Regulating the banking industry and prudent advice

Regulating the banking industry and prudent advice: The Australian Corporate sector   after the Hayne Report.

-Zia Akhtar[1]


The Federal Court in Australia has had to issue several civil penalties to Australian banks who have been found to have sold their products to customers after offering them improper advice.  The Hayne Royal Commission’s interim report in September 2018 has raised the possibility of reforms in the financial regulatory architecture and the adoption of  proper industry codes of conduct in the corporate sector. There is an increase scope for regulatory sector to take a proactive approach in enforcement and issuing compliance from the banks. This will ensure that the financial institutions will be prudent in their dealings and offer impartial advice to their clients.  The Mahlab Report 2018 reports indicates that there is an increase reliance on in-house lawyers in the banking sector and the specialisation in the global market. The argument in this paper is that the litigation  should always be pursued against the financial services industry and this has a proven worth in seeking compensation from the banks and preventing misconduct.

Key words


The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry established in Australia in December 2017 has released damning findings on the corporate and banking sector in Australia and called for regulatory reform. The Commission conducted a survey after whistle- blowers, consumer groups and the regulatory sector raised an alarm about the unethical practices in banks and the financial industry. The misconduct which could be referred for criminal prosecution.  The allegations include alleged bribery, forged documents, failure to verify creditworthiness and over- valuation of insurance premiums. The findings call for the need to evaluate the banking sector in Australia and how civil penalties have been imposed on them and the impact of the Commission on regulating the financial industry which will face more stringent regulations once reforms once the proposed reforms are implemented.

In the past decade, regulators have accused Australia’s major banks and financial institutions of breaching their fiduciary duties to their clients. The banks accused include the Commonwealth Bank, Westpac, ANZ, and National Australia Bank. These are four of the five banks in Australia in terms of capital assets and Money lending institutions include AMP, BT Financial, Aussie Home Loans and St George. The list also enumerates other smaller financial institutions that offer mortgage and insurance to their clients. The regulators have intervened under Section 21 of the Federal Court of Australia Act 1975, Section 21, and Section 12 BA of the Australian Securities and Investments Commission Act 2001.

This has led to a series of inquiries. In early 2018 the Australian Securities and Investments Commission (ASIC), the corporate regulator published a report, ( Report 562: Financial advice: Vertically integrated institutions and conflicts of interest, 24 January 2018) The report states that that though vertical integration [which refers to the business model of combining activities at two (or more) different stages of production] can provide economies of scale and other benefits to both the customer and the financial institution, ‘a vertically integrated business model also gives rise to an inherent conflict of interest. While the law permits this conflict to exist, it must be managed appropriately’. There is a continuing industry-wide investigation by the ASIC into past practices in the interbank short-term money market and its impact on the Bank Bill Swap Rate. (BBSR)

The findings also reviewed advice by banks recommending clients to use their in- house products. ASIC concluded that this was not in the best interests of clients and in 75% of cases they found that this had not satisfied compliance with the ‘best interests’ requirements.  In fact This also showed that 10% of the advice reviewed was likely to leave the customer in a significantly worse financial position.   There was ‘a clear weighting’ of 79 %  of products recommended by advisers towards their own in- house products  where  the products were external ones on the firms approved products lists (APL) and  a weighting of  21% where the products were internal or ‘in house’ products. However, 68% of clients’ funds were invested in products in house.

The report was compiled against the background of the Royal Commission against Misconduct in Banking, etc set up under the Royal Commission Act (RCA) 2002.  This delegated responsibility to the former High Court Justice, the Honourable Kenneth Hayne AC QC, to inquire into financial services entities that have engaged in misconduct or fallen below community standards.  This was defined by the “letters patent”  that set out the terms of reference as ” existing laws and policies of the Commonwealth relating to the provision of banking, superannuation and financial services entities; internal systems of financial services entities; and forms of industry self-regulation”.

This paper considers the banking sector where the evidence of unconscionable conduct has been subject to court proceedings.  It sets out the litigation process and the consent orders that the Federal Court has approved.  The re will be consideration of the banking procedures and the financial services sector after the Royal Commission report that has made several suggestions but which does not advocate a change in the law.  The ethics of lawyers and profession conduct rules are also discussed to strengthen the codes that bind in-house Counsel diligent advice and exercise due care and caution.


Australian banks and federal scrutiny

Australian banks are governed by the Code of Banking Practice, adopted by the members of the voluntary industry group, the Australian Banking Association.  In 2018 Australian Prudential Regulatory Authority (APRA), under the powers granted by the Treasury Laws Amendment (Banking Measures No. 1) Act 2018 created the Restricted Authorised Deposit-Taking Institution(RADI) which was set up by license for new entrants and monitor competition in the  banking system.  Smaller banks which serve the businesses community within the lower risk banking portfolio are obliged to comply with all the industry requirements or vacate the industry, within two years of the grant of the licence. They are considered banks under the amended section 66 of the Banking Act 1959  and classified as Authorised Deposit Taking Institutions (ADI)s.

The large banks have a more recent track record of making misrepresentation when offering financial advice to their clients and the Federal Court routinely sanctions compensation payments made by regulators such as ASIC.  The five leading banks AMP, ANZ, CBA, NAB and Westpac have been ordered to make civil penalty payments after litigation commenced by ASIC under the terms of the above Acts.

These leading banks have offered customers $222.3 million in refunds and interest for failing to provide prudent advice. They have also charged them ongoing advice fees from 1 July 2010 to  August 2018. (18-229 MR). At present ASIC is seeking to provide remedies for ‘Fees for no service’ (FFNS) provided by Australian financial services (AFS) licensees that have identified potential FFNS failings, including Bendigo Financial Planning Ltd, Police Financial Services Ltd (trading as BankVic), State Super Financial Services Australia Limited (trading as StatePlus), and Yellow Brick Road Wealth Management Pty Ltd. The total amount now paid or offered to customers across both groups of licensees is $259.6m.

The Australian Transaction Reports and Analysis Centre (Austrac), the  country’s financial intelligence agency with regulatory responsibility for anti-money laundering and counter-terrorism financing has prosecuted the country’s leading bank for improper conduct. In  Chief Executive Officer of the Australian Transaction Reports and Analysis Centre v Commonwealth Bank of Australia Limited ACN 123 123 124 (NSD1305/2017) the Chief Executive Office sued  the Commonwealth Bank for 53,700 breaches of money laundering and counter-terrorism financing laws under the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act). This was after the bank failed to report $77m worth of suspicious transactions through its ATMs over a number of years prior to October 2017.

The consent order reached for the federal court’s approval included the clause that the Bank “failed to report suspicious matters on time, or at all, involving transactions in the tens of millions of dollars even after it became aware of suspected money laundering or structuring on CBA accounts, it did not monitor its customers to mitigate and manage ML/TF risk, including the ongoing ML/TF risks of doing business with those customers”. (Para 88)

In Australian Securities and Investments Commission v National Australia Bank Limited [2017] FCA 1338, the Federal Court approved civil penalties in the ASIC settlements with ANZ and NAB. The settlements provided for declarations of attempting to engage in unconscionable conduct in attempting to transform where the BBSR set on certain dates, and failing to do everything necessary to ensure that they provided financial services honestly and fairly. Each bank was ordered to pay a total of $50 million towards penalties, costs and a consumer protection fund.  approving ASIC settlement with CBA. The settlement provided for declarations of unconscionable conduct and related contraventions of the Corporations Act 2001 and of the ASIC Act, and an order that CBA pay a total of $25 million towards penalties, costs and a community fund.

Jagot J found the banks liable because (i) making bids or offers on the days described as set out above, and delivered judgment “Further by (ii) failing to have adequate policies and procedures for supervision and monitoring of the conduct of its employees within STIRR (portfolio)”. (Para 40). The judge enumerated that there were “fundamental failings in the culture, training, government and regulatory systems of both NAB and ANZ. The conduct tends to undermine public confidence in the entirety of the Australian financial system”. (Para 115)

The litigation against the banks and their governance and procedures under the terms of BBSR has been supported by prosecutions that have invoked the ASIC codes regarding bank credit extensions. These have raised issues of banks of credit contracts with customers seeking loan payments and involved the approval of consent orders as in the previous cases.

In Australian Securities and Investments Commission v Australia and New Zealand Banking Group Limited [2018] FCA 155 the ANZ was penalised $5 million for 12 breaches of section 128 and the same amount for section 130 of the National Consumer Credit Protection Act 2009 (NCCPA), based on failing to verify customers’ financial information before entering into credit contracts with them. This was an obligation under the section 129 that they carry out this verification.

Middleton, J held that the contraventions “represent significant failures” and they deserved the “significant penalties” because of the need for “general deterrence, in circumstances where ANZ is a very substantial and profitable enterprise” ; “the contraventions were repeated and occurred over a period of two years”; and  ANZ management did “not ensure that relevant policies were complied with;” and in particular, no action was taken despite “management personnel having become aware of the issues”.  ( Para 32)

The latest case in the Federal Court is a decision that points to the discretion of the judge to accept the consent order.  In ASIC v Westpac Banking Corporation [2018] FCA 1733 the Court rejected the  Settlement Offer despite the bank admitting it broke responsible lending laws. The facts concerned the Westpac’s use of the Household Expenditure Measure (“HEM”) that came under scrutiny at the Royal Commission into Financial Misconduct after it emerged they were automating loan approvals using benchmarks rather than taking the time to properly assess a customer’s expenses and income.  The bank admitted that its automated loan approval system used the HEM to calculate potential borrowers’ living costs and claimed that in some 5,041 instances the bank used the HEM instead of actually evaluating the customers’ declared living expenses.  This procedure would have breached the section 128 of the National Consumer Credit Protection Act 2009 because to do this banks assume that all customers are in the bottom 25 per cent quarter for discretionary spending expenses.

Justice Perram state “In these cases, the declared expenses were more than the HEM benchmark and, if those expenses had been used instead of the HEM Benchmark, a flag would have been triggered and the customer’s application would not have been approved without referral to manual assessment … What would have happened after that manual assessment the parties have not told me. Nor have they told me whether any of these 5041 loans were, or were not, suitable for the borrowers.”  [para 16]

His honour also took the unusual step of appointing an amicus curiae, former Solicitor-General Justin Gleeson SC, who perform this task.  He observed that “ASIC had not informed the court how Westpac had breached responsible lending laws” and after “Westpac had admitted it had breached section 128 did not prevent the bank from using the HEM”.   It was prima facie evident that Westpac and ASIC did not identify contraventions in the terms required by the NCCPA, or the specific infringements to be the subject of Court declarations and penalties.  The judge observed that: “ … admirable ingenuity has been applied by the parties’ advisers to the task of drafting the consent orders so as to gloss over the very real differences which exist between them. However, because the parties do not actually agree on what s 128 requires they are unable to agree on how many of the Respondent’s loans were made in contravention of it. This also makes it very difficult to judge the appropriateness of the proposed penalty of $35 million”. [para 11]

This decision to reject a consent order greatly reduces ASIC’s bargaining power that under Section 13 (1) of its parent act needs to reach a certain level of threshold of  “reason to suspect” before it begin its investigation. It could lead to the bank seeking to lower penalties because there no clear contravention of the NCCPA in the above case and there is a likelihood of an out of court settlement.  It also shows that the consent orders that are agreed between the banks and the regulatory authority are open to scrutiny and will be examined for their substance and not just form.


Implementation of the Royal Commission report  

The HCM were derided by the report of the Royal Commission of Banking in September 2018 under the former High Court Justice, Kenneth Hayne AC QC, who inquired into financial services entities that have engaged in misconduct or fallen below community standards.  It questioned not only the adequacy of existing laws and policies but also the effectiveness of regulators and identified the complexity in the law as a main obstacle and in some respects, “as labyrinthine and overly detailed”.  The main proposal was that the ASIC perspective should not be how the “matter be resolved by agreement” but instead when there is a breach “there should be more use of the courts (although bringing proceedings does not preclude negotiation about how they should be resolved)”.

Commissioner Hayne linked this observation to the “culture and conduct of the banks that was driven  by, and was reflected in, their remuneration practices and policies”. He observed that from the executive suite to the front line, staff performance was measured and rewarded based on sales and profits but he does not place entire blame solely to the financial institutions, with the “regulators also failing to check their greed“. Further, he stated that every act “that has been contrary to law is a case where the existing governance structures and practices of the entity and its risk management practices have not prevented that unlawful conduct”.  (Section 3, Chapter 9, p122, Regulation, governance and remuneration).

The Royal Commission has refused to order compensation from the banks or the financial industry in general. However, under powers conferred by section 6P of the RCA, the  Commission can, if appropriate, refer any misconduct to the relevant regulatory body in the financial sector, such as the ASIC, Australian Taxation Office (ATO), APRA or the Australian Competition and Consumer Commission (ACCC), that administers the Trade Practices Act 1974. The regulators do not need to wait for the merits based final report from the Royal Commission which can refer a suspected breach of the law to a regulator for action at any time during the course of the ongoing inquiry.  They can also prevent any money being transferred through a scam account from Australia to a destination abroad. They can compel ASIC to stop the transaction of money being transferred out of the country by the defendants.

The issue is how the recommendations of the Royal Commission be acted upon and if  ASIC can take action in relation to matters in the report. Tom Middleton has suggested that the Royal Commission has the power to activate a “so-called enforcement pyramid” as” a strategic structure of sanctions available” extending from the negotiation based “methods at the base”.  This is to reach quick settlement with the defendants who will have to expend more money as litigation progresses “up the pyramid”.

The Royal Commission can refer the suspected misconduct to any agency or government department under s 6P of the Act. The ASIC has several options under the ‘pyramid’ structure which Middleton states can lead to ASIC’s enforcement methods. These are “(i) Administrative/non-judicial proceedings which at the base of the enforcement pyramid”.  These can ban persons from operating in the financial services industry where they’ve breached the financial services laws (including a failure to meet the “fit and proper person” or “good fame or character” requirements)”. They will informally interviewed and there may be a banning order or ASIC may also obtain enforceable orders to achieve “the relevant regulatory objective” without the need for litigation.

The option “(ii) Civil proceedings” leading to court orders requiring the defendants to “pay compensation” to the effected clients and “ASIC can also apply to the court for ‘asset preservation orders’ or ‘interim injunctions’ to stop the defendants transferring assets out of the country so that those assets are available to meet any future compensation orders made by the court”. The (iii) option of Civil penalty proceedings can ensure that “ASIC can apply to the court for “disqualification orders” against directors to prevent those directors from managing corporations for a specified period. This will sanction those directors for their misconduct and impose a monetary penalty against those directors of up to $200,000 under the section 1317 G of the Corporations Act 2001.  The option (iv) Criminal proceedings are at the “apex of the enforcement pyramid” which are for serious and culpable offences in the extreme cases of misconduct. ( Tom Middleton, The Royal Commission: Beware its Teeth. Legal Insight, Thompson Reuter online 2/2/18)

This Royal Commission report is for increasing regulatory intervention and it has been compiled and produced at the time when there is more compliance required from the financial services industry. The Banking Accountability Executive Regime (BEAR) that came into effect in July August 2018 places emphasis on ethics that needs for it to be practiced top down. The requirements are meant to reflect the constructive link with APRA, and to “take reasonable steps to prevent matters from arising that would adversely affect the ADI’s prudential standing or reputation”

There will be an inevitable increase in enforcement action, and the increased significance of the general obligations under s912A(1) of the Corporations Act 2001 (Cth) (the general obligations), particularly the obligation to do all things necessary to ensure that financial services are provided “efficiently, honestly and fairly”.   The Commissioner has raised the issue whether the enforcement action should be required unless there is a public policy reason not to proceed   This will have an impact on the regulatory sector and strategic enforcement action will be preferred ahead of negotiated infringement notices by enforceable undertakings.  It should also be expected that ASIC will seek to prosecute in areas where case law has not yet provided sufficient guidance on the scope of regulation under the general obligations in s912A, and the requirement to notify significant breaches with reference to s912D will take on a renewed prominence in the financial services sector, and become the main consideration for compliance.


Impact on in-house legal counsel

The reforms proposed by the Royal Commission will concern the advice provided by in house lawyers employed by the financial services industry which have been accused of not meeting their obligations under the Professional Rules of Conduct of the legal profession in Australia.  In most cases, the client of an inhouse counsel will be their employer, but they may be employed by a subsidiary, within a corporate group, that was created to provide services to the parent company.  The banking industry increasingly relies on the in house Counsel within the framework of the globalised legal environment and increasingly relies on the legal profession to underwrite the procedures of business and client confidentiality.

The inhouse Counsel have to protect the interests of their principle and duty to the court and the other party. There are Uniform Rules for Australian solicitors known as the Solicitors’ Conduct Rules (ASCR) developed by the Law Council of Australia and promulgated in June 2011, and amended in 2015. They are a common set of professional obligations and ethical principles for solicitors when dealing with their clients, the courts, their fellow legal practitioners, and regulators. These have been adopted in all the Australian states as a set of uniform rules that govern conduct for both inhouse and external self employed law firms.

The 2018 private sector Mahlab Report that used market intelligence gathered from clients and the financial industry to indicate remuneration and rewards, trends and employment experience for private practice and in-house has shown that there has been a 10 per cent growth in existing legal functions within the corporate sector. It has pointed to the Royal Commission as the main reason for the corporate and banking sector recruiting more lawyers because of an anticipated increase in “regulation, a reduced reliance on external providers for the overseeing of IPOs, takeovers, major litigation or capital raisings”. The Commission ‘s investigations have “necessitated additional recruitment of contract staff into law firms and financial institutions alike as they grapple with the demands of a ‘fast and furious’ commission process and requests for information and analysis going back years”. (

The report states that “the boards of listed companies are particularly keen to have the governance framework and protection that an internal legal function provides.” It points to the need for the “overseas investors often looking to the general counsel as an essential member of a senior leadership team and query why this role does not exist.” In response, Australian companies are “going to market for the first time” in establishing legal functions and overall, the market outlook for in-house legal functions is “very positive,” and “well entrenched”, as it enjoys expansion and major upswing “at a rate not seen since pre-Global Financial Crises days” that swept the banking world in 2007.

The Law Society in Australia has proposed changes to the Uniform Rules of Professional Conduct that will support the compliance in the corporate and banking sector. The proposal to make amendments under the Legal Profession Uniform Law is under consultation from 1 July 2018 concerns the Managed Investment Schemes (MIS). The proposed amendment of s 258 of the Uniform Law will restrict the involvement of law practices in the promotion and operation of mortgage practices and other MIS, as well as the provision of legal services in connection with mortgage practices. These will regulate the industry and increase the  supervision of compliance in the industry by ensuring lawyers carry on their practice with honesty and integrity and do not publicise the financial services sector.


There has been an expansion of the banking sector in Australia that includes deposit taking banks which have been regulated to operate for the savers and investors and they form the strata below the 5 large Australian banks. The regulatory sector has attempted to diversify the client base of customers in the light of the scandals that have accompanied the major banks which have operated in offering financial services and have been found to be in breach of section 128 of the  NCCPA.

The two main regulatory bodies ASIC and APRA have been active in enforcing good regulatory practices and enforcing the regulations in the courts. The consent orders that ASIC has agreed with the banks have not always been approved and there is a scrutiny by the Federal Court of the breach of the laws that invite prosecution for a civil penalty. These have shown a gradient that is on the increase and compensation payments have been levied on the banks on an annual basis.

The speculation that has accompaneid the financial sector and the lack of prudential lending by the banks led to the inquiry conducted by the Royal Commission on banking that released its interim report in late 2018.  This has concentrated on the intersection between the corporate culture, governance and remuneration and its summary does not recommend comprehensive legislative changes to financial services legal framework but does raise a number of issues about potential specific reforms and simplification, and how the current legislation is enforced. It emphasis is on remedial action and it prescribes the regulatory sector and, in particular,  the   ASIC to be more proactive in litigation against the banking and ADIs.

The Royal Commission will increase the employment of inhouse Counsel in the corporate sector because of their overseeing role in ensuring compliance.  The interim report has focused on the   content of the Code of Banking Practice, and there is likely to be more recourse to the insurance companies, and dispute resolution frameworks conducted by the Financial Ombudsman Service and the Australian Financial Complaints Authority.

The Australian financial sector is increasingly part of the global financial industry. It is streaming its laws in the commercial and corporate sector that will be part of an international network and it is necessary that it is scrupulous in its dealings in all transactions. This would require compliance and sound ethical practices for the conduct in accordance with the duty of a fiduciary of due care and diligence.

[1] LLB (Lon) LLM (Lon) Gray’s Inn