Financial misconduct: Can we scare the banks into complying with the law?

Tougher penalties to deter corporate crime are just part of the equation

In late April, Malcolm Turnbull's Coalition government announced a ratcheting up of the civil and criminal penalties for corporate misconduct as it responded to the daily revelations of dishonesty by financial institutions in the ongoing Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

Under the new penalties, individuals face up to 10 years imprisonment and/or fines of nearly $1 million, or three times the benefit of the misconduct they received, while corporations will face fines of as much as $210 million.

"These stronger new penalties will ensure that those who do the wrong thing will receive appropriate punishment," said Treasurer Scott Morrison and Financial Services Minister Kelly O'Dwyer in a joint statement.

The two MPs are the latest in a parade of politicians to promise tougher penalties for corporate misconduct in the decade or so since the global financial crisis.

Regulators and law-makers are meeting public perceptions that corporate criminals are getting off too lightly by imposing bigger fines and longer jail terms.

But Pamela Hanrahan, a professor and deputy head of the school of taxation and business law at UNSW Business School, questions how effective increasing penalties will be in deterring corporate crime.

She says penalties are more complicated than just their magnitude and there are other options than just the "go-to response" of higher penalties.

In her recent paper, Fairness and Financial Services: Revisiting the Enforcement Framework, published in the Company and Securities Law Journal, Hanrahan outlines three changes that could be made to the penalty regime for corporate misconduct and how those changes could play out.

The first is increasing the size of the punishment; the second is changing the person to whom the penalty is attached – for instance, moving it from the company itself to the company's directors; third, and Hanrahan says most significantly, is changing whether companies and individuals are punished by a civil court or a criminal court.

Each of these has different flow-on consequences.

'It’s much more to do with what people think the likelihood is of getting caught and prosecuted’


Deterrent effect

Hanrahan questions whether the right approach has been taken to enforcing compliance in the financial services sector and how the penalties regime fits with that.

She asks whether Chapter 7 of the Corporations Act – which sets out detailed and extensive requirements of financial service providers and outlines what can happen when an individual or corporation is required to comply with the law but fails – is fit for purpose.

The aim of the law was to make people in financial services behave fairly, honestly and with professionalism, yet 15 years later the sector is embroiled in a Royal Commission.

"That seems to me to suggest it hasn't worked or it hasn't worked particularly well because, if it had worked well, then people would have confidence in the professionalism of the financial sector," says Hanrahan, who has been engaged to provide advice to the Royal Commission.

Hanrahan notes that deterrence is only one reason why we use penalties. Sometimes the community wants to see wrongdoers punished. But merely increasing the size of the penalty without making other changes doesn't have much of an additional deterrent effect.

"It's much more to do with what people think the likelihood is of getting caught and prosecuted and this is much more a determinant of whether they are scared into complying with the law than the size of the penalty at the end," she says.

For instance, even increasing the penalty for a particular breach to $100 million would have little deterrent effect if the regulator were perceived as weak and unlikely to prosecute.

Director accountability

The second change explored by Hanrahan is shifting the blame for misconduct from the company to individual directors, in a similar way that the Banking Executive Accountability Regime (BEAR) enacted in February has done.

This was designed to make senior executives and directors in banks more accountable for the actions of their organisation. Instead of trying to identify the individuals who actually committed the misconduct, it punishes the person whose job it is to be accountable.

"Would banks be more likely to obey the law if the chief executive knew that, if the bank didn't obey the law, regardless of his or her personal level of fault, he or she was going to be punished for it?" Hanrahan asks.

This approach was much favoured by state governments, but a concerted campaign by company directors saw state and federal governments pass legislation that individuals can't be held criminally responsible because of the office they hold rather than the thing that they personally did wrong.

"Now, what we're seeing is that that's starting to get eroded with things like the BEAR. They're starting to go back to, 'Maybe if we just said those people are accountable, that will make sure that the corporation does the right thing'," Hanrahan says.

'If it takes 10 years to get to that point, then that works against civil justice as a deterrence factor'


Civil justice

The third possible change – moving from criminal prosecution to civil prosecution – makes a difference because of what prosecutors have to prove in court and the standard to which they have to prove it. In a civil prosecution, it isn't necessary to prove somebody's state of mind and that they meant to do something wrong.

"That's easier. And you only have to prove the elements of the contravention to a civil standard, that's just on the balance of probabilities, not beyond the reasonable doubt," Hanrahan says.

"In theory, that question about, 'How likely am I to get caught and punished?', the more things you put in the civil basket, the more that goes up."

But there is a caveat.

Civil court cases tend to be long and expensive to run. For instance, the civil prosecution of Emmanuel and Julie Cassimatis, the husband and wife founders of collapsed financial planning company Storm Financial — which left more than 3000 clients destitute – took a decade. The couple only received their penalties – a $70,000 fine each – in March this year.

"If it takes 10 years to get to that point, then that works against civil justice as a deterrence factor," notes Hanrahan.

She says combining the three changes – higher penalties, civil prosecution and director liability – may drive more compliance with the banking laws, but asks: "At what cost?"

'When the music stopped'

Introducing a very large penalty, allowing prosecutors to seek it in civil court and imposing the penalty on individuals who are not personally blameworthy "in any sense other than that they happen to be sitting in the chair when the music stopped" would erode some of the legal protections private citizens presently enjoy.

"You're giving the government the power to require a private citizen to pay very large penalties without any of the protections that we traditionally apply to that through the criminal law – things like proof beyond reasonable doubt and the protective laws of criminal evidence and procedure," Hanrahan says.

"The more you push things over in that direction, the more you start to interfere with protections that have traditionally been afforded to private citizens against government action."

As the Royal Commission continues, the issue of how to make banks and other corporations comply with regulatory requirements will likely become an increasing focus.

Hanrahan says that she doesn't necessarily have any answers but all options will need to remain on the table.

"It's really just at the beginning of the discussion rather than providing a solution. We're not doing that at all. We're just trying to open up so that people start to think, 'OK. So, there's a few different things moving around here and it's not just about the headline number'."


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