Parliamentary Joint Committee on Corporations and Financial Services – Oversight of the Australian Securities and Investments Commission


Proof Committee Hansard


Oversight of the Australian Securities and Investments Commission


 FRIDAY, 21 JUNE 2013



This is an uncorrected proof of evidence taken before the committee. It is made available under the condition that it is recognised as such.





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Members in attendance: Senators Boyce and Mr Fletcher, Mr Griffin, Ms O’Neill, Ms Smyth.

Terms of Reference for the Inquiry:

To inquire into and report on:

Oversight of the Australian Securities and Investments Commission



  • BRENNAN, Mr Royce, General Manager, Risk, BT Financial Group
  • BROWN, Ms Eve, Senior Policy Manager, Trustees, Financial Services Council
  • CODINA, Mr Martin, Director, Policy, Financial Services Council
  • COLE, Ms Nerida, Managing Director, Financial Advisory, Dixon Advisory
  • EPSTEIN, Mr Justin, Executive Director, One Investment Group
  • EVERINGHAM, Mr Richard, General Manager, Strategy and Development, Lonsec Research
  • GHANDAR, Mr Amir, Policy Adviser, Audit and Assurance, CPA Australia
  • GRAHAM, Mr Anthony, Executive Director, Macquarie Group Ltd
  • JOND,  Mr  Pierre,  Managing  Director,  BNP  Paribas  Securities  Services;  and  Chairman,  Australian
  • Custodial Services Association
  • KHOURY, Mr Paul, Deputy Chairman, Australian Custodial Services Association
  • McKENZIE, Mr Graeme, Partner, Ernst and Young
  • SMITH, Mr Anthony, Partner, Ernst and Young
  • THOMAS, Mr Mark, Chief Executive Officer, van Eyk Research Pty Ltd
  • VOLPATO, Ms Karen, Senior Policy Adviser, Australian Institute of Superannuation Trustees

Committee met at 10:08.

ACTING CHAIR (Senator Boyce):  I open this public hearing of the Parliamentary Joint Committee on Corporations and Financial Services. Today’s hearing is in two parts. The first part of the hearing will take the format of roundtable with various representatives from Australia’s financial system. The second part of today’s hearing will be the committee’s regular oversight of the Australian Securities and Investments Commission. Before the committee today are two representatives from each of the following gatekeepers: financial planners and advisers, represented by Dixon Advisory and Macquarie Group; custodians, represented by the Chair and Deputy Chair of Australian Custodial Services Association; research houses, represented by Lonsec and van Eyk; auditors, represented by Ernst and Young and CPA Australia; trustees, represented by the Australian Institute of Superannuation  Trustees  and  the  Financial  Services  Council;  and  responsible  entities,  represented  by  BT Financial Group and One Investment Group. I welcome you all here today. The committee greatly appreciates the time that you have made available to appear. I hope you will find the discussion of this roundtable useful and helpful.

The purpose of the roundtable is to explore some of the issues raised in the committee’s report into the collapse of Trio Capital, which was tabled in May last year. The focus of the roundtable will be on the expectation gaps— what some people have referred to as chapter 7 of the report: the difference between what investors and the public expect that you as gatekeepers will do and what is legally required of you. While the Trio report focused on the role of gatekeepers in the context of corporate fraud, the committee is keen to examine your roles more broadly. It is interested not only in how you as gatekeepers see your own roles and responsibilities but in how gatekeepers perceive the roles of other gatekeepers in the financial system. Chapter 7 of the committee’s report into Trio Capital discussed these expectation gaps. The committee has sent you a copy of this chapter and asked if you would read it before today’s hearing. The committee also asked if you would prepare a short summary outlining your views on issues raised in other documents—and I thank you all for providing those summaries to the committee. You should all by now have a copy of each other’s summaries as well and there are spare copies of those summaries with the secretariat if anyone requires one.

I remind everyone that witnesses giving evidence to the committee are protected by parliamentary privilege. Any act which may disadvantage a witness on account of their evidence is a breach of privilege and may be treated by the parliament as a contempt. It is also a contempt to give false or misleading evidence to committee. Witnesses should be aware that, if in the giving of their evidence they make adverse comment about another individual or organisation, that individual or organisation will be made aware of the comment and given a reasonable opportunity to respond to the comment. The committee prefers to hear evidence in public but may agree to take evidence confidentially if the committee believes it is relevant. The committee may still publish confidential evidence at a later date, but we would consult with the witness before doing this. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken and the committee will determine whether it will insist on an answer, having regard to the ground claimed. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. A request to give a particular answer in camera may also be made at any other time.

I might with a question that I asked of some of you before we got going today: is a group of this type likely to get together in the normal course of attending conferences and the like within your industry? I am happy to hear from anybody.

Mr Codina:  Whilst the Financial Services Council, FSC, is here representing trustees, our membership represents most of the organisations and, if you like, business lines that are covered here. With 130-plus members and a countless number of events, including an annual conference in August that most of the people at the table and in the room will probably attend, I would say the answer is: yes and quite regularly.

ACTING CHAIR:  The purpose of the question really was to see if you believe that there were enough opportunities within the industry currently for expectation gaps to be chatted about over drinks or brought up during conferences. Is that your view?

Mr Ghandar:  Firstly, it is a fantastic initiative of the committee to bring us together like this. There certainly are opportunities in conferences within our bodies. Also, CPA Australia, with over 144,000 members, also has representatives who would come together, representing, I would be comfortable in saying, all the groups represented here. The bottom line is that this is a complex system. The layers are therefore good reason and the complexity is as much driven by volume in the financial system as by anything else. What is really important is that there are Australians increasingly coming into the system and being exposed to the system—everyday people who do not really have a great deal of financial knowledge necessarily. They are intelligent Australians who make the best decisions they can based on information that is available in the advice that they can get. What is really positive in coming together like this as much as we can—in fact, may be the key reason we were so pleased to attend today—is if we can work towards providing those Australians with better and better information that they can understand and that is clear, relevant and well tuned to their needs in making their own decisions. That has to be a good thing.

ACTING CHAIR:  The secretary reminds me that Mr Everingham wishes to make a short opening statement.

Mr Everingham:   Thank you for the opportunity to make an opening statement. Lonsec has made its submission available to all participants, so we will take the paper as being read. I will therefore just briefly summarise our position on the two topics specifically raised in relation to research houses. These are the expectations gap between research houses and financial planners and research house business models.

Firstly, on the expectations gap, Lonsec believes the role of research houses is to provide independent opinion on the quality of investment products in the marketplace. In Lonsec’s case, we do this by issuing investment product ratings with supporting investment product research. Lonsec’s ratings are determined on the basis of our level of conviction that the investment products can achieve their objectives and on our opinion of the relative attractiveness of the products versus their peers. Our ratings definitions and our research processes are clearly disclosed to the users of research, being financial advisers. Lonsec does not believe that research houses have either the knowledge or the expertise or the resources to accurately and consistently identify fraudulent conduct which may lead to financial product failure. Nor can research houses accurately and consistently predict extraordinary market events which may cause market failure.

Research houses also produce opinion on the nature of investment products, guidance on how to use them and what features and attributes they may have which may assist in determining investor suitability. However, this advice and opinion must by law be general in nature. We do not know the end investor and, as such, we cannot provide personal advice. This is the role of a financial adviser.

Research houses can certainly continue to improve and professionalise their services further. Research houses should also strive to do what is within their control to close the expectation gap with financial planners. These are the goals and intentions of ASIC and we therefore support Regulatory Guide 79. But financial planners must also accept that with their desire to become true professionals comes the responsibility to understand not only the nature of investment products better but how these investment products should be used and who they are and are not suitable for.

These are the goals and intentions of ASIC and we therefore support regulatory guide 79. The financial planners must also accept that with the desire to become true professionals comes the responsibility to understand not only the nature of investment products better but how these investment products should be used and who they are and are not suitable for. We expect very high standards from our doctors when they prescribe us drugs to improve our physical health; we should have similar standards and expect similar levels of expertise from our financial advisors when they recommend us financial products to improve our financial health.

I will now briefly the research house business models. Much has been said and debated on the topic. During ASIC’s update of RG 79 the regulator took an in-depth look at all research house business models in the context of research quality and whether the conflicts inherent in all models could be managed effectively and robustly. The existence of a range of direct and indirect conflicts under all business models was clearly recognised and no business model was banned. These conflicts exist because the users of research, the financial planners, will not currently bear the full cost of production of high-quality qualitative research. Research houses therefore adopt either a hybridised pay-for-research subscription model or a subscription model where ancillary business units, like funds management arms or data collection arms, cross-subsidise the production of research.

Pay-for-research business models have a direct conflict. Evidence clearly supports that not only can this conflict be effectively and robustly managed but the quality of research produced under this model can and has been industry leading. For the past three years research houses with pay-for-research business models have been awarded Research House of the Year by the Wealth Management Industry’s publication, Money Management. This is an award that takes into account the views of all users of research. The market for the purchase of investment research self-regulates. Research houses are typically contracted by financial planners on short-term bases and market share is quickly stripped from those who are perceived to be producing poor-quality research or research that is influenced by conflicts. To this end the research house with the greatest market share is currently one with a pay-for-research model and a combined market share allocated to all research houses with pay-for- research business models is in excess of 50 per cent.

My final point on pay-for-research business models is around precedent. There is clear evidence for the effective management of the analogous conflicts from free market enterprises in other sectors of the financial services industry, Auditors, property valuers and independent experts in takeover situations are all paid by the entities they provide opinion on. There is also clear precedent for regulators operating under an analogous pay- for-assessment model. In the pharmaceuticals industry the Therapeutical Goods Administration is funded by drug manufacturers on a product-by-product basis to undertake its assessment of product efficacy and safety. Thank you for the opportunity for Lonsec to attend this hearing and to be a contributor to the important work of the committee.

ACTING CHAIR:  Thanks, Mr Everingham. Mr Thomas, would you like to add anything there or respond to

Mr Everingham’s comments?

Mr Thomas:  Yes, I would. All I would say is that there are different models. We have a different model to the pay-for-ratings model; that is a subscriber base where we represent the investor. We do have a funds management arm, which uses that research to provide solutions in that space and we negotiate with certain third parties to run that business. When we are looking at the whole issue around ASIC’s inquiry and roundtables the key piece was the outcome and when I asked ASIC about that it was essentially that they wanted unbiased results. In our data we essentially review managers and set the bar at a certain level. As it turns out, we recommend less than half of the investments we review and in our view that is an unbiased outcome. We are not a library and we do not cover all aspects of the market—superannuation funds are not something that we rate. Other people do that; we rate underlying manufacturers of investment solutions. We then publish that research to out subscribers who pay for our research. Some people have access to it, if they pay for it. We are not a charity—we are a business—and we provide a service which is a value-add and over time that value-add has been positive.

ACTING CHAIR:  Are there any other opening statements? No, okay. In terms of the expectation gap, could any of you comment on whether you believe we need to work at closing the gap by educating consumers—each other’s consumers as well as the end-user of your products—or adding more regulation?

Mr Thomas:  I do believe that the level of disclosure around the advice process is something that has been addressed in a significant form. However, there are other areas particularly in the research space where they are not the sorts of disclosures in the same ways that one would perceive as a disclosure. I think there was mention of a payment for audit reports or specialist reports in other fields, by Mr Everingham. It may well be that the disclosures need to come up to those sorts of levels so that people have their eyes wide open when they are looking at outcomes or using those components in the advice chain.

Mr McKenzie:  From the external audit perspective there is probably no doubt that there is an expectation gap from a consumer’s perspective. In relation to the people around the table here, I believe that we are all pretty much on  the  same  page  in  relation  to  the  role  that  the  external  auditors  play  and,  indeed,  looking  through  the submissions that were made in the last couple of days, I think that is pretty consistent. But certainly in relation to a consumer’s ‘usefulness’ perspective from an external audit, I think that there is still an expectation gap. I know that there is work being done internationally, and also locally, in trying to bridge that gap and there is a fine balance, I think, between making sure that the information is meaningful and useful and reaching the wide audience that we are actually trying to touch in relation to external audits. It can be a challenge, to be frank, and we do need to work within frameworks. I think that education can certainly go a significant way. It is already a fairly heavily regulated industry so whether more regulation is the answer or not, I am not sure it necessarily is. But, equally, I think aspects of education can be challenging in areas such as, for example, self-managed super funds particularly.

The Trio case, I think, is a good example where perhaps people were not necessarily fully aware of what they were investing in and the exposures they were running. Can you educate all those people? I think that that is a challenge. But I know that part of Stronger Super developments et cetera are trying to increase the level of understanding and knowledge of trustees, and that is really, really important. But with end-consumers, it is a battle and many members of superannuation funds still do struggle just to read their member statements let alone a set of financial statements associated with the super funds. So it is an ongoing challenge, I would have to say.

Mr Khoury:  Clearly there are expectation gaps, but they are really synonymous with knowledge gaps. I think that what we need to do is educate the broader community investor public on the roles that different stakeholders play within the financial services sector. From a custodial perspective, we certainly believe that there is sufficient legislation in place. What we need to do is really broaden the education gaps around the role that custodians have.

Ms Volpato:  In my previous roles I dealt with a substantial number of members because I was involved in the marketing and communication strategies for large super funds. Part of those roles included researching members who had exited to self-managed super funds. In the material that the committee distributed with the agenda for today, I noticed that one of the recommendations was that on the ATO websites there should be information for trustees of self-managed super funds regarding the fact that they are on their own if something should actually go wrong. I respectfully suggest that I do not think that would assist. It may be a secondary item of communication for members, but given the level of research I know that members look at mostly when entering into a self- managed super fund, I believe that there should be some direction for the financial planner to hand to the member a leaflet—as well as having it backed up on the regulator websites—that they are on their own in the space. I think that is quite important and would also assist members with their level of understanding.

Senator BOYCE: The Financial Services Council might like to comment on that.

Mr Codina: We do not represent self-managed super funds.

Senator BOYCE:  I realise that, but—

Mr Thomas:   Self-managed super funds’ major investment is property, and I think many Australians are familiar with the asset class of property. The ownership levels in Australia are well above the world averages. I think when we go and buy properties we do an element of research. We go and look at houses, we go to open viewings et cetera and we speak to people. Some of the people we come into contact with are the real estate agents. Everybody that walks in there realises that the real estate agent is representing the seller—it is just something that people understand. Some people might be smart enough to identify that they need a buyer’s representative and go and have that person do some research on their behalf, because they are independent of the seller. In the managed funds world there is not such a clear definition in terms of how that works. That is the issue, notwithstanding that there are different business models, but that difference is not well understood.

Senator BOYCE:  If an analogy were put to investors of how to go about—

Mr Thomas:  If they understand property, an analogy of property and translating that to the managed fund industry might be useful.

Senator BOYCE: Just don’t buy the first house the real estate agent shows you. Is that basically the advice?

Mr Thomas:  Absolutely, and be aware that the real estate agent represents the issuer, who is the seller, not the buyer.

Senator BOYCE:  There is one question I wanted to follow up on from earlier questioning. Mr Cole and Mr Graham, could you explain how your organisations go about using research houses, what you use them for and what your expectations are of the information you are getting from them.

Mr Graham:  We run our own internal research capability but it works in partnership with external research houses. From our perspective, when we look at research that is provided from an external research house, we are very mindful of the reputation, whether the research report is paid for by the fund manager or the subscribers, and the expertise of the research house in a specific area to help inform ourselves. We do see value in the external research houses and see the partnership that we have so that we can use both our resources and external resources to get the best information that we can to feed into our processes, and obviously that feeds into an approved product list that we can then provide to our advisers so that they can then advise their clients.

Ms Cole:  We use a mix of internal research and external research houses as well. That process is something that we use to provide clients with a range of research for them to make a decision on their investments.

May I respond to an issue that was raised by AIST in regard to self-managed super funds. In terms of background, while we are a full financial advice business we also focus on the advice needs of self-managed super funds and we look after approximately 4½ thousand funds. Broadly they will be representative of the type of statistics that the ATO has collected on self-managed super funds, with a slightly older average age of our trustees and a slightly higher average balance for the self-managed super funds.

With regard to the point that was made about trustees being aware of the risks and limitations when they set up self-managed super funds,  my understanding is  that it is a  requirement of the  ATO for trustees to sign a declaration upon commencing a self-managed super fund, which lists a number of specific risks including the limitations for the compensation scheme arrangements that they have access to and that must be signed before they  can  commence  a  self-managed  super  fund.  That  is  certainly  a  process  amongst  other  disclosure  and education requirements that we try to go through with our trustees before they commence the self-managed super fund.

Senator BOYCE:  There have been some suggestions that the payment methods to research houses set up a potential conflict of interest. Could either or both of you comment on whether this affects the way you go about choosing a research house and what are the characteristics you are looking for when you choose an entity to undertake research for you?

Mr Graham:  I guess philosophically we understand the pay-for-research model and we probably just believe in disclosure process. If research is being paid for by the fund manager, I think an average rational person would take  that  into  account  and  that  would  help  inform  them  about  the  research  they  are  receiving.  From  our perspective and coming back to the earlier point it is more about looking at the expertise of the research manager. We are looking at the next layer down—their track record and depth of expertise in a particular area to help inform us even more.

Senator BOYCE:  Would you expect that a research house would have ascertained that the assets that are relied on for their views on a particular organisation have been checked as physically existing?

Ms Cole:  No.

Mr Graham:  You are then into the layering process that has been discussed in a number of the submissions from auditing and the custodian and the RE of the fund manager itself.

Mr Brennan: Perhaps I could comment from the trustee’s perspective. Clearly it is our responsibility to ensure that the products on our platforms are of the highest possible quality. We will definitely use a number of research houses’ input to our evaluation of the quality of the products that are on our platforms. The reason we do that, with all due respect to research houses, is that some are particularly good in some areas and some are particularly good in other areas. It is very much an evaluation and judgement call that the research houses are making. We then back that up with our own internal research capability which we will investigate, if necessary, to quite a high degree of depth with specific product providers—visiting them, checking their processes, checking their procedures, checking their accounts and so on. It is an input, but the end game for us is an independent view that we can then present to our independent trustees that these products are sound and sustainable for our investors.

CHAIR:  Mr Epstein, would you say you use a similar process to that which Mr Brennan has just described? What are the processes you use to mediate the quality of the material you are receiving from research houses and how many do you use?

Mr Epstein:  The research is ultimately for the benefit of the underlying investor. Because of the fact that the expectation gaps exists—for example, the differences in protection between APRA and SMSF or the role of the custodian—  one  of  the  aspects  that  may  perhaps  be  overlooked  is  that  public  expectations  are  probably unrealistic. We have to question whether the hurdles for an individual to run a SMSF are high enough. I do not think that an investor can invest in any product without reading anything and assume that the product is going to be a good product. I do not think it is reasonable to expect that an average Australian can actually run an SMSF. If we relate it back to the property comment and expect that they are going to only invest in property, I do not think that that is a diversified portfolio that warrants the investor investing on that basis. From our perspective not all of our products have research associated with them. We are an independent responsible entity. We are separate from the manager. Ultimately, whilst the manager runs the fund and looks at the investments, we are responsible to the investors for the running of the fund. So it is our obligation to look at the manager and ensure that that manager is not undertaking any fraudulent activity. To expect a research house to go and visit every asset is physically not possible.

CHAIR:  Given that that was one of the major concerns that arose out of the Trio inquiry, how do you suggest we address that? Frankly, we have constituents in our areas who are extremely anxious—hence bringing this gathering here today.

Mr Epstein:  The argument I put forward in my paper is that the role of an independent responsible entity is absolutely critical. That is beneficial to my group in that we do look after a lot. I am not suggesting that groups such as BT, for example, outsource the responsible entity function. Without question, the responsible entity function within BT would be more than capable of performing that function, but ultimately it is the responsible entity that is responsible to the investors. So, whilst it might be appropriate for large responsible entities that look after large fund managers to perform that function, I propose that, in the event that you had a smaller manager or responsible entity looking after that function, there might be an expectation that that responsible entity or that fund would disclose why it did not see it as appropriate to appoint an external responsible entity. They have the expertise and they are independent of the manager.

My background is that I come from an environment where I have worked for what I would say is a fairly large fund manager. It had an internal responsible entity and I would argue that it is questionable whether an internal responsible entity, regardless of whether it has independent directors, is appropriately qualified to determine whether the operations of the fund are run correctly. They do not have the expertise. They do not have the ability to spend the time to actually overlook it day to day.

CHAIR: So how does it get oversight? And is that oversight provided in the best way, in your view?

Mr Epstein:  There are two options here. One is that you have the large responsible entities that are in-house for the large organisations that would have the appropriate systems and processes to ensure that those functions are appropriately undertaken. The alternative is that it is outsourced to a specialist provider that undertakes that function day in day out.

CHAIR: Mr Brennan, do you want to add anything there?

Mr Brennan:  It comes down to fitness, properness, expertise and capability. We are a large organisation and our independent directors are extraordinarily able in this industry. They are, because we have selected them carefully. They keep the appropriate discipline on management. Management, in turn, is extraordinarily capable because we make sure that they are when looking at underlying investments that are being put onto our platforms to our trustee and made available to underlying investors. As you come down the scale, the level of fitness and properness may not be as strong.

CHAIR: By ‘down the scale’, do you mean in terms of size?

Mr Brennan:  In terms of size, and therefore resourcing capability. But in this last year or so ASIC’s powers to regulate and ensure, or at least adjudicate on, the appropriateness and capability of the individual entities that they license—and then ban, if necessary, individuals out of the industry—has strengthened. We have yet to see how that is actually played out and exercised by the regulator.

CHAIR:  So in summary, Mr Brennan, you are confident that, with the increase in ASIC’s activity in the area, there has been some sort of a shift in the regulatory capacity and in the regulator’s awareness of these issues—and also greater general financial community awareness.

Mr Brennan:  I agree with that statement.

CHAIR:  That is very good to hear. There was an article written by Ruth Williams in 2012 which talked about indirect payments as possibly contributing to undue influence and conflicts of interest—such things as licence fees charged by a company where fund managers use that company’s logo on promo materials, advertisements in biennial magazines, sponsorship of investment conferences and these sorts of things. Does that practice continue and do you see any concerns with it? Perhaps that is a question for Mr Everingham and Mr Thomas.

Mr Everingham:  The practice is present. It is a function of the cost sensitivity of the end user of the research. Research houses have a choice. They can adopt a model which is funded, in part at least, by the product issuer. Alternatively, they can cross-subsidise their research activities from other business units. These indirect conflicts generally arise through the activities of the other ancillary business units—not always, but generally. We believe—and  we  submitted  this  to  ASIC  in  the  RG79  process—that  these  types  of  indirect  conflicts  are potentially more problematic, because they are generally not disclosed. They are generally more multidimensional and they are generally not alerted to the end investor. The direct conflict in the pay-for-research model, on the other hand, is apparent and is disclosed. For example, the first line of our disclosure in our research report mentions that we are paid for the research process by the product issuer. Does that answer your question?

CHAIR: Yes, it does. So one is a transparent relationship and the other is a little more obscure.

Mr Everingham:  That would be our contention, yes.

CHAIR: What is your view, Mr Thomas?

Mr Thomas:   I do believe that there is indirect and indirect. You need to look at indirect payments which relate to the process of using the ratings material. Some houses use a royalty system where they are paid by the issuer for the use of the rating. We operate a model which does not employ those sorts of indirect payments. We do have a magazine which has advertising in it. We do have, in that magazine, advertisements from fund managers who we have rated well—but who have also been rated well by our competitors. They put those badges of honour on their advertisements as well. But that is a commercial decision after the event—after the ratings process.

The point I would bring this back to is that it is really about results and independence around those results. When you look at a universe of investments, you need to make sure that you are assessing it on merit. In some cases you will recommend more on merit and in some cases you will recommend less on merit. But ultimately you need to make a decision and you need to provide that advice independently to your users. If you are providing advice and granting a positive recommendation to too many things, clearly you are not being a gatekeeper—at least not in my mind. We drew attention in our submissions to ASIC to the unbiased component. As part of that, we felt that there was clearly a need for higher levels of regulation in the payment-for-ratings process—because, on the analysis we had seen, there was a greater level of recommendation occurring there than on the other side, which is a purely subscription based mechanism where we are just providing advice to the investor and charging them for that.

We recommended a couple of options there, which ASIC chose not to take notice of. One was a quota system of higher regulation if that situation were to occur. The indirect side of it—yes, it is disclosed. We run a magazine. We have a conference. People pay to attend. They may also invite people to come along as their guest. But that is, again, an arm’s-length piece.

CHAIR:  Mr Everingham, can I ask you to respond to the comments that Mr Thomas has just made.

Mr Everingham:  Sure. There has been some information in the marketplace about the spread of ratings. Mr Thomas mentioned that in his comment there. I think to complete that information we would like to say that the spread of ratings under a pay-for-research model is necessarily skewed to the right of the curve, if you like, because of the number of products that have been screened out or not rated. For example, Lonsec, which do operate under this research model, currently rate around 720 headline funds. These permeate through different tax structures and platforms and so forth, but it is essentially 720 funds. There are about 4,000 in the universe of the equivalent total headline funds. So you can see from that that we do not rate the vast a majority of funds. We have significant screening, significant filtering, and we would actually contend that the proposition that pay-for- research leads to a skewing of the ratings that are a positive is actually incorrect.

Senator BOYCE:  I want to perhaps get a simple answer. I appreciate the answer that you gave me, Mr Everingham and Mr Epstein. Who should check to see if there are assets in a company that is offering itself for investment, or an entity that is offering itself for investment? Should anyone have checked to see if there were assets in Trio?

Mr Ghandar:  I might not actually comment specifically on Trio; but, in a general sense, the external auditor in an audit of a set of financial statements in providing their opinion obtains reasonable assurance as to the existence of the assets on the balance sheets. There is no doubt about that. In that whole paradigm, it is also maybe important to recognise with the different layers and the different roles within the system that to some extent it is really all of the above.

Senator BOYCE:  I appreciate that.

Mr  Ghandar:   An auditor has  a role  in  the  annual financial statement audit.  As  the comments  earlier conveyed, also the responsible entities in terms of the assets within the fund have a really crucial role and perhaps more of a day-to-day and during-the-year role and maybe a more granular role than when you are looking at the case of a large set of financial statements. But, in saying that, I think in a complex system which involves quite a number of different players, what is really important with more accessibility to everyday Australians is that the information that gets to those Australians is in a format that they can understand, that is clear and that is reliable—and that is a big part of what auditors do in terms of the annual financial statement audit.

Perhaps if one thing could come out of today it could be to work towards tuning that information, bearing in mind the expectation gaps that exist. As Graeme pointed out, there clearly is an expectation gap in terms of the understanding of the role of an auditor. CPA Australia has developed a guide to understanding auditing and assurance geared towards very simple language, using pictures and using as illustrative a way as possible to describe that role—what the role is and what the value and the benefits of the role are and, of course, also what the limits are in terms of what to expect from a financial statement audit. So, certainly, to come back to the question, yes, the external auditor has a really important role in terms of the existence of those assets.

Senator BOYCE:  As you said, ‘all of the above have a role’ means that none of the above undertook the role in certain areas.

Mr Ghandar:  Once again, perhaps that is more of a performance gap that you are referring to in that specific case than an expectation gap. But, absolutely, my expectation of myself and of others, when I say ‘all of the above’, is that everyone is really thinking about what their role is and what those investors, the Australians at the end of the line, are expecting of them and what they need from the service and actually taking that responsibility very seriously.

CHAIR:  And my understanding—perhaps before we hear from you, Mr McKenzie—is that there is this great feast being planned and prepared at the top, and the question people want to ask is: is the food there in the background before we have the preparation of the feast? I think that that is at the heart of what is concerning people about Trio. While I applaud your efforts to make much more easily accessible an understanding of what auditors do, and that goes to the heart of this growing awareness we have about financial literacy in our country, there still remains for us the concern, no matter how financially literate we make our community: where are the gaps that clearly have been exposed, and what do we collectively need to do to make sure that those gaps, in terms of not just expectation but the reality, are addressed? I guess that is what I want to try and get out of today, if we can possibly. Mr McKenzie, you wanted to make a comment?

Mr McKenzie:   Certainly, just to confirm from an external audit perspective that we do see that both existence—as was covered off—and valuation of the assets are critical from an external audit perspective. To be honest, we do not shy away from that responsibility. That is a fundamental role that we play. In relation to Trio, again, I probably will not comment on specifics there, but it does appear that that was quite a complex structure that was put in place. It does appear that there may well have been fraud associated with that.

To be frank, from an external audit perspective, it is very challenging when there is fraud. We often send confirmations out to confirm the existence and valuation of assets. You receive a confirmation back in good faith. Certainly the antennae might be up if the fund is perhaps externally based overseas, so you might well dig a little deeper, but if you are receiving information back that appears bona fide it can be, I must say, quite a challenge. Also I think that in the Trio situation some of the assets that were invested in appeared from a distance to be quite speculative in nature. Perhaps in better times those investments might well have been very good investments, but certainly at that particular time, the GFC et cetera, the assets may well have existed but the valuation was not perhaps so robust, and ultimately those assets appear to have failed.

CHAIR:  I will switch now to the custodian, because one of the things that we had noted in our inquiry was from ANZ correcting the record. Suggestions had been made to the committee that the custodian is required to confirm the existence of a fund’s underlying assets, but that was clarified for us: that is not correct. That is what we were told by ANZ. What then do custodians do to undertake regular valuations of a client’s assets and be assured that the assets are practically in existence?

Mr Jond:  You have basically two different scenarios. You have a scenario where you are investing into a listed security. In that case you will be relying on information providers, data providers, that are being fed from the stock exchange. If you are relying on or you are investing into fixed income securities, you might have a valuation method which has been signed off by the responsible entity.

CHAIR: Which of those two would be safer, and how would you be sure that they were both safe?

Mr Jond:  In terms of listed securities, if it is invested overseas, we will be relying on a federal banker, locally on the market, which we appoint, which will be the subcustodian in that market. That will be holding these securities. We get statements; we get confirmations of holdings; and some of our employees are undertaking due diligence on a very regular basis on these subcustodians established overseas. I am pretty sure that the standards of the industry on all of this network management are of a similar standard and similar quality.

Mr Khoury: Correct.

Mr Jond:  The difficulty is when one of your clients is investing into listed funds where we cannot rely on the third party to provide us a valuation of these assets. In that situation we will be turning back our clients, which is the responsible entity, to provide us with their best professional opinion about the value of the underlying securities.

CHAIR: Did you want to add anything, Mr Khoury?

Mr Khoury:  Only in that we will receive instruction from the responsible entity, the trustee, in terms of identifying the source of the valuation. Normally we would look for both the primary and secondary sources of the valuation, certainly in the case of listed securities. But in the case of unlisted securities it is much more difficult to obtain those sources, and the particular sources and I am talking about are the Reuters and the Bloomberg type sources for listed securities. For unlisted, typically we would look to the investment manager and the responsible entity to direct us to that valuation. We would then receive the valuation and ensure that it is correctly applied to the holdings and the portfolio.

CHAIR:  So when we have a look at diagram 2—and we are talking about unlisted, as you were just then— where do you see points at which that current structure is risky with regards to the matters that you have just been speaking about? Is it robust or are there points of risk involved in it? Clearly, something went wrong even though this system existed.

Mr Khoury:  I think that the point was made earlier that the structure and the diagram appear correct to me. It is really a performance issue. So did each of these parties involved in the process undertake their obligation in the process correctly? Was the audit correctly prepared? Did the investment manager correctly understand the nature of the securities? Did the custodian necessarily follow the instructions and process and value the securities accordingly? So it really does come down to ensuring that each of those parties understood their obligation and performed it correctly.

CHAIR: So in essence you do not see anything wrong with this structure?

Mr Khoury: No.

CHAIR: Could you see any way in which it might be improved?

Mr McKenzie:  In relation to the diagram, I think from an external audit perspective I would see it slightly differently from how the diagram is drawn. At the moment in the diagram there appears to be a direct relationship between the RFC auditor and the auditor of this responsible entity at the bottom of the page. My experience would be that that relationship would not necessarily exist. It would actually exist, certainly up to the registered superannuation entity, but then probably via the custodian, if a custodian is in place from an external audit perspective. Then, rather than perhaps going over to the responsible entity from an external audit perspective, we would probably go directly, if it is an unlisted asset, to the investment manager in the far right-hand corner.

We may have some interaction with the auditor of the responsible entity of this investment management fund if the investment is a controlled investment of the entity that we are auditing—so a very significant investment. But if it is a ‘normal’ investment, we would more typically go straight to the investment manager because we have no contractual relationship—and, indeed, typically it would certainly be a different firm or a different partner who would be responsible for that other audit of the responsible entity. And looking at many of the funds that we would audit, there would be multiple funds that ultimately a superannuation entity would enter into and so this diagram on the right-hand side could be replicated 20 different times, if you like. So our relationship would not be with the other external audit firm in this case.

CHAIR:  What would have happened if there were a conversation between those two in the case of Trio? This is highly speculative, but let’s just use that as a base example. Would that be the sort of conversation that might have elucidated some problems a little earlier in the sequence of events?

Mr McKenzie:  It might have. It would give, perhaps, a bit more flavour to the overall structure and the real underlying nature of the investments. But I am not sure that it would necessarily have overcome the situation, because as I understand it the individual funds were still signed off, so I would assume that the auditor of the responsible entity therefore did not necessarily have an issue. If those funds were qualified in some way then, as the superannuation auditor, you probably would have become aware of that anyway. But certainly, if they were qualified and you had the discussion with the external auditor, obviously that would be brought out. But I do not think that in the Trio situation that was the case; I think they were unqualified opinions. So I am not sure that the dialogue between the two auditors would actually have brought much to the fore in that situation, other than perhaps a little more understanding of the underlying investments.

Senator BOYCE:  I have a couple of questions for the custodians. I think the Trio inquiry proved that a lot of people did not understand the role of the custodians, such that evidence even had to be corrected. Do you have the wrong name? Should the title that is used by custodians be changed? Where does it come from?

Mr Khoury:   We are strongly of the view that the title ‘custodian’ is firmly appropriate, for a number of reasons. Most importantly, we operate in a global environment and, from a consistency perspective, that is a broadly well-accepted term that we operate in. But ultimately what we are trying to do is avoid confusion, so what we need to do is clearly describe the role of the custodian in the investment process. Regardless of what you end up calling that group of people, it has to be an education process around what our roles are and are not, by defining that. We are certainly happy to be part of the process. We have literature that we have already produced that really talks to the heart of what a custodian is and what their responsibilities are.

Senator BOYCE: How are you distributing that?

Mr Khoury:  Typically it is being distributed through our membership. The Australian Custodial Services Association has its website and its membership. We issue that through the membership and it is freely available through that website. But again our view is that perhaps more can be done in relation to the prospectuses, the PDSs and the documents around investments themselves so that they highlight what the role of the custodian is in those investments.

Senator BOYCE:  Finally, if you were to see what you perceive to be mismanagement or something within a managed investment scheme, what would you do?

Mr Jond:  First of all, I would raise my hand and call my compliance and legal team in the process. Whether it would be a matter linked to potential money laundering or anti-money-laundering or simply something where we deem that the law is being breached, that would be flagged as a suspicious matter to AUSTRAC.

Senator BOYCE:  If the money laundering is the case, you mean?

Mr Jond: No, in any case.

Senator BOYCE: You would go to AUSTRAC?

Mr Jond: Correct.

Mr Khoury:  We certainly have obligations within our businesses to ensure that any of that activity that we would  assume  to  be  potentially  fraudulent  is  brought  to  the  attention  of  the  regulators,  be  they  ASIC  or AUSTRAC, or indeed APRA for superannuation funds. It is certainly within our obligations to make those notifications.

CHAIR: How frequently do you do that?

Senator BOYCE: That was going to be my next question.

Mr Khoury:  We do not do it frequently, and that is on the basis that the clients that we have are typically screened in terms of their capacity to do business in the local and offshore markets. We undergo significant scrutiny and diligence to ensure that the people that we contract with have the right reputation levels and capacity to perform their operation. So no; we do not have a lot of that reporting.

Senator BOYCE: Once a year?

Mr Khoury: No, I would say it is much less frequent than that.

Senator BOYCE: Mr Jond?

Mr Jond: Yes, pretty much the same.

Mr Thomas:  In relation to the industry and the way in this diagram represents the industry and the various players, what appears to me is that there are a number of different checkpoints in the process, but one of the things that are very difficult in any highly regulated environment to forecast or even to identify is deceptive conduct. Whether that happens in the listed markets—we have cases such as Enron, WorldCom et cetera—the parallel that you could draw around Trio with another example would be the Madoff piece. In that case it was clearly made-up and it was deceptive conduct around what they were doing in terms of their performances. That sort of operation is pretty difficult, particularly given the sign-offs that occur at multiple levels with regulators, auditors and responsible entities. Even if we go back to some of the collapses in Australia, such as the Estate Mortgage Group, before the single responsible entity concept was introduced there was an external trustee. There was a listed group by the name of Burns Philp, which had been around for decades, and they were trustees. Even in that case, where there was separation between the fund manager of a large group of long standing, of great reputation, and an underlying investment vehicle, it still fell through the cracks because of deceptive conduct. That is an important point that one must consider around this matter. Fraud is something that is very difficult to identify and does not occur very often, as confirmed by State Street, because it is an exception to the rule. Most of the people that operate in this industry are very honest.

Mr Codina:  I completely endorse that statement and most of what Paul said a little while ago. Obviously, in the face of a particular collapse, call it what you like, there is a desire to understand what went wrong and to draw conclusions about whether there are changes, refinements or reform that may or may not be required. But I think we need a dose of perspective here. We have a $2 trillion funds management industry. I do not have off the top of my head what Trio represents in terms of the failure, but I would suggest to you that it is less than one per cent in that context. The reason I say that is to reinforce the point about the number of suspicious matters or other types of notices that custodians and others in the system may or may not be reporting. The fact is that for the reasons you are seeing there and the level of regulation that exists and that applies to each of those people there is a lot of oversight of what everybody around the table does. Partly because there are so many of us they are actually in some cases relying on us and in other cases scrutinising what we are doing. I think we should not lose perspective.

CHAIR:  I appreciate that. I also want to put on the record that I think Australians generally hold the whole sector in high esteem. It is a critical part of saving for the future and the retirement that they plan for their life and their families. It is not about money; it is about what it provides in terms of life for people in the community. But we are mindful also that as the superannuation guarantee has provided a very large fund now—it is a great asset for our nation and it has been great ballast in the last five years as we have handled the GFC— and the reality is that it becomes and more and more a honeypot and more and more attractive to those who know that systems can be cracked by people who invest a lot of time in creating a capacity to defraud people of their money. Hence our clear concern with the outcomes of Trio, because even though it is a relatively small number of people there is still the man in Kincumber who I doorknocked who has lost everything. It comes down to an individual level for us in our responsibilities. That is part of where we are. I am mindful of the balance and I do not want to indicate that we do not trust the sector. Clearly, we would not be having this conversation with you if we did not value your opinions. I appreciate your being here today.

Mr Codina:  For most individuals who have lost it all that circumstance has largely transpired through the form of their investment being through a self-managed super fund. I think that issue has been well and truly been identified and picked up. I think therefore it is not so much a question of a relevant conversation for today but rather something that government needs to make a policy decision around and consider—which it already has through the form of its response. I go back to what was said a minute ago: I think it is pretty clear that some of the relevant gatekeepers in the case of Trio did not do what the gatekeepers around this table do in relation to the investments that they oversee. That is very well documented and there is obviously legal action around all of that. To describe it as a gap versus an illegality might mean that we are talking at cross purposes. Ultimately we cannot guarantee that people will not break the law, whatever the law is.

Mr Brennan:  I thought some statistics might help. In the last four years we have checked this, we have $80 billion of Australian assets looked after under our responsible entity, as well as 1,100 investment funds and 170 investment managers. We have self-identified within all our scrutiny only one evidence of fraud which we were then able to bring to the regulator’s attention. It does give it a sense of scale, but I do think it is very important that the responsibility entity has the capacity to scrutinise its service providers to a high degree—and those are the custodians—but they are also responsible for selecting an auditor with sufficient capacity and expertise to understand the nature of the investments that are being audited and so on. That is I think an important part that a gatekeeper plays. Not often but we have brought to ASIC’s attention through our research complemented by external research funds where we feel that there may be question marks.

Senator BOYCE: What sort of question marks?

Mr Brennan:  Perhaps the fund is not performing as we would have expected it to—it does not match the description on the tin, if you like.

Senator BOYCE:  How often would you use a fund manager for research as opposed to a research house to do research on a particular fund? There have been suggestions that in a number of cases financial planners would go around the research houses and accept the research presented by a fund manager about their fund.

Mr Graham:  I will take the question on notice as well, but I think that in our experience most planners and advisers would probably look at that practice as very risky in terms of their perception of executing their best interest duties. The common industry practice is that in order to prove that you are acting in the best interests of a client and you have done appropriate research that you would look to independent research to back up that claim. I will take on notice what the Macquarie Group does, but I would say as a general rule it would be a practice that you would be requiring independent research to help support and be able to explain to your client why you are making a decision on a particular fund.

Senator BOYCE:  We have had numerous discussions with ASIC over the years about investment vehicles using the fact that they are registered or licensed with ASIC in advertising. From my perspective that is designed to make consumers think that ASIC thinks it is a good investment. This is one of the expectation gaps that exist. Would any of you like to comment on that particular one or any others you see in that area where the major gatekeeper is being used as a promotional tool?

Mr Everingham:  That is a very interesting question. Most, if not all, of the research houses will state that their main clients are the financial intermediaries rather than the end consumer. As I understand it, ASIC also has a mandate to provide a degree of consumer education around investing and financial products. The degree to which a research house’s research makes it to the end consumer is dependent upon what the financial adviser decides to pass through. Our experience from our organisation, given the sorts of hit counts and so forth we can generate from our website, is that only the most rudimentary short-form pieces of research are making it into statement of advice plans that the financial planners approve. That is my first point.

The second point is that, notwithstanding that we have talked today about the level of regulation we have in our industry and the number of people we have in this advice chain, compared to some other industries we are still relatively lightly regulated. Therefore, some of the functions that are regulated in some other industries are actually free-market functions. The assessment of the relative merits of products is a function that free-market enterprise research houses undertake. If you have a look at the pharmaceuticals industry, it is the regulator. Essentially, it is the TGA.

When it comes to the misunderstanding of what ‘licensed by ASIC’ means, is there, or is there not, an opportunity to do something akin to a Heart Foundation tick? Anybody who has that sort of position of authority generally strays away from that type of activity, but it may or may not be something that is worth considering. ASIC would clearly need a lot more funding and would clearly need a lot more input from private enterprise to help form opinions, but it is one avenue worth considering.

Senator BOYCE:  I must admit I get all shivery at the idea of any sort of statutory or government type body picking winners.

CHAIR:   That might be a good point at which to say thank you to Dr Richard Grampon’s secretary for pointing this out to me. The piece you have put in from Longsec, Mr Everingham, talks about how the information—that small piece of information—is handed on by the financial planners. It is terrible to write such detail and then find that it is only the smallest part that gets passed on. But the reality is, in here, an expectation overreach by financial planners—that you have articulated what a rating is and what it is not. I notice particularly the  expectation  that  well-rated  financial  products  will  consistently  outperform  their  benchmarks  and  that avoidance of financial product failure is sheeted back to you at the research stage. You also follow that with a few recommendations. I would be interested to have you speak to those while the others are here, and perhaps we might get some responses.

Mr Everingham:  Do you want me to talk about the recommendations in particular?

CHAIR:  Could you talk about the first part, the research houses—your experience of overreach by financial planners in terms of what they expect you to be able do, and then, yes, your recommendations.

Mr Everingham:  The first thing I will say is that by necessity that is a generalised statement. Of course there are many good financial planners. The issue that the industry has is that there are not enough of them. If you look at the ASIC shadow-shopping survey, from the last results five per cent or so were deemed good or better in terms of plans audited. It what we see, the use of research by the typical or average planner can perhaps be best described as a compliance tick or something akin to an insurance policy. It is purchased on price upfront and when something goes wrong the features of what you have purchased are closely scrutinised.

In terms of the rating, we do our best in our reports to give guidance on how products should be used. We clearly make it known that a highly rated product is not suitable for everybody and we see it as the role of the financial planner to marry the product to the right client—to determine product suitability. We are making a statement about the outright quality of the product. The planner must sit in the middle between the product and the investor and determine whether or not it is the right fit. We take calls and get feedback. When you have a market downturn as severe as during the GFC you cop a lot of flack. These are points we make in our paper. They are a summary of the flack we have copped post GFC.

Turning to what we think we can do to close the expectations gap between research houses and financial planners, first and foremost it is incumbent upon us to form an industry body. It says something in itself that we do not have one. It speaks to the intensely competitive nature of the industry, but we need to get past that and get together and work together for the common good of the end investor.

CHAIR:  Before we go on, can I just get a response from Mr Thomas about the likelihood of such a recommendation advancing?

Mr Thomas:  Which recommendation specifically?

CHAIR:   The one that Mr Everingham was making about getting an industry body together for research houses.

Mr Thomas:  We do have informal gatherings where we have roundtables and discuss things. Sometimes it is involving the regulator. We would be favourable to regular communication. Whether that requires a body or not is questionable. I believe, though, that the point we are talking about here is a bit of a moot one in relation to disclosure in the statements of advice. Most of the advisory groups that we deal with, self-strategies, they call model portfolios. Those model portfolios are a combination of internal resources that are dedicated sometimes from a vertical structure where they have internal research houses, or they buy stuff in or they have external consultants. Those model portfolios form the basis of the statement of advice, which is then processed via software and a thick document gets produced.

I would concur that the information that is supplied from the research house is of minimal point. In fact it is information, usually one-page documents, that describes performance and fees and where the assets are. But there are no views there. The view part would come in at an earlier stage, when they are constructing the strategy, and it is highly regulated in that space. If you look at the flow information, it is highly concentrated. Whilst we might review 30 strategies in the share market, two or three get 80 per cent of the flows, and those are the facts. I think the system works if the strategy is constructed correctly for the environment, with the right sort of risk appetite— whether you call them vanilla or non-vanilla, listed or unlisted investments. That is where the risk management occurs. The compliance or the paraplanning process is very strict around that, whether it is an institutionally owned group or an independent group. A lot of the boutiques run that process internally. Most of them have investment committees, and it is quite onerous in terms of their fiduciary duty and best-interest obligations under FOFA how they conduct themselves.

There are always going to be people who will shop something because they are looking for a different outcome. I would argue that it is not only the advisers who shop the ratings. The fund managers will also shop the ratings. We have had a number of fund managers refuse reviews from us because they knew they were not going to get a positive outcome. So they chose not to participate. That is something which RG 79 covers: we should disclose to ASIC which fund managers have refused to participate and for what sorts of reasons.

It is a pretty complex area that we are talking about. There are thousands of products, but not many of those products are popular products, and the governance around what is popular and what is not is a fairly institutionalised process. The research houses have consulting divisions, and perhaps that could be discussed as a direct or indirect payment; I am not sure. In my mind it is a professional service that we provide, and if we do not do a good job those people will find somebody else to do that. As a result of that, they put together strategies which incorporate the views of the ratings. But, ultimately, it is the strategy and the risk management, the diversification around that, which the consumer buys with the blessing of the adviser.

CHAIR: Mr Everingham, did you want to add anything else?

Mr Everingham:  No, thank you. I will continue, if you would like me to, on the other points of the recommendations.

CHAIR: Thank you very much.

Mr Everingham:  But I will defer to over there, if you like.

CHAIR:  Mr Brennan, can we come to you in a moment? Mr Everingham, can you finish those other points that you wanted to make?

Mr Everingham:  Our second recommendation for how we, as research houses, can take responsibility for closing what is the main gap that we see relates to us, which is between us and financial planners, is, having formed an industry association, to then proactively and positively engage the financial planning associations themselves. You are probably aware, though submissions to the Trio inquiry, that at least one of the industry association’s current stance is quite hostile towards research houses. So we would be quite keen to engage them closely, to just work through those issues and to try and come to some sort of consensus on the way forward.

With the third recommendation, I think there is some potential. We did a lot of work looking at the pharmaceutical industry when we gave our submission to ASIC for RG 79. What that uncovered was a body called the NPS, National Prescription Service, or MedicineWise, which is funded by government. It is funded by the department of health. It has membership, which is represented from all key stakeholders in that chain. So it has drug manufacturers, it has peak medical people, it has government people, it has the TGA, it has nurses, it has consumers and it has hospital organisations. There are possibly more, but they are all that come to my mind at that moment. The purpose of the body is to educate the intermediaries, the doctors, and to educate consumers. So they have a vast array of information on that website, and they also run training programs for doctors, amongst other activities. I have no idea of whether this is either economically or politically feasible, but it did strike us as something that could be investigated in the financial advice chain. So our third recommendation would be that the committee give some consideration to whether that is actually feasible.

CHAIR:  I appreciate that, Mr Everingham. Mr Brennan?

Mr Brennan:   I was just going to make the observation that we are on the cusp of the commencement of FoFA. FoFA has a best interest duty, and that requires a financial planner to demonstrate why a product that they are using or recommending and building into their portfolios is in the customer’s best interest—their particular best interest—and this includes referencing internal research, external research, if they should be using that, and so on. These new standards are coming in, as we speak. So it is an opportune moment, with this new legislation coming in, and the best interest duty will certainly lift the bar in the financial planning industry overall.

CHAIR:  With regard to the financial planning industry, the Independent Financial Advisers Association of Australia estimated that there are about 18,000 financial planners. I know that some more work is being done on verifying that, as a result of our hearing just the other day. About 80 per cent of those are affiliated in some way with  a  bank,  an  insurer  or  a  fund  manager.  To  what  extent  do  financial  planners  and  advisers  seek  out relationships with product-makers? Could you give us an example of how such an arrangement might work, and the advantages or disadvantages of the current way in which that sector is operating.

Mr Graham:  Just as a point of clarification: where an independent financial adviser seeks out a relationship with a particular product provider?

CHAIR:   They are affiliated in some way already. If they have an affiliation with a fund manager, where would they seek specialist research from in terms of a research house? How does that work?

Mr Graham:  Okay. The standard structure for an adviser is to work through and approve product lists, and, again, I think that is probably an accepted industry practice. So, essentially, the process is that an adviser cannot recommend a product outside their approved product list, unless they go through quite a formal exemption process.

CHAIR:  If their approved product list is not in the best interest of the client, where do they go?

Mr Codina: That has been recalibrated—

Ms Cole:   So they can still provide a recommendation for an investment or a product that is not on the approved product list for the best interest requirement. But most financial advisers would then need to go through the process of having that dealt with, for it to be considered an additional product and added onto their approved product list for professional indemnity requirements.

Mr Graham:  Just to continue the point: in some ways the approved product list structure drives that. Whether it is an internal investment committee or an internal research committee, there is that level of process around it, which is that formal decisions are made whether things are on or off the approved product list. Obviously, the considerations around whether a product is on the approved product list is based on independent research—the view of the group or the business that is providing the advice. Some people specialise in certain areas, and some people have various investment philosophies that will drive them in different directions in terms of what they put on their approved product list. There are advisers who have a preference to recommend managed funds for certain reasons. There are people who prefer direct equities, as Mr Thomas has pointed out. And there are people who structure their whole investment philosophy around more of a model portfolio type structure, where the choice of the individual adviser is actually quite limited. So you pick from a half a dozen, for example, model portfolios, and that is essentially all you are really allowed to do.

It is at this interesting point, as FoFA comes in, that what you are seeing is a rethink of how that process is done from a licensee perspective to make sure that the best interest duty is fulfilled. So it will be interesting to watch the next twelve months as FoFA comes in. We agree with the comment that enshrining best interest raises the bar. It probably gets back to your point, Madam Chair, which we are always coming back to, and that is that you want to keep minimising that rogue element, because even to have one means that that is still somebody who has potentially lost their life savings. So I think the positive aspect of enshrining best interest is that the bar keeps going up, which means it squashes the chances of a rogue element coming in.

Mr Codina:  I just want to add a point to support that and to expand on it, which is that, with the way that FoFA works, the actual provider of the advice has that requirement to provide the advice in the best interest, and that is literally the person sitting in front of the client. But, importantly, under our framework, under Chapter 7 of the  Corporations  Act,  that  individual  effectively  has  to  hold  a  licence  themselves  or  be  an  authorised representative or an employee. Again, under FoFA, the licensee, the holder of the licence, also has, if you like, an obligation to make sure that they are doing what is necessary to ensure that the relevant authorised representative is themselves providing advice that is in the best interest of consumers. So this is where the approved product list is, you could say, at the heart of the licensee trying to help and facilitate the advisers who advise under their licence to actually provide advice in the best interest. So it is quite a robust framework when you put it together in that way.

CHAIR: Mr Thomas.

Mr Thomas:  We opened up with comments around self-managed super space, and there is a note—I think it is RG 146—which talks about the licensing requirements around accountants in that space. It was rolled back. I think it was intended to bring that in this year, and it was pushed back three years. Now, I am not sure what the exposure of those funds was in asset or percentage terms; but, certainly, if you compare the regulation required around providing advice in the self-managed space, it is far less than it is for the financial planning industry, which operates under this model portfolio approved investment list, which is typically off platforms that have responsible entities and which have higher levels of governance, if it is superannuation. There are independent boards that sit for products to come on and off. There are limitations around single-purpose hedge funds. There are limitations around leverage et cetera.

If you are looking for gaps in the system, I would say that the largest gap that you have at the moment would be around the regulation of self-managed super funds and how people are being licensed to establish those in the first place. In many cases, they are established as an adjunct to a small business. But beyond that around where the assets are invested there is very little regulation.

Mr McKenzie:  Just in relation to the self-managed super funds, from 1 July this year there is a registration requirement in relation to the external auditors of self-managed super funds. I have not seen the final numbers, but I know that the number of people who have been actually registered is significantly less than historically have actually been signing off self-managed super funds. So I think that is, actually, a really positive step forward. Again, back to the evaluation of assets, and I am hoping—

Senator BOYCE:   Fewer people are shutting down their self-managed super funds; is that what you are saying?

Mr McKenzie:  No. Previously the requirements were quite broad as to who could sign off an audit opinion of a self-managed super fund.

Senator BOYCE: Yes, sorry; now I see what you mean.

CHAIR: Their responsibility has increased somewhat and the standard has risen.

Mr McKenzie:   That is correct. ASIC is actually going through an approval process and I have had the pleasure of that quite recently.

CHAIR: Said with a smile, Mr McKenzie—please let the record show!

Mr McKenzie:  I am an auditor; certain things amuse me! I think the standard is increasing, but there is no doubt that the overall framework associated with self-managed super is not as robust as some of the models that we were going through previously with custodians, professional trustee houses et cetera imply.

Ms Cole:   As mentioned, we look after a number of self-managed super fund trustees. In relation to the example we have been talking about of Trio, as I understand it, there was examples of self-managed super funds that invested 100 per cent of their assets in Trio and obviously lost them, which was a very bad outcome for those trustees.

CHAIR:  Some people who signed documentation had no idea that they had actually shifted into an SMSF in that process.

Ms Cole:  That is exactly the concern that we would have in the sense that any SMSF that would have 100 per cent of their funds in one single asset is taking on an extreme amount of risk and would not be something that a prudent investor or adviser would be normally recommending. I guess the question that I would have that would have to come back to looking at, rather than blanketly increasing regulation on self-managed super funds further than what we have already had come through with advisers under FOFA, what was the advice that was provided to these individual investors and where did that come from in terms of the failure there? Was it those advisers or were they investing on their own right to put 100 per cent of their funds into one single asset and how did they now  know  they  were  having  a  self-managed  super  fund?  Was  that  the  adviser  misrepresenting  or  acting dishonestly and how was that going to be protected?

CHAIR:  For me it is an interesting comparison to the period when homeowner-builders commenced in the late 1970s and 1980s and anybody could go and get a licence and you commenced building your own home.

Everybody seemed to be doing it. It was a way to save money. There were other pressure points in the economy at the time, as I recall, and this was a way for people to get their home. Ultimately, we have shifted to a model where, before somebody could get that opportunity to owner-invest, they actually have to undertake some sort of an education process to raise their awareness about what it is that they are about to do. To the best of my knowledge, there are not easily accessible courses of that kind for people who are actually forming their own— and that is what happening in many cases—SMSFs in a casual conversation with perhaps their accountant, at best. Sometimes it maybe via a radio conversation and a little bit of reading on the internet.

I hope that that is a fair explanation of some of the SMSFs that might be out there. I am interested in your response to moving things forward because, while we can separate in our conversation out the SMSFs and the regulated funds, in a general conversation that is a distinction that is not always being made. So what do you see as your role in that broader context with the concerns that we have raised this morning here about SMSFs as well?

Mr Graham:  I concur with Ms Cole that in some ways there is a responsibility in the best interests of the client to recommend the right structure that is appropriate for them and also in line with their desires. You have sort of touched on it. It is interesting. SMSF is almost a barbeque conversation at times. It is an emotive desire, which is quite unusual in some aspects. But I think it is fair to say that as planners and advisers—and with the new, raised bar of the best interest duties responsibility that we have to take on—we are recommending an appropriate structure for the client, taking into account what they want to do and the way they want to do it. Our experience is that the desire for an SMSF is to invest in assets that the client wants to invest in. That probably comes back to the fact that not all advisers are living up to their best interest duty; otherwise, the conversation would be around how the client wants to invest. So, if the client is interested in property—and as we know, that is a large part of Australian culture—and wants to invest in direct property, then SMSF is probably the only vehicle that provides them with that capability.

With regard to the question around the desire to invest in direct equities, that again, probably, has traditionally been the domain of the self-managed super fund, although it is interesting to see APRA-regulated funds now moving into that capability. To me it boils down to the point that, as long as the adviser is acting in the best interest of the client, the SMSF has a valuable part to play, if that is the desire of the client in terms of the way they want to invest.

CHAIR: Are there any further comments?

Ms Volpato:  I think, even if we are acting in the best interests of the client—and, certainly, I accept all the comments and endorse the approaching FoFA—it comes down once again to the client’s actual understanding of what is being recommended. So I think it would be useful to actually test the community’s understanding of what is produced in a statement of advice, because in the end, if a recommendation is being made but they cannot actually recollect what is being recommended in the statement of advice because of the complexities of the format of it, then that is an issue that needs resolving.

CHAIR: Do you see any possible path to resolving that? You are saying that is the case, I am assuming?

Ms Volpato:  Yes, I am. I think that improving people’s understanding of a piece of advice that has been produced for them is about the formatting of that advice in a fashion that people can actually easily understand. Do they understand what is being recommended to them, while it is still being underpinned by the requirement to act in the best interests of the client? I think it comes down to user testing and comprehension of the statement of advice.

CHAIR: Mr Ghandar?

Mr Ghandar:  My comments, to some degree, follow on from that. That is to say that the growth in SMSFs certainly underscores the fact that many more Australians are able to gain access to this financial system directly than in the past. That is a very positive thing in many ways—that they are able to take their future into their own hands—but at the same time, obviously, that is a different context for much of the communication within the system. You ask if there is a way we can see forward through that and through the comments made around perceptions of the advice, perceptions of the assets—and, as you mentioned earlier, where is the food and the feast, and does it exist? All of those questions really underscore the importance of the quality of the information and how understandable it is for the everyday people that are becoming exposed to the system.

We mentioned, in our submission, integrated reporting. That is a massive global initiative that is drawing input from a significant investor network, a business network to develop insights and a fully-fledged framework for the type of information that diverse investors—professional and non-professional investors—need. The information they need to grasp is increasingly complex business models and systems. I believe that the principles identified through that substantial work are applicable not only to reporting from individual entities or groups but also as a lens through which you can really reflect on the level and style of information and communication that investors are receiving, from their perspective. That always draws you back to what the needs of the investor are in terms of information, which is really where we need to be focused.

CHAIR:  Do you know if any information is ever presented in a verbal form or video recording for people who might have literacy issues with written documentation, or in multiple languages with mediation? We are a great multicultural nation and I wonder how we are responding to that.

Mr Ghandar:  That touches on another development, which is developments in technology, which to a large extent have led to the greater accessibility of the financial system but at the same time offer a lot of scope for developing new ways and more easily accessible ways to gain information. What you point to there are the very diverse needs of the investors that are involved in the system now, and that is of course in terms of the format and the manner in which information is communicated and also the style and the exact detail of that information. The technology  now  available  holds  great  promise  in  terms  of  continuously  improving  the  information  that  is available. That is a really good point to make, and CPA Australia is involved in a number of projects geared towards understanding how investors and users of financial information perceive the information and how it can be best presented.

Ms Cole:  With regard to accessing advice in different ways, at the moment that is an exciting but also challenging space for advisers. I think FSC has been working, perhaps with ASIC, on some additional guidance around this. The amount of information and the format of what is available on the internet, via YouTube and different web seminars and webinars, for everyday investors to access is incredible. Some of that information goes quite a way along the process to what may be perceived by many investors as giving them advice. That differentiation between what is information and what is advice can be quite hard for them to gather. That will be a very interesting space to watch as well.

Mr Brennan:  I just have a quick comment. We support remote communities such as Karratha with financial planning services, where the financial planner may in fact be in Queensland, via a remote televideo service that we provide there. We are trying to hit even remote areas more easily.

CHAIR:   As a former teacher, I know that there can be a very big gap between the delivery of information and the receipt of the same. Often we do not pay attention until we have to, and sometimes that can be long after the money is invested, hence the importance of the quality of the advice.

Senator BOYCE:   I want to follow up in that area of disclosure and information. The 2013 Morningstar Global fund investor experience report was highly critical of Australia’s policy failure on mandatory portfolio disclosure. There is a quote here:

Australia has major problems with Disclosure. Critically, investors do not have access to the very basic item of portfolio holdings. Australia is the last country in this survey without any form of portfolio disclosure presently or in p roposed regulations. With global best practices being mandatory quarterly disclosure, Australia is very far from the mark.

Could I have some comment perhaps from fund managers or REs on that topic?

Mr Codina:  With due respect to Morningstar, the report is incorrect, and the reason it is incorrect is that there are regulations that are being drafted for the purposes of MySuper, which will be introduced prior to 1 July and will contain portfolio holdings disclosure requirements. On that basis, it is outdated.

Mr Khoury:  From a custodian’s perspective, there is a tremendous amount of work that is being imposed on custodians now to provide the underlying data to support the MySuper regime in terms of portfolio holdings and also from an ASIC perspective. There is a wealth of information that is about to be delivered through those quarterly reportings that you talk about. So I would concur with the FSC that Morningstar may not be as accurate as appropriate.

Mr Jond:  If I can just make one additional comment is that the portfolio disclosure, when in the boundaries of Australia, we can work within a disclosure regime where the custodians and the investors can actually access underlying information. But the real question mark will be whenever investment is made overseas, as to what are the possibilities for enforcing an Australian requirement on a fund domiciled in Europe, Cayman or the US. It goes back probably to the RE, actually imposing on the underlying investment a disclosure requirement.

CHAIR: Does anyone else have any comments?

Mr Epstein:  I don’t think it is realistic. I can tell you we have fund managers that if you want to change an email address, you are not necessarily going to get it. We do look after probably 24 hedge funds, but to expect them to comply to the asset level—it is not going to happen. I am not certain that disclosing at a fund level is necessarily going to be beneficial. If we take the case of what this is all based on, if they had disclosed that they had interests in various assets, would it have made a difference? I am not sure.

CHAIR: Mr Brennan?

Mr Brennan:  I have spent some time in other jurisdictions—the US, UK and elsewhere—where disclosure has been more detailed than in Australia, although I absolutely accept it is coming here. I think it always comes to the appropriate level of disclosure. I think you need to disclose certainly the top 10 or 20 holdings or a substantial part of the portfolio so that the investor can see it is an Australian equity fund: ‘Lo and behold! It is invested in Woolies and BHP and RTZ. They are Australian names that I recognise and therefore am pretty certain it is an Australian equities fund.’ So I think that level of disclosure makes a lot of sense. I think, though, when you get into very complex structures, which sophisticated investors wish to invest in, where you may have a number of funds below an overarching fund and then going down within those and commingling up the BHP holdings of all of them, you may in fact do nothing more than actually mislead. So I think, and I hope, that the disclosure will allow the RE to disclose in a way that is appropriate and is revealing to the investor as opposed to misleading to the investor, because this is a complex area and can easily mislead.

CHAIR: Where too much information  can be a bad thing.

Mr Brennan: Absolutely.

CHAIR:  I am very interested in your comment there about coming from other jurisdictions. How would you characterise the state in which we are right now in Australia by comparison to other jurisdictions in terms of disclosure and other key issues for discussion today?

Mr Brennan:   I was involved in RAN, a mutual fund company in the United States for 3 years. We had several funds. All of the holdings of each of those funds in that family were disclosed—the name, the number of holdings, the dollar value of that exposure—for each of those assets every 6 months. Those statements in turn were audited by our external auditor to ensure they were absolutely correct. They were then entered into our public disclosure document, in that case, our prospectus. It made a lot of sense for us.

CHAIR: How would you characterise Australia by comparison?

Mr Brennan:   There is still more work to do, I think would be the way I would characterise the current situation in Australia. But I believe and see that the regulators view this and I believe are moving in the right direction.

CHAIR: Thank you.

Senator BOYCE:  Can I just ask the custodians: you talked about all the work that has got to get done. Are you ready for this change that is coming on 1 July? Is the industry ready?

Mr Khoury:  That is an excellent question. By and large the industry is responding to what is being required of it. We have been working very closely with both ASIC and APRA to understand both the context of what is being asked for but also the volume of what is being asked for. In fact, they are starting to realign their expectations around that information as well.

So, to answer your question, we are preparing and we are close to readiness—but 1 July beckons. The first reporting sequence, though, does not occur until later in the quarter, so we have some time to deliver there. A significant amount of work is going on in all of our custodian businesses, but also in both the responsible entity businesses and the RSEs, to prepare for that new reporting regime.

Mr Jond:  And as ACSA, we are probably talking to the regulator every two weeks, or something like that, formally.

Senator BOYCE:  Mr Epstein and Mr Brennan made comments around what is useful and what is useless. Are these some of the issues that you have been discussing which make you say that you have realigned expectations?

Mr Khoury:  We have not been talking to the relative use. It is more about what is practical to both source and then report on. I think the point was made earlier that, for the common listed domestic securities, the reporting is thorough and it is there. For the broader, global, unlisted securities where data is not readily available, it is also difficult to source; but we are, again, attempting to do that. It is also difficult because there are multiple structures where there are multiple subholdings and, typically, from a custodial perspective, we would not have insight into what those underlying structures hold. We are now being asked to do a look-through into those structures to try to source  more  information,  and  from  a  practical  perspective  it  is  proving  to  be  quite  difficult.  This  is  the conversation that we are having with both ASIC and APRA.

Senator BOYCE:   Has this raised the potential for yet a new expectation gap where REs and others will assume that there has been some probity done around the holdings and that, in fact, you have not been able to do that? How would you be able to advise people in that area?

Mr Khoury:  We are being clear as to what information we can source and report on. The data itself is going to be audited externally, as well. That is part of the APRA requirement, where the data will be audited on an ongoing periodic basis to support the reporting that we do. So, yes, we are working closely with our clients and the industry broadly to really talk through what are some of the limitations of that reporting. But the challenge is really to make sure that we are ready from 1 July, as we said, and that is not far away.

Mr McKenzie:   From an external audit perspective, the new requirements are quite demanding. The data points are increasing tenfold, and in some entities there are up to 5,000 data points that we need to actually verify. So it is quite a challenge. The whole industry has tried very hard to get on board and put things in place. I think APRA has been fairly understanding and they have pushed back by a year some aspects of the reporting, but the reporting is coming; it is not as though it is going away. In some ways, I have maybe a perverse view on the expectation gap, because I have a slight concern that APRA is going to have so much data, and it will be a question of what they do with that data. In this industry something will go wrong. It is just inevitable that a fund, perhaps, will have some issues. I must say that I have several concerns from an APRA perspective, because there might well be an expectation of: ‘Hang on, APRA. You’ve actually collected this data. What have you done with it? What have you analysed?’ Right down in the detail there is an issue with a particular subfund managed scheme or whatever else. I am not sure that APRA has necessarily turned their mind to this—and I am not saying they have not. But I must say that, with so much data being collected, it is difficult to see, from my perspective, what meaningful information will come back the other way in relation to the MySuper product. I think it is good, clear information; it is very understandable. But once you get into other slices of information, it could be a little challenging.

CHAIR: Yes, Mr Everingham.

Mr Everingham:  I want to make a point about what we would consider useful, because clearly you have to strike a balance between the volume of the information and the usefulness of it. When it comes to disclosing what is in portfolios, the contribution to the risk of the portfolios and the contribution to the return of the portfolios for investors is by far and away dictated by the asset allocation in the portfolio as opposed to any one individual investment. I think the more important disclosure is to ensure that an investor’s asset allocation is staying within the parameters that were intended when the investor went into the portfolio, rather than more and more micro details down to which individual stock they are holding, because then what is to be done with that information? If you look at some other markets, because of perhaps cultural differences, the way managed funds are used and the way portfolios are constructed are vastly different. There are some Asian nations where the typical holding period of a managed funds is three months, whereas we are trying to encourage people here to invest and invest for their future and invest for the long term. The right sort of data is just as important as, I guess, the volume of the disclosure, if you like.

Mr Thomas:  Could I just add to that?

CHAIR: Yes, Mr Thomas.

Mr Thomas:  In relation to disclosure, in the vanilla markets, yes, you have a share portfolio and you can see that you have got 10 per cent with BHP and NAB et cetera. I think Mr Epstein was touching on a very valid point, that sometimes disclosures do not really get to the end point because, in the world of hedge funds, derivatives can make  a  significant  impact  to  the  risk  return  dynamics  that  Mr  Everingham  is  talking  about  and  it  is  not transparent, even in the disclosure, as to what that dynamic or the skews of the return or the risk may be— notwithstanding deceptive conduct, because that is quite a separate issue. The derivative world is a huge world. It is much bigger than the GDP of the global economy; I think it is tenfold in terms of assets. It exists and it is a big part of investing. In most cases it is risk management, but in some cases in the hedge fund world it can skew the underlying piece. The provision of information is overwhelming, let alone being able to understand what derivatives are. I do not think it would add too much to the piece.

CHAIR: Good point, Mr Thomas, well made at this point. Are there any more questions?

Senator BOYCE:  I have got one or two, yes.

CHAIR:  I wanted to hear from the trustees.

Senator BOYCE:  That was partly where I was heading. APRA, 18 months or so ago, was talking about what they perceived to be an expectation gap between the reliance that trustees put on valuations for unlisted assets sourced from custodians and an assumption being made by trustees that the valuations were robust and independent, whereas of course that is not part of your role. Does that gap still exist and, if so, can you tell me more about it?

Ms Volpato:  As we put in our written notes to the committee, because the contract with the custodian is recognising that the custodian does not have that role, there is to be, where possible—as indeed the custodians mentioned earlier today—an agreed price source, where possible; if not, then that obligation does come back to the trustees. In our written notes we also discussed how the need for more detailed risk management planning at the  trustee  office  stage  as  well,  with  a  board  of  directors,  has  certainly highlighted  awareness  of  trustees themselves to be more actively aware of the processes that are used to form these valuations. We see that level of knowledge increasing amidst trustees as well because of these changes to the superannuation system and a heightened awareness, through issues like Trio, of potential for fraud, which I think does bring a greater degree of knowledge within trustees themselves to be more actively engaged in those processes.

Mr Codina:  A comment I would add, and I do not know if APRA is able to clarify, is that I am not sure whether that statement is meant to be a reflection across the entire industry or a part of the industry. I suspect it would not be particularly accurate, certainly of larger superannuation funds.

Senator BOYCE:  I am not suggesting that it is blanket. That certainly was not how they took it. Chair, that is the area I wanted to start on.

CHAIR: That was the question I was about to ask myself, so we are of one mind—a rare moment.

Ms Volpato:  I could perhaps add that, in applying for a MySuper licence, obviously trustees are reviewing and refreshing their ongoing risk management frameworks as well, so that also helps increase focus right across the industry.

CHAIR:  To be really frank with the trustees, one of the comments I have received since we have put out our response to the Trio inquiry was that we have let the trustees get away a little bit lightly. That is the comment that I have had, and I was a bit intrigued. The question I want to ask is: in relation to the trustees’ legal obligations under an RSE licence and SI(S) requirements, what measures do you take with regard to custodians with those sorts of contractual arrangements? Overall, you have mentioned some change in trustees’ awareness—increasing their education and increasing their understanding of the whole structure. Could you fill us in with a little bit more detail about how that further education is going on and how much more carefully the relationships with the other players are being considered by trustees now. What does it look like now in comparison to when Trio happened?

Ms Volpato:  There are certainly the new prudential standards, and they have outsourcing standards as well. They set out quite a detailed list of items that trustees have to take into account in outsourcing to a material outsourced contractor, which a custodian clearly is. As I mentioned earlier, as part of that process, that has certainly raised trustees’ awareness of the various issues that have to be contained within a material outsourced contract. Those things were taken into account prior to Trio right across the industry; I think that would be fair to say. But it has increased awareness of those levels through the material outsource APRA prudential standards.

CHAIR: And the outcome of that, generally?

Ms Volpato:  Governance is a major issue within the trustees of all funds. For example, in AIST’s own case, we  have  recently  surveyed  our  trustee  audience  as  well,  and  governance  continues  to  have  a  much  more heightened level of interest for continuing to improve best practice. So trustees are far more aware of the continuing need to improve their risk frameworks. I think the next main area of focus within the trustee areas of this world is risk appetite and how that actually forms part of their risk management framework as well. Those particular issues arising out of the prudential standards will continue to provide focus on best practice.

Mr Codina:   I will briefly add that I would invite whoever suggested that the trustees got off lightly to volunteer to subject themselves to the prudential standards. The short answer is that prudential standards are directly on point. As was just mentioned, they deal with a range of issues: operational, governance and otherwise. I suspect that the answer therefore is going to be similar to the financial advice base, where the introduction of those prudential standards will clearly raise the bar across the board—for some more than others, but inevitably it will raise the bar.

Mr Brennan:  I concur. The superannuation prudential standards are very closely modelled on the APRA prudential standards for large banks, or the banking industry. We see that because we have been subject to the prudential standards for ADIs for many years. Those are very high standards, matured over quite a long period of time, and as they are inculcated into the superannuation industry more widely in the coming years you will see quite an appreciable lift in risk management and, more generally, across the whole of the operation.

CHAIR:  I am very heartened by that.

Ms Volpato:   I have an additional comment.  I have actually been involved in or subjected to—I think

‘subjected’ is probably the word—an APRA visit when I was working in a large super fund. The degree of rigour that APRA also puts into looking at the funds risk management framework is a long and extensive process. The entire trustee board and the entire senior management team actively examined how they manage risk across their various activities. So that also underpins this entire process that funds go through as well, with the risk management framework.

Senator BOYCE:  Were you talking earlier about the risk appetite of trustee directors? Could you explain that a bit more?

Ms Volpato:  Part of the risk management frameworks with the prudential standards is to look at the trustee’s risk appetite for certain events occurring. That helps escalate or decrease the level of risk of particular things that are reflected within the fund’s risk management framework.

Senator BOYCE: So you are simply saying that it is being more consciously and regularly assessed?

Ms Volpato:  Yes. For example, a question that could be asked of the trustees within a fund is: what keeps you awake at night, as a trustee, given your personal liabilities and responsibilities to the members of this fund? That might help highlight those particular issues that are of an extreme-risk nature to the fund. Then the entire management team and the trustee board have to look at the various processes and procedures within both the fund and the material outsourced providers—be they custodians, investment managers or fund administrators—and at how they can better ensure a decrease in the likelihood of this risk occurring.

CHAIR:    What  measures  do  trustees  undertake  to  assess  the  source  and  adequacy  of  valuation  data, particularly if parts of the unit pricing process are conducted offshore?

Ms Volpato:  I would have to take that on notice.

CHAIR:  There are probably a couple more that I will give to you on notice, but, if you could, please respond to this one. The committee understands that reforms proposed in the further MySuper bill last year will be introduced via regulation, not through the enactment of the bill. Treasury has begun to consult on the draft regulations. One of the proposed changes revolved around the obligations that were incurred when an MIS invested funds from a superannuation fund into a second MIS. The committee understands that the second MIS would be required to report back to the RSE trustee on its portfolio holdings. Could you tell this committee whether that obligation would apply if the second MIS was an unregistered overseas fund?

Ms Volpato:  I would have to take that on notice.

Mr Codina:  Again, based on how I interpret your question, some aspects of that have been touched on a little while ago, in respect of the ability to obtain the information where the scheme or the fund manager is offshore. I think this would not be a unique example of where that exists as a challenge in the system. There would be other areas where a trustee or someone else needs to get information from a fund manager in order to discharge their own legal regulatory obligations in this jurisdiction. It would be a case of working through it in the same way that it is worked through for that purpose. But, until we see the final regulations, the answer is that it is unclear.

CHAIR:  I now move to questions for the audit group. APRA has received anecdotal evidence that, despite custodian-trustee agreements, trustee auditors may not receive reasonable access to custodian information. For example, a custodian may appoint their own auditor to check the offshore net asset value calculations and they may expect the RSE auditor or the auditor of the RE to rely on the report produced by the custodian-appointed auditor. Are trustee auditors satisfied with the level of access that they currently have to custodian information? I will ask my next question depending on your answer.

Mr McKenzie:  I had better be careful of my answer then! There is an audit guidance in relation to dealing with both investment managers and custodians, GS 007, which sets out fairly clearly the responsibilities and the rights of both the user auditor—the auditor who is ultimately signing off the set of financial statements—and the auditor of, in this case, the custodian. There is quite a standard mechanism for sign-off of internal controls at the custodian, which has been in place for many years, where the custodian’s auditor will go in and test the overall control environment at the custodian. That is an efficient and very effective mechanism. I cannot speak on behalf of the custodians, but as opposed to having every audit firm in Australia—be it State Street or BNP et cetera— going into it, you have one organisation very familiar with that organisation doing the control report.

That control report is a very transparent report. It clearly states that there are stated control objectives that have to be covered off in relation to a custodian. They are clearly stated in the GS 007, which was a development made over the last four or five years by the auditing standards board which states that you must cover off these control assertions. It is very transparent reporting on the testing that has been performed and on the results of that testing. That mechanism has been in place for many years. It has been adopted both locally and internationally, and I think that it is an efficient and effective way of gaining assurance over the controls that are operating.

On the question of asset existence and evaluation, under this GS 007 audit guidance standard there are mechanisms where the auditor of the custodian can provide that assurance to the ultimate auditor. The ultimate auditor, and indeed the trustee or the responsible entity, does not necessarily have to have that assurance. It is not as though it is forced upon them. But, again, it is seen as an efficient and effective way to gain assurance. So as opposed to each audit firm going in and testing valuations of, let’s say, BHP shares for this managed scheme and that manage scheme, the one audit firm will test BHP in this case across all of the schemes and ultimately report that to each of the individual auditors. So it is, as I say, an effective mechanism; it is efficient. The reporting back is quite transparent.

As Paul commented before, the existence of valuation of standard style investments—equities and fixed interest et cetera—is fairly straightforward, to be honest, and quite mechanical in how that is done. Where an issue arises, as we have also heard, is where it is an unlisted security. Typically, the auditor of the custodian will not form a view on those types of assets and will specifically call out in their audit opinion that they have not conducted testing on these assets—they typically will have a reference schedule where they are all listed.

Arguably, there has been a potential failing where receiving audit firms have got the opinions. They say, ‘Great, we’ve got an opinion from Ernst & Young, PricewaterhouseCoopers or whoever else. Okay, we’re done,’ without detailed reading of what is included and excluded. I do not think this is a widespread issue, but I can see that it could happen. I know that some of my graduates get the files and say, ‘We’re done,’ and I say, ‘No, we are not done at all.’ In these particular assets, where the other audit firm has not provided assurance at all, we must dig deeper, issue confirmations and get information from the fund managers ourselves on the existence and the valuation of the assets. You are right in saying that there is a mechanism in place. It is a well-documented and approved mechanism, if you like, through the auditing standards. I think it is efficient and effective, but, on the use of the material, you really need to understand what you are getting when you get the material; you must understand those reports in a lot of detail.

CHAIR:  If I could summarise: the level of access really is not too much of an problem, but it is that professional scepticism question again.

Mr McKenzie:  I think that is right. I have not had a situation where a custodian said, ‘No, you cannot come in.’ They would generally say, ‘We do have this report. Why don’t you use that?’ Typically, we would use that and not go into every custodian, but rarely, if ever—I cannot think of a situation with myself—has someone stopped us accessing the custodian’s records.

There is always transparency over the nature of the investments that are held. You can always do, and we do, spot checking to double-check valuations of the investments coming back from the custodian. So, it is not as though it is a blanket reliance on what is coming through.

CHAIR:   In its submission to the Trio inquiry, ASIC suggested that the government might consider an approval process for compliance plan auditors and civil liability provisions for compliance plan audits. What is the perspective of the audit industry regarding these suggestions?

Mr McKenzie:   In relation to the liability, perhaps I might take that on notice. But, in relation to the registration, certainly all corporate auditors are registered via ASIC. On an annual basis we need to submit information as to the audits we have been conducting—audits we have taken on, rolled off et cetera. So I believe there is already registration in place. In relation to compliance plan auditing, that is a personal appointment also, so it is not a firm appointment. I do not necessarily see a need for additional registration of compliance plan auditing. I must say that, from our firm’s perspective, we have decided from a risk management perspective that there will only be certain partners who will sign compliance plan audits, and so it is not a widespread thing. I could not tell you the exact number, but maybe half a dozen or so of us—

CHAIR:  It is an additional control to make sure that the other person adequately—

Mr McKenzie:  That is correct.

CHAIR: They are professionally sceptical and ready to do that.

Mr  McKenzie:    That  is  right,  and  there  are  professional  obligations  in  relation  to  understanding  the corporations law et cetera, specifically in relation to compliance plans. So we do limit the number of parties who will sign off and also review those sorts of matters.

CHAIR:  Could you tell me if you have had any conversations with ASIC about the audit profession in this regard.

Mr McKenzie:  My colleague Tony perhaps could. But there are ongoing discussions with ASIC, as you are aware,  in  relation  to  audit  quality  generally,  professional  scepticism  et  cetera.  I  think  we  are  working cooperatively with ASIC in that regard.

CHAIR:  As I said a little earlier, there are many questions that we have prepared that we have not actually got to, because we did want to have a relatively free-flowing conversation with you and also for you to have the opportunity to hear one another simultaneously. My sincere hope is that that creates an opportunity for further conversations and that each of you has found that it was of value for you to be here this morning. I am mindful that you have taken time out of your work. I have one final question, if I may, for all participants, which you may wish to respond to now or give us something on in writing. Essentially, this is the general question for the end. Australia’s financial services regulatory system operates under the efficient markets theory. The system aims for efficiency, flexibility, competition, innovation and a low cost of capital. Retail investors have access to a wide range of products, including high-risk products. The system aims to prevent regulatory failure, rather than the failure of financial products. Indeed, as ASIC observes, the failure of a high-risk business strategy and consequent investor loss is an essential part of an efficient market. Since the Trio inquiry, ASIC has suggested moving the balance between market efficiency and investor protection more in favour of retail investors. Do the various members of this panel consider that we have got the balance right in Australia between market efficiency and adequate protection for retail investors? If not, what changes would you recommend? It is a short question, with a very simple answer required! Anybody want to go on the record today with immediate responses? Mr Thomas?

Mr Thomas:  In respect of the comments I made previously around how the retail part of the industry gave advice—and that was a model-driven approach—typically in that there are balanced asset allocations varying in terms of exposure to shares and other risky assets and exposures to bonds, which are supposedly defensive assets and have performed very well in the last five years. There is an issue, though, that presents itself at the moment, and this touches on risk. I was interested in the comments made around trustees having to put their risk profiles in. The superannuation system is essentially unfunded for a lot of Australians. If you step back and you look at what is the issue here that we are trying to drive, it is about a lifestyle in retirement. There are some rogue investments, if I could categorise them in that space, and some of them have actually been in the conservative space. Look at some of those hedge fund strategies: they had very low volatility, which is one measure of risk. The question I would put is that we do not want to let the risk management cruel the end objective and make us take too little risk to meet our compounded annual return in excess of inflation. If we were to look at the current investments, a lot of the exposure is in bond markets, which are yielding one or two per cent, which is very unlikely to beat inflation, which is the real enemy in this whole process. So I would think that the major issue is: what are we doing around the defensive assets? A lot of these hedge fund strategies, which are difficult to look at, do operate in that low-risk space. Are we actually over-regulating in some spaces and not letting the natural course of the markets take its effect?

Mr Ghandar:  Thank you, Chair, for that question. It does go back to what has been really underscored throughout  the  discussion  today,  and  that  is  of  course,  as  you  mentioned,  retail  investors  and  increased accessibility of the market. However you calibrate the market, investing is still going to be a matter of balancing up risks and rewards. We start with a belief that Australian investors, whether they are retail investors or professional investors, are focused on weighing up those risks and rewards in whatever way. What we can do to support them, what is really critical to do, is provide them with information that they can understand and use in order to make those kinds of decisions. We got onto the topic of too much information versus not enough information. What we need to be focused on, and what I think this forum is really fantastic in highlighting, is the right type of information and the right way of communicating with those stakeholders in a way that actually recognises their needs broadly and also in a way that they can calibrate individually.

CHAIR: Would anybody else like to make a concluding comment with regard to that?

Mr Codina:  With regard to the question, all I would say is clearly we have just gone through a very, very substantial reregulation of the financial—

Senator BOYCE: Not next week? You don’t want more change next week?

Mr Codina:  No. What I am suggesting is I think the question has been answered: clearly, the pendulum has swung back from wherever the pendulum was. I personally think it is premature to assess exactly what the implications of that will be, but I think there is no doubt that we have been reregulated, not that we were unregulated—so I just want to make that point. We have been reregulated and standards have increased comprehensively across the board, from my perspective, including in relation to the government’s response to this inquiry, some of which is yet to come through as well. I think therefore the question has essentially been answered.

CHAIR: Good. Mr Brennan?

Mr Brennan:  I do believe that the risk appetite is almost pertinent to the individual and the household. It really depends on whether you are at the beginning of life and just starting to build the pot to buy a house before you have got married, before you have got children, or you are at the end and the children have all left and you are about to start drawing down your pension. I think the fundamental to hitting that balance is actually the mix of assets that you hold, which is high-risk assets and low-risk assets. My fear, in the event of trying to go to a higher degree of  investor  protection,  is  you  remove  higher  risk  assets,  which  are actually an  important part of  a youngster’s portfolio, perhaps. Then that turns you around to: how does one hit that balance? Unless you are highly versed in the financial markets, it is actually difficult.

One of the ways we do it in our superannuation product, our Super for Life, is we build cohorts within the portfolio so that if you are born in the 2000s, and therefore relatively young, the asset allocation is struck accordingly. Then as you get older the asset allocation is adjusted until you are approaching retirement and has much more lower risk assets. The trustees overview that asset allocation every six months to every year to ensure that it is operating as designed. By that method we try to glide people through to retirement in the best possible way. It also means that they can pretty much switch off that responsibility for how their assets are mixed. But for us to do that we actually need high-risk assets in the system. Does that make sense? There are two ways you can do it. You can do it as a household, or you can do it as a trustee on behalf of people who have gone into default— they have actually checked out of the decision.

CHAIR:  I understand the appeal of set and forget, believe me. I am sure that many Australians do.

Mr Brennan:  One more thing on the importance of quality advice: I do believe that the future of financial advice, and the way that regulation is coming in, will be progressively lifting the bar in the coming years for financial advice, and I think Australians need good, professional financial advice.

CHAIR:  I know that people want to be able to go and feel confident that they are going to get really good advice, in a way that they perhaps have not done before. There is one wonderful question in here, and the teacher in me really wants to give you a piece of homework. I would be delighted to see the responses—it is almost an essay. I will just give you a reference to it: it arises out of a Journal of Economic Perspectives article by the veteran American economist Burton Malkiel. When you see it you will know what it is. I think it is an interesting one. It talks about whether active investment or passive investment might be the way to go, so it is a real existential question.

I look forward to the responses that we will receive from you in response to our questions on notice. Can I sincerely thank you for this morning. I would be very much appreciative of your responses to whether you found this of use or annoyance to you as you are planning and organising as you move forward in your different roles. Thanks again for what you do and for your civic participation today in the interests of our country.

Proceedings suspended from 12:36 to 13:36


ALDRIDGE, Ms Calissa, Senior Manager, Australian Securities and Investments Commission ARMOUR, Ms Cathie, Commissioner, Australian Securities and Investments Commission HILL, Ms Bronwyn, Senior Manager, Australian Securities and Investments Commission KELL, Mr Peter, Deputy Chairman, Australian Securities and Investments Commission PRICE, Mr John, Commissioner, Australian Securities and Investments Commission

SAVUNDRA, Mr Chris, Senior Executive Leader, Australian Securities and Investments Commission

TANZER, Mr Greg, Commissioner, Australian Securities and Investments Commission

CHAIR:  I reopen this public hearing of the Parliamentary Joint Committee on Corporations and Financial Services. Under section 243 of the Australian Securities Investment Commission Act 200, the corporations and financial services committee is required to oversee activities of ASIC. This hearing is part of that oversight and is the second hearing that the committee will conduct this year in fulfilment of our oversight responsibilities.

I remind everyone that witnesses giving evidence to the committee are protected by parliamentary privilege. Any act which may disadvantage a witness on account of their evidence is a breach of privilege and may be treated by the parliament as a contempt. It is also a contempt to give false and misleading evidence to a committee. Witnesses should be aware that, if in the giving of their evidence they make adverse comment about another individual or organisation, that individual or organisation will be made aware of the comment and given a reasonable opportunity to respond to the committee. The committee prefers to hear evidence in public but we may agree to take evidence confidentially if the committee believes it to be relevant to the inquiry’s terms of reference. The committee may still publish confidential evidence at a later date, but we would consult the witnesses concerned before doing this.

Parliament has resolved that an officer of the Commonwealth shall not be asked to give opinions on matters of policy and shall be given reasonable opportunity to refer questions asked of the officer to superior officers or to a minister. This resolution prohibits only questions asking for opinions on matters of policy; it does not preclude questions asking for explanations of policies or factual questions about when and how policies were adopted. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken and the committee will determine whether it will insist on an answer, having regard to the ground claimed. If the committee determines to insist on an answer, the witness may request that the answer be given in camera. A request to give a particular answer in camera may also be made at any other time. The committee welcomes officers of ASIC. Mr Kell, I invite you to make a short opening statement.

Mr Kell:  We are very pleased to appear today. Our chairman, Greg Medcraft, is abroad chairing the IOSCO meeting in Canada. He sends his apologies, but he is very much looking forward to briefing the committee on developments with IOSCO when he returns. With me are commissioners Price and Tanzer, and our new commissioner, Cathie Armour, who joined ASIC a fortnight ago. As you have heard, also testifying is Senior Executive Leader, Chris Savundra, and senior managers Bronwyn Hill and Calissa Aldridge.

In my brief opening statement, I would like to address three issues. The first is around Commonwealth Financial Planning. As you would know, the Senate yesterday voted to hold an inquiry into ASIC, in part prompted by commentary on our enforcement action against Commonwealth Financial Planning several years ago. We welcome this inquiry and we look forward to the opportunity to provide the inquiry with substantial information on what we do, on what we achieved and what we seek to achieve.

The media is right to shine a light on the conduct that occurred five years ago at CFP, because it reminds the public how far we have come in changing the financial planning sector. There was unacceptable and unlawful conduct at CFP. Clients were given inappropriate advice and many suffered badly because of it, and that is exactly why we took significant enforcement action. Our actions saw seven advisers banned from the industry, and we set up a compensation system that will result in more than 1,100 clients receiving around $50 million in compensation. There are around 37 or so cases, out of that 1,100, that are yet to be resolved. We forced CFP into an enforceable undertaking that has required the group to completely change the way it does business, its compliance, its supervision and so on. This was a large and complex matter, and cases like this involve much background work before a public result is achieved. That is how law enforcement works. ASIC also has to carefully assess information presented to us in such cases and make judgements about what would stand up in court or before a tribunal.

The issue of whistleblowers has come up here, and on this topic it is important to emphasise that we do not discuss whistleblower involvement in any particular case. If ASIC revealed these details, it would compromise the integrity of our whistleblower policy and deter people from coming forward. After all, what person would approach ASIC if they suspected that we might then discuss their case with a newspaper reporter or other journalist? In fact, we go out of our way to protect whistleblowers and, several years ago, successfully fought a case in the Federal Court to conceal the identity of a whistleblower.

More broadly—and, I think, as this committee knows more than most—there is major law reform underway for the financial planning industry, largely in response to mis-selling episodes such as CFP. Conflicts of interest arising from commission-based payments were at the heart of the problems in CFP, and the Future of Financial Advice reforms, which start in a few weeks, include a prohibition against commissions, going forward, and there will be a new duty to act in a client’s best interests. As I said, we are looking forward to discussing these matters further with the inquiry that has just been announced.

The second matter I would like to discuss is Kagara. Both The Sydney Morning Herald and The Age have published a number of articles on the failed mine at Kagara and ASIC’s handling of the financial reporting waiver request, or relief request, for the company. I should note at the outset—and this is important, because it seems to have been confused in some of the reporting—that the handling of this application is a separate issue from the administration of Kagara itself. The articles attacked ASIC and gratuitously named a number of ASIC staff copied into correspondence. We were not given any opportunity to comment on the articles before publication. Amongst other things, the articles imply that ASIC staff did a favour for a former employee who is now Kagara’s administrator. I want to be absolutely clear: ASIC does favours for no-one. Any suggestion otherwise is a serious smear on this organisation and its people. People work here at ASIC because they believe in the public interest and they are committed to very high levels of integrity.

As an ASIC commissioner, or a senior executive, fronting up to criticism in the public arena is part and parcel of the job. For example, it is part of our role to be accountable before committees such as this and to explain what we do. This is not the case for some of the other ASIC staff named in these articles. More broadly, our published policy of many years is to allow companies under various forms of external administration to defer preparing accounts if they meet certain conditions. We do this because of the substantial costs that creditors may otherwise have to bear in preparing accounts for a company with an uncertain future.

This is the approach; we also adopt it with Kagara. ASIC’s normal conditions of relief, such as answering free of charge reasonable inquiries from company members, has applied to Kagara. The Kagara matter was dealt with urgently because financial reports were shortly due and because of timing considerations of related court proceedings where ASIC was contesting orders requested by the administrators about financial reporting. When the administrators understood ASIC was going to contest the court orders that they wanted they decided to apply for more limited relief in accordance with ASIC’s published policy. ASIC understands Kagara’s predicament is a serious matter, very much so, which has had very significant consequences for creditors. But the public can be assured in this matter that all procedures and processes continue to be properly carried out and we will also table a more detailed background document regarding Kagara for the committee. Commissioner Price is happy to answer any questions about ASIC’s handling of that relief application.

The third issue I would like to touch on is unclaimed money. I would like to briefly update the committee on the unclaimed money program. In December last year, as I am sure you are aware, the definition of unclaimed money changed from ‘accounts not accessed in seven years’ to ‘accounts not accessed in three years’. In April this year, there was $709 million of unclaimed money across banking, life insurance and companies that had built up over several years. As a result of the change, there was a one-off increase at the end of May of $471 million. This is composed of $450 million in bank accounts and $21 million in life insurance. The total amount of banking unclaimed money represents around 0.05 per cent of all Australian bank deposits. The new details for the additional accounts that have come through are being uploaded onto ASIC’s free searchable database as we speak. This is happening progressively and it will be completed around 12 July. All those new details will be up there. We will be continuing our program of reuniting consumers with their lost money. This includes promoting the ability of people to undertake free searches through our website and we will also continue our program of writing to potential owners of lost accounts. Over the past five financial years to 2011-12, we returned just under $250 million to the public. So I want to provide that update on unclaimed money. Chair, we are happy now to take questions.

Senator BOYCE: Of that $470 million, how much has been returned? Mr Kell:  That is the money that has now come into unclaimed money— Senator BOYCE:  It would be between seven years and three years, basically Mr Kell:  That is right. So at this point in time—

Senator BOYCE: None of that has come back down?

Mr Kell:  It has just come into the system, so to speak.

CHAIR:  On the Commonwealth bank matter, particularly with regard to whistleblowers, obviously we have had a discussion at a previous ASIC oversight hearing and Mr Medcraft stated that some of our major successes have come from whistleblowers and we want to encourage them and make sure they are protected. You have reiterated that again today, Mr Kell. But I understand at the recent Senate estimates hearing ASIC stated in relation to Commonwealth financial planning that it was a very large and complex matter, and that ASIC secured landmark achievement with enforceable action, undertaking compensation for investors. But the committee is still concerned with the delay in responding to facts provided by whistleblowers, as reported, and one indicated urgent action was required. The question that still lingers is why did ASIC fail to follow up for 16 months on a detailed initial contact from the whistleblower?

Mr Kell:  The fact that we were not coming out publicly saying that we were taking this action or that action does not mean that ASIC was not following up during that period; it does not mean that we were not looking at some of the issues that had been raised with us, that we were not engaging with the company concerned.

Senator BOYCE:  It does not mean you were, though.

Mr Kell:  Yes, that is effectively what I am saying. It is difficult in matters involving whistleblowers to go into details, for fairly obvious reasons. We do not want to say, ‘We dealt with a whistleblower on this date and that date and so on and so forth.’ These issues around the timing are ones that we are looking forward to explaining in more detail with the upcoming inquiry. But I can assure you that we were engaging with CFP prior to the date that people have been talking about in terms of when we commenced our formal investigation. It is fairly standard practice for ASIC to gather information, to analyse information that is being presented to us, to look at complaints that are coming in and to do a fair bit of work prior to a formal investigation commencing. That is fairly standard practice.

Mr FLETCHER: Do you have a formal system of rating your level of intensity of engagement on an issue?

Mr Kell:  Could you be slightly more specific about—

Mr FLETCHER:  You have put to us that you were pursuing this matter even though you were not saying things publicly about it. Is there evidence that you can provide to us on notice that demonstrates an increasing intensity of engagement in this issue?

Mr Kell:  We are looking forward, I should say, about presenting some of that material and providing some context around that, especially in relation to the inquiry that was just announced. We would be happy to present similar information to this committee if you would like.

Mr FLETCHER:  And would that go to such things as the seniority of the ASIC executive or officer who had carriage  of  the  issue  or  the  number  of  officers  who  were  involved  in  pursuing  it—in  other  words,  some quantitative metrics to support the proposition that you were substantially engaged on this issue even though you were not saying things publicly about it?

Mr Kell:  I am not sure it would work in exactly the way you have described. These are issues that we are also reviewing ourselves at the moment in terms of preparing for the sorts of questions that we are going to get as part of this inquiry. It is not necessarily the case that for each investigation there is a neat step-up over a period of time.

Mr FLETCHER:  Let me put the question another way. Do you, for example, at a particular point say, ‘This issue is of sufficient gravity that we should establish an internal task force or working group on it’?

Mr Kell:   If you are asking that generally, yes. If you are asking that in relation to this issue, yes, there obviously was a trigger point where we asked for more information from the company, undertook the formal inquiry and then started processes around establishing a compensation requirement to impose on the company and banning the various advisers and trying to establish who within the company had been providing inappropriate advice—all those sorts of processes that you work through when you are looking a large instance of potentially inappropriate advice across a range of advisers within a large organisation.

Mr FLETCHER:  Can I ask then, on notice: are you able to provide a time line and include on that time line, to the extent possible, evidence demonstrating key milestones in terms of degree of engagement such as, for example, setting up an internal working group?

Mr Kell:  We can certainly provide an account of how ASIC looked at this matter. But I think we will cover many of the things that you are after there, and that is what we will be seeking to do.

Mr GRIFFIN:  On that, I think that, from the committee’s point of view, we are keen to understand the nature of what took place, how seriously it was taken and, frankly, also whether that is in line with what should be the case with this matter.

Mr Kell:  That last point that you raised is a very important one. In the discussion around this issue so far, there has not been a lot of context around how long these processes normally take, what sorts of steps are followed and what resources are required for this matter when you have got other matters that you are also looking at at the same time, such as Storm in this case. So some of that context we are keen to also provide.

Senator BOYCE:  The 16-month delay in doing anything has been in the media over and over. In your view, did ASIC promptly react to the information they were given?  Was there any delay at all in beginning to investigate the claims brought to you?

Mr Kell:  I think we would like to come back to you on that question. Part of the issue here is that many of the people involved—in fact, pretty much all of the people involved—are no longer with the organisation.

Senator BOYCE:  Is that as a result of this?

Mr Kell:   No. The commissioners, for a start, have moved on. Those are the issues that we are looking at within ASIC at the moment, in response. The inquiry having just been announced, the questions only having recently been raised, we are looking at some of these issues. But generally we are comfortable that the result we got will have covered anyone who lost money as a result of CFP’s advice.

Senator BOYCE:  But, given these criticisms were raised over a month or so ago, there has not been any internal process at all up until the announcement of the inquiry yesterday?

Mr Kell:  We have been looking at what was done in the nature of the engagement with CFP and the sorts of issues that were being discussed with the firm at that stage and the complaints that were coming through, but it is a large and complex matter and it is something where, I think, we would like to be fully informed before we provide you with the complete picture.

Senator BOYCE: Thank you.

Mr FLETCHER:  Mr Kell, I wrote to Mr Medcraft on 27 August about the conduct of Mr Nguyen, asking a series of questions. Mr Medcraft wrote back to me on 11 September last year and the letter contains the statement,

‘It is ASIC’s understanding that 11 claims of former Nguyen clients are still being negotiated.’ I just want to understand how that fits with the 37 cases that you have specified in your statement today. Is it possible that more

have come to light or is it potentially a different definition?

Mr Kell:  It is a different definition, effectively. Out of that $50 million and the 1,100 cases that I mentioned, a subset relate to Nguyen—about $23 million, I think, from memory. I will have to double-check that. About $23 million compensation relates to former clients of Nguyen. Two hundred and two former clients have been paid

$23 million. From recollection, there are still nine former Nguyen clients where matters have yet to be resolved. So it is a subset of the larger set of compensation that is being provided, to not only former Nguyen clients but clients of the other planners involved. Does that answer your question?

Mr FLETCHER:  Yes. On notice, could I just get a reconciliation? You may have just given it to me now, but could I get it in writing as well—the reconciliation between that 37 number and the 11 number?

Mr Kell:  Sure.

Mr FLETCHER:  I want to ask about the compensation mechanism. As I understand it, the guiding principle is that Commonwealth Financial Planning will calculate the investment positions that clients would have held had they received appropriate advice, so that sets the benchmark. Then the compensation is determined by reference to the difference between that and the actual balance in their account. Is that roughly correct?

Mr Kell:  Broadly speaking, yes.

Mr  FLETCHER:   Who  proposed  that  mechanism?  Was  it  ASIC  or  was  it  Commonwealth  Financial


Mr Kell:  That is a reasonably common sort of principle for assessing compensation in these types of matters. We put to CFP what we required by way of a compensation system arising out of poor advice.

Mr FLETCHER:  Does that therefore mean that the total amount of compensation paid is an indication of the total amount of loss that was suffered by reason of poor advice?

Mr Kell:  That is, broadly speaking, the objective, yes.

Mr FLETCHER: Subject, presumably, to the caveat that not all cases have yet been resolved?

Mr Kell:  There are a few that have not been resolved.

Mr FLETCHER:  You have given us the total number that went into the system and the total number that remain unresolved, but what we do not know is the split by value.

Mr Kell:  I see—the ones that are unresolved?

Mr FLETCHER:  Are the ones that are unresolved, on average, larger or smaller or about the same as those that have been resolved?

Mr Kell:  I do not know that for sure. I am not sure that they are necessarily the larger ones, if that is what you are indicating. I think there is a mix, but we are happy to take that on notice.

Mr FLETCHER:  Is there any other unifying theme among the ones that have not yet been resolved?

Mr Kell:  Some of the clients are represented by Financial Resolutions Australia, perhaps one-third or one- quarter. There is still work being done on to them to work through the final amount.

Mr FLETCHER:  Has there been any follow-up work done in terms of questionnaires or surveys or other things like exit interviews as to the overall level of satisfaction of those who have received compensation?

Mr  Kell:    No  exit  surveys,  but  perhaps  I  could  take  the  opportunity  to  just  briefly  outline  how  the compensation arrangements are structured so that you understand what we are saying.

CHAIR: That would be helpful.

Mr Kell:   CFP assessed compensation based on the broad parameters you have just discussed. We then required that an independent expert provide a check on those payments—not every single one but a sample to ensure fairness. We then required that, for any client who is not satisfied with the compensation amount, CFP also offer to pay for the client to obtain their own expert accounting or legal advice. The CFP would pay $5,000 for that advice, and in some cases more. We then required that any further disputes that still remained after that occurred could and should be assessed by the free Financial Ombudsman service. So there were several layers of safeguards, protections and checks built into the compensation system.

ASIC itself obviously took an interest and was involved in mediation matters around several complaints and compensation issues. In addition, at the earliest stages of the process, we required that anyone who had received compensation prior to ASIC’s system being imposed on CFP have their compensation reviewed and put through that same process. Also, to deal with timing issues, we required anyone who needed money urgently back at that time to be provided with interim compensation prior to a final amount being arrived at. The compensation system, in other words, that we required had flexibility in terms of providing people with access to money and several levels of safeguards.

Mr FLETCHER:  I have just one other issue. There have been some reasonably serious claims reported in the media about what occurred at Commonwealth Financial Planning after it became evident that complaints had been made to the regulator—correction: there have been two classes of fairly serious claims. One is that, as part of the conduct of certain advisers, there was forgery of documents, forgery of signatures and so on. The second is that it has been alleged that, subsequent to it emerging that complaints had gone to ASIC, there was what was described as a ‘sanitising of files’, which I understand to mean that clients’ files had particular documents removed from them, and in some cases the entire file went missing. Has ASIC investigated those two separate classes of allegations, what are ASIC’s views on those matters and is there further action to be taken?

Mr Kell:  Doing a very careful assessment of the files and the information that is held by CFP particularly in relation to the advisers who provided the inappropriate advice was certainly central to the work we did in this area. We did not find evidence that would support a criminal prosecution or criminal action being taken.

Mr FLETCHER:   I infer from that that you carefully considered whether there were grounds for criminal action.

Mr Kell:  We do as a matter of course in these sorts of matters.

Mr FLETCHER:  Are you able to say what it was that was not present that meant you could not proceed to prosecution?

Mr Kell:   I would prefer to take that on notice to provide a more fulsome response around that, but it is evidence of the sorts of criminal conduct, broadly speaking, that you referred to earlier.

CHAIR: Mr Kell, if such evidence became available, even at this late point, what would ASIC’s response be?

Mr Kell:  The standard response in these sorts of matters is that, if new evidence comes to light that highlights serious misconduct, we will look at it.

Senator BOYCE:  I just want to follow up again on the whistleblower in this case, Jeff Morris. He has sort of outed himself and made some fairly serious claims about ASIC’s lack of interest or lack of activity around the claims he made. Do you have a policy on communicating with whistleblowers? You claim to want to encourage whistleblowers to approach you. What are you doing to encourage that?

Mr Kell:  We have policies relating to the level of confidentiality—that is the most critical issue around whistleblowers—and the way in which that is dealt with and the way in which that confidentiality is protected.

Senator BOYCE:  Not contacting them for a long time would also surely be an issue for a whistleblower, would it not?

Mr Kell:  It is a case by case issue. People who provide information to ASIC in any capacity do not become part of the regulatory action which ASIC is engaging in. Sometimes somebody will be approach immediately; sometimes not immediately. These are issues that arise on a case by case basis. Our obligation is primarily to protect the confidentiality of any whistleblowers. That is a very serious one. So that is primarily what our policy revolves around. Given the level of interest in whistleblowers more generally, not only in relation to this case, we are looking towards the opportunity of reviewing how we communicate in that area, going forward. That is something that we can raise as part of this inquiry. So it is something that we want to make sure that we have developed to the extent that we should.

Senator BOYCE:  Do you have any interaction with Whistleblowers Australia? They are a sort of support group for whistleblowers, I suppose.

Mr Kell:  Not that I am aware of, no.

Mr Price: Not that I am aware of.

Senator BOYCE: There are a lot of nos, can I say for the sake of Hansard.

Mr Kell:  I should have checked, I do not know if any whether of my colleagues want to make any comments about whistleblowers at this stage.

Mr Savundra: No.

Mr Price:  There is a regulatory framework in relation to protections for whistleblowers and those laws were introduced in around 2005-06, I think. They were controversial at the time because there were a couple of competing policy priorities. One is to get useful information to the regulator; the other is you do not want to encourage claims that may not have merit. They are important policy considerations.

Mr Tanzer:  I would certainly like to check that rather than just assume the answer, but I am certainly not aware of that. Mr Day cannot be here today but that is one area that quite frequently has contacts with groups who are relevant to people who might make these sorts of reports. He may well have that sort of contact.

Senator BOYCE:  I am happy for that to go on notice.

CHAIR:  Given that Mr Morris has gone on the public record about the experience of being a whistleblower and he is clearly very unhappy with the timing of the response and a disconnection from engagement with ASIC as it moved forward, what are your plans in terms of engaging Mr Morris’s experience as a point of reflection on how you might move forward with improved processes should this situation rise again?

Mr Kell:  As I indicated earlier, we are taking this opportunity, not only in relation to CFP but more broadly, to consider some of our engagement with whistleblowers and how we manage some of that communication. It is a challenging area. We understand how difficult it can be to come forward as a whistleblower. If there is feedback we can take on board there from various whistleblowers and experience that others law enforcement agencies have, we will certainly seek to learn from that. That is an opportunity that we have as part of this inquiry.

CHAIR:  In Senate estimates, you took a question on notice from the Economics Legislation Committee regarding the estimate of the financial losses incurred by Mr Nguyen’s particular book between October 2008 and when he actually resigned in 2009. Do you have that?

Mr Kell:  I do not have an update.

CHAIR: Could you take that on notice and advise us as well? We are mindful that the Senate—

Senator BOYCE:   We also wanted to try and take it through to when ASIC actually ‘raided’ the Commonwealth—what losses there might have been from his clients between October 2008 and March 2010, when you, hopefully, stopped his activities.

Mr Kell:  I just make one point on that, which is not a unique experience in this case. We seek to make sure that our compensation system that we impose, if there is compensation to be awarded, covers any misconduct whenever it occurs. It is not always the case that you are going to be able to shut down something the day after you hear about it. Compensation, and ensuring that it is adequate and that it covers all instances of misconduct, is very important in dealing with the sort of issue that I think you were trying to get to there. But we will certainly take that on board.

CHAIR:  We may have a couple of other questions on notice, so if we can get those to you and get a response that would be very good. We certainly look with interest to the Senate doing their inquiry as well into this matter.

Moving along to the second matter that you raised in your opening statement, which was with reference to Kagara. I was particularly interested in a comment that you made about your staff at ASIC being copied into come of the communications and then being publicly named as participants. Could you expand on that for me in the first instance?

Mr Price:   What was going on here was commonly called an application for relief. Simplistically, it is a waiver request from various provisions in the law.

CHAIR: How often do you receive those?

Mr Price:  We receive thousands of waiver requests every year. We have been given specific powers granted by the parliament to consider these requests and to deal with unintended consequences of the law in particular situations, and we have quite a well-established policy framework about how we make decisions in these types of situations.

What has transpired here is that there have been a series of articles which have raised concern that ASIC staff may have acted inappropriately in exercising these powers, and they have named specific ASIC staff as part of that. We feel that is very unfortunate because the articles, we feel, do not pay appropriate rate to several key factors. The concern that was being raised was whether there was any favouritism between former ASIC staff members and current ASIC staff members. But the articles actually do not mention a couple of key points. One of the key points is that ASIC was actually contesting court proceedings involving one of the former staff members. If there is a suggestion of favouritism and you are actually contesting court proceedings they are involved in, that is not the sort of friend I would like anyway. The other suggestion in the article is that ASIC inappropriately acted with haste in dealing with the particular matter. Having reviewed the electronic copies of the files, I have at least satisfied myself that the reason for acting urgently in this particular matter was twofold: first, financial reports of the company were due to  be lodged very quickly; second, there were related court proceedings that were on foot. Again, these are court proceedings that were not mentioned in the article that was put before the public.

The other key thing to bear in mind is that the decision that ASIC staff have made in this instance was actually consistent with longstanding and public ASIC policy that is freely available on its website. That policy is set out in  ASIC  Regulatory  Guide  174,  which  deals  with  financial  reporting  relief  for  externally  administered corporations. So what has effectively happened here is that—I might take you to the chronology that has been tabled, because these circumstances are complex and it is going to be the easiest way to explain it—on 20

September 2012 ASIC received correspondence from King and Wood Mallesons, the administrator’s legal representatives, indicating that they would be making a future application to the court seeking an extension of time for the lodgement of financial reports. Then, moving down, you will see that on 12 October 2012 an

application was filed with the report, seeking that relief from financial reporting. Turning over the page, you will

see that on 19 October 2012 ASIC filed an intervention in these court proceedings. We were concerned about the relief the administrators were asking for, firstly because ASIC has the primary regulatory role in dealing with these matters and secondly because we have longstanding policy about when we will grant this relief, on what conditions we will grant this relief and so forth. There was then a discussion between the administrators and ASIC staff on 19 October 2012, and in that discussion it was confirmed that ASIC was going to intervene in the court proceedings. Following that discussion the administrators decided that, rather than attend court and have ASIC intervene, they would simply ask for relief in accordance with ASIC’s longstanding and published policy. They made an application, we granted it urgently and that was the end of the  matter. What really concerns us in this case is that a number of, as I say, ASIC staff have been named simply for doing their job.

CHAIR:  There seems to be quite a gap between the articles that have been published and the facts that you have just laid out before us in some detail, with dates and a sequence of events. How do you explain that, Mr Price?

Mr Price:  I cannot speak for the journalist involved, but I think what has happened is that he accessed certain freedom of information materials that related to financial reporting aspects of this transaction and has not been aware of the broader court proceedings, and the two things are related.

CHAIR: So with half of the information the story amounts not to facts but more to allegations against people?

Mr Price:  Unfortunately, the newspaper made various assumptions without knowing the background behind those court proceedings and, in particular, that ASIC was contesting the relief that the administrators were seeking in the court.

CHAIR: Did the newspaper ever contact you to ask you for this information?

Mr Price: Regrettably, they did not.

CHAIR: Do the newspapers normally contact you about matters of such import?

Mr Price: Some do and some do not.

CHAIR:  I think that is very disappointing to hear. We will move on to the third matter that you raised in your opening statement: the unclaimed money. I know that this has exercised the minds of many Australians who were seeking to get reacquainted with their good friends the dollars. Could you just provide us with a little more information around the timing on this, such as how many have been uploaded? I think you said it was 12 July that you expect to have completed the task of people being able to get on and locate their money.

Mr Kell:  The information is being uploaded progressively, so there will be some information up there now. I suppose the message we are sending is that there will not be 100 per cent of the new information up there until that date in mid-July. We are going to be making sure that we communicate that as clearly as we can to people so that if they do not see their information up there tomorrow, so to speak, they will know to come back in a few weeks time.

It is also the case that, while we are implementing the new calculator that provides for interest payment on money from 1 July onwards, that will mean there will be a short delay of a few weeks in our processing of claims as well—about the same time frame, until about 12 July. So, for a few weeks, our processing of claims will be delayed while we get that new calculator up online and implement it into our payment systems to enable that payment of interest going forward. Otherwise it is pretty much the standard approach that we have had in this area for many years. If people identify that they have a lost account or a relative or others have a lost account, they should contact the institution in the first instance—if it is a bank—to confirm that the money is theirs. The bank then contacts us and we process that within a few weeks in the vast majority of cases.

Senator BOYCE:  Do you undertake any analysis of the unclaimed moneys in terms of being able to improve how you locate people or classes of unclaimed money that might be handled differently?

Mr Kell:  In terms of particular demographics or regional breakdowns?

Senator BOYCE:  If it all belongs to backpackers who forgot to close the account, clearly it is a different issue than if it is pensioners who could well use the money.

Mr Kell:  It is a very diverse set of individuals; I suppose that is my initial response to that. There is a sizeable minority that consists of people that have passed away, for example, and their relatives are unaware that they have had a bank account or shares in a company; people who have moved house, perhaps numerous times; people who have moved jobs, perhaps numerous times—it is a very diverse population that we are talking about here. We have had a letter-writing program, and last financial year we sent out 28,000. We will continue with that. By definition, that is a far from straightforward program to undertake because these people are difficult to track down.

It is also the case—and we have been pleased about this in recent years—that a range of financial institutions also off their own bat, if you like, as a customer service initiative, I suppose, are seeking to help people identify and locate unclaimed money both in this area and, I think, in the other area that we do not administer— superannuation.

Senator BOYCE:  I think they tried to correspond with people around the change in timing as an anger management tool, if nothing else. You have mentioned here that you have returned $250 million over the last five years. Can you tell me how many individuals that is?

Mr Kell:  There have been successful claims over the last five financial years—around 74,000.

Senator BOYCE: And you mentioned that you had sent out 28,000 letters.

Mr Kell:  That was 28,000 letters just in the last financial year. Over those five years we have sent out just over 100,000 letters. The majority of people who have successfully claimed money do not come through via letters. They undertake the free search. When we did some media on this in the latter part of last year, we had sought a response on a free search engine. It actually collapsed for a short period of time, for about a few hours, so there is a strong interest in this.

Senator BOYCE:  Given that you have had $471 million coming in May and only 250 go out over five years, it looks as least as though the federal government will make a profit out of this.

Mr FLETCHER:  Mr Kell, you said that the legislation took effect in December last year. Does that mean that there is, in effect, a 12-month period commencing December last year when you got to bring that forward such that during that period there will be unusually high amounts of money coming in?

Mr Kell:  The supplementary figures covering the change from seven years to three years came in and they were due on 31 May. That will capture the overwhelming bulk of that—

Mr FLETCHER:  Just before we come to the quantum, I just want to understand how it works. Is it the case that prior to December last year there was a steady run rate of money coming in each year as accounts got to the seven-year period and then became subject to the definition of ‘unclaimed moneys’?

Mr Kell:  That is right.

Mr FLETCHER:  So you would have expected a business-as-usual amount to come in in the 12 months commencing December of last year? What roughly is that business-as-usual amount?

Mr Kell:  Around about $100 million—it varies—

Mr FLETCHER:   And then you have on top of that the fact that from December last year through to December this year there will be accounts hitting that three-year point at which they suddenly qualify for the definition of unclaimed moneys?

Mr Kell:  It is roughly like getting four years return in one year.

Mr  FLETCHER:    That is  because, presumably,  the  starting  point is  that every account which  has  sat untouched between three years and six years and 364 days suddenly becomes unclaimed moneys that you can get your hands on on behalf of the Australian people.

Mr Kell:  Broadly speaking, that is correct. It is four years into one year, and when you look at the figure I am talking about, we normally get around $100 million and perhaps a bit more in some years or perhaps a bit less, so it is not surprising that we therefore cost $471 million—

Mr FLETCHER:  So the right way to think about this is that one year’s worth of payments has been replaced with, in effect, four years worth of payments.

Mr Kell:  As a one-off.

Mr FLETCHER:   So therefore the consequence is that, roughly, rather than $100-odd million coming in, there is going to be $450 million.

Mr Kell:  $460 million.

Mr FLETCHER:  One effect is the timing effect, but presumably there is a second effect which is that it is less likely that people will leave an account untouched for seven years than for three years.

Senator BOYCE: One can only leave it untouched for three and bit years now.

Mr Kell:  We do not know the impact that issue might have at this point in time.

Mr FLETCHER:  From first principles, does it seem plausible that behaviourally that would be a way people might treat their money? In other words, they would be less likely to leave it untouched for seven years than for three years?

Mr Kell:  You would imagine there is more likelihood that people may look at their accounts between that three- and seven-year period. As to how many that might affect, at the end of the day that is very hard to say.

Mr Tanzer:  I am not sure about that. I am not sure of the analysis done at the time, but I am not sure that your supposition is right. It might be that 99.9 per cent of people who do not look for three years also do not look for seven years.

Mr FLETCHER:  Could you take on notice whether there is any analysis known to ASIC of that question; namely, the pattern of people’s behaviour in dealing with their money? And, under the law as it previously stood, was there a steadily declining rate of engagement with accounts after one year, two years and three years et cetera?

Mr Kell:  Yes.

Mr FLETCHER:  I want to make sure that I understand that this is effectively a one-time exercise. Just as a matter of logic, it cannot be done again?

Mr Kell:  In moving from seven years to three years?


Mr Kell:  It is a one-off exercise in terms of the impact on how much additional money comes into the system.

Mr FLETCHER:   So it is effectively a one-time change in accounting treatment which makes the overall

P&L look a bit better?

Mr Kell:   You can only move from seven to three years once—or some other time frame. In terms of the decision around what the time frame is, that is a government policy issue and not—

Mr FLETCHER:   I am interested to know about the approach ASIC takes to the way corporates do their accounting. If they engaged in one-time changes in accounting policy to make the P&L look better, is that something that ASIC, as a corporate regulator, would think was worthy of attention?

Mr Kell:  I am not sure that it would be something that would be relevant to our consideration of this issue.

Mr FLETCHER: That is not the question I was asking, Mr Kell.

Mr Tanzer:  It is not a change in accounting treatment. This is a change in legislation. This is not revaluing an asset.

CHAIR:  It is a policy shift.

Mr Tanzer:  It is a policy change.

Mr FLETCHER:   It is highly analogous to a change in accounting treatment. For example, it is quite analogous to a change in the treatment of the subsidy that mobile phone companies pay in relation to a post-paid handset on a contract.

Mr Tanzer:  I would like to think about that a bit more. Perhaps we can discuss that more.

CHAIR:  I go back to the underlying reason for this legislative change, and let us get this on the record today. My understanding, and you can expand, clarify or confirm, is that there are accounts out there where there are funds untouched for some period of time. Over seven years there is quite a depletion of the initial amount of money through account costs. This will capture that money and hold it until such time as people go looking for it, and then they will be able to relocate it. Is that roughly it?

Mr Kell:  Yes. To clarify the actual operation of the unclaimed money process, it is certainly the case that once it is in the system for unclaimed money no fees and charges are applied and on 1 July this year interest will be paid on the moneys that come in going forward.

CHAIR: And that has not been the case until recently?

Mr Kell:  That is correct.

Senator BOYCE: Unless that money was already in interest-bearing accounts.

Mr FLETCHER: ave you had many people saying, ‘Thanks for taking my money and saving it from fees’?

Mr Kell:  We generally do not have that type of engagement in one way or another on unclaimed money. It is simply, ‘We have identified our money; how can we work out how we can get it back?’ We are very happy to help them on that.

Mr Tanzer:  And, without being flippant, I should say—this was years ago when I had some responsibility for this area—we did actually have quite a few people who said, ‘Thank you very much having a system that enables us to find that.’ With it being in one place, it did actually assist in finding that. But I understand the point.

CHAIR:  If you could take this on notice, because I do not know if it will even be possible for you to find it. One of the things I have been very mindful of is women fleeing domestic violence—particularly at the end of a week when we had a quilt with that theme presented to the parliament that is going in the spouses’ lounge—and those sorts of situations where women, often with small amounts of money, have to pick up their life and move on. I do not know what the gender breakdown would be on some of these accounts, but I would be interested in that and in any other further sociological data on the people to whom these accounts belong. It has certainly exercised the minds of the parliament a little bit this week. It would be interesting to find a little of the detail that lies in the background of this.

The other point is that, when people who might not in any other circumstances engage with ASIC’s website come through looking for this, there is an opportunity for a more substantive conversation in terms of financial literacy. What have you got in place to make an easy connection for people doing a money search to then go to the financial literacy dimensions of the website?

Mr Kell:  That is a very good question. We do seek to leverage off the very large numbers we get coming to the unclaimed money section, to encourage them to go to the website MoneySmart more generally to take advantage of the section that allows you to put together a budget or look at some advice about investments. So, certainly, even at the most basic level, part of the program is to introduce them to the website because it is a part of our MoneySmart website, the unclaimed money section, and to leverage off that as far as we can. It is not a large percentage that go to visit other parts of the website; but, because so many people come to unclaimed moneys, there are a large number in absolute terms who then do take the opportunity to look at other information we have on financial literacy, and that is a good thing from our perspective.

Mr FLETCHER: Might we move on to other topics?

CHAIR:   Yes, I think we might move on right now. As you said, Mr Medcraft is at the IOSCO meeting, fulfilling his responsibilities there. I just wanted to give you the opportunity to put anything on the record with regard to IOSCO that you are aware of that would be of interest to the committee.

Mr Tanzer:  One of the major matters that IOSCO and Mr Medcraft are dealing with at the moment relates to the implementation of the G20 reforms with respect to, particularly, the clearing and settlement of OTC derivative transactions. This was a major initiative of the G20 back in September 2009. As is often the case, the detail of the implementation of this became quite complicated and quite difficult to manage, but the principles are basically pretty straightforward. The concern that gave rise to this was the large level of exposure of the largest financial institutions in the world to OTC derivative settlement exposures which they were not really properly aware of in terms of the quantum and the set-off and the nature of the outstanding obligation that was slowing behind some of these complex OTC derivative transactions.

There were basically three elements to the reforms. The first was to require that all OTC derivative transactions be reported just to a trade repository, to report the nature of that trade, so that there was transparency about all of the trades that had taken place. The second level was to say that, where it was possible and where those transactions could be standardised, they should be cleared through a central clearing facility, the intention there being to reduce the counterparty risk on the outstanding liabilities.

The third level was to enhance price formation and transparency even further and where possible to have these derivative transactions, where they really were standardised sufficiently, traded on an established exchange— either an authorised trading platform or something like the Australian Securities Exchange. The highest level is the totality of all of the OTC derivatives transactions; they would all be reported. The next level is that where possible they would be cleared, and that requires a degree of standardisation. The third level, which is really down to volume as well as standardisation, is where they would be exchanged on an established securities exchange.

The operation of this in Australia has reached the stage where ASIC, which is responsible for proposing rules for both the trade repositories and the trading halls that sit underneath them, is very close to issuing those rules to the market, and that will start the process for Australia implementing this regime in our own regime. At the level of IOSCO, there are a number of fairly arcane and fairly detailed issues of technical specificity that need to be worked through, particularly around exactly what derivatives transactions would be covered at the clearing and at the exchange level, and a number of other technical matters that Greg, in his role as chair of IOSCO, is intimately involved with. As chair of the IOSCO board, he is also entitled to a seat at the Financial Stability Board, which is an  emanation  of  the  G20—a  more  working-level  group  of  officials  from  the  G20,  on  which  Australia  is represented by the Treasury and the Reserve Bank of Australia. We get a third seat at that table, effectively, through Greg’s representation as chairman of IOSCO.

CHAIR:  Financial stability certainly matters to the Australian community. It is good to hear that we have a chair at the table—or an extra one. I think Mr Fletcher wants to move on to, perhaps, other matters.

Mr FLETCHER:  Yes, if I may. I would like to ask some questions about Trio and the follow-up from the liquidator’s examination of Tony Maher in December of last year. I would like to quote from a couple of emails I have received from those who lost money as a result of the collapse of the ARP Growth Fund. I quote these to give an indication of the depth of feeling on the part of people who have been defrauded of very substantial amounts of money. One says, ‘It beggars belief that six months have elapsed since the public hearing, with all agencies aware of the court restriction date for return of Maher’s passport, and yet the DPP is still to receive the brief from ASIC to determine if charges will be laid.’ Another says, ‘As you know, members have died, sick from the loss of retirement savings, forced to sell their homes and hide from the shame that has come upon them.’ I would like to know, firstly, whether it is true that Mr Maher has the prospect of having his passport returned to him.

Mr Savundra:  To start with, just to pick up on those points, we certainly acknowledge the hardship that investors face in this. We accept and understand those comments. In relation to Mr Maher, it is true that there is a prospect of him getting access to his passport or, really, having some travel orders which currently are in place lifted. Before I go on to the passport, I will just talk about the progress. Certainly this is a high-priority matter. Clearly, given the public interest and given this committee’s interest, it is a top-priority matter and we are progressing it as quickly as we can. It needs to be understood that evidence given through public examination is generally not admissible evidence. People claim privilege, and those are privileged answers, so you cannot just package up what is said in a public examination and present it to the court. Our exercise is different, and that is to collate and obtain admissible evidence sufficient to establish a contravention of the law.

In relation to restraining Mr Maher—whose passport ASIC has no involvement and never has had any involvement with—from travelling to other countries, the liquidators, shortly before the examinations, which were conducted in December last year, approached the court and obtained travel restraint orders for the purposes of keeping Mr Maher here so that they could complete those public examinations. It is fair to say that those orders were obtained with at least the acquiescence of Mr Maher, so it was not really contested as to the basis of that. The court, on the back of an application by the liquidators, and with no real contest from Mr Maher, granted those orders. One would have thought those orders would ordinarily have lifted after the examinations had concluded; but, because the summons was left open for a period of six months, the court made an open-ended order in relation to Mr Maher’s ability to travel.

We understand that he recently applied to the registrar in those liquidator proceedings. I should stress here that ASIC is not a party to those proceedings. We did attend the public examination and sought to proactively intervene, to assist, if we could—and particularly in relation to the protection of confidential information from foreign regulators, we took that step. Otherwise, we are not a party to those proceedings. We have never sought to obtain or restrain Mr Gresham. I have explained to the committee previously why we have not taken those steps—and I am happy to do so again. He has approached the court to have those lifted, given the public examination has concluded and the period for which that public examination was left open by the court has now expired. He has approached the court before a registrar. A registrar, I think on 12 June, adjourned it off to a judge—because I understand that a judge needs to make this decision—on 8 July.

Mr FLETCHER:  Does ASIC think it is a good idea that this man, who the evidence strongly suggests— although it is obviously a contention entitled to be contested in court—has been involved in defrauding many Australians in very troubling circumstances, should be allowed to leave Australia? There must surely be a suspicion that, if he does that, he will not come back. Therefore, the prospect of bringing him to justice will become remote, and this will be yet another person—along with several other key figures in the collapse of Trio Capital—who will evade the application of proper judicial processes.

Mr Savundra:   I guess the first point I would make is that we can only act within the powers that the parliament gives us. There are a lot of things we would like, but that is another question. We can only exercise the powers that parliament gives us. Clearly, we are investigating this matter with a view to an end. If Mr Maher were to leave the jurisdiction, it would potentially defeat that end. It is certainly not in our interest to spend significant time and significant resources to waste that time. We are just not in that business. We would be more devastated than many if that were to occur, but we need to operate on evidence. The power that the parliament has given us is to restrain people where it will protect aggrieved persons who have lost money to have the ability to recover that money. That power is not just given to us. The power is also given to liquidators, and the power is also given to the investors. So the investors can take this action to restrain Mr Gresham, if they believe there is a basis to do so; the liquidators can bring that action, if they believe there is a basis to do so; and we can, if we believe there is a basis to do so. We currently do not believe that there is a basis to do so.

Mr FLETCHER:  You would appreciate, I think, that the investors would not react warmly to the suggestion that after, in most cases, their life savings have been taken from them, they ought to be funding legal action to restrain this man from going overseas.

Mr Savundra:  I understand that. Certainly if the investors have evidence to give us which demonstrates what we need in order to give us a basis, we would welcome that. We have asked them for that. We would equally welcome it from the investors. So I take your point that investors are in a difficult position, they are suffering hardship, and it is not our expectation and there is not a lack of willingness on the part of ASIC to take this action. There is a lack of legal basis. Unless we are given powers to restrain people, pending completion of our investigation with a view to charging, we cannot do so and we currently do not have that power.

Mr FLETCHER: Why is it taking so long?

Mr Savundra:  It is a complex investigation. I disagree that it is taking so long. Complex matters take time to investigate. We need to obtain admissible evidence. It requires us to engage with international regulators and obtain evidence from them, which takes time, and the timing of which is generally well and truly outside our control. We have had to send staff members to Hong Kong in order to obtain evidence. We have needed to interact with counsel in relation to the sufficiency of evidence. These are the usual parts of the process and we are working through them.

Mr GRIFFIN:  I have a quick question on your earlier comment with respect to the powers that you have got. I guess this is a question for you, and Mr Kell may also want to comment. Would ASIC see it as being desirable to have such powers with respect to enforcement? A follow-up question, which may influence what you say in answer to the first question, is: if so, why haven’t you asked, or have you asked in the past?

Mr Savundra:  From an enforcement perspective it certainly would make our life easier. But there is a serious issue—really one for the policy makers—around personal liberties. It is a fundamental right to be able to travel and have freedom of movement. There are very few other areas of the criminal law where, prior to a person being charged, they can be detained and restrained. It is a fundamental right, some would argue, and it is a fundamental legal principle. From ASIC’s perspective, in terms of what would assist with us progressing enforcement actions, certainly the power would be welcome. But I think many people’s views on this would differ. Equally, we see it even through the existing powers we have before the courts, that the courts are at times reluctant to exercise the power, given the fundamental right that people have of freedom of movement.

Mr Kell:  I would add that, as Mr Savundra indicated earlier, it is obviously not just ASIC that has this power. This is something that I think if you were going to consider it for ASIC you would look at how to applied it to a range of other law enforcement agencies and whether, across the board, law enforcement agencies should have stronger abilities in this area.

CHAIR:  Given that, because of the liquidators’ action and the public hearing, he has already been restrained from being able to leave the country, is there a capacity for an extension of that for a short period of time if there are investigations underway that you can see an imminent closure to? Has any advice been sought to that end?

Mr Savundra:  Certainly ASIC has sought advice in relation to whether there is a legal basis to extend it. Our current view is that there is no legal basis. If the liquidators were of the view that there was a need to further examine Mr Gresham, then it may provide such a basis. The original basis on which the orders were obtained was that it was necessary to obtain the order to keep Mr Maher in the country so that he could be publicly examined. Whilst it is ultimately a matter for the liquidator, it is ASIC’s position that further public examination of Mr Maher is not necessary.

Mr FLETCHER:  Is there any basis on which you can intervene in, you can appear at, the proceedings which I understand are scheduled to be held on 8 July? Are there factors that you could highlight to the court that would affect the court’s decision?

Mr Savundra:  We could intervene in those proceedings. However, we are subject to the Legal Services directions and in order to do so I think we would need to get over the threshold, and it is a fairly low threshold, that there is a reasonable basis or ground for us to be agitating for an order. I do not think we have sufficient to get over that ground.

Mr FLETCHER:  Why is it not a reasonable basis to be agitating? Over $100 million has been defrauded, we have somebody who, all the evidence suggests, was very heavily involved in that fraud and there is a serious public policy question here about confidence in our financial system and public confidence that if people are involved in serious fraud they are not going to get away without their guilt or innocence being tested in a court. That seems to me to be a very substantial question to ask.

Mr Savundra:  It is not the basis of the power, and if you would like me to go into more detail I would suggest we do so in camera. The legal basis is not about justice, it is not about keeping people here so that they can face justice. It is about the necessary protection of aggrieved persons so that they can recover compensation or money off people by which they have been aggrieved. All of the elements you raise there do not really go towards the power that we have been given. But I am happy to expand on that in camera.

Senator BOYCE:  Mr Kell, you would no doubt be aware of a speech made by Senator David Johnston in the Senate  on  Wednesday  about  ASIC.  He  spoke  about  ASIC’s  very  sorry  saga  of  a  vindictive  waste  of Commonwealth money. Do you have a comment on the speech and the information in it?

Mr Kell:  No, I do not at this point in time. I am happy to take that on notice.

Senator BOYCE: Thank you.

CHAIR:  I am just going to foreshadow that there will be some questions on notice with regard to dark pools, particularly since the price improvement rules began in May. We will ask for a bit of an update on that, if possible. Also, we will have some questions on high frequency trading. With regard to that algorithmic high- frequency trading as a new normal, how is the management of that new normal going? Another one is regarding cost recovery issues. There will be a little on auditing, and I do want to put on the public record here this afternoon that this morning we had a round table with the gatekeepers who we identified through our inquiry into Trio.

If I were to make an evaluative comment, I think it was a very fulsome conversation with very active participation by all the gatekeepers here, and I have some hope that it might foreshadow ongoing conversations amongst the network of gatekeepers, who seem very happy to be here and are very keen to enhance the professional capacity that they already have. I note with some hope their conversations with us today about the impact of the best interest duty and impact that has on rising standards. I make a final comment about a shift to regulation, which is sometimes, sadly, simply called ‘red tape’ but which is improving the integrity of the market. I think was generally the mood of those who were here this morning.-

Mr Kell:  We touched on that. Can I say that we had two officers here to observe that conversation and we will certainly be looking at the issues that were raised, and they found that very useful.

CHAIR:  Thank you. We might need to write to APRA, seeing as we do not get to talk to them, to alert them to some of the good commentary and other challenges that were raised this morning as well. Of course, the people who were involved in the Storm Financial issue still have continuing interest in how that is being progressed, and we will give you some questions on notice on that as well if we may.

Evidence was then taken in camera—

Committee adjourned at 15:25