Culture cops: Crafting asic’s regulatory vision

The persistent regulatory scrutiny of Australia’s financial institutions is to intensify with the Abbott government’s announcement of a review into the capabilities of the Australian Securities and Investments Commission (ASIC). The corporate watchdog’s powers will surely be expanded once the review is complete by the end of 2015. But in what ways? And to what end?

The announcement of the review was widely predicted: it is part of the Government’s response to the Financial System Inquiry (Murray Inquiry) which itself recommended periodic reviews of the capabilities of ASIC to ensure that it has the skills and culture to execute its role.

It also reflects the reality that ASIC’s responsibilities have increased over time and now traverse regulatory supervision and enforcement of company and financial services laws in the markets, consumer, investor and creditor spheres.

But bigger questions loom large: should the regulator switch to a user-pays, industry-funded model to give it the enviable war chest of some of its international counterparts? Does the watchdog need its own prosecutorial arm to enable more active pursuit of criminal prosecutions rather than handing responsibility to the Commonwealth Director of Public Prosecutions?

This may well address recurrent criticism that ASIC, too often, pursues civil action and enforceable undertakings at the expense of criminal convictions. And, if it is to become a regulator with sharpened teeth, then must it be freed of its public service remuneration and reward model?

Recent statements by ASIC provide some insight into the likely implications of this capability review and the way in which the domestic regulatory landscape will be reshaped. A more prescient warning of what lies ahead for Australia’s targeted institutions and gatekeepers can also be found in recent offshore experience, especially in the United Kingdom - where institutions grapple daily with the dictates of the Financial Conduct Authority (FCA) - and in the United States where, between them, the Securities Exchange Commission (SEC) and the Consumer Financial Protection Bureau (CFPB) robustly control the agenda. It is all the more important to look offshore as the terms of reference of the capability review command consideration of comparable international regulators.

Empowering culture or enculturating power?

The future Australian regulatory landscape for financial institutions was succinctly framed by Mr Greg Medcraft, Chairman of ASIC, in his 14 August 2015 statement to the Parliamentary Joint Committee (PJC) on Corporations and Financial Services.

Mr Medcraft addressed three issues that underpin, and will circumscribe, the future regulatory scene: the ASIC capability review, the recently announced policy statement on recovering the cost of investigations and ASIC’s revised Strategic Outlook.

Capability Review - conceptual aspirations

The Murray Inquiry recommendation that ASIC’s regulatory activities be funded by industry is one of the key drivers underpinning the capability review. The point is simple: the current tax-payer funded model is insufficient to sustainably finance a regulator whose statutory remit,  level of activity and intervention has markedly expanded and will continue to do so.

ASIC is not the only regulator that will be reviewed: it is simply the first. This is again consistent with the recommendation of the Murray Inquiry that each of the financial regulators undergo periodic capability reviews - but ASIC should be the first, given the significant changes recommended for its funding and powers.

Mr Medcraft has made ASIC’s position clear on the link between regulatory outcomes and funding. In his words: “… we consider we are effective and efficient within the resources we have”. So query what could be achieved with an expanded war chest. At a minimum, the regulator will require substantial additional resources if it is to be effective in implementation of its forthcoming Strategic Outlook.

Capability reviews of federal government departments are not unusual. More significant is the regulatory driver justifying an enhancement of ASIC’s capability; that is, tackling what ASIC sees as poor culture within the financial services industry and focusing proactively on promoting a positive culture.

Recovering the cost of investigations

The first step in enhancing regulatory capability through a user-pays regulatory model is the recovery of investigatory costs. On 29 July 2015, ASIC announced it would now use its power to recover expenses and costs of its investigations which ultimately result in a conviction or judgment.

This decision is effective immediately in respect of new investigations and will apply to current investigations unless proceedings are on foot, charges have been laid, an agreement has been reached in respect of investigation costs or if it would be unfair in the circumstances.

ASIC has existing statutory power to recover investigation costs where there has been a successful prosecution or civil proceeding. But the fact that this power has so rarely been used in the past highlights the renewed determination of ASIC to install a user-pays model and we should now expect to see more frequent recovery of the costs of an investigation from targets.

Interestingly, these investigation costs are not ‘litigation costs’ which may be awarded by the court in the resulting prosecution or civil proceeding but can include direct investigation expenses and costs such as the salary of the investigating ASIC staff member and the costs of external legal counsel and experts.

In order to determine whether such an order should be made, ASIC will consider a variety of factors including impecuniosity, exceptional hardship, the amount recoverable, the extent of ASIC’s success in the proceedings and, importantly, the degree of cooperation given to ASIC’s investigation. Extraordinarily, an investigation costs order will be enforceable in court as a debt due to ASIC and non-compliance can result in a penalty of $8,500 or imprisonment for one year or both.

There is nothing accidental in ASIC’s determination to now activate a power that has otherwise lain dormant for 14 years. It is a pre-emptory strike by a regulator seeking to articulate the case for an expanded resource base as it moves into the capability review.

It also comes at a time when ASIC is, according to earlier statements on 3 June 2015 to the Senate Economic Legislation Committee, discussing with the Director of Public Prosecutions the pursuit of a criminal prosecution of an institution under the Commonwealth Criminal Code.

Subsequently when addressing the PJC on 14 August 2015, Mr Medcraft made it clear that the first target for cost recovery will come from the ongoing investigation into banks in relation to the alleged manipulation of the bank bill swap rate. Market participants would query whether there is a link.
In any event, the law supporting cost recovery has now been jolted from its slumber and institutions exposed to an ASIC investigation need a system of internal cost-capture to provide baseline data as at least one benchmark measure for reference when responding to an ASIC investigation cost recovery order.

Culture and ASIC’s Strategic Outlook

Following on from its first published Strategic Outlook (for 2014-15), ASIC is expected (at the time of writing) to publish its Strategic Outlook for 2015-16 in late August 2015. Based on Mr Medcraft’s statement to the PJC, we understand that its likely focus will include understanding behavioural insights of investors and gatekeepers and ensuring ASIC has the right ‘nudges’ to achieve these objectives. For gatekeepers, the three key behavioural drivers are culture, incentives and deterrence.

Culture is accordingly at the epicentre of ASIC’s focus, a position reinforced by Report 444: ASIC enforcement outcomes: January to June 2015. In that report, ASIC expresses its concerns about culture and that the trust and confidence between institutions and investors has been eroded.

The Strategic Outlook for 2015-16 is expected to zero in on culture in a number of ways as ASIC seeks to incorporate “examinations of culture” into its regulation of conduct. The means by which it will do so include:

  • risk-based surveillance reviews of culture;
  • analysing that data to enhance the understanding of how culture drives conduct; and
  • intervening where culturally-related conduct problems are identified.

The sheer cost of poor conduct is part of ASIC’s justification for making a substantial investment in regulating culture. Report 444 recites that during 2008 to 2012, the cost of poor conduct for the 10 most affected global banks was approximately US$250 billion. On top of this, since 2011, 60% of UK bank profits have been paid in fines and repayments to customers. And in August 2015, The Economist reported that US banks paid, in 2014 alone, more than US$80 billion in fines and penalties for regulatory breaches.

Embedding cultural change is equally a regulatory imperative of the UK and the USA It will also be squarely on the agenda of the global taskforce established this year by the International Organization of Securities Commissions (IOSCO) which will look at retail and wholesale conduct issues and the range of enforcement tools available to regulators.

Lessons from the UK and USA

In its last two pioneering Business Plans, the FCA set the pace for a cultural shift within institutions towards celebrating good conduct that places consumer interests and market integrity at the heart of the financial sector. Two recent key initiatives at the core of the FCA’s ambitious regulatory innovations are also under consideration by the SEC in the USA and are readily transportable to Australia. For that reason they justify careful consideration as ASIC moves towards release of its latest Strategic Outlook.

Individual accountability

First is the FCA’s recently announced Senior Managers Regime and Certification Regime, which commences on 7 March 2016. While the Senior Managers Regime will ensure that senior managers can be held accountable for any misconduct that falls within their areas of responsibility, the new Certification Regime and Conduct Rules aim to ensure individuals working at all levels in banking maintain appropriate standards of conduct.

The Senior Managers Regime focuses on individuals who hold key roles and responsibilities in institutions. This regime will involve allocating and mapping out responsibilities and preparing Statements of Responsibilities for individuals carrying out Senior Management Functions. It requires institutions to ensure that they have procedures in place to assess the fitness and propriety of senior managers but it goes one step further.

The Certification Regime applies to other staff who could pose a risk of significant harm to an institution or any of its customers (for example, staff who give investment advice). Institutions will be required to have in place procedures for assessing the fitness and propriety of staff, for which they will be accountable to regulators. This is supplemented by the Conduct Rules which set out a basic standard for behaviour that those covered by the new regimes will be expected to meet.

The new regime has teeth. The FCA may take disciplinary action in the form of a penalty, suspension or restriction on function should there be a finding of misconduct. At the extreme end, a person will be liable to criminal conviction and even imprisonment if they are responsible for a decision which results in the failure of a financial institution.

Realigning risk and reward: clawback

The second international regulatory development, driven by the FCA (in this case) together with the Prudential Regulation Authority, is an extension of the bonus claw-back period of up to seven years for senior managers. This comes together with a deferral of bonuses for as long as seven years for senior managers and five years for all other staff who take material risks.

These changes give the UK one of the most stringent regimes for governing bonuses and pay and places it well beyond the European Union minimum (40% of variable pay deferred for at least three years).

This regulatory imposition is obviously directed at aligning remuneration and outcomes through rewarding senior managers in positions of responsibility for behaviour which fosters a culture of effective risk management.

Meanwhile, the SEC has taken steps to ensure shareholders are provided with information to evaluate a CEO’s compensation. These new rules require disclosure of the ratio of the compensation of its CEO to the median compensation of its employees.

It is important to remark that the senior manager regime and the remuneration rules are innovations drawn from countries where the global financial crisis bit hard, institutions were identified as having deeply systemic flaws and deficient cultures and draconian regulatory intervention was vital. However, the influence of and implications arising from these developments for the Australian financial industry and the extent to which they will gain interest during the ASIC capability review or in the upcoming Strategic Outlook remains a matter for speculation - and considered reflection. 


Scott Atkins

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Scott Atkins Partner

Scott is the Chair of our Board and an internationally renowned insolvency and restructuring lawyer. He is an inaugural Fellow and a member of the Board of INSOL International. Scott is also Vice President of the Australian Restructuring Insolvency and Turnaround Association (ARITA).

Scott is a trusted adviser to Australia's leading banks and insolvency and restructuring practitioners and has acted on some of the industry's most complex and sensitive banking and insolvency advisory and dispute resolution matters.

Prior to joining HDY, Scott practiced for 7 years as in-house counsel with Commonwealth Bank Group. He is now our Client Relationship Partner for the CBA Group. He is also the co-leader of our cross-border insolvency practice and our regulatory enforcement practice. Scott is recognised by his peers for his leading expertise in cross-border insolvency, acting on both inbound engagements in Australia and advising Australian clients on outbound engagements in the USA, UK, Cayman Islands, Hong Kong and The Netherlands, among other jurisdictions.

Scott was the Australian delegate on the Advisory Committee on Comparative Law established by the American Bankruptcy Institute as part of its Commission to Study the Reform of Chapter 11 of the US Bankruptcy Code. This resulted in a landmark report for the reform of Chapter 11.

He is a published author on insolvency and cross-border insolvency. Most recently, Scott was one of the Australian contributors to the 2015 publication 'International Contributions to the reform of Chapter 11 U.S. bankruptcy code' which is volume 2 of the European and International Insolvency Law Studies series. He also authored the Australian chapter of Avoidance of Antecedent Transactions and Cross-Border Insolvency (INSOL International). Among other publications, he is the co-author, together with Professor Rosalind Mason, of the Australian chapter of Look Chan Ho's leading text: Cross-Border Insolvency: Cases and Materials (Kluwer International).

Scott is a visiting lecturer on cross-border insolvency at the University of Sydney in its undergraduate and postgraduate law programs lead by Professor John Stumbles.

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