Inquiry knocks back investor safety net

In response to a spate of multi-million dollar collapses during the global financial crisis, the federal government asked Richard St John, an authority on governance, in 2010 to investigate the case for a statutory compensation scheme for victims of serious misconduct, such as misappropriation of clients' funds.

The inquiry was launched because the laws provided no guarantee of compensation for investors, who were instead forced to rely on their advisers holding professional indemnity insurance.

However, in his final report, Mr St John has found it would be "inappropriate" and "possibly counterproductive" to introduce a new compensation scheme.

Such a scheme would raise the risk of "moral hazard," the report said, and would reduce the incentive for "stringent" enforcement of existing rules.

"Given the limited regulatory measures to protect retail clients from the risk of licensee insolvency, it would be inappropriate to require more responsible and financially secure licensees to underwrite the ability of other licensees to meet claims against them for compensation," Mr St John, a former general counsel at BHP Billiton, wrote.

The report comes after investors, who lost millions in the collapses of Westpoint, Babcock & Brown and various managed investment schemes, have taken legal action against their advisers.

Figures in the report suggest action against advisers in the Westpoint collapse had produced a fraction of the compensation sought by investors.

Investors in the failed super fund Trio Capital are receiving $54 million in compensation under a separate government scheme.

However, those who invested in Trio through self-managed super are ineligible for compensation.

Instead of a compensation scheme, Mr St John said the government's priority should be to bolster legal protection for retail clients and improve compliance by financial advisers.

"The regulatory platform for financial advisers and other licensees needs to be made more robust and stable before a safety net, funded by all licensees, is suspended beneath it," he wrote.

The Minister for Financial Services and Superannuation, Bill Shorten, said the government was finalising its response to the report, which he described as an "important step" in ensuring proper compensation arrangements.

"Getting these arrangements right is essential - one only needs to consider the recent corporate collapses like Trio, Westpoint and Storm to appreciate this," Mr Shorten said.

The question of compensation for investors is expected to feature in the final parliamentary committee report on the Trio collapse, which is expected to be tabled in the coming weeks.