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Presentation by Elaine Campbell to Duncan Cotterill Law

The subject I’ve been asked to talk about is how to deal with the FMA when things go wrong.

We’d prefer that never happens.

Despite what you might believe from what you read in the media, sorting out things going wrong is only a proportion of our work.

The rest of what we do is dedicated to ensuring things go right.

Special role of legal practitioners

As legal advisers, you will be advising firms on meeting their regulatory obligations.

Ensuring compliance is one thing – making sure clients have the right systems to ensure they are meeting their regulatory obligations.

But - at times, you will be presented with instances where things have clearly gone wrong, where there is either an outcome that is less than would be expected, or – in the worst case – a direct breach of statute or regulation. 

As legal advisers, you are likely to be told about those things quickly.

Or, we would hope you are told about them quickly anyway.

In those instances, we’d encourage you to come to us - voluntarily - and disclose what has happened and what the firm is doing to remedy it. 

We will be looking to enter into a dialogue with you.

At the point of the first contact, we won’t be expecting fully-formed solutions, but we will want to know your client has the resources dedicated to finding them.

In most instances, that will lead us to take a facilitative stance.

From the perspective of your clients, it’s likely to mean we’ll be as interested – or more interested – in the remedial action they are taking, rather than what has gone wrong.

We won’t tell you how to fix the problem.

We don’t provide advice at that level.

But we will back you in making the fix yourselves. Provided that is that we are satisfied the fix will address the root causes, and that the firm is cleaning up any consequences for clients, investors, or other firms.

In extreme cases we might end up having to get involved with you on two levels; compliance and enforcement. 

If we do get involved, how you respond on our compliance concerns might influence our enforcement response.   

Practically, when you are faced with these situations we will be interested to understand how quickly the firms’ systems detected the problem and, if there was a lag in the improvements, how you brought the situation under control to prevent recurrence in the meantime.

I mentioned earlier about these situations involving a dialogue. 

The first time you pick up the telephone should be to let us know that a problem has been identified by your client, and that they are working   on scoping it, as well as remediation. 

Give us a timetable. 

Once a resolution path is agreed we will likely want regular updates on how things are going.

Implementing the Act

Throughout last year – 2014 – we carefully assessed how we would implement the new Financial Markets Conduct Act 2013.

For those of you who don’t know, the Act effectively consolidates securities and financial services law in New Zealand into one statute.

It overhauls directors’ duties in making public offers, it gives the FMA extensive powers, and it recognises the right of investors to high-quality information in making investment decisions.

The Government has been clear on what it expects as a result of the Act.

Markets that are run fairly, and where misconduct is a rare thing, and penalised where we find it.

Better information and advice for investors and consumers.

Firms and professionals that are meeting higher standards of conduct.

We had a choice – which is that we could implement the Act in an incremental way, demanding line-by-line compliance with pre-determined standards.

Box-ticking on steroids, effectively.

Another route – and this is the one we chose – is to allow firms, for the most part, to establish their own systems.

So, we’re focussing our effort, on the results that are apparent in the market, rather than the detail of how you do it.

Role of boards and senior management

Read our strategic priorities, published just before Christmas, and you will see we emphasised the role of boards, senior management, and company governance, in ensuring the outcomes I’ve just described. 

One of the lessons from GFC was the lack of accountability in the board room and I will talk you through an example later.

So, as legal advisers, I’d suggest you aim to start at the top – with boards and the C-suite - when you are giving advice on the Financial Markets Conduct Act.

We are on the record – at various times in the last year - as saying that boards and management teams that want to comply with the spirit of the Act should ask themselves:

-         What information they receive on, for example, complaint rates and what happens to those complaints. The subject of those complaints and recurring patterns of complaints

-         Sales practices, especially those where advisers or sales staff are being remunerated according to sales by-type or by-volume. For these purposes, remuneration includes cash and any soft-dollar benefits

-         Quality of disclosure for products or services, including disclosure to investors or consumers as to the benefits an advisor might be receiving

-         Conduct between professionals. So, for example, in a financial advisory practice how advisers conduct themselves towards advisers from another firm. People often overlook the fact that the FMA is interested in the whole industry, not just the places where firms sell to retail investors or consumers. Wholesale and institutional practices matter - and  we  expressly have jurisdiction  in this area

Good systems should be surfacing these types of issues and allowing boards - or senior management - to make decisions about them, and ensuring consistent follow-up. 

So, ask your clients what systems they do have … and challenge them as to their adequacy. 

Ask to see what management information the board or C-suite receive on these matters and what they do with it, if they do get it.  We think it needs to focus on trends over a long span of time, not just the past month.

There’s been a good example in Australia that illustrates the point.

It’s the subject of several detailed public reports, which makes it easy to discuss.

One of Commonwealth Bank’s advisory firms – Commonwealth Financial Planning – was the subject of a review by the Australian regulator, because it was apparent that some of its advisers were giving very poor advice and to the cost of clients.

That included advisers selling investors products that were unsuitable for them.

Subsequent inquiries indicate losses to several thousand clients as a result.

CBA has already paid 51 million dollars back to clients, and it has been forced into a public remediation that may lead to it paying more.

The misconduct continued over at least five years.

During that time, the Australian regulator had a third-party audit firm checking Commonwealth Financial Planning to try to bring about an improvement.

Commonwealth Bank was – effectively - on notice from the regulator to improve the firm’s performance by a quantum leap.

From the point of view of governance, Commonwealth Bank apparently didn’t have sufficient information – at least at the highest levels – to realise what was happening, even after the regulator put the bank on notice.

The extent of the complaints, and the nature of them, apparently didn’t register.

Decisions were made lower down at the financial planning firm – including an adviser getting a promotion despite grave questions about his conduct – that a well-informed board or senior management team should have questioned.

The remuneration arrangements at the planning firm have also been identified as one of the underlying causes of the chronic misconduct.   

Remember: change in rhetoric is insufficient. There must be a change in the underlying business practices and structures that support what managers say.  

A board can extol the need for good consumer outcomes, but where its structures actively work to undermine that … it just adds up to well-intentioned talk. 

FMA’s hierarchy of supervision

An important point of language.

We’re not especially interested in compliance per se.

Participants should do what regulation requires of them – that is, comply with the law.

In our view – however – compliance is necessary but inadequate on its own.

We’re anticipating higher standards than compliance alone.

Especially as measured in outcomes.

You should be telling your clients that.

A system that complies but which produces poor results - for example, it allows on-going and widespread poor conduct among a sales force – is a poor quality system.

Here’s our hierarchy of supervision.

Licensing is the first rung on our ladder. Required now for almost all businesses that are working in financial services.

From 1 December 2014, the transition period commenced for a further 400 or so businesses, including derivatives issuers and managed funds, to be licensed.

That’s on-top of the ones we already licence or authorise – AFAs, auditors, QFEs, futures’ dealers, registered KiwiSaver schemes, and the NZX and its sub-markets.

Don’t take licensing lightly.

We do decline licences.

Firms applying for a licence would be better served investing early rather than endeavouring to regain ground once they receive a “minded to decline” letter.

Without a licence, a participant doesn’t have a ticket to the game.

If a firm loses its licence, or it’s declined, and continues to operate, it is doing so unlawfully. 

We understand that the consequences for those participants that do not make the grade – they are effectively out of business.

But we must be satisfied that the firm or professional can effectively perform the service in order to get a licence. If they can’t, we will be inclined to decline.

Licensing allows us to make an initial assessment of a business, including who is running it, the how it is governed,   quality of the systems, and operations and whether we think it can continue to meet the regulatory standards.

Firms that are within our licensed or regulated populations are then subject to supervision, including ensuring they are complying with the basics, which in most cases will include licence conditions with ongoing regulatory reporting to the FMA.

The intensity of supervision varies, according to our priorities, and the nature of the business.

The strategic priorities I showed you earlier are a good high-level guide to where we will pay the most attention over the medium-term.

So, taking sales practices as an example, we have been paying particular attention to sales practices where consumers and investors are offered switches between KiwiSaver scheme providers.

We think some of that switching isn’t a benefit to the consumers, and may actually come at their cost.

We published on the subject of KiwiSaver switching practices last year, saying we had concerns about some of the practices we are seeing in our supervision.

Again, we are looking for systems, within firms, that ensure conduct like that isn’t occurring on a widespread and systematic basis. 

Where we had concerns about particular providers, we got engaged at C-suite and board level to make known those concerns and the need for change.

Top of the supervision ladder

Under the Financial Markets Conduct Act, we have some new remedies that we can apply, where we think there is cause.

These include infringement notices, with a pecuniary penalty.

Warnings to firms, which are required to be made public by the firms that are subject to them.

And directions and stop orders, that allow us to direct a firm to change its practices or take a particular action.

To date, we have used the warnings and the direction tools, although in each case where we did so, the firms responded as we had sought before we issued the warning, or directions.

These remedies are in the Act because they are an effective means of ensuring high standard of conduct, allowing us to act quickly and directly if we need to. 

These types of remedies are widely used by regulators overseas … our Australian peer, ASIC, has similar remedies that it uses.

I anticipate that we will be applying these remedies in the future, as part of our regular supervision. 

These are supervisory tools … intended to influence behaviours and outcomes directly, and we won’t retreat where we think they should be used.

Case study – supervision practices

Let me come back to our supervision practices, because that’s where the rubber hits the road.

For the majority of your clients, their biggest engagement with us will be when we come to look closely at their systems and practices.

That’s often by way of a supervision visit, or series of visits.

A few operating principles for supervision visits.

-         Your client needs to get ready well in advance. We will give four to six weeks written notice of a supervision visit. But – in practice – it’s much longer because we have already talked to the firm about it. Firms know well in advance what we will be asking to see, so have it available, and the experts who can speak to it.  Most often the ‘what and the who’ will be agreed in this discussion- your clients know their business best so we  get them to explain how they gain assurance over the issues we are concerned about. For the top end of town, with bigger firms, the FMA also engages via a relationship approach, involving a dedicated FMA person, so we will already be familiar with the firm.  

-         Encourage your client to tell us about problems they are having, and what they are doing to remedy them. The more upfront firms are, the easier it is for us.  Seeing that a firm can identify and resolve problems gives us confidence, so the regulator-to-firm relationship is improving.  Every firm will have problems – we expect this.  We will be suspicious where a firm maintains it has no issues.

-         Specifics matter to us. General statements or general overviews don’t assist us. We are interested in hard data, and specific outcomes. Volunteering high-quality data to us reduces the workload for us and for firms.

-         Tell your clients that they can expect to receive formal, written feedback on what we have found and they should be responding to it. We’re willing to brief at board level, or senior executive level, if required on the results, or get to the results we need. If you don’t think the client has been given sufficient feedback, or your client is unclear, ask for more.

Finally, we are here to facilitate improvements in conduct in the firms we regulate.

We aren’t here to enter into antagonism.

You should expect professionalism from us, and show professionalism to us.

Summing up

To sum up, in advising your clients, I would urge you to:

-         Read our major sector reports as they come out. We publish reports regularly on QFEs, financial advisors, auditors, the NZX, and KiwiSaver, as well as special reports on subjects we believe need attention. Plus read our strategic priorities. They show you the areas we are prioritising, and they give you an insight into what we are finding. Use other peoples’ experience to help your clients. The more you know about what we are anticipating, the easier it will be.

-         Get beyond compliance. Meeting the basics is just that. We are expecting firms to do much more in order to meet the spirit of the Act. Specifically, your client’s should be running systems and practices that reassure them that the highest standards of conduct are apparent. Find out what systems other firms are running and tell your clients about that.

-         Take your advice to the top. We anticipate that boards and senior management will understand the systems that their firms are running, and the results they are producing. Don’t park regulation with a compliance manager and leave it there. It won’t get the priority it requires.

-         Expect feedback from us on what we find. If your clients don’t get sufficient from us, ask for more. Enter into engagements with us professionally and anticipate that we will do the same.