Australian Royal Commission on Banking Misconduct Delivers Final Report Strongly Critical of Australian Banks

On February 1, Kenneth Hayne, Commissioner of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, submitted the Commission’s Final Report to the Governor-General of Australia.  The Commission’s terms of reference vested the Commission with a broad mandate to inquire into misconduct in the financial services sector, including the adequacy of laws, regulations, and industry practices.  The Final Report was tabled in the Australian Parliament on February 4.

At the outset, the Final Report reiterated and expanded on the substantial criticisms of the Australian financial sector that it set forth in its Interim Report.  It stated that

[t]he conduct identified and described in the Commission’s Interim Report [submitted in September 2018] and the further conduct identified and described in this Report includes conduct by many entities that has taken place over many years causing substantial loss to many customers but yielding substantial profit to the entities concerned. Very often, the conduct has broken the law. And if it has not broken the law, the conduct has fallen short of the kind of behaviour the community not only expects of financial services entities but is also entitled to expect of them.

The Final Report also presented four key observations about critical and pervasive failings in financial firms’ treatment of customers:

1. “[T]he connection between conduct and reward.” The Report stated that “in almost every case, the conduct in issue was driven not only by the relevant entity’s pursuit of profit but also by individuals’ pursuit of gain, whether in the form of remuneration for the individual or profit for the individual’s business. Providing a service to customers was relegated to second place. Sales became all important. Those who dealt with customers became sellers. And the confusion of roles extended well beyond front line service staff. Advisers became sellers and sellers became advisers.”
2. “[T]he asymmetry of power and information between financial services entities and their customers.” The Report stated that “entities and individuals acted in the ways they did because they could. Entities set the terms on which they would deal, consumers often had little detailed knowledge or understanding of the transaction and consumers had next to no power to negotiate the terms. At most, a consumer could choose from an array of products offered by an entity, or by that entity and others, and the consumer was often not able to make a well informed choice between them. There was a marked imbalance of power and knowledge between those providing the product or service and those acquiring it.”
3. “{T]he effect of conflicts between duty and interest.” The Report stated that “consumers often dealt with a financial services entity through an intermediary. The client might assume that the person standing between the client and the entity that would provide a financial service or product acted for the client and in the client’s interests. But, in many cases, the intermediary is paid by, and may act in the interests of, the provider of the service or product. Or, if the intermediary does not act for the provider, the intermediary may act only in the interests of the intermediary. The interests of client, intermediary and provider of a product or service are not only different, they are opposed. An intermediary who seeks to ‘stand in more than one canoe’ cannot.  Duty (to client) and (self) interest pull in opposite directions.”
4. “[H]olding entities to account.” The Report stated that “too often, financial services entities that broke the law were not properly held to account. Misconduct will be deterred only if entities believe that misconduct will be detected, denounced and justly punished. Misconduct, especially misconduct that yields profit, is not deterred by requiring those who are found to have done wrong to do no more than pay compensation. And wrongdoing is not denounced by issuing a media release.”

The Final Report set forth a total of 76 recommendations that cover a wide variety of practices and issues in the financial services sector, including consumer lending, access to banking services, enforceability of industry codes, financial advice, superannuation, insurance, and regulation.  Some of the more prominent recommendations according to news.com.au, included:

• Retention of the so-called “twin peaks” model of financial regulation (i.e., oversight by the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA)), although Hayne recommended that the APRA keep a closer watch on banking-sector executive pay and stated that “the enforcement culture of ASIC, not the size of ASIC’s remit, should be the focus of change.”
• Mortgage brokers should be required by law to act in the best interests of borrowers, rather than lenders or themselves, and face a civil penalty for breach of that duty.
• Industry codes of conduct, which ASIC must approve, will include “enforceable code provisions,’ and a breach of such a provision will constitute a breach of law.

Note: The reaction to the Final Report by Australian government authorities and the business sector has generally been measured but positive.  The Government immediately committed, in the words of Australian Treasurer Josh Frydenburg, to “taking action on all 76 recommendations.”  Frydenburg also stated that the recommendations “will have far-reaching consequences across the financial system, including putting in place the banking executive accountability regime, not just within banks which we initiated, but with an insurance and superannuation companies, ensuring trustees of superannuation funds actually face penalties for breaching of their duties.”

ASIC stated that it “will consider the report carefully,” adding that it “identified ASIC’s enforcement culture as the focus of change needed at ASIC. This focus accords with ASIC’s change agenda, that has included the adoption of our ‘why not litigate?’ enforcement stance, the initiation of our Internal Enforcement Review and the enhancement of our governance structures.”  With regard to Hayne’s referrals for possible breaches of financial-services law, ASIC responded that “{c]onsideration of these matters will be prioritised. ASIC does not, as a general policy, comment on actual or potential investigations.”

The Chairman of the APRA, Wayne Byres, stated that the Final Report

is a considered and fair assessment of failings in the financial system and a helpful road map for reform . . . . The commission’s recommendations are wide-ranging. Within them, the commission has identified a number of areas where APRA’s prudential and supervisory framework can and should be strengthened. Many of these improvements are already in train, and APRA is committed to delivering on them. APRA appreciates the commission’s acknowledgment that increasing the intensity of supervision will require additional resources.

The true test of the Final Report, of course, will be the extent to which and the speed with which the Government and the banking sector pursue the report’s recommendations.  Regardless of how difficult it can be to change a bank’s culture, the key Australian banks will need to demonstrate that they are committed to changing their cultures for the better, and willing to play a constructive role in the upcoming discussion of potential legal and regulatory changes.