Published by Australian Financial Review on Tuesday 4 December 2018
One strong message coming out of the Hayne inquiry is that our financial regulators should prosecute misconduct by financial firms through court actions rather than using strategies of negotiation, agreed penalties and enforceable undertakings.
The arguments for doing this involve both punishing wrongdoers and the general deterrent effect on potential wrongdoers of the very public punishments handed out to those found guilty.
The view that we would have had better financial sector behaviour if a more “heavy-handed” prosecution-based approach had been followed is, however, an unproven (and probably unprovable) assertion.
It may be true, but there are at least three good reasons for thinking that the “softly-softly” approach has some merit.
First, in cases of burglary or assault, the victim knows that the wrongdoing has occurred and will (generally) start an action through a report to the police. But in many of the cases considered by the royal commission, the victims were not aware that wrongdoing had occurred. Bad financial advice, fees for no service, sales of inappropriate financial products, excessive (hidden) commissions and fees are examples.
Nor, it is claimed, were the boards and senior executives of large financial firms initially aware that their governance, remuneration and “cultural” strategies were leading to systematic wrongdoings by their staff.
The question then is how are these types of wrongdoings to be brought to light and dealt with? Outside independent investigation (such as by journalists following up tips from consumers or competitors who had suspected some wrongdoing), investigations by financial regulators, or self-reporting by institutions or whistle-blowers among their staff, are the main avenues.
Arguably, institutions may be more willing to self-report (and dob in other miscreant firms) once wrongdoing is recognised by senior management if negotiated settlements rather than court prosecution is a consequence. Particularly where the behaviour is in the grey area of “maybe not compliant” with regulation or community standards, senior management may respond to potentially higher penalties by non-disclosure in the hope of non-exposure.
The second reason is that financial regulation ranges between “black-letter law” and “principles based” regulation. In the former case, acceptable and unacceptable behaviour are clearly distinguished and prosecutions can be readily launched (if deemed more appropriate than reaching some form of negotiated settlement).
Principles-based regulation has the advantage of allowing financial firms the flexibility to decide on the way in which they will act consistent with achieving the objectives of the regulation. But determining whether some form of conduct is consistent with the objectives of the regulation is more problematic. And the regulator and regulated firm may have different views on this!
Consequently, negotiation between regulator and the regulated firm to achieve behavioural changes deemed required by the regulator, and to impose some penalty where past behaviour was clearly inappropriate, seems more appropriate than court actions. Courts are good at dealing with issues which are black and white, less so when there are many shades of grey.
The third reason is that prosecution can be extremely expensive in terms of resource costs (for both parties) relative to the alternative approach of negotiated settlements and enforcement actions. And potential outcomes can be uncertain and different from what the regulator and the regulated firm might otherwise agree on (as the recent Westpac rate-fixing case shows). Speed of resolution is also an important issue.
None of this is to say that the past approach of Australian financial regulators, involving relatively few court actions, has been the right one. It also seems apparent that the approach adopted has not involved as much transparency and publicity as might be desired to achieve a better general deterrence effect.
But there is the risk of the pendulum swinging too far in the opposite direction. Finding the right balance between the “heavy handed” court-based and the more “softly-softly” negotiated settlement approach, and determining the best modus operandi for each are the challenges facing our financial regulators.