Trio Capital exposes investor compensation shortcomings

Susanna Khouri believes the Trio Capital debacle has highlighted the need for better mechanisms to compensate investors for loss.

While debate among regulators, lawmakers and industry observers continues as to whether Trio Capital losses stemmed from fraud or bad investments, there are deeper issues that emerge from close scrutiny of this case.

Helping victims seek financial redress following civil wrongs is what litigation funders specialise in. However, when it came to Trio Capital even they were stumped.

With Trio, it is obvious the system that ought to compensate investors for losses arising from wrongdoing had failed.

Given the heavy losses incurred by investors in the managed investment and superannuation schemes operated by Trio Capital (a burden now also borne in part by Australian taxpayers), it is apparent that there was wrongdoing.

If insurance is not an effective method of securing compensation, then we need to establish an alternative so that future investors do not endure the hardship and frustration experienced by the Trio investors.
 

VIEW ALL

View all

Therefore, it follows there should be avenues to seek financial redress on behalf of the many aggrieved Trio investors.

Unfortunately for the Trio investors who did not invest in funds regulated by the Superannuation Industry (Supervision) Act 1993, there appear to be no viable avenues to pursue redress.

This is a poor reflection on a system with many paid participants with various responsibilities designed to protect unsophisticated investors. When tested to the extreme, the system failed those investors.

The report of the Parliamentary Joint Committee into the collapse of Trio Capital reveals a range of shortcomings in the checks and balances which should provide protection to investors from fraud and losses resulting from an Australian Financial Services Licence (AFSL) holder’s misconduct or failures.

One particular issue identified by the Committee warrants further analysis, and points to an area requiring urgent reform – namely, the adequacy of professional indemnity (PI) insurance held by AFSL holders.

A review of compensation arrangements for consumers of financial services last year by Mr Richard St John concluded that PI insurance was not an effective compensation mechanism for loss arising from licensee misconduct.

But if it is not an effective compensation mechanism, why bother to put AFSL licensees to the cost of obtaining such insurance?

What purpose does it serve? It was certainly little comfort to the Trio investors.

The submissions to the Committee show that Trio investors clearly held an expectation that their financial planner's PI insurance would assist to make good loss caused by the planner’s conduct.

Their bitter frustration and disappointment at learning the truth about these arrangements is understandable.

The three large financial planning groups that channelled clients into Trio are all now insolvent.

In practical terms, recourse to the planner’s PI insurance was therefore the only way the Trio investors could directly pursue compensation for losses arising from their planner’s misconduct and failures.

However, the planners’ levels of insurance were extremely low relative to the size of the claims against them.

After factoring the costs and risks of realising any insurance money, it was simply not viable to pursue a claim against the planners and access the insurance.

This PI issue was not identified by the Committee as one of the numerous “expectation gaps” between the roles and functions the various gatekeepers actually performed versus what Trio investors expected them to perform.

Nevertheless, there is clearly a gap between an investor’s expectation that their planner’s PI insurance would be of sufficient size to meet claims against it and the minimal levels of insurance most planners actually have in place.

What is not generally understood is that it is the AFSL licensee who determines the amount of PI insurance, based on what they consider warranted.

The Australian Securities and Investments Commission does not get involved or approve the amount of PI insurance. So where is the incentive for AFSL licensees to make a proper risk assessment of their business and to take up appropriate insurance?

How should risks be assessed? How should an 'appropriate' or sufficient amount of insurance be calculated?

These answers are not straightforward, but it is clear the present system has holes. I write from experience based upon the numerous claims against AFSL holders that IMF has assessed over a number of years.

It is very evident that AFSL holders – including financial planners – generally carry very low levels of insurance. When significant claims arise, the insurance coverage is generally inadequate, leaving investors to wear their losses.

The Committee’s report makes for sobering reading. It offers a rare insight into how Australia’s financial and superannuation system actually works, and the roles key market participants play in the protection of investors (or fail to play, as the case may be).

Appropriate avenues of financial redress in the event of professional misconduct or failure are an important part of a properly functioning system.

If insurance is not an effective method of securing compensation, then we need to establish an alternative so that future investors do not endure the hardship and frustration experienced by the Trio investors.

Susanna Khouri is the investment manager of IMF (Australia) Ltd.