Should the CSLR have broader powers to claw back funds?

The Compensation Scheme of Last Resort (CSLR), as the name suggests, was intended to be the final option for restitution when a client of a financial services firm has suffered a loss due to some level of misconduct.

However, in practice, the responsible entities are managing to skirt the system and get away with little consequence. Case in point is E&P Financial shutting down Dixon Advisory and transferring the majority of its clients and advisers to another one of its licensees.

Not only did the firm manage to escape almost scot-free – a class action did manage to extract $16 million in damages, though its PI insurance picked up around $12 million of that – it will indeed indirectly benefit from CSLR payments.

“When this compensation is paid, much of it will go to E&P as they still have many of these clients on the books,” FAAA chief executive Sarah Abood told ifa last year.

“It’s certainly what makes me the angriest, that advisers are on the hook for the failings of a listed entity. It’s unbelievable.”

In its recently released submission to the Treasury review of the CSLR, the Financial Services Council (FSC) argued the scheme is not only not sustainable in its present form, but also “no longer acting as a scheme that is truly last resort”.

Considering it only kicked off 14 months ago, this is a strong indication that the design of the scheme is seriously flawed.

Among the 35 recommendations that the FSC laid out are a number related to ensuring there is greater effort to recoup some of the funds from the entities causing the losses.

Subrogation rights

Given the entire point of the CSLR is that claims only reach the scheme if an AFCA determination has gone unpaid, in many cases this is because the firm at fault has entered insolvency.

If they haven’t, the CSLR paying a claim will cause the cancellation of their licence – meaning they will no longer be able to operate.

Among the instances of this happening, many of these firms are already insolvent – such as the first case, which involved Sequoia subsidiary Libertas.

The Explanatory Memorandum for the bill which eventually enacted the CSLR clarifies that the scheme has subrogation rights “in certain circumstances, to recover some or all of the compensation paid on behalf of the relevant entity”.

However, as the FSC noted “with concern”, the CSLR’s most recent actuarial report indicates that no recoveries have been achieved through subrogation.

“In addition, the FSC is not aware of any legal proceedings which have been brought by the CSLR operator to attempt to achieve recoveries through subrogation,” the submission said.

“The FSC strongly supports the proactive use of subrogation powers by the CSLR operator to recover funds delinquent firms and their insurers.”

In response to this, the FSC has recommended that the government consider strengthening the CSLR’s subrogation rights and impose an “obligation to use reasonable endeavours (i.e. not solely providing the CSLR operator a right) to pursue recovery”.

“The FSC considers it important for the CSLR operator to be obliged to thoroughly assess whether funds may be recovered through its subrogation powers. This should be framed as a duty to use reasonable endeavours to achieve cost recovery, rather than a right to pursue it,” it added.

“This is because – in line with the CSLR’s objective of enhancing accountability – the first port of call for CSLR funding should be the entity responsible for a claim, or failing this, its insurer.

“To facilitate the exercise of these rights, FSPs with unpaid AFCA claims should also be legally required to disclose a copy of their professional indemnity insurance policy to the CSLR operator. Alternatively, ASIC should be authorised to provide the CSLR operator with the latest copy of a PI insurance policy provided to them during the AFS licence registration/renewal process.”

Additionally, because the Corporations Act limits the ability of the CSLR to exercise subrogated rights once compensation has been paid, this can result in delays beyond the scheme operator’s control.

“This may prejudice the CSLR operator’s standing in any insolvency,” the FSC said.

“For example, the CSLR operator may, depending on the relevant proof of debts cut-off date, be forced to file out of time and accordingly receive a lower level of priority (or share of the insolvency assets) over the remaining assets of a Chapter 5 body corporate than otherwise would have been the case for an unsecured creditor in its shoes.

“This would place greater, unnecessary pressure on other CSLR funding sources.”

Recommending that the Treasury “investigate this concern”, the FSC said it should consider increasing the standing of the CSLR either through giving it “debts priority unsecured creditor status or another means of streamlining the operation of subrogation rights”.

“The FSC notes that while CSLR operator claims should increase in priority, it should not supersede existing PI insurance claims,” the submission added.

“Maintaining PI insurance claim priority is crucial as it represents the first line of protection and primary risk management tool. Any streamlining of subrogation rights should maintain focus on pursuing the perpetrators of misconduct and their parent companies.”