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EUs generally effective in deterring misconduct: UNSW study

EUs generally effective in deterring misconduct: UNSW study

Enforceable undertakings are generally effective in deterring financial sector misconduct, but there are also areas of improvement, according to a study commissioned by ASIC.

A pilot study undertaken by the University of New South Wales (UNSW), and commissioned by the Australian Securities and Investments Commission (ASIC), evaluated the overall effectiveness and efficiency of enforceable undertakings (EUs), which are contracts between ASIC and a financial services or credit provider as alternatives to civil or administrative action.

The qualitative study found that an EU can drive behavioural change in that it motivates businesses to take action to avoid the perceived effects of harsher sanctions and the “intrusion of outsiders” such as regulators, in addition to avoiding financial and time costs, reputational damage and the subsequent loss of customers and class action suits — or a combination of these factors.

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“Even though an EU may not include an admission of liability, the promisor has to acknowledge that ASIC’s concerns are reasonably held. This provides a ‘road map’ for class action lawyers to build their case,” the UNSW report stated.

The report claimed that ASIC’s publication and distribution of EUs, with the help of media dissemination, leads to increased awareness of EUs in the financial services industry and accurate understanding of their general purposes.

“Although the wider community may not hear about an EU being entered into, it has been observed  that competitors of the promisor are generally aware that an EU has been entered into, tarnishing the reputation of the organisation,” the report stated.

UNSW professor Dimity Kingsford-Smith said in a statement that a clear finding of the study, contrary to the researchers’ expectations, is that a majority of interviewees believe their organisations were deterred by EUs involving their competitors.

Further, according to the ASIC-commissioned study, EUs have the potential to improve business practices and ensure compliance through clarification of which practices are or aren’t compliant; through reinforcing compliant practices, encouraging continuing improvement, and legitimating internal arguments for improvement; and through the exit of “incapable” providers from the industry.

Costs affect businesses differently

While the research overall found EUs to be effective, it also uncovered areas of improvement that are worth consideration.

One of the shortcomings identified in the report is that the impact of EUs is not consistent across industries or businesses of different sizes, which could impact conformity.

“Larger organisations, for example, have the resources to implement the changes that are required. Smaller organisations may have limited resources and may struggle to implement the changes needed to keep pace with best practices,” the UNSW report stated.

It also acknowledged the “severe” costs associated with EUs, including those involved with negotiating an EU, according to the report. This is because organisations are aware of the significant costs of implementing an EU and seek legal or other professional advice prior to entering into an EU, which is compounded by the length of the negotiation process (sometimes years), as it could mean that before an organisation even enters into an EU, it could remedy the alleged misconduct, making the EU promises irrelevant.

There are additionally costs associated with making changes to compliance systems, including the costs of expert advice, training, corrective advertisement and customer remediation.

On the other hand, complying with the terms outlined in an EU is also perceived by some respondents as more cost-effective than being subject to court proceedings.

Inconsistency in the application of EUs

Respondents to the study also pointed out what they perceived to be an inconsistency in the application of EUs by ASIC, saying that there is confusion as to why some businesses are able to escape EUs, while others have to submit to them.

The UNSW report noted that the use of informal settlements or “shadow EUs” — which don’t involve the formalities associated with EUs generally, such as publication on the EUs register — could be contributing to the perception of inconsistency, as there is “little transparency regarding the process attached to shadow EUs”.

“In most cases, the only public acknowledgement that a shadow EU has been entered into is through an ASIC media release, with no disclosure of the terms attached to the private settlement,” the report stated.

“While use of EUs to further ASIC’s regulatory purposes is to be encouraged, an inconsistent use may undermine the legitimacy of EUs and their deterrence.”

The UNSW report suggested that there needs to be a greater balance between the use of EUs and the use of civil and criminal penalties.

“Unreasoned action against some participants in the industry and not others may lead to resentment. Resentment may lead promisors to comply with the letter rather than the spirit of an EU, and for peer providers to do likewise or for general deterrence to fail altogether,” it said.

Other areas of improvement

The sustainability of changes implemented by organisations to comply with EU terms was brought into question by an interviewee, who noted a case where a competitor made changes initially, but reverted to some of the poor conduct that led to the application of the EU in the first place. This was partly attributed to there being a lack of regulatory repercussions for backsliding as well as poor corporate memory.

Aside from lack of motivation to change poor compliance practices, overconfidence in existing practices and rationalisations for misconduct, the UNSW study noted that EUs don’t address the true causal factor of the alleged misconduct, which could be impacting an organisation’s ability to sustain the changes.

“[A] professional adviser noted that EUs focus on specific deficiencies of a licensee, not shortcomings in relation to the general obligations breached: ‘there is little deterrence in my experience around the general obligations.’ This means that EUs are viewed as ‘a compliance arrangement rather than a resolution of customer issues’,” the report stated.

“That same professional adviser concluded: ‘A regulatory change in approach may be needed in the way the true causal factor for the breach is identified’.”

Based on feedback from interviewees, the study also suggested that EUs should contain terms for follow-up reviews at three and five years from completion of the initial EU, and that such reviews should be publicly reported on.

It further proposed that “understanding how regulators might best formulate EU terms to trigger positive mechanisms in general deterrence would also be helpful”.

ASIC said that it will move on to a scoping study on potential options for further research into the impact of EUs and other regulatory actions, as well as discuss with other regulators the potential to work collaboratively on future research.

[Related: Harsher penalties for misconduct introduced into Parliament]

EUs generally effective in deterring misconduct: UNSW study
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