In brief - What will the Commission's findings mean for the future of fines and penalties cover?

The insurance industry could face potentially significant repercussions from the banking royal commission's findings, which may include increased premiums, stricter regulation and focus on underwriting discipline. In particular, the possibility of class actions, civil penalties and criminal prosecutions means that considerable focus could be directed at cover for civil fines and penalties under professional indemnity, and directors' and officers' insurance policies. 

Banking royal commission's terms of reference

In a letter to the Treasurer on 30 November 2017, signed by the chairpersons and chief executives of ANZ, Commonwealth Bank, NAB and Westpac, the "big four" banks argued that despite prior resistance, it was in the national interest for the political uncertainty to end. On the same date, the Prime Minister announced a royal commission into the banking sector. 
 
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was established via Letters Patent executed by the Governor General on 14 December 2017. The Letters Patent contain the terms of reference for the Commission and notes the right of Australians to be treated honestly and fairly in their dealings with banking, superannuation and financial services providers:
 
The highest standards of conduct are critical to the good governance and corporate culture of those providers… these standards should continue to be complemented by strong regulatory and supervisory frameworks that ensure all Australian consumers, including business, have confidence and trust in the financial system.
 
The Commission was called to enquire into a range of matters, including:
  • Whether conduct by financial services entities might amount to misconduct and if so whether the question of criminal or other legal proceedings should be referred to the relevant agency.
  • The effectiveness of mechanisms for redress for consumers of financial services who suffer detriment as a result of misconduct by financial services entities.
  • The adequacy of:
  1. existing laws and policies of the Commonwealth relating to the provision of banking, superannuation and financial services entities;
  2. internal systems of financial services entities; and 
  3. forms of industry self-regulation -
to identify, regulate and address misconduct, meet community standards and expectations and provide redress to consumers.
  • The effectiveness and ability of regulators of financial services entities to identify and address misconduct. 
  • Whether change is required - in the legal framework, practices of entities and regulators.
The Hon Kenneth Hayne AC was appointed Royal Commissioner. His Honour was a Justice of the High Court from 1997 to 2015, prior to which he was a Justice of the Victorian Supreme Court and the Victorian Court of Appeal. On his retirement, His Honour was appointed a professorial fellow at the Melbourne Law School, University of Melbourne.

Commission receives more than 5,000 submissions and produces twelve banking industry background papers since commencement

Public hearings commenced on 12 February 2018. 
 
The hearings are being conducted in a number of rounds - one for each of consumer lending practices, financial advice, and loans to small and medium enterprises. 
 
As at 18 May 2018, 5,540 submissions had been received by the Commission, predominantly in relation to banking, financial advice and superannuation. The online form for submissions includes opportunities to describe the misconduct of a financial services entity, what contributed to the misconduct, and steps taken to complain about the misconduct. Submissions can also include views on changes the Royal Commission should recommend. 
 
To date, the Commission has published twelve Background Papers, including papers authored by the Commission, Treasury and APRA. The papers address:
  1. Features of the Australian banking industry
  2. Features of the Australian mortgage industry
  3. Features of car financing in Australia 
  4. An overview of the Australian law regarding everyday consumer credit
  5. A request for information reforms to Consumer Lending
  6. Features of the Australian financial planning industry, training requirements for financial advisors and financial products available to retail investors
  7. The legal framework of the provision and sale of financial products and advice 
  8. Reforms in the regulation of financial advice
  9. Regulatory framework for authorised deposit-taking institutions (ADIs)
  10. Credit for small business
  11. A request for reforms to small business lending
  12. Financial services and small and medium sized enterprises.
The hearings have been conducted by reference to case studies in relation to particular topics. The Commission hears evidence from consumer witnesses, from representatives of the relevant bank and from representatives of consumer advocacy groups. 

Rowena Orr QC delivers submissions to the Commission following completion of round 1 and 2 hearings

Round 1 and round 2 hearings are complete. Written submissions, exhibits, webcasts and transcripts are provided on the Commission's website. 
 
In closing submissions for rounds 1 and 2, Counsel assisting the Commissioner, Ms Rowena Orr QC, submitted that it was open to the Commission to make findings of misconduct and conduct falling below community standards and expectations by a number of financial services entities. 
 
The misconduct and conduct that has fallen below community standards and expectations was submitted to have occurred in respect of:
  • consumer credit products: home loans, car loans, credit cards and overdraft facilities 
  • the selling of insurance with credit products.
  • a variety of account administration and processing errors made by financial services entities in connection with credit products, such as home loans 
  • the provision of financial advice by employees and authorised representatives of financial services entities, in the context of fees being charged for no service, platform fees, inappropriate advice, improper conduct, and the disciplinary regime 
Responding submissions were invited in writing in both cases.

Potential impact of the Commission for the insurance industry

The Commission has been closely watched by many and has attracted heavy media attention. The implications of potential findings for the insurance industry are extensive - particularly for professional indemnity, and directors' and officers' insurance. 
 
Following the Commission there is the potential for civil class actions, proceedings for civil penalties and criminal prosecutions. These actions might be brought against companies and individuals.
 
ASIC has come under scrutiny for the extent to which it has exercised its powers in the financial sector. This might suggest a more active regulatory environment in future. 
 
Media have reported on whether the Commission might result in increased insurance premiums, more intense focus on underwriting discipline and the tightening of the scope of policy coverage. 

The future for fines and penalties cover?

As part of the fallout from the Commission, the extent to which claims against defendants are capable of being insured, or should be insured, is likely to attract attention. Fines and penalties is one area where considerable focus could be directed. 
 
It is common for professional indemnity and directors' and officers' insurance policies to extend cover for civil fines and penalties. 
 
Policies generally carry exclusions for dishonest, fraudulent or intentional acts or omissions. However, these exclusions can be problematic in practice. One of the common reasons for this is that many policies require insurers to advance defence costs until such time as there is a final, non-appealable adjudication, establishing the alleged acts or omissions. This means that actions are often resolved by negotiation prior to a final adjudication - in those circumstances the exclusions are not triggered. Further, claimants may deliberately avoid making such allegations which would otherwise trigger these types of exclusions. There is also no guarantee that a final judgment will contain the findings required to establish that the exclusion applies. 
 
The insurability of conduct, as a matter of public policy, might also come into play. In 2013, The Honourable TF Bathurst, Chief Justice of New South Wales was asked to provide a "View from the Bench" in relation to insurance law. In his remarks, His Honour considered directors' and officers' insurance and commented:
 
In the case of directors and officers, personal liability seeks to respond to the fact that such persons, along with other "gatekeepers" such as auditors, have a significant role to play in ensuring sound company practice and market integrity. This "gatekeeper theory" suggest that holding directors and officers directly liable not only provides a deterrent to reckless behaviour by such officers, but will lead to better overall conduct by companies…. Personal liability also seeks to respond to circumstances where directors' and officers' wrongdoing is motivated by self-interest…
 
In those circumstances, it can be argued that D&O insurance provides too much insulation from risk, creating a moral hazard by removing any chance that directors will have to meet liability from their personal funds.
 
There are of course legislative restrictions on the extent to which directors and officers can be indemnified for their personal liability, including those in the Corporations Act 2001. Beyond the legislative provisions, there is likely to be increasing levels of disagreement between industry participants, regulators, and possibly the judiciary, as to the extent that the types of conduct alleged in the Commission should be insurable for the "gatekeepers" Bathurst CJ had in mind.

What next at the Commission?

Round 3 hearings commenced on 21 May 2018 and conclude on 1 June 2018.
 
An interim report is to be produced by the Commission on 30 September 2018. A final report and findings are due on 1 February 2019. There is widespread discussion as to whether the Commission's term may be extended. 
 
The insurance industry will be closely watching and preparing itself for potentially significant repercussions.

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal or financial advice. Please seek your own legal or financial advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​

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