By George Gilligan, UNSW

SYDNEY: 13 June 2014 – In June and July 2014 two very significant reports regarding the Australian financial sector are scheduled to be issued. On 15 July 2014 the Financial System Inquiry (FSI) chaired by Mr David Murray AO will publish its Interim Report. Following the release of the Interim Report, the FSI Committee will undertake a period of stakeholder consultation which will include: a second round of submissions; sector briefing sessions; public forums; and stakeholder meetings. In addition, the FSI Committee will travel overseas between Saturday 19 July and Friday 1 August to consult with international stakeholders. Prior to the release of the FSI Interim Report, the Senate Economics References Committee will release its final report on the performance of the Australian Securities and Investments Commission (ASIC). The Senate Committee had intended originally to publish its final report by 30 May 2014 but on 28 May 2014 the Committee tabled an interim report requesting an extension of time to present its final report. The Committee now intends to table its final report no later than 26 June 2014. The controversial revelations and their implications that prompted the report being delayed are discussed in this article.

The Senate Economics References Committee and ASIC have had a testy relationship over the last year. The inquiry into the performance of ASIC itself was referred by the Senate on 20 June 2013. It was prompted by the Committee’s dissatisfaction with the manner in which ASIC had responded to whistleblowers within Commonwealth Financial Planning Limited (CFPL) who had first tipped-off ASIC about alleged wrongdoing within CFPL in October 2008. CFPL is a wholly owned subsidiary of Australia’s largest bank the Commonwealth Bank of Australia (CBA), CFPL operates under the business advice structure of Colonial First State (CFS) which is also part of CBA. Whistleblowers at CFPL including Mr Jeff Morris, allege that they first anonymously blew the whistle to ASIC in October 2008 about Mr Don Nguyen and some of his CFPL colleagues, not only that they engaged in systematic misconduct involving substantial numbers of clients and up to $300 million in client money for which they had responsibility, but also that files relative to this activity were being ‘cleaned up’ within the bank. Some of the alleged misconduct by Mr Nguyen has been reported by the Sydney Morning Herald to include: forging client signatures, creating unauthorised investment accounts and overcharging fees, with some clients losing more than half their life savings. Eventually in August 2010 CFPL implemented a client compensation program, in March 2011 Mr Nguyen was disqualified from providing financial services for 7 years and in October 2011 ASIC entered into a two year enforceable undertaking with CFPL.

In its evidence in the June 2013 hearing before the Senate Economics Legislation Committee ASIC pronounced itself satisfied with this regulatory response but Members of the Senate certainly were not. Senator Cameron put on formal notice to ASIC Deputy Commissioner Mr Peter Kell a series of questions not only about Mr Nguyen, but also about the procedures of ASIC in these contexts and how financial institutions like CBA value integrity in their operational cultures and workplaces. For example, Senator Cameron queried what would be the implications if financial planners could resign on the basis of illness when they had been engaged in illegal activities and then walk away to another financial planning agency. Also whether it was appropriate for the CBA or any agency, when they knew that their officer had acted illegally, to first of all offer a pittance to resolve the losses of the individuals and then progressively up the offer and put these individuals through more stress. Senator Cameron directly asked Mr Kell whether such behaviour was a culture or a process in financial organisations and what could ASIC to do to resolve such situations, including what checks and balances could ASIC use to ensure banks and financial organisations put in place procedures to stop such abuse happening in the future.

Senator Cameron asked important questions about the core operational cultures of financial institutions, not only what value they place on prioritising the well-being and best interests of their clients, but also the integrity of the people whom they employ and the extent to which they promote integrity within the workplace environments that they control. Senator Cameron’s questions also highlighted whether the requirements that ASIC demands through its enforceable undertakings regime place sufficiently stringent conditions on financial professionals whose business strategies are damaging to their clients’ best interests. The revelations of May and June 2014 suggest that in relation to not only CFPL, but also Financial Wisdom, (another significant financial planning subsidiary owned by CBA), that they do not.

For example, in May 2014 following investigations by Fairfax Media and the ABC Four Corners program, it was revealed that ASIC had given inaccurate testimony to the Senate Committee because it had relied on information supplied by CFPL. In particular ASIC had not been aware that the compensation payments given to former clients of CFPL and Financial Wisdom had not been the same despite both being CBA financial planning entities. ASIC expressed ‘extreme disappointment’ with CBA and regretted that it, [ASIC], had misled the Senate Committee.

The particular Fairfax Media/Four Corners investigation had centred on Rollo Sherriff and other financial planners at a Cairns based financial advisory firm Meridien Wealth, which was an authorised representative of Financial Wisdom, which was in turn a wholly owned subsidiary of CBA. Sherriff was Meridien Wealth’s star financial planner writing extremely large amounts of business, often based on risky margin lending strategies, many of which were inappropriate for his clients. Sherriff’s inappropriate financial advice strategies were known within the CBA from the early 2000s. In fact in October 2004 the Financial Planning Association withdrew Sherriff’s status as a certified financial planner for five months, but Financial Wisdom fought this disciplinary action on Sherriff’s behalf. Eventually in 2010 CBA launched an investigation into Sherriff which has resulted in more than $7 million compensation to nearly a hundred clients. However according to May 2014 media reports: ‘The actions of Sherriff were buried by the bank, with clients forced to sign confidentiality agreements in order to receive compensation.’

The revelations are enormously embarrassing for CBA as they attest to poor cultural practices regarding regulatory compliance. The bad news on the giving of financial wisdom by Financial Wisdom and CFPL has not stopped coming for either CBA or ASIC. In June 2014 it has emerged that ASIC’s investigations in 2006 found evidence that in ASIC’s view there seemed to be a ‘correlation’ between the totals of business written by CBA’s financial representatives and whether CBA chose to revoke an authorisation, with high producers not being sanctioned by CBA. Despite these insights the subsequent insufficient regulatory response by ASIC towards CBA subsidiaries has been well documented. However, the power of bad publicity to change this dynamic has been amply demonstrated in recent weeks as CBA has scrambled to protect its reputation and ASIC has been more proactive in its dealings with CBA. On 6 June 2014 the Australian Financial Review reported on what it sees as a breakdown of trust between ASIC and CBA, with the regulator pushing for tighter licensing conditions for CBA financial planning representatives.

The concerns of the financial press have been echoed by the Senate Committee. Its Chair Senator Mark Bishop requested that ASIC consider placing increased conditions on CBA’s licence in relation to its compensation processes. Senator Bishop admitted that he was to an extent confounded by the current inquiry because he did not have a clear idea of what its outcome should be and he was: ‘..unclear what has occurred.’ As the earlier discussion details the Senate Inquiry began in June 2013 with a sense of dissatisfaction with ASIC’s regulatory performance. Senator Bishop’s admitted confusion at this late stage of the inquiry about what its outcome should be attests to the complexities of regulating financial services and the dilemmas that regulatory actors in this space face.

The CFPL and Financial Wisdom scandals are windows on the deep-rooted misbehaviour that can become entrenched in the selling of financial products and services. Law breaking and deviant behaviour can become socially normative within any company or industry, especially if industry leaders, board members or senior managers set moral codes which may facilitate regulatory deviance. Corporate cultures do not exist in a vacuum; nor are they mere reactive responses to externally mandated rules. Instead they reflect the values of the organisation and its people. The most significant element in regulatory compliance is the choice by people to comply. This occurs as part of their reflexive theoretical understanding of their own personal standing within an organisation or industry, and/or in response to their own sets of normative values. This is perhaps the area of greatest potential for improving behaviour in the Australian financial sector, impacting upon individuals within organisations and activating their own value systems to work towards crime prevention, reducing and/or eliminating bad behaviour in organisations, re-aligning incentive structures, improving organisational cultures and prioritisation of the public interest.

These issues should be core to how Senator Bishop and his colleagues frame their final report with the objective of improving financial regulation wisdom. It is not simply an issue of sets of quantitative performance metrics that might be imagined for ASIC or indeed any regulatory actor, metrics that ultimately may prove rubbery in nature. Quantitative measurement should be involved in a regulator’s remit, but the Senate Inquiry should also consider recommending regulatory strategies that combine more robust processes and standards on harder strategies such as licensing conditions and remuneration systems, with softer professional educative and other normative initiatives that sheet personal and collective accountability within financial institutions, especially in the area of financial advice to investors. The performance of the regulator has to have an element of impacting positively upon the predominant cultural mores of an industry and its constituent organisational actors, the regulator cannot achieve this without sufficient regulatory tools and resources underpinned by political will.