House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 12 - Investigating and remediating misconduct (recommendations 1.6 and 2.9)

Outline of chapter

12.1 In addition to the measures described in Chapter 11, Schedule 11 to the Bill implements recommendations 1.6 and 2.9 of the Financial Services Royal Commission, which called for Australian financial services licensees and Australian credit licensees to be required, as a condition of their licence, to make whatever inquiries are reasonably necessary to determine the nature and full extent of the misconduct. Licensees are required to investigate potential and actual misconduct engaged in by financial advisers and mortgage brokers, and to inform and remediate affected clients.

Context of amendments

12.2 A person who carries on a financial services business must hold an Australian financial services licence (section 911A of the Corporations Act). A financial services licensee is subject to general obligations under section 912A of the Corporations Act, including the obligation to do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly (section 912A(1)(a) of the Corporations Act).

12.3 A financial services licensee must have in place adequate arrangements for compensating retail clients for loss or damage suffered because of breaches of the Corporations Act by the licensee or its representatives (section 912B of the Corporations Act).

12.4 Similarly, a person must not engage in a credit activity if the person does not hold an Australian credit licence authorising the person to engage in the credit activity (section 29 of the Credit Act). An Australian credit licensee is subject to general conduct obligations under section 47 of the Credit Act, including the obligation do all things necessary to ensure that the credit activities authorised by the licence are engaged in efficiently, honestly and fairly (section 47(1)(a) of the Credit Act).

12.5 A credit licensee must also have in place adequate arrangements for compensating consumers for loss or damage suffered because of breaches of the Credit Act by the licensee or its representatives (section 48 of the Credit Act).

12.6 ASIC's Regulatory Guide 256: Client review and remediation conducted by advice licensees provides guidance on the broader remediation framework under general licensee obligations (see sections 912A and 912B of the Corporations Act). The guide also includes guidance in support of these obligations, which Australian credit licensees should also consider in reference to their obligations under the Credit Act.

12.7 Despite these requirements imposed on financial services licensees, the Financial Services Royal Commission found that when an Australian financial services licensee detects that an adviser has engaged in misconduct (whether by giving inappropriate advice or otherwise), entities do not always consider what steps they should take to see whether the adviser may have acted inappropriately in respect of matters other than those that are the immediate focus of attention. Commissioner Hayne found that the result is that the damage done by an adviser may not come to light until long after the event, which works to the detriment of both the affected clients and the entity.

12.8 To address these findings, the Financial Services Royal Commission recommendation 2.9 was that a financial services licensee should be required, as a condition of their licence, to take the following steps when they detect that a financial adviser has engaged in misconduct in respect of financial advice given to a retail client (whether by giving inappropriate advice or otherwise):

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make whatever inquiries are reasonably necessary to determine the nature and full extent of the adviser's misconduct; and

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where there is sufficient information to suggest that an adviser has engaged in misconduct, tell affected clients and remediate those clients promptly.

12.9 Recommendation 1.6 of the Financial Services Royal Commission was that credit licensees should take the same steps in response to detecting misconduct of a mortgage broker as those referred to in recommendation 2.9 for financial advisers.

Summary of new law

12.10 Schedule 11 implements recommendations 1.6 and 2.9 of the Financial Services Royal Commission, which called for Australian financial services licensees and credit licensees to be required, as a condition of their licence, to investigate potential and actual misconduct engaged in by financial advisers and mortgage brokers, and to inform and remediate affected clients.

12.11 The obligation on Australian financial services licensees and credit licensees to investigate and remediate contains two limbs:

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first, when a licensee detects misconduct, the licensee is required to:

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within 30 days, inform potentially affected clients of misconduct; and

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investigate the nature and full extent of any misconduct (including the loss or damage the affected client or consumer has suffered or will suffer) within a reasonable amount of time; and

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second, once an investigation is complete, the licensee is required to:

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within 10 days, inform the affected client of the nature and full extent of the misconduct; and

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within 30 days, remediate the client's or consumer's loss.

12.12 The amendments made by Schedule 11 to implement recommendations 1.6 and 2.9 builds on an existing remediation framework that aims to ensure consumers are remediated in a fair, honest and efficient manner and put back in the position they would have been had the misconduct not occurred. The purpose of recommendations 1.6 and 2.9 is to address a particular sub-set of licensees (those that provide personal advice and credit assistance) and high-risk conduct that has historically remained undetected for undue periods. It does not replace existing obligations, nor remove a person's existing rights to take civil action or complain through alternative dispute resolution processes.

12.13 The existing remediation framework under a licensee's general obligations and the specific obligations under the amendments to notify, investigate and remediate must be considered concurrently. For example, in circumstances where a person falls out of scope at any stage of the obligations under the amendments to notify, investigate and remediate, they must continue to consider the requirements under the existing remediation framework in deciding whether it is fair, honest and efficient to remediate.

Comparison of key features of new law and current law

Detailed explanation of new law

Amendments to the Corporations Act

12.14 The amendments to the Corporations Act impose the new investigation and remediation obligations. These obligations require Australian financial services licensees to:

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notify clients affected by misconduct (section 912EA of the Corporations Act);

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investigate the nature and full extent of misconduct and remediate affected clients (section 912EB of the Corporations Act); and

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maintain records to show compliance with these obligations (section 912EC of the Corporations Act).

Notifying clients affected by certain reportable situations

Obligation to notify affected clients regarding misconduct

12.15 Under the obligation to notify misconduct, an Australian financial services licensee must take reasonable steps to notify a person if all of the following are satisfied:

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the licensee or a representative of the licensee provides or has provided personal advice to the person in relation to a relevant financial product;

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there are reasonable grounds for the licensee to believe that a reportable situation has arisen, and that reportable situation:

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amounts to a significant breach of a core obligation;

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amounts to gross negligence;

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amounts to serious fraud; or

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is a reportable situation because other circumstances prescribed by the regulations exist; and

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there are reasonable grounds for the licensee to suspect that both:

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the person has suffered or will suffer loss or damage as a result of the reportable situation; and

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the person has a legally enforceable right to recover the loss or damage from the licensee.

[Schedule 11, item 6, section 912EA(1) of the Corporations Act]

12.16 The person that must be notified is the affected client. Notifying the client allows the client to consider their rights and the ways they can mitigate potential loss or damage arising from the reportable situation.

12.17 The circumstances where a licensee detects misconduct that has potentially resulted in loss or damage for a client are provided at sections 912EA(1)(a), (b) and (c) of the Corporations Act.

12.18 First, there must be a person who receives or has received personal advice from the licensee or a representative of the licensee as a retail client in relation to a relevant financial product.

12.19 Personal advice is defined in section 766(3) of the Corporations Act. Generally, personal advice is financial product advice that is given or directed to a person where:

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the advice has considered one or more of the person's objectives, or

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a reasonable person might expect the provider to have considered one or more of those matters.

12.20 A representative of a licensee is defined in section 910A of the Corporations Act. This includes an authorised representative of the licensee, an employee or director of the licensee, an employee or director of a related body corporate of the licensee, or any other person acting on behalf of the licensee.

12.21 A retail client is defined in sections 761G and 761GA of the Corporations Act.

12.22 Second, there must be reasonable grounds for the licensee to believe that:

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a reportable situation that amounts to a significant breach of a core obligation has arisen, or

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a reportable situation that amounts to either gross negligence, serious fraud, or other circumstances prescribed by the regulations has arisen.

12.23 There are reasonable grounds to believe where there are facts that would induce a reasonable person to believe the truth or existence of the circumstance. This threshold relies on the common law meaning of term 'reasonable grounds to believe' and is not defined by legislation for the purposes of this section. This is a higher threshold than that of reasonable grounds to suspect a circumstance. In determining whether the grounds are reasonable, a person may take into account the facts and circumstances of the situation.

12.24 The core obligations of a licensee are defined at the breach reporting obligations under section 912D. These core obligations are discussed from paragraph 11.20.

12.25 What constitutes a significant breach will depend on the circumstances of the case. This is discussed from paragraph 11.25.

12.26 A reportable situation as mentioned in section 912D(2) of the Corporations Act includes gross negligence, serious fraud, and any other circumstances prescribed by the regulations. This is discussed from paragraph 11.51.

12.27 Third, there must be reasonable grounds for the licensee to suspect that the client who has suffered or will suffer loss or damage as a result of the reportable situation also has a legally enforceable right against the licensee to recover the loss or damage.

12.28 There are reasonable grounds to suspect where there are facts that would induce a reasonable person to suspect the truth or existence of the circumstance. This threshold relies on the common law meaning of the term 'reasonable grounds to suspect' and is not defined by legislation for the purposes of this section. In determining whether the grounds are reasonable, a person may take into account the facts and circumstances of the situation.

12.29 However, this threshold is lower than that of reasonable grounds to believe in a circumstance. Reasonable grounds to believe require that there are facts that would induce a reasonable person to believe in the truth or existence of the circumstance.

12.30 A person's legally enforceable right to recover loss or damage as mentioned in section 912EA(1)(c)(ii) of the Corporations Act is made with reference to the loss or damage the affected client suffered or will suffer as a result of the reportable situation under section 912EA(1)(c)(i) of the Corporations Act. Therefore, the relevant legally enforceable right against the licensee is the right to seek to recover loss or damage they suffered or will suffer as a result of the reportable situation. In this sense, it does not require that an affected client already has an enforceable judgment against the licensee, but rather, a right to seek recovery of the loss or damage.

12.31 The requirements under section 912EA(1)(c) of the Corporations Act, along with the requirement under section 912EA(1)(a) of the Corporations Act establish the adviser-client relationship between the licensee and the person, who is an affected client. The loss or damage an affected client has suffered or will suffer does not need to be the result of the personal advice, but rather, as a result of the reportable situation.

Example 12.1 : Reasonable grounds to suspect that a person has a legally enforceable right to recover loss or damage

Zebra Services Corporation is an Australian financial services licensee. Zebra Services Corporation has reasonable grounds to believe that one of their employees, Angela, who is an adviser, has committed serious fraud.

Zebra Services Corporation has a list of Angela's clients as at the time of the fraud she is believed to have committed. Based on the circumstances of the fraud, Zebra Services Corporation has reasonable grounds to suspect that five of Angela's clients are affected clients as a result of the reportable situation as they may have a claim against Zebra Services Corporation for the loss or damage suffered as a result of fraud. Zebra Services Corporation must notify these five affected clients under section 912EA of the Corporations Act. Additionally, Zebra Services Corporation must investigate and remediate the reportable situation under section 912EB of the Corporations Act.

12.32 An affected client may have a legally enforceable right to recover loss or damage against the licensee in relation to the reportable situation where there is a potential claim that if pursued by the affected client, may be enforced as a judgment by the court against the licensee. Accordingly, this requires an affected person to have standing to seek loss or damage resulting from the reportable situation and can include circumstances where a court has the discretion to make an order for loss or damage. For example, a client may have a legally enforceable right to recover loss or damage against the licensee for negligence or breach of contract, or where a compensation order may be available (for example, under section 1317HA of the Corporations Act).

Example 12.2 : Legally enforceable right to recover loss or damage - Fees for no service

Greater Flamingo Advisory is an Australian financial services licensee. Greater Flamingo Advisory has reasonable grounds to believe that they have significantly breached a core obligation. This is because they detected that they have engaged in fees for no service conduct, contrary to their obligation under section 912A(1)(a) of the Corporations Act to do all things necessary to ensure that the financial services covered by the licensee are provided efficiently, honestly and fairly.

Greater Flamingo Advisory discovers that they were obliged to provide financial advice to thirty of their clients by the end of the previous financial year. In twenty of these cases, they found breaches of contract where the financial services they promised were not actually performed, or could not have been performed. Greater Flamingo Advisory has found reasonable grounds to suspect that there are twenty clients who may have a claim against Greater Flamingo Advisory for breach of contract for loss or damage as a result of the reportable situation. In the remaining 10 cases, there was no reportable situation.

Greater Flamingo Advisory must notify those twenty affected clients under section 912EA of the Corporations Act. (Additionally, Greater Flamingo Advisory must investigate and remediate the reportable situation under section 912EB of the Corporations Act).

12.33 A client would not have a legally enforceable right where, for example, the underlying cause of action has been extinguished or barred as not enforceable by expiry of the relevant limitation period. However affected clients may still have rights that they are able to pursue through internal dispute resolution and through AFCA. Licensees should take this into account in determining whether they should extend the breadth of their remediation consistent with ASIC's regulatory guidance.

12.34 Similarly, there may be circumstances where a reportable situation would not result in a client with a legally enforceable right against the licensee for loss or damage as a result of that reportable situation. This may occur where, for example, there is no cause of action available to the client for loss or damage as a result of the reportable situation, or where there is no loss or damage. In determining whether there is loss or damage to a client, it is not relevant to consider whether or not that loss or damage is material.

Example 12.3 : No loss or damage as a result of the reportable situation

Mallard Corporation is an Australian financial services licensee. Mallard Corporation has reasonable grounds to believe that it has significantly breached its obligation to ensure that its representatives are adequately trained to provide financial services under section 912A(1)(f). In this case, there were two staff members out of a team of nine who continued to avoid mandatory training, and Mallard Corporation did not enforce the obligation.

Further, Mallard Corporation, through its representatives has provided personal advice to retail clients in relation to relevant financial products.

While there are clients who have received relevant advice from Mallard Corporation and Mallard Corporation was at fault for not enforcing mandatory training, the two staff members who were not adequately trained to provide financial services never provided advice to a retail client of Mallard Corporation.

Accordingly, Mallard Corporation would have no reasonable grounds to suspect that there is a person (who is an affected client) with a legally enforceable right to recover loss or damage as a result of the reportable situation. Therefore, Mallard Corporation does not have an obligation to notify clients under section 912EA of the Corporations Act.

12.35 It is relevant for the licensee to consider a claim that may be enforceable against them as this consideration will assist the licensee's obligation under section 912EB of the Corporations Act to investigate and remediate the reportable situation.

12.36 There may be circumstances where a client has suffered loss or damage as a result of negligent advice which caused them to invest in a particular product and that investment yielded a lower return than they would have received if they invested in a different product with proper advice. However, a client may not suffer loss or damage in all circumstances where they have invested in a product that yielded a lower return than they would have in a different product. For example, where a client knowingly accepted a level of investment risk suited to their circumstances with the objective of obtaining higher returns, the lack of gain or the crystallisation of a loss may not be considered a relevant loss or damage.

Form and period for giving notice

12.37 A notice to an affected client of a reportable situation must be provided in writing and should contain sufficient information to give the affected client an understanding of the nature of the reportable situation and the basis for the suspicion that the client may have suffered or will suffer loss or damage. The notice may include, for example, the date of the reportable situation, a description of the reportable situation, the consequences of the reportable situation, how a client may be affected and information about the investigation that is to be carried out. Where there is a form approved by ASIC for the purposes of the notice, a licensee must notify the affected client in the approved form and include the information or other material required by the form. [Schedule 11, item 6, section 912EA(2) of the Corporations Act]

12.38 The notice must be given to the affected client within 30 days of the licensee first knowing or is being reckless with respect to the misconduct they detect, including that this misconduct has potentially resulted in, or will result in, loss or damage which the client has a legally enforceable right to recover.

12.39 In satisfying this obligation, a licensee has qualified privilege and is protected from an action of defamation in relation to the information contained in the licensee's notice to affected clients. The licensee is also not liable for any action based on breach of confidence.

Consequences of failing to notify affected clients: civil penalty provision

12.40 A licensee who contravenes the obligation to notify an affected client of misconduct is liable for a civil penalty (see section 1317E of the Corporations Act). [Schedule 11, item 6, section 912EA(5) the Corporations Act]

12.41 In considering the imposition of this civil penalty, regard has been had to the Guide to Framing Commonwealth Offences.

12.42 In addition to giving rise to the requirement to notify an affected client, the existence of a reportable situation and reasonable grounds to suspect that the affected client has an enforceable right to recover loss or damage also triggers the obligations to investigate and, where necessary, remediate the affected client. Notifying the affected client means that the client is put on notice that an investigation, and possible remediation, is to follow. If the investigation or remediation does not eventuate or is not completed within the provided timeframes, the affected client can, for example, notify the firm through an internal dispute resolution process. Other options may be to bring the matter to the attention of AFCA or ASIC, or pursue a private remedy. Given the potential incentive from the perspective of a licensee to circumvent these processes by failing to notify the affected client that they have potentially suffered loss or damage, it is necessary and appropriate to impose a civil penalty where the obligation is not complied with.

12.43 It is also necessary and appropriate to impose a civil penalty. This is the case because the imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any loss or damage flowing from the investigated misconduct not being provided to the affected client. Current measures to encourage investigations into misconduct have not been sufficient and the Financial Services Royal Commission found that entities have not always considered what steps they need to take in response to detections of misconduct.

12.44 Further, the conduct causes serious harm to people. The imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any loss or damage flowing from the investigated misconduct not being provided to the affected client.

12.45 The imposition of a civil penalty fits into the overall legislative scheme. The civil penalty for a contravention of the obligation to investigate and remediate misconduct is consistent with the treatment of other contraventions of the general obligations imposed on an Australian financial services licensee. For example, a civil penalty applies with respect to the general obligation imposed on licensees under section 912A of the Corporations Act to do all things necessary to ensure that the financial services covered by the licensee are provided efficiently, honestly and fairly, and the obligation to ensure that representatives of the licensee are adequately trained.

12.46 The declaration of a contravention of a civil penalty provision and pecuniary penalty orders are dealt with in sections 1317J and 1317G of the Corporations Act.

12.47 The maximum penalty applicable to a failure by a financial services licensee to notify an affected client of a reportable situation is 5,000 penalty units for an individual and 50,000 penalty units for a body corporate (see sections 1317G(3) and (4) of the Corporations Act). If the court can determine the benefit derived and detriment avoided because of the contravention, the applicable penalty may otherwise be that amount multiplied by three (see sections 1317G(3)(b) and (4)(b) of the Corporations Act). In the case of a body corporate, the applicable penalty may otherwise be 10 per cent of the annual turnover of the body corporate (not exceeding an amount equal to 2.5 million penalty units) (see section 1317G(4)(c) of the Corporations Act). This is consistent with the maximum penalty that is applicable in relation to a contravention of the general obligations of a financial services licensee.

12.48 Consistent with all pecuniary penalty orders made under section 1317G of the Corporations Act, when considering the penalty for a failure by a financial services licensee to notify an affected client of a reportable situation, the court must take into account all relevant matters. Section 1317G provides that these matters include:

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the nature and extent of the contravention;

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the nature and extent of any loss or damage suffered because of the contravention;

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the circumstances in which the contravention took place; and

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whether the person has previously been found by a court to have engaged in similar conduct.

Investigating and remediating certain reportable situations

Obligation to investigate misconduct

12.49 A financial services licensee must conduct an investigation into the misconduct if all of the following are satisfied:

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the licensee or a representative of the licensee provides or has provided personal advice to the affected client as a retail client in relation to a relevant financial product;

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there are reasonable grounds for the licensee to believe that a reportable situation has arisen, and either:

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that reportable situation amounts to a breach of a core obligation; or

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that reportable situation amounts to gross negligence or serious fraud, or other circumstances prescribed by the regulations exist; and

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there are reasonable grounds for the licensee to suspect that both:

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the person has suffered loss or damage as a result of the reportable situation; and

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the person has a legally enforceable right to recover the loss or damage from the licensee.

[Schedule 11, item 6, section 912EB(1) of the Corporations Act]

12.50 The circumstances where a licensee detects misconduct that has potentially resulted in, or will result in loss or damage for a client is provided at sections 912EB(1)(a), (b) and (c) of the Corporations Act in the obligation to notify affected clients of misconduct. Accordingly, the threshold for the obligations under section 912EA(1) of the Corporations Act (to notify affected clients of misconduct) and section 912EB(1) of the Corporations Act (to investigate and remediate misconduct) are the same.

12.51 The elements of each requirement relevant to the obligation to notify affected clients of misconduct are discussed at paragraph 12.15.

12.52 The specific obligation to investigate and remediate misconduct by financial advisers is intended to support existing obligations to remediate consumers and therefore to restore trust in the Australian financial services sector.

12.53 The obligation to investigate and remediate misconduct, does not, on its own, create a new cause of action for affected clients in relation to the reportable situation. Along with general law actions, statutes may create a right for a person to seek a compensation order against the licensee for loss or damage (for example, under section 1317HA of the Corporations Act).The availability of a compensation order to a person may form the basis on which a client may have a legally enforceable right to recover loss or damage from a licensee.

Timing and duration of the investigation

12.54 The licensee must commence the investigation within 30 days after the licensee first knows or is reckless with respect to the matters mentioned in sections 912EB(1)(a), (b) and (c) of the Corporations Act (where misconduct detected resulted in, or will result in loss or damage for a client). [Schedule 11, item 6, section 912EB(2) of the Corporations Act]

12.55 The licensee must complete the investigation as soon as reasonably practicable after it is commenced. An investigation may be considered complete when a financial services licensee has considered the matters and done the things provided in section 912EB(3) of the Corporations Act, discussed from paragraph 12.62.

12.56 During the investigation, as affected clients and ASIC have been informed of the misconduct under sections 912EA and 912D of the Corporations Act, respectively, the licensee must complete the investigation within a reasonable amount of time. During this time, an affected client may continue to consider their rights and remedies against the licensee and ASIC may also consider commencing compliance and enforcement action.

12.57 Accordingly, the obligation to investigate and remediate misconduct does not extinguish the right of an affected client to bring an action against the licensee. All of the affected client's rights continue to exist alongside the investigation and remediation process, including rights to complain through internal or external dispute resolution processes.

12.58 The law does not prescribe what a reasonable time for the duration of the investigation is. This provides the licensee with flexibility to accurately and reasonably assess misconduct and the loss or damage caused. The reasonable amount of time for an investigation will depend on the circumstances of the case, including (but not limited to) the size of the licensee's business, the extent and period of the misconduct and the nature of the loss or damage caused by the licensee to affected clients.

12.59 After the completion of the investigation, the licensee must take reasonable steps to notify the affected client of the outcome of the investigation in writing. The notification should contain sufficient information to give the affected client an understanding of the nature of the conduct identified, any related misconduct, a description of how the conduct affected the client's interests, and an assessment of the loss or damage for which the licensee reasonably believes the affected client is entitled to seek recovery. Where there is a form approved by ASIC for the purposes of the notice, a licensee must notify the affected client in the approved form and include the information or other material required by the form. [Schedule 11, item 6, section 912EB(5) of the Corporations Act]

12.60 The notice must be given to the affected client within 10 days after the completion of the investigation.

12.61 In satisfying this obligation, a licensee has qualified privilege and is protected from an action of defamation in relation to the information contained in the licensee's notice about the outcome of the investigation. The licensee is also not liable for any action based on breach of confidence. [Schedule 11, item 6, sections 912EB(6) and (7) of the Corporations Act]

Matters to be considered in the investigation

12.62 In conducting the investigation, the licensee must do all of the following:

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identify the conduct that gave rise to the reportable situation;

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quantify the loss or damage that there are reasonable grounds to believe:

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the affected client has suffered or will suffer as a result of the reportable situation; and

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the affected client has a legally enforceable right to recover from the licensee; and

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do anything prescribed by the regulations.

[Schedule 11, item 6, sections 912EB(3) and (4) of the Corporations Act]

12.63 It is intended that investigations are thorough, complete and robust. Investigations should reveal the full details and extent of the relevant conduct. An investigation may reveal further conduct that itself constitutes a reportable situation under section 912D of the Corporations Act and requires a report to be lodged with ASIC under 912DAA of the Corporations Act. If in practice the quality and completeness of investigations is observed to be inadequate, more specific requirements for investigations may be prescribed by regulations. The component steps that comprise the investigation are described below.

12.64 First, a licensee must identify the conduct that gave rise to the reportable situation. This conduct can include an act or omission, or a series of acts or omissions that gave rise to the reportable situation.

12.65 There may be circumstances where a licensee who identifies the conduct that gave rise to the reportable situation is put on notice and discovers that the same conduct or related conduct gives rise to further reportable situations. When this occurs, the licensee must comply with the obligation to report those further reportable situations under section 912DAA of the Corporations Act. In general terms, the obligation to report under section 912DAA of the Corporations Act will arise where there are reasonable grounds for the licensee to believe that a relevant reportable situation has arisen. Accordingly, a licensee must take into account the factual circumstances of the reportable situation and the conduct that led to the reportable situation.

12.66 Further, there may also be circumstances where in identifying the conduct that gave rise to the reportable situation, the licensee may identify more clients that were also affected by the same or similar conduct. Where this occurs, the obligations to notify, investigate and remediate would apply equally to a later identified client as they do to an originally identified client or clients. Where misconduct has occurred in relation to a client, there is an expectation that the advice given to clients in similar circumstances be investigated by the licensee to detect any wider misconduct.

12.67 Second, in the course of the investigation, a licensee must quantify the loss or damage that there are reasonable grounds to believe that:

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the affected client has suffered or will suffer, and

•

the client has a legally enforceable right to recover.

12.68 It is also prudent for licensees to keep affected clients informed of the progress of the investigation as affected clients can continue to consider their rights and remedies against the licensee.

12.69 The term 'reasonable grounds to believe' is not defined in legislation for the purposes of this provision. Instead, the threshold relies on its common law meaning. This is discussed at paragraph 12.23.

12.70 The amendments do not prescribe how a licensee must determine the quantum of the loss or damage an affected client suffers or will suffer. Generally, in determining the loss or damage arising from the reportable situation, a licensee should have regard to legal principles.

12.71 Typically, a licensee will need to:

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identify each affected client;

•

determine the nature of the legally enforceable right available to the affected clients;

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evaluate the type of remedies available to the affected client based on the misconduct; and

•

determine the amount of the payment.

12.72 When investigating and determining loss or damage to affected clients, a licensee should have reference to any underlying liabilities they may have to that client based on causes of action available to the client in relation to the reportable situation.

12.73 The types of legally enforceable rights to recover loss or damage will depend on the circumstances of the case. For example, an affected client may have a legally enforceable right against the licensee to recover loss or damage as a result of the reportable situation where the underlying claim rests on negligence, dishonest conduct, breach of contract, breach of fiduciary duty, or where a compensation order may be available (for example, under section 1317HA of the Corporations Act).

12.74 Third, in conducting the investigation, the licensee must do anything else prescribed by the regulations.

12.75 The approach to include additional requirements in the regulations is intended to ensure effective compliance and the integrity of the provision. This will allow an evaluation of industry practices to ensure that licensees continue to comply with the policy intent of the provision and actively investigate misconduct.

Obligation to compensate the affected client for loss or damage

12.76 A licensee must take reasonable steps to remediate the affected client within 30 days once an investigation under section 912EB(1) of the Corporations Act is complete, and where there are reasonable grounds to believe that:

•

the affected client has suffered or will suffer loss or damage; and

•

the client has a legally enforceable right to recover loss or damage from the licensee.

[Schedule 11, item 6, section 912EB(8) of the Corporations Act]

12.77 Nothing in section 912EB of the Corporations Act precludes the licensee from providing a remedy to an affected client outside of the obligation to investigate and remediate misconduct.

12.78 The obligation to investigate and remediate misconduct is intended to ensure that licensees actively provide a remedy to affected clients where a reportable situation has resulted in loss or damage in relation to which the affected client would have an enforceable right to recover, without requiring the affected client to engage in a court process.

12.79 The term 'reasonable grounds to believe' is not defined in legislation for the purposes of this provision. Instead, the threshold relies on its common law meaning. This is discussed at paragraph 12.23.

12.80 A licensee should consider the facts and circumstances of the case to determine whether they have reasonable grounds to believe that the affected client has:

•

suffered or will suffer loss or damage; and

•

a legally enforceable right to recover that loss or damage.

12.81 As the payment from the licensee is provided on the basis of the loss or damage an affected client suffered or will suffer as a result of the reportable situation, it is not the intention to require licensees to include amounts for damages that do not reflect the loss or damage, such as profit gained by the licensee as a result of the reportable situation, aggravated damages or punitive damages.

12.82 In addition to the requirement that an affected client is compensated for loss or damage suffered, a licensee may also consider other relevant forms of remedies that would complement compensation provided to the affected client. The amendments do not limit the types and combinations of different remedies which a licensee may additionally provide to an affected client having regard to the loss or damage the affected client suffered or will suffer.

12.83 There may be circumstances where non-monetary remediation would be appropriate to accompany the monetary remediation that is required by the amendments. Depending on the circumstances of each case, some possible non-monetary remediation may include the rescission of a contract, assisting a client to transfer to a more appropriate product, and the setting aside of a portion or a whole amount of debt owed to the licensee by the affected client.

12.84 At the completion of the investigation, there may be circumstances where the results of an investigation show that there is no liability under section 912EB of the Corporations Act for a licensee to remediate as the licensee does not have reasonable grounds to believe that a client suffered or will suffer loss or damage to which they have a legally enforceable right to recover. These may include circumstances where at the end of the investigation:

•

the licensee finds that there were no clients affected by the reportable situation; or

•

the client does not have a cause of action, or does not have a legally enforceable right against the licensee in relation to the reportable situation; or

•

the client suffered no loss or damage as a result of the reportable situation.

Example 12.4 : Licensee has no liability to client

Sable Corporation is an Australian financial services licensee. Sable Corporation has notified ASIC under section 912D of the Corporations Act that it has reasonable grounds to believe that there was a significant breach of a core obligation.

Sable Corporation has reasonable grounds to believe that it did not maintain the competence to provide financial services (under section 912A(1)(e) of the Corporations Act) for three months. With respect to this, Sable Corporation has already notified five clients that could potentially be affected.

Sable Corporation investigated the nature and full extent of the misconduct and the outcome of the investigation shows that no client had suffered any loss or damage with respect to the misconduct. The loss or damage suffered by the clients in this case is determined to be nil. Sable Corporation communicates the outcome of the investigation to the five potentially affected clients.

The right of affected client to pursue legally enforceable rights

12.85 For the avoidance of doubt, nothing in this section affects any legally enforceable rights of the affected client to recover loss or damage that the affected client suffers, or will suffer, as a result of a reportable situation, nor does it remove the affected client's right to complain about the outcome or remediation process. [Schedule 11, item 6, sections 912EB(10) and (11) of the Corporations Act]

12.86 The amendments are intended to ensure that licensees investigate and remediate misconduct proactively. The amendments rely on the existing rights of the affected client and do not alter those rights. Accordingly, an affected client's rights are not extinguished by the operation of this section.

12.87 However, a court may take into account the remedy provided by a licensee in relation to a reportable situation. For example, where a licensee has provided a partial remedy to the affected client, the court may take this fact into account to alter its award of damages if an action is brought successfully by the affected client in relation to the same facts. This provision ensures that a client is not enriched unjustly in the same case.

Re-triggering of licensee obligations

12.88 There may be circumstances where during the course of an investigation, or after the investigation, licensee obligations are triggered or re-triggered.

12.89 At any time, including during an investigation, a licensee may have reasonable grounds to believe or suspect that further reportable situations have arisen in accordance with section 912D. Where appropriate, this will also trigger obligations under sections 912EA and 912EB of the Corporations Act to notify affected clients, investigate misconduct and remediate affected clients.

Example 12.5 : Investigation reveals further notifications to ASIC and clients

Tortoiseback Services is an Australian financial services licensee. During Tortoiseback Services' investigation of misconduct in relation to its adviser, Nav, it finds further reasonable grounds to suspect that another adviser working in the same team, Suma, was grossly negligent.

Accordingly, the obligation on Tortoiseback Services to notify ASIC in relation to misconduct on the part of Suma under section 912D of the Corporations Act is triggered. Tortoiseback Services has reasonable grounds to suspect gross negligence on the part of Suma which could potentially affect three of Tortoiseback Services' clients. Therefore, alongside the investigation into Nav, Tortoiseback Services is also required to notify, investigate and remediate clients affected by Suma's misconduct under sections 912EA and 912EB of the Corporations Act.

Consequences of failing to investigate and remediate misconduct: civil penalty provisions

12.90 A licensee who contravenes any of the following is liable for a civil penalty:

•

section 912EB(1) of the Corporations Act - the obligation to investigate certain reportable situations;

•

section 912EB(5) of the Corporations Act - the obligation to notify the outcome of the investigation within 10 days;

•

section 912EB(8) of the Corporations Act - the obligation to remediate the affected client within 30 days.

[Schedule 11, item 6, section 912EB(9) of the Corporations Act]

12.91 In considering the imposition of this civil penalty, regard has been had to the Guide to Framing Commonwealth Offences.

12.92 The imposition of a civil penalty for contravention of the obligations is necessary and appropriate. This is the case because the conduct to be deterred was identified in the Financial Services Royal Commission. In particular, it was found that where a licensee detects misconduct, it should always consider what steps need to be taken to uncover the extent of the conduct beyond the immediate focus of attention. Current measures to encourage investigations into misconduct have not been sufficient and the Financial Services Royal Commission found that entities have not always considered what steps they need to take in response to detections of misconduct.

12.93 Further, the conduct causes serious harm to people. The imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any loss or damage flowing from the investigated misconduct not being provided to the affected client.

12.94 The imposition of a civil penalty fits into the overall legislative scheme. The civil penalty for a contravention of the obligation to investigate and remediate misconduct is consistent with the treatment of other contraventions of the general obligations imposed on an Australian financial services licensee. For example, a civil penalty applies with respect to the general obligation imposed on licensees under section 912A of the Corporations Act to do all things necessary to ensure that the financial services covered by the licensee are provided efficiently, honestly and fairly, and the obligation to ensure that representatives of the licensee are adequately trained.

12.95 The declaration of a contravention of a civil penalty provision and pecuniary penalty orders are dealt with in sections 1317J and 1317G of the Corporations Act.

12.96 The maximum penalty applicable to a failure by a financial services licensee to investigate a reportable situation, notify an affected client of the outcome of the investigation or compensate an affected client is 5,000 penalty units for an individual and 50,000 penalty units for a body corporate (see sections 1317G(3) and (4) of the Corporations Act). If the court can determine the benefit derived and detriment avoided because of the contravention, the applicable penalty may otherwise be that amount multiplied by three (see sections 1317G(3)(b) and (4)(b) of the Corporations Act). In the case of a body corporate, the applicable penalty may otherwise be 10 per cent of the annual turnover of the body corporate (not exceeding an amount equal to 2.5 million penalty units) (see section 1317G(4)(c) of the Corporations Act). This is consistent with the maximum penalty that is applicable in relation to a contravention of the general obligations of a financial services licensee.

12.97 Consistent with all pecuniary penalty orders made under section 1317G of the Corporations Act, when considering the penalty to be ordered for a failure by a financial services licensee to investigate a reportable situation, notify an affected client of the outcome of the investigation or compensate an affected client the court must take into account all relevant matters. Section 1317G of the Corporations Act provides that these matters include:

•

the nature and extent of the contravention;

•

the nature and extent of any loss or damage suffered because of the contravention;

•

the circumstances in which the contravention took place; and

•

whether the person has previously been found by a court to have engaged in similar conduct.

Obligation to keep records of compliance

12.98 The notification and remediation obligations are intended to require licensees to proactively provide a remedy to affected clients without affected clients needing to involve the courts, ASIC or another regulator. However, to encourage compliance and to allow compliance to be monitored, a licensee must keep records sufficient to enable the licensee's compliance with the obligations to notify, investigate and remediate clients affected by misconduct to be readily ascertained. [Schedule 11, item 6, section 912EC(1) of the Corporations Act]

12.99 The regulations may specify records the licensee must keep. Regulation-making powers have been inserted to allow particular records that must be kept as part of the obligation to be specified. [Schedule 11, item 6, section 912EC(2) of the Corporations Act]

12.100 Allowing the regulations to specify records to be kept will provide the Government with the necessary flexibility to make timely changes in response to changing industry practices and allow the law to adapt to changes in technology. This will help to support licensees to discharge the obligation while ensuring that records required to be kept are appropriate to evidence compliance with the underlying requirement to notify and remediate clients following misconduct. By staying current to industry practices and development in technology, the regulations encourage licensees to be proactive about addressing misconduct, and for them to develop practices to accurately record instances of misconduct and how they have remediated affected clients. At the same time, the regulations, as opposed to another type of legislative instrument, provide more certainty to licensees about their record keeping obligations.

12.101 Allowing the regulations to specify records will provide a flexible approach to ensure the regime only imposes obligations on licensees to the extent appropriate. The regulations would be subject to disallowance and therefore will be subject to appropriate parliamentary scrutiny.

Consequences of failing to keep records of compliance

12.102 A licensee who contravenes the obligation to keep records to show compliance with the obligations to notify, investigate and remediate clients affected by misconduct commits an offence and is liable for five years imprisonment. In considering the imposition of the criminal offence, regard has been had to the Guide to Framing Commonwealth Offences. [Schedule 11, item 6, section 912EC(1) of the Corporations Act]

12.103 The criminal offence aims to deter and punish the behaviour as appropriate while ensuring the effectiveness of the notification and remediation framework. The inclusion of the criminal offence is necessary and appropriate for the following reasons:

•

the Financial Services Royal Commission recommended that where there is sufficient information to suggest that an adviser has engaged in misconduct, licensees must tell affected clients and remediate those clients promptly. The requirement that licensees maintain records is necessary to ensure that the obligation is complied with;

•

the requirement for maintenance of records of compliance is also necessary to ensure that licensees make whatever inquiries are reasonably necessary to determine the nature and full extent of the adviser's misconduct;

•

the maintenance of proper records will allow ASIC to monitor compliance with the obligation and to ascertain whether it needs to take further action in relation to a licensee;

•

the obligations encourage structural change in licensee behaviour towards addressing misconduct by requiring records to be kept not just about the misconduct, but also about how they have remediated affected clients.

12.104 The maximum penalty of five years imprisonment reflects the seriousness of the offence and provides a court with guidance on how to punish criminal behaviour. The maximum penalty is generally reserved only for the most egregious cases. The default fault elements in the Criminal Code apply to the corresponding physical elements of the offence. Applying default fault elements is consistent with Part 2.2.4 of the Guide to Framing Commonwealth Offences.

Amendments to the Credit Act

12.105 The amendments to the Credit Act impose the new investigation and remediation obligations. These obligations require Australian credit licensees to:

•

notify consumers affected by misconduct (section 51A of the Credit Act);

•

investigate the nature and full extent of the misconduct and remediate affected consumers (section 51B of the Credit Act); and

•

maintain records to show compliance with these obligations (section 51C of the Credit Act).

Notifying consumers affected by certain reportable situations

Obligation to notify an affected consumer regarding misconduct

12.106 Under the obligation to notify misconduct, an Australian credit licensee must take reasonable steps to notify a consumer (the affected consumer) if all of the following are satisfied:

•

the licensee, or a representative of the licensee, provides or has provided credit assistance to the affected consumer in relation to a credit contract secured by a mortgage over residential property;

•

the licensee, or the representative of the licensee, is a mortgage broker;

•

there are reasonable grounds for the licensee to believe that a reportable situation has arisen, and either:

-

that reportable situation amounts to a significant breach of a core obligation; or

-

that reportable situation amounts to gross negligence, serious fraud and other circumstances prescribed by the regulations; and

•

there are reasonable grounds for the licensee to suspect that both:

-

the consumer has suffered or will suffer loss or damage as a result of the reportable situation; and

-

the consumer has a legally enforceable right to recover the loss or damage from the licensee.

[Schedule 11, item 16, section 51A(1) of the Credit Act]

12.107 The consumer that must be notified is the affected consumer. Notifying the consumer allows the consumer to consider their rights and the ways they can mitigate potential loss or damage arising from the reportable situation.

12.108 The circumstances where a licensee detects misconduct that has potentially resulted in loss or damage for a consumer are provided for by sections 51A(1)(a), (b) and (c) of the Credit Act.

12.109 First, there must be a consumer who receives or has received credit assistance in relation to a credit contract secured by a mortgage over residential property.

12.110 Generally, this obligation requires credit licensees (who are mortgage brokers) to notify affected consumers when they detect misconduct in circumstances where a mortgage broker has provided credit assistance. The term 'credit assistance' is defined at section 8 of the Credit Act. The term 'credit contract' is defined at section 4 of the National Credit Code and generally refers to a contract under which credit is or may be provided.

12.111 A representative of a licensee is defined in section 5 of the Credit Act. This includes an employee or director of the licensee, an employee or director of a related body corporate of the licensee, a credit representative of the licensee, or any other person acting on behalf of the licensee.

12.112 Second, the licensee or the representative of the licensee who provides or has provided that credit assistance must be a mortgage broker.

12.113 The term 'mortgage broker' is defined under section 15B of the Credit Act. It provides that a licensee or a credit representative of a licensee is a mortgage broker if:

•

they carry on a business of providing credit assistance in relation to credit contracts secured by mortgage over residential property;

•

the licensee does not perform the obligations, or exercise the rights, of a credit provider in relation to the majority of those credit contracts; and

•

in carrying on the business, the licensee provides credit assistance in relation to credit contracts offered by more than one credit provider.

12.114 Generally, this describes mortgage brokers who provide credit assistance over mortgage contracts offered by more than one credit provider. Accordingly, a credit licensee or representative who deals only with mortgage contracts offered by one credit provider is not considered a mortgage broker.

12.115 Third, there must be reasonable grounds for the licensee to believe that:

•

a reportable situation that amounts to a significant breach of a core obligation has arisen, or

•

a reportable situation that amounts to gross negligence or serious fraud has arisen.

12.116 There are reasonable grounds to believe where there are facts that would induce a reasonable person to believe the truth or existence of the circumstance. This threshold relies on the general law meaning of term 'reasonable grounds to believe' and is not defined by legislation for the purposes of this section. This is a higher threshold than that of reasonable grounds to suspect a circumstance. In determining whether the grounds are reasonable, a person may take into account the facts and circumstances of the situation.

12.117 The core obligations of a licensee are defined in the breach reporting obligations under section 50A. These core obligations are discussed from paragraph 11.134.

12.118 What constitutes a significant breach will depend on the circumstances of the case. This is discussed from paragraph 11.136.

12.119 A reportable situation as mentioned in section 50A(2) of the Credit Act includes gross negligence, serious fraud, and any other circumstances prescribed by the regulations. This is discussed from paragraph 11.162.

12.120 Fourth, there must be reasonable grounds for the licensee to suspect that the consumer who has suffered or will suffer loss or damage as a result of the reportable situation also has a legally enforceable right against the licensee for the loss or damage.

12.121 There are reasonable grounds to suspect where there are facts that would induce a reasonable person to suspect the truth or existence of the circumstance. This threshold relies on the common law meaning of the term 'reasonable grounds to suspect' and is not defined by legislation for the purposes of this section. . In determining whether the grounds are reasonable, a person may take into account the facts and circumstances of the situation.

12.122 However, this threshold is lower than that of reasonable grounds to believe in a circumstance. Reasonable grounds to believe require that there are facts that would induce a reasonable person to believe in the truth or existence of the circumstance.

12.123 A person's legally enforceable right to recover loss or damage as mentioned in section 51A(1)(d)(ii) of the Credit Act is made with reference to the loss or damage the affected consumer suffered or will suffer as a result of the reportable situation under section 51A(1)(c)(i) of the Credit Act. Therefore, the relevant legally enforceable right against the licensee is the right to seek to recover loss or damage the affected consumer suffered or will suffer as a result of the reportable situation. In this sense, the threshold does not require that an affected consumer already has an enforceable judgment against the licensee, but rather, a right to seek recovery of the loss or damage.

12.124 The requirements under section 51A(1)(d) of the Credit Act, along with the requirements under sections 51A(1)(a) and (b) of the Credit Act establish the mortgage broker-consumer relationship between the licensee and the person, who is an affected consumer. The loss or damage an affected consumer suffered or will suffer does not need to be the result of the credit assistance, but rather, as a result of the reportable situation.

Example 12.6 : Reasonable grounds to suspect that a consumer has a legally enforceable right to recover loss or damage

Zebu Home Loans is an Australian credit licensee who is a mortgage broker. Zebu Home Loans has reasonable grounds to believe that one of their employees, Hal, who is an employee mortgage broker, has committed serious fraud.

Zebu Home Loans has a list of consumers served by Hal as at the time of the fraud he is believed to have committed. Based on the circumstances of the fraud, Zebu Home Loans has reasonable grounds to suspect that five of Hal's clients are affected consumers as a result of the reportable situation as they may have a claim against Zebu Home Loans for the loss or damage suffered as a result of fraud. Zebu Home Loans must notify these five affected consumers under section 51A of the Credit Act. Additionally, Zebu Home Loans must investigate and remediate the reportable situation under section 51B of the Credit Act.

12.125 An affected consumer may have a legally enforceable right to recover loss or damage against the licensee in relation to the reportable situation where there is a potential claim that if pursued by the affected consumer, may be enforced as a judgment by the court against the licensee. Accordingly, this requires an affected person to have standing to seek loss or damage resulting from the reportable situation and can include circumstances where a court has the discretion to make an order for loss or damage. For example, a consumer may have a legally enforceable right to recover loss or damage against the licensee for negligence, breach of contract, or where a compensation order may be available (for example, under section 178 of the Credit Act).

12.126 A consumer would not have a legally enforceable right where, for example, the underlying cause of action has been extinguished or barred as not enforceable by expiry of the relevant limitation period. However affected consumers may still have rights that they are able to pursue through internal dispute resolution and through AFCA. Licensees should take this into account in determining whether they should extend the breadth of their remediation consistent with ASIC's regulatory guidance.

12.127 There may be circumstances where a reportable situation would not result in a consumer with a legally enforceable right against the licensee for loss or damage as a result of that reportable situation. This may occur where, for example, there is no cause of action available to the consumer for loss or damage as a result of the reportable situation, or where there is no loss or damage. In determining whether there is loss or damage to a consumer, it is not relevant to consider whether or not that loss or damage is material.

Example 12.7 : No loss or damage as a result of the reportable situation

Marmoset Corporation is an Australian credit licensee who is a mortgage broker. Marmoset Corporation has reasonable grounds to believe that it has significantly breached its obligation to ensure that its representatives are adequately trained to engage in credit services under section 47(1)(g) of the Credit Act. In this case, there were two staff members out of a team of nine who continued to avoid mandatory training, and Marmoset Corporation did not enforce the obligation.

Further, Marmoset Corporation, through its employee mortgage brokers has provided credit assistance over mortgages to consumers.

While there are consumers who have received relevant assistance from Marmoset Corporation and Marmoset Corporation was at fault for not enforcing mandatory training, the two staff members who were not adequately trained never provided credit assistance to a consumer of Marmoset Corporation.

Accordingly, Marmoset Corporation would have no reasonable grounds to suspect that there is a consumer (who is an affected consumer) with a legally enforceable right to recover loss or damage as a result of the reportable situation. Therefore, Marmoset Corporation does not have an obligation to notify consumers under section 51A of the Credit Act.

12.128 It is relevant for the licensee to consider a claim that may be enforceable against them as this consideration will assist the licensee's obligation under section 51B of the Credit Act to investigate and remediate the reportable situation.

Form and period for giving notice

12.129 A notice to an affected consumer of a reportable situation must be provided in writing and should contain sufficient information to give the affected consumer an understanding of the nature of the reportable situation and the basis for the suspicion that the consumer may have suffered or will suffer loss or damage. The notice may include, for example, the date of the reportable situation, a description of the reportable situation, the consequences of the reportable situation, how a consumer may be affected and information about the investigation that is to be carried out. Where there is a form approved by ASIC for the purposes of the notice, a licensee must notify the affected consumer in the approved form and include the information or other material required by the form. [Schedule 11, item 16, section 51A(2) of the Credit Act]

12.130 The notice must be given to the affected consumer within 30 days after the licensee first knows or is reckless with respect to the misconduct they detect, including that the misconduct has potentially resulted in, or will result in, loss or damage which the consumer has a legally enforceable right to recover.

12.131 In satisfying this obligation, a licensee has qualified privilege and is protected from an action of defamation in the licensee's notice about misconduct to affected consumers. The licensee is also not liable for any action based on breach of confidence. [Schedule 11, item 16, sections 51A(3) and (4) of the Credit Act]

Consequences of failing to notify affected consumers

12.132 A licensee who contravenes the obligation to take reasonable steps to notify affected consumers of misconduct is subject to civil penalties. [Schedule 11, item 16, section 51A(1) of the Credit Act]

12.133 In considering the imposition of this civil penalty, regard has been had to the Guide to Framing Commonwealth Offences.

12.134 In addition to giving rise to the requirement to notify an affected consumer, the existence of a reportable situation and reasonable grounds to suspect that the affected consumer has an enforceable right to recover loss or damage also triggers the obligations to investigate and, where necessary, remediate the affected consumer. Notifying the affected consumer means that the consumer is put on notice that an investigation, and possible remediation, is to follow. If the investigation or remediation does not eventuate or is not completed within the provided timeframes, the affected consumer can, for example, notify the firm through an internal dispute resolution process. Other options may be to bring the matter to the attention of AFCA or ASIC, or pursue a private remedy. Given the potential incentive from the perspective of a licensee to circumvent these processes by failing to notify the affected consumer that they have potentially suffered loss or damage, it is necessary and appropriate to impose a civil penalty where the obligation is not complied with.

12.135 It is also necessary and appropriate to impose a civil penalty. This is the case because the imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any loss or damage flowing from the investigated misconduct not being provided to the affected consumer. Current measures to encourage investigations into misconduct have not been sufficient and the Financial Services Royal Commission found that entities have not always considered what steps they need to take in response to detections of misconduct.

12.136 Further, the conduct causes serious harm to people. The imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any loss or damage flowing from the investigated misconduct not being provided to the affected consumer.

12.137 The imposition of a civil penalty fits into the overall legislative scheme. The civil penalty for a contravention of the obligation to investigate and remediate misconduct is consistent with the treatment of other contraventions of the general obligations imposed on an Australian credit licensee. For example, a general obligation is imposed on licensees under section 47 of the Credit Act to do all things necessary to ensure that the credit activities authorised by the licence are engaged in efficiently, honestly and fairly.

12.138 The declaration of a contravention of a civil penalty provision and pecuniary penalty orders are dealt with in sections 166 and 167 of the Credit Act.

12.139 The maximum penalty applicable to a failure by a credit licensee to notify an affected consumer of a reportable situation is 5,000 penalty units for an individual and 50,000 penalty units for a body corporate (see sections 47(4) and 167B(2)(a) of the Credit Act). If the court can determine the benefit derived and detriment avoided because of the contravention, the applicable penalty may otherwise be that amount multiplied by three (see sections 167B(1)(b) and (2)(b) of the Credit Act). In the case of a body corporate, the applicable penalty may otherwise be 10 per cent of the annual turnover of the body corporate (not exceeding an amount equal to 2.5 million penalty units) (see section 167B(2)(c) of the Credit Act). This is consistent with the maximum penalty that is applicable in relation to a contravention of the other general obligations of a credit licensee.

12.140 Consistent with all pecuniary penalty orders made under Part 4-1 of the Credit Act, when considering the penalty for a failure by a credit licensee to notify an affected consumer of a reportable situation, the court must take into account all relevant matters. Section 167(3) of the Credit Act provides that these matters include:

•

the nature and extent of the contravention;

•

the nature and extent of any loss or damage suffered because of the contravention;

•

the circumstances in which the contravention took place; and

•

whether the person has previously been found by a court to have engaged in similar conduct.

Investigating and remediating certain reportable situations

Obligation to investigate misconduct

12.141 An Australian credit licensee must conduct an investigation of misconduct if all of the following are satisfied:

•

the licensee or a representative of the licensee provides or has provided credit assistance to the affected consumer in relation to a credit contract secured by a mortgage over residential property;

•

the licensee, or the representative of the licensee is a mortgage broker;

•

there are reasonable grounds for the licensee to believe that a reportable situation has arisen, and either:

-

that reportable situation amounts to a significant breach of a core obligation; or

-

that reportable situation amounts to gross negligence, serious fraud and other circumstances prescribed by the regulations; and

•

there are reasonable grounds for the licensee to suspect that both:

-

the consumer has suffered loss or damage as a result of the reportable situation; and

-

the consumer has a legally enforceable right to recover the loss or damage from the licensee.

[Schedule 11, item 16, section 51B(1) of the Credit Act]

12.142 The circumstances where a licensee detects misconduct that has potentially resulted in, or will result in loss or damage for a consumer is provided at sections 51A(1)(a), (b) and (c) of the Credit Act in the obligation to notify affected consumers of misconduct. Accordingly, the threshold for the obligations under section 51A(1) of the Credit Act (to notify affected consumers of misconduct) and 51B(1) of the Credit Act (to investigate misconduct) are the same.

12.143 The elements of each requirement are discussed above (regarding section 51A(1) of the Credit Act, the obligation to notify affected consumers of misconduct).

12.144 The specific obligation to investigate and remediate misconduct by mortgage brokers is intended to support existing obligations to remediate consumers and therefore to restore trust in the mortgage broking sector.

12.145 The obligation to investigate and remediate misconduct, does not, on its own, create a new cause of action for affected consumers in relation to the reportable situation. Along with general law actions, statutes may create a right for a person to seek a compensation order against the licensee for loss or damage (for example, under section 178 of the Credit Act). The availability of a compensation order to a person may form the basis on which a consumer may have a legally enforceable right to recover loss or damage from a licensee.

Timing and duration of the investigation

12.146 The licensee must commence the investigation within 30 days after the licensee first knows or is reckless with respect to the matters mentioned in sections 51B(1)(a), (b) and (c) (where misconduct detected resulted in, or will result in loss or damage for a consumer). [Schedule 11, item 16, sections 51B(2) and 51B(4) of the Credit Act]

12.147 The licensee must complete the investigation as soon as reasonably practicable after it is commenced. An investigation may be considered complete when a credit licensee has considered the matters and done the things provided in section 51B(3) of the Credit Act, discussed from paragraph 12.154.

12.148 As affected consumers and ASIC have been informed of the misconduct under sections 51A and 50A of the Credit Act, respectively, the licensee must complete the investigation within a reasonable amount of time. During this time, an affected consumer may continue to consider their rights and remedies against the licensee and ASIC may also consider commencing compliance and enforcement action.

12.149 Accordingly, the obligation to investigate and remediate misconduct does not extinguish the right of an affected consumer to bring an action against the licensee. All of the affected consumer's rights continue to exist alongside the investigation and remediation process, including the affected consumer's rights to complain through internal and external dispute resolutions processes.

12.150 The law does not prescribe what a reasonable time for the duration of the investigation is. This provides the licensee with flexibility to accurately and reasonably assess misconduct and the loss or damage caused. The reasonable amount of time for an investigation will depend on the circumstances of the case, including (but not limited to) the size of the licensee's business, the extent and period of the misconduct and the nature of the loss or damage caused by the licensee to affected consumers.

12.151 After the completion of the investigation, the licensee must take reasonable steps to notify the affected consumer of the outcome of the investigation in writing. The notification should contain sufficient information to give the affected consumer an understanding of the nature of the conduct identified, a description of how the conduct affected the consumer's interests, and an assessment of the loss or damage for which the licensee reasonably believes the affected consumer is entitled to seek recovery. Where there is a form approved by ASIC for the purposes of the notice, a licensee must notify the affected consumer in the approved form and include the information or other material required by the form. [Schedule 11, item 16, section 51B(5) of the Credit Act]

12.152 The notice must be given to the affected consumer within 10 days after the completion of the investigation.

12.153 In satisfying this obligation, a licensee has qualified privilege and is protected from an action of defamation in the licensee's notice about the outcome of the investigation. The licensee is also not liable for any action based on breach of confidence. [Schedule 11, item 16, sections 51B(6) and 51B(7) of the Credit Act]

Matters to be considered in the investigation

12.154 In conducting the investigation, the licensee must do all of the following:

•

identify the conduct that gave rise to the reportable situation;

•

quantify the loss or damage that there are reasonable grounds to believe:

-

the affected consumer has suffered or will suffer as a result of the reportable situation; and

-

the affected consumer has a legally enforceable right to recover from the licensee; and

•

anything prescribed by the regulations.

[Schedule 11, item 16, section 51B(3) of the Credit Act]

12.155 Firstly, a licensee must identify the conduct that gave rise to the reportable situation. This conduct can include an act or omission, or a series of acts or omissions that gave rise to the reportable situation.

12.156 There may be circumstances where a licensee who identifies the conduct that gave rise to the reportable situation is put on notice and discovers that the same conduct or related conduct gives rise to further reportable situations. When this occurs, the licensee must comply with the obligation to report those further reportable situations under section 50B of the Credit Act. In general terms, the obligation to report under section 50B of the Credit Act will arise where there are reasonable grounds for the licensee to believe that a relevant reportable situation has arisen. Accordingly, a licensee must take into account the factual circumstances of the reportable situation and the conduct that led to the reportable situation.

12.157 Further, there may also be circumstances where in identifying the conduct that gave rise to the reportable situation, the licensee may identify more consumers that were also affected by the same or similar conduct. Where this occurs, the obligations to notify, investigate and remediate apply equally to a later identified consumer or consumers as they do to an originally identified consumer. Where misconduct has occurred in relation to a consumer, there is an expectation that the advice given to consumers in similar circumstances is investigated by the licensee to detect any wider misconduct.

12.158 Secondly, in the course of the investigation, a licensee must quantify the loss or damage that there are reasonable grounds to believe that:

•

the affected consumer has suffered or will suffer, and

•

the consumer has a legally enforceable right to recover.

12.159 It is also prudent for licensees to keep affected consumers informed of the progress of the investigation as affected consumers can continue to consider their rights and remedies against the licensee.

12.160 The term 'reasonable grounds to believe' is not defined in legislation for the purposes of this provision. Instead, the threshold relies on its common law meaning. This is discussed at paragraph 12.116.

12.161 The amendments do not prescribe how a licensee must determine the quantum of the loss or damage the affected consumer suffers or will suffer. Generally, in determining the loss or damage arising from the reportable situation, a licensee should have regard to legal principles.

12.162 Typically, a licensee will need to:

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identify each affected consumer;

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determine the nature of the legally enforceable right available to the affected consumers;

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evaluate the type of remedies that are available to and are appropriate for the affected consumer based on the misconduct; and

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determine the amount of the payment.

12.163 When investigating and determining loss or damage to an affected consumer, a licensee should have reference to any underlying liabilities they may have to that consumer based on causes of action available to the consumer in relation to the reportable situation.

12.164 The types of legally enforceable right to recover loss or damage will depend on the circumstances of the case. For example, an affected consumer may have a legally enforceable right against the licensee to recover loss or damage as a result of the reportable situation where the underlying claim rests on negligence, breach of fiduciary duty, or where a compensation order may be available (for example, under section 178 of the Credit Act).

12.165 Thirdly, in conducting the investigation, the licensee must do anything else prescribed by the regulations.

12.166 The approach to include additional requirements in the regulations is intended to ensure effective compliance and the integrity of the provision. This will allow an evaluation of industry practices and ensure that licensees continue to comply with the policy intention of the provision and actively investigate misconduct.

Obligation to compensate the affected consumer for loss or damage

12.167 A licensee must take reasonable steps to remediate the affected consumer within 30 days after an investigation under section 51B(1) of the Credit Act is completed and where there are reasonable grounds to believe that:

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the affected consumer has suffered or will suffer loss or damage, and

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the consumer has a legally enforceable right to recover loss or damage from the licensee.

[Schedule 11, item 16, section 51B(8) of the Credit Act]

12.168 Nothing in section 51B of the Credit Act precludes the licensee from providing a remedy to an affected consumer outside of the obligation to investigate and remediate misconduct.

12.169 The obligation to investigate and remediate misconduct is intended to ensure that licensees actively provide a remedy to affected consumers where a reportable situation has resulted in loss or damage in relation to which the affected consumer would have an enforceable claim, without requiring the affected consumer to engage in a court process.

12.170 The term 'reasonable grounds to believe' is not defined in legislation for the purposes of this provision. Instead, the threshold relies on its common law meaning. This is discussed at paragraph 12.116.

12.171 A licensee should consider the facts and circumstances of the case to determine whether they have reasonable grounds to believe that the affected consumer has:

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suffered or will suffer loss or damage; and

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a legally enforceable right to recover that loss or damage.

12.172 As the payment from the licensee is provided on the basis of the loss or damage the affected consumer suffered or will suffer as a result of the reportable situation, it is not the intention to require licensees to include amounts for damages that do not reflect loss or damage, such as profit gained by the licensee as a result of the reportable situation, aggravated damages or punitive damages.

12.173 A licensee may also consider other relevant forms of remedies that would complement the affected consumer. The amendments do not limit the types and combinations of different remedies which a licensee may additionally provide to an affected consumer having regard to the loss or damage the affected consumer suffered or will suffer.

12.174 There may be circumstances where non-monetary remediation would be appropriate to accompany monetary payment. Depending on the circumstances of each case, some possible non-monetary remediation may include the rescission of a contract, and the setting aside of a portion or a whole amount of debt owed to the licensee by the affected consumer.

12.175 At the completion of the investigation, there may be circumstances where the results of an investigation show that there is no liability under section 51B of the Credit Act for a licensee to remediate as the licensee does not have reasonable grounds to believe that a consumer suffered or will suffer loss or damage in relation to which they have a legally enforceable right to recover. These may include circumstances where at the end of the investigation:

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there was no consumer affected by the reportable situation; or

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the consumer does not have a cause of action, or does not have a legally enforceable right against the licensee in relation to the reportable situation; or

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the consumer suffered no loss or damage as a result of the reportable situation.

Example 12.8 : Licensee has no liability to consumer

Salamander Corporation is an Australian credit licensee who is a mortgage broker. Salamander Corporation has notified ASIC under section 50A of the Credit Act that it has reasonable grounds to believe that there was a significant breach of a core obligation.

Salamander Corporation has reasonable grounds to believe that it did not maintain the competence to provide credit services (under section 47(1)(f) of the Credit Act) for 3 months. With respect to this, Salamander Corporation has already notified five consumers that could potentially be affected.

Salamander Corporation investigated the nature and full extent of the misconduct and the outcome of the investigation shows that no consumers suffered any loss or damage with respect to the misconduct. The loss or damage suffered by the consumers in this case is determined to be nil. Salamander Corporation communicates the outcome of the investigation to the five potentially affected consumers.

The right of an affected consumer to pursue legally enforceable rights

12.176 For the avoidance of doubt, nothing in this section affects any legally enforceable rights of the affected consumer to pursue loss or damage that the affected consumer suffers, or will suffer, as a result of a reportable situation. [Schedule 11, item 16, sections 51B(9) and (10) of the Credit Act]

12.177 The amendments are intended to ensure that licensees investigate and remediate misconduct proactively. The amendments rely on the existing rights of the affected consumer and do not alter those rights. Accordingly, an affected consumer's rights are not extinguished by the operation of this section.

12.178 However, a court may take into account the remedy provided by a licensee in relation to a reportable situation. For example, where a licensee has provided a partial remedy to the affected consumer, the court may take this fact into account to alter its award of damages if an action is brought successfully by the affected consumer in relation to the same facts. This provision ensures that the consumer is not enriched unjustly in the same case.

Re-triggering of licensee obligations

12.179 There may be circumstances where during the course of an investigation, or after the investigation, licensee obligations are triggered or re-triggered.

12.180 At any time, including during an investigation, a licensee may have reasonable grounds to believe or suspect that further reportable situations have arisen in accordance with section 50A of the Credit Act. Where appropriate, this will also trigger obligations under sections 51A of the Credit Act to notify affected consumers and 51B of the Credit Act to investigate misconduct and remediate affected consumers.

Example 12.9 : Investigation reveals further notifications to ASIC

Tapir Services is an Australian credit licensee that is a mortgage broker. During Tapir Services' investigation of misconduct in relation to its adviser, Nomos, it finds further reasonable grounds to suspect that another mortgage broker working in the same team, Sutte, was grossly negligent.

Accordingly, the obligation on Tapir Services to notify ASIC in relation to misconduct on the part of Sutte under section 50A is triggered. Because Tapir Services has reasonable grounds to suspect gross negligence on the part of Sutte which could potentially affect three of Tapir Services' consumers. Therefore, alongside the investigation into Nomos, Tapir Services is also required to notify, investigate and remediate consumers affected by Sutte's misconduct under sections 51A and 51B of the Credit Act.

Consequences of failing to investigate and remediate misconduct: civil penalty provisions

12.181 A licensee who contravenes any of the following is liable for a civil penalty:

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section 51B(1) of the Credit Act - the obligation to investigate certain reportable situations;

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section 51B(5) of the Credit Act - the obligation to notify the outcome of the investigation within 10 days;

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section 51B(8) of the Credit Act - the obligation to remediate the affected consumer within 30 days.

[Schedule 11, item 16, section 51B(8) of the Credit Act]

12.182 In considering the imposition of this civil penalty, regard has been had to the Guide to Framing Commonwealth Offences.

12.183 The imposition of a civil penalty for contravention of the obligations is necessary and appropriate for the following reasons:

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the conduct to be deterred was identified in the Financial Services Royal Commission. In particular, it was found that where a licensee detects misconduct, it should always consider what steps need to be taken to uncover the extent of the conduct beyond the immediate focus of attention;

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the conduct causes serious harm to people. The imposition of a civil penalty is intended to decrease the instances of investigations not being carried out and any remediation for loss or damage flowing from the investigated misconduct not being provided to the affected consumer;

•

current measures to encourage investigations into misconduct have not been sufficient and the Financial Services Royal Commission found that entities have not always considered what steps they need to take in response to detections of misconduct; and

•

the imposition of a civil penalty fits into the overall legislative scheme. The civil penalty for a contravention of the obligation to investigate and remediate misconduct is consistent with the treatment of other contraventions of the general obligations imposed on an Australian credit licensee. For example, a general obligation is imposed on licensees under section 47 of the Credit Act to do all things necessary to ensure that the credit activities authorised by the licence are engaged in efficiently.

12.184 The declaration of a contravention of a civil penalty provision and pecuniary penalty orders are dealt with in sections 166 and 167 of the Credit Act.

12.185 The maximum penalty applicable to a failure by a credit licensee to investigate a reportable situation, notify an affected consumer of the outcome of the investigation or compensate an affected consumer is 5,000 penalty units for an individual and 50,000 penalty units for a body corporate (see sections 47(4) and 167B(2)(a) of the Credit Act). If the court can determine the benefit derived and detriment avoided because of the contravention, the applicable penalty may otherwise be that amount multiplied by three (see sections 167B(1)(b) and (2)(b) of the Credit Act). In the case of a body corporate, the applicable penalty may otherwise be 10 per cent of the annual turnover of the body corporate (not exceeding an amount equal to 2.5 million penalty units) (see section 167B(2)(c) of the Credit Act). This is consistent with the maximum penalty that is applicable in relation to a contravention of the other general obligations of a credit licensee.

12.186 Consistent with all pecuniary penalty orders made under Part 4-1 of the Credit Act, when considering the penalty to be ordered for a failure by a credit licensee to investigate a reportable situation, notify an affected consumer of the outcome of the investigation or compensate an affected consumer the court must take into account all relevant matters. Section 167(3) of the Credit Act provides that these matters include:

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the nature and extent of the contravention;

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the nature and extent of any loss or damage suffered because of the contravention;

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the circumstances in which the contravention took place; and

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whether the person has previously been found by a court to have engaged in similar conduct.

Obligation to keep records of compliance

12.187 The notification and remediation obligations are intended to require licensees to proactively provide a remedy to affected consumers without affected consumers needing to involve the courts, ASIC or another regulator. However, to encourage compliance and to allow compliance to be monitored, a licensee must keep records sufficient to enable the licensee's compliance with the obligations to notify, investigate and remediate clients affected by misconduct to be readily ascertained. [Schedule 11, item 16, section 51C(1) of the Credit Act]

12.188 The regulations may specify records the licensee must keep. Regulation-making powers have been inserted to allow particular records that must be kept as part of the obligation to be specified. [Schedule 11, item 16, section 51C(2) of the Credit Act]

12.189 Allowing the regulations to specify records to be kept will provide the Government with the necessary flexibility to make timely changes in response to changing industry practices and allow the law to adapt to changes in technology. This will help to support licensees to discharge the obligation while ensuring that records required to be kept are appropriate to evidence compliance with the underlying requirement to notify and remediate consumers following misconduct. By staying current to industry practices and development in technology, the regulations encourage licensees to be proactive about addressing misconduct, and for them to develop practices to accurately record instances of misconduct and how they have remediated affected clients. At the same time, the regulations, as opposed to another type of legislative instrument, provide more certainty to licensees about their record keeping obligations.

12.190 Allowing the regulations to specify records will provide a flexible approach to ensure the regime only imposes obligations on licensees to the extent appropriate. The regulations would be subject to disallowance and therefore will be subject to appropriate parliamentary scrutiny.

Consequences of failing to keep records of compliance

12.191 A licensee who contravenes the obligation to keep records to show compliance with the obligations to notify, investigate and remediate clients affected by misconduct commits an offence and is liable for 5 years imprisonment. In considering the imposition of the criminal offence, regard has been had to the Guide to Framing Commonwealth Offences. [Schedule 11, item 16, section 51C(3) of the Credit Act]

12.192 The criminal offence aims to deter and punish the behaviour as appropriate while ensuring the effectiveness of the notification and remediation framework. The inclusion of the criminal offence is necessary and appropriate for the following reasons:

•

the Financial Services Royal Commission recommended that where there is sufficient information to suggest that a mortgage broker has engaged in misconduct, licensees must tell affected clients and remediate those clients promptly. The requirement that licensees maintain records is necessary to ensure that the obligation is complied with;

•

the requirement for maintenance of records of compliance is also necessary to ensure that licensees make whatever inquiries are reasonably necessary to determine the nature and full extent of the mortgage broker's misconduct;

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the maintenance of proper records will allow ASIC to monitor compliance with the obligation and to ascertain whether it needs to take further action in relation to a licensee;

•

the obligations encourage structural change in licensee behaviour towards addressing misconduct by requiring records to be kept not just about the misconduct, but also about how they have remediated affected clients.

12.193 The maximum penalty of five years imprisonment reflects the seriousness of the offence and provides a court with guidance on how to punish criminal behaviour. The maximum penalty is generally reserved only for the most egregious cases. The default fault elements in the Criminal Code apply to the corresponding physical elements of the offence. Applying default fault elements is consistent with Part 2.2.4 of the Guide to Framing Commonwealth Offences.

Application and transitional provisions

12.194 Schedule 11 commences on 1 October 2021. [Clause 2]

12.195 The obligation to investigate and remediate misconduct applies from 1 October 2021.

Amendments to the Corporations Act

12.196 The amendments apply from 1 October 2021. Accordingly, the obligation for an Australian financial services licensee to notify affected clients, and investigate and remediate misconduct applies to reportable situations arising on or after 1 October 2021. [Schedule 11, item 9, section 1671E of the Corporations Act]

Amendments to the National Consumer Credit Protection (Transitional and Consequential Provisions) Act 2009

12.197 The amendments apply from 1 October 2021. Accordingly, the obligation for an Australian credit licensee to notify affected consumers, and investigate and remediate misconduct applies to reportable situations arising on or after 1 October 2021. [Schedule 11, item 18, section 4 of Schedule 16 to the National Consumer Credit Protection (Transitional and Consequential Provisions) Act 2009]