Comprehensive response to combating superannuation investment fraud

Recommendation 1(a):

The committee acknowledges the shortcomings, identified by Mr Richard St. John, of a statutory compensation scheme for consumers of financial services, and a scheme of financial assistance for investors in managed investment schemes along the lines of Part 23 of the Superannuation Industry (Supervision) Act 1993 (SIS Act). However, the committee recommends that further efforts be made to investigate avenues to protect investors in the case of theft and fraud by a managed investment scheme.

The Government accepts the recommendation

The Government will consult on:

• changes to the Corporations Law to strengthen the professional indemnity insurance requirements of providers of financial services (see response to Recommendation 2.1 of St. John report). The changes would:
  • give legislative force to key aspects of ASIC standards of adequacy for professional indemnity insurance such as the scope of cover, policy exclusions and coverage of representatives;
  • require licensees to report annually to ASIC, as part of their financial reporting requirements, on the adequacy of their professional indemnity insurance cover.
• risk management processes by a responsible entity of a registered managed investment scheme that deal explicitly with the risk of fraud.
  • This will be included in a consultation paper on improved governance arrangements for a responsible entity of a registered managed investment scheme which will respond to several recommendations of this report. The consultation paper will have regard to related Stronger Super reforms, for example, in relation to dual regulated entities.

Recommendation 1(b):

The committee recommends that the government assist those who invested in the Professional Pensions Pooled Superannuation Trust (PPPST), and were induced to move their funds to the ARP Growth Fund.

The Government notes the recommendation

• Part 23 of the SIS Act excludes self-managed superannuation funds (SMSFs) from compensation as they are not regulated by the Australian Prudential Regulation Authority (APRA).This exclusion applies regardless of whether they invested in the PPPST.

Recommendation 2:

The committee recommends that consideration be given to improving the active detection of investment fraud through systems that can identify 'outlying' patterns in investment performance. To this end, the committee encourages partnerships between the regulators and experts in the private sector.

The Government accepts the recommendation

• The Government will task the Heads of Commonwealth Operational Law Enforcement Agencies to consider systems and other approaches that can assist in identifying 'outlying' patterns in investment performance and other fraud indicators.

Recommendation 3:

The committee recommends that the Australian Taxation Office (ATO) include a clear, understandable, large print warning on its website that SMSF trustees are not covered in the event of theft and fraud. This warning must be effectively communicated to all existing SMSF trustees through the guidance material of the Australian Securities and Investments Commission (ASIC).

The Government accepts the recommendation

• The ATO has updated its website indicating that SMSF trustees do not have the same access to compensation as APRA-regulated funds in the event of theft or fraud.
• ASIC has also updated its MoneySmart website material on SMSFs to warn consumers about access to compensation.

Recommendation 4:

The committee recommends that the guidance material provided by the ATO for SMSF investors clearly state the difference between the protections and compensation arrangements for investors in funds regulated by APRA as distinct from the limited protections available to SMSF investors.

The Government accepts the recommendation

• The ATO will seek to amend its registration process to add additional warnings that SMSF members are not eligible for compensation.
• ASIC will also consult on requiring advisers, on the establishment of SMSFs, to advise clients that they do not have access to compensation arrangements under the SIS Act.

Recommendation 5:

The committee acknowledges the Future of Financial Advice reforms, particularly the provisions addressing conflicted remuneration. Nonetheless, it recommends that ASIC conduct a specific and detailed investigation of both planners' and accountants' advice to SMSF investors in Trio Capital. This investigation must examine what information was provided to these investors regarding their duties and responsibilities, and whether they were informed—either verbally or in writing—that they are not entitled to compensation in the event of theft and fraud.

The Government accepts the recommendation

• ASIC has already undertaken a detailed and specific risk based investigation of people who provided financial advice relating to Trio.
• As part of the investigation, ASIC identified inadequate disclosure, including on the relationship between Trio/Astarra, by financial advisers. ASIC has undertaken a range of actions on various financial advisers who advised on Trio, including banning and cancelling their licences.

Recommendation 6:

The committee recommends that the Government consider whether current processes are adequate when there is a change of ownership or control of a company which holds an Australian Financial Services Licence (AFSL), or whether there is a need for more detailed scrutiny of the new owner.

The Government accepts the recommendation

• The Government will consult on whether ASIC should have more powers when an AFSL holder changes ownership. Currently, ASIC's powers to cancel an AFSL are limited. This can allow industry entry to a person who would have failed the 'good fame and character' licensing test if they had sought the licence directly.
• As part of the same process, the Government will also consult industry on APRA's powers for licensing superannuation funds. An internal review concluded that APRA's powers to approve or refuse a change in superannuation fund ownership were limited (see response to Recommendation 13).

Recommendation 7:

The committee recommends that the Government investigate options to improve the oversight and operation of compliance plans and compliance committees. The committee suggested a number of improvements that could be made including the detail to be included in the plans, qualitative standards and approval processes for auditors, director liabilities and competence of compliance committee members.

The Government accepts the recommendation

• The Government will consult on ways to enhance compliance processes including considering the need for more detailed compliance plans, legislating minimum requirements (such as experience and qualifications), qualitative standards for compliance plan auditors and oversight of the appointment of compliance committee members. This will be included as part of consultation on improved governance arrangements for a responsible entity of a registered managed investment scheme which will respond to several recommendations of this report.

Recommendation 8:

The committee recommends that as part of its review of regulatory arrangements relating to custodians, ASIC should consider changing the name 'custodian' to a term that better reflects the current role of a custodian. This new term—reflecting the limited role of custodians—must be used in Product Disclosure Statements.

The Government accepts the recommendation

• ASIC has released a consultation paper about the use of the label custodian and its use within disclosure documents. This work will be progressed in the context of ASIC's recently released report into custodian services in Australia.

Recommendation 9:

The committee recommends that the government release a consultation paper to investigate the best mechanism for a responsible entity of a registered managed investment scheme to disclose its scheme assets at the asset level. The objective must be to enable scheme members to legally require specific information on the portfolio holdings of the registered managed investment schemes in which they have invested.

The Government accepts the recommendation

• The Government will consult on the disclosure of managed investment scheme assets, having regard to the Stronger Super reforms on portfolio holdings disclosure by superannuation funds. This will be included as part of consultation paper on improved governance arrangements for a responsible entity of a registered managed investment scheme which will respond to several recommendations of this report.

Recommendation 10:

The committee recommends that ASIC provide all necessary funding for PPB Advisory to pursue its investigation to a full conclusion, including where necessary conducting examinations on oath of figures such as Mr Jack Flader and others it considers necessary as part of the investigation. The committee recommends that ASIC fund the phase 2 investigation by PPB Advisory as a matter of urgency.

The Government accepts the recommendation

• ASIC has provided the funding requested by PPB Advisory in accordance with the rules of the Assetless Administration Fund (AA Fund). ASIC will consider any future requests it receives for funding from PPB Advisory in accordance with the rules of the AA Fund.

Recommendation 11:

The committee recommends that the Australian Federal Police, in cooperation with ASIC and APRA, pursue criminal investigations into—and, where applicable, criminal sanctions against—the key figures responsible for defrauding investors in Trio as a matter of high priority.

The Government notes the recommendation

• The Government notes this recommendation as the decision to investigate possible criminal offences is a matter for the Australian Federal Police. ASIC is cooperating with, and providing relevant information to, the Australian Federal Police. It is not appropriate to discuss the content of that information or the likely outcome of any possible AFP assessment.

Recommendation 12:

The committee recommends that the government investigate the options for a scheme to recover assets from those found to be personally involved in fraud and theft, with the proceeds to go to those found to have been defrauded.

The Government accepts the recommendation

• The Government will task the Heads of Commonwealth Operational Law Enforcement Agencies to consider the matters raised in this recommendation.

Recommendation 13:

The committee recommends that APRA conduct an internal assessment of the adequacy and timeliness of its checks to monitor the ownership of superannuation vehicles. This process must review why key 'trigger points' in events that led to the collapse of Trio Capital were not identified.

The Government accepts the recommendation

• APRA has undertaken an internal review of the adequacy and timeliness of its checks to monitor the ownership of superannuation entities following the collapse of Trio. The Government's Stronger Super reforms strengthen APRA's ability to address emerging issues within superannuation through providing APRA with the ability to issue prudential standards and broader data collection powers. The internal review concluded, however, that APRA powers to approve or refuse a change in superannuation fund ownership remain limited. The Government will also consult industry on APRA's powers for licensing superannuation funds.
• The Government will also release a paper by the Treasury in relation to the Trio Capital fraud and an assessment of the regulatory framework.

Recommendation 14:

The committee recommends that the Australian Federal Police consider the options to create an organisational focus on the matters pertaining to superannuation fraud. This should occur in close consultation with the Australian Crime Commission given its work in coordinating Task Force Galilee.

The Government accepts the recommendation

• The Government will task the Heads of Commonwealth Operational Law Enforcement Agencies to consider opportunities to enhance fraud detection capabilities.

Recommendation 1

It would be inappropriate and possibly counter-productive to introduce a last resort compensation scheme at this stage.

The Government accepts the recommendation.

• The Government's decision is made in the context of the significant reforms, including Future of Financial Advice (FOFA) and Stronger Super, to raise conduct standards in the financial industry. Industry is in the process of adjusting to those reforms, which require licensed participants to put the best interests of consumers ahead of their own, and have a wide reach in the industry (affecting financial advisers, margin lenders, credit providers and mortgage brokers, and trustees and directors of APRA regulated superannuation funds).  The benefits of this additional consumer protection are still emerging, and are expected to see a decline in financial adviser misconduct (which has triggered compensation awards to date).
• In making its decision the Government is mindful of case evidence that a small proportion of consumers awarded compensation do not receive their full entitlements if the licensee becomes insolvent. It recognises the human cost borne by individuals involved in such cases. There is an incomplete picture about the number of consumers affected and the scale of loss that remains uncompensated. To assist in any future reconsideration of a scheme, effort will be put into improving data collection on consumer losses resulting from licensee misconduct.
• The Government accepts other changes recommended by the St. John report, particularly the strengthening of professional indemnity insurance and capital requirements for AFS licensees (referred to specifically below). The changes have a twofold affect. First to improve the capacity of a licensee to pay compensation when required at levels assessed to be adequate for their business. Second to provide a more rigorous regulatory platform for considering a last resort scheme in the future, which is more in keeping with other parts of the financial system where last resort schemes apply.
• The Government will leave open for future consideration the need for a last resort scheme which will take account of any residual level of under-compensation after improvements in the industry's conduct standards. Any additional protection of this type would better protect consumers but at a cost to all other licensees in the financial industry.
• In the current adjustment phase, the industry will not be asked to contribute to other licensees' compensation shortfall. The Government encourages professional bodies to themselves consider possible solutions to the issue of under‑compensation, such as the implementation of their own professional body scheme which further protects retail clients in the event of a member insolvency.

Recommendation 2.1

Require licensees to provide ASIC with additional assurance that their professional indemnity insurance (PII) cover is current and is adequate to their business needs.

The Government accepts the recommendation.

• The Government will consult on draft legislative amendments to the Corporations Act to strengthen the professional indemnity insurance (PII) requirements of providers of financial services. The legislative amendments would:
  • give legislative force to key aspects of ASIC standards of adequacy for PII, such as the scope of cover, policy exclusions and coverage of representatives;
  • require licensees to report annually to ASIC, as part of their financial reporting requirements, on the adequacy of their PII cover.

Recommendation 2.2

More attention should be given, on a risk targeted basis and in conjunction with the level of their insurance cover, to the adequacy of licensees' financial resources to enable better management of risks and unexpected costs such as compensation liabilities.

The Government accepts the recommendation.

• ASIC is already undertaking a sector‑by‑sector review of licensee capital adequacy requirements, with the first changes commencing on 1 November 2012 for responsible entities of managed investment schemes and with other sectors consulted on, or notified of the timeframe or possible outcomes for their sector.
• ASIC will continue to consult stakeholders as it progresses its sector‑by‑sector review.

Recommendation 2.3

ASIC should take a more pro‑active approach in monitoring licensee compliance with the requirement to hold adequate PII cover and any new requirement in regard to financial resources, and in targeting licensees who are most at risk.

The Government accepts the recommendation.

• The Government will support ASIC in this objective by the proposed legislative changes on PII (see recommendation 2.1) which will give ASIC additional information on which to base its risk-based assessment and monitoring of licensees. The process proposed in response to Recommendation 2.4 will also consider ASIC powers in support of its role in regulating this sector.

Recommendation 2.4

To assist ASIC in playing a more pro‑active role in administering the licensing regime with respect to compensation arrangements, consideration should be given to clearer powers to enforce standards and to sanction licensees who do not comply through:

• powers to deal with phoenix activity, both through licensees establishing new entities or by former directors who re-emerge in the industry as authorised representatives;
• ability to deal with disreputable industry participants; and
• access to an infringement notice regime.

ASIC for its part should be prepared to take action in appropriate cases to enforce its published views of what is required by the licensing conditions on insurance cover or financial resources. In the event that it becomes apparent that the current legal framework provides insufficient basis for effective enforcement action, consideration should be given to clearer legislative backing for regulatory standards on the adequacy of insurance or financial resources.

The Government accepts the recommendation.

• The Government will consult on measures to increase the flexibility of ASIC's enforcement and compliance powers, dealing with the matters in this recommendation and in recommendation 6 of the Trio Report.
• Since 1 July 2012 ASIC has had additional powers to deny, suspend or cancel licences and to ban individuals from the financial services industry (implemented through the Corporations Amendment (Future of Financial Advice) Act 2012).

Recommendation 2.5.1

In dealing with licensees who give up their licence or reduce the scope of their licensed activities, ASIC should seek, where possible to secure ongoing protection for retail clients including by imposing appropriate conditions in relation to the termination of a licence or the amalgamation or takeover of a licensed business.

The Government accepts the recommendation.

• ASIC imposes varied licensing conditions (for example by requiring continued External Dispute Resolution (EDR) scheme membership and PII cover) wherever possible when a licensee voluntarily ceases to trade, amalgamates or gets taken over, though insurers determine whether to extend insurance cover in such circumstances.

Recommendation 2.5.2

There are risks to consumers where they deal with financial services providers that:

• have a licence, but operate beyond the scope of that licence because they provide products or services that are not covered by the licence; or
• should be licensed under the Corporations Act but are not,

and accordingly have limited or no compensation arrangements.

While acknowledging the difficulties in identifying outlaw activity, the importance of concerted enforcement effort by ASIC to police the boundaries of licensed financial service activities is emphasised. In its approach to the handling of complaints about outlaw activities ASIC should be transparent and provide as much feedback to complainants as possible in order to encourage further assistance.

The Government accepts the recommendation.

• ASIC has advised the Government that it will continue to police the licensee perimeter in accordance with its risk-based approach to monitoring and surveillance. ASIC welcomes both licensees and consumers voicing their concerns when they observe suspicious or risky behaviour in the industry. In the past four years ASIC has taken action against several unlicensed operators.
• The Government is establishing a process to improve information exchanges between relevant agencies to detect investment fraud and identify criminal activity (see recommendation 2 of Trio Report). 

Recommendation 2.5.3

(a)Where a licensee (or its administrator or liquidator) does not respond to claims from a consumer or the licensee cannot be contacted after reasonable inquiry, ASIC should be able to provide the consumer with information it has about the insurance policy including the name of the insurer and the policy number. This would assist the consumer to decide whether there is a prospect of recovering compensation should the claim proceed and be successful.

(b)The third party rights provisions of the Insurance Contracts Act 1984 should be extended, as was proposed by a review of that Act in 2004, to apply where a consumer cannot recover compensation awarded against the insured and there is capacity to meet that liability from the insured licensee's PII policy.

The Government accepts the recommendation.

• The Government will ask the Insurance Reform Advisory Group (IRAG) to consider the balance of benefits to consumers in the limited circumstances described and the possible imposition on insurers that provide PII to a licensee that cannot be contacted by a consumer with a compensation claim after reasonable inquiry. The IRAG will be asked to consider this issue as part of its 2013 agenda. The Government will consider the advice of IRAG before determining whether, and in what form, any policy intervention is required.

Recommendation 2.5.4

ASIC should give further consideration, in its approach to the adequacy of PII cover, to the treatment of defence costs with a view to striking a reasonable balance between the interests of licensees and insurers on the one hand, and consumers on the other.

The Government accepts the recommendation.

• ASIC has advised the Government that it will reconsider the treatment of defence costs in the next update of its regulatory guidance on Compensation and insurance arrangements for AFS licensees (RG 126). ASIC will consult stakeholders on proposed changes to the regulatory guide.

Recommendation 2.5.5

Given their key role in the regime for the protection of consumers of financial services, and marked increases in their jurisdiction, EDR schemes and ASIC should give more attention to the adequacy of the EDR scheme processes as those schemes grow beyond their origins as forums for small claims. Issues for consideration include: rights of review; transparency; capacity of a member to join in a proceeding other members that might be liable; cost contribution by complainants; liability standards; relevance of regulatory guidance and other operational issues discussed in Chapter 2.

The Government notes the recommendation.

• Similar issues have been raised with ASIC in prior consultations but were found not to fully support the governing principles for EDR schemes of 'accessibility, independence, fairness and efficiency' and government benchmarks which include the provision of dispute services free to consumers. On balance, such changes have not been pursued.
• There are opportunities for continued improvements to the operation of EDR schemes through ASIC's ongoing processes (involving EDR schemes, industry associations and consumer representatives) and periodic independent reviews of individual schemes.

Recommendation 3.1

As a matter of strategic approach, it would be timely to review the present relatively light handed regulation of certain product issuers, in particular managed investment schemes, including the possible need, in accord with developments at the international level, to move to a somewhat more interventionist approach.

It would be appropriate also, in the course of any such review, to direct more attention to the responsibilities of licensees who provide financial products for retail clients. While the review has not had an opportunity to test these proposals, a first step might be to consider measures along the following lines by which product issuers would be expected to assume more responsibility for the protection of consumers of their products:

(a) Subject product issuers to more positive obligations in regard to the suitability of their product for retail clients.

Such obligations might be applied in particular to managed investment schemes in issuing products to the retail market, and would apply at each stage of a product's life cycle including its distribution and marketing. Amongst other things, the product issuer might be required to state the particular classes of consumers for whom the product is suitable and for whom the product is unsuitable, and the potential risks of investing in the product.

A stronger approach by managed investment schemes to the management of risk of fraud, particularly by employees or representatives, might also be sought.

(b) Consider the development of standardised product labelling so that financial products, particularly managed investment schemes, are described on a consistent and more meaningful basis.

This might apply to such terms as capital guaranteed, capital protected, conservative, balanced, diversified, growth, defensive, fixed interest, or hedged, as well as other like descriptors.

(c) While the review has not looked into these matters in any depth, the significance of the role of gatekeepers, such as research houses, should be kept in mind in any strategic consideration of consumer protection in the financial services sector.

The Government notes the recommendation.

• The Government will consult on improved governance arrangements for a responsible entity of a registered managed investment scheme in response to several recommendations of the Trio report.
• As noted in response to recommendation 1, the industry is adjusting to significant reforms. For similar reasons, the Government is mindful not to undertake the recommended review of the responsibilities of managed investment schemes at this stage.
• The Government will leave open the possibility for such a review in the future, and will monitor changes made by international regulators to strengthen the responsibilities of product issuers, such as for managed investment schemes, in their jurisdictions.

Recommendation 3.2

Some rebalancing of responsibilities of product issuers and financial advisers towards retail clients could be addressed through changes to the operation of EDR schemes by resolving the inability of EDR schemes to apportion responsibility for misconduct amongst responsible licensees. The operating rules of EDRs should be changed to enable them to make awards that recognise the proportionate liability of product issuers, financial advisers or other licensees.

Further, consideration should be given to the clarification of clause 5.1(i) of the terms of reference of Financial Ombudsman Service (FOS) which excludes consideration of disputes about the 'management of the fund or scheme as a whole'. The aim would be to remove any doubt about the ability of FOS to deal with consumer disputes in respect of misleading product disclosure statements or other practices of issuers in marketing their products.

The Government notes the recommendation.

• See response to recommendation 2.5.5.