Does the CSLR disincentivise clients taking action directly?

Speaking on a Financial Advice Association Australia (FAAA) webinar about the implementation of the Compensation Scheme of Last Resort (CSLR), Sarah Abood questioned whether the existence of the scheme made clients that have suffered a loss from financial misconduct more likely to forego court actions against a firm directly.

CSLR chief executive David Berry noted that if an Australian Financial Complaints Authority (AFCA) determination is made after the firm has entered administration, it is entirely at the discretion of the administrator whether to recognise the determination as a debt owed by the organisation.

“If the organisation’s not in administration and the determination has been issued, that’s recognised as an obligation for the organisation to pay. So, the ability to recover funds from the organisation or proceeds from any liquidation is a lot clearer,” Berry said.

“Once it goes into administration or liquidation, it’s at the discretion of the administrator or liquidator. If they accept a claim as a debt to be paid, then we can recover funds from that organisation, but that is up to them.

“We’re certainly pushing, and time will tell how successful we are at it, but it’s not an easy ask. There’s nothing to incentivise an administrator or liquidator to accept additional claims.”

According to Abood, this issue is among the FAAA’s “many advocacy points”, arguing that the CSLR being in place creates a “risk-free mechanism” for clients up to $150,000.

“If anyone wants to recover that or approach by the courts, there’s costs involved, there’s the risk that you’ll lose,” she said.

“Our concern is that there will be less action taken against firms that go into liquidation as a result of the CSLR.”

Speaking with ifa, FAAA general manager policy, advocacy and standards Phil Anderson said that while class actions were launched against Dixon Advisory before the CLSR was in place, that only made sense while it was still operating.

“The prospect of significant proceeds being obtained that naturally declined as soon as it went into administration. Going into administration is often a strategy to exposure to significant compensation,” Anderson said.

“If you’ve got risk of something going into administration, then why would you pursue it through the courts? Why wouldn’t you just wait for the work through AFCA, get a determination, and then you’ve got the backdrop of CSLR kicking in.”

He added that, given the nature of licensees means they are not “hugely capitalised”, there is a significant exposure to the risk the business will enter administration as soon as things go wrong.

“One of the things that we have suggested is that if there was an ability for the CSLR to be able to make a special levy on a parent entity of a business that put a subsidiary into administration, that’s one way of providing a disincentive to place a subsidiary into administration,” Anderson told ifa.

“That is one potential solution, given that there are deep consequences of changing the insolvency laws, then your only other solution is to find a way of penalising the entity that put the subsidiary into administration, and that would be through some sort of special levy.

“That’s something that we’ve given a bit of thought to. How do we avoid the Dixon Advisory-type scenario without fundamentally changing the insolvency laws in Australia?”

Who acts on behalf of the firm?

Also speaking on the webinar, Shail Singh, lead ombudsman, investments and advice at AFCA, said the body has an “obligation to be fair to both parties”.

“The consumer is required to make a prima facie case, firstly. They need to convince us adequately that they have a case,” Singh said.

“Now, in circumstances where a financial firm can’t respond or is unable to respond, we treat those matters extremely seriously, and we would put them before a panel of a consumer representative, a financial representative, and an ombudsman, to determine if we have enough information to satisfactorily decide whether the conduct was inappropriate and whether compensation is justifiable. But it is a much trickier situation to deal with.”

Abood argued that a “core issue” is that once a firm is insolvent, there is nobody acting on behalf of the firm.

“There’s no one saying, ‘Well, hang on a minute, here are all the reasons why we don’t believe that claim is fair and reasonable’,” she said.

While the administrator is appointed to sit in place of the AFSL in AFCA proceedings in cases such as these, Singh conceded that “the reality is they sometimes do and will provide an explanation for the claim, and they sometimes don’t”.

“We do go to the administrator first and ask them if they have any comments. We try to get documentation from them, so we get a fuller understanding of what’s going on,” he said.

However, the main obligation of an administrator is to the creditors, which Abood said effectively puts them in the position of “acting on behalf of the client, rather than the firm that is being accused”.

“That’s something that is the case at the moment, but we’d like to see a change, and we would like to see the firm being explicitly represented by someone with the firm’s interest in mind, or the advisers’,” she said.

According to Anderson, it highlights a “real problem” with the design of the compensation process.

“If you didn’t have the CSLR, then AFCA determinations would be irrelevant. Those simply wouldn’t be paid,” he told ifa.

“It’s one thing to have an AFCA determination that was submitted and processed during the time that the business was operating, and therefore the licensee had the ability to defend it as best they could. That’s a genuine process where you’ve got two parties competing over what the right outcome is.

“In the case, you’ve got a party who can make a complaint, and maybe they are supported or facilitated by a third party, some sort of advocate on their behalf, and you’ve got no one defending it on the other side. The administrator has little incentive to do that. Where do they benefit from that, particularly if the complainant is also a creditor of the company that’s in administration?”