Remediation Round-Up: Legal basis for remediation

This article is a part of our Remediation Round-Up series which explores potential issues for financial services licensees when conducting remediation and ways to optimise the design of remediation programs.

 

Issues to consider
Is your potential remediation program:

• sufficient to cover any statutory, contractual, tortious or equitable claims that customers could bring in respect of the conduct sought to be addressed by the remediation?
• tailored to address the risk of further litigation or ASIC regulatory action, including potential enforcement action or the use of ASIC’s proposed directions power?

Please get in touch with our experts on remediation issues in respect of financial and credit services if you have any questions.

 

Introduction

Prior to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), remediation for misconduct played a cornerstone role in ASIC’s regulatory strategy. While the Royal Commission has prompted a regulatory pivot towards enforcement, remediation continues to be a central tenet of regulation in financial services.

The obligation to remediate usually arises in the context of a legal liability, deriving from a potential cause of action against a licensee. Effective remediation is important in ensuring protection of consumer interests. But it can also play a crucial role in managing legal and regulatory and reputational risk faced by a licensee (including the potential to reduce future compensation claims and enforcement).

Remediation is also important from the perspective of a licensee doing all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly. In some cases, remediation where it forms part of the financial service might be seen as a necessary step towards negating the relevant defect or misconduct, so as to ensure that the overall service has been provided efficiently, honestly and fairly.

This chapter covers the key legal reasons why licensees may need to consider remediation. It is important for a licensee to consider the source of potential liability as this will impact on the nature and quantum of any remediation.

Remediation is relevant to many different regulatory settings, including statutory regimes governed by ASIC, APRA, the ACCC and AUSTRAC. Unless the context otherwise requires, references in this guidebook to ASIC should be interpreted as extending to these other agencies.

 

Contract, equity and tort

Remediation may arise due to a need to discharge potential liability for:

• contractual damages;
• account of profits or breach of trust, where the financial service provider is a fiduciary;
• equitable compensation for fraud, mistake, unconscionable dealing or any other categories of unconscionable conduct; or
• tortious damages for negligence or misrepresentation.

 

Statutory causes of action

Remediation of an affected customer may be required where there has been a breach of a legislative obligations, such as:

• contravention of a civil penalty provision in the Corporations Act 2001 (Cth) (Corporations Act);
• contravention of a provision of Sub-division C or Sub-division D of the ASIC Act 2001 (Cth) (ASIC Act); or
• as a superannuation trustee, breach of a statutory covenant under the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act).

In all cases, there must be some loss or damage to the customer that needs to be remedied. In some cases, this will not be immediately apparent. For example, where a customer has made a decision based on defective disclosure, what is the quantifiable loss to the customer that must be remedied?

In some cases, it is either not possible to definitively assess what quantum of loss has occurred or whether certain customers have in fact been impacted, or alternatively, it is prohibitively expensive to investigate and ascertain the exact parameters of customer loss.

 

Case study – remediation reduces liability in litigation

A customer class action was filed against a major bank in relation to the sale of financial products. The class action alleged, among other things, breaches of ASIC Act sections 12CB and 12DA and Corporations Act sections 961B and 961G. With engagement from ASIC, the bank had proactively completed a remediation program to provide refunds for the affected clients, before proceedings were filed. In the class action, the claims would be reduced by the value of the remediation, thereby demonstrating how remediation can be used to mitigate against potential litigation.

 

AFCA systemic issue remediation

The Australian Financial Complaints Authority (AFCA) has broad power to investigate issues that it considers to be systemic in nature. As part of this process, the AFCA Rules empower AFCA to unilaterally require member firms to do or refrain from doing anything to resolve the systemic issue, which specifically includes requiring member firms to remedy loss or disadvantage suffered by a consumer or small business:

“whether or not the recipient of the remedy has complained.”

The likelihood that AFCA will investigate a systemic issue may depend on a number of factors such as the nature of the alleged conduct, the volume of customer complaints to EDR and the nature of regulator involvement.

Given this risk, and depending on the circumstances, a remediation program may need to take into account the position that AFCA may take on the approach and scope for remediation, if AFCA were to become involved.

AFCA is also required to report certain matters to ASIC, APRA, the ATO or in some circumstances, any other appropriate body. A mandatory reporting obligation with respect to a particular complaint or issue arises if AFCA:

• identifies a systemic issue;
• becomes aware that a serious contravention of any law has occurred;
• becomes aware of a contravention or breach of the governing rules of a regulated superannuation fund or approved deposit fund, or the terms of an annuity policy, life policy or retirement savings account;
• becomes aware that a financial services provider may have refused or failed to give effect to a determination made by AFCA; or
• considers that a complaint that has been settled may require investigation.

AFCA is not specifically required to notify the financial services provider when it intends to report or has reported any of these matters to a regulator. Additionally, these reporting obligations arise when AFCA forms the relevant view about the matter, and in this regard ASIC has indicated that AFCA should not necessarily wait until a matter has been finalised.

 

AFCA external dispute resolution

Individual complaints to AFCA about particular conduct can also result in a member firm being required to provide a greater amount of compensation than that which a customer may be entitled to under the law, and greater than what is offered under a remediation program.

This is because AFCA is not required to make a determination that adheres to the law. Rather, AFCA is required to make a determination primarily by reference to what it considers to be fair in all the circumstances.

In this regard, it may be appropriate to consider whether remediation is warranted to proactively address this risk.

 

Breach reporting and ASIC directions

On 31 January 2020, the Government released exposure draft legislation which will enable ASIC to give binding directions to financial services licensees to address suspected prior or future contraventions of a financial services law.

This will give ASIC a far-reaching new power to give directions, including a direction on a licensee to establish and implement a specified customer compensation program as prescribed by ASIC.

The directions power is expected to give ASIC a tool to mandate particular aspects of a remediation program, without a need for lengthy negotiation. For example, it may be possible that a direction could be given to require remediation to occur:

• to specified classes of affected customers;
• through specified methods (e.g. with specified requirements around the format, timing and content of communications with customers); and
• of a specified amount to each affected customer.

These powers have not yet been enacted, and it remains to be seen how intrusive they may be and how ASIC will use them.

 

Ex gratia remediation

In some cases, a licensee may determine to implement an ex gratia remediation program. This could be for reputational reasons, as well as to avoid having to undertake a costly and time consuming review to determine whether remediation is legally required.

In such cases, the licensee will need to give careful consideration to the proposed remediation approach, including the quantum of remediation and whether the remediation should be used to seek a discharge from potential future claims.

 

Determining whether the remediation exercise is ex-gratia or is in satisfaction of a legal obligation

This is an important issue as it is often not clear whether the relevant financial institution has a strict legal obligation to compensate or is rather offering payments on an ex-gratia basis. In some cases, there may be a legal obligation but the financial institution is knowingly paying above the required level of compensation because it is too difficult or too costly to determine the exact quantum of compensation.

 

‘Efficiently, honestly and fairly’

The Corporations Act 2001 (Cth) (Corporations Act) imposes a statutory obligation on financial services licensees to:

“do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly”

Although customers do not have standing to make a claim for compensation for a breach of this obligation, ASIC has expressed a view that the obligation itself requires licensees to remediate customers ‘if things go wrong when financial services are provided and clients suffer loss or detriment’.[1]

This view does assume that remediation is a material part of a financial service (noting that above obligation applies to financial services covered by the Insurer’s AFSL).

From one perspective, in a situation where a financial service has not been provided efficiently, honestly and fairly, remediation might be seen as a necessary step towards negating the relevant defect so as to ensure that the overall service has been provided efficiently, honestly and fairly.

For example, it could be said that a customer who is charged an incorrect fee for a financial service will still have been provided the service efficiently, honestly and fairly if they are appropriately compensated for any excess fee.

Less clear is ASIC’s position that affected customers should be identified and compensated in an ‘efficient, honest and fair manner’. This has not been tested in court, and in any case the actual extent to which licensees would be required by this obligation to conduct remediate customers in a particular manner will depend significantly on the particular facts of a situation. such as:

• the practicality, cost and time requirements of taking one possible remediation approach over another;
• the quantum of remediation that affected customers are legally entitled to receive, weighed against the cost of a particular remediation approach; and
• the number and proportion of affected customers that are likely to receive compensation.

 

Sources of compensation funds

An integral part of remediation is to consider where funding for remediation will emanate from. Issues of insurance cover, the right of indemnification for trustees, third party redress, as well as whether shareholder funding is necessitated may be relevant to a particular remediation exercise. These issues will be addressed in a future article of the Remediation Round-Up series.

 

To keep up to date with the Remediation Round-Up series and our latest regulatory updates see our blog FSR Australia Notes.

 

[1] RG 256.14