Introduction

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Financial Services Royal Commission) seventh and final round of public hearings commenced on 19 November and ran until 30 November.  The focus of the hearings was on the causes of misconduct and conduct falling below community standards and expectations by financial services entities (including culture, governance, remuneration and risk management practices), and on possible responses, including regulatory reform.  In addition, the hearings considered the role of the regulators, the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) in supervising the actions of financial services entities, deterring misconduct by those entities, and taking action when misconduct may have occurred.

A high level overview of some of the issues explored in the course of questions to ASIC Chair James Shipton, NAB Chair Ken Henry, NAB CEO and Managing Director Andrew Thorburn and AMP Acting CEO Michael Wilkins is below.

[Note: For coverage of the some of the issues to arise in the first week of Round 7 hearings (see: Governance News 26/11/2018]

Australian Securities and Investments Commission (ASIC)

Counsel Assisting challenged various aspects of ASIC's enforcement approach including: ASIC's failure to take enforcement action or delay in doing so, ASIC's approach to determining the appropriate remedy for a breach, the efficacy of ASIC's use of negotiated outcomes rather than litigation to resolve issues (and civil or criminal action has not been pursued in some instances) and ASIC's method of evaluating its own performance in relation to enforcement.  Counsel Assisting also questioned whether ASIC investigators are too close to the institutions they regulate.  For example, the practice of allowing institutions to fact check media releases prior to their release was questioned, Commissioner Hayne stating that 'ASIC should know what it alleges'.  
In addition, Counsel Assisting questioned whether the relationship between ASIC investigators and institutions under investigation was too close (citing emails showing that ASIC commissioners appeared to be discussing enforcement proposals directly with senior representatives of the institution under investigation).  
ASIC Chair James Shipton said:

• Delays unacceptable: Mr Shipton said that the delays in taking action should not have occurred in the examples identified by Counsel Assisting, but also identified lack of resourcing as a factor in causing the delay.
• Mr Shipton agreed that ASIC had 'over-utilised' and 'over-relied' on negotiated outcomes in the past, and had also historically focused on customer remediation at the expense of enforcement.
• Enforceable undertakings: In relation to enforceable undertakings, and community benefit payments in particular, Mr Shipton said 'I’ve asked the team to look very seriously at the utility of community benefit payments, but more broadly, what I’ve asked the team to look at is the utility and the appropriateness of enforceable undertaking and similar arrangements, given the fact that it’s very clear to me that we need to be more agile, willing and faster in applying court-based enforcement actions'.   Mr Shipton maintained however, that enforceable undertakings have a place, and remain appropriate as part of ASIC's overall enforcement approach, citing a UNSW study indicating that enforceable undertakings do have some deterrent effect.

[Note: The study Mr Shipton referred to appears to be an ASIC commissioned study: The general deterrence effects of enforceable undertakings on financial services and credit providers.  See: Governance News 29/10/2018.]

Mr Shipton also suggested that the lack of certainty of outcome (in relation to litigation), the financial cost and lack of resources to pursue litigation were also important factors to be taken into account, though he acknowledged that the consequences of breaching an enforceable undertaking (an expression of 'disappointment' by the regulator in the form of a media release) are not strong enough.  He added that he expected enforceable undertakings will be utilised less in future, given that ASIC will have access to a 'more effective penalty regime for that fundamentally important provision of s912A' of the Corporations Act 2001 (Cth) and that when they are used that they should include a 'forthright and robust admission of wrongdoing and responsibility'.

• Commitment to taking more 'court based action': Counsel Assisting noted that ASIC's submission in response to the Commission's Interim Report accepted that 'the proper starting point of enforcing compliance with the law is litigation'.  Mr Shipton agreed that this is the case.  He went on to say that ASIC will be 'testing the limits of the law more' going forward. 'I want to make it crystal clear we will be undertaking more court based actions.  We will be more adventurous as it were in pushing points of law.  We will be taking more let's call it risks because we now have through my direct engagement with the government more funding to do exactly that' Mr Shipton said.
• Extension of the Banking Executive Accountability Regime (BEAR):  Asked what additional powers (that are not 'pending') ASIC needs, Mr Shipton reiterated his support for the extension of the BEAR to cover conduct.  'I am a very strong advocate of the BEAR regime being extended across to our areas of responsibility and jurisdiction.  I mentioned earlier that I believe that we should be having far more deterrent effect on business leaders in financial institutions and to better enable the efficiency of that deterrent effect having a BEAR regime that would apply to them would make a direct linkage and make that wish more effective' he said.  More specifically, Mr Shipton agreed that the accountability obligations imposed by BEAR should mirror the sorts of conduct obligations imposed under the UK Senior Managers Conduct Regime.  Asked whether ASIC should apply the BEAR regime to itself (as the UK Financial Conduct Authority is required to do under the UK regime) Mr Shipton appeared to agree in principle:  'I think it’s an excellent suggestion…And I think it provides a good governance framework for regulatory agencies' he said.
• Efficacy of the close and continuous monitoring (embedding ASIC staff within large financial institutions) program: Asked about the efficacy of ASIC's new supervisory approach in which ASIC staff are embedded into large financial institutions, Mr Shipton said that he believed the scheme will be effective (though it has only been in place for a short time).  He added that it had already been effective in highlighting that in some instances, the 'raw message' from ASIC was not being relayed to senior decision makers.
• Does ASIC need additional oversight?  Asked for his views on the 2014 Financial System Inquiry recommendation that a Regulatory Assessment Board be established to monitor regulators, Mr Shipton said that he would prefer improving the current system on the basis that he believes it capable of delivering the same benefits/level of oversight as a regulatory board could achieve.  The Commissioner asked: 'What I suggest to you is that it all just becomes self-referential.  ASIC determines the base, judges itself against the base.  What I want to ask of you is where is the intellectual rigour in that process?'  Mr Shipton disagreed that there was no rigour in the process, stating 'I would submit that the intellectual rigour is that that baseline [for behaviour in the financial services sector once established] would be for everybody to see… If we can see those baselines and we – and the world can see those baselines improving, then that must mean that both the financial institutions themselves are improving, and it also must mean that the regulator is improving, and that is, I believe, an objective assessment'.

NAB

Questions to NAB Chair Ken Henry and NAB CEO and Managing Director Andrew Thorburn included questions on the themes of cultural change, the scope of board accountability and accountability within the organisation more broadly, and remuneration.

Remuneration

• Why pay variable remuneration? Mr Thorburn said that the shift away from fixed pay in the industry is attributable to two causes: aligning and incentivising employees to act to optimise the short, term financial interests of shareholders, and the need to 'compete in the global talent pool'.  Asked whether the implementation of the Sedgwick recommendations had decreased the bank's ability to compete in the global talent pool, Mr Thorburn said that it hadn't but that this was because the change was implemented Australia-wide, and because the talent pool for the retail part of the bank is largely drawn from Australia.  Mr Thorburn said that for other roles such as technology roles, there was a need to be 'competitive' in the financial package offered to attract and retain talent.  In addition, Mr Thorburn said that in his view, profit might drive good or bad behaviours (depending on the way in which it is structured) and that it was important to be able to reward employees for exceptional performance (though he did not agree that the primary motivator for employees is money).
• Revised remuneration structure for frontline staff:  The Commission heard that frontline staff continue to be paid an element of variable remuneration, but that the way in which performance is assessed has been revised in line with the Sedgwick recommendations to include a greater focus on non-financial measures.  The Commissioner asked 'what message' employees subject to the revised pay structure would 'take away from it' and what 'behaviours' Mr Thorburn regards 'this system as reinforcing'.  Mr Thorburn said that the message employees would take away is 'firstly, achieving in a number of areas is very important.  Second, those areas, at least 50 per cent of them are about the customer and their relationship and their engagement with us, not what we’re selling them, to come back to that term.  And thirdly, that the risk elements of a person’s role must be very clear and it is their own personal responsibility to understand them and to achieve them'.  In terms of the behaviour he regards the system as reinforcing, Mr Thorburn said that he believes the plan reinforces 'our values' (a focus on building a relationship with the client, that the bank is winning more business and that risk is 'my responsibility').  Counsel Assisting suggested that the inclusion of some non-financial targets is not viewed by the lender as 'problematic' on the basis that there is a more holistic assessment of the employee’s performance, that its expected that leaders will instil in employees the right type of culture (in terms of dealing with customers) and on the basis that the target is not a 'pure dollar value target' to which Mr Thorburn agreed.  Asked whether the changes made to the remuneration structure in line with the Sedgwick recommendations had adversely impacted staff performance Mr Thorburn said he hadn't heard 'anything to that effect'.
• Would NAB consider moving to a fixed pay structure for frontline staff?  Mr Thorburn said that NAB 'should consider it' but that it would need to be considered carefully.  'I would still be a bit worried if we did it – we would have to think through the unintended consequences but one of which would be – you know, you’ve got really good bankers, and I think being able to recognise them with an incentive payment – let’s say they’re at 10 per cent and you could give them 1.5 times that so they get 15 per cent, I think that’s a – that’s a good thing' he said.
• Stop the practice of charging ongoing fees for advice? Counsel Assisting asked a number of questions in relation to charging clients ongoing advice fees for provision of financial advice, suggesting that charging ongoing advice fees, is in effect 'rebranding' grandfathered commissions, 'traditionally you got paid a commission because you were part of a distribution network, and you didn’t have to provide a service, and now it has been rebranded as a fee for service but you’re still not providing a service' he said.  Industry wide, Counsel said, there is an issue of services not being provided in exchange for the ongoing fee.  He suggested that one way of addressing this would be to cease the practice.  Mr Thorburn responded that this would 'be a dramatic way to fix it', adding that the issue was not the fee itself but rather the appropriateness of 'controls' to ensure the service is provided in exchange for the fee.  'I think having fees for certain services that you’re clear with your client around and then are provided is a possible very legitimate commercial activity that a bank could do' he said.  He added that he did not 'have a fundamental problem' with clients paying an ongoing fee for financial advice on a monthly or quarterly basis, 'if the fee is $12,000 a year that could be paid $1000 on a monthly basis' he said.
• Would NAB consider moving to a fixed pay structure for executives? Mr Thorburn said that he would have 'some concerns about abolishing it because I think it would make our sector – which is a very important one for Australia – less competitive and I don’t think we would be able to retain and attract the talent we need to make our banking system really excellent'.  Mr Thorburn also explained that 60% of executives' variable remuneration will now be deferred for 4 years and that the board retains discretion to withdraw it over that time.
• Changes to executive remuneration: Dr Henry was asked a number of questions in relation to changes made to the way in which NAB executives are remunerated, Counsel Assisting questioning the reasoning behind NAB's current approach (where the short term and long term variable reward schemes have been collapsed into a single form of variable remuneration), the transparency of the 'hurdles' involved and whether it incentivises the appropriate behaviour/the effectiveness of the scheme in holding executives accountable.  Commenting on current remuneration scheme, Dr Henry said 'NABs view clearly today is that incentives should be aligned with customer experience – customer outcomes, to be clear…That instead of positioning the business in this way, that the purpose of the business should be to maximise shareholder returns subject to customer tolerance and subject to regulatory tolerance, that, rather, the purpose of the business should be about maximising the outcomes for customers subject to financial viability.  And it is a rather profound distinction'.  Dr Henry acknowledged that the new scheme had had a mixed response from shareholders, fund managers and proxy advisers some of whom had expressed support, and some of whom would prefer that no change had been made.  Dr Henry also rejected the view that the scheme rewards short-term performance.  Separately, Dr Henry was also asked whether the decision not to reduce executive bonuses in light of the issues identified, demonstrated 'intolerance' of issues, Dr Henry said that the decision not to do so was justified.
• Operation of the two strikes rule: Asked whether the two strikes rule 'requires boards to focus too much on financial measures in the design of their remuneration systems at the expense of measures that are directed to things like reducing the risk of misconduct or ensuring good outcomes for customers' Dr Henry said that he agreed.   Asked what changes he would make to the rule, he said: 'boards have to accept that they have an accountability for matters which go beyond the financial performance of their business within a particular year, and the share price performance in a particular year.  I think that – I think that that’s the case.  I do think that’s the case.  How that is operationalised in a way that has the relevant stakeholders holding the board accountable for its performance, I don’t know.  And that really is, in my view, your challenge, and I think it’s really hard.  I think it’s really hard'.

Culture and the Role of the Board

A number of questions to NAB Chair Ken Henry focused on the issue of board accountability, the scope of board oversight/responsibility and the board's role in 'prescribing' the culture of an organisation.

• Can boards 'prescribe' culture?  Asked whether it's 'appropriate or even possible to prescribe a particular culture for financial services entities?' Dr Henry said that in his view it is not, but that regulators in Australia and overseas are increasingly taking 'a keen interest' in the culture of financial institutions.  Dr Henry also questioned whether the board can 'ensure' a particular culture 'We have said consistently to APRA the word "ensure" is a bit strong.  It’s really difficult for a board to be held accountable for ensuring anything, just as it’s rather difficult to hold APRA to that – to that standard of ensuring an appropriate risk culture' he said.  He said that the board 'has the principal role to pay in respect of the development of the culture of the organisation' but that 'ensure is a bit of a strict standard'.  'Model, lead, encourage, those words are…more obvious than "ensure" he said.'
• Role of the regulators in relation to culture?  Asked to comment on the role of regulators in this context, Dr Henry said that in the context of banking, culture is best overseen by APRA (rather than an ASIC) and that it is appropriate that the regulator take an interest in the form of questioning, challenging, nudging and through issuing prudential standards eg CPS 220 Risk Management (ensuring the board has formed a view of the risk culture within the organisation).  Asked what more regulators could do, Dr Henry said that 'APRA has done more' for example requiring all banks to undertake a review of their own organisations following the release of the prudential review into the CBA.  He added 'I think also through its leadership of the industry through its supervisory practices, APRA can influence the culture of institutions.  And I think it is occupying that space'.
• Assessing whether the desired culture had been achieved? Asked how he will assess whether the desired culture has been embedded at NAB, Dr Henry said that he would assess it by reference to the information about various form of risk, in monthly risk reports from the Chief Risk Officer, through tracking improvement in the net promoter score, and decrease in the number of complaints and through directors visiting branches and talking to staff where there are instances of poor conduct.  Asked how long it would take to embed the desired culture at the lender, Dr Henry said it would take up to 10 years.  Counsel Assisting challenged whether these measures would be sufficient to monitor improvements.
• Boards should be accountable to the community (rather than purely to shareholders): Asked to whom boards should be ultimately accountable, Dr Henry said that they should be accountable to shareholders, to customers, and to the community 'now and our future community'.  Asked how boards could 'achieve that accountability' Dr Henry said that it could be achieved through 'governance of the organisation' and more particularly, by boards accepting that they are accountable to the community rather than purely to shareholders.
• Level of detail required in communications to the board: Counsel Assisting asked a number of questions in relation to the level of detail provided to the NAB board and risk committee in relation to risk issues, Counsel alleging that there had been delay in the past (in the example under discussion) in escalating/reporting, and questioning whether the level of detail reported was sufficient given there was no explanation of the issue/background to the issue being reported or the business it related to, the root cause or details of possible contraventions of the law/possible penalties.  Asked whether the 'inadequacy of information has been fixed in those reports' Dr Henry responded 'I certainly hope it has been fixed....there is always a risk that issues are not being elevated to the board that the appropriate time and in the appropriate form.’  He went on to say later, that 'there's an expectation…that management is doing it [reporting] in the interests of the corporations, and that what…management needs from the board is guidance on particular issues, but not every matter', as such there is an element of risk that 'not every matter gets presented to the board in a way that would alert the board to the importance of the question'.
• Role of the board in challenging management: Dr Henry was asked a number of questions in relation to the way in which particular matters were escalated and managed and more particularly, what the organisation, and the board could have done differently.  A number of questions centred on whether the board could have stepped in earlier, to challenge the way in which management was addressing a particular issue.   Dr Henry agreed that the board could have stepped in sooner in that instance, though he did not agree that the board had not challenged management.  Counsel Assisting queried this, given (precise) details of the exchanges were not reflected in board minutes.
• Clarification of the law is needed on when organisations should act?  The Commission heard that 'it has typically been the case' at NAB, that risk matters may not have been reported to the board/risk committee until after discussions with ASIC.  Asked whether this practice (ie advising ASIC before the risk committee) should change, he agreed that it should.  He added that 'I wonder whether it’s necessary, in all occasions, to negotiate with ASIC at all, rather than simply notify and get on and fix it'.  He went on to say that the 'habit' of negotiating an outcome with ASIC had 'contributed to an insufficient pace of remediation for customers'.  Dr Henry suggested that in this context, clarification of the law would assist the organisation to be able to take action (without waiting for direction from ASIC): 'I have wondered whether in this case NAB should not have, years ago, funded some of our customers to take us to this place, to this Federal Court and get an outcome…The Commissioner of taxation behaves in this way quite a lot.  He has a budget to fund lawsuits against himself, in that case to provide law clarification – clarification of the law'.  The Commissioner asked whether clarification is necessary:  'The triplet which I never get in the right order in 912A is honest, efficient, fair? Those ideas are ideas of disarming simplicity.  The board, above all else, will have its view, will it not, about efficient, fair and honest? And if what has happened contravenes that standard, does it not follow inexorably that something needs to be done about it?'   Dr Henry responded, 'It seems simple when you say it.  It’s pretty challenging, really, for boards.  It is pretty challenging.  And maybe that’s – maybe that’s it.  Maybe it’s as simple as that'.

AMP

Questions to AMP's acting CEO Michael Wilkins included questions in relation to the issues of vertical integration, preventing fee for no service issues, the issue of fees more generally (ongoing advice fees and grandfathered commissions) and the possible extension of the Banking Executive Accountability Regime among others.

Extension of the Banking Executive Accountability Regime (BEAR) to insurance and superannuation?

The Commissioner asked Mr Wilkins, whether 'in respect of an organisation like AMP that engages in a number of different financial services, that there would be advantage in having an accountability regime that was not restricted to banking?'.  Mr Wilkins agreed, adding that AMP has made the decision to implement some BEAR requirements (remuneration aspects) across 'the organisation, rather than just to the bank'.  The Commissioner asked whether 'apart from the remuneration consequences which have their particularly important part to play in BEAR, just accountability mapping and accountability statements, are those steps that would have value in AMP in its activities beyond banking' (ie in superannuation and insurance) to which Mr Wilkins agreed, 'there would be benefit from that.  And I think some of the overseas models where similar arrangements have been put in place apply to – to broader areas of conglomerates' he said.

Vertical integration

The Commission heard that AMP remains committed to the vertical integration model, 'we believe in vertical integration.  We think it’s – it’s a – an appropriate structure that does have benefits for the consumer as well' Mr Wilkins said.  Mr Hodge outlined a number of advantages the model has for customers including: affordability of advice 'because of the greater scale that's…afforded'; 'comfort and confidents' for customers in dealing with a 'large integrated organisation knowing that that organisation will stand behind the advice…and remedy any issues…that may emerge; and the benefit of advisers having access to the 'feedback loop' which allows them to 'feedback back into the product manufacturing component' feedback concerning the appropriateness of products.  Counsel Assisting challenged this reasoning, and questioned more generally whether conflicts can be addressed within a vertically integrated model.  Mr Wilkins said that 'advisers do have a best interest obligation, and I don’t think that it naturally follows that they do not exercise that best interest obligation if they’re in a vertically integrated group, or that the risk of them not doing that is any less if they are in an independent role'.

Fees

A number of questions to Mr Wilkins concerned the approach taken to identifying, reporting and addressing fee for no service issues, including in relation to how these issues can be prevented going forward.

Ongoing fees for financial advice

Mr Wilkins acknowledged that in past, 'policies and procedures' to educate financial advisers on the need to ensure service was provided in exchange for ongoing advice fees were inadequate, and that it is a 'normal expectation' that where a fee is paid a service should be provided.  Mr Wilkins detailed a number of changes implemented at the organisation to address the issue, and maintained that that there is now acceptance within the organisation that the conduct is unacceptable.

• A number of questions were asked in relation to ongoing advice fees generally including in relation to whether advice is necessary/has value and whether the fee is sufficiently transparent to customers.  Mr Wilkins maintained that that ongoing advice has value stating that 'each customer is different, and their needs are different, and what we need to be able to do is to make sure that the product and service offerings that we have, particularly the service offering, caters to that need'.
• Asked about ongoing fees in relation to superannuation products, Mr Wilkins said that it would depend on the product, as to whether advice fees are justified.  For MySuper products he said that there no ongoing advice fees should be paid, but for self-managed superannuation funds, it was appropriate. 
  Phasing out grandfathered submission.
• Mr Wilkins was asked a number of questions in relation to AMP's submission to the Commission's Interim report which maintained that grandfathered commissions should not be banned.  He explained that since the response was submitted, AMP has amended its position and are 'now saying that we favour a phased approach to the removal of grandfathered commissions'.  Time would be needed, Mr Wilkins said 'for advisers to be able to go and make alternative arrangements with their customers to change the basis of their remuneration from their grandfathered commissions to a more contemporary fee for service type arrangement'.  Asked how long would be needed, Mr Wilkins said that 'one year would be too short.  Three years would probably be the maximum'.

Accountability and oversight of financial advisers

• Adherence to Australian Banking Association protocols are sufficient: The Commissioner asked Mr Wilkins for his view generally on how the industry, 'or the law generally should deal with the problem of the so-called rolling bad apple, that is, the adviser who is not sufficiently competent or engages in conduct of a kind that the advice licensee condemns, moves from business to business?'  Mr Wilkins said the in his view 'there should be more protocols for that in place' adding that AMP was an 'early adopter' of the Australian Banking Association (ABA) 'protocols…And I think that that’s an appropriate protocol'.  Asked whether this is 'sufficient', Mr Wilkins said that it is, 'I think it is a sufficient step, but there also needs to be better monitoring of the activities of those advisers and a – a quicker consequence from organisations where those advisers are not meeting the appropriate standards' he said.
• Individual licensing? Asked for his view, by the Commissioner, on whether individual licensing is 'simply a bureaucratic step too far, or a useful step?' Mr Wilkins said 'I think that it probably would be an overly bureaucratic step to go with that'.  Counsel Assisting challenged this, querying why if they're [advisers] to be professionals' like doctors, engineers, lawyers and accountants individual  licensing would be inappropriate.  Mr Wilkins maintained that it would be an 'overly bureaucratic step at this time.'

[Sources: 23 November 2018 - Draft Transcript for Day 64; 26 November 2018 - Draft Transcript for Day 65; 27 November 2018 - Draft Transcript for Day 66; 28 November 2018 - Draft Transcript for Day 67]