AN INDEPENDENT report has played down the need for a new safety net to protect investors who lose money due to misconduct by their financial advisers.
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.
Frequently Asked Questions about this Article…
What did the independent Richard St John report say about creating a statutory compensation scheme for investors?
The report concluded a new statutory compensation scheme would be "inappropriate" and "possibly counterproductive." It warned such a safety net could create moral hazard and weaken incentives for strict enforcement of existing rules, so it did not recommend introducing a government-funded compensation scheme for victims of adviser misconduct.
Why was an inquiry into investor compensation for adviser misconduct launched in 2010?
The inquiry was launched after a spate of multi‑million dollar corporate and managed investment collapses during the global financial crisis. The government asked Richard St John to investigate because existing laws gave no guarantee of compensation for investors, who were instead forced to rely on their advisers' professional indemnity insurance.
How could a compensation scheme create a moral hazard for financial advisers and licensees?
According to the report, a safety net funded by all licensees could reduce the incentive for stringent enforcement and allow weaker or riskier licensees to rely on others to underwrite their claims. That risk of moral hazard might encourage poorer conduct or weaker compliance across the industry.
What did the report recommend instead of establishing a new investor compensation fund?
Mr St John recommended the government prioritise strengthening legal protections for retail clients and improving compliance by financial advisers. He said the regulatory platform for advisers and licensees should be made more robust and stable before any safety net is considered.
What compensation did investors receive after the Trio Capital collapse, and who was excluded?
Investors in the failed super fund Trio Capital received $54 million in compensation under a separate government scheme. However, people who invested in Trio through self‑managed super funds (SMSFs) were ineligible for that compensation.
Did legal action against advisers recover investor losses from collapses like Westpoint?
The report notes that action against advisers in the Westpoint collapse produced only a fraction of the compensation investors had sought, indicating legal action did not fully make investors whole in that case.
How did investors typically rely on protection before the report's findings?
Because the law offered no guaranteed compensation, investors typically had to rely on their financial advisers holding professional indemnity insurance to cover losses from misconduct—rather than a statutory government safety net.
What did the government say in response to the St John report and what happens next?
The Minister for Financial Services and Superannuation, Bill Shorten, said the government was finalising its response to the report and called it an important step toward proper compensation arrangements. The issue of investor compensation was also expected to feature in the final parliamentary committee report on the Trio collapse, due to be tabled in the coming weeks.
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