Bigger sticks, smaller budget: ASIC's enforcement in 2015

In brief

In 2014, the Australian Securities and Investments Commission (ASIC) was chastened by the Senate Economics References Committee, which wants ASIC to be more effective, but encouraged by the Financial System Inquiry, which wants ASIC to take on greater powers. Meanwhile, the Federal Government has reduced ASIC's funding. The release of ASIC's latest six-monthly enforcement report and its updated regulatory guide on enforceable undertakings provides an opportunity for Partners Matthew McLennan and Alex Cuthbertson and Associate Catherine Li to consider how ASIC might reconcile its competing enforcement priorities in 2015.

Which enforcement areas have come under pressure to change?

Broadly speaking, both the Senate Committee and the Financial System Inquiry (the·FSI) have urged ASIC to be given more teeth and to use them more aggressively. In particular, they recommended changes in the following enforcement areas:

To the extent these changes require legislation, it seems unlikely that they will take effect in 2015. That does not, however, mean that ASIC will not seek to pursue these objectives using its existing regulatory toolkit.

What competing pressures does ASIC face?

The negative media reporting in the wake of the Senate Committee and FSI recommendations no doubt compounded the pressure on ASIC. At the same time, however, ASIC must handle any expansions in its enforcement approach within the confines of its changing funding realities.

In the May 2014 federal budget, ASIC's funding was slashed by around $120 million over four years. In the current financial year, ASIC will lose 12 per cent of its operating budget and 209 staff, which is in addition to the 59 already lost in the past year. The ASIC team responsible for financial advisers – a regulated population of particular interest in 2014 – has held nine times more industry meetings (192 meetings compared to 22 in the previous year) using less staff (28 compared to 29). In the coming year, ASIC will also be forced to reduce proactive surveillance substantially.⁸

While diminishing resources are unlikely to translate rapidly into drastically different enforcement outcomes, the latest enforcement report does show that a total of 604 enforcement outcomes were achieved in 2014, down from 711 in 2013.9 Taking into account the time lag for matters to progress from surveillance to enforcement, it is conceivable that the anticipated loss in staff and surveillance could reduce ASIC's enforcement outcomes in the coming years.

In response to the budget cuts, ASIC has proposed a new funding model under which regulated industries pay a levy to ASIC for policing them. The user-pays model is supported by the FSI¹⁰ and, if approved by the government, could raise a reported $287 million for ASIC's operations.¹¹ However, the design and implementation of that funding model remains uncertain.

What changes are likely to happen?

Faced with competing demands, ASIC's enforcement approach will have to address this question in 2015: If the legislative changes recommended by the Senate Committee and the FSI are not made in the near future, how will ASIC achieve the objectives of those recommendations using its existing powers and within its funding constraints?

Tougher, clearer and more transparent EUs

EUs have been a favoured tool in ASIC's enforcement kit. In the past two years, EUs and negotiated outcomes comprised around 6 per cent of all enforcement outcomes, double the number of civil penalty actions taken by ASIC.¹² It may not be practical for ASIC to reverse that trend in the short term. Instead, ASIC has announced that where it negotiates agreed outcomes through EUs in the future, the terms of those EUs will be as specific and clear as possible and the monitoring more independent.¹³

On 19 February 2015, ASIC released an update to its regulatory guide on EUs, RG 100, which was last updated three years ago.¹⁴ The update appears to be geared towards strengthening the impact of EUs by improving the transparency of the EU process and the reporting of compliance outcomes. Major changes to RG 100 include:

• A new subsection expanding the possible terms imposed by EUs to include 'community service obligations' under which a promisor may be required to disgorge unlawful profits, fund education programs or pay money to charities.
• A new section explaining that ASIC will publicly report on a promisor's compliance with undertakings for all EUs accepted on, or after, ⁹ March 2015.
• A new section on the involvement of independent experts, including ASIC's review of independent expert reports, the appointment of independent experts (whether by ASIC or by the promisor), ASIC's assessment of the independence of the expert and its management of potential conflicts of interest, and the publication of summaries of expert reports.

Additional licence conditions as a step-up from EUs

While the FSI recommended that ASIC be given more power to address systemic compliance issues by imposing licence conditions, according to ASIC it already has the power to do so. ASIC states, in Regulatory Guide 98, that it can impose a range of licence conditions such as precluding an AFS licensee from providing certain types of financial services, and compelling it to engage an independent external consultant to provide ongoing remediation reports to ASIC.¹⁵

The imposition of additional licence conditions on two financial planning businesses in August 2014 (albeit by consent) is a timely example of ASIC utilising the AFS licensing regime as a more serious alternative to entering into an EU. It is conceivable that ASIC will continue to exercise its licensing powers in a more flexible and assertive way in 2015, pending any legislative reform.

Greater control over and broader use of independent experts

In the updated RG 100, ASIC has detailed its new approach to engaging independent experts in the EU process, especially around issues such as expert independence and conflicts of interest. In practice, ASIC appears to have also taken heed of the Senate Committee's criticism of its earlier selection of a global accounting firm as the independent expert reviewing a financial planning business' EU. In November 2014, ASIC appointed a local advisory practice to oversee compliance with the additional licence conditions mentioned above. ASIC announced that the form was chosen following a competitive tender process.¹⁶ The appointment of a local firm may signal ASIC's move away from relying on the big four accounting firms as independent experts, and may become more commonplace as ASIC exerts greater control over the selection and conduct of independent experts engaged to monitor regulated entities.

The Senate Committee and the government alike have also contemplated that ASIC may appoint independent experts to assist with investigating and reporting on regulated entities in the earlier stages of enforcement.¹⁷ Such appointments would give ASIC the benefit of shifting parts of its enforcement costs onto the regulated entities who would be asked to fund any independent expert reviews. In the context of EUs, this has already been expressed through the updated RG 100, which provides that where ASIC appoints an expert, the promisor must bear the cost of the expert's work.¹⁸

More investigation and litigation against large businesses and in areas of interest

As discussed above, ASIC may not have the resources to abandon negotiated settlements and pursue civil and criminal litigation across the board. However, the Senate Committee's call for increased litigation was only directed at 'the big end of town'.¹⁹ This sentiment was echoed by ASIC in its latest enforcement report, which highlighted the recent civil penalties imposed on big companies.²⁰ As a further illustration of ASIC's increased pursuit for higher civil penalties, on 19 February 2015, ASIC obtained its largest civil penalty ever when the Federal Court awarded penalties totalling $18.975 million against a payday lender and a loan funder for their failure to comply with the National Consumer Protection Credit Act 2009 (Cth).

ASIC may be able to spare the investigation and litigation of large and complex cases from the brunt of its budget cuts through the use of its Enforcement Special Account, which was established in 2006 for that very purpose. Over the past three years, ASIC has steadily built the balance of the Enforcement Special Account from $20 million to $51 million; a further $30 million will be received in the present financial year.²¹ While the government rejected the Senate Committee's recommendation to bolster the balance of the Enforcement Special Account even further, it accepted that ASIC should be allowed to better utilise the account, and reduced the annual threshold that ASIC is required to spend on each case before accessing the account from $1.5 million to $750,000, effective from 1 July 2014.²²

This change could cause a fiscal bias in ASIC's choice of enforcement targets, as it enables ASIC to devote additional resources on pursuing fewer, larger, businesses and matters in its current and future areas of interest, which include serious corporate fraud and financial market benchmark rates (both the possible manipulation of the Australian bank bill swap rate (BBSW) and conduct surrounding the WM/Reuters fix rate).²³ In the second half of 2014, ASIC already accessed the Enforcement Special Account to cover its ongoing costs of monitoring the financial planning arms of major banks.²⁴ As at December 2014, ASIC was reportedly spending 20 per cent of its market enforcement resources on its BBSW investigations.²⁵ In 2015, these extensive monitoring and investigative activities may well result in well-funded major litigation being brought by ASIC against key industry players.

More criminal penalty actions pending introduction of heavier penalties

ASIC restated its case for higher penalties in its latest enforcement report, highlighting the penalties available to overseas regulators and citing the need to 'amplify the fear of prosecution' particularly by large firms.²⁶

It is difficult to predict the extent to which the law will be changed to grant ASIC's wish in this respect; the FSI for one has cautioned against introducing 'the extremely high penalties for financial firms recently seen in some overseas jurisdictions'.²⁷ In the interim, ASIC may be inclined to make more frequent use of criminal penalty proceedings to increase the severity of its enforcement actions, especially against large businesses. This would be feasible as the number of criminal proceedings commenced by ASIC has actually fallen in the past three years, comprising only 65 per cent of total enforcement outcomes in 2014 compared to 71 per cent in 2013 and 74 per cent in 2012.²⁸

Exercise of greater banning powers remains uncertain

In the event ASIC is given additional power to ban financial advisers from managing or holding positions of influence in a financial services company, there will be practical obstacles to ASIC wielding that power to its full extent.

As a starting point, ASIC will have to increase its commitment to pursuing individuals. It will need to establish that the relevant individual has in fact supervised or managed the provision of financial services by others, and an expansive banning order is warranted to drive cultural changes within the organisation in question and remove that person from the industry entirely. The Senate Committee has noted that such powers should only be available in limited cases of egregious breaches, and that the affected individuals should have access to robust procedural safeguards, including the right to appeal to the Administrative Appeals Tribunal (AAT).²⁹ However, ASIC has had mixed successes in defending the use of its existing banning power before the AAT. Since 2006, there have been 12 reported reviews of banning orders imposed by ASIC; of these, ASIC's banning orders were reduced in length in four cases and set aside or stayed in another three. It therefore remains to be seen whether, and to what extent, ASIC will be able to exercise greater banning powers over individuals.