ASIC Is Not Soft: Who’s Next In Line For Scrutiny?

Originally published by Cuffelinks

Although recent ASIC enforcement action and the Royal Commission have predominantly focused on the financial advice and lending practices of AMP (AX:AMP) and the major banks, emerging patterns teach us that non-bank lenders and financial advice firms are the next targets.

How do we know this?

ASIC’s approach

ASIC’s modus operandi is to first investigate potential regulatory issues within big targets, where misconduct is widespread and evidence is easy to find. This serves as a learning exercise, helping ASIC to ascertain the nature and scale of misconduct, and what to look for.

Investigation complete, ASIC generally releases a report on its findings and concerns. You’d expect that diligent compliance teams would read those reports, look within for similar problems, notify ASIC of any breaches and start a clean-up.

That’s what ASIC hopes for too. But, if no one falls on their sword – and the past few years have demonstrated how reluctant financial advice licensees are to do so – ASIC brings out the big guns of enforcement.

Naturally, they’ll start with the banks and big targets, who’ve proven easy to make examples of. But here’s the rub. By the time that work is nearing completion, ASIC has a template for investigating smaller players. They know what to look for, where to find it, what questions to ask, with a standard methodology.

ASIC’s methodology

It goes like this:

• Require from financial advisers a list of clients and information about the advice (s912C notice) and from credit providers, a list of borrowers and information about the loans from the lender (s266 notice).

• At the same time, require production of policies and procedures dealing with the area of concern (s33/s267 notice for AFSLs/credit providers) and production of policies and procedures dealing with the area of concern of past files or loans.

• If their concerns are borne out, some recent files may be requisitioned to see if any improvements have occurred, hoping that by now the firm’s compliance team will have acted on the report (s33/267 notice).

• An optional next step is for ASIC to bring the CEO or other senior managers in for questioning (s19/253 examination).

• If ASIC finds breaches which have not been voluntarily reported, enforcement action will follow.

So reading the tea leaves to be found in ASIC’s Corporate Plan for 2017/18 to 2020/21, its Enforcement Outcomes report for July-December 2017 and the carnage emerging from the Royal Commission, here’s a snapshot of what advisers and non-bank lenders should be looking for in their businesses. If they don’t, ASIC will!

Concerns with non-bank advisers

1. Charging fees for no advice – Over 27,000 customers have received a refund of fees charged for ongoing services that weren’t provided. ASIC estimates at least 150,000 more refunds will be required, and the problem is not limited to the banks. Selling grandfathered investment trail commission books must be in jeopardy, even if the government doesn’t legislate to end grandfathering.

1. Life insurance churning and inappropriately recommending super money be used to pay for life premiums – ASIC now receives regular exception reports on high lapse rates from insurers, from which they’ve become highly adept at detecting bad practices.

1. Failing to consider whether clients’ existing products will meet their objectives before recommending replacement – The minimum standard requires financial modelling of both options and a clear case for change, all of which is clearly explained in the Statement of Advice.

1. Inappropriately recommending SMSFs – It’s not just low balances that ASIC is concerned about, as client financial literacy and willingness to manage the responsibilities inherent in an SMSF are just as important.

1. Recommending services that clients don’t need or don’t value – These could include platforms or simply high ongoing service levels.

1. Recommending in-house financial products to generate extra revenue when there’s no additional benefit for the client – Vertical integration is not limited to banks. Advisers who operate Managed Discretionary Accounts (MDAs) or Separately Managed Accounts (SMAs) run the same risks.

Concerns with non-bank lenders

1. ASIC wants to make sure consumers have not been put into loans they can’t afford, don’t understand, or don’t meet their needs. As part of its focus on credit, ASIC will be looking at brokers who do not arrange loans responsibly and lenders who do not lend responsibly.

1. Brokers are expected to assist consumers to decide whether they can afford a loan, and if they can’t, help them to find a realistic method of achieving their goals. And lenders must not lend to customers if they cannot afford to repay. It’s not sufficient to use the Household Expenditure Measure as a proxy for actual expenditure. Verified evidence of actual revenue and expenses must be analysed.

1. Interest only, vehicle finance, and high-risk products are a priority. Although home loans and personal loans are not immune, ASIC is especially concerned about interest-only home loans, car finance, and high-risk lending products such as payday loans and consumer leases.

1. Brokers and lenders must ensure that reverse mortgage borrowers – who are typically older people at or near retirement – understand the costs and implications of taking out these products. The minimum requirement is for these borrowers to be given a Reverse Mortgage Information Statement, and taken through the Reverse Mortgage Calculator in person.

1. ASIC is preparing to get tough on lenders and lease providers using unfair contracts. It has recently warned lenders to ‘fix up’ unfair contracts immediately or face legal action. Some lenders have already paid heavy fines, refunded repayments, written off debts, or contributed to community programs. Others have lost their credit licence.

1. Lenders are now expected to have systems in place to identify and reduce the risk of loan fraud. This follows some egregious fraud cases where brokers either ignored forged or false documentation, or worse, falsified information for clients to increase the likelihood of their application being accepted.

1. The jury is out on mortgage broker remuneration. Commissions and other financially-based incentive schemes have a propensity to incentivise brokers to recommend loans.

1. Frustrated with its lack of progress in encouraging responsible lending practices through enforcement action, ASIC has taken the radical step of recommending that the industry move away from incentives that create conflicts of interest. This will be echoed by the Royal Commission.

1. Credit repair, where ASIC will take action against companies that charge consumers exorbitant fees to clean up their credit history or who put them into insolvency rather than negotiate hardship arrangements.

ASIC’s track record is impressive

The criticism that ASIC is receiving in the Royal Commission and the media for being a soft cop on the beat isn’t borne out when you look at the statistics. In the second half of 2017 alone, ASIC’s enforcement actions banned 54 people and companies from providing financial services or credit and instituted 232 summary prosecutions for liability offences and a further 17 sets of criminal proceedings. It raised $21.7 million in civil penalties and $94.4 million in compensation and remediation for investors and consumers.

If you’re not sure whether your business is at risk, or if you receive an ASIC notice, it’s best to get on the front foot.

Claire Wivell Plater of The Fold Legal is a leading financial services and credit lawyer. She actively advises both digital and ‘analogue’ businesses on commercial and regulatory issues and is a member of the Federal Treasurer’s Digital Advisory Group.