As 2013 draws to a close, our Australian contentious FSR team has been asked what they forecast the significant regulatory developments will be in 2014.
With broad inquiries into our key regulators and the financial industry on the horizon, as well as a general privatising of the regulatory function, 2014 promises to bring more change and challenge.
We hope you find these insights valuable as we look forward to assisting you respond to these developments.
ASIC’s response to criticisms: 'More power, please'
The role of Australia’s corporate, markets and financial services regulator is likely to continue to grow in 2014.
A Senate inquiry into the performance of ASIC was announced in June this year, following widespread criticism of ASIC’s perceived failure to act promptly despite its awareness of potential misconduct in several cases. The inquiry will:
- examine ASIC’s legislative framework and whether there are any barriers preventing ASIC from fulfilling its legislative responsibilities and obligations,
- review the accountability of the regulator, and
- consider the workings of ASIC's collaboration, and working relationships, with other regulators and law enforcement bodies.
ASIC has used the opportunity presented by the inquiry to provide a Christmas wish list of expanded powers. ASIC seeks:
- More powerful search warrants, increasing the scope of information ASIC could obtain when executing such warrants.
More and higher penalties, expanding the nature and scope of penalties that ASIC can seek by:
- significantly increasing civil penalties and introducing disgorgement provisions to remove any benefit of the commission of an offence,
- introducing a broader infringement notice regime, and
- reviewing the criminal penalties in the corporations legislation to eliminate ‘inconsistencies’.
Tighter financial services and credit regulation, which would entail:
- improving adviser competence through a national exam for retail advisers, mandatory reference checking and an employee adviser register,
- allowing ASIC to ban a person from managing a financial services business or credit business, and
- giving ASIC greater discretion to refuse to issue an Australian financial services licence and take more information into account in making this decision.
- Facilitating whistle-blowing: Expanding the scope of who can be a ‘whistle-blower’ and introducing a presumption that ASIC cannot be compelled to disclose documents which would reveal a whistle-blower’s identity, unless compelled to do so by a court or tribunal.
'Son of Wallis' financial services inquiry – gen-Y edition
The Treasurer has finally released draft Terms of Reference for the long foreshadowed further review of the Australian financial system, dubbed 'son of Wallis' or 'Wallis II' after the last inquiry into the Australian financial system by Stan Wallis in 1997. It was the implementation of the recommendations of that review that led to the ‘twin peaks’ structure of regulation with the establishment of ASIC and APRA, alongside the Reserve Bank, which helped Australia weather the global financial crisis.
However, the report of the Wallis inquiry itself highlighted the need for further review, given its now jarring overview title of The Financial System: towards 2010.
The draft Terms of Reference demonstrate some of the new Government’s likely focus areas in 2014 and beyond:
- Competition in the banking sector – encouraging more international banks into Australia, in particular after the domestic consolidation post-GFC, and the capital that they may bring.
Managing risk, in particular moral hazard – the Government will no doubt be keen to establish structures and systems that:
- remove or at least reduce the need for Government guarantees in the banking sector,
- maintain support for lending, in particular lending to small business,
- secure the position of our financial institutions, and
- don’t impose too high or anti-competitive regulatory and prudential burdens on the Australian financial services sector.
- The objectives and roles of financial regulators – the balance of which regulators (ASIC, APRA and the Reserve Bank) should be responsible for what, and how they operate themselves and co-ordinate, will likely be reviewed, in particular following recent significant changes in this regard in the UK.
- New technologies and markets – not only does the development of new ‘currencies’ such as Bitcoin need to be considered but also now ubiquitous services, such as PayPal, and the now mainstream superannuation industry, something that barely cracked a mention in the 1997 Wallis report.
- Taxation system interactions – both direct interactions, such as dividend franking, more indirect consequence, such as taxing of superannuation and the general impact of the tax system on the financial services system.
With the Terms of Reference not yet finalised, a final report is due by 1 November 2014, with an interim report for consultation purposes some time before then. This is a similar timeframe to that taken by the previous inquiry and will leave the head of the new inquiry, David Murray, the former head of the Future Fund and the Commonwealth Bank with a gargantuan task. Murray is someone very much versed in, and who lived and breathed the outcomes of, the 1997 inquiry.
Son of Wallis is likely to advocate more incremental reform than its father, though the changes it will have to grapple with in the 17 years since the last review are likely more extensive, international and rapid. Whether it can do the job required by industry and its political masters is yet to be seen but we have no doubt the interim report due around June 2014 will be one of the most hotly discussed and debated issues next year.
Report early, report often
ASIC will undoubtedly continue to focus on breach reporting in 2014. At a time when the corporate regulator is under-resourced, it is increasingly reliant on entities bringing significant issues to its attention.
There are now numerous statutory obligations requiring the reporting of known, or suspected, breaches of the law to regulatory authorities. Prime amongst these is s.912D of the Corporations Act, being the requirement for Australian financial services licensees to self-report significant breaches of their financial services licensing obligations. A relatively recent introduction, as of late 2012, is that ASX, Chi-X and APX market participants are required to file a ‘suspicious activity report’ whenever they have ‘reasonable grounds to suspect’ that insider trading or market manipulation has taken place. From May 2014, this obligation will extend to trading in ‘dark pools’.
ASIC has recently expressed concern as to the 'narrow' approach it perceives some entities are taking to their reporting obligations. Guidance has been issued outlining ASIC’s views on the topic. This makes clear that ASIC expects entities to '[err on the side of caution' and report matters, even if there is uncertainty as to whether there is a legal obligation to do so.
ASIC is using (among other things) regular compliance visits to review compliance incident registers and reports, to assess whether AFS licensees are appropriately reporting breaches as required by s.912D. Borrowing a strategy employed by the UK Financial Conduct Authority, ASIC is also relying on reporting statistics, to identify where entities may be systematically under-reporting.
Accordingly, it is critical to have in place effective systems to ensure that potential breaches are appropriately assessed, and that a decision not to report can be justified if later queried. Further, given the potential for breach reports to contain damaging admissions and be used in subsequent actions (by the regulator or third parties), care must be taken in the drafting of any breach report.
Watch this space – in its latest appearance before Senate Estimates, ASIC was quizzed about whether there is a general obligation on directors to report serious corporate offences by their companies to ASIC (there isn’t). This was in the context of anti-bribery and corruption. So the Parliamentarians may look to expand reporting obligations further.
Bounty hunters coming to Australia?
Debate is emerging on whether the Federal Government should introduce financial incentives for whistle-blowing in corporate Australia.
The current provisions in Australia relating to whistle-blowers are limited to providing protections from civil or criminal liability and compensation for any resulting victimisation.
Following the successes of the US whistle-blower ‘bounty’ program (with over 6,500 whistle-blower reports since its inception in July 2010), and the announcement that both the European Commission and UK Government are considering introducing similar programs, questions are surfacing as to whether bounties could work here in Australia. Although we consider that it is unlikely that any such incentives will be adopted in Australia in the near future, we nonetheless think that this will create a focus on whistle-blowing. Such a focus can already be seen in ASIC’s submission to the Senate inquiry (see above).
In the US, the Securities and Exchange Commission can pay awards of up to 30% of the regulator’s recoveries above US $1 million. Awards can be made to persons who provide ‘original information’ relating to breaches of a range of securities laws, including market manipulation, insider trading, fraud and corruption. While the program has only been in operation since 2011, the SEC has already announced substantial awards, including one of US $14 million in Oct 2013.
Assuming a similar level of reward could be offered in Australia for information relating to breach of a similar provision of the Corporations Act 2001, an Australian whistle-blower would likely recover much less.
Notwithstanding the fact that financial whistle-blowing incentives are unlikely to be introduced, the increased regulatory focus on whistle-blowing in Australia means that corporates should ensure they have adequate internal integrity frameworks appropriate to their business.
Cybercrime: Medcraft chooses the red pill
IOSCO highlighted cybercrime in securities markets as a key new risk requiring careful analysis in its recently published Securities Markets Risk Outlook 2013-2014. Given ASIC’s Chairman, Greg Medcraft, is also the Chairman of the IOSCO board, we expect this will be an item on ASIC’s regulatory agenda for 2014.
Chairman Medcraft predicted in a speech on 31 October 2013 that cybercrime would be 'the next black swan event'. He considered that regulators needed to 'start thinking about how to address the risks to the financial system that cybercrime poses', in particular ensuring key participants in financial markets have 'adequate risk management … to ensure they are cyber-attack resilient'.
Major financial centres are already taking the threat seriously. For instance, large scale cyber security exercises have been conducted in New York and London this past year. The US Securities Industry and Financial Markets Association conducted an exercise on 18 July 2013 codenamed 'Quantum Dawn 2'. The Bank of England, the Treasury and the Financial Conduct Authority oversaw a similar exercise on 12 November 2013 codenamed 'Waking Shark 2'. Both were intended to allow individual firms and the financial services sector as a whole to test their resilience in the face of a street-wide cyber-attack.
A similar stress test within Australia is a possibility, although we think it is more likely that ASIC will seek to address the issue through one or more of the following:
- engaging with industry bodies, market participants and exchanges to better understand differing practices in cyber security,
- implementing regulation or guidance specifically aimed at enhancing resilience to cyber-attacks,
- engaging with other securities regulators to form information-sharing networks to build capability in this area,
- taking enforcement action against a market participant should they be subject to a cyber-attack where there has been a failure to implement adequate security and the incident results in market disruption.
Although this is a hot topic more generally within the corporate world, we expect that there will be regulatory focus specifically on the threat to orderly financial markets posed by cybercrime.
Pick me: selective briefing of analysts
The events surrounding Newcrest’s private briefings and market announcement in May/June this year has triggered a renewed focus by ASIC on listed companies’ interactions with analysts and their compliance with continuous disclosure obligations more broadly.
ASIC is sure to take steps to encourage companies to tighten up procedures to prevent inadvertent or intentional disclosure of price-sensitive information in their communications with analysts. Such steps may include:
- Engagement with stakeholder bodies to encourage them to lift industry standards.
- Conducting further targeted surveillance on listed companies’ analyst briefings.
- Additional guidance from ASIC or potentially new targeted regulations.
- Enforcement action against companies who fail to adhere to their regulatory obligations.
ASIC may ultimately borrow heavily from the Newman Report, a report by the former Chair of the ASX – Maurice Newman - commissioned by Newcrest into the incident earlier this year. The report made 17 recommendations relating to Newcrest’s framework for continuous disclosure compliance.
During the reporting season following the Newcrest events, ASIC conducted ’spot checks’ with selected companies to 'hear how companies brief analysts and understand their procedures'. ASIC Commissioner John Price flagged the possibility that 'stronger regulatory action' may be needed.
Although ASIC recognises that analysts play an important role in the market, the dialogue between investor relations professionals and analysts must take place within the bounds of the continuous disclosure obligations imposed on listed companies.
Complex products: keep it simple
There can be little doubt that ASIC Chairman, Greg Medcraft, will have issued an edict to his team that they are to keep a close eye on any potential mis-selling of financial products during 2014.
During 2013, Chairman Medcraft has spoken a number of times of ASIC’s challenge to 'keep pace' with innovation-driven complexity, including product complexity, so that it can meet its strategic objectives of ensuring: (i) a fair, orderly and transparent market and (ii) that investors are confident and informed. He has been an outspoken critic of misleading descriptions being applied to hybrid securities, particularly in the context of retail investors. Just last week, ASIC released a further report (REP 377 - Review of advice on retail structured products) on the topic, with Deputy Chairman Kell noting 'our warning against inappropriate selling of complex products cannot be clearer'.
As recognised by the IOSCO Securities Market Risk Outlook 2013-14, in the current environment of historically low real interest rates – investors are searching for yield – and this had let to an increase in the issuance of complex products. In these circumstances, there is a heightened risk that complex products may be mis-sold to retail investors (often on behalf of self-managed superannuation funds), when they don’t understand or correctly value the risks inherent in those products.
Chairman Medcraft has repeatedly stated that product manufactures and issuers need to 'wise-up and do the right thing' by ensuring that the products they sell are appropriate for the investor and aren’t being 'mis-sold'.
Issuers of complex products and financial advisers recommending them need to be aware that 'mis-selling' is a hot topic for ASIC and may be subject to increasing scrutiny in the future. To avoid ASIC intervention, steps should be taken to ensure investors are sufficiently educated about a complex product’s features and risks.
ASIC flexible when it comes to settlement
While ASIC has been lobbying for harsher penalties for serious market misconduct, at the other end of the enforcement spectrum it has been adopting a far more measured approach. We see this as a productive development and would encourage its continuation in 2014.
ASIC has available a number of enforcement tools, ranging from:
- criminal prosecutions,
- civil penalty proceedings,
- infringement notices,
- administrative actions, such as disqualifications or banning orders, and revocation, suspension or variation of licences, through to
- negotiated resolutions.
One option in terms of negotiated resolutions is an enforceable undertaking. An enforceable undertaking is a public document (available on ASIC’s web-site), the terms of which are enforceable by a court. Enforceable undertakings often provide outcomes such as compensation for affected persons and a process for independent review of a person’s compliance procedures. The number of enforceable undertakings being accepted by ASIC has increased slightly in recent years, but is still well short of the extensive use which was seen in the period shortly after their introduction (1999 -2003).
In recent times, we have seen increased use by ASIC of negotiated outcomes falling short of enforceable undertakings. This is usually reflected (in a public sense) in a media release by ASIC stating that the regulator had concern about certain conduct (eg, that specified advertising was potentially misleading) and that, in response to those concerns, the relevant company has agreed to take action to address the issues raised.
It will be interesting to observe whether, in 2014, the trend towards outcomes of this nature continues. In our view, the flexibility and efficiency of these kinds of resolutions means that they should be strongly encouraged. However, with the pressure on ASIC to show ‘results’, there is a risk that ASIC may feel that outcomes of this nature are less desirable, given that they are not recorded in traditional enforcement ‘statistics’.
Market manipulators beware
We predict that there will be an increased focus on market manipulation by ASIC, and a higher preparedness of the Commonwealth Director of Public Prosecution to prosecute such offences.
This is due to:
- ASIC’s success this year in the High Court decision of DPP v JM  HCA 30, which provided guidance on the meaning of 'artificial price' in section 1041A of the Corporations Act,
- the continued focus of ASIC on market integrity,
- the new reporting obligation noted above which requires market participants to notify ASIC if they have reasonable grounds to suspect that a person has entered into a transaction which involves market manipulation, and
- ASIC’s recently enhanced next-gen market surveillance technologies (Market Analysis Intelligence), which will result in ASIC identifying a greater number of cases of market manipulation.
ASIC is expected to provide guidance in light of the recent decision of the High Court, on what it sees as constituting market manipulation, in the coming months and is likely to be more active in this space into the future.
ASIC wants your legal advice
ASIC contends that privileged communications can be provided to it on a confidential basis without resulting in a wider waiver of privilege. In 2013, it formalised a policy to this effect (ASIC Information Sheet 165: Legal professional privilege).
In 2014, we expect to see a stronger push by ASIC for access to privileged material, such as internal investigation reports. As observed in a recent speech by Justice Weinberg of the Victorian Court of Appeal, it is not surprising that ASIC would seek this material, given its financial constraints and the pressure it faces to deliver results. When it embarks on a complex investigation, ASIC may feel that any written advice will provide a short-cut to identifying whether there has been any serious wrongdoing.
Justice Weinberg’s speech referred to an article by HSF partner, Andrew Eastwood, published in the Australian Business Law Review earlier in 2013. That article explores a number of the issues associated with the voluntary provision of your legal advice to a regulator.
A critical issue that requires careful consideration is whether such disclosure will constitute a general waiver of privilege. This is an especially important consideration in Australia given our active class action industry. It is relatively common-place for plaintiffs to seek, through subpoenas and other means, the production of documents obtained by ASIC in the course of its investigations.
In 2013, ASIC released guidance on the benefits of co-operating with ASIC’s investigations, including that co-operation may lead ASIC to seek less severe remedies – see ASIC Information Sheet 172: Cooperating with ASIC. Given the increasing use of shareholder class actions, companies need to be aware of, and balance the benefits of co-operating and providing information to ASIC against, the potential risk that the information may be subsequently provided to shareholders to be used as evidence in a class action.
In the last decade, Australia has seen an increased use of shareholder class actions seeking compensation for breaches of corporate governance obligations. There is a persuasive argument that the increased use of shareholder class actions can positively impact corporate behaviour and reduce the burden on regulatory bodies, such as ASIC.
ASIC has provided guidance that it will only seek compensation for individuals where there is a public interest in doing so, beyond the affected consumers. ASIC Chairman Greg Medcraft has publicly supported the use of shareholder class actions, if they are 'done responsibly'. When ASIC has concerns about the fairness of a class action, it may intervene, just as it did this year in relation to the settlement of the Storm class action. In this regard, see ASIC Information Sheet 180: ASIC’s approach to involvement in private court proceedings. Mr Medcraft has also said that within the bounds of relevant legislation, ASIC is happy to provide information to individuals to support those actions. This position is supported by ASIC Information Sheet 181: Providing information and documents to private litigants.
Ganging up: cross-border investigations
Given the growth of cross-border financial services, and increased pressure on regulators to deliver tangible results post-financial crisis, regulators are increasingly seeking assistance from their overseas counterparts in investigating issues, particularly in market misconduct cases. We expect to see ASIC increasingly looking to cooperate with their overseas counterparts, resulting in more cross-border investigations.
Corporates are increasingly facing the prospect of being investigated and ultimately sanctioned in multiple jurisdictions for the same conduct.
An increase in cross-border cooperation raises a number of issues for corporates including:
- complying with reporting obligations in multiple jurisdictions,
- structuring internal investigations and interactions with regulators across borders, where disclosure obligations and the protection of privilege may differ,
- managing relationships with multiple regulators, who may cooperate as a united front or compete with one another for the regulatory spotlight,
- settling enforcement action where global settlements are practically very difficult to negotiate, particularly where not all regulators involved are coordinated.