Royal Commission's Interim Report: Understanding The Culture Of Greed And Poor Corporate Behaviour In Australian Financial Sector (essay).

The article (below) appeared in the Australian Financial Review (1 October 2018) after the release of the Royal Commission’s interim report on Friday 28 September 2018:

“The royal commission's interim report on Friday lashed the banks, insurers, wealth managers, financial planners, mortgage brokers and superannuation providers for a culture of greed that it concluded was the result of remuneration misincentives and a failure to follow and enforce rules” (p.1).

Mr Frydenberg [Treasurer] told The Australian Financial Review in an interview yesterday that the interim report made clear the financial sector must significantly lift  its  standards and start putting people before profits, and that the regulators must heed the message about better enforcement of existing laws” (p.1).

(Article by: Kehoe, Eyers, Turner, McInnes & Frost)

1. By applying three or more specific cases used in ‘Volume 2 case studies’ of the Interim reportof the Royal Commission, and by applying agency theory, explain how and why “a culture of greed … was the result of remuneration misincentives” (Kehoe et al, 2018, p.1). (1,000 words) (50 marks)

2. The ASX Corporate Council provides  eight central corporate  governance  principles  and recommendations  (2014, 3rd edition) that companieslisted on the  Australian  Securities Exchange must comply  with.Given  that listed banks  and  financial  services’companies must comply with the ASX corporate governance principles, why are there so many examples of poor (unethical) corporate behaviour, as has been revealed by the Royal Commission? Do you think Mr Frydenberg’s callthat the “financial sector must significantly lift its standards  and  start putting people before profits”(Kehoeet al, 2018, p.1)canbe achieved? Provide justification for your response.

3. Compare the behaviour and actions of the Australian banking and financial services sector to the USA banking and financial services organisations implicated with the Global financial crisis (2008). Do you think that a repeat of the Interim Royal Commission findings can be prevented in Australia if the warning of Mr Frydenberg [Treasurer] “the regulators must heed the message about better enforcement of existing laws” (Kehoe et al, 2018, p.1) is followed? Justify your stance by providing cases and discussing any relevant legislation/regulation and the enforcement of legislation/regulation (or lack thereof) in those cases. 

Fees for no service

A Royal Commission (RC), highest form of public inquiry authority of Australia, uncovered the extensive wrongdoing in the financial industry of Australia in the year 2018. RC published the report in which they accuse the industry for valuing the profits over the interest of people. This report mainly expressed the culture of greed adopted by banks and financial institutions of the Australia. This report is named as “scathing” assessment by the government of Australia. This interim report clearly reflects the poor behavior of financial sector.

Since February 2018, the inquiry has heard number of allegations related to customer exploitation and corporate misbehavior. Question is put by the Commissioner Kenneth Hayne, why such misconduct had taken place in the banks and financial institutions. Further, commissioner criticizes the wrong and unethical actions of banks and financial institutions.

Might be the answer of this question is greed, as organization earns short term profits at the cost of basic values, ethics, and honesty. One more reason is there, at the time when misconduct was revealed, either it is not punished or the consequences fail to meet the seriousness of the actions (BBC, 2018).

Following are the three cases published in the Interim report volume 2, and also the way through which these cases clarify the culture of greed in the banks and financial institutions-

Fees for no service- Commonwealth Bank of Australia identify the cases related to fees for no service between the period of July 2007 to June 2015. During this time, CFPL, BW Financial Advice and Count Financial clients were charged from the continuing fees in terms of financial advice, but in reality no such advice was given to the clients. It was acknowledged by the CBA that, they refund almost $118.5 million which also includes interest to all those clients who were affected by this conduct of bank (Daily Mail, 2018). There are number of systematic failures in the CBA which contributed in this conduct-

• CBA fails to ensure the supervision or monitoring in terms of identifying whether planners met their financial service obligations.
• CBA fails to assign the CFPL clients to the active advisers.
• No single source of data is present in terms of identifying the status of constant fee charging from the clients.

The main reason of this conduct is the culture of the organization, as there is misconduct tolerance on part of the CBA executives, which means, conduct of advice licensees of risk were possibly cause damage to the interest of clients but it ensures financial advantage to the CBA in terms of its advice licensees. This misconduct tolerance power of management result in this conduct, as management gives more preference to the financial advantages and not to the interest of their clients.

Inappropriate Advice- Almost 22 financial advisers of Westpac are identified by the ASIC in their “Advice Compliance Program” in the year 2015 in terms of giving the inappropriate advice and this conduct was reported to ASIC. Further, BT financial group take participation in this program conducted by ASIC because of which 11 more financial advisers were identified in terms of giving the inappropriate financial advice.

In terms of this conduct, Westpac pay almost $2.75 million to all those clients who were get affected by the inappropriate advice given by the financial advisers. There are number of evidences which highlight the reasons of this conduct and also reflect that current remuneration framework of the Westpac with its importance on revenue measures, can place the interest of their customers at risk (The Guardian, 2018).

Inappropriate Advice

Improper conduct by advisers- AMP identified almost 81 advisers who were involved in the serious compliance concerns, which means, these advisers were involved in the conduct that was dishonest, illegal, deceptive and/or fraudulent, or gross incompetence or gross negligence. Further, almost 440 financial advisers involved in the conduct which include breach of internal business rules of standards (RC, 2018).

Agency theory introduces the concept in which financial planners and portfolio managers of the organizations are acting as the agents on part of their clients and investment made by them. However, there are number of agency conflicts arise between the agents and clients and this happen because both the parties are driven by different motivations. In other words, both the parties have different goals and because of this easily conflict arise between them (Teebom, 2018).

Above stated case studies of CBA, Westpac, and AMP clearly reflects the culture of greed and such remuneration framework where there is lack of financial motivation for the employees and financial advisers. In case of Westpac, there were no such measures through which financial advisers of the organization were recognized or rewarded when they ensure the best interest of the consumer. In case of CBA, number of evidences were presented by Ms Perkovic’s which established that CBA directed, encouraged or tolerated the identified failings or any such culture is encouraged which result in this conduct. Lastly, in case of MP, reasons are similar as of CBA and Westpac (RC, 2018).

When agents only act in the self-interest, which means they fail to act in the interest of clients then these interest can be redirected in the favor of clients by making change in the incentives. Organization mainly focuses on giving the incentives to those clients which achieves the sales quota, as this encourage the dishonest practices among the employees in terms of reaching the sales targets. Banks further introduce incentives which related to the financial advantage of the organization, and this is the further reason which motivates the employees in acting in the best interest of the business. It is necessary for the banks and organizations to change and redirect their incentive policy by focusing on the interest of their consumers also.

Banks can also use the standard-principle agency models in terms of resolving these issues and restricting such type of practices, as it helps the organization in creating the win-win situation between the employees and clients.

Financial sector of Australia had been shocked few months ago by the revelations made by the royal commission in their interim report, and these revelations drive down the reputations and share price of biggest organizations of the country. This report clearly identifies the non-compliance of ethical standards and corporate governance principles.

Number of cases was reported in which particular way of doing the business by the biggest organizations of financial sector such as CBA, Westpac, AMP, etc. cause actual or possible damage to the customers. However, such ways are not altered by the business even after the identification of its damages, because any change in these procedures cause competitive disadvantage for the organization (Westbrook and Packham, 2018).

Improper conduct by advisers

Inquiry conducted by royal commission heard the cases related to fraud, misconduct, board level deception, bribery, fee-gouging, etc. and moreover, there were accusation of charging fees from dead people. All these cases clearly indicate that, organizations fails to comply with the principles of corporate governance introduced by ASX.

Principle 3 clearly states that all the listed organization must act ethically and responsibly while conducting their business practices. Acting ethically and responsibly not only includes the compliance with legal obligations only, and also involves acting with honesty and integrity and in such manner which is consistent with the reasonable expectations of investors and the broader community (ASX, 2010).  

Such actions of banks and financial institutions reflect the culture where financial advantages are preferred at the cost of honesty and ethical standards. At the time when misconduct was revealed, either it is not punished or the consequences fail to meet the seriousness of the actions, and this is also the evidence which clearly reflects that profits are preferred over the people.

Above stated facts clearly reflects that there is need that “financial sector must significantly lift its standards and start putting people before profits”.

In Australia, regulatory compliance was treated as cost of doing the business instead of the base on which complete business is based. In other words, regulatory compliance was not used as the foundation for conducting the business transaction by the financial sector of Australia.

Regulators are also responsible for this conduct of banks and financial institutions in some manner. Exiting regulatory framework fails to assist the regulators in terms of imposing the discipline on organizations. Regulatory complexity increases the pressure on the resources available to regulators and allows the organization to develop such culture which allows the breach of compliances in indirect manner. Regulatory complexities affect the conducts of banks and other financial institutions, as they interpret the legal requirements in their favor (RC, 2018).

This can be understood with the help of example, ASIC fails to create the required consequences on the conducts of banks and financial institutions. In other words, financial organizations earned profits by contravening the law and cause damage to the customers, which means, profits earned by organizations were more in comparison of the damage cause to the customers. There was no such evidence present which shows that ASIC take this into account while negotiating the results with the accused organizations.

It can be said that, regulators can play more active role in in ensuring that such actions are restricted in Australia. Existing laws are sufficient and there is no need to make changes in the existing laws. The only thing required in this context is the more strict enforcement of laws in Australia (Soos, 2018).

For the Purpose of restricting such incidents, it is necessary to impose pressure on financial firms and regulators in terms of significantly clean up the cultural problems of industry. These problems can be resolved through the reforms in which executives of the bank will be held accountable for the constant misdeeds of the employees and management. In other words, accountability of the unethical actions will also impose on the top management of the organization. Interim report published by Royal commission clearly held the banks, insurers, financial planners, etc. accountable for developing the culture of greed and further states that this culture is the result of the remuneration disincentives and failure of management to follow and enforce the rules in effective manner.

Mr. Frydenbergy also state that financial sector needs to lift their standards in terms of dealing with the customers and they need to put the people before the profits, and responsibility also imposed on the regulators to enforce the existing laws in serious manner (Kehoe et al, 2018).

On the other hand, things are completely different in USA as there strict enforcement of laws and punishments against all those organizations which involved in any such conduct. In other words, forceful actions are taken against the management of the organizations if regulators find any kind of wrongful conduct on continuous part in the organization. It can be said that, regulatory environment of USA is completely different from Australia, as it is very strict and severe consequences of breach in USA.

USA Banking system ensures stability, because any instable operations will have ripple effects consumers and other sectors (national/international). Supervision in this context must be focus on financial stability which follows up the trends and analyses the financial and other actions of the banks. Therefore, it can be said that banking system of USA is completely different from Australian banking industry, as there are strict provisions against the organizations involved in any such conduct (Deloitte, 2014).

References:

ASX, 2010. ASX Corporate Governance Council. Available at: https://www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf. Accessed on 27^th November 2018.

BBC News, 2018. Australian banking inquiry: Misconduct 'driven by greed'. Available at: https://www.bbc.com/news/world-australia-45674716. Accessed on 27^th November 2018.

Daily Mail, 2018. More fees for no service questions for CBA. Available at: https://www.dailymail.co.uk/wires/aap/article-5631101/More-fees-no-service-questions-CBA.html. Accessed on 27^th November 2018.

Deloitte, 2014. Enforcement actions in the banking industry. Available at: https://www2.deloitte.com/content/dam/insights/us/articles/bank-enforcement-actions-trends-in-banking-industry/DUP1372_EnforcementActionsBanking_120815.pdf. Accessed on 27^th November 2018.

Koehr, J. Turner, James, E. McInnes, William and Frost, J. (2018). Reality check on the big stick. The Australian Financial Review, 1.

RC, 2018. Interim Report (volume 1). Available at: https://financialservices.royalcommission.gov.au/Documents/interim-report/interim-report-volume-1.pdf. Accessed on 27^th November 2018.

RC, 2018. Interim Report (volume 2). Available at: https://financialservices.royalcommission.gov.au/Documents/interim-report/interim-report-volume-2.pdf. Accessed on 27^th November 2018.

Soos, P. 2018. Banking inquiry has already exposed shocking corruption – but it needs more time. Available at: https://www.theguardian.com/australia-news/commentisfree/2018/mar/22/banking-inquiry-has-already-exposed-shocking-corruption-but-it-needs-more-time. Accessed on 27^th November 2018.

Teebom, L. 2018. The Agency Theory in Financial Management. Available at: https://smallbusiness.chron.com/agency-theory-financial-management-81899.html. Accessed on 27^th November 2018.

The Guardian, 2018. Banking royal commission: Asic head told 'you are not naming enough names' – as it happened. Available at: https://www.theguardian.com/australia-news/live/2018/nov/22/westpac-macquarie-commonwealth-bank-bosses-pay-royal-commission-live?page=with:block-5bf5f3cbe4b0c5a9540a2f6f. Accessed on 27^th November 2018.

Times, C. 2018. Banking Royal Commission is on track to expose a culture of greed. Available at: https://www.smh.com.au/national/act/banking-royal-commission-is-on-track-to-expose-a-culture-of-greed-20180313-h0xfc6.html. Accessed on 27^th November 2018.

Westbrook, T. and Packham, C. 2018. UPDATE 2-Australia's banks put profit over people - inquiry report. Available at: https://www.cnbc.com/2018/09/28/reuters-america-update-2-australias-banks-put-profit-over-people--inquiry-report.html. Accessed on 27^th November 2018.