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The purpose of this Chapter is to consider the conduct of financial services licensees which should be covered by compensation arrangements, the particular occasions causing loss and who should be entitled to claim. Put another way, in what circumstances should the law require the pooling of clients' risk, with the consequent risk of requiring innocent financial services licensees to contribute? You may wish to consider separately the situations when a licensee is solvent and able to pay claims, and when it is insolvent or unable to pay. |
124. What conduct should be the subject of compensation arrangements for the financial services sector? The starting point is the phrase `provides a financial service'.34 This encompasses:
- providing financial product advice;
- dealing in a financial product;
- making a market for a financial product;
- operating a registered scheme;
- providing a custodian or depository service; and
- conduct of a kind prescribed by any regulations made for the purposes of paragraph 766A(1)(f).
125. This description triggers a series of questions:
- Should compensation be required in relation to all these activities?
- Should compensation arrangements extend to advising?
- In what, if any, circumstances should making a market trigger the need for compensation arrangements?
- Is it desirable, or consistent with the treatment of other financial products, that a responsible entity of a registered scheme be required to have compensation arrangements with respect to all aspects of operating the scheme?
- To what extent should compensation arrangements apply in relation to operating a custodial and depository service?
- In this case there is no distinction between the financial service and the financial product.
- Should such arrangements be required in relation to the compliance of financial services licensees who are issuers with the product disclosure requirements (as well as the conduct of issuers, such as advising, which is comparable to that undertaken by intermediaries and which has triggered the requirement for a financial services licence)?
- Should compensation arrangements extend to licensees' conduct of discretionary trading accounts?
126. Should compensation arrangements be limited to the conduct of financial services licensees and their representatives, and not include unlicensed providers of financial services?
127. Should compensation be payable when a licensee (or its representative) is acting outside the terms of its licence (or authority), but in circumstances which would require a financial services licence (or authority)?
Possible acts or omissions causing loss
128. There is a range of circumstances within the ambit of `providing a financial service' in which the conduct of the financial services licensee may cause loss to the client. They include:
- giving personal advice without a reasonable basis for the advice;
- false, misleading or deceptive conduct;
- failing to execute the client's instructions;
- failing to return to a client when requested any money or property belonging to the client that has been entrusted to the licensee;
- unauthorised transfer of a financial product belonging to the client;
- a licensee becoming insolvent, particularly where there is a deficiency in trust property.
129. Some of the possible grounds for claiming are discussed below. A number are not mutually exclusive. You are encouraged to comment on their appropriateness and suggest others.
130. For the sake of simplicity, this paper has been written as if all wrongdoing is by the licensee itself. There will obviously be occasions on which the conduct causing loss is that of the representative for whose relevant conduct the licensee is responsible under new Chapter 7.
131. This would provide compensation for losses in respect of financial products or funds entrusted to a financial services licensee for the purpose of a dealing where defalcation or fraud is proved. It is the basic criterion for the current fidelity funds held by the stock markets (other than the ASX) and the Sydney Futures Exchange.
132. Note that:
- intention must be proved, including in the event of a deficiency on insolvency or unauthorised transfer, before the claim will be paid;
- there is uncertainty about the meaning of `defalcation' (see footnote 91).
(ii) Loss of property (including funds) entrusted to the licensee
133. An alternative is to focus on the loss of property (whether financial products or funds) entrusted to a licensee without the need to prove intention or fault. Examples are:
- money is entrusted to the licensee for the purchase of a financial product but the licensee does not arrange for the purchase of the product nor repay the funds;
- financial products are held on behalf of the client pending sale but the licensee does not account for the proceeds nor return the financial products;
- unauthorised transfer of financial products and share certificates wrongly cancelled;
- this is discussed further at paragraphs 216 to 222.
Taking this one step further:
- unauthorised transfer of funds from client accounts with authorised deposit-taking institutions to which the financial services licensee has access.
(iii) Deficiency (on insolvency/inability to pay) in funds and financial products held on trust
134. This closely follows the ground for claiming described in (ii) above but would apply on insolvency or an inability to pay claims. It is shown separately because it is the area covered by a number of the overseas statutory schemes — see Attachment D.
(iv) Failure to enter into and complete transactions according to instructions
135. This would involve putting the client in the same position as if the financial service provider had carried out the client's instruction for purchase or sale.
136. The argument in favour of this concept forming a basis for a compensation regime is that it is more appropriate for, for example, insurance than the models described in (ii) and (iii) above.
137. The problem relates to consequential loss. In the case of a failure to execute a securities transaction, this may involve loss of capital gain, dividends or a bonus issue. This may be significant, but consider the following scenarios in the context of failure to execute an instruction to arrange insurance cover:
- a financial services licensee takes a client's money and leads him or her to believe on reasonable grounds that insurance cover has been arranged, but fails to execute:
- instructions to obtain a disability policy;
- the client has a heart attack, cannot work and cannot get further cover;
- or instructions to obtain a policy covering a house and its contents;
- and the house subsequently burns down uninsured.
138. This provides greater protection for consumers, at greater cost to industry, than the models described in (ii) and (iii) above.
139. Two notes of caution in considering this model:
- The CASAC Consultation Paper (which considered a scheme relating to securities, derivatives and units in
managed investment schemes) recommended that return of property should not extend to `opportunity' or `consequential pecuniary' loss.35 The argument was that to cover these might significantly increase the cost and assessment requirements of the scheme. - The `contract guarantee' in Subdivision 4.3 of Part 7.5 of the Corporations Regulations provides a ground for claiming against the National Guarantee Fund where the transaction has been entered into but not completed - this is not the same as ground (iv).
(v) All the specific obligations of the financial services licensee imposed by new Chapter 7
140. Compensation arrangements in these circumstances cover losses consequential on the financial services licensee failing to comply with the specific obligations imposed by new Chapter 7.
141. The extent of this requirement, and issues associated with current section 912B, are examined further in Chapter 6 of this paper.
(vi) All the actions you could have taken against the licensee in his capacity as a licensee (on insolvency/inability to pay)
142. This is based on the model proposed for discussion in the CASAC Consultation Paper.
143. Allowable claims would include not only return of property but also claims relating to improper acts or omissions in the provision of financial services by firms now in default. It therefore covers claims in tort (for example, negligence), contract, statutory liability and the grounds on which an external dispute resolution scheme might have made a determination, where the conduct causing loss was the provision of financial services by the financial services licensee. This is on the basis that the grounds on which retail clients may lawfully claim against licensees in relation to their investments should be the same whether the licensee is solvent, or not.
144. It is inappropriate for financial services compensation arrangements to provide compensation to clients in relation to the obligations of a financial services licensee in its other roles — for example, as a company which has issued shares to the consumer, as the trustee of a superannuation scheme in which the consumer has invested or as the occupier of premises.
145. According to the CASAC Consultation Paper, its proposed model would complement the investor protection required by other provisions of the new Chapter 7 — that is, the compensation arrangements required by section 912B and the requirement for ASIC-approved external dispute resolution procedures.
146. The arguments against the breadth of this model are:
- the cost to the industry as a whole and whether the pooling of risk in such a spectrum of circumstances is justified:
- the complexity of the investigations and decisions which the scheme operator would be required to make:
- the scheme administrator would be required to judge a case of the factual complexity of the recent matter of Ali v Hartley Poynton;36
- this problem, however, is not limited to this model;
- all other legal action against a financial services licensee is affected by a winding up order — should claims by clients of the financial service licensee be treated differently?
147. The relationship of compensation arrangements and external dispute resolution scheme determinations is addressed in paragraphs 296 to 303. This discussion raises the question whether compensation arrangements should be required to cover the determinations of all approved external dispute resolution schemes.
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Principal issue 4 (a) In what circumstances should compensation arrangements be required in relation to a financial services licensee? (b) Should different criteria or a different mechanism apply depending on whether the financial service provider is solvent or unable to pay/insolvent? (c) Should compensation arrangements relate only to the situation where the financial services licensee is unable to pay/insolvent? |
148. Should only retail clients have access to the scheme37 or should all (barring, for example, those connected with the wrongdoers or who have profited from the wrongdoing) be entitled to make claims but the payments be limited to a cap appropriate for retail clients?
149. Adopting the former course means that financial services licensees which only have wholesale clients would have no obligation to have compensation arrangements.
150. Further reasons for limiting the scheme to retail clients are described by CASAC.38 They are:
- wholesale clients may be better able than retail clients to assess the risk of dealing with particular intermediaries, or have a greater capacity to reduce risk either by diversifying their activities among several intermediaries or by obtaining insurance, if available, to cover any consequences to them of the insolvency of an intermediary;
- caps on compensation may still allow many retail clients to recover all or most of any eligible losses, whereas wholesale clients may only recover an insignificant proportion of those losses unless the caps were set very high;
- limiting the scheme to retail clients may substantially reduce the cost of the scheme and/or increase funds available to compensate those clients.
151. On the other hand, we note that the National Guarantee Fund currently includes no requirement that a claimant be retail.
152. If wholesale clients remain entitled to claim, should their claims be judged against the same criteria as retail clients, some of those criteria, or different criteria altogether? Should they, for example, only be entitled to claim against compensation arrangements for loss of property entrusted to a financial services licensee?
Referral business and excluded claimants
153. There are two further issues related to the question of who should be entitled to claim:
- treatment of `referral business', where the retail client's instructions are, for example, passed by a financial planner to a stockbroker;
- in these circumstances, the financial planner (wholesale) may be treated as the client of the stockbroker, leaving the retail client with no remedy under the compensation arrangements for a wrong caused by the stockbroker;
(an analogous situation may exist where a client seeks the issue of a financial product through an intermediary, but the issuer fails after receipt of the funds and before issue of the product);
- in these circumstances, the financial planner (wholesale) may be treated as the client of the stockbroker, leaving the retail client with no remedy under the compensation arrangements for a wrong caused by the stockbroker;
- defining excluded claimants - that is, those with a connection with the failed financial service provider or have had responsibility for, or profited from, the financial difficulties of the relevant financial service provider.
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Principal issue 5 Who should be entitled to claim? |
D: Measure and nature of compensation
154. The discussion above relates to the circumstances in which compensation should be payable and to whom. The further questions about how to measure the loss for the purpose of calculating compensation (for example, whether consequential loss should always be provided) and what type of compensation should be provided (for example, financial products or their value in cash) are discussed at paragraphs 270 to 278.
E: Mechanisms to provide compensation
155. While there are a variety of mechanisms through which compensation can be
provided, they generally fall into three categories - those arranged by financial services licensees, those arranged by market licensees and statutory schemes.
156. These three possible avenues (and issues particular to each of them) are therefore examined separately - financial services licensees in Chapter 6 and market licensees in Chapter 7. The questions whether a broad statutory scheme is warranted and if so, its structure, are examined in Chapters 8 and 9.
35 See CASAC Consultation paper, page 11.
36 Ali v Hartley Poynton, Victorian Supreme Court, Smith, J., 16 April 2002.
37 The Financial System Inquiry (the Wallis Committee) Final Report (at pages 280-281) recommended an additional layer of consumer protection for retail transactions, and that financial protections (such as fidelity funds) should be suitable only for retail persons.