An Updated Proposal to Establish a
Financial Services Compensation
Scheme
May 2015
Page 1 of 50
Introduction
The purpose of this Report is to contribute to the current discussions about the role,
design and implementation of a compensation scheme of last resort in financial services.
The Financial Ombudsman Service Australia (FOS) has been a longstanding proponent
for such a scheme over a number of years, as set out in our various submissions. We
consider the lack of such a scheme is the missing element in current reform efforts to
professionalise the financial advice and planning industries.
The policy that licensees should have adequate compensation arrangements is clearly
set out in the Corporations Law. What is clear from the continued existence of unpaid
FOS determinations is evidence that the clear policy intent of the current Corporations
Law is not being delivered by the current approach.
This Report updates the work done in 20091 on the detailed compensation scheme
design by consultants engaged by FOS. It takes into account developments since that
time and also reflects FOS’s renewed focus in our more recent submissions on concerns
about unpaid FOS compensation awards. However, the approach proposed is largely
along the lines set out in the 2009 report with a number of refinements.
The Report also sets out a governance structure, scope and operations of a proposed
last resort compensation scheme and legislative changes that would be required to
support it. Further, it provides a brief overview of the work that has been undertaken to
date on the potential funding mechanisms for such a scheme.
The implementation of a compensation scheme involves a number of design decisions
relating to coverage, operational approach to determining claims, funding mechanisms and
transitional arrangements. These design issues will have an impact on how the Scheme is
set up, costs and funding arrangements.
The approach taken by FOS in its recent submissions, and as reflected in the proposals
set out in this Report, are for the implementation of a cost effective last resort
compensation scheme on an ongoing basis to cover the major issues FOS has
experienced in relation to unpaid determinations. The scheme is intended to cover the
following:



Retail clients of Australian Financial Services (AFS) Licensees
Claims for unpaid determinations or awards by an External Dispute Resolution
(EDR) scheme, courts or relevant tribunals, and
with appropriate Caps on the amount paid for each claim.
This approach has been adopted to seek to reduce the costs involved in the
establishment and operations of a compensation scheme and address any concerns
about the potential for moral hazard. We continue to consider that the key focus should
be on the impact of unpaid compensation on consumers, who are directly impacted and
the broader implication this has on trust and confidence in the financial sector.
1
Proposal to Establish a Financial Services Compensation Scheme: Prepared by Professional Financial Solutions Pty Ltd
October 2009 (revision of July 2009 report)
Page 2 of 50
FOS would be very happy to work with Government, Treasury, ASIC and all stakeholders
on how best to design and fund a cost effective financial services compensation scheme.
While we have drawn on the work undertaken for FOS by consultants for the purposes of
this Report, the contents and views of this Report are those of the Office of the Chief
Ombudsman and the various consultants referred to, are not responsible or liable for any
of the information or views expressed in this Report.
Page 3 of 50
Contents
1
Executive Summary
6
2
Overview
11
2.2
3
4
5
6
7
Are there other examples of schemes that compensate consumers?15
Overview of the proposed Scheme
16
3.1
Introduction
16
3.2
Benefits of the Scheme
18
3.3
Risk minimisation measures
19
How would the Scheme work for consumers?
21
4.1
When may the Scheme pay compensation?
21
4.2
How much would the Scheme pay?
22
4.3
Does the Scheme cover Fraud?
22
4.4
How would a consumer make a claim?
23
How much would the Scheme cost?
24
5.1
Outline of funding arrangements
24
5.2
Overview of funding design
24
5.3
Estimates of the costs of the Scheme
25
How could Government facilitate the industry-based Scheme
26
6.1
26
Amendment to regulatory framework
Conclusion
27
Appendix A – Financial Ombudsman Service
28
Appendix B – Melzan Report on Compensation Funds
29
Appendix C – Scheme Rules – Discussion Version (May 2015)
30
1
Definitions
32
2
The Scheme
33
2.1
Purpose of the Scheme
33
2.2
Amendment of the Rules
33
2.3
Governance of the Scheme
33
2.4
Annual Report
33
2.5
Independent Review of the Scheme
34
2.6
Audit
34
2.7
Complaints against the Scheme
34
3
When will the Scheme pay compensation?
35
3.1
What is the procedure for making a claim for compensation?
35
3.2
What are the qualifying conditions for paying compensation?
35
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4
5
6
7
3.3
Who may make a claim?
35
3.4
Which claims are covered?
35
3.5
Who is a relevant person?
36
3.6
When may the Scheme determine a participant is in default?
36
3.7
Publicising declarations of default
37
3.8
Assistance to claimants
37
Assignment of Rights
38
4.1
Compensation payments made conditional on an assignment
38
4.2
Payments to the Scheme
38
4.3
Recoveries
38
4.4
Off-set of recoveries
38
Rejection of application and withdrawal of offer of compensation
39
5.1
Inaccurate and incomplete applications
39
5.2
Rejection of applications
39
5.3
Discretion to reject applications
39
5.4
Withdrawal of offer
39
5.5
Interim payments
39
5.6
Withdrawal of misplaced offer
39
Payment of compensation
40
6.1
Timing of payment
40
6.2
Table of compensation limits
40
6.3
Method of payment of compensation
40
6.4
How is compensation to be quantified?
41
6.5
Personal representatives, agents and joint claims
42
Transitional provisions
43
Appendix D - PI insurance provisions
44
Appendix E - Financial Claims Scheme
45
Appendix F – Existing Australian compensation schemes
47
Appendix G – UK and proposed Australian Scheme comparison
49
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1 Executive Summary
The missing element in current reforms
In a number of public submissions, including to the Financial System Inquiry (FSI), FOS
has advocated the establishment of a Financial Services Compensation Scheme. This
Report recommends how such a Scheme would operate. It is based upon work
completed by FOS with the assistance of Professional Financial Solutions Pty Ltd in
2009, but has been revised to take account of views put forward publicly since then by
FOS in a number of submissions, the Australian Securities and Investments Commission
(ASIC) and most recently in the Joint Consumer Submission to the Senate Standing
Committees on Economics2.
The Financial System Inquiry’s Interim Report examined uncompensated loss arising
from unpaid FOS determinations and acknowledged that it is a pressing issue given the
limitations of professional indemnity insurance (PI) as a compensation mechanism.
For example, although ASIC’s RG126 minimum requirements seek to ensure that PI
coverage is adequate, the cover afforded by PI policies can in practice be subject to
significant limitations, for example, where coverage does not include fraud or dishonesty
or some of the riskier activities of the licensee.
However, the Inquiry did not address or propose a solution to this problem in its Final
Report.
We consider this clear gap in the consumer protection framework should be addressed
so that consumers can have confidence that if things go wrong, they will be compensated
when a decision is made by FOS in their favour.
In our view, it is in the interests of all financial system participants to find a solution to the
problem of unpaid compensation to enhance consumer trust in financial services.
The role and benefits of a financial services compensation scheme
The introduction of a compensation scheme would address this gap and assist retail
clients who suffer a loss due to insolvency or disappearance of an Australian Financial
Services (AFS) licensee. A compensation scheme would bring Australia’s financial
services compensation arrangements into line with other international financial services
centres such as the United Kingdom.
We envisage a Scheme where all stakeholders play an important role. It would be:
• Supported by the Federal Government, through a requirement on AFS licensees
to become members of the Scheme.
• Subject to approval by the Australian Securities and Investments Commission;
2
The Joint Consumer Submission p.3 argues that a last resort compensation scheme should extend to the credit industry as well as
the financial services industry. There is logic to this given that since 2010 EDR has been mandatory for the credit industry and the
risk of non-payment of EDR determinations arises equally in that industry. FOS’s experience of non-compliance with determinations
has, however, been primarily in relation to financial services. Our past submissions and modelling of costs have been in that context.
So this Report retains that focus. http://consumeraction.org.au/wp-content/uploads/2015/05/Joint-consumer-submission-LastResort-Compensation-Scheme-05052015.pdf
Page 6 of 50
• Funded by AFS licensees through regular levies; and
• An industry-based scheme operated by an entity governed by the key
stakeholders: industry and consumers with an independent chair.
The Scheme would benefit consumers by providing a fundamental element of protection.
It would:
• Address gaps created by the existing reliance on PI insurance; and
• Partially compensate retail clients in the event that an AFS licensee becomes
insolvent or disappears up to a level that reflects the design of EDR schemes with
the ability to spread payments over a few years; and
• Provide an equitable and readily accessible avenue by which to obtain
compensation;
• Create an incentive for retail clients to exercise proper prudence when selecting
an AFS licensee, by paying only part (not all) of their full claim for compensation
against the AFS licensee.
The Scheme also promises significant benefits for the financial services sector. For
example it would:
• Enhance the reputation of relevant markets and consumer confidence in EDR
schemes, the regulatory system and financial services sector more broadly,
particularly in the current financial climate; and
• Maintain existing incentives for both retail clients and AFS licensees to recognise
and manage their risks.
Funding the Scheme
It is proposed that the cost of the Scheme would be pre-funded by AFS licensees
through a levy either collected by Government for distribution to the Scheme or paid
directly to the Scheme. We acknowledge that further analysis and detailed work will need
to be undertaken to update and refine the estimated costs and proposed funding
arrangements for the compensation scheme.
Legislation Required to Support the Scheme
The introduction of the Scheme would need to be facilitated by the Federal Government
by requiring all AFS licensees to become members of the compensation scheme as part
of the obligation to have arrangements to compensate retail clients under the
Corporations Act 2001 (Cth) and providing for funding arrangements as part of
introduction of levy funding for the regulator or, alternatively, clear power that would
enable the Scheme to do so on its own behalf.
Governance Arrangements
The governance and legislative arrangements of the proposed compensation Scheme
are modelled on the approach that currently applies to industry- based External Dispute
Page 7 of 50
Resolution Schemes under the Corporations Law rather than a more direct statutory
scheme, such as the one that operates in the United Kingdom.
Transitional Arrangements
The proposed transitional arrangement is for the Scheme to only respond where at the
time the Scheme is established there is a clear legal liability for payment of
compensation which is clearly and readily identifiable, without further investigation and
merits assessment.
We consider this is clearly the case where a dispute has been accepted as being within
FOS’s jurisdiction and it has been through a formal merits assessment resulting in an
FOS determination in favour of the retail client. This would apply to FOS determinations
issued since FOS was established on 1 July 2008.
Some Limitations of the Proposed Scheme
The current approach, as set out in this Report, is for reliance to be placed on the role of
EDR schemes, courts or tribunals in making the assessment and determination of
customers’ claim for compensation.
We recognise there may be claims by retail customers for compensation where the
claims have not been the subject of a formal merits assessment and decision. The
challenge is that these would require a separate process for acceptance and review of
the claim on its merits, and assessment of any compensation.
This raises some difficult and complex issues about retrospectivity, scope of claims to be
covered, and how any assessment process would work should such claims be included
in any transitional compensation arrangements as part of the implementation of a
compensation scheme. The current proposal is for the scheme to only respond where a
clear legal liability for compensation exists at the time the scheme is established or for
claims that occur after that date in accordance with the proposed scheme rules.
If as a matter of public policy it was considered important to cover a wider set of possible
claims, further detailed consideration would be required on a mechanism for assessment
and determination of any such claims, either as part of the proposed establishment of a
financial services compensation scheme or a as a separate one-off process.
Comparison of the FOS Scheme with Richard St John approach to scheme design
The report by Mr Richard St John Report, while not supportive of the introduction of a
scheme of last resort at that stage, set out in Chapter 6 (observations on a last resort
scheme3) the elements for such scheme should one be desired at any stage.
The model proposed by Mr Richard St John shares many of the features of the model set
out in this report in terms of coverage of retail clients in circumstances where, by reason
of the insolvency or lack of financial resources compensation, compensation is not able
to be paid for eligible claims. The proposal also involves caps on compensation claims.
The major differences are that, similar to the UK Financial Sector Compensation Scheme
(FCSC), the scheme proposed by Mr Richard St John would be a statutory scheme that
3
Richard St John Report April 2012- Chapter 6: Observations on a last resort scheme
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would make its own assessment of merits of claims for compensation based on a
specified liability standard and determine the compensable loss.
Under the key elements set out by Mr Richard St John in his report, a person seeking
compensation would not be expected to go through a court or an EDR process before
submitting a claim to the scheme. However, the scheme would be able to take into
account but not be bound by an award of compensation made by the court or an EDR
scheme. The scheme would also be able to make a ruling on a firm’s insolvency or its
incapacity to pay without waiting for an insolvency or bankruptcy to be fully declared. In
terms of governance arrangements, Mr Richard St John proposes the scheme be
administered by statutory body and refers to the Superannuation Complaints Tribunal as
a possible model.
While such a scheme may have some advantages in dealing with a number of the issues
of scope and coverage set out above, the revaluation of the eligible claim by the scheme
itself would add significantly to the costs and professional resources required of the
scheme, and any such costs would need to be funded by industry. There is also a
concern it could delay the assessment of compensation and require further explanation
for consumers who are already distressed.
FOS accepts that a compensation scheme could be structured either as an industry
scheme with legislative backing, modelled on current industry based EDR arrangements,
or as a standalone statutory entity. The different models will involve a number of public
policy trade-offs, in particular between the scope of its operations and costs to industry
and also on the extent of industry and consumer involvement in any governance
arrangements.
The approach proposed by FOS in this Report is based on seeking a cost effective co –
regulatory approach to address the current longstanding issue of unpaid compensation
when financial services participants do not have the resources to do so.
Unique Opportunity to Address this Problem
This updated Report is intended to contribute to the policy discussion on how best to
establish a cost effective financial services compensation scheme.
We consider there is a unique opportunity for all stakeholders to support the introduction
of financial services compensation scheme to enhance consumer confidence and trust in
the financial sector.
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Disclaimer
The contents and views of this Report are those of the Office of the Chief Ombudsman
and the various consultants referred to, are not responsible or liable for any of the
information or views expressed in this Report. FOS makes no guarantee, representation
or warranty and accepts no responsibility or liability as to its accuracy or completeness.
FOS acknowledges the work done in respect of Scheme design, rules and funding by
Professional Financial Solutions Pty Limited and Grant Thornton.
Neither this Report nor any of the documents appended to it constitute legal advice and
accordingly should not be relied upon as legal advice. The Report provides an overview
of the key issues relevant to the development of a compensation scheme. It will be
necessary for legal advisors to be engaged to advise on any rules under which the
Scheme may operate, prepare any agreements, assist in the preparation of the
Scheme’s constitution and related matters.
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2 Overview
1.1
Why does Australia need a Financial Services Compensation Scheme?
As FOS’s experience of unpaid determinations highlights, there are retail clients entitled
to compensation by their financial services licensee, but where the prospects of recovery
are at best highly uncertain.
During the period from 1 January 2010 to 31 December 2014 FOS data highlights that:
• there were 26 FSPs unwilling or unable to comply with 120 FOS determinations
made in favour of consumers (176 individuals affected);
• the value of the outstanding amounts awarded by these determinations was
$12,686,956.69 plus interest as at 31 December 2014;
• these represent 30.07% of the total value awarded by our Investments, Life
Insurance and Superannuation decision makers and 25.85% of the total number of
binding decisions made in this space.
These figures represent only a small proportion of all the awards FOS issues across all
our jurisdictions in banking, insurance, life insurance and investments and only a very
small percentage of all FOS members are involved. It is primarily in the financial planning
and advisory sector where the problems arise, with 69% of non-compliance relating to
disputes in that sector. The number of firms involved also represents only a small
number of the total number of FOS member firms engaged in the financial advisory
sector.
Since 30 September 2014, the value of unpaid FOS determinations has increased by
nearly 4%. This increase was caused by the liquidation of a single financial advisory firm
which could not pay compensation totalling almost $1.8 million, awarded in six
determinations.
2.1.1 Recent steps to protect consumers
Over 2007-2008, the Federal Government took a number of important steps to better
protect retail clients.
The first involved making it mandatory for AFS licensees to hold Professional Indemnity
insurance unless they are prudentially regulated by the Australian Prudential Regulatory
Authority (APRA) or they have other compensation arrangements that are approved by
ASIC. The second involved the introduction of a Financial Claims Scheme administered
by APRA for the benefit of the retail clients of certain insolvent prudentially-regulated
licensees.
The recent FOFA reforms and current review of initiatives to enhance the training and
competence of financial advisers are also designed to improve customer outcomes.
However, these steps do not remove entirely the risk that consumers will not be
compensated, as discussed further below.
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2.1.2 Inadequacies of Professional Indemnity insurance
At present, AFS licensees are required to have arrangements for compensating retail
clients under the Corporations Act 2001 (Cth). The Corporations Regulations provide that
this may be achieved either by holding adequate PI insurance or making another
arrangement approved by ASIC.4
ASIC Regulatory Guide 126 provides guidance in relation to compensation and
insurance arrangements. It sets minimum requirements as to matters including:
• the amount of PI insurance cover;
• the scope of the cover;
• what exclusions are not acceptable;
• automatic reinstatements; and
• the level of excess under the PI policy.
This has gone some way towards improving PI insurance as a consumer protection
mechanism and reducing the risk that a retail client’s losses, as a result of licensee
misconduct, are not able to be compensated by a licensee because of lack of financial
resources.
But, as ASIC expressly states in Regulatory Guide 126, “It is important to recognise the
limitations of PI insurance as a consumer protection mechanism. PI insurance is not
designed to protect consumers directly and is not a guarantee that compensation will be
paid.”5 Specific limitations identified in the Regulatory Guide are:
• The nature and extent of coverage of PI insurance is limited by what the PI
insurance market will provide and the market is subject to fluctuations6.
• Because PI insurance generally operates on a ‘claims made’ basis and only
covers claims notified within the policy period, the availability of PI insurance may
be defeated by a licensee in financial difficulties failing to notify claims promptly or
failing to maintain PI insurance7.
• PI insurance generally does not include automatic run-off cover (and to the extent
it does this is generally only for 12 months and for members’ voluntary
liquidations). On the other hand, advice claims typically arise 2 to 7 years after the
advice. As a result, there is a risk that the licensee might have ceased business
or been wound up before the client realizes they have suffered a compensable
loss and so PI insurance is not then available8.
• PI insurers may exclude some areas of cover in policies for risk management
reasons9.
4
Appendix E sets out the relevant provisions of the Corporations Act 2001 and the Corporations Regulations.
RG 126.7 and 126.8
RG 126.33
7
RG 126.37
8
RG 126.39 and RG.40
9
RG 126.10
5
6
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The same warning was sounded by Mr. Richard St. John in April 2012 in his report
Compensation arrangements for consumers of financial services provided to the then
Minister for Financial Services and Superannuation. As well as identifying the problems
discussed by ASIC in Regulatory Guide 126, his report discussed the following additional
limitations associated with relying on PI insurance as a consumer protection
mechanism10:
• The availability to consumers of PI insurance can be defeated by a licensee
breaching its contract, for example, by failing to take reasonable steps to lessen
liability in relation to a claim.
• Although ASIC’s RG126 minimum requirements seek to ensure that PI coverage
is adequate, the cover afforded by PI policies can in practice be subject to
significant limitations, for example, the coverage does not include fraud or
dishonesty or some of the riskier activities of the licensee.
• Although ASIC’s RG126 minimum requirements seek to ensure that a licensee
fixes the excess that it is required to pay under its PI policy in the broader context
of the strength of its financial resources, the PI insurance available in the market
has been moving to higher excess levels, especially in relation to claims that
would fall within the jurisdiction of an EDR scheme.
• Although ASIC’s RG126 minimum requirements seek to ensure the adequacy of
the amount of PI coverage, PI insurance can in practice be quickly exhausted
where a licensee is faced with a large number of claims, or a number of large
claims, particularly if the PI insurance covers other business, for example,
wholesale client business or non-financial services business, or if the licensee is
part of a group of licensees that share a single cap.
Because these limitations are largely inherent to PI insurance, they cannot be fully
addressed by tightening requirements in relation to PI insurance. As ASIC stated in its
submission in December 2014 to the Senate inquiry into the Scrutiny of Financial Advice,
“expand[ing] mandatory PI coverage may impose additional costs and regulatory burden
while failing to adequately address the problem. PI insurance requirements will never be
at the level required to cover situations of medium to serious systemic loss”.
However, this does not mean that the current regime and standards for PI Insurance
should not be subject to further review and enhancement. While not eliminating the need
for a compensation scheme, any improvements in PI coverage and effectiveness can
play an important complementary role in reducing the costs and calls upon the proposed
last resort compensation scheme.
2.1.3 Gaps in existing compensation schemes
For some sectors of the financial industry, there are already compensation schemes in
place:
10
Page 31 - 34
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 The National Guarantee Fund is a compensation fund available to meet certain claims
which arise from dealings with participants of the Australian Stock Exchange and, in
limited circumstances, participants of the Australian Clearing House Pty Ltd. The NGF
may pay compensation for the matters listed under the Corporations Regulations (see
Part 7.5) including compensation for loss that results if a dealer transfers securities
without authority.
 The Australian Stock Exchange Supplemental Compensation Fund is designed to deal
with claims that arise from a client suffering a loss as a result of giving money or other
property to a stockbroker and that money or property being misappropriated. Also
covered is the situation where a client gives a stockbroker authority over property and
there is subsequent fraudulent misuse of the authority by the stockbroker.
 The Financial Claims Scheme, introduced by passage of the Financial System
Legislation Amendment (Financial Claims Scheme and Other Measures) Act 2008
(Cth) is intended to introduce a crisis management framework to assist deposit holders
and policyholders in the event of the insolvency of a general insurer or deposit-holder.
 Superannuation legislation enables a trustee of an APRA-regulated superannuation
fund (or approved deposit fund) to apply to the Minister for a grant of financial
assistance if the superannuation fund incurs loss as a result of fraudulent conduct or
theft. If the Minister exercises this discretion, the cost of the financial assistance is
recouped through an industry levy.
Compensation schemes such as these leave a number of gaps, primarily because they
only provide recourse to the clients of some AFS licensees.
2.1.4 Summary of inadequacies in existing arrangements
The following table summarises the existing compensation arrangements and any
relevant inadequacies.
Compensation
arrangement
Who does it protect?
Inadequacies
Requirement that AFS
licensees hold professional
indemnity insurance in
accordance with ASIC
Regulatory Guidance.
AFS licensees.
Even with strict guidance
from ASIC, it is up to the PI
market to determine
whether it will offer run-off,
how it will impose limits to
aggregate claims, excess
levels, what types of fidelity
it will cover.
Financial Claims Scheme
Retail clients who hold a
deposit or policy with a
prudentially regulated entity
that becomes insolvent and
may not meet its obligations
to retail clients.
Retail clients do not have
direct access to PI cover,
except in very limited
circumstances.
The FCS only provides
compensation for retail
clients that have purchased
certain products.
It does not provide
protection for retail clients
that have purchased other
products, or have purchased
Page 14 of 50
Compensation
arrangement
Existing compensation
arrangements (e.g. NGF,
SIS Compensation)
2.2
Who does it protect?
Inadequacies
For further information,
see Appendix F.
a service such as personal
financial advice.
Cover situations where
clients have lost money or
property through fraud or
dishonesty.
They do not cover all
financial services: relate
primarily to stockbrokers
and superannuation funds.
Are there other examples of schemes that compensate consumers?
In a number of other countries including the United Kingdom, Canada and the United
States, there are compensation schemes in place to protect consumers who deal with
financial planners, insurance brokers and other financial advisors (as also detailed in the
Appendix B report).
Research on the various international models of financial services compensation
arrangements indicate that the United Kingdom scheme provides a relevant model for a
compensation scheme in Australia to reduce the gaps in consumer protection.
The UK scheme is:
• a centralised fund established by legislation and backed by a legislative
requirement on authorised firms (similar to ‘AFS licensees’ in Australia) to hold PI;
• administered by the regulator, the Financial Services Authority;
• funded on an ongoing basis through levies on authorised firms; and
• available to individuals where an authorised firm is unable, or likely to be unable,
to pay claims against it (insolvency).
The proposal for an Australian Financial Services Compensation Scheme contained in
this Report is based to some degree on the UK scheme, although, as set out in Appendix
G, there are also some important differences between the proposed Australian scheme
and the scheme that exists in the UK.
Page 15 of 50
3 Overview of the proposed Scheme
3.1
Introduction
The Compensation Scheme we propose is designed to be a limited scheme of last
resort. In that way, it will complement PI insurance as a compensation mechanism and
be specifically focused on assisting retail clients who suffer a loss due to the insolvency
or disappearance of an Australian Financial Services licensee. Consistent with ASIC’s
views expressed in its December 2014 submission to the Scrutiny of Financial Advice
Enquiry, the Scheme “would only provide compensation where all other options have
truly been exhausted”11.
A Compensation Scheme would bring Australia’s financial services compensation
arrangements into line with other international financial services hubs such as the United
Kingdom and enhance consumer confidence in the financial services industry. As stated
in the Joint Consumer Submission to the Scrutiny of Financial Advice Enquiry: “It is
effectively the missing piece of the financial services regulatory architecture”12.
Compensation

The Scheme would cover key gaps left by the current protection regime, including the
failure to pay in the event that an AFS licensee becomes insolvent. It would protect
consumers in the event of fraud, dishonesty and misappropriated funds, in addition to
negligence and other causes of action.

Retail clients could receive compensation up to a portion of the EDR scheme limits.
The proposed Scheme shares some important features with the UK scheme, but is
also designed to meet the particular gaps in consumer protection and the specific
regulatory environment in Australia. Appendix G contains the important points of
difference between the Scheme and the UK scheme.

Details on compensation are set out in Part 4 of this Report.
Funding

All the establishment and operating costs, and compensation costs of the Scheme
would be funded by all AFS licensees.

As is the case for financial industry levies, we propose that a financial services
participant’s level would take into account its sector of operation.

A variety of funding models would be possible with funding either collected by
Government as is the case for the financial industry levies, or funding set by the
Scheme and invoiced by it to the financial services participant members of the
Scheme.
11
ASIC submission p.53
Joint Consumer Submission p.4- http://consumeraction.org.au/wp-content/uploads/2015/05/Joint-consumer-submissionLast-Resort-Compensation-Scheme-05052015.pdf
12
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Rules

A set of Rules would govern the level and nature of compensation and the
circumstances in which it may be paid.

The Scheme would have the power to borrow where necessary.

The Scheme would have the power to take an assignment of rights from a claimant
and pursue a recovery. It is anticipated that it would stand in the shoes of the
claimant, becoming a creditor in the winding-up of an insolvent AFS licensee where
there is a reasonable prospect of dividends. The Scheme would have the same
priority in the queue of creditors as the claimant has prior to the assignment.

Appendix C sets out examples of Scheme Rules for discussion purposes.
Governance

The Scheme would be industry-based. It would be operated by an independent body,
governed according to its Constitution and by a Board of directors representing both
consumers and industry with an independent chair.
Regulatory framework

We are proposing that, by an amendment to the regulatory framework, each AFS
licensee that provides financial services to retail clients would be required to become
a member of the Scheme, as part of the ‘compensation arrangements’ they are
required to have to hold an AFS license.

The Scheme would, by proposed amendment to legislation or regulations, be subject
to approval by ASIC, in a similar manner to the existing requirement that EDR
schemes are approved by ASIC.

We also suggest that an explicit link is created between ASIC’s financial services
industry banning powers and successful claims on the Scheme, so as to give ASIC
stronger powers to address phoenix operations (see Part 6.1 of this Report).
Interaction between the Scheme and existing compensation mechanisms

The Scheme would provide compensation to some retail clients who may currently
have access to compensation under the NGF and SIS Compensation. Careful
consideration and consultation will be required to determine the extent to which the
Scheme will potentially replace the need for those funds.

The Scheme would develop an appropriate arrangement, such as a Memorandum of
Understanding with the APRA-administered Financial Claims Scheme. For example,
the Scheme may wish to make a claim to FCS funds if it has imposed a levy on an
insolvent prudentially-regulated AFS licensee. In addition, the Scheme may require
access to information held by the FCS in order to make a default determination about
an AFS licensee.
Page 17 of 50
Interaction between the Scheme and EDR schemes

The Scheme would not replace the need for EDR schemes. Rather, because it would
ensure that most awards made by an EDR scheme were actually paid, it would
underline the need for EDR schemes and bolster consumer confidence in EDR. The
interaction between the Scheme, EDR schemes and PI insurance is set out in Figure
2.
Figure 2
3.2
Benefits of the Scheme
The following table sets out the benefits that the proposed Scheme would bring.
Benefit
Reasons
Addresses key gaps in
consumer protection


Accessible to retail clients
Appropriate level of
compensation
Affordable for licensees and
does not put upward
pressure on prices
Covers fraud and misappropriation of funds
Covers insolvent or missing AFS licensees
 Directly accessible by retail clients
 Clear eligibility criteria
 Measures in place to ensure those with low levels of
financial literacy are aware it exists and can access it
 Compensation aligned to EDR scheme jurisdiction,
therefore meets retail clients’ reasonable expectations of
what level of compensation they might receive, even in
cases of insolvency
 Segment of industry that causes loss to retail clients pays
the compensation within reasonable limits
Page 18 of 50
Benefit
Provides incentive for risk
management
Compatible with other
compensation arrangements
Industry-based: governed by
independent corporate entity,
the Board of which comprises
representatives of industry
and consumers.
Allows for regulatory
oversight by ASIC within an
industry-based structure
3.3
Reasons
 PI market encourages licensees to manage risks in order to
obtain PI at an affordable premium
 Benefit limits encourage retail clients to choose AFS
licensee carefully – whilst the Scheme is aligned to the EDR
award limits, the claimant may only receive part of their
award
 Supports, and does not attempt to replace EDR schemes
 Supplements the requirement that non-prudentially
regulated AFS licensees hold PI insurance
 Can operate in parallel with the Financial Claims Scheme
 Could remove the need for multiple fidelity schemes – e.g.
NGF.
 Stakeholder ownership. Initiation of external dispute
resolution schemes in 1990s demonstrated that industry
engagement can improve culture of risk management inside
AFS licensees.
 Independent from industry, while funded by industry and
industry represented on Board.
 Independent from consumer groups, while consumers are
the beneficiaries of the Scheme and consumer groups are
represented on the Board.
 Approved by ASIC or meets criteria to be set by ASIC.
 The success of EDR schemes demonstrates the strength of
this model of an industry-based scheme, which meets the
high standards set by the financial services regulator.
 As with EDR schemes, ASIC could provide guidance on the
independence of the scheme.
Risk minimisation measures
The Scheme has been designed to minimise the risks that are associated with
compensation schemes.
Potential risk
How the Scheme minimises risks
That AFS licensees could
exercise less caution or even
become willing to engage in
fraud in the knowledge that
retail clients will be
compensated by the Scheme.
 The existence of a Scheme would not change the legal
liability of the AFS licensee which will still go through the
EDR scheme or court process. Their financial failure
would be a precursor to resort to the Scheme.
 To further ensure financial services providers’ ‘skin in the
game’13, ASIC’s banning power could be invigorated if a
person has been implicated in a claim that is successfully
made on the Scheme.
13
Richard St. John, Compensation arrangements for consumers of financial services, concluded that a last resort scheme would not
encourage risker behaviour by licensees. Nevertheless as a general proposition he advocated more ‘skin in the game’ on the part of
licensees p. 120.
Page 19 of 50
Potential risk
How the Scheme minimises risks
That if retail clients know they
have recourse to a
compensation fund, they will
not be as careful as they would
otherwise be when selecting
an AFS licensee.
 The Scheme would reduce this potential risk because it
caps the maximum benefit that a retail client may claim.
The retail client will only be partially compensated by the
scheme.
That some AFS licensees
might take steps, such as
corporate restructuring, to
avoid paying levies.
 This risk could be taken into account in designing levies.
That the regulator will take less
responsibility for AFS licensee
standards and adherence to
these (regulator moral hazard)
 The inevitable delay before consumers receive payment
through the Scheme and the benefit limits will mean that
ASIC will continue to be aware of the adverse
consequences for consumers and for confidence in the
financial services industry if AFS licensees fail and so will
continue to be motivated to ensure sufficiency of
regulatory requirements and adherence to these
 Also the retail client will have to go through an extended
process to make the claim: first EDR or the courts and
then the Scheme. Given the time a claim would take and
the effort involved, a change in a client behaviour in
selecting an AFS licensee is highly unlikely14.
14
Joint Consumer Submission to Scrutiny of Financial Advice Enquiry, 5 May 2015 p.4, rejected the notion that a last resort scheme
would introduce moral hazard: “this risk is not realistic as almost no consumers understand the detail of regulatory arrangements”.
Page 20 of 50
4 How would the Scheme work for consumers?
The Scheme would operate in accordance with the Scheme Rules (a discussion version
of which is contained in Appendix C) that would govern:

When and how the Scheme would compensate retail clients;

The level of compensation available from the Scheme;

Governance of and reporting by the Scheme;

Rejection of application and withdrawal of offer of compensation;

Timing and method of payment of compensation; and

Transitional matters.
4.1
When may the Scheme pay compensation?
Our proposal is that there are five key elements to a successful claim to the Scheme:
a) The claimant must be a retail client;
b) The claim must be against an AFS that has agreed to pay levies to the Scheme;
c) The claimant must have received a determination in their favour by:
(i) an EDR scheme; or
(ii) a court or tribunal of competent jurisdiction15;
d) The determination must relate to the provision of a financial service no more than six
years prior to the commencement date; and
e) The Scheme has declared that the AFS licensee is in default, meaning that they are
unable or likely to be unable to satisfy at least one claim against it. The Scheme may
form this view if:
(i)
the body corporate is insolvent;
(ii)
the individual is bankrupt; or
(iii)
the AFS licensee cannot be contacted at its last place of business and
reasonable steps have been taken to establish a forwarding or current
address, but without success.
15
Further consideration will need to be given as to whether the Scheme should be able to enforce a legally binding settlement that
has been reached between the AFS licensee and the retail client. A settlement is often an outcome of the EDR scheme process and
is efficient for both the parties to the dispute and the EDR scheme. If a settlement cannot be enforced through the compensation
scheme, this would mean that the retail client would have a disincentive to agree to a settlement if there was any doubt as to the
financial strength of the AFS licensee.
Page 21 of 50
4.2
How much would the Scheme pay?
There are suggested limits on the level of compensation that the Scheme pays contained
in Rule 6.2 of the Rules in Appendix C. Proposed limits are set by reference to FOS limits
of financial jurisdiction (currently $309,000).
These suggested limits will require further consideration and consultation with
stakeholders to ensure workability and equity. Careful consideration will need to be given
to the limits applicable to income stream products.
An example of the operation of the Scheme compensation limits is set out below.
Scheme Rule 6.2
(discussion version
of the Scheme Rules
– see Appendix C)
On up to the first
$120,000 a payment
of 90% will be paid
On the excess over
$120,000 and up to a
total claim made
amount of
Example Claim 1
Example Claim 2
Example Claim 3
$100,000
$180,000
$350,000
90% of $100,000
90% of $120,000
90% of $120,000
= $90,000
= $108,000
= $108,000
Plus 70% of $60,000
Plus 70% of $80,000
= $42,000
= $56,000
Plus nil in this case
$200,000 – a further
70% of this amount
On the excess over
$200,000 and up to a
total claim made
amount of
$280,000 – a further
50% of this amount.
Plus 50% of
$109,000
Plus nil in this
case
Plus nil in this case
Nil on the last
Nil on any amount over
$280,000
Total Claim Amount
Payable
4.3
= $54,500
$41,000
$90,000
$150,000
$218,500 (the
maximum possible
claim payment)
Does the Scheme cover Fraud?
The Scheme would cover fraud. It is important that the Scheme cover fraud because:
1. Fraud is often a factor in major collapses such as Trio Capital Limited affecting
multiple retail clients to a substantial extent.
2. Although corporate AFS licensees are expected by ASIC does not expect sole trader
AFS licensees to hold PI insurance that extends to fraud cover. This is because the
Page 22 of 50
PI insurance market does not, and is very unlikely ever to, extend cover to fraud by
an individual insured. This means that retail clients are exposed where a sole trader
AFS licensee perpetrates a fraud.
3. In the case of corporate AFS licensees, it would seem that PI insurance cover does
not always cover fraud, notwithstanding ASIC’s stated expectations as to this16.
4. Although there are several compensation schemes that operate as fidelity funds in
the financial services sector, they have a narrow application and do not provide any
measure of protection to the vulnerable retail clients of other financial service
providers, such as financial planners.
It is not intended that the Scheme would make determinations on fraud. Rather, a
claimant would require a court or EDR scheme award with respect to the fraud.
4.4
How would a consumer make a claim?
Figures 3 and 4 are flow-charts indicate the various matters which a retail client would
need to consider prior to making a claim.
Figure 3
Figure 4
16
Richard St. John, Compensation arrangements for consumers of financial services p.33.
Page 23 of 50
5 How much would the Scheme cost?
5.1
Outline of funding arrangements
The Scheme’s funding requirements must be sufficient to meet payments in respect of
accepted claims and to cover the costs to establish and operate the Scheme.
The proposed Scheme is to operate as an industry-based scheme whereby all AFS
licensees will be responsible for all claims and costs and fund these by paying annual
levies.
5.2
Overview of funding design
A levy structure would need to balance the competing concerns of keeping the levy
‘affordable’ (requiring a wide levy-paying group) and keeping the levy ‘fair’ (targeting the
group to which the ‘responsible’ AFS licensee belonged). It also has to be economic to
collect the levy (not less than a minimum amount) and to provide AFS licensees with
some certainty as to their maximum exposure (cap exposure either by reference to a
dollar amount, maximum percentage of the licensee’s revenue or other criteria to set levy
premium).
In the interests of fairness, borrowing can be used to fund establishment costs and to
smooth annual fluctuations particularly while reserves are being accumulated as shown
in the table below.
Cost
Timing of funding
Establishment costs
Initial levy funding, government funding of initial
establishment costs or some other
mechanisms such as borrowing.
Ongoing operating costs including
interest on any borrowings
Pre-funded.
Standard costs of
compensating claimants
Pre-funded.
Significant costs of compensating
claimants where the Scheme has
declared a default
Post-funded.
Levied at the beginning of a financial year for
projected management costs for that year.
Levied at the beginning of a financial year for
projected standard compensation costs
standardly expected for that year.
Levied as required, for as many years as
necessary.
Page 24 of 50
5.3
Estimates of the costs of the Scheme
FOS has obtained some preliminary estimates of the costs of the Scheme from
Professional Financial Services Pty Ltd in 2009 and Grant Thornton in 2014. Modelling
by Professional Financial Services assumed:
• A scheme encompassing all financial services providers;
• A scheme that decided the merits of complaints as a precursor to deciding
whether the claim is covered;
• Claims of $12 million per annum; and
• Claim numbers of up to 180 per annum.
Based on this, Professional Financial Services’ modelling estimated that establishment
and operating costs in Year 1 would total some $2.3 million comprising:
• One-off establishment costs of $1.1 million (legal, accounting, IT and actuarial
fees, recruitment fees, communication costs); and
• Annual administration costs of $1.2 million (Board, CEO and 6 staff costs, legal,
accommodation, ICT and administration costs).
The estimates assume leverage offered by FOS, for a fee, covering provision of space
in existing FOS premises, accounting, telephony and some IT support.
Grant Thornton analysed costs for a narrower scheme that just applied to financial
advice and registered managed investment schemes and that assumed, as proposed in
this Report, that the scheme would not determine complaints but rather its role would be
confined to deciding whether unpaid EDR and court determinations are covered by the
scheme. Accordingly their modelling assumed:
• Claims of $10.15 million; and
• 1.75 FTE staff.
Based on these assumptions, Grant Thornton calculated:
• One-off establishment costs of $300,000 (legal fees, recruitment fees and
communication costs); and
• Annual administration costs of $800,000 (Board, 2.75 FTE staff, legal,
accommodation, and ICT and administration costs).
For further details regarding funding options please see reports by Professional Financial
Solutions Pty Limited17 and Grant Thornton18.
We have not updated the figures provided in these reports or the assumptions on which
they are based for the purposes of this Report. We accept that further detailed work will
be required to validate the operational costs and fund arrangements for the scheme, as
part of any detailed establishment work required for the implementation of the scheme.
17
Proposal to Establish a Financial Services Compensation Scheme: Prepared by Professional Financial Solutions Pty Ltd
October 2009 (revision of July 2009 report)
18
FOS submission to FSP Interim Report- Appendix 2 page 21: http://www.fos.org.au/custom/files/docs/fos-submission-to-fsiinterim-report-august-2014.pdf
Page 25 of 50
6 How could Government facilitate the industry-based Scheme
The proposed Scheme would be an industry-based Scheme, but would need to be
underpinned by legislative support from the Government.
6.1
Amendment to regulatory framework
It is proposed that:
1)
All AFS licensees that provide financial services to retail clients would be required
to become a member of the Scheme, in order to meet the obligation to have
‘compensation arrangements.
Just as an AFS licensee is required to become member of an approved EDR
scheme, so too would AFS licensees be required to become a member of the
Scheme, subject to its approval by ASIC.
One way to achieve this addition to the existing regulatory framework may be to
amend Corporations Regulation 7.6.02AAA. Such an amendment could provide
that the requirement contained in the Corporations Act 2001 (Cth) to have
compensation arrangements is subject to the requirement that, in addition to
holding adequate PI insurance, AFS licensees participate in a compensation
scheme.
2)
The Scheme is subject to approval by ASIC, in a similar manner to the existing
requirement that EDR schemes are approved by ASIC and must comply with
standards set or approved by ASIC.
To provide appropriate regulatory oversight of the Scheme, amended Regulation
7.6.02AAA could provide that the compensation scheme must be approved by
ASIC. This would provide the basis for ASIC developing or approving governance,
operational and reporting standards.
3)
An explicit link is created as between ASIC’s financial services industry banning
powers and successful claims on the Scheme so as to give ASIC stronger powers
to address phoenix operations.
The problem of phoenix operations is discussed in Mr. Richard St. John’s report
Compensation arrangements for consumers of financial services. That report notes
the “disturbing incidence of cases” where “the principals [of a licensed entity, that is
wound up unable to pay its compensation liabilities,] re-enter the industry as
representatives for another licensee … [or] by forming a new company and being
granted a new financial services licensee before it becomes apparent that the
misconduct of the prior licensee has resulted in large scale client loss”19.
To address this, ASIC’s banning powers in Part 7.6 of the Corporations Act could
be amended to expressly permit ASIC to ban a person who has been implicated in
conduct that results in a successful claim on the Compensation Scheme.
19
Richard St. John, Compensation arrangements for consumers of financial services p. 44
Page 26 of 50
7 Conclusion
For a number of years, there has been concern expressed about unpaid EDR
determinations and the significant personal distress that these can bring. A
Compensation Scheme of last resort has been proposed as a solution to this problem.
Meanwhile other reform initiatives were underway that are aimed at improving industry
standards and strengthening regulatory powers. These have not however, completely
removed the problem of unpaid EDR Determinations. In fact, the problems with the
current approach to compensation in the Corporations Law have only become more
apparent.
The Joint Consumer Submission of 5 May 2015 has most recently raised again the need
for a last resort scheme20.
This FOS Report aims to contribute to the debate by providing more detail about the
benefits of such a scheme and an explanation of how it could be integrated into the
current regulatory structure and how it would be operated.
FOS would be happy to contribute to further exploration of the issues including funding
options and transitional issues.
20
http://consumeraction.org.au/wp-content/uploads/2015/05/Joint-consumer-submission-Last-Resort-CompensationScheme-05052015.pdf
Page 27 of 50
Appendix A – Financial Ombudsman Service
Independent dispute resolution services for the vast majority of Australian banking,
insurance and investment disputes are now available under one roof. On 1 July 2008, the
Banking & Financial Services Ombudsman (BFSO), Financial Industry Complaints
Service (FICS) and Insurance Ombudsman Service (IOS) merged to form the national
Financial Ombudsman Service. The Credit Union Dispute Resolution Centre (CUDRC)
and Insurance Brokers Disputes Limited (IBD) became, respectively, the Mutuals and
Insurance Broking divisions of the Financial Ombudsman Service on 1 January 2009.
FOS dispute resolution services are free to consumers.
This independent umpire provides free, fair and accessible dispute resolution for
consumers and some small businesses unable to resolve a dispute directly with their
financial services provider. External dispute resolution processes can help to resolve
disputes through negotiation or conciliation as an alternative to court proceedings and
can make decisions which are binding on participating financial services providers.
The FOS helps to increase public awareness and access to external dispute resolution
processes for consumers by providing a single national service for banking, insurance
and investment disputes in Australia. Membership of the Financial Ombudsman Service
is open to any financial services provider carrying on business in Australia.
FOS independent dispute resolution processes cover complaints about financial services
including:
• Banking;
• Credit;
• Loans;
• General insurance;
• Life insurance;
• Financial planning;
• Investments;
• Stock broking;
• Managed funds; and
• Pooled superannuation trusts.
Page 28 of 50
Appendix B – Melzan Report on Compensation Funds
Melzan Insurance Consulting prepared a background report in 2007 on international
compensation funds and design options for an Australian compensation scheme. A copy
of this Report can be found at this link.
Page 29 of 50
Appendix C – Scheme Rules – Discussion Version (May 2015)
Introduction
This document proposes Rules for a scheme for compensating consumers when
Australian Financial Services (‘AFS’) licensees are unable or likely to be unable, to
satisfy claims against them because they have become insolvent.
The compensation scheme has been modelled largely on the compensation scheme that
is in place in the United Kingdom (called the Financial Services Compensation Scheme),
which provides compensation to consumers where financial service providers are unable
or likely to be unable, to satisfy claims against them.
This compensation scheme forms part of a larger framework intended to compensate
retail clients. The Corporations Act 2001 (Cth) requires AFS licensees to have
arrangements for compensating retail clients for losses they suffer as a result of a breach
by the licensee or its representatives of their obligations under Chapter 7 of that Act.
They may do so by obtaining adequate Professional Indemnity insurance (‘PI’).
However, the requirement to hold PI is not a mechanism for providing compensation
directly to consumers. Rather, PI is a means of reducing the risk that a licensee cannot
pay claims because of insufficient financial resources.
This compensation scheme is a mechanism for providing compensation directly to
consumers. The body established to operate and administer the compensation scheme
is the Financial Services Compensation Scheme Limited (‘Scheme’). The rules enable
the Scheme to pay compensation only to retail clients, as defined in the Corporations Act
2001 (Cth). The rules specify who is eligible to receive compensation and in what
circumstances, how much compensation can be paid to a claimant; and how the Scheme
will be funded.
The Scheme provides information to claimants and potential claimants about the way the
Scheme works and the procedures that claimants need to follow when making a claim.
Outline of the Rules
These rules are divided into seven parts covering all aspects of the Scheme.
Part 1: Definitions
This part sets out the definition of terms used in the Rules.
Part 2: The Scheme
This part sets out the broad obligations of the Scheme, including the obligation to publish
an Annual Report and to develop procedures for dealing with complaints.
Part 3: The qualifying conditions for paying compensation
This part sets out the qualifying conditions that must be satisfied before the Scheme can
pay compensation to claimants. These are that a claimant is eligible to claim; the activity
that gave rise to the loss is covered by the Scheme; the person against which the claim
Page 30 of 50
is being made is covered by the Scheme; and that the claimant has assigned their rights
to the Scheme. Claims covered by the Financial Claims Scheme are excluded21.
Part 4: Assignment of rights
This part enables the Scheme to make an offer of compensation conditional on the
claimant assigning to it their rights to claim. If the Scheme recovers from the insolvent
AFS licensee a greater sum than it has paid to the claimant, it must pay the balance to
the claimant.
Part 5: Rejection of application and withdrawal of offer of compensation
This part allows the Scheme to reject an application for compensation or withdraw an
offer of compensation in specified circumstances.
Part 6: Payment of compensation
This part requires the Scheme to pay a claim for compensation within a specified time
unless certain conditions apply and specifies the maximum amount of compensation the
Scheme can pay to a claimant, on the basis that there should be some part of the claim
which is not compensable and for which the claimant must bear the loss.
Part 7: Transitional issues
This part specifies the manner in which transitional issues are to be dealt with by the
Scheme.
21
These discussion version Rules do not, however, exclude claims that are covered by the NGF or SIS Compensation. This
presupposes that these schemes would not continue to have separate operation but rather their scope would be subsumed by the
compensation scheme under these Rules.
Page 31 of 50
1 Definitions
In these Rules the following expressions have the following meanings:
ASIC
Means the Australian Securities and Investments
Commission.
Authorised
representative
The meaning given to that term under Chapter 7 of the
Corporations Act 2001 (Cth).
Board
Means the Board of Directors of the Scheme.
Constitution
Means the constitution of the Scheme.
Compensation
scheme
Means the scheme established for the purpose of
compensating retail clients in cases where participants and
the authorised representatives of participants are unable, or
likely to be unable, have failed to satisfy covered claims
against them because they have become insolvent, or in
circumstances where retail clients have suffered a pecuniary
loss due to the dishonesty of a participant or the authorised
representative of a participant.
Covered claim
Means a claim which is covered by the compensation
scheme, as defined in Rule 3.4.
External dispute
resolution scheme
(‘EDR’)
Means any external resolution scheme approved by ASIC
under Chapter 7 of the Corporations Act 2001 (Cth).
Industry association
Means the relevant industry body representing one or more
types of participants.
Participant
Means any AFS licensee providing financial services to retail
clients who enters into the funding agreement, and thereby
agrees to be bound by these Rules.
Participant
agreement
Means the agreement reached between the participant and
the Scheme including but not limited to, the participant’s
agreement to comply with these Rules and fund the
Scheme22.
Relevant person
Means a person whose acts or omissions give rise to a claim
for which the Scheme provides cover, as defined in Rule 3.5.
Retail client
Any person who at any material time was a retail client, as
defined in Chapter 7 of the Corporations Act 2001 (Cth).
Scheme
Means the Financial Services Compensation Scheme Limited
22
This presupposes that the Scheme will have responsibility for levying its financial services participant
members. The alternative would be for the Government to levy participants and then distribute the money
to the Scheme.
Page 32 of 50
2 The Scheme
2.1
Purpose of the Scheme
The Scheme must administer the compensation scheme in accordance with these Rules.
The Scheme may pay compensation to retail clients in accordance with these Rules.
2.2
Amendment of the Rules
The board may amend these rules in accordance with the constitution after consultation,
as the board considers appropriate, with participants, the industry association or industry
associations representing participants, ASIC, External Dispute Resolution Schemes and
relevant consumer groups.
2.3
Governance of the Scheme
2.3.1 Composition of the board
The board consists of an independent chair, and an equal number of directors
representing the interests of participants, and the interests of consumers, appointed in
accordance with the constitution.
2.3.2 Responsibilities of the board
The board’s responsibilities include the following:
a) overseeing and monitoring the activity of the Scheme;
b) setting the levies for participants;
c) approving any borrowing by the Scheme;
d) ensuring that these Rules are adhered to;
e) analysing statistical information in relation to the Scheme; and
f) effecting appropriate changes to these Rules after consultation in accordance with
Rule 2.2.
2.4
Annual Report
The Scheme must make and publish an Annual Report. The Annual Report must include
information on:
a) the number of claims received;
b) the nature of the claims received;
c) the distribution of claims across product and market segment;
d) the outcome of the claim;
e) the length of time between when each claim was made and resolved;
f) the number and nature of defaults that the Scheme declares; and
Page 33 of 50
g) the manner in which the Scheme is funded.
2.5
Independent Review of the Scheme
2.5.1 Matters for review
The board must commission an independent review of the Scheme three years after the
commencement of the Scheme and at least once every five years thereafter or as
otherwise agreed with ASIC. The review shall cover the following areas:
a) whether the scope of the Scheme is appropriate;
b) satisfaction with the Scheme of participants and complainants;
c) whether the Scheme has complied with these Rules;
d) public awareness of the Scheme and its operations;
e) effectiveness of these Rules.
2.5.2 Results of review
The Scheme will make the results of the independent review available to participants,
ASIC and to the public.
2.6
Audit
The board must cause the accounts of the Scheme to be audited annually.
2.7
Complaints against the Scheme
The Scheme must put in place and publish procedures for the handling of complaints
relating to any aspect of the operation of the compensation scheme.
Page 34 of 50
3 When will the Scheme pay compensation?
3.1
What is the procedure for making a claim for compensation?
The Scheme must produce and publish information for claimants and potential claimants
on the operation of the compensation scheme, including the Scheme’s procedures for
receiving and handling claims.
3.2
What are the qualifying conditions for paying compensation?
The Scheme may pay compensation to the claimant if it is satisfied that:
a) the claimant is a retail client (or legal personal representative of a retail client) who
has made an application for compensation;
b) the claim is in respect of a covered claim;
c) the claim is against a participant that the Scheme has declared to be in default:
(i) after commencement of the Scheme on [date]; and
(ii) not more than 12 months prior to the claimant lodging their claim with the
Scheme; and
d) where the Scheme requires, the claimant has assigned the whole or any part of
that claimant’s rights against the participant or against any third party to the
Scheme on the terms required by the Scheme.
3.3
Who may make a claim?
To be eligible to receive compensation, the claimant must be a retail client. The Scheme
may also pay compensation to a person who makes a claim on behalf of another person
if the Scheme is satisfied that the person on whose behalf the claim is made:
a) is or would have been retail client; and
b) would have been paid compensation by the Scheme had they been able to make
the claim themselves.
3.4
Which claims are covered?
A covered claim is a claim:
a) brought in relation to any act or omission by a participant or any act or omission
for which a participant may be responsible;
b) subject to the transitional provisions in Rule 7, in relation to the provision of a
financial service on or after [date – 6 years prior to commencement date],
including the provision of all forms of financial services, financial advice or
financial products such as derivatives, foreign and payment products; foreign
exchange contracts, general Insurance, securities, managed investment schemes,
life insurance products, superannuation, and other financial investment products;
and
Page 35 of 50
c) in respect of which there has been a determination in favour of the claimant23 by:
(i) an External Dispute Resolution Scheme; or
(ii) a court or tribunal of competent jurisdiction,
provided that the claim is not covered by the Financial Claims Scheme pursuant to the
Financial System Legislation Amendment (Financial Claims Scheme and other
Measures) Act 2008 (‘FCS Act’)24.
Examples of financial products include: derivatives, foreign and payment products;
foreign exchange contracts, general Insurance, securities, managed investment
schemes, life insurance products, superannuation, and other financial investment
products.
A covered claim includes a claim where there has been:
(i) a failure of the relevant person to pay or deliver money or property that was
received by the relevant person in the course of providing financial services,
where the failure arises from or is constituted by an act or omission that involves
dishonesty, or
(ii) a fraudulent dealing with property that was received by the relevant person in the
course of providing financial services, where the fraudulent dealing arises from or
is constituted by an act or omission that involves dishonesty.
3.5
Who is a relevant person?
A relevant person is a person who was, at the time the act or omission giving rise to the
claim against it took place:
a) a participant; or
b) an authorised representative of a participant.
3.6
When may the Scheme determine a participant is in default?
A participant is in default if the Scheme has determined it to be in default under this Rule.
The Scheme may determine a participant to be in default after the commencement of the
Scheme on [date] when, in the opinion of the Scheme it is unable or likely to be unable to
satisfy at least one covered claim against it as the participant:
(i) is a body corporate and becomes insolvent at a particular time if, and only if, at
that time:
23
This would mean that the Scheme would not be able to enforce a legally binding settlement that has been reached between the
AFS licensee and the retail client. If a settlement cannot be enforced through the compensation scheme, this would mean that the
retail client would have a disincentive to agree to a settlement if there was any doubt as to the financial strength of the AFS licensee.
As noted earlier in this Report, this would prejudice the efficiency of EDR and court processes. For this reason, some extension of
the Scheme’s ambit in this area may be appropriate.
24
The requirement for an EDR Determination or a court decision means that the scheme could not be used as a vehicle to enforce a
Deed of Settlement that had been reached between the financial services provider and the claimant. This would create inefficiency in
those situations where the participant is willing to admit to fault and to agree a settlement – the claimant would not be able to concur
with this in circumstances where there was a reasonable apprehension that the participant may become insolvent and so fail to pay
the agreed compensation. To address this, it may be appropriate to allow a claim where the claimant and the participant have
entered into a legally binding settlement agreement.
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A. an administrator of the body corporate is appointed under section 436A, 436B
or 436C of the Corporations Act 2001 (Cth);
B. the body corporate commences to be wound up or ceases to carry on
business;
C. a receiver, or a receiver and manager, of property of the body corporate is
appointed;
D. the body corporate is appointed, whether by a court or otherwise; or
E. the body corporate enters into a compromise or arrangement with its creditors
or a class of them;
(ii) a natural person and becomes insolvent at a particular time if, and only if, at that
time:
A. a creditor's petition or a debtor's petition is presented under Division 2 or 3 of
Part IV of the Bankruptcy Act 1966 against the person; or a partnership in
which the person is a partner; or 2 or more joint debtors who include the
person;
B. the person's property becomes subject to control under Division 2 of Part X of
the Bankruptcy Act 1966;
C. the person executes a deed of assignment or deed of arrangement under
Part X of the Bankruptcy Act 1966; or
D. the person's creditors accept a composition under Part X of the Bankruptcy Act
1966; or
(iii) cannot be contacted at its last place of business and that reasonable steps have
been taken to establish a forwarding or current address, but without success; or
3.7
Publicising declarations of default
If the Scheme makes a determination of default pursuant to Rule 3.6, the Scheme must
take appropriate steps to ensure that the default is published and that potential claimants
are informed of how they can make a claim for compensation as soon as possible after a
determination has been made that a participant is in default. The default may be
published on the website of the Scheme, and made available on request by telephone or
in writing.
3.8
Assistance to claimants
The Scheme may agree to pay the reasonable costs of the retail client bringing or
continuing insolvency proceedings against a participant (whether those proceeding
began before or after a determination of default), if the Scheme is satisfied that those
proceedings would help it discharge its functions under these Rules.
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4 Assignment of Rights
4.1
Compensation payments made conditional on an assignment
The Scheme may make payment of compensation to a claimant in respect of a covered
claim conditional on the claimant assigning the whole or any part of their rights against
the participant, or against any third party or both, to the Scheme on the terms required by
the Scheme.
4.2
Payments to the Scheme
If a claimant assigns the whole or any part of that claimant’s rights against any person to
the Scheme as a condition of payment, the effect of this will be that any sum payable in
relation to the assigned rights will be payable to the Scheme and not the claimant.
4.3
Recoveries
If the Scheme takes assignment of rights from the claimant under Rule 4.1, it may pursue
such recoveries as it sees fit. If the Scheme makes recoveries through rights assigned
under 4.1, it may deduct from any recoveries paid over to the claimant under Rule 4.1
part or all of its reasonable costs of recovery and distribution (if any).
4.4
Off-set of recoveries
Where compensation was paid under Rule 6.1.3, if a claimant agrees to assign their
rights to the Scheme and the Scheme subsequently makes recoveries through those
rights, those recoveries must be paid to the claimant to the extent that the amount
recovered exceeds the amount of compensation.
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5 Rejection of application and withdrawal of offer of compensation
5.1
Inaccurate and incomplete applications
If an application for compensation contains any material inaccuracy or omission, the
Scheme may reject the application.
5.2
Rejection of applications
The Scheme may reject an application if the Scheme considers that a claim in respect of
the liability would have been defeated by a defence of limitation at the earlier of:
a) the date on which the participant is determined to be in default; and
b) the date on which the claimant first indicates in writing that they may have a claim
against the participant.
5.3
Discretion to reject applications
Where a claimant fails to respond to correspondence or a request for information from
the Scheme within the time allowed for such a response, the Scheme may write to the
complainant at the last address provided by the complainant requiring a response to that
correspondence within one calendar month, failing which the Scheme may reject an
application for compensation. If the claimant fails to respond within one calendar month
after a letter is sent under this Rule, the Scheme may reject the claim. If the Scheme
rejects an application under this Rule, it may, at its discretion decide to reinstate that
application.
5.4
Withdrawal of offer
The Scheme may withdraw any offer of compensation made to a claimant if the offer is
not accepted or if it is not disputed within 90 days of the date on which the offer is made.
The Scheme may repeat any offer withdrawn under this clause. The Scheme must
withdraw any offer of compensation if it appears to the Scheme that no such offer should
have been made.
5.5
Interim payments
Where the amount of compensation offered is disputed by the claimant, the Scheme may
withdraw the offer and may consider making a reduced or interim payment before doing
so. The Scheme may repeat any offer withdrawn under this clause.
5.6
Withdrawal of misplaced offer
The Scheme must seek to recover any compensation paid to a claimant if it appears to
the Scheme that no such payment should have been made, unless the Scheme believes
on reasonable grounds that it would be unreasonable to do so, or that the costs of doing
so would exceed any amount that could be recovered.
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6 Payment of compensation
6.1
Timing of payment
6.1.1 When must compensation be paid?
Subject to Rule 6.1.2, the Scheme must pay a claim as soon as reasonably possible
after:
a) it is satisfied that the conditions in Rule 3.2 have been met; and
b) it has calculated the amount of compensation due to the claimant, and
c) the claimant has accepted the Scheme’s offer of compensation and met any
condition imposed by the Scheme under Rule 4.1 as to assignment of rights,
and in any event within three months of that date.
6.1.2 When may payment be delayed?
a) The Scheme may postpone paying compensation if the Scheme considers that
the claimant should first exhaust their rights against another participant or a third
party, or make and pursue an application for compensation to any other person.
b) The Scheme may at its discretion pay a claim in instalments over a period of up to
24 months if the claim is received in a financial year in which the Scheme has
received or expects to receive large scale claims.
6.2
Table of compensation limits
The limits on the maximum compensation sums payable by the Scheme are set out in
the below table:
Scheme compensation limits
90% of the first $120,000
Plus 70% of the next $80,000
Plus 50% of the next $109,000
Maximum possible compensation $218,500
6.3
Method of payment of compensation
6.3.1 To whom must payment be made?
If the Scheme determines that compensation is payable, it must pay it to the claimant, or
as directed by the claimant.
6.3.2 Reduced or interim payments
If the Scheme is satisfied that in principle compensation is payable, but considers that
immediate payment in full would not be prudent because of uncertainty as to the amount
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of compensation payable to a claimant, it may decide to pay an appropriate lesser sum in
final settlement, or to make payment on account.
6.3.3 Reasonable prospects of recovery from third parties
The Scheme may also decide to make a payment on account or to pay a lesser sum in
final settlement if the claimant has any reasonable prospect for recovery in respect of the
claim from any third party or by applying for compensation to any other person.
6.4
How is compensation to be quantified?
6.4.1 Compensation payable
Provided the qualifying conditions for payment of compensation under Rule 3.2 have
been met, the amount of compensation payable to the claimant is:
a) the sum of covered claims relating to the same type of default determined under
Rule 3.6 that the claimant has against a participant in default;
b) less the amount of any liability which the participant may set off against any of
those claims;
c) subject to Rule 6.2 that sets limits on the amount of compensation payable for
various types of default.
In calculating the compensation payable, the Scheme may rely, to the extent that it is
relevant, on any determination by:
(i)
an External Dispute Resolution Scheme; or
(ii)
a court of competent jurisdiction.
6.4.2 What is excluded from the calculation of compensation?
The Scheme must not pay compensation for any claim to the extent that it relates to or
depends on:
a) a failure of investment performance, except where the claim concerns poor
advice, non-disclosure or misrepresentation or other misconduct by the relevant
person;
b) a contractual obligation to pay or promise to pay which the Scheme considers to
have been undertaken without full consideration passing to the participant or in
anticipation of possible insolvency; or
c) the mere fluctuation in the value of an investment.
6.4.3 Set off
In calculating the compensation payable, the Scheme must take into account any
payments to the claimant (including amounts recovered by the Scheme on behalf of the
claimant) made by the participant or the Scheme or any other person, if that payment is
connected with the relevant person’s liability to the claimant.
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6.5
Personal representatives, agents and joint claims
6.5.1 Personal representatives
Where a person makes a claim as the personal representative of another, the Scheme
must treat the personal representative in respect of that claim as if he were standing in
the shoes of that other person.
6.5.2 Agents
If a claimant has a claim as an agent for one or more principals, the Scheme must treat
the principal or principals as having the claim, not the claimant.
6.5.3 Joint claims
If two or more persons have a joint claim, each of those persons is taken to have a claim
for their share, and in the absence of satisfactory evidence as to their respective shares,
the Scheme must regard each person as entitled to an equal share. A joint claim is
subject to the compensation limits set out in Rule 6.1.3 as if the claim were made
by one person.
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7 Transitional provisions
These Rules will apply to claims in respect of determinations made by an External
Dispute Resolution Scheme or a court or tribunal of a competent jurisdiction on or after 1
July 2008.
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Appendix D - PI insurance provisions
Section 912B of the Corporations Act 2001(Cth) (‘Act’) provides that:
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 representatives. The arrangements must meet the requirements
of subsection (2).
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.’
The regulations made under the above sections are contained in the Corporations
Regulations 2001 from Reg. 7.6.02AAA.
These regulations provide:
a)
that the requirement to have compensation arrangements is subject to the
requirement that AFS licensees hold adequate PI insurance; and
b)
that prudentially regulated deposit-taking institutions, general insurers and life
insurers are exempt from the requirement that AFS licensees hold adequate
PI insurance.
ASIC has provided guidance for AFS licensees on ‘Compensation and Insurance
Arrangements’ under Regulatory Guide 126.
In the alternative, an AFS licensee may apply to ASIC to have its ‘alternative
arrangements’ to PI insurance approved by ASIC.
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Appendix E - Financial Claims Scheme
Financial Claims Scheme
In mid-October 2008, the Federal Government introduced and passed the Financial
System Legislation Amendment (Financial Claims Scheme and Other Measures) Act
2008.
The FCS Act is intended to introduce a crisis management framework to assist deposit
holders and policyholders in the event of the insolvency of a general insurer or depositholder.
General insurance policyholders
The FCS Act provides a compensation scheme for eligible policyholders if a general
insurer fails. The FCS Act features a Policyholder Compensation Facility which will be
administered by the APRA.
The following classes of policyholders will be eligible to claim compensation:

individuals who have insured against risks in Australia with an APRA-regulated
general insurer;

small businesses (those with an annual turnover of less than $2 million);

certain family trusts; and

Australian-based non-profit organisations.
APRA will determine claims. Claims will be assessed solely by reference to the policy’s
terms and conditions.
Where APRA pays compensation, the claimants rights will be transferred to APRA and
APRA may recover in the liquidation process.
A levy is to be imposed on general insurers where the assets of an insolvent general
insurer do not cover the costs of the Policyholder Compensation Facility and its
administration. The details will be prescribed in regulations.
The levy amount will not exceed 5% of the gross premiums received by a general
insurer.
Deposit holders
The FCS Act enables APRA to pay holders of accounts and other selected financial
products with insolvent ADIs the net credit balance of those accounts and products.
These benefits are not automatic: they will only apply if the Treasurer declares that the
FCS applies to a particular ADI.
If the FCS applies to an ADI then the holder of an account is entitled to receive the net
credit balance of their protected account plus accrued interest. Regulations may
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prescribe limits on the amount payable but the Government’s recent announcements
indicate that there is no intention to impose a limit until 2011.
Unlike the general insurance arrangements, both corporations and individuals may apply.
Claimants need not be Australian residents.
There is a limit of $20 billion per ADI.
A levy is to be imposed on ADIs to help fund the FCS. The details will be prescribed in
regulations.
The levy paid by an ADI cannot exceed 0.5% of the ADIs liabilities to its depositors.
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Appendix F – Existing Australian compensation schemes
National Guarantee
Fund
Purpose
Legislation
ASX Supplemental
Compensation
Fund
Provides compensation in Compensation for
various situations including retail clients who
to clients of failed ASX
entrusted property to a
stockbrokers who have
stockbroker who have
entrusted property to the
trading permission to
broker and in cases of
deal in futures, claims
unauthorised transfer of
where client suffers
securities (Division 4 of
loss due to
Part 7.5);
misappropriation or
fraudulent misuse of
property
Corporations Act 2001
National Guarantee Fund
Act 1987
Exclusions
Administration
Loss arising from:

investment decisions

a Dealer failing to act
to buy or to sell

Money lent to a dealer

Conduct by an entity
other than the
specified entity which
is the Dealer

Alleged unauthorised
withdrawal or
misappropriation by
the Dealer

Individual derivatives
contracts or futures
Securities Exchanges
Guarantee Corporation
Limited, statutory trustee,
subsidiary of ASX
SIS Compensation
Losses suffered from
fraudulent conduct or
theft
Covers regulated
super funds and
approved deposit
funds
Corporations Act 2001 Superannuation
Industry (Supervision)
Act 1993
‘Excluded persons’ are Self-managed funds
not able to make a
and exempt public
claim. These include
sector funds
the Dealer, a spouse,
relative etc.
Loans to the Dealer
are not covered
Claims Review
Panel of the
Australian Stock
Exchange Limited
Trustee applies to
the Minister for a
grant of financial
assistance
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National Guarantee
Fund
Funding
ASX Supplemental
Compensation
Fund
SIS Compensation
Minimum fund of $80M
set
Minimum fund of
$2M
Consolidated
Revenue
Original funding from
merge of state fidelity
funds
Potential to apply
Levy funded as a
percentage of fund
assets, post funded
levies
Investment income
Potential to apply levy or
borrow funds
Net assets currently
under management of
$96.8 million
Compensation
Limits
Unlimited
$1,000,000 for
fraudulent misuse
or defalcation of
money or property
by a single market
participant.
Minister’s
determination.
$1,000,000 from
any series of
claims arising out
of the same set of
circumstances.
$100,000 for any
one claimant
arising out of a
single set of
circumstances.
Time Limits
Claim to be made within 6
months unless otherwise
set by SEGC.
Claim to be made
Nil.
within 6 months unless
otherwise set.
3 months to appeal
disallowed claims.
In addition, there is an obligation on the operators of other financial markets on which the
trades of retail clients are executed to have compensation arrangements (Division 3 of
Part 7.5). These arrangements are required to cover fraud and defalcation by brokers on
these markets.
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Appendix G – UK and proposed Australian Scheme comparison
Feature
United Kingdom – Financial
Services Compensation
Scheme (UK scheme)
Australia – proposed Financial
Services Compensation Scheme
(‘compensation scheme’)
Scope of cover
Covers claims in relation to all
financial services, including
claims relating to products offered
by firms that are prudentially
regulated (such as deposit-taking
institutions, general insurers, life
insurers).
Unlike the UK scheme, the Australian
compensation scheme does not need
to cover claims with respect to deposits
and general insurance products
because they are covered by the
Financial Claims Scheme (‘FCS’).
Caps on
compensation
Up to £50,000 depending on the
nature of the financial service.
Suggested payment limit of up to
$218,500. This payment would be a
percentage of the total claim – a retail
client who receives EDR or court
award of $309,000 or above could
receive only $218,500 from the
Scheme.
By comparison Financial
Ombudsman Service of the UK
limit is £100,000.
By comparison, Australian Financial
Ombudsman Service limit is generally
$309,000.
Funding
Levies applied to firms authorised Two options are proposed in this
by the Financial Services
Report: levies could be imposed by
Authority (‘FSA’).
Government for distribution to the
Scheme or alternatively the Scheme
could directly levy financial services
participant members.
Levies are imposed on that part
of the industry responsible for a
default. Where default is large,
compensation costs will be borne
by all authorised firms.
Levies referable to the sector of the
AFS licensee and so higher levies
would be imposed in the sectors most
responsible for claims.
Claims are pursued with solvency Like the UK scheme, the compensation
practitioners where there is a
scheme will have the power to seek to
likely payout.
take assignments and pursue recovery
of funds in the winding up of an AFS
licensee.
Default
declarations
UK scheme declares firm in
‘default’ where they are unable or
likely to be unable to satisfy at
least one claim against it.
Australian scheme would only declare
AFS licensee in ‘default’ where formal
insolvency/ bankruptcy steps have
been taken or where the licensee has
disappeared.
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Feature
United Kingdom – Financial
Services Compensation
Scheme (UK scheme)
Governance
UK scheme is governed by a
Unlike the UK scheme, the Australian
body which forms part of the UK compensation scheme would be a nonfinancial services regulator (FSA). profit industry-based scheme governed
by an independent Board comprising
representatives from industry and
consumers.
Relationship to
EDR
The UK scheme is separate from The Australian compensation scheme
the UK Financial Ombudsman
would be independent from EDR
Service (UK FOS).
schemes, yet a close relationship with
FOS promises financial leverage
benefits.
Relationship to
regulator
Recoveries
Australia – proposed Financial
Services Compensation Scheme
(‘compensation scheme’)
Does not recognise quantum of
awards made by UK FOS
(although it does recognise
decisions on liability) –
reconsiders facts and UK scheme
makes its own decision.
Unlike the UK scheme, the Australian
compensation scheme would require a
claimant to obtain an award from an
EDR scheme or a court prior to
seeking compensation through the
compensation scheme.
UK scheme was set up under the
Financial Services and Markets
Act 2000 (FSMA), and is funded
by levies imposed by the
regulator (FSA).
Unlike the UK scheme, the
compensation scheme is independent
from the regulator (ASIC) although it
would be approved by or meet
standards set by ASIC. This is
modelled on the current approach to
EDR scheme regulation in Australia.
UK scheme has power to step
into shoes of claimant and seek
recovery of compensation paid to
claimant in winding-up
proceedings.
Like the UK scheme, the Australian
compensation scheme would have the
power, with consent, to step into shoes
of claimant and seek recovery of
compensation paid to claimant in
winding-up proceedings.
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