The Commonwealth Treasury


COMPENSATION FOR LOSS IN THE FINANCIAL SERVICES SECTOR ISSUES AND OPTIONS September 2002

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Chapter 8: Is a broad statutory scheme warranted?

The purpose of this Chapter is to ask whether a broad statutory compensation scheme is warranted and, if so, what should it cover and how should it be structured.

A: Is a broad statutory scheme warranted?

223. Our tentative conclusion from the discussion above is that:

224. A conservative questioner might ask:

225. The advantages of a broad statutory scheme are:

226. The disadvantages of such a scheme are:

Principal issue 10

Do the financial services industry and consumers consider that a broad statutory scheme is warranted?

B: In what circumstances should a broad statutory scheme apply?

Solvency/insolvency/inability to pay

227. The options would appear to be to provide for payment in certain specified situations when the financial services licensee:

228. The argument against covering situations prior to insolvency is that the client has other avenues of redress at this point and there are presumably assets to satisfy successful claims (including the mechanisms required under section 912B).

229. The overseas statutory schemes overwhelmingly address the situation where the financial service provider is unable to pay or insolvent. This was followed by CASAC60 which proposed immediate payment to claimants (within the caps), even where there is some likelihood of an eventual return to those claimants in the insolvency.

230. The second option provides a measure of flexibility over the third in that insolvency is not necessary. However, it may leave the client in some uncertainty as to whether the scheme is available in a given situation and requires some definitive statement that the licensee is unable to pay (which may of itself have consequences on the licensee's financial situation).

Principal issue 11

If a broad statutory scheme is warranted, when should it be available?

(a) Should it be available prior to insolvency? or only on inability to pay/insolvency?

The grounds on which it would pay claims

231. In brief, the grounds on which compensation could be available include losses as a result of the licensee's defalcation and fraud, losses of property (including funds) entrusted to the licensee, deficiency on insolvency, failure to enter into and complete transactions as instructed, or some other breach a relevant obligation. These are discussed in Chapter 5 of this paper.

232. It should be noted that the cost of administering compensation arrangements rises in proportion to the complexity of the investigation and decisions to be made by the scheme operator. The issue of administrative complexity is discussed at paragraphs 121 to 123.

Principal issue 11

(b) On what grounds should claims be paid?

C: The CASAC proposal

233. The Companies and Securities Advisory Committee (CASAC) issued in September 2001 a Consultation Paper that proposed for discussion a scheme to compensate retail clients of insolvent financial services licensees who were intermediaries.61 The scheme would:

234. The model which the Committee proposed for discussion:

Responses to CASAC's Consultation Paper

235. CASAC received nine responses to the consultation paper (of which seven were in writing). A number of submissions supported the proposed scheme, one expressing the view that it would:

236. Some other submissions raised concerns about possible `moral hazard' and the methods and implications of financing the scheme. Was there evidence of such a lack of consumer confidence as to justify the scheme? Why was the UK model (which differs significantly from the US and Canadian models) being adopted?

237. It was also suggested that CASAC should only develop its compensation scheme in the light of ASIC's financial licensing requirements and that detailed justification was needed to move away from the recommendations on risk management and financial safety of the Financial System Inquiry (the Wallis Committee).

238. There was opposition in two submissions to the possibility of compensation for negligent advice and several asked whether the separate treatment of investments (as distinct from superannuation, insurance and deposit products) was consistent with the Financial Services Reform Act. One submission sought a regulation impact statement, while another suggested a discussion of possible alternatives, such as reforming and improving the current schemes.

D: Overseas schemes

239. Review of the overseas schemes (summarised in Attachment D) indicates:

240. It should be noted that several of these schemes are market-related, although separately administered. Further details of the schemes in the UK, US and Canada were summarised by CASAC and are available on www.camac.gov.au.

241. Both the model CASAC proposed for discussion and some of the overseas schemes give rise to the question whether a statutory scheme limited to market participants or market transactions is warranted. This is discussed at paragraphs 212 to 215.

60 See CASAC Consultation Paper, page 12.

61 This paper is available on the Committee's website: www.camac.gov.au.

62 Any breach of trust, defalcation, fraud or misfeasance by the intermediary or any person employed by the intermediary.