Collins: FSR should be scrubbed – Part II

I said in my last article that I would discuss alternatives to the FSRA in my next column. This now seems more appropriate than ever given the interest the industry is currently attracting. And especially since both theInvestment and Financial Services Association(IFSA) and theFinancial Planning Association(FPA) believe that the Financial Services Reform Act (FSRA) is going to resolve all the woes of the industry. I believe in fairies at the bottom of the garden too!

My view is that you cannot expect people to behave properly just because there are laws and regulations. The laws and regulations have to be policed.

Let’s look at two examples. In NSW, where I live, it has recently become an offence to use a mobile phone when driving. How many people have changed their behaviour? Not many from what I’ve noticed. Why? Because it is not heavily enforced.

The same cannot be said about “driving under the influence”. This has been rigorously enforced, with testing units always on the road. And people’s behaviour has changed. Why? Not really because of the law, but because it is very heavily enforced — and being enforced pro-actively.

Let’s look at FSR. Most of the effort is going into licensing, not enforcing. And what effort is going into enforcing is reactive — after a complaint is received.

We have three options. Option 1 is to persist with the FSRA (and have very few resources left to enforce). Option 2 is to have no regulation (and have no rules to enforce). Option 3 is to have registration instead of licensing (and have pro-active enforcement). My arguments against the FSRA (Option 1) I set out in my last article, so in this article I will focus on the other two options.

For an example of where Option 2 (no regulation) is working, we need look no further than New Zealand. Across the Tasman, there are no specific laws and regulations covering the securities and financial services industry. There are no Managed Investments Act (MIA) or FSRA equivalents. (Also they don’t have a Byzantine array of tax, social security and superannuation laws.)

What they do have is an over-archingFair Trading Actwhich covers all industries, including the securities and financial services industry.

If an investor has a complaint, they go to the government department administering the Fair Trading Act. If the department believes the investor has a case, the department will then sponsor the investor’s case through the court. This is probably a lot cheaper to run than our system. Also, it would be interesting to know if there is any more or any less dishonesty in New Zealand than there is here.

This option would appeal to me if I thought we could develop a self-regulatory environment. However, it appears that both of the major industry bodies (IFSA and FPA) don’t want this. There could be many reasons for this. One I dare suggest is that they know that they would find it difficult to stand up to their members. It seems that we all need the crutch of the government enforcer.

Therefore, my preference is for Option 3. In this option, FSRA would be replaced with an Act that defined a code of conduct, registration, not licensing, and more importantly, a requirement for the Australian Securities and Investments Commission (ASIC) to collect and analyse a comprehensive range of statistics. It would also be strong in enforcement, including substantial monetary fines. In this option, the resources currently put into licensing would be put into pro-active enforcement.

The code of conduct would flesh out common law requirements on fiduciary responsibilities, misleading and deceptive behaviour, and disclosure. It would separate out advice from implementation. Further, it would cover off the ‘know the client’ situation. There would be a broader ‘know what you’re talking about’ rule rather than the current ‘know the product’ rule, as the current rule pre-supposes that advice always includes advice on a product.

There are many countries in the world where advisers are registered and not licensed (for example, USA and Germany). The difference is that when you register, that’s what you do, with a minimum of fuss and paperwork. You don’t have to prove all the things (and provide the documentary evidence) that you now have to do for the FSRA.

But when you do register, you are given the code of conduct rules and told that they will be pro-actively enforced. And that’s the big difference — the resources are used on enforcement, not licensing processing.

ASIC, nor its predecessors have ever collected operational statistics on the industry. Even today ASIC cannot even tell you how many dealers (in retail financial planning) and advisers there are. I would have ASIC collecting more information about the industry than they would know what to do with.

The information collected would be to the detail of every transaction generated in the industry. This is already done for share trades and will be possible once managed fund transactions are automated. These transactions would be analysed for unusual activity. This is the basis of pro-active enforcement.

Just imagine an adviser has never used XYZ fund manager. This manager announces a conference in Paris later this year with expenses paid subject to volume written over the next six months. The adviser starts placing business with XYZ. Under Option 3, ASIC could pick this change of behaviour up and pay the adviser a visit. Pro-active enforcement!

Finally, I would introduce hefty monetary fines for fund managers, the dealers and the advisers. Nothing like a monetary penalty to focus the attention of this industry. The fine would either be in lieu of or in addition to other penalties, such as enforceable undertakings and so forth.

Which neatly leads me to theAustralian Prudential Regulation Authority(APRA). It should be disbanded and its responsibilities revert to theReserve Bank of Australia(RBA) and ASIC. (In my last article I commented on APRA also.)

ASIC should be totally responsible for superannuation. Where is the prudential risk with superannuation? Unlike the UK, where the majority of products are capital guaranteed, very few, if any, are in Australia. Many years ago we moved the risk to the member with defined contribution plans. The member wears all the investment risk — as we currently well know.

Even for defined benefit funds the risk is being borne by the employer — and who regulates the employer — not APRA but ASIC. Further, most of the defined benefit funds these days are for government and related employees — and who’s responsible for these funds?

I would be interested in any other ideas to provide clients with more timely protection and a regime that doesn’t burden those in the industry who are complying.

We have to stop mindlessly making regulation more complex and more stifling. What Treasury (the authors of the FSRA) know about financial services is only too evident in the six trillion pages of Act, regulations, policy papers and practice notes that make up the FSRA.