Is ASIC more concerned about relationships with boards than enforcing the law?

A recent decision by Australian Securities and Investments Commission to deny a newspaper access to a confidential bank document raises questions about its attitude to regulating the financial services industry.

In the wake of the banking royal commission, the Australian Financial Review made a freedom of information^[1] request, seeking a report prepared for the Commonwealth Bank board by its lawyers, Speed & Stracey.

ASIC obtained a copy of it from the bank as part of its post-royal commission intensification of oversight.

The report is important because it deals with astounding claims that emerged during the royal commission.

Under questioning, the bank’s chair Catherine Livingstone said she had voiced concerns at a board meeting^[2] about its responses to breaches of money laundering laws that led to a record A$700 million ^[3]penalty.

The concerns were not recorded in the board minutes. Her recollections were disputed by others present.

Keeping accurate minutes is a core obligation under the Corporations Act. Breaches attract heavy penalties because minutes can become central evidence in prosecutions.

ASIC has chosen not to pursue Livingstone and the Commonwealth Bank board.

In its response to the Australian Financial Review’s request, ASIC said:

ASIC’s (regulatory) function is best achieved by maintaining a trusting and cooperative relationship with organisations who have shown a willingness to voluntarily provide information to ASIC on a confidential basis.

The statement raises questions about how ASIC balances its relationship with those it regulates with its job of enforcing the law.

In the final report of the banking royal commission Commissioner Kenneth Hayne challenged regulators such as ASIC to ask - why not litigate^[4]?

It’s a question still relevant today.

After losing a case against Westpac^[5] in the Federal Court over the way it approved loans, ASIC decided not to appeal^[6] to the High Court because it wanted to be a “force for the recovery”.

“We are in a very different economic environment than we were when we started this case,” its chairman James Shipton said on Monday. “The world has changed. We are cognisant of that.”

ASIC has long extolled the virtues of “co-regulation^[7]”, which it defines as “circumstances where the administration and enforcement of regulatory obligations occur in collaboration with industry”.

Read more: In defence of ASIC: there's more to regulation than prosecution^[8]

Co-regulation, sometimes called meta-regulation^[9], is a concept with some advantages. By subcontracting regulation to professional organisations, boards and managers closest to the action, the uber regulators can save money and concentrate on the big picture.

But it relies on those managers acting well.

Shipton stressed how important this was to ASIC in a speech delivered while the royal commission was sitting:

…industry, and the people within it, need to do more to support the proper functioning of the financial system. They need to take more of a leadership role in promoting professionalism. For example, the industry itself, working with standard setting and professional bodies, could promote and perhaps even require professionalism within their sectors.

After the royal commission, ASIC embedded psychologists^[10] in boardrooms to assess the quality of board decision making^[11].

This unnerved directors^[12], but didn’t seem to produce many meaningful insights^[13].

While seeming reasonable, co-regulation is unreasonably one-sided. It extracts promises to do better in the future, while undermining the courts’ ability to hold them to account.

It sends the message that undocumented boardroom recollections, for instance, are acceptable, or at least no more than a regrettable lapse.

Yet finding after finding in the fields of criminology, business ethics, public administration and political science suggests that what matters most for misconduct is not psychology but structure.

One multi-disciplinary study entitled Beyond bad apples and weak leaders^[14] examined both prisoner abuse in Baghdad’s notorious Abu Ghraib prison and also the falsification of architectural internship report in the United States.

Read more: The way banks are organised makes it hard to hold directors and executives criminally responsible^[15]

It found that in both of these very different environments organisational structures and incentives contributed more to bad behaviour than “bad apples” with bad psychology.

For banks, what needs attention are

• Board structure^[16]. Current structures are susceptible to capture by executives or dominant shareholders, with independent directors have limited desire or ability to monitor what’s going on.

• Organisational design^[17]. Removing hierarchies, outsourcing and creating temporary project teams limits oversight and opportunities to raising concerns about ethically problematic conduct.

• Pay for Performance^[18]. Bonuses distort decision making and create incentives that can reward misconduct.

• Policies and procedures^[19]. Poor ones create confusion and make decisions excessively reliant on discretion.

• Conflicts between laws and norms^[20]. Maximising shareholder value is not an express legal duty of directors, but companies have justified breaking the law in its pursuit.

• Moral/ethical language in guidelines^[21]. Their absence opens the way for a focus on instrumental goals (often linked to bonuses) without consideration of ethics.

• Consequences^[22]. Prosecuting corporations^[23] doesn’t deter office bearers, prosecuting individuals does. The last prominent Australian company director to go to jail was Rodney Adler^[24], in 2005.

Immediately actionable ideas include putting employees and unions^[25] on boards, reemphasising the pivotal role of boards and directors^[26], increasing real diversity^[27], reducing outsourcing and temporary teams, embedding ethics^[28] in decision making processes, and criminal prosecutions of company directors and company executives.

References

1. ^{^} freedom of information (www.afr.com)
2. ^{^} voiced concerns at a board meeting (financialservices.royalcommission.gov.au)
3. ^{^} A$700 million (theconversation.com)
4. ^{^} why not litigate (asic.gov.au)
5. ^{^} Westpac (www.regulationasia.com)
6. ^{^} not to appeal (www.afr.com)
7. ^{^} co-regulation (asic.gov.au)
8. ^{^} In defence of ASIC: there's more to regulation than prosecution (theconversation.com)
9. ^{^} meta-regulation (www.routledge.com)
10. ^{^} psychologists (www.afr.com)
11. ^{^} board decision making (download.asic.gov.au)
12. ^{^} unnerved directors (aicd.companydirectors.com.au)
13. ^{^} meaningful insights (www.afr.com)
14. ^{^} Beyond bad apples and weak leaders (journals.sagepub.com)
15. ^{^} The way banks are organised makes it hard to hold directors and executives criminally responsible (theconversation.com)
16. ^{^} Board structure (theconversation.com)
17. ^{^} Organisational design (link.springer.com)
18. ^{^} Pay for Performance (www.jstor.org)
19. ^{^} Policies and procedures (journals.sagepub.com)
20. ^{^} Conflicts between laws and norms (journals.sagepub.com)
21. ^{^} Moral/ethical language in guidelines (journals.aom.org)
22. ^{^} Consequences (www.jstor.org)
23. ^{^} corporations (www.smh.com.au)
24. ^{^} Rodney Adler (www.smh.com.au)
25. ^{^} employees and unions (theconversation.com)
26. ^{^} reemphasising the pivotal role of boards and directors (www.smh.com.au)
27. ^{^} real diversity (www.brisbanetimes.com.au)
28. ^{^} ethics (www.jstor.org)