Chapter 10: Other Issues

The purpose of this Chapter is to address some of the many issues that may be considered subsidiary or consequential in the design of compensation arrangements. These include the treatment of APRA-regulated bodies, limitations on payments (capping) and the required connection with Australia.

These issues are not only of relevance to any broad statutory scheme.

A: Treatment of APRA-regulated bodies and those with high financial requirements

265. If standard compensation arrangements such as professional indemnity insurance are required, should all financial services licensees be required to have them?

266. Financial services licensees which are regulated by APRA would appear to be in a special position and it may be that the standard requirement for compensation arrangements are inappropriate.68

267. Should such licensees be allowed to `self-insure' (that is, to set aside particular funds for the purpose), or make other arrangements approved by ASIC in place of professional indemnity insurance, if that is required? Should such bodies be exempt from any requirement for professional indemnity insurance or, indeed, any compensation arrangements? Are different approaches appropriate for different types of body regulated by APRA?

268. Should the following be treated the same way:

  • other licensees which are subject to high financial requirements?
  • licensees with high market capitalisation?
  • licensees with the requisite connection with bodies which are APRA-regulated, have high financial requirements or high market capitalisation?

269. We note that:

  • no prudential regulator can guarantee that a body under its supervision will not fail;
  • while APRA is concerned about the financial soundness of prudentially regulated bodies, those bodies can still, for example, fail to comply with new Chapter 7, to execute the orders of clients or to acknowledge that an officer has defrauded a client.

Secondary issue 18

Should special provision be made for financial services licensees which are regulated by APRA, have high financial requirements or high market capitalisation, or have the requisite connection with such a body?

B: Measure and nature of compensation

270. The appropriate measure and nature of compensation will depend on the grounds for claiming which the compensation arrangements provide.

271. Looking briefly at the possible grounds for claiming discussed in Chapter 5:

      (i) Defalcation or fraudulent loss of funds and property entrusted to a financial services licensee

      (ii) Loss of property (including funds) entrusted to the licensee without the need to prove fault

      There are several possible approaches in this context:

    • to restore the financial product or funds to the claimants-this is consistent with the notion that the purpose is to put the claimant in the same position as prior to the financial services licensee's wrongful conduct:
        • if this approach is taken, then, if the loss is of financial products, the aim would be to restore those products;
        • if the financial products are not available, then their value (as at the date of the wrongdoing) would be payable;
    • an alternative approach would be always to pay the value of the proved claim, as at the date of the wrongdoing.
    • (iii) Failure to enter into and complete transactions according to instructions

      The object in this case is to put the claimant in the same position as if the financial services licensee had executed and completed the transaction according to instructions.

    • For example, in the case of securities, compensation would be in the form of the securities instructed to be purchased (if available), or the amount which the seller would have received if the sale instructed had in fact been executed, plus any immediately consequential loss (such as dividends).
    • In the case of, for example, an insurance contract, the issue becomes more difficult:
        • it would be inappropriate to empower the scheme operator to require an insurance company to issue a policy it no longer writes; further, the client may have suffered significant consequential loss (for example, if the house burned down uninsured).


      (iv) All the obligations of the financial service provider under new Chapter 7

      Where the obligation has a related liability provision in new Chapter 7,69 then the measure of damages is likely to be indicated in that provision.

      However, where the claim relates to a provision without a related liability provision, then the compensation requirements would need to provide instructions.

      (v) All the actions you could have taken against the failed licensee in its capacity as a licensee

      This puts the scheme operator in the invidious position of judging enormously complex situations and then deciding on the measure of damages in accordance with the usual rules in comparable court actions in tort and contract, under a relevant statute or the rules of an external dispute resolution scheme. This, however, is not a problem limited to this model.

272. In any case, the payment will be subject to any cap set — see paragraphs 279 to 281.

Consequential loss

273. There are several options in relation to paying claimants for consequential loss including:

  • not paying consequential loss;
    • In relation to claims for the return of client property (in the case of securities and units in managed investment schemes) or recognition of contractual rights (in the case of derivatives), the CASAC Consultation Paper suggests that recovery of consequential pecuniary loss is not appropriate,70 on the basis that these losses might significantly increase the cost and assessment requirements of the scheme;
  • providing a discretion for the compensation administrator;
    • as in the case of the provisions governing the National Guarantee Fund, which provide the SEGC (the scheme administrator) with a discretion to pay certain consequential loss in cases of unauthorised transfer.71

Accounting for profits

274. It is inappropriate for a compensation scheme to account to the client for profits made by the licensee from misuse of the clients' assets/property.

275. In trust law, seeking compensation with interest is an alternative to requiring the trustee to account for the profits (the first being based on disavowal of the trustee's conduct, while accounting for profits is based on adoption of the trustee's conduct). A claimant cannot seek both.

276. The claim for compensation of a person who has recovered from the wrongdoer on either ground should, to that extent, be reduced.

Interest, costs, contributory negligence

277. Interest should be payable on any cash compensation payable (excluding amounts attributable to the costs of making the claim) calculated from the date of entitlement to make the claim until the date of payment. The cost of pursuing the claim should also be recoverable.

278. Where appropriate, any contributory conduct of the claimant or the claimant's failure to mitigate the loss should be taken into account.

Secondary issue 19

How should the loss be measured and should consequential loss be cov

C: Should there be capping of payments?

279. This question has two limbs:

  • where the scheme provides that any person (whether retail or wholesale) can claim against the fund;
    • in this case limiting payments (capping) will assist in any actuarial assessment of the amount required in the fund;
  • where only retail persons can claim;
    • is it appropriate to cap payments? or should such payments be uncapped?

280. The CASAC Consultation Paper72 suggested that caps would help keep costs within reasonable bounds and reduce investor expectations. It indicated that a cap, if sufficiently liberal, might ensure that most retail claimants recover all or a significant portion of the funds due to them.

281. Another question in this context is whether there should be a minimum threshold for claims. While this could reduce the number of small claims, CASAC pointed out that it could also discriminate against the retail investors who have very limited funds.

Secondary issue 20

(a) Should there be capping of the amounts paid in response to claims?

D: What form of capping is appropriate?

282. If the view is taken that capping should be imposed, then the following questions arise:73

  • what is the appropriate cap?
    • one submission in response to the CASAC paper indicated that any caps should be sufficiently high to ensure that virtually all claims by retail clients can be met, given the increasing number of inexperienced retail clients with large lump sums of superannuation to invest, which may represent their life savings;
    • the UK model provides for payment of 100 per cent of the claim up to a certain amount, followed by declining percentages up to further specified limits;
        • an alternative is a fixed percentage of each allowable claim;
    • caps can be calculated per insolvent intermediary, as a percentage of the available compensation funds, on the amount which can be paid in a particular period or per client per event;74
  • should it be the same for all grounds on which claims can be made? and for services in relation to all financial products?
  • how should multiple accounts relating to the one family or group of companies be treated for capping purposes?
    • if a client transacts in the name of a spouse, family trust or controlled companies, should each be treated as a separate client for capping purposes?
    • the CASAC Consultation Paper suggests that treating each of these persons or entities as a separate client would give an advantage to those persons who transact in the greatest number of capacities;
    • one submission to CASAC opposed this on the basis that it is unrealistic to assume that one spouse is a mere nominee of the other or that children do not act independently of their parents.

Secondary issue 20

(b) If capping were accepted, what form of capping would be appropriate?

E: Subrogation75

283. Generally, claimants who accept compensation are required to assign, or are deemed to have assigned, their relevant rights against the licensee to the scheme operator. This is obviously appropriate, at least to the extent of the payment made by the scheme operator to the client.

284. Taking this one step further, a scheme may require subrogation of all rights against the licensee so that the scheme operator can take a class action for all the claims of affected retail persons (with any surplus (over administrative costs) being paid to the successful claimants).

285. Clearly, retail claimants should not be financially disadvantaged by subrogating their rights in return for compensation, nor should the scheme profit from exercise of subrogation rights.

286. Subrogation implies it is a scheme of first resort. An alternative, which may be considered appropriate to a pre-insolvency situation, is to require the claimant to take all reasonable steps before claiming from the fund.

What will not be recovered through subrogation

287. There are, however, limitations on how much can be recovered through subrogation:

  • where the grounds to be established to make a claim involve complex investigations and decisions for the scheme operator, there will be an increase in the administrative costs which will not be recovered through subrogation;
  • there may be situations where it may not be worth pursuing an ex-licensee (for example, where it has assets of little value, and no valid professional indemnity insurance policy).

Actions which prejudice subrogation76

288. It is clearly undesirable to allow the possibility of compensation being required to be paid in relation to a claim where the retail client has already been paid out by another entity and the scheme operator's rights to subrogation have been prejudiced.

289. The solution adopted in relation to the National Guarantee Fund is to provide the SEGC, which administers the Fund, with a discretion to reduce the payment:

  • where the claimant has received a benefit from a third party to whom they have assigned rights and remedies in relation to the loss; and
  • to the extent that the claimant has, without the SEGC's consent, adversely affected the SEGC's rights of subrogation.77

290. The CASAC proposal gives a wider discretion to the scheme operator — any action by a claimant that prejudices the subrogation rights of the scheme against the intermediary should permit the scheme operator to reject or reduce the claim.

F: Connection with Australia

291. What is the appropriate connection with Australia? Just how far should an Australian compensation scheme spread? The questions in this connection include the following:

  • should clients or purchasers who are resident overseas have access to Australian compensation arrangements?
  • what if the licensee has no place of business in Australia?

292. CASAC78 proposed that its scheme apply to any retail client, wherever located, who had dealt directly with an Australian intermediary, wherever located, in relation to any investments on any Australian exchange or `over the counter' market. The Committee considered that this would help to promote Australian financial markets to overseas retail investors, who would be protected in their dealings with Australian intermediaries through a compensation scheme that compares favourably with the more limited coverage of overseas schemes.

293. CASAC also considered there was an issue whether the nexus should extend to Australian intermediaries trading on an overseas exchange or `over the counter' market.

294. One submission to CASAC agreed with the Consultation Paper that the scheme, if it could be extended to foreign clients of local intermediaries without imposing an excessive cost on those intermediaries, could enhance Australia's competitive position in global markets.

295. Another submission expressed the view that the necessary connection with the Australian market may depend on what protection key overseas compensation arrangements offer to Australian investors when they deal directly through an overseas intermediary, or via an Australian intermediary who then uses an overseas agent.

Secondary iss
ue 21

What is the appropriate connection with Australia?

G: Relationship with external dispute resolution schemes

Requirement for licensees to be members of external dispute resolution schemes

296. Subsection 912A(2) of the Corporations Act requires financial services licensees who deal with retail clients to have a `dispute resolution system'. A dispute resolution system consists of:

  • internal dispute resolution procedures; and
  • membership of one or more external dispute resolution schemes that are approved by ASIC.

297. The Corporations Regulations set out the bases against which ASIC will approve external dispute resolution schemes.79 ASIC has also released policy statements setting out how it will administer the external dispute resolution provisions.80

298. The existence of a requirement for each licensee to be a member of one or more external dispute resolution schemes is relevant to the context in which any compensation arrangements will operate.

Features of external dispute resolution schemes

299. Some features of the coverage of external dispute resolution schemes, which are relevant in this context, are:

  • Monetary Limits
    • Different external dispute resolution schemes currently operate different monetary claims limits. These range, for example, from $250,000 for complaints about life insurance to $100,000 for complaints about investment advice. The existence of these limits means that the external dispute resolution schemes do not provide a mechanism for assisting retail clients with larger claims.
  • The determinations
    • The basis of the determinations is wider than strict legal liability. Complaints are generally determined by reference to the law, good industry practice and fairness in all the circumstances.
    • A determination will often take the form of an order that a firm compensate a consumer for direct loss or damage caused by that licensee. Some schemes also provide for a variety of other non-monetary determinations (depending on the circumstances of the complaint). For example, under the Insurance Brokers' Dispute Facility, an insurance broker may be directed to perform a specific service, implement rectification procedures or publish corrective advertising.
  • Enforcement of decisions.
    • Members of external dispute resolution schemes are contractually bound to comply with a decision of that scheme, including an order that the firm pay an amount in compensation to a retail client. However, the leverage of the external dispute resolution scheme over the member firm will be reduced where that firm is prepared to surrender its licence, rather than meet a claim, or is no longer a member of the particular scheme.
  • Solvency and insolvency
    • We see no, or very little, role for external dispute resolution schemes once a licensee has become insolvent.
    • Intermediaries typically rely on professional indemnity insurance that is `endorsed' to meet external dispute resolution monetary awards made against them depending on the amount awarded and the amount of the excess. In the absence of effective `run-off' cover, the payment of compensation to a complainant where the licensee has later become insolvent is not guaranteed.
  • Other jurisdictional limitations
    • In practice all of the external dispute resolution schemes have limits on the types of complaints they deal with.

300. External dispute resolution schemes generally have a discretion about whether to deal with a particular complaint under their Rules and broadly expressed powers to consider complaints about member licensees. However, a complaint that involves an allegation of fraud, for example, may be declined by a scheme if it determines that testing of the evidence and/or cross-examination of the parties is necessary to reach a decision, and that the matter should more appropriately be dealt with in a court.

Roles of external dispute resolution schemes and compensation arrangements

301. This leads to consideration of the respective roles of external dispute resolution schemes and compensation arrangements. In our view, the primary purpose of compensation arrangements is to ensure there are assets to meet proved claims (that meet the criteria). The primary purpose of external dispute resolution schemes is to determine disputes between licensees and clients where the scheme criteria are met. Such schemes cannot provide certainty that the licensee will pay an amount awarded in circumstances where the licensee is prepared to surrender its licence or otherwise becomes insolvent. This means that, in their primary roles, there is no capacity for conflict between external dispute resolution schemes and compensation arrangements.

302. It is only in considering access to compensation that you may see the possibility of conflict, duplication or choice. Ways of accessing compensation arrangements will depend on the nature of those arrangements and their coverage. It may be via a court judgment, an external dispute resolution determination or a direct approach to the compensation scheme operator. Following a winding up order, there will not be the same choice of access routes, as explained in paragraph 53.

303. The relationship between external dispute resolution schemes and compensation arrangements thus raises the following issues:

  • What is the appropriate relationship between such schemes and arrangements?
  • Should clients be required to use an external dispute resolution scheme (if available) before claiming against a compensation fund where the financial services licensee is solvent?
  • Should compensation arrangements be required to cover all external dispute resolution determinations that are not complied with (for example, because of incapacity to pay)?
    • Your answer to this should be considered in the context of Principal Issue 4.
    • Could this lead to inequitable outcomes, given the different coverage of the various schemes?

Secondary issue 22

What is the appropriate relationship between compensation arrangements and external dispute resolution schemes?

H: Excess funds

304. Prior to the commencement of the Financial Services Reform Act, Chapter 7 made provision for excess funds in the National Guarantee Fund to be used for `securities industry development' purposes.81 The new Chapter 7 makes provision for excess funds in the National Guarantee Fund and other fidelity funds to be used for `financial services industry development' purposes.82

305. If a new compensation regime involved compensation funds (whether held by markets or others), then should provisions allowing for excess payments to be made for financial services education and other appropriate development purposes be retained?

306. The CASAC Consultation Paper83 suggested that levies should be reduced or suspended to avoid this situation and that the operator should be entitled to invest excess funds. However, it concluded that `To use the excess funds for any other purpose would only be justifiable if it directly or indirectly promoted the investor protection goals of the Scheme.'

307. One submission to CASAC supported the proposal that the Scheme operator should be entitled to invest excess funds to increase the revenue available to the Scheme (though it also considered that excess funds should be able to be used for educational purposes).

Secondary issue 23

Should excess funds in a compensation scheme be available for financial industry development purposes, or should there be mechanisms to discourage the build up of such excess funds?

I: Should there be time limits for claiming?

308. Should there be a limit on the time within which one could claim? If so, what should it be and when should it commence?

309. The CASAC Consultation Paper84 suggests three months from notification to `all remaining retail clients'; but in the case of formal liquidation, CASAC suggests that claims made to the liquidator and passed on to the scheme operator would be subject to time limits on creditors making claims in a liquidation.

310. This assumes an ability to identify all clients. In the absence of this capacity (for example, through poor records), the time limit would need to provide for publication of notices in newspapers and sufficient time to prepare and lodge claims after this.

Secondary issue 24

Should there be time limits for claiming and, if so, how should they be set?

J: Level of detail in the legislation

311. In designing any mandatory compensation arrangements, regardless of the mechanism chosen, there is a question about the level of detail to be included in the relevant legislation and the extent to which the detail should be left to be resolved by other means. Those means include being prescribed in regulations, set by ASIC or left for the scheme operator to decide in, for example, disallowable instruments or rules requiring approval.

312. The current solution reflected in section 912B is to set the general requirement in the legislation but to require that the arrangements must satisfy any regulations in place or be approved in writing by ASIC. The factors that ASIC must have regard to are also specified. They include the financial services being provided and `run-off' cover.

313. Similarly, the obligation on those market licensees which are not covered by the National Guarantee Fund to have compensation arrangements sets out the issues to be addressed but leaves the detail to be set by market rules (which need to be approved as part of the compensation arrangements).85

Secondary issue 25

What is the appropriate level of detail in the legislation?

68 It should be noted that, if this argument is accepted, in combination with section 14 of the Insurance (Agents and Brokers) Act/section 985B of the new Chapter 7 (which provides that payment to an insurance intermediary of a premium is a discharge of the insured's liability to the insurer) the area of conduct of insurance intermediaries under discussion in the context of compensation requirements will be limited.

69 For example, section 953B.

70 See CASAC Consultation Paper, page 11.

71 Corporations Regulation 7.5.58.

72 See CASAC Consultation Paper, pages 12-13.

73 See CASAC Consultation Paper, pages 13-14.

74 See CASAC Consultation Paper, pages 13-14.

75 See CASAC Consultation Paper, pages 14-15.

76 See CASAC Consultation Paper, page 15.

77 Corporations Regulation 7.5.75(2).

78 See CASAC Consultation Paper, page 10.

79 Corporations Regulations 7.6.02.

80 ASIC Policy Statements 139 and 165.

81 Division 5 of Part 7.10.

82 Section 892G and Corporations Regulations 7.5.86-92.

83 See CASAC Consultation Paper, page 19.

84 See CASAC Consultation Paper, page 14.

85 Section 885B.