'Tough cop' ASIC vs a Royal Commission

In brief

Written by Partner Paul Nicols and Managing Associate Edward Martin

Has talk of a royal commission turned the ASIC Capability Review into an unlikely catalyst for an enhanced enforcement agenda?

Having waited patiently for the publication of the ASIC Capability Review since December last year, we got more than we bargained for when it was published on 20 April.

With Labor pushing hard for a royal commission into the banking and financial services industry and an election looming, the Government moved swiftly to announce broad reform measures to equip ASIC with stronger powers and funding (largely through the new 'user-pays' model), as well as a new Commissioner with a financial crime prosecution background, to ensure that, in ASIC, Australia has a 'tough cop on the beat' that can respond to misconduct and launch prosecutions. ASIC is tough but it's going to be an even tougher enforcer, we are told.

The Government's approach also pays heed to ASIC's consistent calls for more powers and tougher penalties for breaking financial laws in line with other countries, in which context Greg Medcraft memorably described Australia as 'a paradise for white collar crime' in October 2014 . What is a bit puzzling about the Government's 'tough cop' announcement, however, is that it was couched as a response to the ASIC Capability Review report (the Report). The Report, however, didn't exactly toe the 'ASIC needs more funding and powers to be a more effective enforcer' line.

The Government's reform package will enhance and, to some degree, transform ASIC's enforcement agenda and processes and it received the immediate and relatively vigorous support of the Australian Bankers' Association, so it is worth taking some time to consider the Report to which the reforms are said to respond, as well as the wider context, to understand them and how they are likely to unfold. It's useful first to have in mind the Government's key enforcement reforms.

Enforcement and consumer protection in the reform package

The Government's reform package, with funding totalling $127.2 million, is expressly aimed at better enabling ASIC to combat misconduct in the banking and financial services industry. Key reforms directly relating to enforcement and consumer protection include:

• $9.2 million in funding for ASIC and the Treasury to accelerate implementation of, among other things, a review of ASIC's enforcement regime, including penalties, to ensure that it can effectively deter misconduct. This is to ensure ASIC has the powers it needs to protect consumers and 'police' the financial sector.
• $57 million in funding for increased surveillance and enforcement on an ongoing basis in the areas of financial advice, responsible lending, life insurance and breach reporting.
• $61.1 million to enhance ASIC's data analytics and surveillance capabilities as well as improving ASIC's information management systems.
• The appointment of an additional Commissioner with a financial crime prosecution background.
• ASIC to work with Financial Ombudsman Service (FOS) on a review of FOS's small business jurisdiction, including whether it should cover a wider range of small business loans and a review of monetary limits and compensation caps.
• Establishing a panel of eminent persons to review (and report by the end of 2016 on) the role, powers and governance of all of the financial system's external dispute resolution and complaints schemes and assess the merits of better integrating these schemes.

ASIC Capability Review – ASIC already has 'too heavy an emphasis on enforcement'

Despite what one may think when looking at these reforms, the review was not a review of ASIC's enforcement capability. The capability review terms of reference, set in July 2015, cast the review in the context of the Government's consideration of the Murray Inquiry recommendation for ASIC's regulatory activities to be funded by industry (which the Government announced, with the reform package, will commence in the second half of 2017). The review was to consider how ASIC uses its resources and powers to deliver its statutory objectives and assess ASIC's ability to perform as a capable and transparent regulator.

The Report focused on a number of high-level themes including the effective use of ASIC's governance architecture, reorienting ASIC for greater external focus and implementing a cultural shift to become less reactive and more strategic and confident.

Some key observations relating to ASIC's enforcement role in the Report were:

• ASIC has a tendency to be reactive and is often excessively issue driven (that is, responding to high-profile events) rather than strategic in its focus.
• ASIC has too heavy an emphasis on enforcement (often a reactive tool) in the articulation of its role, often describing itself as an 'enforcement agency' above all else.
• Notably, some 38 per cent of ASIC's resources are allocated to the enforcement function, which is significantly greater than domestic and international peer regulators.
• In the result, the Review said: 'While enforcement is a critical element of ASIC's toolkit, especially in terms of its deterrence impact and overall credibility of the regulator, in the Panel's view, a better balanced approach emphasising the full scope and use of ASIC's regulatory toolkit would be more appropriate for a modern and dynamic conduct regulator.'
• The origin of ASIC's culture is, partly, the 'police-like' culture of its predecessors, the ASC, NCSC and the Corporate Affairs Commissions of the states. The 'police-like' culture is distinct from the culture of a conduct regulator with enforcement powers like ASIC is today. ASIC's internal culture is more defensive, inward looking, risk averse and reactive than is desirable for a conduct regulator.
• ASIC's approach to litigation sometimes lags behind recent progress made by other Australian regulators.
• There is a perception that ASIC's selection of cases for litigation can be risk averse (tending to prefer cases with a higher probability of success, rather than selecting cases that have strong merits, but also allow ASIC to test the veracity of the law).
• Although not specifically an enforcement issue and hardly controversial, it was also noted that data management and analytics should be improved across ASIC. This is indirectly relevant to ASIC's ability to deal with large volumes of data in investigations.

In short, as it related to enforcement, the Report recommended allocating resources based on strategic priorities (likely meaning allocating less to enforcement); rebalancing ASIC's communications about its enforcement role; and enhancing its enforcement effectiveness through developing a more targeted risk based approach to litigation. There was no mention of the need for additional powers or increased penalties or, indeed, additional funding for enforcement.

ASIC's stated actions in response to these recommendations, set out in Appendix E to the Report, do not exactly suggest that a significant change in practice will be implemented to put them into effect. For example, on the question of resource allocation, ASIC simply says that it will 'continue to' deploy resources according to strategic priorities.

Finally, given the Government's announcement of a new commissioner with a prosecution background, it's worth also noting that the Report recommended the elevation of the current commissioner role to that of a full time non-executive function, with commensurate strategic and accountability focus, free from executive management responsibilities – the concern partly being that the dual non-executive and executive line management role of the commissioners undermines accountability as commissioners cannot effectively detach themselves from their executive concerns when acting in their governance role. Appointing a further commissioner based on a criminal prosecution background rather than strategic conduct regulator nous perhaps suggests the Government's regard for this recommendation.

The royal commission context

As the Report does not sit comfortably with the Government's 'tough cop' enforcement position, it's perhaps more useful to consider the political context – being Labor's call for (and the Government's rejection of) a royal commission – to understand the Government's reform package and what it is likely to mean.

Royal commissions can be very wide ranging (even evolving) in scope, whether brought under the Royal Commissions Act 1902 (Cth) or bespoke legislation, gather extensive amounts of information (for which there are broad powers) and result in the production of a report and recommendations (rather than a judgment or findings) by an eminent lawyer (or small group of eminent commissioners).

Although Labor has not published proposed terms of reference, they have said that the royal commission into misconduct in the banking and financial services industry would examine, among other things, the extent of illegal and unethical behaviour in Australia's financial services industry; the culture, ethical standards and business structures of Australian financial services institutions; whether Australia's regulators are really equipped to identify and prevent illegal and unethical behaviour; and comparable international experience with similar financial services industry misconduct and best practice responses. In particular, Labor has highlighted vertical integration and internal pressure to cross-sell products (and hence wealth management businesses at some banks) as an area worthy of particular scrutiny.

The outcome of Labor's proposed royal commission is difficult to predict but it's clear that ASIC's enforcement powers and practices will once again be in the spotlight.

The reform package and ASIC enforcement

Of most immediate interest to ASIC following the announcement of the reform package is the prospect of increased civil and criminal penalties, with Commissioner Greg Tanzer quoted in The Australian on 27 April 2016 making the case for higher penalties and disgorgement of profits to bring the penalties ASIC can extract into line with its foreign counterparts (such as in the US and UK). Against the background of calls for a royal commission, it is easy to see an argument being made for increasing the penalties to which Australian financial institutions are potentially subject for misconduct. Financial institutions will also, no doubt, have a keen interest in the progress of the FOS and external dispute resolution/complaint scheme reforms, which could ultimately impact operations and the risk profile of certain business lines.

In addition, it seems to us that the reforms could well have a direct impact on ASIC's enforcement activity in a number ways. For example:

• Data requests: ASIC has said that the volume of data collected by ASIC in the evidence gathering stage of investigations is increasingly too large for keyword searches and manual reviews of subsets of documents to be effective and efficient¹. Funding for improved data analytics capabilities could mean broader and more inclusive document and information requests from ASIC, rather than more targeted requests for relevant documents, on the basis that ASIC will locate the relevant documents itself using advanced forensic tools.
• Breach reporting: Part of the Government's funding package is directed toward increased surveillance and enforcement in relation to breach reporting. Breach reporting has been on ASIC's agenda for some time. For example, ASIC has stressed AFS licensees' obligations under s912D of the Corporations Act 2001 (Cth) to report significant breaches to ASIC as soon as practicable (and in any case within 10 business days) noting that breach reports are an important source of intelligence for ASIC. Failure to comply with s912D obligations is an offence. Financial institutions should not be surprised if breach reporting is a significant focus for ASIC in coming months.
• Industry funding enforcement: The primary element of the Government's reform package is the introduction of the 'user-pays' model, which is discussed elsewhere in this edition. At present, an effective handbrake on the number and scale of investigations into financial institutions is ASIC's budgetary constraints. With a 'user-pays' model, and in the absence of effective transparency and accountability measures (which the ABA will no doubt push for), the handbrake is off.

Conclusion

The nature of the reform package announced by the Government is likely to mean that the comments and recommendations in the Report will be quietly set to one side. The Government has set up a 'tough cop on the beat' ASIC against Opposition calls for a royal commission. ASIC's police-like enforcement agency persona is likely to overwhelm the Report's vision of ASIC as a strategic conduct regulator, at least in the near term.