Australian Securities and Investments Commission Should Ponder Overseas Failure of "Why Not Litigate?" Mantra (Australia Financial Review)

Enforcement regulators in the United States and United Kingdom reacted to public anger over bad bank behaviour. Ten years later, they have decided there are better ways than going to court. Tim L'Estrange, Partner-in-Charge of Jones Day's Melbourne Office, and Daniel Moloney, an associate in Melbourne, outline why ASIC should reflect on those lessons learned.

As has been well publicised, the political and public pressure of the Royal Commission has seen the Australian regulators rapidly change their enforcement approach to focus on litigation. The same thing happened a decade ago in the United Kingdom and the United States, with regulators taking a hard line approach to litigation.

Ten years on, both have recently pulled back from this approach, acknowledging outcomes are more nuanced than a tally of wins in court. It is a pity that we now seem to be barrelling down an overly rigid path toward litigation where time and money could no doubt be better deployed. In light of the failed policy experiences of overseas regulators following the global financial crisis ("GFC"), it is unfortunate that we are adopting a similarly inflexible mantra and expecting a different result.

ASIC has been vocal about its "why not litigate?" mandate, and in the coming months has said it will put up to 50 matters into the courts, many of them arising from the Royal Commission. ASIC Deputy Chairman Daniel Crennan QC has said these numbers represent ASIC's deliberate "shift towards a more litigation-oriented agency".

This shift is not surprising and was perhaps inevitable, given Commissioner Hayne's appraisal of the regulators' enforcement activities. Commissioner Hayne posited that "improving compliance with financial services laws cannot be achieved by focusing only on negotiation and persuasion".

But will the regulators go too far the other way? Will their focus on litigation only serve to diminish confidence in them and the financial services sector more widely?

ASIC's recent unsuccessful action against Westpac in the Federal Court demonstrated the stark difference between a Royal Commission and the realities that regulators will face in bringing successful actions against corporations and individuals. The Court's rejection of an earlier offer of settlement for $35 million also demonstrated that resolving those cases by agreed settlement may not be effective if the Court does not agree to the terms.

It is not easy to litigate against highly sophisticated financial institutions which are experienced in dealing with the complex regulatory framework of the Australian financial services industry, despite what might have been suggested by the examination of specific case studies at the Royal Commission.

It might be expected that the regulators experience a number of losses in court over the coming years as the "litigation blitz" unfolds. ASIC has tacitly acknowledged this with Mr. Crennan QC stating that "[u]nfortunately, that can result in the regulator losing cases. But that's the world of litigation".

This places financial institutions in a difficult position: they wish to restore confidence following the Royal Commission and to maintain productive relationships with our regulators, but may be faced with actions by regulators where they consider their position to be legally right.

In the United States, the Securities and Exchange Commission ("SEC") recently turned away from its previously aggressive enforcement strategy of pursuing all legal violations regardless of impact on investors and markets (based on the "broken windows" theory of crime deterrence—when a window is broken and someone fixes it, it is a sign that disorder will not be tolerated). The SEC did this because it diverted resources from high-priority issues, encouraged financial institutions to be extremely wary of engaging in constructive dialogue and provided poor incentives for the SEC by rewarding them for the quantity, rather than quality, of their cases. The strategy, in the view of some, also imposed unwarranted costs on companies and individuals.

In the United Kingdom, the Financial Conduct Authority ("FCA") has acknowledged the importance of a "more multi-faceted approach to regulation which again reflects the collective response of hard won experience over the last ten years". The FCA observed that 10 years ago was a period of "public anger" following the GFC. Ten years on, whilst there may still be public suspicion of financial institutions, the FCA has changed its approach because it says it realised from experience that early detection and quick and effective regulatory action is more effective than higher fines and harsher penalties alone.

This change in the FCA's approach has seen it make greater use of its regulatory intervention powers against financial institutions, including requiring enhanced reporting and independent audits or restricting product offerings. By doing so, the FCA benefits from faster, more targeted and cheaper action, whilst financial institutions avoid formal fines and the associated reputational damage. This approach can, however, put financial institutions in regulatory limbo as the application of regulatory intervention powers can be protracted, lack procedural certainty and be subject to regulator discretion.

It is a pity that we now seem to be barrelling down an overly rigid path toward litigation where time and money could no doubt be better deployed. In light of the failed policy experiences of overseas regulators following the GFC, it is unfortunate that we are adopting a similarly inflexible mantra and expecting a different result.

The lessons from these experiences are useful and point to why a "litigation blitz" may not achieve the outcomes desired.

Reprinted with permission from the August 26, 2019 issue of Australia Financial Review (subscription required). Further duplication without permission is prohibited. All rights reserved.
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