Of misconduct and men: Hayne strikes against industry, regulators in scathing interim report

The royal commission has cited poor enforcement, perverse incentives and a lack of personal accountability as three key ingredients in the financial sector's public fall from grace.

The release of today's interim report will be remembered as "a day of shame for Australia's banks."

On the positive side, this will also be marked as the day when the financial services industry began it's long road to redemption — and the restoration of public trust.

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AT MIDDAY TODAY, financial services inquisitor Kenneth Hayne took a car to Government House in Canberra. He had a meeting with the Governor-General — and quite possibly, with history.

Hayne was set to hand down the explosive interim findings from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. In his lap was an inch-thick, thousand-page interim report. It was the first time in Australian history that the ruthless, profit-driven behaviour in parts of the financial sector had been laid open to scrutiny, with the comprehensive powers of a royal commission.

The tome in Hayne's lap was secured, very literally, with belts and braces. For a man enamoured of symbolism, it was as if he wanted to say to the Governor-General, the industry and the wider Australian public: "Strap yourselves in ..."

Industry braced for impact

The interim report detailed the causes of the extensive financial sector misconduct, which was detailed in 9,388 public submissions. Hayne said the inquiry had unearthed new cases of misconduct and delved into cases that were already known and had been handled by regulators. He said the revelations had brought "public attention and condemnation" to the country's largest industry; a sector that employs more than 400,000 Australians.

In far too many cases, Hayne said regulated entities had pursued short-term profit at the expense of basic standards of honesty. He attributed this to the lack of meaningful consequences and the leniency of the country's key regulators, the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA).

"Selling became [the sector's] focus of attention. Too often it became the sole focus of attention. Products and services multiplied," Hayne said in the interim report. 

"Banks searched for their 'share of the customer's wallet'. From the executive suite to the front line, staff were measured and rewarded by reference to profit and sales."

The interim report found that misconduct often went unpunished. When action was taken the consequences did not match the seriousness of the misconduct.

"The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court," Hayne said, in one particularly scathing turn of phrase. 

"Much more often than not, when misconduct was revealed, little happened beyond apology from the entity, a drawn out remediation program and protracted negotiation with ASIC of a media release, an infringement notice, or an enforceable undertaking that acknowledged no more than that ASIC had reasonable 'concerns' about the entity's conduct." 

Banking's "day of shame"

The banking sector's peak industry body acknowledged, in no uncertain terms, the damage that had been done. Anna Bligh, chief executive of the Australian Banking Association, was not in a mood for spin.

In a moment of extreme candour, she said today was a "day of shame" for Australia's financial institutions.

Bligh, a consummate media performer, looked uncharacteristically uncomfortable in front of the camera. She fumbled words, then shuffled nervously from side-to-side, like a swimmer standing thongless on the beachsand in Brisbane's blistering mid-summer heat.

Was Bligh subconsciously questioning the wisdom of her decision to become the face of the industry during its most difficult year in history? Was $600,000 a year worth the collateral damage to her personal brand?

The "day of shame" line was layered with meaning. It was something you'd expect to hear from Denise Brailey, or Derryn Hinch, not the banking sector's chief media protagonist.

"This report is the first step towards building the banks that Australians deserve. All banks will now take the time to examine the report in detail and do all that must be done to make things right," said the lady who led Queensland, stoically, through the 2011 summer floods.

"Immaterial" penalties

The inquiry found that the fines and other penalties that had been handed down, such as contributions to financial literacy, were immaterial for the large banks. 

"Enforceable undertakings might require a 'community benefit payment', but the amount was far less than the penalty that ASIC could properly have asked a court to impose," the report said. 

"Too often, entities have been treated in ways that would allow them to think that they, not ASIC, not the Parliament, not the courts, will decide when and how the law will be obeyed or the consequence of the breach remedied."

James Shipton, chairman of ASIC, said the agency was digesting the report's "serious and important observations of ASIC's role as a regulator." Speaking delicately (as the heir of Tony D'Aloisio and Greg Medcraft's empire) he said the agency would be doing some extensive self-reflection with the benefit of Hayne's findings.

"ASIC will carefully consider these observations, as well as the broader findings in the report and will respond fully in its submission." — James Shipton, ASIC

"Culture, conduct and compliance"

The government said the report had shown that "the culture, the conduct and the compliance" across the sector was well below the standard that the Australian community expects.

In political circles, the excoriating tone of Hayne's report was no surprise.

Josh Frydenberg, the federal treasurer, said the report had shone a "very bright light" on the poor behaviour of our financial sector. 

"This is clearly unacceptable and cannot continue," he told a media scrum.

The treasurer said one clear finding from the report was that regulators needed to take more aggressive enforcement action.

"What is clear from the report is that, too often, the regulator would seek a negotiated outcome as opposed to taking the next step, which would be to litigate and to make these entities face court," Frydenberg said during a media briefing.

"Too often they were seeking merely just to negotiate."

Frydenberg said the commission now needed to determine whether new laws are required, or whether existing laws simply need to be better enforced.

Consumer backlash

Consumer groups said the interim report highlighted the need for the government to take swift and resolute action to ensure that financial services firms, and their senior management, are held accountable.

"The lack of consequences for banks and lenders for misconduct is driving poor lending and sales practices that are hurting Australians who can least afford it," said Gerard Brody, chief executive of the Consumer Action Law Centre.

Brody, a perennial campaigner for the rights of vulnerable Australians, urged Hayne to make a recommendation that hits the sector where it hurts most: the bottom line.

"Where loans are found to be irresponsibly lent, debts should be waived. This will provide the right incentive for banks to do the right thing," he said.

Karen Cox, coordinator of the Financial Rights Legal Centre, said irresponsible lending was a major concern for vulnerable consumers. She supported calls for a much stronger penalties regime with clear individual accountability.

"Providing a financial service has become a licence to write an open cheque to yourself from the funds in your custody." — Karen Cox

"Banks and other financial service providers have been treating the law, the regulator and their customers with contempt for too long. We need real penalties that bite, not just get factored into the cost of doing business," Cox said.

Regulatory backlash

The country's smaller banks have warned, however, against a regulatory backlash. They said this would impose an undue burden on the parts of the sector that had been functioning well, without addressing the roots of the problem. 

Michael Lawrence, chief executive of the Customer Owned Banking Association, said the solution lies in properly administering the laws and regulations that already exist.

"The royal commission [found] that breaches of existing laws are not prevented by passing some new law," he said. "New layers of law and regulation add to compliance costs and complexity."

Lawrence said Hayne had acknowledged that increasing regulatory complexity was not the pathway to better customer outcomes. Instead, it was essential to ensure that the larger players cannot game the system, exploit loopholes or capture regulators.

"The largest entities, being very sophisticated and well-resourced, are well able to find out what the law requires of them," Lawrence said.

Funding enforcement 

In some good news for regulators, the treasurer indicated that it would look favourably upon any requests from ASIC for greater enforcement and supervision resources. This is a strong departure from the "death by a thousand cuts" that agencies such as ASIC have experienced for years under the Commonwealth efficiency dividend. In reality, any federal "investment" has been illusory and simply reversed earlier cuts (while the regulatory perimeter continues to expand).

The treasurer indicated that the government would seek to ensure greater personal accountability as a result of the royal commission.

"The individuals involved, they're ultimately the ones who must be held accountable and responsible for their actions," he said. 

"ASIC needs to be stronger in its approach. It needs to pursue litigation and impose the penalties that are available to it, rather than some of these negotiated settlements, which have seen the perpetrators of these offences or misconduct get off too lightly."

Brody said the government needed to provide proper resourcing for ASIC and APRA to be able to "hold the industry to account" for misconduct.

Cox, meanwhile, said customer outcomes need to remain at the heart of any new funding for ASIC. 

"The regulator must be empowered to act quickly and effectively on the findings of reports, like ASIC's recent work on credit cards and direct sales of life insurance. [It needs] to ensure that financial products are working for the consumers they are meant to serve," she said. 

Deadline extension

As we all know, the royal commission experienced months of resistance from the former Turnbull government and the financial sector. In the end, the damning money laundering allegations against the country's largest and most respected bank in late 2017 became the proverbial straw that broke the camel's back. The industry capitulated and the government established a royal commission on December 14, 2017.

The Turnbull government was criticised at the time for setting terms of reference that were too wide, with a deadline that was too tight. The widespread view was that Hayne could not get to the bottom of the issues in the time allowed; that Turnbull had intentionally hobbled the inquiry.

Perhaps the critics underestimated Hayne and his formidable team of silks and assistants?

The final report is due to be submitted to the Governor-General by February 1, 2019. Given the impact of today's report, it is inevitable that this deadline will be extended.

It's clear that Hayne has done the country a great service. What's less obvious (but will become apparent in time) is that he's also done the financial sector a great service.

The industry needed an intervention. Ideally, it will emerge from this period of purgatory stronger, more ethical and better positioned to power the economic growth the nation so desperately needs.

Hayne, the former High Court judge, is doing the job that Australians had entrusted to their financial regulators.

Stay tuned for "round two" in this bruising — but historic — regulatory battle.

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