, an annual review might require the application of a deal of time, skill and judgment. Whether it did would depend not only upon the skill and diligence of the adviser but also upon what investments the client had, whether the client’s circumstances had changed and whether investment conditions had changed either generally or in relation to one or more of the products in which the client had invested. Absent extraordinary external events or radical change in the client’s personal position, it would be very easy to provide the service with little time and little effort. And, as pointed out above, the less the work that is done, the greater the financial advantage to the adviser.”
- “the fees charged under ongoing service arrangements were, and still are, often charged ‘invisibly’: by being deducted from the client’s investment accounts”. (How are opaque fees in the interest of consumers? When do consumers choose opaque fees over transparent fees?)
- “despite clients not coming to an adviser asking for ongoing advice, most clients of [Westpac’s representatives] would be on an ongoing advice arrangement”. (In other words, clients were directed into ongoing arrangements when this isn’t what they were after.)
The following comments were specific to intermediaries such as mortgage brokers, but I’d say it applies more broadly:
- “arguments [against changes to remuneration practices] based on predictions of industry damage or collapse should be examined with special care.”
Sunshine is the best disinfectant. The specific examples of misconduct in the report break my heart. But I look forward to the hearing more from the Royal Commission and seeing positive changes for consumers as a result of this painful exercise.
Whether New Zealand has an equivalent commission or not, I hope the lessons that are learned in Australia turn into positive outcomes for Kiwi consumers as well.
The comments in the interim report should be considered by local financial institutions, advice practitioners, regulators, and policymakers.
But I’ll add one other comment. The thing that ultimately influences and “regulates” the behaviour of for-profit organisations is the bottom line. Consumers need to expect more from the organisations providing them with products and services. If you’re a consumer and you’re not getting what you want, you need to walk and look for organisations that provide what you’re after.
Appropriate regulations, and appropriate enforcement of these regulations, will help enormously. But if Kiwis vote with their dollars, I have no doubt that the conduct of these organisations will change for the better.