Should the CSLR be extended to cover managed investment schemes?

Not including managed investment schemes (MIS) in the Compensation Scheme of Last Resort (CSLR) is a “significant flaw”, according to the SMSF Association.

In its submission to the Senate’s inquiry into the collapse of Dixon Advisory, the SMSFA argued that the scope of the CSLR should be extended to include financial product providers and MISs.

“The responsibility for funding unpaid consumer losses should be shared evenly across the sector,” it said.

“However, the CSLR does not reflect this shared responsibility as it excludes product manufacturers. We believe this is a significant flaw in the proposed scheme, given that manufacturers whose products are poorly designed and improperly fail do not contribute to the CSLR, yet they have caused significant consumer detriment in the past.

“Consumers, particularly direct investors and SMSF trustees, should also have a right to be protected and have recourse where losses are incurred due to misconduct, misrepresentation or fraud by a product issuer or manufacturer.”

The association raised concerns that future product failings could be deemed to be a financial advice failure, which it said would put greater pressure on “not only the sustainability, but the viability, of the CSLR”.

“We believe the exclusion of MISs from the CSLR regime has created a significant consumer protection gap in the current regulatory settings that must be addressed to protect those who choose to invest in such products without seeking professional financial advice – either by choice or because they may not realise, they are directly investing in a financial product,” the SMSF Association submission said.

It added: “Excluding MIS products from the CSLR continues to encouraging the creation of inappropriate high-risk products being marketed directly to Australians, including those near retirement who are not able to sustain any incurred financial losses, as in the case of Sterling Income Trust.

“The SMSF Association recommends that the scope of the CSLR is amended to specifically include MIS products.”

The Financial Advice Association Australia (FAAA) also singled out the inclusion of MISs as particularly important, though recommended that the CSLR’s scope cover all Australian Financial Complaints Authority members.

“Substantial consumer harm has been caused by product failure rather than advice failure, harm that currently has no recourse (e.g. Sterling, Mayfair etc). People have lost their homes and life savings,” the FAAA said in its submission.

“The current situation encourages inappropriate risk-taking and higher risk products to be launched and sometimes targeting elderly consumers with insufficient financial resilience to withstand losses (as the wholesale limits are too low). These consumers then become entirely dependent on the social security system.”

This lack of coverage for product failures, it added, threatens to create a situation where any future MIS failures where financial advice was provided will be defined as advice failures, even when, as was the case with Dixon Advisory, they are “caused or substantially contributed to by product failures”.

No guarantee of reduced cost to advisers

Not all of the submissions to the inquiry agree that folding MISs into the CSLR is the right way to go.

The Financial Services Council (FSC) argued this could “potentially increase the cost burden on financial advisers” and that there are “more appropriate mechanisms that could reduce the cost burden”.

“If complaints against MISs were to be brought within the scope of the CSLR, it is not immediately clear that basis for it not also being expanded to capture other subsectors such as banking, superannuation or insurance,” the FSC said in its submission.

At the top of the list of problems with incorporating MISs into the CSLR is creating a situation where the government is underwriting investment risk.

“Investment inherently involves risk, and losses in these schemes are typically linked to market performance or the underlying asset values,” the FSC said.

“Unlike financial advice failures, losses in MISs may not stem from misconduct or negligence. Including them in a CSLR might create an inappropriate expectation for compensation where the loss is market-driven rather than a failure of regulatory obligations or advice standards.

“If the objective of the CSLR is to protect consumers from all downside risk and financial loss, additional subsectors such as banking, superannuation and life and general insurance companies could arguably be captured, which would be problematic for the general financial services industry.”

It would also see the regulatory costs pushed onto consumers in the form of increased fees. Given this is already a concern for financial advisers, a CSLR levy on MISs would risk “double-charging consumers”.

“This would happen if a client invests in an MIS and simultaneously receives advice from a financial adviser, as both the MIS and the advice service could pass on their respective CSLR-related costs to the consumer,” the submission said.

Along with design and distribution obligations, which aim to reduce the risk of consumer detriment by enduring products are only distributed to their target market, the FSC said ASIC’s product intervention powers enable the regulator to step in and potentially limit MIS failures before they occur, “reducing their risk of failure and the need for CSLR coverage”.

“Furthermore, there is a moral hazard risk that including MISs within the scope of the CSLR might discourage ASIC from the proactive use of its product intervention powers to protect consumers,” it added.