Draft regulation raises fears over PI levels

It’s ot surprising that Perth-based lawyer Mark Halsey should describe the draft Corporations Act Regulation 7.6.02AAA as “scary” in its implication for its intended audience of smaller, independently owned financial planning licensees.

After all, Halsey calculates that compliance with the draft regulation, as drawn up by Federal Treasury, would require some of these licensees to acquire professional indemnity cover “in the order of $50 million”.

The director of Halsey Legal Services, a financial services specialist, makes his calculation based on a “worst case” interpretation of the wording in the draft regulation, which is intended to overcome the problems of uninsured Australian Financial Services licensees, as highlighted by the recent Westpoint collapse.

Barring Treasury’s acceptance of any proposed industry changes to the wording of the draft — the deadline closed on November 30 — the draft regulation will come into force in early 2007.

It is intended to introduce a mandatory professional indemnity (PI) insurance framework into the financial advisory industry, requiring licensees to have arrangements in place to enable them to pay any compensation claims that may be made against them.

Financial planning firms that are connected to a bank or life insurance office, and where those organisations provide it with a guarantee, will not have to have the PI insurance — thereby effectively exempting most of the larger financial planning licensees from the regulation.

This is in itself is a problem for Halsey, among others in the industry, in so far as the regulation will offer a “substantial competitive advantage to planning firms owned by banks and life insurance companies over small, independently owned firms”.

However, the key problem for Halsey is the “ambiguity arising from the actual wording of the draft”, which has allowed him to calculate a PI figure of $50 million — a calculation that, incidentally, has the support of other industry spokespeople.

He has related problems with “some of the passages” in Treasury’s accompanying commentary on the draft, which he believes contradicts the wording in the actual draft despite or because of its attempts to reassure industry about the intention of the regulation.

Fundamentally, Halsey’s concerns turn on the draft regulation stating that licensees’ insurance must be “adequate, having regard to the highest possible liability that could arise in connection with all claims in respect of which the licensee could be found liable …”.

“In a worst-case interpretation of the ‘highest possible liability’, using a licensee’s number of clients as a benchmark, you can calculate enormous levels of aggregate liability cover that would be required for even a very small licensee,” he said.

For Halsey, the key contradiction in Treasury’s written commentary on the regulation is that it states the intention of the regulation is “not to guarantee that all retail claims will be met in all circumstances”.

He is supported by the comments of Financial Planning Association (FPA) policy manager John Anning, among others, in so far as he sees a contradiction between the regulation and the commentary.

Anning told Money Management that the FPA holds the view that the “wording of the draft regulation is not a match for the written commentary on the draft regulation that the Federal Treasury has provided”.

“The commentary is unexceptional, in the sense you could not take exception to its wording, but when you look at the wording of the draft regulation it does seem to imply a different approach to calculating the cover required,” he added.

According to Anning, Halsey is only “one of a number of industry spokespeople who have raised with us as an issue the use in the guidance of the term ‘to have regard to maximum possible liabilities’”.

“This term means that what licensees would need to do would be to work out all their possible liabilities, in other words the number of clients by the amount of the maximum claim, and then purchase that amount of cover,” he said.

“In fact, we’ve had some FPA members tell us that even if these levels of PI cover are actually available to them in the marketplace, how would they be able to afford $50 million worth of it?” he said.

The FPA is currently talking to Treasury, and as part of these discussions a meeting was recently organised with David Love, Treasury’s manager — corporations and financial services division, to talk to FPA members.

“The majority of the feedback from our members is that while they do not disagree with Government’s preferred insurance option of PI, they are concerned with its calculation as it is written in the draft regulation.”

Anning said the fears of members had been allayed somewhat by Love’s “willingness to register that the draft regulations may not be well-worded, and that as an issue of parliamentary drafting it is something that he is prepared to have a look at”.

Love also agreed to “take on board a few comments from FPA members that PI cover may not offer the protection that Treasury is hoping for, in terms of the exclusions that are common in PI policies”.

In tandem with these discussions, Anning said the FPA is also working on a written submission to Treasury “to be ready in time” to beat the written submissions deadline on November 30.

The FPA will use its submission to also argue for a transition period, he said, and for a gathering of stakeholders to check out whether PI cover in fact is the best method of insurance to meet Treasury’s objectives.

In fact, Halsey has already made a submission to Treasury with the support of the Association of Independently Owned Financial Planners.

He too has received verbal assurances from Treasury in response to his letter that it did “not intend for the draft regulation to be overly prescriptive or to set mandatory minimums of insurance cover”.

He added that his submission embraced a further assurance from Treasury that the regulation “should largely permit licensees to consider their own circumstances and to adopt a reasonable level of insurance cover for potential liability”.

His proposed changes are actually based on a comment he had received from Treasury staff that the intent of the regulation was for licensees to “determine a ‘reasonable’ estimate of their potential liability and insure themselves accordingly, and that is not going to be overly onerous”.

The changes essentially involved removing the expression “adequate” from the draft and replacing it with “reasonable”, so that the draft regulation would read: “… the licensee must use a reasonable basis to ensure that the cover provided by insurance represents a reasonable estimate of the likely liability of the licensee …”.

This version provides a “much clearer representation of Treasury’s stated intention to have the level of cover largely determined by the licensee using a reasonable basis, having regard to the unique factors that relate to that licensee’s business,” Halsey said.