Current compensation arrangements

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  1. Current compensation arrangements

This chapter describes in more detail the approach under the Corporations Act to the protection of retail clients who deal with providers of financial services. It covers the compensation arrangements required of licensed providers of financial services, the place of professional indemnity insurance in those arrangements, the administration of the compensation arrangements, the grounds for compensation claims, the avenues for consumer redress, and the more concrete compensation arrangements available in particular segments of the financial services sector:

  1. Compensation arrangements required of licensees are intended to reduce the risk that claims by retail clients cannot be met by licensees due to their lack of available financial resources.

  2. A retail client who suffers loss or damage because of a breach of a licensee’s statutory obligations in regard to conduct or the disclosure of information may claim compensation from that licensee.

  3. Retail clients may seek such redress by legal action through the courts or by using the dispute resolution process a licensee has to make available.

  4. The compensation arrangement required of most licensees is to hold professional indemnity insurance. Certain licensees are exempted from this requirement on the basis of their relative financial strength.

  5. Professional indemnity insurance is an indirect means for compensating clients. Where a licensee’s policy responds to a claim it assists the licensee to pay any compensation awarded to a client. Where this is not the case, the client’s prospects of recovering will depend on the available financial resources of the licensee.

  6. Separate more direct statutory compensation arrangements cover some critical elements of the financial services sector. These include:

    1. the National Guarantee Fund (and similar arrangements) to protect clients of stockbrokers;

    2. the Financial Claims Scheme covering loss by depositors or policyholders due to insolvency of an authorised deposit taking institution or general insurer; and

    3. a scheme of financial assistance to compensate for loss incurred by a superannuation fund trustee from fraud or theft.

Arrangements under s912B of the Corporations Act

    1. Licensed providers of financial services who deal with retail clients are required to have in place:

  • a dispute resolution system that meets specified standards (s912A); and

  • arrangements for compensating clients for loss or damage suffered because of a breach by the licensee of its statutory obligations (s912B).

    1. The policy intent of s912B was to ‘reduce the risk that compensation claims to retail clients cannot be met by the relevant licensees due to the lack of available financial resources’.1 The rationale was described as follows in a Treasury paper:2

Retail clients of financial services licensees are exposed to the risk of suffering losses arising from misconduct of the licensee or its representatives. This can result in claims for compensation against licensees. There is a risk that some financial services licensees could be faced with a situation in which they are unable to meet all such claims against them, unless some arrangements were made in advance ... the losses under consideration do not include losses arising from sources such as market fluctuations or the collapse of an issuer of a financial product.

    1. Section 912B declares that a licensee who has retail clients must have arrangements for compensating those clients for loss or damage suffered because of a breach by the licensee of its relevant statutory obligations. It provides as follows:

912B(1) If a financial services licensee provides a financial service to persons as retail clients, the licensee must have arrangements for compensating those persons for loss or damage suffered because of breaches of the relevant obligations under this Chapter by the licensee or its representative. The arrangements must meet the requirements of subsection (2).

912B(2) The arrangements must:

(a) if the regulations specify requirements that are applicable to all arrangements, or to arrangements of that kind satisfy those requirements; or

(b) be approved in writing by ASIC.

912B(3) Before approving arrangements under paragraph (2)(b), ASIC must have regard to:

(a) the financial services covered by the licence; and

(b) whether the arrangements will continue to cover persons after the licensee ceases carrying on the business of providing financial services, and the length of time for which that cover will continue; and

(c) any other matters that are prescribed by regulation made for the purposes of this paragraph.

912B(4) Regulations made for the purposes of paragraph (3)(c) may, in particular, prescribe additional details in relation to the matters to which ASIC must have regard under paragraphs (3)(a) and (b).

    1. Although s912B commenced on 11 March 2002, its practical operation was deferred until 2008 to allow for consultation to be undertaken on the content of the required arrangements.3 In the intervening period, regulations and an ASIC class order allowed licensees to continue to comply with the pre existing requirements for compensation:

  • for securities dealers and advisers — a $20,000 security bond provided to ASIC to compensate a person who suffered a pecuniary loss due to failure to carry on the business adequately and properly; and

  • for insurance brokers, operators of managed investment schemes and of investor directed portfolio services — professional indemnity insurance and in certain cases insurance against fraud.

    1. Following consultation the then Government expressed a preference for compensation arrangements to be based on professional indemnity insurance.4 The use of professional indemnity insurance as the default arrangement for compensation is embodied in the regulations. Corporations Regulation 7.6.02AA requires a licensee to hold professional indemnity insurance which is adequate having regard to specified considerations that relate to the licensee’s business, clients and exposure to claims. These considerations include:

  1. the licensee’s membership of a scheme (or schemes) mentioned in paragraph 912A(2)(b) of the Act, taking account of the maximum liability that has, realistically, some potential to arise in connection with:

  1. any particular claim against the licensee; and

  2. all claims in respect of which the licensee could be found to have liability; and

  1. relevant considerations in relation to the financial services business carried on by the licensee, including

  1. the volume of business; and

  2. the number and kind of clients; and

  3. the kind, or kinds, of business; and

  4. the number of representatives of the licensee.

    1. Attachment A sets out the relevant regulation in full as well as the regulation covering the disclosure of information on compensation arrangements by a licensee.

Exemptions from compensation arrangements

    1. The regulation provides an exemption from the need for compensation arrangements for a licensee who is:5

  • an ‘exempt licensee’ — a general insurance company, life insurance company and ADI regulated by APRA;

  • a ‘related licensee’ — a licensee related to an exempt licensee and which holds a guarantee from the exempt licensee that is approved by ASIC.

    1. The apparent rationale for the exemption of a licensee who is also regulated by APRA is that those licensees have to meet APRA’s capital adequacy and other prudential requirements. The expectation is that prudential oversight of these entities means they are less likely to fail and more likely to have the financial capacity to meet claims for compensation from their own funds. Such licensees are effectively able to self insure against the risk of compensation claims that might arise from their clients.

    2. An entity that is related to an APRA regulated entity may be able to secure a guarantee that ensures payment of its obligations for compensation of retail clients. As such a guarantee would have capital implications for the APRA regulated entity there have been only a few arrangements of this type to date.

Alternative arrangements

    1. ASIC is empowered by s912B(2)(b) to approve in writing compensation arrangements other than professional indemnity insurance. In approving alternative arrangements, ASIC is required to have regard to a number of factors prescribed in s912B(3)(c) and by regulation. The regulation requires ASIC to have regard to whether those alternative compensation arrangements provide coverage that is adequate having regard to matters of the kind referred to in regulation 7.6.02AA(1). That is, the adequacy of the compensation arrangements must have regard to the licensee’s volume of business, the number of clients, the kinds of business undertaken and the number of representatives.

Coverage of representatives

    1. A licensee’s insurance policy is expected to cover possible breaches committed by its representatives as well as breaches by the licensee itself. 6 A representative includes:7

  • an employee or director of the licensee;

  • an employee or director of a related body corporate of the licensee;

  • an authorised representative appointed in writing by the licensee;8 or

  • any other person who acts on the licensee’s behalf.

Authorised representatives are not required to have separate compensation arrangements of their own because they are covered by their licensee’s compensation arrangements.

Disclosure of compensation arrangements

    1. The regulations require licensees to include in the FSG they provide to their clients a statement about the kind of compensation arrangements they have in place and whether those arrangements satisfy the requirements under s912B.9 For licensees who hold professional indemnity insurance, ASIC requires a statement that they have such insurance in place and whether it will cover claims in relation to the conduct of employees and authorised representatives who no longer work for them.10 Other licensees have to state that they have alternative arrangements approved by ASIC or that they are exempt from the requirement for compensation arrangements.
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