ATIONAL INANCE ROKING EGULATION

Transcription

1 ATIONAL INANCE ROKING EGULATION REGULATORY IMPACT STATEMENT DISCUSSION PAPER The contents of this Regulatory Impact Statement Discussion Paper are for discussion only and do not represent the views of any State or Territory Government or the Australian Government

2 Comments are invited on any aspect of the paper. Details of costs to the industry of any proposed option are sought, as well as comment on any assumptions made in the paper. Submissions may be sent electronically or in hard copy. Enquiries to: Lucas Kolenberg (02) The address for submissions is: Submissions by post should be sent to: National Finance Broking Regulation 2004 Policy & Strategy Division Office of Fair Trading PO Box 972 PARRAMATTA NSW 2124 Final date for submissions: 15 February

3 CONTENTS PAGE 1 INTRODUCTION OVERVIEW REGULATORY IMPACT STATEMENT REQUIREMENTS INDUSTRY OVERVIEW THE FINANCE AND MORTGAGE BROKING INDUSTRY Size and value of the broker industry Value of Broker Transactions Categories of industry players Role of Mortgage and finance brokers Mortgage managers Intermediaries who provide loan-reduction services Remuneration within the broker industry FEATURES OF THE BROKER INDUSTRY WHICH MAY IMPACT NEGATIVELY ON CONSUMERS Increased reliance by lenders on brokers Minimal barriers to entry Conduct engaged in by fringe operators Financial consequences of accessing credit or advice from fringe players MAINSTREAM PLAYERS QUALITY OF ADVICE Financial cost of poor recommendations EFFECTS OF A COMMISSION BASED REMUNERATION STRUCTURE Reverse competition Practices which flow from these arrangements Limited capacity of consumers to differentiate between brokers Fees issues DISCLOSURE OBLIGATIONS USE OF COLD CALLING TO SOLICIT CLIENTS FACTORS WHICH ACT AGAINST THE PROVISION OF QUALITY SERVICES No ongoing relationship with clients Lack of accountability Inability of lenders to discipline bad brokers REGULATION AND REMEDIES REGULATION OF BROKERS IN AUSTRALIA Legislation Regulating Brokers General Regulation of Brokers State/Territory Fair Trading Agencies Self-Regulation Liability of lenders for conduct of brokers Accreditation of brokers by lenders REGULATION IN OTHER COUNTRIES CONSUMER REMEDIES Difficulties in accessing redress mechanisms Legal Redress Tribunal Access Access to alternative dispute resolution SUMMARY OF IDENTIFIED PROBLEMS AND THE CONSEQUENCES FOR CONSUMERS LEVEL OF CONSUMER DETRIMENT REASONS FOR GOVERNMENT INTERVENTION MARKET FAILURE IN RELATION TO CONSUMERS Imperfect or costly information Fraudulent, unconscionable or misleading conduct MARKET FAILURE IN RELATION TO LENDERS

4 5 OBJECTIVES OF GOVERNMENT INTERVENTION POLICY OPTIONS RETAIN THE STATUS QUO Benefits/Advantages Costs/Disadvantages SELF-REGULATION MODEL Benefits/Advantages Costs/Disadvantages CONSUMER EDUCATION Benefits/Advantages Costs/Disadvantages MANDATORY CODE OF CONDUCT Benefits/Advantages Costs/Disadvantages BROKER SPECIFIC REGULATION PROPOSALS TO REGULATE THE BROKING INDUSTRY SCOPE OF FINANCE BROKING LEGISLATION Benefits/Advantages Costs/ Disadvantages HOW IS A BROKER TO BE DEFINED? HOW WILL LEGISLATION MEET GOVERNMENT OBJECTIVES? OBJECTIVES 1 AND LICENSING/REGISTRATION/NEGATIVE LICENSING Benefits/Advantages Costs/Disadvantages COMPETENCY OF BROKERS Benefits/Advantages Costs/Disadvantages OBJECTIVES 2 AND PROVIDE CONSUMERS WITH SUFFICIENT INFORMATION TO CHOOSE A SUITABLE BROKER REQUIRE BROKERS TO DEMONSTRATE THAT THEIR RECOMMENDATION IS APPROPRIATE FOR THE CONSUMER S CIRCUMSTANCES AND, WHERE POSSIBLE, THE BEST AVAILABLE Benefits/ Advantages Costs/ Disadvantages Benefits/ Advantages Costs/Disadvantages Benefits/Advantages Costs/ Disadvantages OBJECTIVE PROVIDE A MEANS OF EMPOWERING CONSUMERS TO INFLUENCE BROKER BEHAVIOUR BY PROVIDING CONSUMERS WITH EFFECTIVE REMEDIES AGAINST BROKERS WHO DO NOT ACT FAIRLY OR COMPETENTLY Benefits/Advantages Costs/Disadvantages STAY OF ENFORCEMENT PROCEEDINGS Benefits/Advantages Costs/Disadvantages COMPENSATION FOR CONSUMERS Benefits/Advantages Costs/ Disadvantages ACCESS TO AFFORDABLE REMEDIES Benefits/advantages Costs/Disadvantages IMPACT ON COMPETITION CONSULTATION Attachment A Attachment B 4

5 1 Introduction 1.1 Overview Deregulation of the finance market in the late 1980s provided a major impetus to changes in both the volume of credit products offered and also in the structure and composition of the industry. As new players entered the market, the competition for market share became intense. One of the ways in which credit providers could reach more customers without a branch presence was through intermediaries such as finance and mortgage brokers. At the same time, more consumers were able to access credit, and the products evolved to meet demand and to provide a differentiation between products which would provide a basis for competition. The broking market in turn has grown to meet the demand. As products became more complex, consumers turned to brokers to assist them in their choices. However, as has been seen with other intermediaries who occupy a position of some power, consumers have not always been well served and their lack of expertise has been, in many cases, exploited. The growth in the industry has been mirrored by growth in consumer problems. State fair trading agencies have become aware of rising levels of consumer detriment and this has been reinforced by reports from financial counsellors and credit legal centres. The broking market has been subject to a minimum level of regulation, but as a result of the increasing levels of consumer detriment there have been calls by both consumer advocates and the industry itself for governments to address the problem. This Regulatory Impact Statement Discussion Paper details proposals to address the problems identified. 1.2 Regulatory Impact Statement Requirements Finance and mortgage broking issues are relevant to all jurisdictions. The Ministerial Council on Consumer Affairs has acknowledged the importance of this issue by including it on the strategic agenda and has agreed to progress as a matter of urgency proposals to address the problems raised. Proposals for standard setting and regulatory initiatives which are made at a national level and which have the potential to restrict competition are required to include evidence that the competitive effects of the regulation have been considered; that the benefits outweigh the likely costs; and that the restriction is no more restrictive than necessary in the public interest. This document sets out the problems reported in the marketplace and identifies those structural elements which are considered to be an impediment to effective marketplace solutions. Possible regulatory approaches are canvassed and proposals for a national regime are set out, with analysis of the potential costs and benefits to the community. Acknowledgement Parts 2 and 3 of this paper incorporate material from the Report to ASIC on the finance and mortgage broker industry compiled by the Consumer Credit Legal Centre and commissioned by the Australian Securities and Investments Commission. The information in those parts

6 has been updated where appropriate and some minor changes made. Case studies in those parts are taken from the original report, and were supplied by caseworkers. The information in that report was obtained from surveys undertaken as part of the research, or from material sourced elsewhere. References are provided. 6

7 2 Industry Overview 2.1 The finance and mortgage broking industry The broker industry in Australia is relatively new, and has experienced a rapid growth in the last ten years. This growth has resulted from the substantial increase in the variety of mortgage products offered, strong credit growth to finance the acquisition of mortgage assets and the recent boom in the residential property market. Industry sources suggest that the use of brokers is as cheap or cheaper than traditional distribution methods. Their assistance can also provide value to consumers by saving them time and money Size and value of the broker industry IBIS World estimates that, in , mortgage brokers generated around $630 million in revenue. Industry gross domestic product is estimated to be approximately $271 million (see Table 1). Over the five-year period to , industry revenue increased from $332 million to $629 million, representing an average annual growth rate of 11%. The mortgage broking industry has also been growing at a significantly faster rate than national gross domestic product (GDP). Industry GDP grew to $271 million in , and grew at an annual rate of 9.4% in the five-year period to Higher demand for mortgage brokers' services over recent years has also led to increasing industry profitability. The large variety of mortgage products has brought about increased complexity for consumers in finding a suitable home loan Value of Broker Transactions The last ten years have seen a transformation of the Australian housing finance market. In , Australians borrowed $15 billion in housing finance from lenders (who were then almost exclusively banks, building societies and credit unions). The Reserve Bank of Australia data shows that total housing lending was approximately $452.6 billion in March Current estimates of broker-introduced loans are around 30% to 33% of total new housing loans. Based on these estimates, the total value of brokerintroduced housing loans can be approximated to between $136 and $150 billion. Precise figures on the number and value of the loans that brokers are responsible for are not available; estimates of these figures can vary significantly. Solomon Smith Barney estimated that the value of the Australian broker home loan market was $29.5 billion for the calendar year to December However, APRA reported in January 2003 that brokers accounted for 23% ($76 billion) of home loans with banks, credit unions and building societies, and $86.6 billion of credit with these institutions in total. 3 Table 1: Size of Industry Key Statistics (IBIS World, Mortgage Brokers in Australia, April 2004) Industry Turnover $m Industry Gross Product $m Employment 1, , , , , ,389.0 Units Total Wages $m 1 Reserve Bank of Australia, Bulletin Statistical Table D02, Lending and Credit Aggregates, March Solomon Smith Barney, Australia s Mortgage Market, 2 May Australian Prudential Regulation Authority (APRA), Report on Broker Originated Lending, Jan. 2003, p. 2. 7

8 Mortgage originators provided many of these loans. The bulk of these originators are small in scale, and have no branch network or existing distribution channels. They have relied on brokers to negotiate credit between consumers and third parties, and have given a huge impetus to the growth of the finance broker industry. Brokers do not deal only with mortgage products. They provide access to all products, although some will deal exclusively with mortgage finance. All types of lenders have become dependent on brokers for market share. Banks have compensated for the loss of business resulting from branch closures by utilising applications through brokers. On average, each bank has been using brokers for almost ten years, and currently receives loan applications from 740 brokers. 4 It is estimated that the four major banks received 60% of all broker loan applications in the March 2002 quarter. Credit unions and building societies have been slower to establish relationships with brokers, with these institutions using, on average, only 13 brokers and having dealt with them for only three to four years. 5 The use made of brokers by banks, credit unions and building societies has undergone rapid expansion, with 38% of these institutions planning to increase their rate of broker usage, and 25 individual lenders arranging to use brokers for the first time when surveyed in One high profile example of this trend in the market was the announcement by three credit unions - Australian Central Credit Union, Australian National Credit Union and Credit Union Australia that they had secured an 8.2% share in Mortgage Choice, one of the nation s leading mortgage broker organisations. The move was designed to increase the percentage of future broker-written credit union home loans, with these three credit unions being included on Mortgage Choice s panel of lenders. It is noted, however, that following the recent downturn in mortgage lending, some of the banks are reported to have imposed a ceiling on the proportion of mortgages written through brokers. 7 The resultant increase in broker numbers has been enormous. Solomon Smith Barney, in a 2001 report into the Australian mortgage industry, estimated that there could be more than 10,000 individuals operating in the Australian broker market, with 50 new brokers entering the market each week. 8 Seventeen per cent of respondents to the Broker Survey had been operating for two years or less. 9 Data from the Market Intelligence Strategy Centre, while not measuring individual brokers, estimates that there are currently 2000 broker firms operating Australia wide. 10 In addition, while there is significant concentration at the upper end of the broker market (a rough estimate from senior industry sources suggested that, prior to the entry of Aussie Home Loans into the marketplace, the top three players had around 40% of the market, while the top ten had around 55%), the industry has a long tail of small operators. 4 APRA, op.cit, p Ibid. 6 Ibid., p Business Review Weekly June , p38. 8 Solomon Smith Barney, op.cit. 9 Consumer Credit Legal Centre, Report to ASIC on the finance and mortgage broker industry, March 2003, Appendix B, Table B4, p Market Intelligence Strategy Centre, Mortgage Broking, Media Release. 17 April

9 2.1.3 Categories of industry players The expansion of the finance broker industry has seen the development of a number of different types of participants, with three broad categories of intermediaries: 11 mortgage and finance brokers; mortgage managers; and intermediaries who promote loan or debt reduction schemes (in which the borrower refinances an existing home loan). While all three types of intermediaries act as a link between the consumer and credit providers, they do so in different ways, outlined below. There is a fourth category of brokers, those who are active in soliciting funds from investors and making these available as loans to the public. Historically there have been problems with the conduct of brokers in this area, particularly in Western Australia, where the government held a number of inquiries into the conduct of brokers in the 1990s, resulting in criminal charges against approximately 20 brokers involved in fund-raising activities. This type of fund-raising is now more strictly regulated by ASIC, following amendments to the Managed Investments Act An examination of this part of the industry is outside the scope of this report. Consumers are relatively inexperienced when using brokers and they can be dependent on them for advice because of the confusing range of loans and providers; some brokers are prepared to exploit that dependency. This section of the paper examines the current nature, structure and operation of the broker industry in Australia, and the way in which this can operate to both the benefit and disadvantage of consumers Role of Mortgage and finance brokers A key issue in this area is that there are vastly different views of the role and responsibilities of the broker. Possible variations of the role of the broker are: To advise the consumer about the best option or options available, from a broad range of products, following a careful analysis of their personal circumstances; To present a range of options (with no express or implied recommendation) and allowing the consumer to select the product they consider most appropriate for their own circumstances; or To simply arrange credit for the borrower (usually from a preferred lender), without regard to whether a cheaper or more appropriate product is available. At a practical level these views translate into significantly different methods of operating. The large player end of the market is dominated by a number of aggregators. These are organisations that provide infrastructure and administrative support to brokers who agree to become members. The aggregator organises a panel of lenders, facilitates the processing of loan applications and enters into commission-sharing arrangements with broker members. Typically, aggregators have panels of 40 lenders or more (and a greater number of products). The range of products available, and the infrastructure support mean that brokers in these organisations are readily able to review a broad range of credit products. It does not necessarily follow that this will result in recommendations with a greater match between the needs of the consumer and the product selected. One broking firm in a recent edition of their on-line newsletter stated: 11 It should be noted that the nomenclature used to designate the different types of broker can vary significantly from state to state. For example, in Western Australia the term mortgage broker appears to be rarely used. 9

10 ..our view is that brokers should be seen as essentially agents of lenders like salespeople in department stores. They have access to a range of products and knowledge of the market, so they are useful. But their advice should be taken with a grain of salt. 12 At the other end of the market are brokers who, while they may represent that they can 'arrange finance', forward virtually all loan applications to a few selected lenders (or, indeed, may channel all applications to one particular lender), and operate as de facto agents for those lenders. 13 At present there is no general obligation on brokers to provide upfront disclosure on their role, and there is therefore potential for brokers and consumers to have different expectations in relation to the desired outcome. It is likely that many consumers would assume the broker is undertaking a broad review on their behalf and may not be advised, or otherwise realise, that the functions being carried out by the broker are much narrower. The consumer is also generally not provided with a written recommendation which they can use to test the broker's decision, or assess the extent to which their individual circumstances have been considered. In the absence of any such recommendation the consumer can assume, wrongly in some cases, that the broker has undertaken a detailed review when this is not the case Mortgage managers Mortgage managers are linked to the wave of new non-mainstream mortgage financiers. The mortgage managers have arrangements with a wholesale lender to distribute the funds, usually through individually packaged home loans. The mortgage manager will arrange for the completion of a loan application, and the collation of documents supporting such applications. Once the loan is approved and disbursed, the mortgage manager will continue to administer the loan on behalf of the lender, by accepting payments, issuing statements, monitoring defaults and responding to any inquiries by the borrower. Despite this close relationship, they are not agents of the lenders but have established an identity which does not fit the generally understood categorisations. Some mortgage managers also operate as brokers, in that they will solicit loan applications, which are forwarded to lenders other than those for whom they manage the loans. The distinction between brokers and mortgage managers is one that will not necessarily be apparent or easily understood by the consumer. In other words, consumers can easily believe that the mortgage manager is selecting the loan from a pool of products when this is not the case Intermediaries who provide loan-reduction services The third category of intermediary promotes credit products indirectly, in that they advertise themselves as offering services that, it is claimed, will result in consumers being able to pay off their home loan more quickly than at present. These intermediaries therefore emphasise their advice services (as providing the key to paying off your home loan more quickly) rather than the credit product. There is a broad range in the level of sophistication of these 12 See 13 They are likely, nevertheless, to be treated in law as agents of the borrower and not the lender; see Custom Credit Corporation Ltd v Lynch [1993] 2 VR

11 intermediaries, with some doing little more than arranging refinances or debt consolidations at a cheaper interest rate. However, other bodies promoting loan-reduction services arrange for the borrower to refinance their existing home loan to a different credit product which, it is represented, will allow the borrower to achieve savings through maximising the use of their money. These operations usually: charge a significant upfront fee to give the borrower details of the methodology of their loan-reduction services; advise the borrower to refinance their home loan (and may earn commissions from the lender they recommend); arrange for the new loan to be connected with an offset account (so that living expenses are purchased by way of credit card, and the consumer s salary is offset against the home loan balance during the interest-free period on the card); and provide the borrower with budgeting advice, and encourage them to make increased repayments Remuneration within the broker industry Brokers receive remuneration in three main ways: fees charged to the client; upfront commissions; and trail commissions. Generally, most brokers derive their revenue from commissions, or a combination of fees and commissions. Responses to the Broker Survey 14 indicated that: 97% of respondents received commissions or financial benefits from credit providers; 57% of respondents did not charge their clients fees; and 40% of respondents charged their clients fees and also received commissions. There is currently no regulation of remuneration in Australia, with the exception of fees charged to clients in the Australian Capital Territory and in Western Australia. Individual brokers can therefore determine how they will be remunerated. The following matters are noted about commissions: the average initial commission paid by lenders was approximately 0.5% to 0.7% of the amount borrowed; the survey recorded one instance of a lender who paid an upfront commission of 4% of the amount borrowed; most lenders pay an average trail commission of approximately 0.3% of the outstanding balance of the loan. This amount is usually paid on a monthly basis; the highest trail commission noted in the Broker Survey was calculated at 1.7% of the outstanding loan amount; and bonuses can also be earned where the volume of business placed with a lender over a period of time meets or exceeds specified targets. The recent APRA survey of Australian authorised deposit-taking institutions (ADIs) noted that banks, credit unions and building societies paid, on average, an upfront commission of 0.51% for commercial loans, 0.77% for personal loans and 0.57% for housing loans. The average trail commission paid by these institutions was 0.17% for commercial loans, 0.06% for personal loans and 0.23% for housing loans. These figures suggest that some lenders, presumably non-mainstream operators, are paying commissions that are significantly above industry averages. Assuming that the cost of these 14 CCLC Report, op.cit., Section B.4 in Appendix B. 11

12 commissions is recouped from the borrower, and that at least some of these borrowers could qualify for loans elsewhere, this raises at a general level, the issue of whether or not reverse competition leads these brokers to place loans with a lender who is more expensive but who pays a higher rate of commission. The APRA survey also stated: Over half of the institutions (53%) base the broker s remuneration solely on the volume of business generated, providing brokers with an incentive to generate loan volume without appropriate regard for risk. With such an incentive structure, it is critical that ADIs have procedures in place to ensure their own credit assessment standards are rigorously applied to broker-introduced loans. 15 As with other industries, some lenders also provide soft dollar payments, through offering a range of financial benefits to selected intermediaries. These benefits can include marketing subsidies, assistance with office equipment, and profit-sharing arrangements. Where legislation imposes disclosure obligations on brokers, it generally excludes any requirement to disclose these types of financial benefits. Exceptions are the recently commenced New South Wales legislation in that it requires soft dollar benefits to be disclosed 16, while Victoria s legislation, the Consumer Credit (Victoria) Act 1995, defines fees to include reward whether monetary or otherwise. The prevalence of commission-based remuneration creates the possibility of conflicts of interest between the interests of the broker and their client. However, some of the broker firms, usually the larger ones or the aggregators, seek to mitigate the effect of commissions on the choice of product by rebating part of the payment to the borrower, or by paying fixed salaries to their employee brokers. Similarly, the aggregators generally have commission-splitting arrangements with individual brokers. These may vary with the identity of the lender and/or the volume of business placed. To the extent that broker remuneration is based purely on volume (rather than the identity of the lenders or the value of commissions offered), this may remove conflicts of interest that might otherwise arise in relation to the advice being offered. It does not, however, remove any conflicts of interest in relation to the size of the loans generated. Finally, it is worth noting another form of payment common in the broker industry, namely payments by brokers to third parties for referring potential clients to them. These fees are widespread in the industry. The Broker Survey found that 65% of respondents promoted their services though a range of third parties, including real estate agents, accountants, lawyers, collection agencies, car dealers, building contractors and financial planners. 17 In the majority of these cases, the brokers offered commissions or other financial incentives for these referrals. Where legislation imposes disclosure obligations on brokers, it only requires them to disclose payments that they will receive, not payments they make to third parties. Again, the New South Wales legislation is an exception 18. Consumers will generally therefore be unaware of the existence of these payments, and of the fact that they are not being given a personal recommendation to a broker. 15 APRA, op.cit., p Consumer Credit Administration Regulation 2002, Clause 2D. 17 CCLC. Op.cit., Table B.16 in Appendix B, p Op.cit., 2E 12

13 2.2 Features of the broker industry which may impact negatively on consumers This section of the paper seeks to analyse the structural features of the industry and suggests the consequences in terms of risks and outcomes for consumers that arise out of those structural features Increased reliance by lenders on brokers As noted above, reliance by lenders on brokers for market share is increasing. As well, the Australian Banking Industry Ombudsman (now the Financial Services and Banking Industry Ombudsman) has also noted an apparent increase in the delegation to brokers by banks of the responsibility of explaining the loan offer or security documents or both, including an apparent refusal by banks in some cases to have direct contact with the borrower, instead referring all questions to the broker. 19 The shift by major lenders in distribution channels from branch networks to brokers has also seen at least some of those lenders reduce their internal risk checks and credit assessment criteria. For example, APRA has noted that some credit unions and building societies were providing loan advance-to-valuation ratios of up to 100%, and that they were also accepting applications where the only deposit was provided through the Commonwealth Government s First Home Owners Grant (without the borrower therefore having any established savings history). 20 The use of brokers can leave lenders exposed to a higher risk of defaulting borrowers, and can also make them more susceptible to mortgage fraud, although the extent of this may vary depending on the stringency of any accreditation checks carried out by the lender before accepting applications from the broker, and on the type of loans (with some lenders having in place stricter requirements in respect of mortgage loans as opposed to unsecured loans). Where the credit provider s primary goal is market exposure and not the quality of the loan portfolio, this impacts also on consumers as brokers sell products which are either inappropriate to their needs or are unaffordable Minimal barriers to entry In the absence of a uniform or national occupational licensing regime, there are minimal barriers to entry to the industry. Currently, except in Western Australia, a person is not required to be licensed or to have training or educational qualifications before being able to practise as a broker. ACT requires registration, but this is not attached to any conditions. There are also minimal capital requirements since brokers can easily operate without premises or overheads, without employees and without personal indemnity insurance, encouraging fly-by-night operators. Some brokers have run significant practices without ever meeting clients, operating solely through telephone and facsimile contact. This leaves the market wide open to operators who may have no intention of providing a bona fide consumer service, but seek only to defraud or exploit the more vulnerable or unsuspecting consumer. This is demonstrated in case studies supplied and also by practices identified in the successful action against rogue brokers such as Credit 19 ABIO Bulletin, Dec. 2002, p Media Release [MR 02/37], 19 September

14 Accounting Consultants in New South Wales 21, where some hundreds of consumers are thought to have been affected. A graphic example of one such scam is a broker who attracts clientele through newspaper advertisements with statements such as: No credit checks. Finance OK if not working. When consumers approach the broker, they are told they need to pay a $600 application fee. If they cannot afford the fee upfront, the broker tells them to apply for a credit card and then pay the fee through a cash advance. The broker then may or may not arrange a loan for the consumer, depending on the person s circumstances. The conduct identified through case studies includes: brokers recommending interest only loans in inappropriate circumstances; brokers misrepresenting the savings available from changing a home loan; brokers charging excessive fees, or fees in circumstances where the broker is aware that there is little prospect of the borrower being approved for a loan; brokers arranging for borrowers to declare, incorrectly, that a loan is for investment rather than personal use (with the result that the consumer loses statutory protections provided under the Uniform Consumer Credit Code); borrowers being placed into a loan where they could only afford the repayments with substantial hardship (81% of the caseworkers surveyed by the CCLC (NSW) who dealt with broker complaints indicated that they often saw problems of this type); and brokers arranging finance for an amount less than that requested by the customer (particularly where the funds were required to complete a property purchase). These practices result in higher costs to consumers, an increased risk of default by the borrower, and exposure of their home where this was used as security for the debt Conduct engaged in by fringe operators Business purpose test Consumers can unknowingly sign away their rights in relation to credit regulated by the Consumer Credit Code by signing a business purpose declaration. Under section 11 of the Code, the Code is presumed to apply to a transaction unless the debtor declares before entering into the contract that the credit is to be applied predominantly for business or investment purposes. Unscrupulous brokers may ask or require a consumer to sign such a declaration before they will provide access to any credit. Those consumers who either do not understand the implications or are too desperate to consider the effect of signing away their rights may be persuaded to sign the declaration and as a consequence do not have access to any of the redress mechanisms under the Code. Fraudulent applications The following is a case study of a fraudulent application: A broker previously worked for a particular lender. He then left the lender and began contacting some of its clients, telling them that he had left because that lender is stealing your money and offering to help them refinance. Mr H was one of the clients approached by the broker. Mr H had recently been retrenched, and had income from a part-time job only. Mr 21 Commissioner for Fair Trading v Rowland Thomas & Ors [2004] NSWSC 479. The case concerned a scam finance broker operation involving non-provision of services, excessive commissions, misleading and unconscionable conduct. 14

15 H had purchased an investment unit off the plan sometime previously. The unit was nearly completed, with settlement approaching. The broker told Mr H that he could arrange for him to refinance his existing loan, and get finance for the purchase price of the investment unit. The broker arranged for false documents to accompany Mr H s loan application, including doctored bank statements, and a false reference from an employer, suggesting that Mr H was employed in sales, and earning over $80,000 in commission annually. The loan application was approved. It should be noted that the nature of the fraud in these types of transactions often makes enforcement actions problematic. Applications for credit that contain false information about the borrower s financial position are invariably signed by the consumer. Establishing that the false details were included without the borrower s consent or knowledge can be extremely difficult. Other complicating factors can be the existence of oral representations by the broker, the complex nature of the transaction, and, potentially, significant time lapses between the conduct of the broker and its discovery by the borrower. When added to the relatively small amounts of money involved, these factors mean that there are considerable difficulties in having a significant number of these matters investigated and prosecuted by the police. Interest only loans The case studies indicate that brokers are making widespread use of interest only loans. The repayments on these loans only meet the interest charged on the credit, so that at the expiration of the term of the loan (commonly one or two years only), the capital must be repaid. The repayments may be lower than a mainstream home loan, as they only meet interest rather than also reducing the outstanding capital (although this depends on the interest rate charged). Interest only loans are therefore generally of benefit only to small and specialist categories of borrowers, such as those experiencing short-term cash flow problems (where the short time frame means that the consumer will have to bear the costs of refinancing their home loan within a short period of time) or professional property investors seeking enhanced tax benefits. A review of the conduct of some brokers who arrange interest only loans suggests that they are being used in asset based lending, and that they are associated with patterns of behaviour which include: (a) (b) (c) (d) (e) Brokers targeting financially vulnerable consumers through advertisements containing statements such as Pensioners welcome. Can t get finance elsewhere? Need finance in a hurry? Brokers charging borrowers large establishment fees as well as legal fees or valuation fees where the broker has not made any payment to a third party for these fees. Brokers and lenders being unconcerned about the capacity of the borrower to make repayments, and lending on the basis that there is sufficient equity in the property to cover enforcement expenses should there be a default in payments. Lenders protect themselves from actions by borrowers under the Uniform Consumer Credit Code by: (i) requiring the borrower to execute a Business Purpose Declaration irrespective of the actual purpose of the loan; (ii) obtaining a certificate from an accountant advising that the borrower can afford the loan. Brokers assist with the execution of these documents and often are aware that these documents are incorrect. Brokers will sometimes arrange a second refinance for the borrower if they are unable to make the repayments on the first refinance. 15

16 This practice is known as equity skimming in that there is little value for the borrower from these refinances and the effect is to skim the equity from the property to the broker (through high fees) and the lender (through high interest rates, application and exit fees, and, if necessary, enforcement costs). As is evident from the newspaper advertisements this conduct is deliberate and systemic, and designed to exploit, rather than assist, consumers in a vulnerable situation. The following case study demonstrates the consequences for an individual borrower as a result of this practice. Case study Mrs M is an aged pensioner. As her only income is the pension, she was struggling to meet even her basic living requirements. She is poorly educated and has difficulty reading and writing. She owned her own home in country Victoria, a property valued at $40,000. Mrs M decided to consolidate her debts, primarily a debt owed to Legal Aid (incurred for divorce and custody proceedings). Legal Aid was not demanding payments from Mrs M, but she felt she should pay off the debt. Mrs M found an advertisement for a finance broker in a newspaper. The advertisement stated no credit checks and loans up to 90% of valuation. Mrs M rang the broker and gave some initial details over the phone. She then attended an appointment at the broker s office with a friend. The finance broker advised at this meeting that he could arrange a loan of $24,000 for her, although it would have to be secured with a mortgage over Mrs M s property. The broker provided her with a loan document and mortgage. Due to her literacy problems, which would have been evident to the broker, she was unable to understand them. Her friend suggested she take them to a solicitor, but the finance broker told her she could not do so, and that if she wanted the loan, she would have to sign immediately. Mrs M asked how long the loan was for, but an evasive answer was given. The broker did not explain that the loan was interest only in nature, and that the principal had to be repaid in 12 months. The interest rate on the loan was 13% and the contract provided for the broker to receive a procuration fee of $1500 (or 6.25% of the amount of the loan). Mrs M felt she had no choice except to sign the documents. She was able to meet the monthly repayments, although with some difficulty. When the term of the loan expired, Mrs M was unable to repay the capital sum of $24,000. She sought legal assistance and was advised to sell her home as otherwise she risked losing her outstanding equity in the property in legal action that was likely to be unsuccessful. There is a variation to this practice, whereby brokers recommend home loans (often with mainstream lenders) where the repayments cover interest only for the first few years. The amount of the repayments can then increase significantly to cover both principal and interest. The highly leveraged/geared nature of these loan means the borrower will have to change established spending habits in order to meet repayments that can increase by up to 40% (without taking into account any additional amounts payable due to rises in interest rates). Accordingly, loans of this type have greater risks for consumers than traditional principal and interest loans, as the initial "interest only" nature of the repayments means that they are paying significantly more overall, and that - during the period when repayments are only covering interest - any equity is only being accrued through increases in the value of any property purchased with the funds. Brokers recommending these products without carefully explaining to borrowers the way in which they operate and ensuring that the consumer is comfortable with the increase in repayments place borrowers at risk of being overcommitted, possibly not at present, but when repayments increase. 16

17 Misrepresenting the financial benefits available Some intermediaries market themselves on the basis that, where the consumer has an existing home loan, they are able to offer the consumer a more competitive product that will enable their mortgage to be paid off more quickly. This approach uses as a marketing tool the confusion created in consumers by the proliferation of products in the marketplace. It is likely that most consumers believe that there are home loans that are cheaper or better than their own, but that they also find the task of searching the marketplace to identify these loans too daunting. These debt reduction schemes often recommend that the consumer refinance from their existing home loan to a line of credit. The interest rate charged under a line of credit is usually higher than that charged for a standard variable rate loan (even one with offset and redraw options). Lines of credit allow the borrower to make offset savings by making the bulk of their purchases through a credit card and having their salary/income deposited in the loan in the period between the date of purchase and the date of payment, thereby reducing the interest accruing on their home loan. In practice the extent to which the loan can be repaid more quickly depends to a far greater extent on the capacity of the borrower to make additional repayments, rather than offset savings. However debt reduction schemes are providing advice rather than a product. It follows that the advice may be able to be applied to a consumer s existing home loan and that in order to justify a refinance to a line of credit the scheme will represent that the product it recommends has some unique characteristics not applicable to the consumer s existing home loan. The recommendation by the debt reduction scheme may be supported by a graph or a comparison in which it is assumed that the consumer: (a) does not make additional repayments to their existing home loan; and (b) does make additional repayments to the replacement home loan. This assumption may not be explicit and the scheme may suggest that the loan can be repaid more quickly due to offset savings. There are, therefore, three significant risks inherent in the operation of debt reduction schemes: (1) Where the scheme has not properly investigated the capacity of the consumer to make additional repayments it will not have a proper basis for representing the extent of any future repayments savings ( a future repayments risk ). (2) The scheme may advise the client that they need to refinance their existing home loan in order to achieve savings of time and money, when the advice could be applied to their existing home loan, without the consumer incurring transaction costs ( an unnecessary refinance risk ) (3) Where the mortgage reduction scheme produces a comparison between the consumer s existing home loan and the replacement loan in which additional repayments are attributed to the replacement loan but not the existing loan, there is a risk that this comparison will be misleading or deceptive ( a misleading comparison risk ). The extent to which these risks occur in practice will vary from broker to broker. However they are inherent in the operation of these schemes. Consumers can suffer financial loss by refinancing. These losses include: - any early repayment penalties charged by their existing lender; - fees charged by the scheme (typically$3-5,000), and application fees and disbursements charged by the lender; and 17

18 - where the consumer is unable to make any, or any significant additional repayments, the additional interest charged due to being refinanced at a higher interest rate. Case study Ms J had a standard variable interest rate home loan with an outstanding balance of $114,000. Ms J was cold called by a telemarketer offering to talk to her about how she could save money on her mortgage. Ms J was interested in increasing her loan to buy a computer (to work from home) and agreed to a visit. The person who visited Ms J only discussed finance with one particular lender, and did not disclose that he was a broker. He led Ms J to believe he acted for that lender, and that she would only have to pay the lender s application and loan fees. The broker gave Ms J a series of documents to sign. These included a broker agreement (which was not explained to her) and an application for a loan of $120,000. In fact, the loan was to be provided through a line of credit. This type of finance was completely inappropriate and unnecessary for Ms J, while the interest rate was more expensive than on her existing loan. When the loan settled, Ms J paid around $4000 in fees, including nearly $3000 to the broker, as well as the lender s application fees and solicitors costs. This meant there were insufficient additional funds available for her to buy a computer. The justification for switching loans may be problematic for a number of reasons. First, as the bulk of the savings derive from increased repayments, there may not be any economic advantage in the consumer switching home loans (given the transaction costs they will incur). Secondly, assessing the capacity of the consumer to adhere to a revised budget is difficult and time-consuming and rarely done thoroughly (by, for example, reviewing their spending habits over a period of time). No provision may be made for cash reserves for contingencies (such as the unexpected need to replace a car). Thirdly, if the borrower is unable to repay the amount outstanding on the credit card in full each month, they become liable for interest on that sum at credit card rates. As a result, the representation that the borrower may save years on their home loan can easily result in them being switched into a more expensive product, and one that has high-risk consequences if they are unable to maintain a budget. Responses by caseworkers and the case studies provide some instances of consumers agreeing to refinance their home loan in circumstances where the economic benefits of doing so were questionable at best, either because of the high fees charged by the broker or because the refinanced home loan was at a higher interest rate. These transactions suggest that there was either reliance by the consumer on oral statements by the broker, or an implicit understanding by the consumer that the broker is acting in the interests of the consumer to obtain the best loan, or, at a minimum, a loan that reasonably meets their needs. This means that the broker and the client may have completely different views of the transaction, which allows the broker to charge high fees Financial consequences of accessing credit or advice from fringe players The greatest risk for consumers who receive recommendations or advice from fringe players is that the conflicts of interest will be greater. The economic consequences for the consumer are therefore also likely to be more detrimental and may result, for example, in the possible loss of the home rather than a refinance at a slightly higher interest rate. At a time when the need for Australians to make provision for their financial security on retirement is becoming increasingly important unscrupulous brokers have the capacity to cause large numbers of people to enter into transactions that are potentially hazardous, and that may result in the transfer of wealth (through home equity) from the consumer to the broker or to a third party. 18

19 2.3 Mainstream players quality of advice As well as failing to discourage an operator who is clearly dishonest from practising as a broker, the lack of entry requirements may result in brokers whose intentions are to act honestly, but are simply lacking in appropriate skills or knowledge. Western Australia is the only jurisdiction which requires a broker to receive training. This impacts on the quality of service provided and the suitability of the credit product recommended to the consumer. Currently, brokers are under no statutory obligation to undertake inquiries and research in order to have a reasonable basis for recommending a particular credit product. If such an obligation existed in law, brokers would have to consider a range of factors, including: the capacity of the borrower to meet repayments, both currently and taking into account reasonably foreseeable circumstances (eg possible increases in interest rates); a comparison of the cost of different products available from a pool of credit products; consideration of the terms and conditions of the loan, including matters such as whether interest rates can be varied under the credit contract, whether the loan is principal and interest, interest only, or a line of credit, the extent to which redraws of credit are available, the consequence of any default by the borrower, and the penalties, if any, for repaying the loan early; where the recommendation involves refinancing an existing credit product, such as a home loan, an analysis of the advantages and disadvantages of proceeding with the refinance (eg a comparison of interest rates and fees and charges between the loans and an assessment of the effect of transaction costs); the loan amount requested by the consumer, the use of those funds and any time frame within which the funds are required (eg settlement of a property purchase this is now addressed in NSW following commencement of its new legislation, the Consumer Credit Administration Amendment (Finance Brokers) Act 2003, on 1 August 2004) ; and the extent to which the individual needs a buffer of funds in order to meet unexpected contingencies. Brokers are also not currently required by law to provide consumers with a written statement setting out the reasons for recommending a particular product. In the research for the CCLC report to ASIC, caseworkers did not come across any instances or examples where consumers were provided with a recommendation setting out these matters. The extent to which brokers review the range of factors listed above in determining which credit product to recommend is unknown, and presumably varies significantly between brokers. However, the range of problems identified in the case studies and the responses by brokers to surveys provide evidence of a failure by some brokers to address the consumer s personal circumstances or research the range of products available. For example, 11% of the brokers surveyed advised that they did not compare credit products. It should be noted that of more than 1100 surveys sent out, 166 responded and that those brokers who responded were members of the major industry associations. Similarly, only 54% of those brokers had a written agreement with their client, setting out the type of credit sought by the client. Of this figure of 54%, only 73% advised that the agreement addressed the amount of credit and type of loan being sought, and only 51% advised that the agreement specified the interest rate requested by the client. These results suggest that some brokers either do not obtain clear instructions from the consumer about the finance required, or that they do not record or communicate these instructions in a manner that ensures borrowers have a clear appreciation of the terms of the broker s engagement. In practice, this can result in brokers channelling clients to the same credit provider, or same few credit providers, without adequately considering the consumer s circumstances or the 19

20 price of competing products. In extreme cases, the broker agreement can be completed in terms that are self-serving and designed to secure the broker s fees irrespective of the quality of the service provided by the broker. An example of such self-serving conduct is broker agreements (sighted by caseworkers) stating that the credit to be arranged should have an interest rate of between 6% and 20%, which allows the broker to fulfil the terms of their engagement even if arranging finance that is disadvantageous to the borrower. APRA has recently expressed concerns about credit unions and building societies adopting an overly aggressive approach to residential property lending due in part to an increased reliance on brokers to originate business and a lack of due diligence by the lenders in assessing the creditworthiness of applicants. This is consistent with some brokers both failing to adequately consider the capacity of their clients to meet repayments under the credit arrangements they are recommending, and arranging for their clients to borrow the maximum amount possible Financial cost of poor recommendations The potential costs of poor recommendations can be very high in that even a small differential in the interest rate applicable to a 25-year home loan can produce very different results. The effect is illustrated in the following examples of a refinance to a less competitive product: Loan A a loan of $175,000 at 5% repaid over 25 years with fortnightly repayments will have repayments of $469.94; and Loan B a loan of $175,000 at 5.5% repaid over 25 years with fortnightly repayments will have repayments of $493.72, resulting in an additional $15,547 being paid by the consumer over the life of Loan B. 2.4 Effects of a commission based remuneration structure Reverse competition The fluid nature of the housing market indicates that a degree of reverse competition is taking place, with lenders competing against each other to gain access to broker distribution channels, either through increasing the commission they are prepared to pay brokers, or through the lenders offering volume bonuses to brokers (to ensure they receive the bulk of their loan applications). Brokers are therefore in a strong bargaining position, with lenders seeking to gain access to their client base. Many lenders, especially mainstream institutions, have implemented accreditation processes for brokers, assessing such matters as their experience, management capacity, professional indemnity insurance status, and tracking the outcomes of the loans submitted. However, these measures are by no means uniform, with APRA reporting that 32% of banks, credit unions and building societies will accept loan applications from non-contracted brokers Practices which flow from these arrangements The effect of these arrangements varies across the industry. However, they can increase rather than decrease the cost of the credit obtained by the consumer, in that, in some instances, the loan arranged through the broker will be more expensive than one arranged directly with the lender, and consumers may not be directed towards cheaper or competitive loans where no commission is paid. 22 APRA, op. cit., pp

21 Instances of inappropriate sales and pressure selling are typical of industries dominated by commission-based sales. This is true of the broker industry as intermediaries seek to maximise both the number of loans granted and the value of those loans. Most home loans are expected to have a life of seven years or less, so that the size of the upfront commission is likely to be the major influence on the broker s choice of loan. Trail commissions create only marginal incentives for brokers to place the borrower in a loan where they can afford the repayments Limited capacity of consumers to differentiate between brokers There are a number of reasons why consumers are unable to readily differentiate between brokers, or to judge the quality and cost-effectiveness of the services they are offering. The broking industry is relatively new, which means that many consumers have had only limited dealings with brokers. This relative inexperience means that they are not necessarily equipped to be able to evaluate the information they are given by the broker, or to compare it with previous dealings with other brokers. Depending on the jurisdiction brokers may be under no obligation or under only a limited obligation to disclose upfront the fees they will charge and the commissions they will receive. It is the experience of caseworkers (and some regulators, including ASIC) that this information asymmetry is exploited by some brokers, by, for example, charging fees according to the amount of credit obtained by the borrower. In these instances, the broker does not advise the borrower of its fees upfront, but adjusts the amount it charges according to the amount of surplus credit obtained available to meet its fees. Also, brokers are under no obligation to disclose to borrowers the reasons for recommending a particular credit product. Where consumers are only provided with either limited information or no information it is difficult for them to assess the quality and cost-effectiveness of the services the broker is providing Fees issues Case studies involving disputes about fees raise the following issues: brokers charging fees that are excessive 46% of the caseworkers who dealt with broker complaints indicated that they often saw problems about brokers charging excessive or undisclosed fees; brokers charging fees that appear to be calculated according to the bargaining capacity of the individual consumer, and not according to the work to be undertaken. The broker survey showed that, in relation to brokers who varied the fee they charged to the client, only 8% varied the fee according to the amount of work done to arrange the finance (other responses indicated the fee was varied according to the amount of the loan, the type of finance, and the outcome of negotiations with the client); brokers not disclosing to consumers the amount of the fees that they would charge (with this figure only becoming apparent on settlement of the loan, when the broker deducts their payment from the loan proceeds); brokers refusing to leave a consumer s home until they have signed an agreement committing them to paying a significant fee to the broker; brokers charging either the full amount of their fees, or a significant proportion of them, even where the broker was unable to arrange a loan or the consumer was dissatisfied with the product recommended by the broker and did not proceed with the recommendation; and brokers using unfair tactics to enforce payment of their fees. 21

22 Case studies Mr and Ms J had experienced difficulties in obtaining a loan from a mainstream lender. They contacted a broker who had placed newspaper advertisement offering loans with no credit checks. They paid an initial fee of $200 to the broker to arrange them a home loan. The broker did not provide them with a written broker agreement, in breach of the requirements of the Consumer Credit (Victoria) Act Before the broker had been able to arrange a loan, Mr and Ms J changed their mind about going through with the transaction, as they considered they would be unable to afford the repayments under a home loan. The broker then demanded fees of $2000 from Mr and Ms J, who then approached the Consumer Credit Legal Service (CCLS) for assistance. CCLS wrote to the broker stating that no fees were payable as he had failed to provide them with a written agreement. The broker wrote back stating that the reason he did not provide Mr and Ms J with any documents was because they told him they wanted to purchase a property as an investment, as they were unable to afford finance for a residential property. Mr and Ms J advised CCLS that they had told the broker the finance was only for a home they would live in themselves. CCLS was able to get the broker to drop his claim for the $2000 brokerage fee, and to refund the $200 fee paid to the broker by Mr and Ms J. Ms O and her partner arranged for a broker to visit them at home to discuss options for refinancing her home loan. The broker advised Ms O that he would be able to find them a cheaper loan, and, as a result, Ms O and her partner signed a broker agreement that day. They did not read it before signing it, and the broker did not explain it to them. The broker subsequently contacted Ms O and sent her documents to sign to enter into a new loan, to refinance her home loan. However, when Ms O examined the agreement she decided not to go ahead with it, as it was not cheaper and she believed she would not be able to afford the higher repayments. She is now being pursued for a $6000 brokerage fee referred to in the broker agreement, even though the finance arranged by the broker did not meet her needs. The following case study (reported in the Sydney Morning Herald on 22 May 2004) shows the way in which unscrupulous brokers will charge exorbitant fees according to the needs of the borrower. The borrowers owned a number of properties and required bridging finance in order to complete settlement of a Sydney unit they had bought off the plan. Mainstream lenders rejected their application for finance. They arranged a short-term loan through AAA Law Mortgages. The loan cost them $10,000 in fees and charges, and interest was charged at 6% a month (rising to 8.5% a month on default). Unbeknown to the borrowers, the loan was provided by the broker's wife. The broker said he would be able to arrange a permanent loan on more favourable terms. The terms of this later loan included charges of $70,000 for loan expenses and brokerage, and interest was charged at 9%. The borrowers rejected the second loan, and the broker's wife is now suing them for possession of their three properties. 2.5 Disclosure Obligations In general terms, the statutory requirements on brokers to disclose their fees vary but are comprehensive only in New South Wales. Nor has self-regulation led to universally high levels of disclosure. The broker survey results showed that 25% of brokers who charged fees to their clients provided that information to their clients in an oral form only, and not in a formal document. Similarly, 35% of brokers who received commissions from the lender only advised their clients of this orally, while 5% stated that they did not inform their clients about commissions at all. 22

23 Payments by brokers to third parties for referring potential clients to them are widespread in the industry. As noted in Section 2.1.7, the broker survey found that 65% of respondents promoted their services though a range of third parties. In the majority of cases, the brokers offered commissions or other financial incentives for these referrals. The types of third parties who received commissions included real estate agents, accountants, lawyers, collection agencies, car dealers and building contractors, where the consumer would not ordinarily assume or consider a commission might be paid. Jon Denovan, Chairman of the MIAA Legislative Committee, has described these payments as among the most objectionable of practices in the industry. It is the experience of caseworkers that these commissions or payments are never disclosed to the consumer, and that the referral to the broker is therefore seen by the consumer as personal and reflecting a positive experience by the third party. In fact, the payment of the commission means that the referral is not impartial, and the failure to disclose this payment means the consumer is not in a position to objectively assess the value of the referral. It also suggests that the standards applying to disclosure of fees and commissions within the industry are generally poor. Many brokers charge a significant percentage of their fee if the borrower decides not to proceed with the loan. This, combined with the absence of any explicit obligation on the broker to make a recommendation that is reasonably suitable (or any sanction on the broker when they fail to do so), inhibits the capacity of consumers to negotiate with brokers, or to select a cheaper loan than that recommended by the broker. The European Union prohibits brokerage fees in circumstances where the broker is remunerated by commission from the lender, or where no finance is actually arranged. There is also evidence that some brokers flout the law by charging fees in advance of securing credit for their clients, in direct contravention of legislative prohibitions in some States. 23 The existence of fraudulent conduct by brokers and disregard for legislation is consistent with some of the extreme conduct identified in the case studies behaviour that is driven solely by profit motives rather than acting in the best interests of the client and suggests that some brokers are able to exploit both the significant existing weaknesses in the regulatory framework and the trust placed in them by their clients for their own ends. The structural factors driving this conduct (as identified in Section 2.2) suggest that this conduct will continue unabated, in the absence of stringent and robust government intervention. 24 Other matters about which the consumer would ordinarily be unaware include the range of loans reviewed by the broker, the range of commissions offered to the broker by those credit providers, and the different interest rates and fees charged in respect of those loans. Most consumers would also be unaware that by signing a declaration that the loan is for investment purposes (and therefore outside the UCCC regime), they make it significantly easier for the lender to take possession of any security, such as the their home, in the event of default. 2.6 Use of cold calling to solicit clients Many consumers make contact with brokers, either as a result of advertising or in response to a direct approach by the broker. Neither of these methods is necessarily an effective way of identifying a broker who will provide efficient or cost-effective services. The difficulties in comparing the services offered by brokers are exacerbated where the initial approach is made through the broker cold calling on the consumer in their own home. 23 Final Report of the NSW National Competition Policy Review of the Credit (Finance Brokers) Act 1984, p Industry efforts to deal with fraud and other improper practices are detailed in Section 4.2 of this paper. 23

24 The finance intermediary industry is an area where cold calling (or an unsolicited approach to potential customers) takes place on a regular basis. For example, the Broker Survey indicated that 22% of brokers employed cold calling as a marketing strategy, with brokers using telephone contact and visits to consumers homes and workplaces to initiate contact. Consumers in their own home are particularly vulnerable to making uninformed decisions due to a variety of factors, including: the inability to walk away from a sale; an inherent politeness towards a person who is a guest in their own home; the nature of the sales staff who are often trained to exploit this sense of obligation and who may refuse to leave until the sale is complete; and logistical difficulties comparing prices, often resulting in the consumer committing themselves to paying excessive fees. Door to door sales of credit are prohibited under the Consumer Credit Code, however, broking is not prohibited. In most jurisdictions there is some protection from telephone or door to door sales in the form of a cooling off period. 2.7 Factors which act against the provision of quality services No ongoing relationship with clients Most brokers (as distinct from mortgage managers) will have only limited contact with the borrower once they have been placed in a loan. Once the loan or credit has been arranged, the broker has little reason to continue to be involved. The relationship is different from other intermediaries, such as insurance brokers or financial planners, where there is a need to provide ongoing advice in relation to the investment or insurance product initially recommended. While some brokers do provide a continuing service to their clients after they have arranged the loan for them, the results of the survey of brokers suggest this is limited to a small minority. The absence of any ongoing relationship means that the broker has minimal financial incentives (through earning ongoing fees or business from the borrower) to ensure their initial advice and choice of product is sound and reasonable Lack of accountability Where consumers have suffered damage or loss as a result of the conduct of a broker, they are usually unable to access timely and effective remedies. Brokers, unlike other intermediaries in the financial services industry, are not required to be members of an alternative dispute resolution scheme, so that consumers have few options for obtaining redress apart from instigating legal action, with its attendant uncertainty and expense. The lack of accountability by brokers means that they can refuse to respond to complaints, even where a community advocate helps the consumer, because the difficulties and cost in taking Court action means the consumer is unlikely to pursue the complaint. A further complicating factor for consumers is that generally they will not have any redress against the lender for the conduct of the broker; in other words, the development of the broker industry has seen responsibility at the point of sale shift from lenders to brokers, who are in practice often unaccountable Inability of lenders to discipline bad brokers It is also possible for brokers to manipulate the competition between lenders to avoid stringent supervision of their activities. Brokers are in a position where they can respond to attempts by credit providers to scrutinise their business by switching to different lenders. 24

25 Ultimately the only sanction a lender can impose is to refuse to have further dealings with a broker (where, for example, they consistently submit poor or even fraudulent loan applications). However, this has no effect on whether or not the broker remains in the marketplace, as they can easily direct their credit applications to a new financier. The position is similar to that of life agents in the early 1990s, where bad agents (who had their employment terminated by one insurer) were able to rotate between different insurers. APRA s Report on Broker-originated Lending noted that, since first utilising brokers, the average bank has ceased dealing with 70 brokers. 25 The three most common reasons for ceasing business with a broker are: poor quality of loan applications (59%); lack of volume of business (59%); and fraud (24%). 26 The report also found that, if a loan becomes impaired (through default by the borrower), only 25% of institutions have recourse to the broker, usually through ceasing to pay trail commissions, rather than being able to claw back the upfront commission. 27 Lenders are liable to the borrower for the conduct of brokers only in extremely limited circumstances. Accordingly, they have minimal incentives to impose standards of conduct on brokers. Attempts at improving industry standards through self-regulation are relatively undeveloped and, for a variety of reasons, have generally had at best a limited impact on the industry overall. 25 Ibid., p Ibid. p Ibid. 25

26 3 Regulation and Remedies 3.1 Regulation of Brokers in Australia Legislation Regulating Brokers The level of statutory regulation of finance brokers varies from jurisdiction to jurisdiction within Australia. South Australia, Tasmania, the Northern Territory and Queensland do not currently have broker-specific legislation. The other four jurisdictions do have legislation directly regulating brokers. New South Wales The main features of the NSW Consumer Credit Administration Amendment (Finance Brokers) Act 2003 are set out below: Coverage: Only brokers who negotiate or obtain credit covered by the Consumer Credit Code are regulated. That is, only credit provided for personal, domestic or household use. A finance broker must enter into a written contract with a consumer before commencing finance broking. The contract must be signed by the consumer and a copy must be given to the consumer. The contract must contain: particulars of the amount of credit to be obtained; the term over which the credit is to be repaid; the maximum periodic payment the consumer is prepared to pay; repayment arrangements if a regular repayment is not acceptable to the consumer; the maximum interest rate payable; the date by which the credit is to be secured; a statement that the finance broker s recommendations will not necessarily be drawn from all lenders that offer credit of the nature being sought; the name and address of the finance broker; the ACN if the broker is a company; the name and address of the principals of the relevant business if the broker trades under a business name; the amount of commission (if any) payable by the consumer, or if the amount is not known, the method of calculating it and an estimate of the amount payable; when and how the commission will be payable; if a financial or other benefit will be received by the broker from a person other than the consumer, a statement of that fact in the terms prescribed by regulation; any other matter that may be prescribed: the regulation will prescribe a description of any special loan features required by the consumer if any financial or other benefit will be paid to any referring source. The regulation also requires that the broker: give a statement identifying each credit provider on the broker s panel of lenders; give a statement that these credit providers do not necessarily represent all the credit providers who offer credit of the nature sought be the consumer; make a statement to the effect that the credit provider will receive a financial or other benefit from a person other than the consumer; indicate the range of the benefit (highest and lowest amounts); 26

27 disclose to the consumer before the credit contract is entered into the actual amount of commission that the broker will receive from the credit provider; whether or not the broker can determine or recommend conditions of the credit contract (for example, the interest rate or the term of the loan), and if so, the effect of any such condition on the level of commission payable; state whether he or she is authorised to set such rate, term or fee; disclose any benefit that will be received by the broker s firm from the credit provider; disclose any interests or relationships of the finance broker that could be expected to influence the broker s recommendation; The broker must not demand commission from the consumer before the credit is secured. The right to claim the commission depends on the terms of the finance broking contract being met and must not exceed the amount stated or estimated in the finance broking contract. The broker may charge commission if the consumer declines the credit, if the credit secured meets the terms of the finance broking contract and the contract has not been validly terminated before the credit is secured. This right to claim commission must be stated in the finance broking contract. The finance broker must keep records of the broking transaction and the broking contract for 7 years. The broker must not accept valuation fees, credit application fees or credit establishment fees except in the circumstances specified in the Act. Victoria and Australian Capital Territory These jurisdictions adopt a similar approach to New South Wales, however the requirements are less comprehensive. The legislation is not detailed in full in this paper but may be referred to in the summary at attachment B. In both Victoria and the Australian Capital Territory the legislation encourages brokers to have written agreements with their clients by providing that if the broker does not have a formal agreement, a civil penalty applies in that they are prohibited from demanding or receiving any fee from the client. Where the broker has a written agreement with their clients, that document must include a number of specified matters, such as the amount of credit required and, in Victoria, the agreement must set out the fee or how to calculate the fee. The list of specified items does not include matters such as disclosure of commissions or spotters fees paid by brokers to third parties, or any time limits within which the credit must be arranged. 28 Western Australia Finance brokers in Western Australia are regulated by the Finance Brokers Control Act 1975 (the FBCA). The Finance Brokers Control Amendment Bill 2003 (the Bill) passed both Houses of the Parliament on 10 November 2004 and will amend the FBCA when assent is given. Brokers are also subject to a mandatory code of conduct prescribed by Regulation under the FBCA. Coverage: 28 See s37j of the Consumer Credit (Victoria) Act 1995 and s35 of the Consumer Credit (Administration) Act

28 The FBCA applies to a person who, as an intermediary and in the course of business, negotiates or arranges loans of money for others, or, who in the course of business manages loans of money arranged or negotiated for or on behalf of others. The purpose of the loan is irrelevant and, subject to the consent of all parties to a transaction, a finance broker can act for either a lender or borrower. Exemptions: The following persons and classes of persons are exempted from the FBCA: Insurance companies; Authorised deposit taking institutions; Australian Financial Services licensees authorised to deal in securities within the meaning of the Corporations Act 2001; Legal practitioners; Housing societies registered under the Housing Societies Act 1976; Suppliers of goods and services arranging loans for payment of goods and services; Corporate bodies authorised by law to accepts grants of probate of letters of administration on behalf of deceased estates; and Persons and classes of persons exempted from the Act by Regulation. Entry requirements: Unless otherwise exempt, persons seeking to carry on business as a finance broker must hold a licence. The licensing authority is the Commissioner for Fair Trading. The term of a licence is three years (cost $350). The prerequisites for the grant of a licence to a natural person are: Over 18 years of age; Possession of prescribed educational qualifications; Ordinarily resident in Western Australia; Fit and proper person of good character and repute; Sufficient financial resources; and An understanding of the requirements of the Act. Body corporates and partnerships can also be licensed provided a minimum number of directors/partners are personally licensed. Fees and remuneration: Brokers fees and remuneration are regulated by the Minister. Other controls and requirements: Mandatory professional indemnity insurance; Maintenance of and annual auditing of trust accounts; Bond or guarantee in an approved amount to secure obligation to account for monies received on behalf of others; Business and all branch offices to be effectively managed by a licensed person; Prohibition on holding multiple licences and operating multiple businesses under a single licence; Prohibition against subcontracting with unlicensed persons; Disclosure requirements; Appointment by court of supervisor to broker s business; Written appointment to act; and Prohibition against receiving fees before loan negotiated. 28

29 Summary Only Western Australia has an occupational licensing regime, under which a finance broker must satisfy certain requirements before they can practise as a broker. The ACT requires a person to be registered as a finance broker before they can practice, and some categories of people are excluded from being registered as brokers. Both New South Wales and Victoria have negative licensing, i.e. a capacity to prohibit brokers from trading. There are two significant limitations in the application of the broker-specific legislation to the activities of brokers or broking transactions: First, in New South Wales, Victoria and the ACT the legislation only applies to those transactions regulated by the Uniform Consumer Credit Code (UCCC), which regulates credit which is predominantly for personal, domestic or household use. It has been noted by consumer advocates and fair trading agencies that some fringe brokers regularly utilise Section 11 Declarations to oust the jurisdiction of the UCCC, irrespective of the actual purpose of the credit. Secondly, the legislation only applies to intermediaries where they negotiate or obtain credit for consumers. It does not extend to people who provide advice in relation to mortgages. This is an issue particularly in the area of debt reduction services. Intermediaries in this area regularly split themselves into two entities, to limit the application of broker-specific legislation. One entity cold-calls consumers and represents that significant savings can be achieved through refinancing; in undertaking these activities it does not need to comply with the broker legislation. If the consumer agrees the loan application will be arranged, often by the same person, but acting on behalf of a second entity, who will comply with any legislative requirements (but at a time when the consumer is already committed to the transaction). There are some significant limitations in the matters brokers are required to disclose to consumers, both in relation to the terms of their broking contract and the credit product recommended. These limitations include: disclosure of financial benefits received from lenders is required only in NSW and Victoria; no obligation to disclose the range of lenders and products that the broker can arrange, or to disclose whether the broker offers independent advice or merely channels loan applications to one or a few selected lenders (except in NSW); no obligation to advise how the broker has assessed the borrower s capacity to meet repayments under the recommended credit product; and no obligation to provide clients with any analysis of the advantages or disadvantages of refinancing an existing credit contract. It will be noted from the description of broker specific legislation set out above that there are major differences between jurisdictions in what is required of brokers in order to comply. This is a major impost on those broking firms that have a national market. This is examined further in the discussion of regulatory options General Regulation of Brokers ASIC has had the federal regulatory role in relation to credit, including the conduct of brokers, since 11 March ASIC s responsibility for credit and finance brokers arises under the ASIC Act 2001 (the ASIC Act). The ASIC Act does not prescribe detailed disclosure or contractual requirements in relation to credit. Rather, the ASIC Act sets out a number of broad standards of conduct in relation to credit facilities, including: prohibiting unconscionable conduct and misleading or deceptive conduct; prohibiting making false or misleading representations; and 29

30 implied warranties of due care and skill and fitness for purpose into contracts for the provision of financial services. ASIC s current position is that it will generally focus on issues that are national in scope and/or have a clear systemic aspect. 29 ASIC does not usually seek to intervene or mediate with lenders on behalf of individual consumers who may need immediate assistance about a problem with a loan or other credit product. ASIC has stated that because [it] can often not help directly in these cases, [it] will have an important referral role to play. 30 The level of regulation of brokers under the ASIC Act is therefore responsive, in that action can only be taken where unfair conduct has already occurred State/Territory Fair Trading Agencies ASIC shares the credit jurisdiction with State/Territory fair trading agencies (or their equivalent), as analogous prohibitions exist in some Fair Trading Acts. In addition, these agencies are also responsible for monitoring compliance with the UCCC. Some jurisdictions take a similar response to ASIC in relation to individual complaints, while some will negotiate with a broker on the consumer s behalf as well as conducting targeted enforcement action. They also usually have dedicated resources to negotiate hardship variations in repayments with the credit provider, where the credit contract is regulated by the UCCC Self-Regulation There are two main industry bodies representing brokers: the Finance Brokers Association of Australia (FBAA) and the Mortgage Industry Association of Australasia (MIAA). These bodies require their members to comply with internal codes of conduct. The MIAA Code of Practice is currently under review. The current Code is binding on every MIAA member and specifies minimum standards of professional conduct and good industry practice to be adhered to by members. It also specifies minimum requirements of professional qualifications and/or experience as well as professional indemnity insurance that are required to be a member of the MIAA. The Code sets out procedures for consumer complaints handling, which include informing the consumer about the Credit Ombudsman Service Limited, an independent dispute resolution scheme approved by ASIC. The Code requires full disclosure of fees and commissions paid by or to the broker as well as requiring the broker to inform the consumer if they are acting as agent of the credit provider and of any conflicts of interest they may have. The Code requires the broker to act with due care and diligence and to establish and maintain honest and honourable dealings with the consumer. The FBAA also requires its members to comply with its Code of Practice, which was upgraded in October Members are required to discharge their duties competently and with integrity and honesty; to avoid conflicts of interest but, if they arise, to disclose such conflict as soon as practicable. FBAA members must disclose fees and commissions paid or received. Members must assist the client to understand their contractual benefits and obligations with the finance broker and credit provider and maintain written reasons for recommendations made to clients. Members are required to make all reasonable inquiries of the client as to their income, assets and liabilities and also supply details of their credit history. 29 See 30 Ibid. 30

31 Members are required to comply with the Australian Standard AS4269 for complaints handling and, if any complaint is not resolved, to refer the complaint to a Referee for determination. The limitations of the self-regulatory regime established by the FBAA and the MIAA have been publicly acknowledged across the broker industry, with both peak industry bodies calling for a greater degree of government regulation. Phil Naylor, chief executive of the MIAA, has said: Brokers in any sector will always have some propensity for fraud and improper practice. Two years ago, we set up a framework for self-regulation of our membership. At that time, our preference was for self-regulation of our membership but things have changed; the mortgage market has heated up and there has been a lot more scrutiny of brokers. The community s perception is that self-regulation is not enough. 31 Similarly, in February 2003, the FBAA publicly adopted a goal of uniform national legislative registration of brokers within three years, with mandatory training requirements for entrants Liability of lenders for conduct of brokers Generally, brokers are characterised in law as an agent for the borrower and not the lender. Where there is a written agreement between the lender and the broker this usually stipulates that the broker is not an agent of the lender. Prima facie, therefore, the lender will generally not be held responsible for any unfair conduct by the broker towards the borrower. Where the broker has acted unfairly and yet is not an agent of the lender, the borrower cannot rely on the broker's conduct as a defence to any Court action brought against them by the lender. For example, if the broker misrepresented the interest rate charged by the lender, the borrower would not be able to take the lender to Court and argue that the lender had to charge the lower (misrepresented) interest rate. The borrower s remedy would be against the broker, seeking compensation for the additional interest charged. However, there are three exceptions to this general rule, where the borrower may be able to seek relief directly against the lender for the conduct of the broker: 1 the first exception is where there are unusual facts that lead to the conclusion that the broker has either actual or ostensible authority to act as the agent of the lender, not the borrower. The fact that the broker receives a commission from the lender, and that the broker has been supplied with credit applications by the lender and been instructed how to complete them, will in themselves not usually be sufficient circumstances to establish actual or ostensible authority. 33 This approach is outmoded and does not adequately address the situation where the broker regularly or invariably channels credit applications to only one lender, or to a small number of lenders (and where volume-based commission arrangements are designed by the lender to create financial incentives for this to happen); 2 the second exception is where the credit is regulated by the UCCC and the broker is a linked supplier with the lender. In this case, the lender will be responsible for statements made by the broker, under s118 of the UCCC. There are a number of preconditions that must be satisfied before this section will apply which inhibit the extent to which consumers can rely on it; and 31 Quoted in Bridle the Brokers, Business Review Weekly, 28 November 2002, pp FBAA chief seeks national registration, February 2003 at 33 See, for example, Morlend Finance v Westendorp [1993] 2 VR 284; Custom Credit Corporation Ltd v Lynch [1993] 2 VR

32 3 borrowers can seek relief from unjust credit contracts under s70 of the UCCC and, in New South Wales, under the Contracts Review Act Under the Contracts Review Act 1980, a credit contract can be found to be unjust because of the conduct of a third party (such as a broker), even where the lender was ignorant of that conduct. However, the state of knowledge of the lender will be relevant in determining whether or not to grant relief, as the competing claims of the lender and the borrower need to be considered. 34 The issue has not been considered in relation to the interpretation of s70 of the UCCC, but it is possible that the Courts will find that a similar two-stage inquiry should be undertaken. If this is the case, then in extreme or exceptional circumstances, the Courts may grant relief to a borrower with respect to the lender, even though the lender was unaware of the conduct of the broker. In general terms, lenders have minimal incentives to maintain vigorous and regular supervision of the conduct of brokers given their limited legal liability for the conduct of the brokers, and the additional expense and cost that would be incurred in doing so. Lenders, where confronted by a wayward broker, can adopt the straightforward, cost-effective approach of refusing to deal with that broker Accreditation of brokers by lenders APRA released the results of a survey of use of brokers by ADIs (ie banks, credit unions and building societies). The survey found that approximately 60% of these institutions had in place an accreditation process for brokers. The process could include: 35 only accepting business from approved, contracted brokers; identifying and tracking broker-introduced loans; internal review of loan applications; maintaining records of rejected broker-introduced applications; and regular reviews of the broker. APRA commented that there is a high proportion of ADIs doing business with brokers about whom they have relatively little knowledge. 36 It can be speculated that the level of supervision of brokers by non-adis is generally less rigorous. Before releasing the report, APRA had publicly called on lenders to review or improve the due diligence assessments they make of brokers who submit applications to them. Charles Littrell, APRA s Executive General Manager of Policy Research and Consulting, said: One hopes lenders are keeping track of the quality of the loans that brokers are sending them. It is the broker s role to maximise the size of the loan that it can secure for the client and to present the client to the lender in the most favourable light. To that extent, loan broker intermediation has the ingredients for higher default rates. 37 This statement urges lenders to actively supervise brokers. Consistent with this approach, Wizard Financial Services and RESI Mortgage Corporation jointly released ten ethical guidelines for brokers. The guidelines were a response to their concerns about the extent to which the conduct of some mortgage brokers were seen to be damaging the industry as a whole. They made public calls for the guidelines to be imposed nationally, as representing minimum standards of conduct for brokers. The release of those guidelines was, in itself, recognition of deficiencies in the standard of behaviour within the broker industry, and the inability of lenders to regulate or properly supervise brokers. 34 Nguyen v Taylor (1992) 27 NSWLR APRA, op. cit., p Ibid. 37 Quoted in Bridle the brokers, Business Review Weekly, 28 November 2002, p

33 3.2 Regulation in Other Countries This section of the report reviews the nature of the broker industry in a number of other countries, and the models of regulation in those countries. It should be noted that regulation is generally restricted to broking in relation to lending secured by way of mortgage over real estate. Detail of that regulation is to be found in Appendix A, and an overview is set out below. The UK and European Union have now harmonised their regulation of brokers or credit intermediaries and require: Licensing or registration; Broker to advise whether they are acting on an execution only basis or providing advice and, if the latter, provide details of the number of lenders and credit products reviewed prior to making a recommendation; Broker must assess whether or not a loan is appropriate for the borrower and further consider what type of loan is suitable and which product best meets the consumer s needs and financial circumstances; Brokers are subject to the compulsory jurisdiction of the Financial Services Ombudsman, the complaint handling scheme for financial services in the UK. A higher level of regulation applies to mortgages identified as inherently more risky for the borrower, such as equity release mortgages for older borrowers. In the US the mortgage broker industry is regulated by ten Federal laws, five Federal enforcement agencies and over 45 state laws or licensing boards. The main Federal act is the Real Estate Settlement Procedures Act The regulatory agency s Statement of Policy on broker fees is that: Broker payments must be commensurate with the amount normally charged for similar services; and The broker fee disclosure must be accompanied by a description of what services the broker will perform, as well as the broker s total compensation for performing those services. State laws generally require surety bonds, some require licensing or registration, some have educational requirements and some require experience. Individual states may have additional requirements for example, New York, which has requirements for broking high cost or predatory loans. Similarly Canada regulates on a state by state basis and generally requires registration, written agreements with full disclosure and educational requirements. In New Zealand, brokers are not specifically regulated but the peak industry association requires members to comply with a Code of Ethics and Standards. Some regulation of the industry is provided through general fair trading legislation and credit legislation. 3.3 Consumer Remedies Difficulties in accessing redress mechanisms The current mechanisms for obtaining redress against brokers are generally inadequate to provide timely and effective remedies for consumers. There are a number of reasons for this. The first reason is that consumers have few options for obtaining redress apart from instigating Court action, with its attendant uncertainty and expense. Brokers, unlike other intermediaries in the financial service industry, are not required to be members of an alternative dispute resolution (ADR) scheme, giving consumers a choice 33

34 apart from Court action. The Broker Survey indicated that only 51% of brokers had in place a formal procedure for responding to customer complaints. It should be noted in respect of the broker survey that nearly all responses were from MIAA and FBAA members, and that these organisations are unlikely to attract members from the fringe broking industry. As well, 26% of the caseworkers surveyed by CCLC (NSW) who dealt with broker complaints indicated that direct negotiations with the broker were never successful in resolving complaints. 38 These responses are consistent with a lack of accountability by brokers, and the lack of any incentives for them to adopt effective complaints handling procedures. They reflect the fact that brokers, if they are so minded, can ignore complaints, even where the consumer is assisted by a community advocate, because of the difficulties for the consumer in taking action elsewhere. The second reason why redress is difficult to obtain is that commonly the loss suffered by a consumer will be the amount they are required to pay a third party. Usually the third party will be the credit provider, but it may also be, for example, the vendor of a property when the consumer cannot pay the purchase price because the broker failed to arrange finance. The consumer will be under financial pressure because of the third party either having received or demanded payment, and the focus of their attention will be on resolving the dispute with the third party. The fact that a third party is involved inhibits the capacity of the borrower to contemplate or bear the cost of any legal action. The following case studies illustrate the problems that can arise for a consumer. Case study Mr B is a single father with a young child, working four days a week. He was living in his own (mortgaged) home, and was interested in buying an investment property, as a way of becoming more financially secure. Mr B approached a broker for advice, initially to determine whether or not he could borrow money to purchase an investment property, and, if so, how much. The broker informed him that he would be able to borrow over $300,000, with the precise figure depending on the rental income received from the investment property to be purchased. Relying on this advice, Mr B found a property for about $250,000. The broker then lodged an application for finance for Mr B with a bank, which was approved. However, when Mr B began budgeting to meet the repayments, he realised he could not afford them. He contacted the bank and the broker, and discovered that the broker had misrepresented his financial situation on the application form to the bank, by suggesting that he would be getting additional rental income from the property in which he and his child were living. Mr B was advised that if he did not proceed with the purchase of the investment property, he would lose his deposit. He therefore has had to move out of his home, and live with his parents. Despite this, he still finds it difficult to meet repayments on both loans and is considering selling one of the properties. Case Study Karl Suleman Enterprizes Pty Ltd was a high-profile company which promised investors high rates of return (through what was essentially a pyramid scheme). Some consumers obtained large sums for investment in the scheme through mortgaging their homes. Many of these loans were arranged by an intermediary, Boushra Gadallah, through Perfect Loans Pty Ltd (trading as Sunline Home Loans) and Xclent Accountants Pty Ltd (trading as Gadallah & Co). 38 CCLC Report, op.cit.,section C.5 in Appendix C. 34

35 In May 2004 ASIC banned Gadallah from acting as an investment adviser for a period of 10 years 39. ASIC found that Gadallah: failed to exercise reasonable care in compiling and verifying information in home loan applications and taxation returns used to obtain loans for investors failed to exercise reasonable care in assisting borrowers to invest in high risk investments even though he knew they were likely to collapse. It is noted that Gadallah was only banned from acting as an investment adviser and that under current legislation he cannot be banned, by either State or Federal agencies, from working as a broker Legal Redress Consumers considering taking legal action against brokers face a number of barriers including the inaccessibility, delays, daunting formality and high costs of the Court system. In addition, it is the nature of broker disputes that they tend to be either about fees (where the amount of money involved is relatively small compared to the costs of legal action), or arise in circumstances where a third party is involved and demanding payment from the consumer (commonly the lender or the vendor of a property if a sale does not proceed). In some cases, the consumer can be left with a dispute with a lender that is the direct result of the actions of the broker, and where the broker may not be able to be located, or where enforcement of any judgement against the broker is problematic, and the lender refuses liability on the basis that the broker was the borrower s agent. As discussed above, brokers are often characterised in law as agents for the borrower and not the lender (even where the broker has received a commission from the lender and that the broker has been supplied with credit applications by the lender and been instructed how to complete them). Practical examples of the difficulties this characterisation creates for borrowers include: misrepresentations by the broker about a break cost or the availability of features such as redraws are unlikely to be attributed to the credit provider; unconscionable behaviour such as the broker misrepresenting the nature or terms of the finance to third parties who do not benefit from the loan, but become parties to the transaction (either as guarantors or borrowers) will not be attributed to the credit provider where there is nothing on the face of the application to suggest that this has occurred. The unjust contract provisions of the UCCC may not provide relief as the court will have to decide between the competing interests of two innocent parties, the third party borrower/guarantor and the credit provider. similar limitations apply where the broker misrepresents the borrower s financial or personal circumstances, without the knowledge of the borrower. Relief that may have been available against the credit provider for knowingly overcommitting the consumer will not be available unless the consumer can somehow demonstrate knowledge of the misrepresentation by the credit provider. Other problems for consumers in taking action directly against the broker include an absence of corroborating evidence (where the consumer relied on oral statements contrary to written documents), lack of access to documents held by the lender, and possible time delays. It is also not easy to evaluate the prospects of success of any Court action, given the lack of clear standards within the industry, as to what constitutes acceptable behaviour. A particular problem arises for borrowers where they have signed an effective declaration that the loan is for business purposes, under s11(2) of the UCCC, even though the money is 39 ASIC Media Release , 18 May

36 in fact for personal use. In these circumstances, the borrower will be unable to access the statutory remedies in the UCCC, including redress for breach of disclosure requirements and relief from unjust contracts in s70 of the UCCC. These remedies are generally broader than other actions. It should also be noted that s70(2)(l) of the UCCC directs the Court, in determining whether or not a transaction is unjust, to consider: whether at the time the contract, mortgage or guarantee was entered into or changed, the credit provider knew, or could have ascertained by reasonable inquiry of the debtor at the time, that the debtor could not pay in accordance with its terms or not without substantial hardship This provision was included, in part, because of the reluctance of the Courts to acknowledge that over-commitment of borrowers might, in itself, constitute grounds for relief. CCLC (NSW), and other caseworkers, have noted that some non-mainstream and fringe lenders (particularly those providing interest only loans) systematically use the business purposes declaration to avoid the jurisdiction of the UCCC. Borrowers using such lenders tend to be financially desperate, so that one specific consequence of the use of these declarations is to deny them access to the sole statutory remedy available for redress (and when any nonstatutory remedy is legally problematic). Disempowered consumers are rarely in a position where they are able to commence proceedings regardless of the actions of the broker. They either attempt to withdraw from the relationship with the broker, or they proceed with the transaction and problems arise when they are unable to meet their commitments under the loan contract. In the former case, typically it is the broker who commences legal action in order to recover their fees, usually on the basis of a written document that is difficult to refute in a court of law. In the latter case, the consumer is in dispute with the credit provider and the broker s fees, while often substantial, pale into insignificance against the costs and consequences of an expensive and unsuitable loan. The range of difficulties confronting consumers contemplating taking legal action against brokers means this is rarely pursued as an option, even where the conduct of the broker has been extreme and may have caused the loss of the family home. Case study Mr K had been sick and working part-time. He was behind in his home loan repayments and had outstanding credit card debts. He received a default notice from the mortgagor. The bank declined his application for a loan to meet the arrears. As a result, he contacted a broker advertising in the newspaper as being able to find finance for people rejected by other lenders. The broker told Mr K he could organize a loan, but that he would have to refinance his existing home loan. Mr K s original lender charged a break fee of several thousand dollars. The broker arranged an interest only loan, and charged a fee of $2600. The lender charged an establishment fee of over $3000. Mr K soon fell into arrears on the new loan, and Court proceedings were commenced. The lawyer examined the documents he had signed when applying for the loan. These included documents outlining the fees charged, and a business purposes declaration. The lawyer advised Mr K that the costs of fighting the Court case would be significant, and he was unlikely to succeed in arguing that the loan was regulated by the UCCC, or therefore that the loan was unjust Tribunal Access In New South Wales and Victoria consumers may apply to a tribunal for relief in certain limited circumstances. In Victoria, the consumer can apply to a court or tribunal where the 36

37 broker accepts fees to which he or she is not entitled. In New South Wales, under the recently commenced legislation, applications may be made to the Consumer Trader and Tenancy Tribunal in respect of a broker s non-compliance with the contract, engaging in unjust conduct, or charging excessive commission. While this option is less expensive than court action, it is still a daunting prospect for many consumers who are intimidated by the quasi-legal environment and the formal hearings. More particularly, those consumers who are the least sophisticated and who fall prey to rogue brokers are the least likely to use this system. As well, only limited issues can be dealt with in such a forum and the credit contract itself cannot be affected by any action taken. Where the credit obtained is not covered by the Consumer Credit Code the Tribunal does not have jurisdiction Access to alternative dispute resolution Unlike other intermediaries or product providers in the financial services area, there is no alternative dispute resolution (ADR) scheme with comprehensive coverage of brokers. 40 In fact, consumers can only have a dispute in relation to the conduct of a broker heard by an ADR scheme in the following limited circumstances: where the intermediary is a member of the Credit Ombudsman Service Limited, originally Mortgage Industry Ombudsman Scheme (MIOS). Membership of this scheme is voluntary. Complaints to the scheme were up 31% for the year to June 30, however, 37% related to non-members. The scheme s shortcomings were detailed in a recent newspaper article. 41 where the intermediary or their employer is a member of the Financial Industry Complaints Service, usually because the intermediary is a financial planner and has recommended or assisted the borrower to take out credit as part of an overall investment plan; where the intermediary is a related corporation to a bank. In these cases, the consumer can complain to the Banking and Financial Services Ombudsman (BFSO),(previously the Australian Banking Industry Ombudsman) about the conduct of the broker. The BFSO extended its coverage on 13 August 2003 to brokers who join the scheme. There are currently 19 broker members. where the lender is a bank or a credit union and the consumer may be able to claim relief against the lender rather than the broker (see for example, CCLC Report, p. 53). In these cases, the consumer can complain to either the BFSO or the Credit Union Dispute Resolution Centre. However, even where the broker may be found to have acted as an agent of the credit provider, these two schemes may still be unable to hear complaints about matters such as the fees charged by a broker, or where the broker failed to obtain a loan for the client, or failed to do so within any time limits specified by the consumer. The limited access to an ADR scheme means that many consumers have little option but to go to Court, particularly when dealing with the smaller or fringe brokers. Perversely, these brokers are those most likely to adopt unfair practices and therefore to have dealings with consumers who are most likely to need redress. 3.4 Summary of identified problems and the consequences for consumers The preceding chapters outline in detail the consumer detriment seen by both financial counselling caseworkers and legal centre staff, and the industry practices thought to be causing the problems. These are summarised below: 40 Only 37% of respondents to the Broker Survey were members of an ADR scheme; CCLC Report, op.cit. see Table B.18 in Appendix B. 41 Rights issue, Sydney Morning Herald, 11 August, 2004, p.8. 37

38 Problems: Brokers are not obliged to disclose details of their functions and operations so that consumers expectations of the role of the broker may not be realistic; There is nothing on which consumers can base an assessment of the quality or cost effectiveness of broking services; Brokers are not uniformly required to enter into a contract with the consumer for their services; Brokers are not uniformly required to tell the consumer the number and identity of lenders on their panel; Brokers are not uniformly required to disclose the costs that will be borne by the consumer; Brokers are not uniformly required to disclose the factors, financial and other, that may influence their recommendations; Brokers are not required to give consumers reasons for recommending a particular loan; Brokers are not required to support any representation of the benefits the consumer will receive in switching loans or refinancing; There is no uniformly applied system of accountability for brokers, especially at the fringe broker level; The lack of a continuing relationship between broker and client does not provide an incentive for a broker to provide a good service; There are limited avenues for accessible consumer redress; Brokers misrepresentations are difficult to prove. Consequences: Consumers may enter into credit contracts that they cannot afford to repay without substantial hardship; Consumers may be locked into an uncompetitive credit product; Consumers may enter into contracts for credit which are inappropriate for their credit needs; Consumers may enter into loans which they believe will be cheaper but which cost them more in the long run; Consumers may not get access to credit in time to complete a purchase; Consumers may be charged exorbitantly high fees and commissions; Consumers may be charged unrefundable commissions upfront and may not gain access to the credit they need; Consumers may lose their homes or suffer substantial financial loss; Consumers have very limited access to redress. 3.5 Level of Consumer Detriment It is difficult to establish even a rough estimate of the extent of consumer financial detriment. The number of complaints received by fair trading agencies is one indicator, although such data is more useful in identifying trends rather than the size of a problem. A benchmarking survey conducted in 1997 found that of the consumers surveyed who had experienced a consumer problem, only 13% had approached a government agency such as the (then) Department of Fair Trading seeking assistance. This is consistent with a 1995 study undertaken by the Society of Consumer Affairs Professionals in Business Australia (SOCAP), where less than 15% of consumers had approached government or community organisations with a complaint. 42 In more recent times, during , only 4 people out of several hundred consumers who were victims of a broking scam had contacted the New South Wales Office of Fair 42 Keys Young, Benchmark Study of Consumer Protection and Marketplace Issues in New South Wales, Final Report, 1997, p27. 38

39 Trading to make a complaint, while in another matter, 23 people out of a potential 100+ had made a complaint to the same office. It is clear, therefore, that complaints data will not reflect the magnitude of the problem in the community at large. Not all inquiries proceed to a complaint. When inquiry and complaint data is reviewed, it seems that the practices which are the subject of an inquiry or complaint are in similar proportions to the whole. It may be the case that when making an inquiry, consumers are advised to approach the trader about the issue in the first instance. Many consumers lack confidence in their capacity to negotiate a solution and those who will approach a trader are likely to be in the higher income brackets and with a higher level of education. 43 Again, it is the most vulnerable consumer who will not achieve a satisfactory resolution. While it is not possible to draw firm conclusions from complaint data in the various States as to the effect of the legislation in that jurisdiction, some tentative suggestions may be made. Western Australia is the only jurisdiction with a licensing regime. It should be noted, however, that the licensing regime applies to brokers of commercial credit as well as consumer credit, so that the number of complaints would not be directly comparable. In the financial year , 88 complaints were received against brokers. Complaints fell mainly into the following categories: channelling consumers to lenders whose products may not be in the best interests of consumers; charging fees in excess of the Maximum Remuneration Schedule; consumers complaining about debt reduction schemes and those brokers claiming that their debt reduction schemes are not broking and should not therefore make then subject to the regulatory regime; and cold calling in contravention of the Door to Door Trading Act. Western Australia makes the point that they have a high profile in relation to broking and are therefore likely to attract more complaints because of that fact. Western Australia does not have any recent recorded incidence of fraudulent behaviour or major misleading, deceptive or unconscionable practices. This could be attributed to their licensing regime and both the screening or compliance activity that accompanies such a regime. This can be, at best, a tentative interpretation. Victorian data registers 702 inquiries and 63 complaints for The largest category of complaints comes under the general term of unfair conduct, which includes non-supply of service, required documentation not issued or is defective, unfair contract terms and unfair or unjust trader. Non-supply of service and unfair trader are the largest sub-categories. The largest single number of complaints otherwise relates to overcharging, or undisclosed or unreasonable charges. Substandard services caused the second largest number of complaints. Inquiries differed in composition only in respect of substandard services, which were much lower in the list of complaints. Because data collection at this time is not harmonised between jurisdictions, it is difficult to draw firm conclusions about the effect of any regulatory regime. The lack of a screening process in Victoria could be related to the large proportion of unfair conduct issues and nonsupply of service, which could reflect fraudulent activity. Since Western Australia appears not to have a comparable data collection system, comparisons are not possible. In New South Wales for the period , there were 149 complaints registered. 43 Ibid, p27. 39

40 Misleading and deceptive conduct, unconscionable conduct and unsatisfactory/nonperformance of service constituted the largest proportion of complaints by far. The largest single category outside of that grouping was for complaints about commissions that have been charged before any credit is obtained. At the time of this data collection, the new legislation had not commenced and requirements were simply that commissions should not be demanded or accepted before credit was obtained, as well as rules for dealing with third party fees and retaining records of transactions. The smaller number of complaints in Victoria compared to NSW could be related to their more comprehensive regime at that time, but both jurisdictions share the high proportion of unfair conduct complaints. Like Victoria, New South Wales has no licensing or registration requirements. With respect to level of consumer detriment, this takes many forms. In the Credit Accounting Consultants matter, which was the subject of NSW legal action referred to previously, consumers paid between $2,000 and $18,000 for a service which would constitute nonsupply or unfair conduct in complaints data. The Supreme Court of NSW ordered $1,300,000 to be paid in compensation to victims of this broking firm in One consumer recently signed up (with an X ) for a broker to obtain a $30,000 loan for a $10,000 fee. The case studies have detailed the losses that can result from refinancing when this is not in the best interest of the consumer. Many consumers have lost their homes by being persuaded to take out inappropriate high cost products. The financial impact on consumers of these practices is demonstrated by the following studies. Study 1 Debt Reduction Schemes One of the problem areas in relation to finance brokers is debt reduction schemes where the broker targets consumers through promising to refinance the consumer into a facility that can be paid off in a much shorter period of time. Section of the paper sets out in detail the reasons why these claims are spurious, and why they result in consumers being refinanced to a line of credit at a higher interest rate. One agency has conducted a detailed examination of one of these schemes. It is possible to quantify the costs to consumers. During a recent five month period the debt reduction schemes arranged: (a) 374 refinances of consumers to credit facilities provided by a related corporation; and (b) 87 additional loans to mainstream lenders. The average loan size was $246,400. Where the lender was a related corporation it charged an interest rate above the level charged by mainstream lenders, usually by 0.5%. The involvement of the debt reduction scheme meant that the consumer paid refinancing costs of a minimum of $4285, made up of: 1. Fees charged by the broker, usually $3300; 2. Application fees of $865; and 3. Solicitors fees of a minimum of $

41 Consumers incurred two types of loss as a result of the refinance: additional interest charges and transaction costs. It is possible to quantify these losses. Additional Interest Charges It is possible to calculate the additional interest charges paid by the consumer using the following information: 1. The average loan size was $246,400 (and this includes refinancing costs of $4285). 2. In relation to the 374 refinances to credit facilities provided by a related corporation a review of the files suggests that the average interest rate on the consumer's existing loan was 6.5%, and the interest rate on refinance was 7.5%. However, a conservative estimate of 0.5% as the average difference between the loans is used. 3. In relation to the 87 refinances to credit facilities provided by mainstream lenders a review of the files suggests that the average interest rate on the consumer's existing loan was 6.5%, and the interest rate on refinance was 7.0%. However, a conservative estimate of 0.2% as the average difference between the loans is used. 4. The debt will be paid out in an average of 15 years (that is, although the loan itself may be refinanced prior to this time, it is assumed that the liability incurred by the consumer will take 15 years to discharge). Additional Interest Paid Where Lender Was A Related Corporation Interest payable for loan of 7% over 15 years: $152, Interest payable for loan of 6.5% over 15 years: $137, Difference $14, Additional Interest Paid Where Lender Was A Mainstream Lender Interest payable for loan of 6.7% over 15 years: $144, Interest payable for loan of 6.5% over 15 years: $137, Difference $7, Transaction Costs The loss to consumers from refinancing is a minimum of $4285, as set out previously. This is a conservative estimate as it does not include additional fees or costs such as stamp duty, nor any penalties or discharge costs charged by the lender whose facility is being refinanced. Total Losses It is possible to quantify the overall losses for consumers: Losses Where Lender Was A Related Corporation Individual Losses: $ $14, = $18, Total Losses: $18, x 374 = $7,064,

42 Losses Where Lender Was A Mainstream Lender Individual Losses: $ $7, = $11, Total Losses: $11, x 87 = $999, Overall Losses $7,064, $999, = $8,063, These losses are over a 5 month period. The company has been operating in similar fashion since 1999, and its business has expanded rapidly since that time. Reviews of websites and the operation of other brokers has identified a minimum of another 20 companies operating debt reduction schemes, at least three of whom have large scale operations. Study 2 Brokers Arranging Interest Only Loans Another problem area in relation to finance brokers is where brokers arrange 'interest only' loans for consumers in financial difficulties, and who may be in arrears on their existing home loan. Section of the paper sets out in detail the way in which these brokers systematically target and exploit financially vulnerable consumers by arranging refinancing where the consumer is having difficulty in meeting the repayments on their existing loans. One agency has conducted a detailed examination of one of these schemes. The costs to consumers are variable and include: Brokerage fees of between $2000 and $4000. Lender's application fee and expenses of between $2000 and $7000. Fees charged by borrower's solicitor and existing lender of $1400. Additional interest through interest being charged at rates, of between 8% and 18.75% A review of 41 files showed that 18 borrowers failed to make payments on time within first 3 months. This level of default is considered typical by the agency. The lenders involved in these matters will usually commence enforcement action following an initial default and failure to remedy the default following service of a letter of demand (rather than negotiate with the borrower or arrange a revised payment schedule, as is the usual method of operation of mainstream lenders). It is estimated that between 10% and 25% of the borrowers in default to these types of lenders will lose their home as a result of court action by the lender. These consumers suffer additional losses: Enforcement costs of a minimum of $3000, where court action commenced. Loss of equity in their home through sale of their property at an auction price, or through additional transaction costs where the consumer is able to refinance to a mainstream lender. Study 3 Broker Has Conflict of Interests The decision of the NSW Supreme Court in Investmentsource Corporation Pty Ltd v Knox Street Apartments Pty Ltd & Others [2002] NSWSC 710 provides evidence of the losses consumers can suffer due to a failure by the broker to identify conflicts of interest. 42

43 The case concerned the marketing and promotion of inner city units by a Henry Kaye company, Investmentsource Corporation Pty Ltd ("Investmentsource"). It is understood that, consistent with his usual method of operation, Henry Kaye used his wealth creation seminars to encourage consumers to purchase these units and that Investmentsource assisted consumers to arrange finance (in order to ensure that consumers proceeded with the sale). In fact, Investmentsource had negotiated with the owner of the units to obtain exclusive rights to market them. Investmentsource had negotiated to receive a commission from the owner for the sale of each unit; the amount of commission received by Investmentsource was not fixed but was the amount by which the purchase price exceeded a minimum sale price set by the owner. There was no evidence that the consumers were told about these arrangements and it can be presumed that they were unlikely to have agreed to purchase the units if this was the case. Investmentsource sold 31 units and earned commission of $1,330,589. This equates to a profit of $42,922 on each sale through inflation of the property price. Assuming that the consumers borrowed money to finance the purchase of a unit with a loan at an interest rate of 6.5% and that the liability was discharged over a period of 15 years, the additional interest paid by a consumer on the sum of $42,922 would be $24, The total loss to consumers can be estimated as: (42,922 + $24,379.41) x 31 = $67, x 31 = $2,086, Study 4. Broker Arranges Less Finance Than Borrower Required to Complete Purchase One agency has examined the conduct of a broker that arranged finance for consumers to purchase homes. The broker had a practice of assuring the borrower he could arrange a loan for sufficient money to enable the borrower to complete the purchase, even where this was not the case. Borrowers suffered damage as a result, including costs resulting from postponing or defaulting on settlement (such as additional charges, penalties and loss of deposit). The losses resulting to consumers where they lost the deposit could be significant. In one instance, where the conduct of the broker was reviewed in detail the loss to the consumer was over $50,000. Study 5 Broker Charges Borrower Fee Irrespective of Whether Able to Arrange Finance Some brokers will charge the borrower an upfront fee to arrange finance, and will demand payment of this fee even where they may be unable to arrange finance for the borrower. This creates particular problems where the borrower is a business, as in these circumstances the amount of credit required may be quite high, and the failure to obtain credit can impact significantly on the cashflow of the business, and its capacity to continue trading. One agency had two complaints about a broker where the broker charged upfront fees of $15,000 and $25,000 to obtain credit. In neither case was the broker able to arrange finance, and in one case it demanded (but did not receive) an additional fee in order to 'get the money through'. In both cases the business was under financial pressure due to both payment of the fee and the failure of the broker to arrange credit. 43

44 While there can be no accurate estimate of costs to the community, it is clear from the studies presented that the costs are significant. 44

45 4 Reasons for Government Intervention 4.1 Market failure in relation to consumers Markets can be an effective mechanism for resource and product allocation provided that (a) consumers are armed with full, or at least adequate, knowledge about the nature of goods and services and the terms of the transaction with the supplier, and that (b) traders compete fairly with each other. However, this may not occur because of asymmetrical information and dissimilar bargaining positions. The underlying principle is that well-informed consumers know best what goods and services will satisfy their needs and wants. In economic terms, society achieves its optimal welfare outcome when individuals are free to pursue their own best consumption options. The efficient allocation of productive resources in a market economy relies on the informed choices made by consumers and the competitive behaviour of market participants. Where this optimal outcome is not achieved, market failure is said to occur. The problems demonstrated in the preceding chapters appear to flow from two main categories of market failure, that of imperfect or costly information and unfair competition resulting from fraudulent or unfair conduct of fringe brokers. This is addressed in more detail below Imperfect or costly information The range of consumer credit products offered by the various financial institutions is too complex to allow consumers to make rational selections of products that are best suited to their needs. The Caseworker Survey referred to in previous chapters has demonstrated that a large percentage of caseworkers reported that their client had sought broking services because they believed they could secure a better deal, and a substantial percentage that the client either had no time or desire to compare different products themselves. In order to make a rational choice of product the consumer asks a broker, who can limit the cost of the transaction to the consumer by accessing information in a cost efficient way, to assist in that choice. The broker is then in the position of agent of the consumer in searching for the product, while being also the agent of the credit provider in informing the consumer about the product in such a way that will allow the consumer to make a rational choice. Remuneration for this service may come from either party or both parties. Remuneration may vary between credit providers and lead to a bias in favour of the credit provider providing a higher commission, thereby subverting the potential for the consumer to make a rational choice. Large numbers of brokers have entered the market in recent years. This should theoretically benefit the consumer by reducing the opportunity cost loss of potential borrowers either spending valuable time researching products themselves, or going into the branch of a credit provider and being sold only that credit provider s products. In view of the time poorness of consumers, it is unlikely that the consumer will have had sufficient resources or capacity to research the whole market and they may not therefore be accepting the most appropriate loan for their purposes. A UK study of consumer behaviour in accessing a home mortgage reports that consumers have difficulty in comparing different mortgage products and that the largest percentage 45

46 (23%) stay with the lender they have previously used, while the second largest percentage (20%) chose the mortgage product recommended by an intermediary. 44 While there may be significant numbers of consumers who have benefited from a broking service, that by no means is the case for all consumers. The background information suggests that a significant number of brokers demonstrate unethical or fraudulent practices while others are lacking the knowledge and expertise required to provide adequate broking services. In a market with perfect information and perfect competition, the market would have corrected this situation by consumers avoiding brokers who are unethical or incompetent. However, in the finance broking market, most consumers do not have the information or expertise to judge whether a broker is going to act honestly and in their best interests and provide a quality service. The broker service provided is not one that is regularly used and therefore the consumer is not likely to have developed skills in assessing broker performance. The complexity of the credit market also means that the consumer does not have the expertise to judge the quality of the advice provided by the broker. This lack of expertise is precisely the reason why a broker (who is presumed to possess specialist knowledge) is being employed. The consumer is in a position where they are dependent on the broker's skill and expertise, and where that skill and expertise is the reason they have chosen to employ the broker. This dependency leaves them vulnerable in their dealings where the broker does not act scrupulously. There are other aspects of finance broking of which consumers would be unaware. Many brokers have access to a very limited number of lenders, so that they are not necessarily sourcing the best loan available for the consumer. The access to lenders may reflect a number of factors: whether the lender has rejected the broker because there is insufficient volume of business; or the broker has not met the lender s accreditation criteria; or the broker has proven to be engaging in fraudulent activity or some other activity with which the lender prefers not to be associated. Also, the broker may have rejected the lender because they do not pay commission. These are matters of considerable importance, and the consumer would have no way of accessing that information Fraudulent, unconscionable or misleading conduct The background material contains descriptions and case studies of fraudulent activity by brokers, as well as conduct which demonstrates an unwillingness to act in accordance with the law. The activities described are able to be carried on because of the trust placed in a broker by the consumer and consumers relative inexperience or naivity in financial matters. Professor Jeffrey Carmichael, one of the members of the Financial System Inquiry, and formerly Chairman of the Australian Financial Institutions Commission and Chief Manager of the Markets Group of the Reserve Bank, has commented on the role of market misconduct in producing market failure as follows: Financial markets cannot operate efficiently and effectively unless participants act with integrity and unless there is adequate information on which to base informed judgements The two areas of misconduct that are most common in financial markets are: Unfair or fraudulent conduct by market participants; and Inadequate disclosure of information on which to base investment decisions. 44 Financial Services Authority, Choosing a Mortgage, table

47 Regulation to address these sources of market failure is usually referred to as market integrity regulation By protecting markets in this way, market integrity regulation seeks to promote confidence in the efficiency and fairness of markets. Market integrity regulation typically focuses on: Disclosure of information Conduct of business rules Entry requirements through licensing Governance and fiduciary responsibilities; Some minimal financial strength conditions 45 Professor Carmichael goes on to describe the functional split of the four regulators each aligned with correcting one of the sources of market failure. At the Federal level the regulators with the major responsibility for market integrity are the Australian Competition and Consumer Commission and the Australian Securities and Investments Commission. The Fair Trading agencies would be the State Government equivalent. This commentary underlines the importance of dealing with market misconduct with the goal of encouraging an efficient and effective financial marketplace. It recognises that it is unrealistic to expect that sufficient numbers of the most disadvantaged consumers will acquire enough expertise to identify and avoid operators who act unfairly. These fringe operators target those people in the community who are easy targets because of their financial or social situations. Changes in this demographic are slow and are not likely to occur because of education programmes or because of experience gained in using a service on a regular basis. Currently, remedies against unethical and incompetent brokers are difficult for consumers to access and therefore do not provide an effective incentive for brokers to behave ethically and to provide a quality service. Brokers know that a consumer will often have no recourse against the broker. In summary, market failure in respect of consumers accessing credit through brokers is demonstrated by: Consumers being unable to readily distinguish between unscrupulous brokers and those who will act in the consumer s best interests; Consumers entering into inappropriate or uncompetitive credit products; Consumers being unable to access remedies for financial loss. 4.2 Market failure in relation to lenders A significant and, from a regulatory viewpoint, disturbing trend in the broker industry is the incidence of fraudulent mortgage applications. The shift in responsibility for the preparation of the loan application from persons such as bank employees to brokers has seen a shift in the interests of that person, from applying proper risk assessment techniques to earning commissions through having the loan approved. Increased reliance on brokers therefore creates an increased risk of this type of mortgage fraud. At the soft end, mortgage fraud can involve the broker misrepresenting the consumer s personal or financial information in order for the lender to finance a marginal application for credit. Because brokers have ongoing contact with a credit provider, they become familiar with its lending criteria and can manipulate the content of applications to ensure the loan will 45 Carmichael J, The Australian Model of Integrated Regulation 47

48 be approved. There are a number of ways in which the broker can camouflage the borrower s circumstances, such as not disclosing all liabilities, reducing the number of dependants, or inflating the value of assets. More sophisticated mortgage frauds can involve identity theft, where the application is made on behalf of a non-existent or reconstructed individual, the security offered is illusory or vastly inflated in value, and the funds advanced by the lender are simply stolen. According to a newspaper report, mortgage fraud is a thriving suburban industry in Sydney, with finance brokers manufacturing false identities for customers and then arranging loans of up to $50, Mortgage fraud practices have undoubtedly taken advantage of the search for increased market share by lenders. John Kavanagh, a financial services journalist, writes: Among police and fraud experts, there is a belief that in the fiercely competitive home loan market, some big banks in their effort to secure market share were prepared to deal with almost any broker who brought them business. This meant that, in the past, they have lent money to home buyers through brokers who had no relevant qualifications or experience in the industry, no business record, who were not members of the industry association, and who were known to use heavy-pressure sales tactics on consumers. 47 Precise figures on the scale of mortgage fraud are not available, but it has been estimated that this type of fraud accounts for 3.2% of all frauds committed against financial institutions, and for 12.9% of the value of all financial institution losses. 48 The extent of the problem is such that some professional indemnity insurers have identified those lenders who are known to have particularly lax lending practices (leading to an increased risk of fraud), and have refused to provide insurance cover to valuers in transactions involving those lenders. The cost of these frauds is passed on to all consumers through increased interest rates, to cover the losses incurred by lending institutions. The prevalence of mortgage fraud is an additional reason why there have been calls for national regulation of the broker industry. Simon Purcell is the Legal Director of Latrobe Capital and Mortgage Corporation Ltd, part of the Latrobe Group, which has a mortgage book of $1.2 billion. He has stated: The undisputed existence of mortgage fraud has prompted moves to more tightly regulate the industry, especially at broker level. Hopefully, this intent to weed out mortgage fraud will result in industry support for a single national regulator for all secured loans; and broker licensing requirements along the lines of those applying to stockbrokers and financial advisors. Meanwhile the Mortgage Industry Association is intent on weeding out fraud and is working on its own selfregulatory regime. However this appears likely to fail unless it can force the national registration and licensing of every mortgage broker within the next two years Daily Telegraph, 24 February 2003, p Bridle the brokers, Business Review Weekly, 28 November 2002, p Simon Purcell, Legal Director of Latrobe Capital and Mortgage Corporation Ltd, Warning: Mortgage fraud on the rise, Money Management, 27 June 2002, p Simon Purcell, Legal Director of Latrobe Capital and Mortgage Corporation Ltd, Defrauding the great Australian dream, Journal of Banking and Financial Services, 116, August 2002, p

49 5 Objectives of Government Intervention A perfectly competitive and fair finance broking market would provide consumers with sufficient information to be able to purchase the cheapest available finance broking advice which also fulfils the purpose for which it was sought, that purpose being to help the consumer to choose the best available loan for their circumstances. The finance broking market does not currently operate in this fashion and the role of government intervention in the market is, where possible, to assist in bringing about these conditions of operation. This will require government action to: Provide consumers with the opportunity of choosing a finance broker who will act in the consumer s best interests, and who is competent to recommend a suitable loan; Provide consumers with sufficient information to choose a suitable broker; Require brokers to demonstrate that their recommendation is appropriate for the consumer s circumstances, and, where possible, is the best available; Provide a means of empowering consumers to influence broker behaviour by providing consumers with effective remedies against brokers who do not act fairly or competently; and Provide credit providers with confidence that the incidence of mortgage fraud by brokers will decline, and that offending brokers will be excluded from the marketplace. 49

50 6 Policy Options 6.1 Retain the Status Quo This option would mean that clients of brokers who wish to access credit for personal, domestic or household purposes would have certain remedies available to them under the legislation as outlined in paragraph 2.3 of this paper. The scope and limitations of current broker-specific legislation are discussed in that section and include: Lack of consistency of regulation between jurisdictions, which disadvantages firms having national operations; Limited entry requirements, so that in most jurisdictions anyone can set up a broking business without experience or expertise; Restriction of jurisdiction to those brokers accessing credit covered by the Uniform Consumer Credit Code, except in Western Australia; Except in New South Wales and Victoria, no requirement to disclose financial or other benefits paid by lenders, Except in New South Wales no requirement to disclose fees paid by brokers for referrals; No requirement to disclose the range of lenders or products a broker can access except in New South Wales; No requirement that the broker demonstrate that the recommended product is suitable for the consumer's circumstances and is the best that broker can access. General regulation under the Fair Trading and ASIC Acts is limited in scope to unconscionable conduct; misleading and deceptive conduct; false and misleading representations and implied warranties of due care and skill and fitness for purpose. The Consumer Credit Code also covers some aspects of broking behaviour. It applies to brokers in relation to advertising of credit products, and to representations which are material to entry to a credit contract. The Code also applies to a person obtaining a business purpose declaration, however, unethical brokers may deny access to those remedies that exist under the Code by requiring the consumer to falsely sign a business purpose declaration. The Code does not deal with the entire range of functions performed by a broker so that there is, currently, a gap in accessing remedies for those clients, both with regard to the credit contract itself and to broker behaviour. While legislation currently in place provides a range of enforcement and redress options, most consumer remedies provided would require court action to access, except in those states where jurisdiction is vested in tribunals. Court action is prohibitive for most consumers, and could only be undertaken by the few who had the financial resources and a willingness to negotiate that process. In any event, the remedies do not affect the credit contract itself, which may be totally unsuitable for the consumer who may then not be in a position to refinance. As well, experience has demonstrated that the most disadvantaged consumers are unlikely to approach a Tribunal even if they have been made aware of the possibility of application and have the kind of documentary evidence required in that forum. While state fair trading agencies may take action under the fair trading laws, the time and resources involved would require that only the major scams were pursued, leaving the majority of consumers to fend for themselves. 50

51 There are currently few remedies available to broking clients who obtain credit for business or investment purposes, except general contract law, state fair trading acts (depending on jurisdiction) and the ASIC Act. This legislation may provide remedies in certain circumstances, generally misleading and deceptive conduct, false representations and unconscionable conduct. However, as with consumer transactions, these remedies rely on court action and the expense involved may also be prohibitive to most small business or investor broking clients. All the general legislation which might possibly be used for enforcement and redress requires action to be taken after the misdemeanour occurs, which means that many consumers may suffer major detriment before any possibility of relief is achieved. The rapid expansion of the finance broking industry in recent years, and the range of problems identified, has led to calls for a consistent and comprehensive approach in addressing the problems identified in dealing with the broking industry. The nature of the industry, which is essentially to assist consumers to deal with a very complex financial market, does not lend itself to improvement through competition. Certainly, the increased numbers of brokers operating in the market has not led to improvements across the board, but rather to increased incidence of consumer detriment Benefits/Advantages For finance brokers Brokers would not incur any additional costs from changes to the regulatory environment. Those brokers who do not act in the best interests of the consumer would continue to benefit from excessive commissions and fees. For consumers None identified. For government None identified. For credit providers Fringe credit providers would continue to benefit from exposure to the market through fringe brokers. They would be shielded from action by government or the consumer by their status as third party to any disputes Costs/Disadvantages For industry Industry would continue to bear the costs of four different broking regulatory regimes. Broking businesses can involve writing loans for customers over state and territory borders. Therefore, any differences in the regulatory environment between jurisdictions will impede brokers operations and act against the efficiency of the service provided to the consumer. A further feature of the industry is that a large proportion of brokers are involved in either franchise or aggregator groups which are usually nationwide in their operations. A regulatory environment which differs from jurisdiction to jurisdiction militates against the efficiency of such groups, and individuals. The costs imposed by such a system put brokers at a competitive disadvantage with credit providers who operate under a uniform regulatory scheme. Brokers who operate across boundaries would have in place compliance systems for four regulatory regimes. This obligation imposes costs in time, human and financial resources. Such costs would inevitably be passed on to the consumer. 51

52 For consumers Consumers would continue to be disadvantaged in jurisdictions which do not have broking legislation and from the lack of comprehensive protections in the other jurisdictions. Those costs incurred by brokers in dealing with differing regulatory regimes would be ultimately borne by the consumer. For government Government would be subject to increasing criticism for failing to address problems in the broking industry. Government would also continue to bear the cost of major enforcement action. The costs of one recent action taken in relation to CAC were estimated to be between $122,000 and $140,000. In another action, where costs were minimised because the defendants agreed to consent orders, costs were capped at $12,000. Significant cases where injunctive orders are sought face costs of application to the Supreme Court of a minimum of $5,000. The costs set out above relate to action against two firms over a period of one year incurred by one agency, so that if applied Australia-wide over a period of time, some millions of dollars would be expended. For credit providers Credit providers would continue to suffer losses from poor quality loans and from the fraudulent activities of some elements of the industry. In summary, the status quo appears inadequate in addressing the market failure. There is little in the current regulatory framework to assist consumers to make an informed choice of either broker or product, and little in the way of accessible remedies to encourage brokers to act in the best interests of consumers. In addition, the status quo does not provide consistency between jurisdictions so that national businesses are required to deal with several different sets of legislation. This acts against an efficient marketplace and increases costs both to business and consumers. Maintaining the status quo is not, therefore, the proposed option. 6.2 Self-Regulation Model This option would rely on brokers peak industry organisations developing comprehensive rules of conduct and process, as well as developing effective dispute resolution mechanisms. While there are currently two main industry associations, the Mortgage Industry Association of Australia, and the Finance Broking Association of Australia, which provide professional services to their members and have codes of conduct and dispute resolution schemes, these associations do not by any means represent the whole market. While the MIAA estimates its membership at 75% of the market, this is limited to serious mortgage brokers. The problem with any voluntary membership scheme is that it cannot affect the conduct of non-members. Rogue operators are most unlikely to join any such association. Without complete coverage of the market, there is little that can be done to influence behaviour and provide feedback and sanctions which might bring about change. The most that can be done is to expel rogue operators from being members of the association. This would merely swell the ranks of those brokers who do not act in the consumer s interests. 52

53 The success of self regulation relies to a great extent on there being a relatively homogeneous industry with few major problems. As noted previously, the broker industry is very diverse, with a large number of players and a range of brokers of different size, market segments and structure. The market is multi-layered, in that there are aggregators as well as mortgage managers and mortgage/finance brokers. There are some large national operators as well as some franchised operations. Some operators are closely aligned with a very limited number of credit providers while others are essentially independent. The concerns and interests of these operators may be quite different and the problems encountered by consumers would reflect those concerns and interests. The problems outlined previously in this paper are numerous and varied, and can be relatively severe in their impact on broking clients Benefits/Advantages Since a degree of self regulation is currently in place and industry has acknowledged the limitations of their capacity to expand their activities, it is unlikely that there would be significant difference in the benefits from those outlined for the status quo above under this option Costs/Disadvantages See comments under In summary, the fractured nature of the industry militates against effective self-regulation, which, as a general principle, has the greatest influence in industries with a relatively small number of players, where those players are relatively homogenous, and where there is a single strong industry body. In these circumstances, the interests of the players tend to converge, giving them a similar commitment to improving standards of conduct through selfregulation. In effect, self regulation has been in place for some years and, while some benefits may have flowed to consumers from the efforts of the major industry associations and their codes of conduct, this has not and could not have any impact on non-members. Self-regulation, therefore, is not likely to achieve the government s regulatory objectives and is not a proposed option. 6.3 Consumer Education One model of regulation would be status quo or self-regulation with improved education of consumers. Educational material might encompass information as to what a consumer should ask a broker; advice on the consumer s rights under the law, and how to access the redress mechanisms available. There are a number of matters to be considered in assessing the effectiveness of any model that relies solely on education to deliver information (and, implicitly, bargaining power to consumers): 1. Educational materials will usually not be received by the consumer when they are most likely to be receptive to that information. Research indicates that consumers are most likely to be engaged by educational information if the delivery of that information is targeted or made available when most likely to be receptive to that information. In the case of finance brokers, consumers are most likely to be receptive in the period between deciding to use a finance broker and entering into a contract with that broker to arrange finance. In most instances this 53

54 will only provide a relatively small opportunity for government to provide information, and there will be considerable impediments to timing delivery of information appropriately. Consideration must also be given to whether consumers would know how and where to access information at this time. Information about redress mechanisms if provided at point of sale or earlier is not likely to be of interest to the consumer. Most consumers do not contemplate problems at that stage and with the amount of paper that is generated by credit transactions generally, it is unlikely to be useful. Most consumers seek advice and assistance only when they are under extreme pressure and sometimes when it is too late in the process to be very effective. 2. Educational information is unlikely to be received or acted upon by those most in need of the information. Research shows that different groups within the community respond best to education programs that are specifically targeted to their needs. For educational materials to be effective a broad range of different programs addressing these various needs is necessary. The Consumer and Financial Literacy Taskforce sponsored by the Commonwealth has noted that people with higher levels of consumer and financial literacy (and less need for consumer education) tend to be the larger users of consumer education programs. One subset of people who use brokers is those people who cannot obtain credit from mainstream lenders. These people are by definition financially vulnerable, and are often seeking credit that will be secured by a mortgage over the family home. Even where these people may have received and absorbed educational materials, their capacity to negotiate with the broker is extremely limited (i.e. because they are in an extremely weak bargaining position). It is the experience of regulators that, in many instances, the broker will offer to arrange finance on onerous terms, and with the consumer having no capacity to negotiate with the agreement offered on a 'take it or leave it' basis. In the absence of specific legislative obligations (as is the current position), these consumers enter into agreements under which brokers can charge high fees and refinance consumers into loans they are in fact unlikely to be able to afford. The options available to them at that stage are inadequate as described in Section 3 above. 3. Educational materials must compete with information provided by brokers. Many medium or large brokers have financial resources that enable them to disseminate information (principally through websites and advertising) that is likely to have as much impact on consumers as government sponsored materials. Websites with enticing graphics and modern displays, or advertisements with snappy slogans are also more likely to be accessed by consumers at the time when they are seeking finance (that is, when the information presented by the broker is of more immediate interest, and therefore more compelling). The information presented through websites and advertising is designed to promote the broker's activities and interest the consumer in using the broker. The extent to which this information may not be accurate is indicated by a recent action by ASIC. In September 2004 ASIC took action in relation to a website calculator which produced a comparison between the borrower's existing loan and an alternative loan. However, the assumptions embedded in the calculator meant that additional repayments were attributed to the alternative loan, but not to the borrower's existing loan. This produced a distorted comparison which suggested that the consumer would always 54

55 be better off financially by refinancing to the alternative loan. The calculator appeared on over 100 websites. 4. For educational materials to be effective, they must be long term and are, therefore, reliant on ongoing government funding. The Commonwealth Government has recently established a financial literacy taskforce. However it is clear that the task of improving financial literacy is long-term and requires a sustained effort. Education in relation to the use of brokers is only one small aspect of this project and it is not clear that government funding (at both a Commonwealth and State level) in the financial services area will be directed towards materials in relation to the use of brokers. As noted above, different programs are necessary to meet the different needs of various groups in the community, increasing the expense to government. It would appear self evident that improved financial literacy, as well as the provision of information on a consumer s rights under the law would assist consumers in conducting financial transactions. Fair Trading agencies and other community organisations currently provide a range of materials for consumers to assist them in their choices and in accessing redress. As stated above, this strategy, while useful, is likely to benefit only a relatively small proportion of the market and would be unlikely to assist those most in need Benefits/Advantages For industry Fringe brokers would continue to attract the more disadvantaged consumer and also those who are time poor and unable to access appropriate materials at the time needed. Reputable brokers could expect to deal with a larger percentage of knowledgeable consumers. For consumers The more financially literate consumer would have greater access to relevant material which could improve their bargaining position. For government Some consumers would have enhanced financial literacy and therefore less need for complaint and enforcement services. For credit providers Fringe credit providers would continue to make available high cost loans. Some borrowers would be more financially literate and better able to select a reputable broker, which would benefit credit providers offering products through such brokers Costs/Disadvantages For industry Reputable brokers would continue to be subject to unfair competition from fringe brokers. The image of the broking industry would not be improved. For consumers 55

56 The disadvantaged and time poor consumer would continue to be subject to fraudulent or misleading behaviour and would pay an unnecessary financial premium for both the broking service and the credit product. This would contribute to market inefficiencies. For government Government resources would be directed to operations which are unlikely to deliver benefit to the target demographic. Government would continue to be subject to criticism for failing to address market problems. For credit providers Mainstream credit providers would continue to run the risk of poor quality loan portfolios. In summary, it is unlikely that educational materials will, in themselves, deliver any effective outcomes for consumers. Any educational campaign needs to be viewed in the broader context of ongoing discussions about financial literacy and as an adjunct to other regulatory mechanisms. This is not a proposed option. 6.4 Mandatory Code of Conduct A mandatory code of conduct is a regulation prescribed under legislation which usually makes specific to an industry those general principles outlined in the head legislation. A mandatory code is generally considered more flexible than legislation in that it is not subject to parliamentary scrutiny and therefore may be able to react more quickly to events in the marketplace and be changed to reflect new practices It is not clear that this would be the case with any scheme such as that being called for in relation to the broking industry. Brokers, credit providers and consumer advocates are united in their opinions that any broking scheme should be uniform in nature. With any uniform scheme, agreement between jurisdictions must be achieved, and this is time consuming. As well, most parliaments are concerned to ensure that regulations do not exceed their statutory function and have systems in place for scrutinising regulations as well as legislation. The COAG requirements for consultation and cost benefit analysis apply equally to proposals in the form of a regulation, so that a stringent consultation process is required in certain circumstances, depending on the effect of the regulatory proposal. It is likely, therefore, that the flexibility, or timeliness, which is considered to be a benefit of mandatory codes, may not apply in this case. Another benefit that is sometimes claimed for mandatory codes is that they can clarify the application of laws in respect of certain industry practices. One reason for this is that they are generally written in language that is less legalistic than the legislation itself. This has sometimes proved difficult in situations where legal interpretation is necessary, as the language of codes may be less legally precise. If mandatory compliance is needed this may be a disadvantage rather than a benefit. A related issue is the enforcement of mandatory codes. As a regulation, only low level enforcement mechanisms are appropriate. Indeed, there is a perception in the market that a code is less compulsory than legislation. It is instructive to note that in NSW, the provisions in the Fair Trading Act permitting the development of mandatory codes, have been repealed. Over time the three mandatory 56

57 codes under that legislation have been incorporated into legislation, this having been recommended by a series of reviews where it was considered that any marketplace failure was best addressed by relevant legislative provisions rather than the making of a potentially unenforceable code of conduct. The repeal of the enabling provisions in the Fair Trading Act followed a NSW Court of Appeal decision which confirmed the predominance of contractual rights over the Retirement Village Code of Practice, ruling that the Code did not override specific contractual obligations with which it conflicted Benefits/Advantages For industry The language of a mandatory code of practice may clarify the requirements of the legislation and assist compliance. For consumers In those jurisdictions where there is currently no broker specific legislation, the mainstream broker may provide a better service. For government Mandatory codes usually include alternative dispute resolution procedures which would mean less need for government to provide complaint handling services. For credit providers A mandatory code which aims to raise industry standards would have a positive effect on some brokers, which would benefit credit providers offering products through such brokers Costs/Disadvantages For industry Reputable brokers would continue to face unfair competition from fringe brokers and may suffer loss of business from a consumer perception that the industry as a whole should not be trusted because of lack of effective enforcement options. Mandatory codes usually require industry involvement in administration, review and dispute resolution which can be costly. For consumers Consumers would continue to be subject to unfair practices from fringe brokers and a suboptimal service from mainstream brokers resulting from a lack of enforcement possibilities. For government Government would continue to be subject to criticism that the problems in the industry were not being addressed. For credit providers Mainstream credit providers would continue to subject to the risk of poor quality loan portfolios. In summary, it is likely that the objective of providing effective remedies in order to provide an incentive for brokers to act in the consumer s best interests and provide a quality service, would be subverted by a mandatory code s low level enforcement capacity and potential for imprecise legal interpretation. 57

58 It is considered, therefore, that a mandatory code of practice would not satisfy the Governments objectives in respect of finance broking and would further enshrine the inconsistencies in regulation between jurisdictions. A mandatory code of practice is not the proposed option. 6.5 Broker Specific Regulation Section 3.1 notes the piecemeal nature of broker specific legislation in Australia. It is also noted that the legislation which could be used on a national basis, such as the ASIC Act and the various Fair Trading Acts, cover broad categories of misdemeanour such as misleading and deceptive conduct and false representations, or unconscionable conduct, and that this is responsive legislation. The limitations of that legislation and the inaccessibility of remedies to consumers are also discussed. That section also refers to the Uniform Consumer Credit Code. Its coverage of broking transactions is minimal, and the Consumer Credit Legal Centre in its report for ASIC, has noted the very limited capacity for redress under that legislation, as well as the fact that the Code was drafted when broking was in its infancy and there was no experience of the practices discussed in this paper. State based legislation takes different approaches, largely responding to the market at the time of the legislation s development, and, in the case of Western Australia that response was developed to address matters raised in a high profile inquiry that are not relevant to the industry in other jurisdictions. There has been significant discussion of the need for regulation of the industry in the public forum. All industry players as well as consumer advocates seek a national solution, given the increasing number of brokers who have national operations or franchises, and in view of the fact that the credit industry is largely national. National solutions, where appropriate, are considered to enhance the efficiency of the market. None of the options discussed above appears to have the capacity to address a complex and fragmented market where problems stem largely from the reliance of the consumer on the broker to make sense of an even more complex credit market, and where fraud and unfair conduct are not isolated occurrences. In summary, national legislation would appear to be the most appropriate means of securing Government objectives. The Federal Government has declared its position, which is to leave regulation to the states in view of the fact that the states have jurisdiction over consumer credit matters. The option which emerges, therefore, is nationally uniform or consistent legislation which could incorporate features of existing state-based legislation, where these are seen to address those problems identified in the industry, and where such features would serve government objectives. Nationally uniform or consistent broker specific regulation is therefore the proposed option. The costs and benefits of this approach are set out in relation to the proposed components of the regulation. National Uniformity If the regulation of finance broking is to remain with the States and Territories, a means to apply and maintain uniformity or consistency is essential to the efficient working of the broking market. 58

59 A number of regulatory schemes operate with a degree of consistency between states without a formal uniformity agreement. Others, such as the various Travel Agents Acts are subject to a Participation Agreement which requires certain uniform provisions to be incorporated into each state Act. In that case each jurisdiction has the carriage of its own legislation through the Parliament. Similarly, in respect of Co-operatives, Ministers agreed to core consistent elements of legislation, but without formally signing an agreement. There are now significant differences between jurisdictions and amendments are introduced by each jurisdiction but not synchronously. There may be as much as 2 years difference between jurisdictions in adopting the provisions. The model which aims to ensure the highest degree of uniformity is one in which one jurisdiction secures the passage of legislation which has the unanimous support of all jurisdictions, and the others then adopt that legislation as a law of their jurisdiction as in force for the time being. This means that any future amendments in the state which passed the original legislation would apply automatically in all other jurisdictions, those amendments having previously been agreed between the parties. This is generally referred to as a template model. One example of legislation which is subject to this model is the Uniform Consumer Credit Code. The rules for achieving and maintaining uniformity are set out in the Australian Uniform Credit Laws Agreement That Agreement in fact permits a choice of process for achieving consistency in regulation. Jurisdictions can either choose the template process or opt to pass alternative consistent legislation. At the time the Agreement was made in 1993, all jurisdictions except Tasmania and Western Australia chose the template process. Tasmania chose a modified template process under which the initial legislation and any amendments are adopted by proclamation. Western Australia originally chose to pass alternative consistent legislation, which meant that the initial legislation and every amendment had to undergo the usual parliamentary process, with the risk of amendment by one of the Houses. In practice, there are problems in achieving synchronicity, and in 2003 Western Australia adopted a model similar to Tasmania. The Code Uniformity Agreement also permits certain things to be non-uniform, allowing for differences in structure or policy between jurisdictions. The non-uniform matters are listed in the Agreement. These are: (a) the fixing of maximum interest rates payable under consumer credit contracts; (b) the establishment of trust funds with designated purposes into which forfeited interest charges may be paid; (c) the establishment of a scheme for the licensing or registration of credit providers; (d) the vesting in a Tribunal of jurisdiction which, under the Initial Legislation is vested in a Court; (e) such other matters as are approved by unanimous resolution of the Ministerial Council. No additional matters have been added since that Agreement was signed. The Uniformity Agreement recognises that it cannot interfere with the sovereign powers of each Parliament, however, jurisdictions are required to not pass conflicting legislation or legislation which would negate the operation of the Code. Uniformity of credit laws has been generally maintained since 1996 and the processes outlined in the Agreement appear to have worked well. It would seem appropriate, therefore, that a similar scheme apply to any national regulation of finance broking, with similar provision for specified matters to be non-uniform. 59

60 7 Proposals to Regulate the Broking Industry This section sets out a regulatory scheme which it is suggested would address the problems between brokers and consumers which result in market inefficiencies and consumer loss. In effect, the proposals combine features of the Western Australia and New South Wales approaches, but these are enhanced to address current practices and problems. 7.1 Scope of finance broking legislation Issue - should finance broking legislation extend to all finance broking transactions? Finance broking legislation in NSW, Victoria and ACT only extends to transactions where the credit to be obtained is covered by the Uniform Consumer Credit Code. This means that the credit is provided, or intended to be provided, wholly or predominantly for personal, domestic or household purposes. In Western Australia, there is no purpose test and almost all broking transactions are regulated. Both consumer and broker representatives argue that finance broking legislation should extend beyond consumer credit to credit which is to be used for investment and small business purposes. Both groups consider that consumers seeking credit for investment and small business purposes can be just as vulnerable as those whose credit is for domestic or household purposes. Broker representatives also see little sense in having to comply with different regulatory requirements for the same consumers, depending on the purpose for which they are intending to use their loan. Possible responses The scope of finance broking legislation could be determined by a test similar to the retail client test used in the Corporations Act The retail client test in the Corporations Act determines when a person is to be treated as a retail client and therefore receive the protections offered by the Act. These protections consist of disclosure requirements relating to the sale of financial products and conduct requirements applying to sellers of financial products. This test, contained in section 761G(6) of the Corporations Act, provides that a financial product (other than general insurance, superannuation and retirement savings accounts), or a financial service related to such a financial product, is provided to a person as a retail client except in four instances: where the price of the financial product, or the product in relation to which the financial service is provided, exceeds the prescribed amount (currently set at $500,000); where the business acquiring the product or service is above a certain size; where an individual acquiring the product or service provides evidence of a nominated level of personal wealth; or where the person acquiring the product or service is a professional investor. Product value exemption This exemption is based on the assumption that persons who can afford to acquire financial products or services with a value above the prescribed amount do not require the protections given to a retail client, as they may be presumed to have either adequate knowledge of the product or service, or the means to acquire appropriate advice. 60

61 The product value exemption in the retail client test, which in the case of credit products would focus on the amount of credit a consumer wishes to acquire, would inappropriately exclude a consumer from the protection of finance broking legislation. This is because there is a vast difference between having $500,000 to invest and borrowing $500,000. It cannot be assumed that a person who wishes to obtain a large amount of credit is a sophisticated consumer or has a certain level of financial resources, particularly if the credit is for a business. In this context it should be noted that the Consumer Credit Legal Centre has dealt with cases of vulnerable, low income consumers being provided with large loans. Further, it would not seem appropriate to make the scope of finance broking legislation more limited (at least in relation to the amount borrowed) than the coverage of the Uniform Consumer Credit Code. As the Credit Code covers all consumers who obtain credit for personal, domestic and household purposes, regardless of the amount of credit being obtained, it would not be appropriate to limit finance broking legislation to consumers whose loans are below an amount that might constitute a consumer purchase. Big business exemption This exemption excludes businesses above a certain size from being given the protections available to a retail client, provided the financial product or financial service is used in connection with that business. A big business is defined as one that employs more than: 100 people if it is a manufacturing business; or otherwise, 20 people. A big business exemption would appear to be appropriate for finance broking legislation. Such businesses do not need the protection of the legislation and the requirement to comply with the terms of the legislation may unnecessarily restrict competitive business practices. The exemption would leave small businesses with the protection of the legislation. There is, however, an issue with regard to businesses which are, essentially, $2 shelf companies, and which may be set up for the purposes of borrowing large amounts of money for, say, a securitisation program, and which may be multimillion dollar enterprises. It is proposed, therefore, that a small business, as defined above, which seeks to borrow more than $2 million be excluded from the coverage of the finance broking legislation. Individual wealth exemption This exemption enables a person to provide evidence that they have: net assets of at least $2.5 million; or gross income for each of the last two financial years of at least $250,000. If a person provides a certificate to this effect, they will no longer have the retail client protections. Wealthy individuals may therefore choose to decline these protections, on the basis that they have either experience in making investments or the means to seek appropriate advice. It is difficult to imagine why someone would want to decline the protections of finance broker legislation. Further, an individual wealth exemption would not seem to be appropriate for finance broking legislation, as it would make the scope of broking legislation more limited than that of the Credit Code. The Code covers all personal, domestic and household credit, regardless of the consumer s income. The professional investor exemption 61

62 The Corporations Act excludes persons who are considered to be professional investors. These include: financial services licensees; bodies regulated by the Australian Prudential Regulation Authority; bodies registered under the Financial Corporations Act 1974; trustees of superannuation funds, approved deposit funds, pooled superannuation trusts and certain public sector superannuation schemes; persons who control at least $10 million; listed entities or related bodies corporate of listed entities; exempt public authorities; investment companies as defined by the Corporations Regulation; and foreign equivalents of the above. The professional investor exemption was included in the Corporations Act in response to concern by industry that retail protections would otherwise apply to financial and investment entities that are not big businesses. It is not proposed to provide an exemption similar to the professional investor exemption for finance broking legislation. It is considered that the size of a business is a better measure of whether it requires the protection of finance broking legislation or has the resources to obtain its own advice, than the type of activities the business carries out. Proposed option That finance broking legislation cover all credit unless the applicant is a business entity which employs more than: 100 people if it is a manufacturing business; or otherwise, 20 people; or the credit sought is more than $2 million Benefits/Advantages For finance brokers There will be certainty of application of any national finance broking legislation. For consumers All consumers and small businesses will receive the benefits of the legislation. Instances of fraudulent broker practices in relation to small business loans have been identified and demonstrate the need for coverage of the legislation beyond consumer credit. For government There would be fewer complaints from consumers and small business about broking problems. Small business could expect access to credit suitable for their needs. For credit providers Credit providers could expect better quality loans for a wider range of products Costs/ Disadvantages For finance brokers Possibly higher compliance costs if more transactions are covered by legislation. However, brokers have expressed the advantages of one regulatory scheme covering all transactions. 62

63 For consumers If there are higher compliance costs, these may be passed on to consumers. For government Should the proposals in the following sections be adopted, there would be less need for government enforcement activity. If these are not adopted there may be an increase in the level of enforcement activity undertaken by governments. For credit providers None identified. 7.2 How is a broker to be defined? The market for credit is very fragmented. Potential borrowers can go directly to a credit provider, or to intermediaries who they can identify as finance or mortgage brokers, or they may access credit when making a purchase in a store or a motor dealership. In all cases except for credit providers, the person who provides access to the credit will receive a payment or benefit for doing so, whether it is from the consumer or the credit provider or some other party. Where a person provides those intermediary services for payment, and they have the authority to recommend more than one credit product, they are to all intents and purposes providing a broking service. It is proposed, therefore that a broker should be defined, widely, as a person who acts, or purports to act, as an intermediary to negotiate or obtain credit for a person (other than the intermediary s employer, or a principal who is not the client of the intermediary) in return for a commission or financial benefit, whether payable to the intermediary by the person, the credit provider or any other person or body. In this way, it is the function that is being addressed, which establishes a level playing field for all that provide this service. This approach has recently been adopted in New South Wales the Consumer Credit Administration Amendment (Finance Brokers) Act 2003, that legislation having been drafted in response to a National Competition Policy Review of the Credit (Finance Brokers) Act The definition of broker in that legislation may provide a useful basis for any national scheme. While the New South Wales legislation regulates only brokers who access consumer credit as defined in the Consumer Credit Code, the definition would need to be extended to encompass the proposed scope of any national scheme. Should any intermediaries that are caught by this definition be exempt? The New South Wales legislation exempts second tier intermediaries, such as document handlers who are, in fact, intermediaries between the broker and the consumer in certain circumstances and between the broker and the credit provider. These intermediaries are not those with the responsibility for negotiating and obtaining credit and have therefore been exempted. Others currently caught but who will be exempt are those intermediaries who are obliged by their agreements with the credit provider to offer only one brand of credit. This issue is referred to earlier in this paper in the context of mortgage managers who are, in the consumer s perception, offering credit as a lender, not a broker. In such cases, it is considered that no useful protection would be provided to the consumer by issuing a finance broking contract and making the disclosures required by the legislation. 63

64 The possibility of commercial lease broking being exempted has been raised by that section of the industry, as that type of broking is considered not to be comparable with the focus of this paper. Further comment on this issue is welcome. 64

65 8 How will legislation meet Government objectives? 8.1 Objectives 1 and 5 Provide consumers with the opportunity of choosing a finance broker who will act in the consumer s best interests, and who is competent to recommend a suitable loan. Provide credit providers with confidence that the incidence of mortgage fraud by brokers will decline, and that offending brokers will be excluded from the marketplace Problem to be addressed Brokers who do not set out to act in the consumer s interests may be described as fraudulent, recognising that not all the practices identified would constitute fraud for the purposes of the law. These are brokers who enter the market, act fraudulently or unfairly and with a clear intention to take clients money without providing a legitimate service. It is impossible to quantify the numbers of such brokers, or traders who hold themselves out as brokers, as a percentage of the whole. The APRA report noted that the third most common reason for ADIs ceasing to deal with certain brokers was fraud (at 24%). Poor quality of loan applications (which may include a high incidence of unfair, misleading and deceptive conduct) was equal first at 59%. It is likely that credit providers other than ADIs would have similar experiences. While no data is available, it is likely that the nonconforming lender would attract a higher percentage of fraudulent and unfair brokers. In New South Wales, one recent case against a firm of brokers, Credit Accounting Consultancy (CAC), resulted in Supreme Court orders that the defendants involved in the case pay $1.3 million to compensate the victims of their practices. These individuals have been banned from offering or arranging credit for consumers in New South Wales and are now subject to criminal charges in respect of their practices. The NSW Office of Fair Trading was involved in two years of investigation and eighteen months in the Court in bringing their operations to a halt. However, there is nothing to prevent these operators from starting up in another jurisdiction where there are no probity checks and the process could be repeated. While the number of such brokers may be relatively small compared to the whole, it can be seen from this one example that the impact on consumers is high. The $1.3 million in the case cited above is by no means expected to cover all consumers losses in dealing with CAC. The migration of these fraudulent brokers following a prohibition from trading is by no means unusual, and New South Wales has been informed that another such operator who was prohibited from trading in New South Wales has been operating in Queensland. Traders such as those referred to above are competing unfairly with those brokers who are acting lawfully and providing a bona fide broking service. They also are the cause of considerable consumer detriment, much of which will not be compensated. They not only are the cause of financial losses to consumers but they also tarnish the public image of all brokers and may make the public less willing to use a broking service. An appropriate response to this sort of problem may be to prevent people with a history of unfair or fraudulent conduct from operating as a finance broker. The usual process undertaken by Government to screen industry entrants is that of probity inquiries as a condition of granting a licence. 65

66 The type of entry requirement chosen in any regulatory scheme would depend on the degree of detriment suffered by consumers, and how the market may be affected by any barriers to entry. It also depends on the objectives of regulatory authorities. The various entry mechanisms are outlined below. 8.2 Licensing/Registration/Negative Licensing Negative Licensing While negative licensing is not actually an entry requirement, a discussion of its merits is included as it is the regulatory scheme in force in Victoria and New South Wales. Of the systems currently in place, negative licensing is the least burdensome on industry. Negative licensing is the term applied to a system where there is no formal requirement to be licensed, but where a trader who contravenes the law can be required to comply with certain conditions, and, in extreme cases, be prohibited from trading. In essence, negative licensing places no obligations on the finance broker, except an implicit obligation to act in accordance with any legislation that may be in place, or to suffer the consequence that they may be prevented from continuing in that business. The obligation is on the government agency to investigate complaints about broker behaviour and, where appropriate, to take administrative or legal action against that broker. The power to prohibit a trader from operating in a particular jurisdiction is usually an administrative one, with appeals to an independent authority. Negative licensing may be the regulatory option of choice in situations where there are few complaints about industry behaviour and the participants are easily identified and contacted. Those jurisdictions which currently have this system have seen the broking industry grow at a rapid rate, and significant consumer detriment occur. Negative licensing cannot prevent the entry of undesirable elements, nor can it provide access to industry participants. It is difficult to undertake regular compliance activity when the industry participants cannot be identified and their location is unknown. To pursue and prosecute illegal broker behaviour may take many months of activity. It is, therefore, a significant burden on government resources and neither prevents nor discourages consumer detriment. In respect of consumer identification of legitimate traders, there is no way of checking a broker s bona fides. This is not to say that a licensed trader will never contravene the laws, but it is less likely that a person who is willing to undergo probity checks and pay license fees, as well as fulfilling other requirements for a licence to be issued, will set out to defraud a consumer. Registration Registration requires simply that a trader register their trading operations with a regulatory authority and is required only in the Australian Capital Territory. This system can provide greater protection than negative licensing by attaching a number of operating requirements, such as requiring education to be undertaken or that a broker must obtain professional indemnity insurance. It can also facilitate communication and provide for disciplinary action by deregistering a broker and thereby prevent them from trading. Registration does not, however, screen those wishing to operate in the industry. People with poor trading records, or criminal records, can operate even if it is only until they are investigated and deregistered. There may be significant consumer detriment before this can happen. 66

67 In respect of those who operate outside the law, and depending on the requirements of the scheme for proof of identity, registration does not provide certainty that the person who registers does so with their real name, nor that they can be found when required. This is a circumstance commonly encountered by fair trading agencies when pursuing rogue brokers. Registration, therefore, would seem appropriate in an industry where there is generally an intention to comply with the law, but where the standard of service needs to be improved. It will not prevent unscrupulous brokers from entering the market, nor will it ensure that they can be contacted when complaints are received. It will not prevent major consumer detriment or unfair competition. Licensing Licensing can prevent entry by checking a person s record and excluding undesirable individuals from legitimately entering the market. Currently licensing is required only in Western Australia. In New South Wales, prior to 1996, licences were required for finance broking and for nonbank credit providers. However, when the Consumer Credit Administration Act was being developed to commence synchronously with the Consumer Credit Code, that regime was replaced by a negative licensing scheme. One reason for this was that the Consumer Credit Administration Act provided the same disciplinary regime for credit providers as well as finance brokers. Because banks could not be licensed by the States, to apply a licensing requirement only to credit providers who were not ADIs was thought to be discriminatory and potentially anti-competitive. In order that the Act should not require two kinds of disciplinary regimes, and because the finance broking industry had not yet developed the practices now evident, a negative licensing regime was applied to both industries. This essentially means that in most jurisdictions anyone at all can hold themselves out to be a finance broker, without any knowledge of the industry and without capital. Some brokers operate entirely by telephone or electronic means. The proliferation of brokers who fraudulently exploit the client may reflect the lack of entry requirements and probity checks. Those who operate fraudulently generally target those consumers who are naïve in financial matters or who are desperate for access to credit. Purpose of entry requirements Entry requirements have traditionally been used to: Keep individuals with a history of unfair or unlawful trading or conduct out of the market; Facilitate more effective and responsive disciplinary action Facilitate effective communication with the sector Allow consumers to identify a trader who has satisfied certain entry criteria Place entry conditions on participants Require a level of competency to trade in the industry Require traders to comply with ongoing requirements in order to remain in the industry Proposal In view of the experiences of consumers in unlicensed markets, and the financial consequences of those transactions, many of which flow from fraudulent behaviour, it is proposed that a reasonably high level of screening would be appropriate for participants in this industry and that a licensing scheme be introduced. Should the Code uniformity scheme be adopted, consideration may be given to making the licensing of brokers one of those matters permitted to be non-uniform. While this would be consistent with current practices, it should be recognised that those states which chose to 67

68 lower any barriers to entry would face the prospect of a large migration of fraudulent traders, with the consequential impact on the regulatory agency s resources and the likely increased detriment to consumers in that jurisdiction. Any licensing/registration cost should be determined in relation to the cost to the regulatory authority. This would establish that any applicant for a broking licence had sufficient commitment to that project to be prepared to outlay a small amount in the form of a licence fee. It would also relieve the government of any additional cost in establishing and maintaining a licensing system. Any licensing scheme would: Require an applicant to be a fit and proper person Impose probity checks to include: convictions for offences involving dishonesty cancellation of any licence, registration or permission to trade in a regulated occupation, profession or business undischarged bankrupts a person who has breached any undertaking in relation to fair trading legislation Exclude a person from being a director of a finance broking business if they have been disqualified from trading Exclude persons under 18 Exclude any mentally incapacitated person Who should hold a licence in any broking business One function of any licensing regime is to ensure that a designated person is responsible for carrying out the requirements of applicable legislation and is accountable for any deficiencies in the performance of those requirements. Clearly, sole traders would need to hold a licence. If a business was set up as a partnership, it is unlikely that one partner would want to take responsibility for another and risk losing their broking licence because of the other s wrongdoing, so that all trading partners should be separately licensed. Where a company has a small number of employees or contractors who are subject to the control and supervision of the employer, then only the employer need be licensed. With larger businesses which have numerous branches or a web of operations, and whose brokers are employees, contractors or franchisees, it is unlikely that the employer could be considered to control and supervise the broker on a day to day basis. The larger the business, the less likely it is that a person will be closely supervised. However, if one of the functions of licensing is to ensure that someone is responsible under the law, it is a major incentive for the licensee to ensure that brokers in their employ, or under contract, are of good character and reputation, and that they are properly trained and supervised. Office bearers in such large business entities with appropriate line responsibilities should hold a licence on the business s behalf. They need not be directors. Nevertheless, where the employer is geographically distant, and there are a large number of branches with broking business being carried on by one or more brokers, then each branch should have at least one licensed broker on the premises who has an appropriate supervisory capacity in respect of other brokers on the premises. All those carrying out broking functions must be authorised by a licensee to do so, whether the employer or the person on the premises, depending on the corporate structure and the devolution of responsibilities. 68

69 Membership of an ADR scheme, as proposed later in this paper, should follow the licensing regime. A licensee should also be responsible for ensuring that all brokers and other employees who carry out functions which require expert knowledge are appropriately trained. In proposing such a scheme, it is recognised that many brokers, whether they are to be licensed or authorised, and who are currently operating throughout Australia would be required to make application to remain in the industry. The MIAA has pointed out that the requirements listed above for obtaining a licence are almost identical to their membership criteria, and that their membership comprises a significant percentage of the industry. For others, the requirements would not pose a problem for those with a good trading history, and it would achieve the goal of excluding those currently in the industry who would not meet probity requirements. Appropriate lead time would be required for government to establish licensing systems and process applications, and for industry participants to apply for a licence. It is not suggested that there be any break in continuity of trading during this time. Should any broker already trading be unable to obtain a licence, it would be possible to make application to a relevant appeal body if they could demonstrate an acceptable trading history Benefits/Advantages For brokers Brokers generally would experience increased public confidence and an opportunity to expand their businesses. There has been a significant amount of negative media coverage in the last two years which may cause consumers to avoid using a broker to access credit. Brokers currently express concerns that their image is being tarnished by unscrupulous operators. Brokers would also not face unfair competition from those elements currently operating who mislead consumers into believing they are offering legitimate services, and who appear to be able to offer what legitimate brokers cannot offer if they are acting honestly. For consumers Consumers could have confidence that brokers do not have an established record of dishonesty. They could check whether a broker was licensed. The risk of being defrauded by a broker would be significantly diminished. Major financial losses may be avoided. For government Government would receive positive community support for screening out fraudulent persons from the industry. A reduction in protracted legal actions against disreputable brokers would result in there being a reduced demand on compliance and enforcement resources. The cost of administering the scheme would be funded by licence fees. For credit providers Credit providers would have increased confidence in using broker services. The background information shows that 24% of cancelled bank/broker relationships are due to fraud. The risk of bad loans would be reduced. Smaller credit providers could enter the market by using broker intermediaries who had undergone probity checks. All credit providers could increase their exposure to consumers Costs/Disadvantages For brokers 69

70 The broker would face the cost of a licence. This may vary from one jurisdiction to another according to the overheads of the agency and the nature and cost of checks performed by that agency. The only agency which currently licenses finance brokers is Western Australia. The cost of a licence is $350, renewable every three years. That fee is not set with any relationship to the costs to the licensing agency, but it is estimated that self funding would not result in higher licence fees. By comparison, the licence fee for financial services advisers is $270 or $230. For consumers If the cost of the licence is reflected in the cost of a service to consumers, this may represent a marginal increase in commissions charged. It is likely that the cost to consumers would be negligible. For government A cost recovery scheme would not impose costs on government. The cost of establishing the scheme could be averaged out over a period of time and included in the licence fee. For credit providers No costs identified. 8.3 Competency of brokers A number of the problems experienced by consumers may result from the brokers lack of appropriate skills or knowledge. Apart from the skills required to run a small business, brokers should be aware of legislative requirements that impact on their operations. Brokers also need to have considerable knowledge of the finance market and of the products that are available as well as the art of communication with a client in order to best assess their needs. While training is currently a requirement in Western Australia, no other jurisdiction requires it. There is a requirement for certain education qualifications for membership of the Mortgage Industry Association of Australia (MIAA), unless the person can demonstrate sufficient practical experience. The Finance Brokers Association of Australia (FBAA) also requires completion of a course or sufficient relevant experience before membership is available. Training is also provided by some of the franchised groups. There is, however, no common standard in either the training or the experience required. Experience alone does not guarantee appropriate skill or knowledge. Brokers who do not have the benefit of an active industry association may be unaware of new developments, both product and regulatory. Therefore, there should be some formalised training, even for people who have been in the industry for a while. Certainly, if new legislation is introduced, knowledge of that legislation plus other legislative requirements such as under the Uniform Consumer Credit Code and state fair trading acts should be a required training component. To date, there has been little in the way of broker-specific training available. Non-specific financial services competency training has been available, and this is currently under review. It will, when completed, have a specific broking component. This is a package developed by the National Finance Industry Training Advisory Board, which in turn is subject to the Australian National Training Authority. Whether this is considered appropriate cannot be determined until the review is finalised in late September The provision of financial product advice, regulated under the Corporations Act 2001, requires advisers to be licensed and for the licensee to ensure that advisers are appropriately trained. The training package referred to above will overlap with finance broking training and it is envisaged that similar requirements to those prescribed for financial 70

71 advisers could also apply to finance brokers, but tailored to the functions of the industry. Again, this is subject to the final form of courses currently being developed, and the fine detail is not yet available. Financial services advisers meet the training standards required by the legislation if they satisfactorily complete approved training course relevant to their activities. Those courses must be assessed by an authorised assessor meeting the relevant requirements for knowledge and skills, if appropriate, and listed on the ASIC training register. Courses on basic deposit products and non-cash payment products do not need to comply with these requirements but can, instead, be assessed by the licensee. As an alternative, advisers with at least 5 years relevant experience over the immediate past 8 years may demonstrate their competence by being individually assessed. Proposed option A scheme which operates similarly to the ASIC scheme outlined above in targeting the required skills, but is flexible with respect to the knowledge and skills of brokers making the transition from the unregulated market to a regulated market, is envisaged as a model for the national finance broking scheme Benefits/Advantages For brokers A skilled broker would be expected to generate significant consumer confidence and the expectation of repeat business. There would be a reduction in complaints by consumers. For consumers There would be an increased likelihood that consumers would be placed in appropriate loans and that the relationship between the consumer and broker would be transacted with due regard to the relevant laws. Consumers could expect to benefit financially from being placed in an appropriate loan. For government There would be fewer complaints about brokers and a reduced impact on resources. For credit providers The quality of loans would be improved. There would be greater consumer satisfaction with the loans they were placed in which would result in a greater retention rate of customers and less use of credit providers internal complaints systems Costs/Disadvantages For brokers There would be a cost to the broker of fees for undertaking the required courses. The Mortgage Industry Association of Australia charges $165 for its Initial Compliance Pack on line, which includes Uniform Consumer Credit Code, Privacy and Compliance essentials. Where loan writers do not have at least two years broking or lending experience they are required to successfully complete the TAFE Certificate III in Mortgage Lending, available on line via MIAA at a cost of $900, subject to some reductions where the broker has completed the MIAA Initial Compliance Pack, or another equivalent course recognised by MIAA. A large number of existing brokers therefore already pay the cost of education. While the new courses would contain more comprehensive education requirements, some reductions would be expected for those who could demonstrate an appropriate level of training. 71

72 For consumers Any cost outlaid by the broker may be passed on to the consumer. This would be minimal. For government None identified For credit providers None identified 8.4 Objectives 2 and 3 Provide consumers with sufficient information to choose a suitable broker Require brokers to demonstrate that their recommendation is appropriate for the consumer s circumstances and, where possible, the best available Problem to be addressed Most consumers currently have no way of assessing the value of any broking service. For example, knowing how many lenders are on the broker s panel, or whether the lending panel comprises mainstream, non-conforming or non-retail credit providers is an important issue in deciding whether a broker is going to access a competitive product. Also, it is important for consumers to know the influences to which the broker is subject and, in fact, whether the broker is likely to be acting in their own interests or the client s. Brokers may currently place consumers in loans which the consumer cannot afford or which are inappropriate for the consumer s needs. Even if the loan is affordable or reasonably appropriate for the consumer, it may not be the best loan which the broker can access for the consumer. Proposed option Require the finance broker to enter into a written contract with a consumer before commencing finance broking and that the contract contain details of the broker s access to credit providers as well as details of the credit required by the consumer. This would mirror a requirement in the NSW Consumer Credit Administration Amendment (Finance Brokers) Act The New South Wales legislative requirements are outlined in Section It is proposed that Part 1A Divisions 2,3 and 4 would be used as a basis for disclosure requirements in the national scheme, but that consumer remedies would be available as detailed in this paper. Other practices which come to light between the time the New South Wales legislation is enacted and the time any national regulatory scheme commences may also need to be addressed. For example, it has been noted that unscrupulous brokers are taking a caveat over any property held by the small business applicant and, knowing the applicant is desperate for the loan, do not find finance assuming that the applicant will go elsewhere. The broker then demands payment to remove the caveat. The practicalities of removing the caveat through an objection to the Land Titles Office and court action usually render this course of action impractical. Practices such as these should be expressly prohibited. There may be other businesses or practices which are structured to avoid regulation, such as advice or mortgage reduction schemes. These should be specifically captured by any definition of intermediary. 72

73 8.4.1 Benefits/ Advantages For finance brokers Requiring the details of the credit required to be set out in the broking contract will assist the broker to gain a picture of the consumer s needs before finance broking commences. This should help to prevent the broker obtaining credit which does not match the consumer s needs. A written contract will also assist brokers to prove that they have met the consumer s requirements in the event of any dispute. For consumers The consumer will be able to judge whether the broker can add value in sourcing a credit product and whether the broker appears to be acting impartially. Requiring the details of the credit required to be set out in the broking contract will encourage the consumer to apply their minds to the issue of the type of credit sought before finance broking commences. This should help to prevent the problem of brokers securing credit which does not match the consumer s needs, and the requirement for a written contract is important in the event of any dispute about the consumer s stated needs. The inclusion in the broking contract of the maximum periodic repayment that the consumer is prepared to pay should help to prevent consumers entering into loans which they cannot afford. Expressing the amount the consumer can afford to pay in terms of the periodic repayment amount as well as the maximum interest rate or fees and charges should give a consumer a realistic idea of the cost of the loan, as looking at the interest rate or fees and charges alone does not give an idea of the dollar amount involved. The repayment amount is the consumer s main yardstick of affordability for credit purchases, but without other specifications such as the term of the loan or type of credit provided, this can be manipulated. For credit providers Fewer consumers being placed in loans which do not meet their needs should result in fewer consumers being dissatisfied with their credit product and deciding to refinance. For government Fewer consumers being placed in credit contracts which do not match their needs should result in fewer complaints to Government and fewer cases being brought to courts and tribunals Costs/ Disadvantages For finance brokers Preparing computer systems to accommodate the requirements for a contract would require some initial outlay but this would be minimal when averaged over a number of years. Including the information on the consumer s credit requirements in the broking contract would involve some work for the finance broker but this should be part of their normal broking practice in determining the client s needs. For consumers While specifying the type of credit required in the broking contract is likely to assist many consumers to obtain credit which meets their needs, it will not necessarily always ensure that a consumer is placed in the best loan which the broker can access for the consumer, or even an appropriate loan. 73

74 There are several reasons for this: Firstly, the consumer may sign a broking contract in which the credit specifications are not affordable or appropriate for the consumer. This may be because the broker has persuaded the consumer to obtain credit which is unaffordable or inappropriate. Some brokers have a tendency to inappropriately recommend interest only loans. This can mean that, although the consumer can afford the regular repayments, they will not be able to afford to pay off the principal at the end of the loan term. Lines of credit have become increasingly popular with brokers, especially those marketing debt reduction schemes. The increased level of promotion of lines of credit is indicated by ASIC s recent action in removing calculators providing simulations between a standard loan and a line of credit from 100 websites. Requiring a loan to match the contract specifications requires only that. If a number of loans match the specifications there is no requirement that the broker recommend the best or most suitable of these loans, whether in terms of price or other features. In the case of refinancing, matching the contract specifications does not require a comparison of whether the consumer will be better off entering into the new loan than remaining with their existing loan. Termination fees can be considerable, sometimes amounting to two or three months additional repayments. For credit providers For the reasons outlined above, the requirement to specify the details of the credit required in the broking contract will help many consumers but will not always ensure that a consumer is satisfied with their loan, nor prevent default on a loan or refinancing to another loan. For government The requirement to specify the credit details in the broking contract will not always ensure that a consumer is satisfied with their loan. Vulnerable consumers may still complain to Government and bring cases to courts and tribunals. Additional proposals to address these limitations Require the finance broker to enter into a written contract as outlined above and provide the consumer with a statement of reasons setting out why the credit product recommended by the broker is the most appropriate product for the consumer s circumstances. The statement of reasons could be required to address how the credit product recommended by the broker meets the specifications in the finance broking contract and why the particular features of the loan make it the most appropriate product for the consumer s circumstances. If cheaper finance is available the statement of reasons could explain why this has not been recommended. If the broker recommends that the consumer refinance an existing credit facility, the statement of reasons could also address: why the new product is more beneficial for the consumer than the existing product; any charges the borrower will or may incur in relation to the disposal of the existing product; any charges the borrower will or may incur in relation to the acquisition of the recommended product; any pecuniary or other benefits the borrower will or may lose (temporarily or otherwise) as a result of taking the recommended action; any other significant consequences for the borrower of taking the recommended action; where a change in credit product is recommended because of features other than price, whether or not those features are available under the borrower s existing credit contract (and at what cost). 74

75 Where the capacity of the borrower to make repayments greater than the borrower s existing repayments is relevant to the recommendation, the statement of reasons should contain: a statement of what the repayments will be, and a comparison of the savings which would be achieved with the borrower s existing credit facility, if the consumer were to make the increased repayments to that facility. Where the broker recommends that the consumer refinance to a line of credit facility, the statement of reasons should address why the consumer requires the extra credit provided by this facility, and what the repayments would be if the borrower draws down the full amount of credit available. Where the broker recommends an interest-only loan, the statement of reasons should clearly state why this is better for the consumer than a principal and interest loan, and how the broker and consumer have agreed that the consumer will pay off the principal when it is due Benefits/ Advantages For finance brokers Providing a statement of reasons would help the broker to clearly articulate to a consumer why a particular loan is the most suitable loan for the consumer s circumstances. For consumers A statement of reasons would help to clarify to a consumer exactly how a particular loan will meet their needs. Where the broker provides a number of choices, a statement of reasons would help the consumer to decide which loan is the best available loan for their circumstances, rather than simply one of a number of loans which fits the criteria specified in the broking contract. Requiring a broker to justify a refinancing recommendation by explaining why the recommended loan is superior and what costs the consumer will incur in switching loans should help a consumer to decide whether they will gain by refinancing. Where refinancing recommendations are based on the consumer needing to make larger repayments, providing the consumer with an analysis of the savings which would be achieved if these repayments were applied to their existing loan will give the consumer a clear picture of whether refinancing will actually provide any benefits. Explaining why an interest-only loan is beneficial for the consumer and how the consumer will pay off the principal should alert the consumer to the potential problems with such loans. For credit providers A statement of reasons such as that proposed would help consumers to find the best loan for their circumstances, and should reduce the number of consumers who are unhappy with their loans and either default or refinance. For government A statement of reasons would help consumers to find the best loan for their circumstances, and should reduce the number of consumers who complain to Government or bring cases to courts or tribunals. 75

76 8.4.4 Costs/Disadvantages For finance brokers Providing a detailed statement of reasons will involve extra time and paperwork for brokers but could be considered to be a normal part of a broker s role. One industry association considers that this would amount to less than one hour s work. For consumers While a broker can provide in a statement of reasons a number of arguments why a loan is the most suitable one for a consumer, this will not always ensure that the loan is actually the best one for the consumer. There may be another loan which the broker has failed to mention which would be better for the consumer. A statement of reasons also does not necessarily ensure that the recommended loan is even appropriate for the consumer, if the consumer has signed a broking contract with credit specifications which are not actually suitable for the consumer s needs. For government While a statement of reasons should increase the number of consumers who are satisfied with their loans, it will not ensure that all consumers are placed in optimal or even appropriate loans. These consumers may still complain to Government and bring cases to courts and tribunals. For credit providers While a statement of reasons should increase the number of consumers who are happy with their loans, it will not ensure that all consumers are placed in optimal or even appropriate loans. These consumers may still default or refinance. Additional proposal Require brokers to enter into a written contract, provide a statement of reasons and have a reasonable basis for recommending or obtaining a particular loan for a consumer. This requirement would go beyond the statement of reasons by requiring a loan to actually be suitable for a consumer rather than just requiring the broker to present arguments why the loan is suitable. A third party can usually only judge whether a broker s recommendations are reasonable and a legislative requirement, which will be assessed by an independent third party, should not go beyond requiring reasonable recommendations. The reasonableness of a broker s recommendations can only be judged in the context of the information to which the broker has access in making those recommendations. It would be unfair to judge a broker for not taking into account information of which the broker was unaware. In order to provide a consumer with useful advice about credit products, a finance broker should collect information about the consumer s income, assets, liabilities, expenditure patterns and the purpose for which the consumer needs the credit. It is not proposed that a legislative requirement of reasonableness should attempt to give a general definition of when a recommendation will be reasonable, as this will vary according to the circumstances of each case. However, given that recommending a loan which is unaffordable for a consumer will never be reasonable, it is proposed that the legislation should state that a reasonable recommendation will need to take into account, among other things, whether a consumer can afford to repay the loan without substantial hardship. 76

77 The ASIC guide PS175 provides useful guidance for financial product advisers on what is appropriate advice in respect of financial products. The relevant sections of that document could be adapted for use by finance brokers in assisting their understanding of reasonableness Benefits/Advantages For finance brokers Requiring a broker to have a reasonable basis for recommending or obtaining a credit product will improve consumer confidence in the broking industry and encourage industry growth. For consumers A requirement that the broker have a reasonable basis for their recommendations should help to prevent consumers being placed in unaffordable or inappropriate loans. This requirement would greatly improve on the requirement that a broker provide a statement of reasons, as the statement of reasons, although it may help many consumers, will not necessarily prevent a consumer being placed in a loan which is actually inappropriate and/or unaffordable. For government The requirement should help to reduce the number of complaints to Government and cases being brought to courts and tribunals. Should these statements initially not be satisfactory, and be challenged by consumers, this is a matter that could be dealt with by an alternative dispute resolution scheme. For credit providers This requirement should help to reduce the number of consumers defaulting on their loans and/or refinancing Costs/ Disadvantages For finance brokers For those providing a genuine statement of reasons, the requirement that the product be appropriate would not impose any additional cost. The requirement will require the finance broker to carefully consider the recommendations they make to a consumer, but this should be part of the finance broker s usual function. For those who may try to work back from their choice of product to justify it when in fact it is not appropriate, the requirement that the product be appropriate may result in action by the consumer to remedy the situation. For consumers Brokers may be reluctant to recommend or obtain loans which the broker considers to be unsuitable. However, while a consumer may not like this, it is clearly beneficial for a consumer to be aware that a loan may not be appropriate for their circumstances. For government Should any alternative dispute resolution scheme not be able to satisfy the consumer in its decisions, deciding whether a broker has a reasonable basis for recommending or obtaining a loan may be a more time consuming task for a court, or tribunal than simply checking whether a loan matches the specifications in the broking contract or whether the broker has prepared an adequate statement of reasons. However this is likely to be balanced against the fact that fewer cases are likely to be brought to courts and tribunals. 77

78 For credit providers Brokers may submit fewer inappropriate loan applications to credit providers. However, credit providers should not be approving loans which consumers cannot afford or are not suited to the consumer s needs, and granting fewer loans which are otherwise unsuitable should lead to fewer defaults and refinances. 8.5 Objective 4 Provide a means of empowering consumers to influence broker behaviour by providing consumers with effective remedies against brokers who do not act fairly or competently. Problem to be addressed As discussed elsewhere in this paper, the inaccessibility of consumer remedies is seen as a contributing factor to market failure in respect of this industry, with the result that there is no effective incentive for brokers to behave ethically and provide a quality service. As well, consumers accessing credit which falls within the scope of the Consumer Credit Code may be denied access to remedies in respect of the credit contract by virtue of using a broker intermediary. This is because the broker is not an employee of the credit provider, nor in many cases an agent of the credit provider, and in the absence of such a link the Code can not be accessed for any remedy that may have been available if the consumer went directly to the credit provider. Possible responses While some remedies in respect of broker conduct may be available under the Consumer Credit Code, that legislation does not attempt to deal with all broker practices. Indeed, there was a very small broking industry when the Code was developed. In any event, the proposed regulatory scheme would cover broking activities which are not within the jurisdiction of the Code. It would not seem appropriate for clients who access consumer credit through brokers operating under a comprehensive regulatory scheme to have to go to the Consumer Credit Code for those remedies that may be available in respect of broker behaviour, nor to have less protection with respect to the credit contract itself than consumers who obtain credit directly from the credit provider. This in itself could encourage unfair practices by credit providers. Broker specific legislation should therefore: ensure that consumers are not disadvantaged with respect to remedies available under the Consumer Credit Code by accessing consumer credit through a broker rather than directly from a credit provider; provide remedies with respect to broker behaviour. Since any broker legislation would not attempt to establish agency, any remedies should not affect the credit contract itself, except in very limited circumstances. Where both broker and credit provider are involved in any unfair conduct, there should be an opportunity for the parties to be joined, or for one to be able to claim compensation from the other, if appropriate. The need for remedies appears to stem from the following main sources of broker misconduct: failure to enter into a finance broking contract; breaching the requirements of the finance broking contract; failure to provide a statement of reasons; recommendation of an inappropriate product; accessing credit not covered by the Consumer Credit Code (by misuse of the business purpose declaration); falsifying consumer details in order to obtain credit; misrepresenting the nature, cost or details of the credit to the consumer. 78

79 Proposals to deal with such conduct as well as for contraventions of the administrative scheme are set out below. Proposed option Offences (criminal or monetary penalties consistent with the severity of the offence) would be created where certain requirements are contravened; Compensation would be available to consumers where the contraventions result in consumer detriment. The broker would be required to compensate the consumer for any loss suffered from the broker s actions, including loss resulting from not having the protection of the Code. There could be a requirement for any dispute resolution scheme to consider: costs involved in entering the credit contract fees/commissions paid by the consumer to the broker or any other party price of the product compared to an appropriate product cost of refinancing to an appropriate loan value of any other loss suffered by the debtor as a result of being denied the remedies under the Code In the event of consumer detriment a broker would not be entitled to be paid by the consumer for any broking services; Administrative sanctions would be provided for breach of any licensing/registration requirements. Remedies exist in some jurisdictions in relation to excessive commissions. Remedies should also be provided in any national broking legislation. While it is not intended to mandate the level of fees, consideration could be given to referring to a standard, or accepted level of fees in the legislation or regulations in the same way that the Commonwealth Bank standard variable interest rate is used as a benchmark for various purposes in the credit industry. This would provide some guidance to consumers and brokers, and may assist in reducing the incidence of fees being charged that are significantly higher than industry standards (for example, fees of 20% or more of the amount borrowed as identified in some of the case studies in the ASIC broker report) Benefits/Advantages For finance brokers Remedies which impact on a broker would be likely to discourage disreputable traders from entering the market and encourage the use of broker services by both credit providers and consumers. Public perception of brokers would be improved. For consumers Consumers would have greater confidence in using a broker service. They would not be financially disadvantaged by using a broker service instead of a credit provider and they would be compensated for any loss resulting from non-compliance with broking legislation. Fair competition could reduce the cost of broker services. For government Government would have fewer complaints from consumers about broker conduct. Fewer compliance resources would be expended on broker misconduct. There would be less public criticism about the lack of government action. For credit providers 79

80 Remedies which are attached to broker conduct would weed out dishonest brokers. This would give credit providers confidence in using brokers as a means of reaching a wider market. This could encourage smaller lenders to enter the market Costs/Disadvantages For brokers Those brokers unable or unwilling to provide the quality of service required by the legislation may be required to make significant payments of compensation to consumers as well as penalties if offences are committed. For consumers None identified. For Government Cost of administrative sanctions and disciplinary procedures. However, these are likely to be offset by a reduction in court action currently undertaken against rogue brokers. For credit providers Possible cost of reviewing arrangements with brokers who are found to be in contravention of broking legislation. However, this is already done by lenders in respect of fraudulent brokers, and it is likely that these numbers would be reduced. 8.6 Stay of enforcement proceedings Problem to be addressed Section 86 of the Consumer Credit Code permits a consumer who has been given a default notice or a demand for payment, to negotiate with the credit provider a postponement of the enforcement proceedings. If the consumer is unable to negotiate such a stay, application may be made to the Court for a postponement. In such cases, the Court would consider whether to grant the postponement on the merits of the case, which would include the capacity of the debtor to put the contract back on foot. One of the effects of obtaining credit through a broker has been that some broker clients have lost their homes through inappropriate loans that they have agreed to on the broker s recommendation without a clear understanding of the financial consequences. Credit providers may not negotiate a stay if they can not see that a debtor s circumstances will change in the forseeable future. The Court is also unlikely to order a stay on the same basis. Proposals outlined above in respect of remedies (section 8.5) require a court or ADR scheme to consider certain factors in assessing any damages. Where a consumer has a claim against a broker that may result in damages or compensation that could allow the home to be saved, the consumer should be permitted to apply to a court for a stay of proceedings and the legislation should require the court to take certain matters into consideration. The Court currently has powers to grant injunctive relief in appropriate cases, however, in the past courts have been extremely conservative in their assessment of damages and in their application of contract law. While the Court will necessarily have discretion to consider the circumstances of each case, the quantum of damages will also be guided by the legislation, as set out in the Remedies section of this paper. 80

81 Proposed option Where a consumer has a claim against a broker for compensation or damages (whether in the court or under an ADR scheme) which is in respect of conduct by the broker that the consumer claims has caused the mortgagee to embark on the forced sale of their home, the Court may order a stay of enforcement proceedings. In determining whether a stay is appropriate, the Court will have regard to: whether the home is the primary residence of the debtor; whether it is likely that the home could be saved if a stay is granted; whether the case against the broker is likely to result in damages which could be applied to reduce the amount of the loan due to the credit provider to such extent that the debtor could afford to make repayments; and whether the consumer can make a reasonable repayment arrangement during the hearing of the dispute The Court will have a power to compel documents and other evidence to be produced by the broker and credit provider The Court will have power to compel the credit provider to participate in any negotiations Any ADR scheme must also have the scope to deal with such matters, depending on the circumstances of the case and the Rules of the ADR scheme. The Court will have power to direct that damages due from the broker be paid to the credit provider to reduce the outstanding balance, if this will make the contract viable. The right to apply to the Court for a stay under broking legislation would be a more sophisticated and developed version of the borrower s right to apply for a stay under the Consumer Credit Code, since the rights under the Code are very limited. While there are some novel aspects to this right (including joinder of the broker as a third party, and referral to the ADR scheme as a mediator) this approach is broadly consistent with current approaches to the use of mediation to resolve court proceedings. For example, in NSW Part 7B of the Supreme Court Rules gives the Supreme Court discretion to refer a matter to a mediator irrespective of the consent of the parties. If necessary, the broker legislation would recognise ADR schemes as appropriate vehicles to mediate in these types of disputes. Note: While the term consumer is used, it should be noted that it is not proposed that any distinction be drawn between a consumer loan or any other loan to which the broking legislation will apply. The stay of enforcement provisions will, therefore, apply equally to small business loans for which a mortgage is taken over the debtor s home as security Benefits/Advantages For finance brokers Minimal, except that some complaints may be resolved more quickly (due to pressure of court action) than would otherwise be the case. For consumers Enhanced opportunity, in appropriate cases, to retain possession of real property. For government Reduction in the number of evictions, and consequent claims by borrowers on government services. Greater accountability of brokers for poor or misleading advice (as once property is sold borrowers are less likely to complain). Reduced demand on court services due to capacity to refer cases for mediation through the ADR schemes. For credit providers Reduction in the number of evictions, and greater accountability of brokers. 81

82 8.6.2 Costs/Disadvantages For finance brokers May become involved in court/mediation actions (although impact may be minor given that intention is for these matters to be resolved quickly). For consumers Small increase in amount owing to credit provider where stay does not prevent sale of property. For governments None identified. For credit providers While credit providers are likely to claim this as a cost, it is noted that the circumstances in which the criteria for a stay will be met are very limited and should not give credit providers any grounds for concern, given that the debt will still be secured over real property, and the court can, in appropriate cases, require the borrower to maintain repayments when ordering the stay. If the other parts of the legislative proposal, such as entry requirements, broker/client contracts, statements of reasons etc are implemented, the number of applications for a stay should be so few as to have no impact on the credit industry. 8.7 Compensation for consumers Even if a consumer obtains an order requiring the broker to pay the consumer a sum of money, the broker may not have enough money to pay the consumer. Possible responses This could be dealt with in two ways, which are: requiring a broker to hold professional indemnity insurance; or requiring that the broker contribute to a fidelity fund administered by the Government or an independent body. The latter possibility is thought to possibly discriminate against smaller brokers and is not a proposal at this time. Require broker to hold professional indemnity insurance Many finance and mortgage brokers currently hold some sort of professional indemnity insurance. Members of the Mortgage Industry Association of Australia and the Finance Brokers Association of Australia are required to hold professional indemnity insurance as a condition of membership. Affordable professional indemnity insurance is becoming easier for brokers to obtain, as insurers are being educated about the risks involved in insuring brokers and are lowering premiums as a result. There are currently about six underwriters offering PI insurance for brokers and for one-person brokers a PI insurance policy currently costs around $800 p.a. The following can be said about the usual scope of PI insurance policies in the finance broking industry: Generally policies will cover negligent activity in the ordinary course of conducting a broking business. The cover will usually apply even if the liability arises under contract, the Trade Practices Act, or the ASIC Act, but only if the claim would have been successful if made in negligence. If the damages assessed under a claim for breach of 82

83 contract, trade practices or fair trading legislation are larger than the damages that would be payable under a claim for negligence, the policy will normally only pay out the lower amount that would have been paid if the claim was for negligence. Some policies have specific extensions for trade practices/fair trading liability, but that is not a standard feature. There is no cover for acts, errors or omissions by the insured themselves that are done with the intention of causing a third party loss, damage or injury, or with reckless disregard for the consequences. These include fraud, forgery or dishonesty. However some policies cover dishonest, fraudulent, criminal or malicious acts or omissions by an employee of the insured, but not a sub-contractor. A broker would not ordinarily be liable for the dishonest acts of subcontractors, but often aggregators are made liable for the dishonest acts of their sub-originators pursuant to the head origination agreement. There is a dollar limit on the amount of cover. The policy will usually specify the limit of cover that applies for any one claim and the limit that applies to the total of claims made during the policy period. Other limits on cover might include a limit on legal costs (though this is rare), investigation costs, and specified risks (for example advising in relation to interest rates). Most policies are claims made policies (which means that claims are covered by the policy in place at the time the claim is made, and will not be covered if there is no policy in place at that time). These policies usually provide that a broker will not be covered for claims which were known about when the policy was taken out. Therefore if the cover is allowed to lapse, the broker will not be covered for any claims made during the period of the lapse. Proposed option In order to ensure that compulsory PI insurance provides consumers with the maximum possible protection, it is proposed that brokers be required to hold professional indemnity insurance which: Covers risks which arise from the work which the broker actually undertakes, regardless of what name the broker gives to that work. For example, a broker may call him or herself a mortgage broker, but actually undertake the functions of a mortgage manager. Unless the policy takes account of the nature of the work the broker undertakes, the broker may not be insured for liabilities incurred in the course of that work. Covers conduct which can result in a claim for breach of contract and/or breach of the Trade Practices Act, the ASIC Act or fair trading legislation, where such a claim could also be made in negligence. Provides continuous coverage for consumers. This means that the broker must be required to maintain continuous cover, with no gaps. If the policy is a claims made policy, the broker must also be required to maintain run-off cover for a suitable period after the broker ceases to trade (probably at least 6 years). Provides for a monetary limit for claims of not less than $1 million. Is provided by an insurer that is APRA regulated, and has a Standard and Poors rating of A or higher. Covers decisions of any accredited alternative dispute resolution scheme to which brokers are required to belong. In view of the volatile nature of the insurance market, the requirement to hold professional indemnity insurance could be located somewhere other than in legislation (for example, in a regulation) so that it could be removed quickly if such insurance suddenly ceased to be available Benefits/Advantages For finance brokers 83

84 Costs of claims are spread out over time (through payment of PI premiums) rather than being required to be met through a lump sum payment. For consumers The major benefit of PI insurance for consumers is the assurance of being paid any money owed to the consumer as a result of negligence, breach of contract or breach of fair trading or trade practices legislation by the broker. For credit providers Limited impact given that some credit providers already require brokers to hold PI cover in order to obtain accreditation for that lender. For Government Assists in effective running of ADR scheme as a means of providing compensation to borrowers. PI insurers who refuse to offer cover to brokers on the grounds of poor business practices assist in excluding marginal players from the marketplace Costs/ Disadvantages For finance brokers While it is arguable that the requirement to hold satisfactory PI insurance cover may be a barrier to entry to the industry this would not appear to be the case in practice, given that the cost of PI cover appears to be falling, and that this requirement already exists informally (given that some PI insurance is required by the MIAA as a condition of membership, and that it is also required by some lenders in order for the broker to obtain accreditation from that lender). For consumers In some instances the cost of PI insurance may be recouped through increased costs passed onto the consumer. However, this would be limited for two reasons. First, many brokers already have PI cover. Secondly, where the broker s income is derived from the commission paid by the lender, any increase in commission will depend on the broker-lender relationship and not the cost of PI cover. For credit providers None identified. For Government None identified 8.8 Access to affordable remedies The capacity to access effective remedies is essential in ensuring that a market functions efficiently. Industry has no incentive to provide a reputable service if consumers are unable to enforce their rights. The cost of legal action is prohibitive given that disputes are frequently in respect of relatively small amounts of money. In any event, for many of the most vulnerable consumers the prospect of approaching a court or tribunal is a daunting one. Broker clients must be able to access remedies that are cost efficient and, in this way, influence the way that brokers perform their functions. If consumers are able to compare between brokers who are trading efficiently and fairly, the market will operate more efficiently. 84

85 Proposed option Alternative dispute resolution schemes would appear to be the most cost efficient way of ensuring affordable access to remedies and enforcement. However, consistent application of such schemes across all industry members would be necessary in order to be effective. Licensing or registration is necessary in order to impose a requirement for membership of a scheme which fulfils this need, but that does not require membership of an industry body in order that a consumer has access to remedies. The financial services industry has established a number of reputable alternative dispute resolutions systems which provide affordable and independent dispute resolution that consumers find easier to deal with than court or tribunal systems. Any ADR scheme should have a wide scope to deal with complaints in order that the need for legal action be avoided wherever possible. Proposed option That brokers be required to be a member of an ADR scheme approved by ASIC. This could operate in a relatively straightforward way, and would have a number of advantages. This approach would take advantage of the already existing ASIC standards for ADR schemes in the finance sector. Membership of an ASIC approved scheme is now compulsory under the FSRA regime. These standards are rigorous and well-understood in the financial services industry and consumer bodies, as they have been the subject of extensive consultation with stakeholders. Requiring membership of an ASIC approved scheme would ensure consistency in the way that ADR schemes work across the finance sector, as nearly all other financial services providers are subject to this requirement. ASIC already has experience and resources to assess and monitor ADR schemes (thereby avoiding a duplication of resources in other agencies). It is worth noting that the Credit Ombudsman Service Limited and the other scheme covering this area, the FSBO (formerly ABIO), are already approved by ASIC. It is highly likely that there will only be these two schemes in this sector. ASIC has developed expertise in evaluating ADR schemes, and issued detailed public guidelines setting out how it assesses a scheme against six key benchmarks: accessibility, independence, fairness, accountability, efficiency and effectiveness. The guidelines are set out in Policy Statement 139 Approval of external complaints resolution schemes (issued on 8 July 1999) and Policy Statement 165 Licensing: Internal and external dispute resolution (issued on 28 Nov 2001). While ASIC involvement has the advantages outlined above, it may be prudent to include in any regulatory scheme a power to prescribe an acceptable ADR scheme by regulation. There may be circumstances where ASIC is unable, for reasons not currently forseen, to approve schemes which might be acceptable in certain circumstances. This regulatory power should be included in any national broking legislation as a failsafe mechanism. Operation of ADR schemes ADR schemes operate in accordance with Membership Rules. As part of the approval process ASIC reviews these Rules and tests them against the six benchmarks and the guidelines in Policy Statements 139 and 165. Where necessary, ASIC will recommend changes to the Rules before approving the scheme. All schemes so far approved in the 85

86 finance sector have had to make significant improvements to their structure and operations to meet approval standards. The Rules determine what types of complaints the scheme can hear, and what complaints are outside its jurisdiction. It is usual for ADR schemes to exclude some types of complaints: complaints above a specified monetary limit; complaints relating to conduct beyond a specified time limit; complaints that have not been through a member's internal complaints handling procedure; and complaints relating to particular matters of commercial judgement (usually limited to particular areas eg insurance underwriting decisions). Schemes approved by ASIC usually have the following features: the ADR scheme is responsible for enforcement of payment of successful claims (including through the threat of loss of membership and consequent loss of licence). the ADR scheme acts as a source of market information in that it is required to report complaints statistics and trends on a quarterly basis, and also instances of serious misconduct and systemic problems. These reports could, in the case of mortgage brokers, be distributed via ASIC to state and territory agencies or directly to state and territory agencies. the ADR scheme acts as an informal method of improving industry standards through providing feedback to members, attending conferences and issuing practice notes addressing common issues. Mechanism for ensuring membership The introduction of a licensing or registration mechanism would be the most obvious and straightforward "hook" for ensuring compliance with this requirement. In ASIC's experience compulsory membership cannot be achieved through industry bodies as they do not have universal coverage. This is especially the case in industries with a large number of smaller players. An advantage of this approach is that it means the ADR schemes in effect have a tool to help enforce compliance, in that failure to comply with a scheme decision will mean that membership is terminated (subject to an appropriate process). This then becomes a relatively straightforward breach of the licence or registration condition that the government agency can then enforce. The alternative to a licensing/simple registration mechanism is a "stand alone" legislative provision stipulating that brokers are required to be members of an ADR scheme. However, the disadvantages of this approach are that enforcement of this requirement is likely to be more resource-intensive than through taking action for removal or suspension of a licence. Requirement for an internal dispute resolution procedure The usual method of operation of ADR schemes is that they require members to pay a fee for each complaint. One of the implicit consequences of this approach is that it creates a financial incentive for brokers to develop or improve their internal dispute resolution or complaints handling procedures. Consideration could be given to making this requirement explicit by creating a specific statutory obligation that the member have in place internal dispute resolution procedures that comply with appropriate standards. Interaction with other ADR schemes It can be anticipated that any broker-specific scheme will develop informal referral mechanisms with other ADR schemes, particularly those in relation to credit providers (such as the FSBO and the credit union schemes). These links may assist, in appropriate cases, in the credit provider agreeing to a stay of any court action until the broker-specific ADR 86

87 scheme has made a determination in relation to a complaint. This may only assist borrowers with credit facilities through banks and credit unions. It should be noted also that any decision under an ADR scheme would generally bind only the industry member and not the broker client, who would be free to refuse to accept the scheme s ruling and take action through the court or tribunal system Benefits/advantages For brokers The ADR scheme(s) effectively imposes a form of discipline on the industry by ensuring that firms meet certain standards in dealing with customers, resulting in greater consumer confidence in the industry. For consumers Consumers can have their complaints handled in a fair, efficient and low cost manner. For government ADR schemes have an informal role in supervising the industry in two ways. They can help identify systemic trends or problems that can then be addressed by industry, regulators and/or governments, and they are also likely to be a point through which brokers who are not members of the ADR scheme will be identified. For credit providers Issues that affect the consumer s repayment capacity can be resolved more quickly Costs/Disadvantages For brokers The costs are primarily borne by industry rather than regulatory authorities. Indicative costs are available from schemes already operating. The Financial Services and Banking Ombudsman annual membership fees are $550 for two writers, plus $275 for each additional writer, up to $5,500. Additional fees are charged on the basis of complaints received. The Credit Ombudsman Service Limited (formerly Mortgage Industry Obudsman Scheme) have a membership fee scale which is graded according to the number of writers ranging from $165. Fees are also charged for individual complaints. Cost comparisons may be made with the Financial Industry Complaints Service (FICS), an ADR scheme for financial planners. Where there are less than 50 advisers, a minimum fee of $550 is charged. With larger organisations where there are more than 400 advisers, there is a maximum fee of $10,740. Insurance Brokers Disputes Ltd charges $400 plus $60 per broker per annum. For consumers None identified. For government None identified. 87

88 For credit providers None identified. 88

89 9 Impact on Competition The proposals outlined above are considered to have a positive impact on competition. Although some traders would be prevented by the probity checks of any licensing regime from entering the market, these are traders who would be unlikely to compete fairly with brokers who offer a legitimate service. The only reasons that prospective market entrants might be deterred, other than being unable to pass the probity checks, are the costs that might be associated with licensing or registration fees, gaining educational requirements and professional indemnity insurance. While these may amount to $2-3,000, depending on the cost of educational requirements, this is a relatively small outlay for any small business to make, and would not be inconsistent with entering any other similar occupation. Again, the only potential traders this is likely to deter are those who are not committed to a bona fide business. Similarly, the costs involved in providing contractual documentation and the time required to provide the statutory disclosures and the statement of reasons are costs that may be considered to be normal costs associated with a business enterprise for which fees are charged. Commissions paid to the industry from credit providers are quite substantial and brokers are not precluded in these proposals from charging the consumer. Cost should not therefore be a barrier to entry to the market. The proposals are intended to enhance competition in the industry by redressing the imbalance in power and information between consumers and brokers. The information required to be provided in the finance broking contract will assist consumers to choose a broker who can provide access to the sort of credit they need and at a price they can afford. Educational requirements should encourage greater efficiency of the broking service and increase the possibility of the broker accessing an appropriate and affordable credit product. This should have a positive impact on market efficiency. The requirements for membership of an ADR scheme, as well as appropriate redress provisions, will allow consumers to enforce their rights in a cost efficient manner, thereby proving an incentive to brokers to act lawfully and efficiently. Professional indemnity insurance should ensure that compensation is available to the consumer. 89

90 10 Consultation In developing these regulatory proposals, preliminary papers were circulated for comment to the following organisations: Mortgage Industry Association of Australia Finance Brokers Association of Australia Gadens Lawyers (legal advisers to MIAA) Australian Bankers Association Credit Unions Services Corporation (Australia) Limited Australian Finance Conference Australian Association of Permanent Building Societies Consumer Credit Legal Centre Inc Proposals for further consultation This Regulatory Impact Statement will be made widely available from government websites and through mailout on request. It is intended that its availability will be advertised in national newspapers. The paper will be sent directly to those organisations listed above, and to those who have expressed interest. Comments are invited on any aspect of the paper. Details of costs to the industry of any proposed option are sought, as well as comment on any assumptions made in the paper. Submissions may be sent electronically or in hard copy. Enquiries to: Lucas Kolenberg (02) The address for submissions is: Submissions by post should be sent to: National Finance Broking Regulation 2004 Policy & Strategy Division Office of Fair Trading PO Box 972 PARRAMATTA NSW 2124 Final date for submissions: 15 February

91 Attachment A United Kingdom In the United Kingdom, it is estimated that brokers are responsible for approximately 60% of mortgages. 50 In order to have lenders accept applications, brokers usually have to be registered with the Mortgage Code Compliance Board; in 2000, there were 10,470 broker firms, representing 43,569 mortgage advisers. The main industry body for the mortgage lending industry is the Council of Mortgage Lenders (CML). It has 145 members who provide over 98% of the first mortgages on residential property in the United Kingdom. The CML also sponsors a voluntary Mortgage Code that covers the activities of both lenders and mortgage intermediaries. Generally, lenders who subscribe to the Code do not accept business from brokers who have not also agreed to adopt the Code. The Code obliges brokers to: disclose their status with respect to the lender and the borrower; disclose at the outset whether they receive a fee for arranging the client s mortgage; provide clients with fair terms and conditions, setting these out clearly and in plain language; have internal procedures for handling complaints fairly and speedily; and be a member of an alternative dispute resolution scheme (typically the Mortgage Code Arbitration Scheme). Government regulation of broker activities in the United Kingdom currently takes place through the Consumer Credit Act 1974, the Office of Fair Trading Guidelines for Non-Status Lenders and Brokers, and precedents under the Unfair Contract Terms Regulations The Consumer Credit Act 1974 encompasses all forms of consumer credit and hire purchase and prohibits false or misleading advertising. The Non-Status Lending Guidelines for Lenders and Brokers is a series of guidelines issued by the Office of Fair Trading (OFT). They are specifically directed at enhancing the protection provided to consumers whose credit rating made it difficult for them to obtain finance. The guidelines apply to both lenders and brokers and provide that: there should be transparency in all dealings with potential and actual borrowers, with full and early disclosure and explanation of all contract terms and conditions, and all fees and charges payable; contract terms and conditions should be fair, and should be written in plain English to ensure that borrowers understand the nature of the loan agreement and their rights and responsibilities; there should be no high pressure selling, and adequate time should be allowed for the borrower to reflect on the terms and conditions of the loan and to obtain independent advice before signing; advertising and other promotional material should not mislead, and there should be no cold-calling or canvassing of trade premises without the borrower s prior consent; brokers should disclose at the outset their status with regard to the borrower and the lender, the extent of the service offered to the borrower, together with any brokerage fee or commission payable by the lender; 50 See See also Jason Clout, Mortgage broking looks set to expand, The Australian Financial Review, 12 April 2002, p

92 lenders should take all reasonable steps to ensure that brokers and other intermediaries regularly marketing their products do not engage in unfair business practices, or act unlawfully, and that they serve the best interests of the borrower; and there should be responsible lending, with all underwriting decisions subject to a proper assessment of the borrower s ability to repay. However, from mid-2004, the Financial Services Authority (FSA) 51 will be responsible for regulating mortgage lending, and brokers to the extent that they arrange mortgage loans. 52 This change has been triggered by the need for the UK to meet standards set by the European Union. To avoid dual regulation, mortgages entered into after the FSA assumes responsibility for mortgage lending will be carved out of the jurisdiction of the Consumer Credit Act 1974 and will be regulated solely by the FSA. The FSA proposals include: brokers will either be licensed by the FSA directly, or authorised to operate by an entity that is itself licensed by the FSA; brokers must advise borrowers whether or not they are acting on an execution only basis, or providing advice, and, if the latter, provide details of the number of lenders and credit products reviewed prior to making the recommendation; the broker must assess whether or not a loan secured by mortgage is appropriate for the borrower, and, if so, further consider what type of loan is suitable and which product best meets the consumer s needs and financial circumstances; a higher level of regulation applies to mortgages identified as inherently more risky for the borrower (such as equity release mortgages for older borrowers); and brokers will be subject to the compulsory jurisdiction of the Financial Services Ombudsman (the complaint scheme for financial services in the UK). They will also be required to meet internal complaint-handling benchmarks. European Union In the European Union, brokers (or credit intermediaries ) are subject to limited regulation by European Union (EU) legislation under Consumer Credit Directive 87/120/EEC. 53 The legislation has recently been redrafted with brokers now subject to the following obligations: brokers must be registered within each Member State in which they operate; brokers must offer or arrange the most appropriate type of credit, taking into account the financial situation of the consumer, the advantages and disadvantages of the recommended product, and the purpose of the credit; brokers must indicate, in advertising and documents provided to clients, whether or not they work exclusively with a limited number of lenders, or whether they operate independently; and brokers cannot demand or receive brokerage fees from clients where they are remunerated by commission from the lender, or where they do not arrange finance for the client. United States of America In 2000, there were approximately 30,000 mortgage broker companies in the USA, employing an estimated 240,000 brokers. Mortgage brokers are the biggest source of mortgage lending and are responsible for approximately 72% of home loans originated in the United States An independent, industry-funded body that regulates the financial services industry in the UK. See 52 CP146:The FSA s approach to regulating mortgage sales, FSA, August See 54 See See also Jason Clout, Mortgage broking looks set to expand, The Australian Financial Review, 12 April 2002, p

93 The National Association of Mortgage Brokers (NAMB) is the only national trade association representing the US mortgage broker industry. It currently has only 13,000 members who are obliged to subscribe to a Code of Ethics and to Best Business Guidelines. These are significantly less detailed than the UK Mortgage Code. The code and the guidelines stipulate that members must: conduct business in a manner reflecting honesty, honour and integrity; conduct their business activities in a professional manner; endeavour to be accurate in all advertisements and solicitations; avoid unauthorised disclosure of confidential information; conduct their business with all applicable laws and regulations; disclose any equity or financial interest they may have in the collateral being offered to secure a loan; and provide written disclosure of fees, and thoroughly explain the loan process to their clients. The NAMB also provides members with a model borrower broker disclosure agreement, which explains to clients the relationship their broker has with lenders. The mortgage broker industry in the United States is currently regulated by ten Federal laws, five Federal enforcement agencies and over 45 State laws or licensing boards. 55 A table of selected requirements is set out below. State Licensing Rules United States State Regulator Selected Requirements Alabama State Banking Must show a net worth of $25,000. Submit three letters Department of character reference and three letters of reference Alaska Arizona Department of Community and Economic Development State Banking Department concerning experience. Initial license fee of $500. The state of Alaska does not regulate mortgage lending or mortgage brokering, regardless of lien position. Required to maintain a surety bond for $10,000 to $15,000. Must have three years of experience in lending and pass a written exam. Arkansas Securities Department Company required to maintain a net worth of $25,000 and surety bond of $35,000. No specific education or experience required. California Colorado Connecticut Delaware Department of Real Estate; Department of Corporations Division of Securities, Department of Regulatory Agencies Department of Banking, Consumer Credit Division Office of the State Bank Commissioner Most brokers register under the Department of Real Estate. They must have two years' of industry experience during the last 5 years or a four-year college degree and pass an exam. Pay a license fee of $75 and take a required examination. Required to maintain a surety bond for $40,000. No specific education or experience requirements. Mortgage brokers must maintain a bond of $25,000 and provide references from companies that have done business with them. No specific education or experience requirements. 55 Details of individual licensing requirements can be found at: 93

94 State Regulator Selected Requirements Office of Banking and Financial Institutions District of Columbia Florida Georgia Hawaii Office of the Comptroller, Department of Banking and Finance Department of Banking and Finance Department of Commerce and Consumer Affairs Brokers are required to maintain a surety bond ranging from $12,500 to $50,000. No specific education or experience requirements. Mortgage brokers are not subject to any specific financial requirements. Applicants for a broker's license must receive classroom education and pass a written test. Mortgage brokers are required to maintain a net worth of $25,000 or surety bond for $50,000. They must also have two years of lending experience or complete 40 hours of coursework in the field. Maintain a surety bond for $15,000. Mortgage brokers have no specific education or experience requirements. Idaho Department Of Finance A surety bond for $10,000 for home office and additional $10,000 for each office outside of Idaho. Applicants for mortgage broker license must have three years experience in residential mortgage lending if they are in charge of the place of business. Illinois Office of Banks and Real Estate, Bureau of Residential Finance Mortgage brokers must have a net worth of $35,000 and a surety bond for $20,000. Licensees are also required to have three years' experience in real estate financing or attend mortgage lending classes. Indiana Secretary of State, Securities Division Registered loan brokers are required to post a $50,000 bond. They also must take 24 hours of classes on loan brokering. Iowa Division of Banking Must maintain a surety bond for $15,000. No specific Kansas Kentucky Louisiana Maine Maryland Office of the State Bank Commissioner, Division of Consumer and Mortgage Lending Department of Financial Institutions Office of Financial Institutions Office of Consumer Credit Regulation Division of Financial Regulation education or experience requirements. Mortgage brokers are required to meet specific requirements. Must maintain a surety bond for $50,000. Applicants for a mortgage loan broker license must complete a 30-hour training course. Must have net worth of $50,000 or a surety bond of the same amount. Brokers are also required to complete 10 hours of education and pass a lending exam. Registered credit services organizations, which include mortgage brokers, must maintain a bond in the amount of $10,000. No specific education or experience requirements. Mortgage brokers are required to maintain a surety bond ranging from $15,000 to $75,000. They must have three years' experience. Massachusetts Division of Banks Mortgage brokers must demonstrate financial responsibility but are not required any specific requirements. Brokers must show a year's experience in the field; related course work can trim the experience requirement. Michigan Minnesota Division of Financial Institutions Department of Commerce Mortgage brokers are required to maintain a net worth of $25,000 and a bond for $25,000. No specific education or experience requirements. No specific financial, education or experience requirements. 94

95 State Regulator Selected Requirements Mississippi Department of Banking and Consumer Finance Mortgage brokers are required to maintain a surety bond for $25,000. They must also have two years' lending experience or pass an exam. Missouri Division of Finance Mortgage brokers are required to maintain a net worth of $25,000 and a surety bond for $20,000. No specific educational or experience requirements. Montana Nebraska Nevada Department of Administration Banking and Financial Institutions Division Department of Banking and Finance, Financial Institutions Division Department of Business and Industry, Financial Mortgage brokers are required to pay a license application of $500 and loan originators $400. A broker applicant must have minimum of 3 years experience as a loan originator and take an exam to test experience. Surety bond of $25,000 required. Surety bond for $50,000 required. No specific educational or experience requirements. Brokers must have or work in an office with a supervisor who has two years' mortgage lending experience. Institutions Division New Hampshire Banking Department Mortgage brokers must maintain a surety bond for $20,000. No specific educational or experience requirements. New Jersey New Mexico Department of Banking and Insurance Regulations and Licensing Department, Financial Institutions Division Brokers are required to have a net worth of $50,000 and a bond for $50,000. They also must pass a written exam. Must maintain a $25,000 surety bond, and pay a $400 initial license application fee. No specific educational or experience requirements. New York Banking Department Mortgage brokers are required to have two years of experience in the field. North Carolina Office of the Commissioner of Banks Must maintain a $25,000 surety bond. No specific educational or experience requirements. North Dakota Department Of Banking and Financial Institutions Must maintain a surety bond for $25,000. No specific educational or experience requirements. Ohio Department Of Commerce, Division of Financial Institutions Oklahoma Oregon Department of Consumer Credit Department of Consumer and Business Services, Division of Finance and Corporate Securities Mortgage brokers must maintain a surety bond of $25,000 for their main office, plus $5,000 for each branch office. They must also have 3 years' experience in the lending field or an associate's degree in finance, banking or business administration. Brokers must have three years continuous experience in the residential mortgage loan industry, real estate sales or lending industry. There is a $750 initial application fee and a $150 test fee. Licensed mortgage brokers are required to maintain a surety bond for $25,000 to $50,000. They must also have at least 3 years' experience in mortgage lending or a related business. Pennsylvania Department of Banking Mortgage brokers must maintain a bond for $100,000. No specific educational or experience requirements. Rhode Island Department of Business Regulation South Carolina Department of Consumer Affairs Licensed brokers must have a net worth of $10,000 and post a $10,000 bond, plus $5,000 for each additional office. They are also required to have five years' experience in the field. Must maintain a surety bond for $10,000. To obtain a license, brokers must have worked for two years as a loan originator. They can substitute six hours of academic study for one of those years. 95

96 State Regulator Selected Requirements South Dakota Division of Banking No minimum financial requirements, no specific educational or experience requirements. Tennessee Texas Utah Vermont Virginia Washington Department of Financial Institutions Finance Commission of Texas, Savings and Loan Department Department of Financial Institutions Department of Banking, Insurance, Securities & Health Care Administration State Corporation Commission, Bureau of Financial Institutions Department of Financial Institutions, Division of Consumer Services Mortgage brokers must maintain a surety bond for $90,000, pay a nonrefundable $100 investigation fee, have a tangible networth of $25,000 and pay a $500 license fee. No specific educational or experience requirements. Mortgage brokers must maintain a net worth of $25,000 or a surety bond of $50,000. They must also have a bachelor's degree in finance, banking or business administration and 18 months' experience in lending or three years' lending experience. Must have surety bond for $25,000. No specific educational or experience requirements. All broker apps must take an exam. Brokers must maintain a bond for $10,000. No specific educational or experience requirements. Brokers must maintain a surety bond for $25,000 with a $500 application fee. Mortgage brokers must maintain a surety bond for $20,000 to $60,000. Applicants must pass an exam or demonstrate two years' experience in the field. West Virginia Division of Banking Must maintain a net worth of $10,000 and a bond for $25,000. No specific educational or experience requirements. Wisconsin Department of Financial Institutions Mortgage brokers must maintain a bond for $10,000 or net worth of $100,000. No specific educational or experience requirements. Wyoming Division of Banking File a license application and a $150 fee. Source: Mortgage Academy The main Federal Act regulating the activities of mortgage brokers is the Real Estate Settlement Procedures Act 1974, which is administered by the US Department of Housing and Urban Development (HUD). On 5 October 2001, HUD issued Statement of Policy , which detailed HUD s position on broker fees. HUD stated that: broker payments must be commensurate with the amount normally charged for similar services; and in order for broker fee disclosure to be meaningful, it must specify what services a mortgage broker will perform and the broker s total compensation for performing those services (including any commission paid by the lender). This information must be disclosed as early as possible in the broker consumer transaction. There is considerable variation in the regulation of brokers at a state level in the United States. New York State provides an example of an interventionist regulatory model. In New York State, mortgage brokers are required to be registered under Article 12 D of the Banking Law and Superintendent s Regulation Part 410. Broker conduct is regulated chiefly by the General Regulations of the Banking Board Part 38 and Part 41, both of which are administered by the State of New York Banking Department A summary of Part 41 can be found at: 96

97 Part 38 prohibits fraudulent, deceitful or misleading broker advertising. Advertisements that promise immediate loan application approval fall into this category. Brokers are required to disclose, either in writing or via electronic media, a number of specified matters including: that the broker cannot guarantee acceptance into any particular loan program, nor promise any specific loan term or conditions; whether the broker places loans primarily with any three or fewer lenders; the maximum commission and/or any premiums or bonuses payable by the lender to the broker; fees to be paid by the borrower directly to the broker (with a prohibition on these fees being calculated as a percentage of the principal amount of the loan or amount financed); and whether or not a loan imposes a pre-payment penalty on the borrower. The legislation also contains a number of measures designed to protect consumers from brokers who regularly place their customers in high cost or predatory home loans. 57 These measures include requirements that: brokers must not publish fraudulent, deceitful or misleading broker advertisements, such as those promising immediate approval of loan applications; borrowers must sign a statement, in a minimum 12-point type, advising them to shop around and determine comparative interest rates and other fees and charges; and brokers must not offer repayment terms that exceed the borrower s capacity to repay the loan. Recent amendments to the legislation have placed additional obligations on brokers who organise high cost home loans, including that: borrowers receive certification from a financial counsellor that the borrower has received counselling on the advisability of the loan transaction; and brokers arrange refinance only when the new home loan has tangible net benefit to the borrower. Canada The leading industry body is the Canadian Institute of Mortgage Brokers and Lenders (CIMBL). It currently has over 2500 members and it estimates that 25% of all new mortgage business is written by brokers, although there are significant variations between provinces. 58 In Ontario, for example, brokers are said to generate some 70% of new mortgage business. Members of CIMBL are obliged to abide by the Institute s Code of Ethics, which is administered by internal committees. The main thrust of the provisions in the code relate to disclosure, conflict of interest and advertising. 59 The committees can impose significant penalties for violations of these provisions, including compensation to clients, fines and termination or suspension of membership. The activities of Canadian finance brokers are regulated by the individual provinces, rather than nationally. In Ontario, mortgage broker activities are governed by the Mortgage Brokers Act Mortgage brokers are required to be registered, and the Superintendent of 57 For first mortgage to be characterised as a high cost loan, the loan must have an annual percentage rate that exceeds by more than eight percentage points the yield on US Treasury securities having comparable periods of maturity or the fees associated with the loan must exceed 5% of the total loan amount. 58 Canadian Institute of Mortgage Brokers and Lenders, Blueprint for change in the Canadian mortgage broker industry:recommendations for effective mortgage broker regulation,28 Sep 2001, p.5. See 59 See Code of Ethics at 97

98 Financial Services has the power to refuse registration of a mortgage broker who makes false, misleading or deceptive statements in any advertising material. In order to be registered, an applicant must successfully complete an educational program approved by the Superintendent. The program takes two semesters to complete on a full time basis. In June 2004, the Financial Services Commission of Ontario published a Consultation Paper titled Improving the Mortgage Brokers Act which canvasses submissions on improvements to the legislation, recognising that broking is an ever growing industry and that brokers are not adequately regulated. In British Columbia, mortgage brokers are regulated under the Mortgage Brokers Act 1996 and must be registered. Brokers are prohibited from arranging a mortgage on behalf of a borrower unless the broker has a written agreement specifying the remuneration of both the mortgage broker and any other person for all services related to arranging the mortgage. Brokers must also provide a written disclosure statement, which outlines any direct or indirect interest the broker (or any associate or related party of the broker) has or may acquire as a result of the transaction. British Columbia also requires brokers to undergo specified courses as a condition of registration. New Zealand It is estimated that 25% of all mortgage business in New Zealand is sourced through mortgage brokers. 60 The peak mortgage broker industry body is the New Zealand Mortgage Brokers Association (NZMBA), which currently has over 320 members. To become a member of the NZMBA, a broker must have: a proven history of relevant experience; an acceptable personal record; no ratified public objection to their membership; mortgage broking as their principal activity; approval from at least six major financial institutions; at least $1 million in professional indemnity insurance cover; and a full range of product types and options on offer. All members must also have completed (and passed) an approved training and accreditation program. The NZMBA requires members to adhere to a Code of Ethics and Standards, which contains a number of general obligations. For example, it requires member brokers not to misrepresent, conceal or exaggerate any pertinent facts relating to any transaction in which they are involved. Additionally, the NZMBA code places a duty on brokers to maintain their knowledge and skills at a level required to ensure that their clients receive competent service based on up-to-date knowledge and practice. A recent article on the New Zealand broking experience has commented on the influence of commissions on market share: In 1999, ANZ was the only New Zealand bank to offer trailer commissions to brokers and they received a larger share of their business from this channel than other banks. In 2000, the National Bank and Westpac instigated similar 60 See 98

99 commission structures and were rewarded with an increased share of business through brokers, and ANZ s share decreased." 61 There is currently no specific regulation of finance broker activities in New Zealand. Similar to some jurisdictions in Australia, the activities of finance brokers are regulated by more generic fair trading legislation, as well as the credit legislation where the broker arranges a credit contract, which is subject to that legislation. 61 Shaun Drylie and Claire Matthews, Going for Broker, Journal of Banking and Financial Services, 117 February 2003, p

100 Attachment B COMPARISON OF INTERSTATE FINANCE BROKER LEGISLATION PROVISION NSW VIC ACT WA TAS,SA,NT Commonwe alth Corporation s Act 2001 Legislation Current status Licensing/ Registration Repealing Credit (Finance Brokers) Act Amends Consumer Credit Administration Act 1995 Awaiting commencement Negative licensing Repealed Finance Brokers Act 1969 in 1998 and inserted new part into Consumer Credit (Victoria) Act 1995 Commenced 1 July 1999 No disqualifying provisions may apply ie negative licensing Consumer Credit Administration Act 1996 New Bill to amend Finance Brokers Control Act 1975 introduced into Parliament 3 December 03. Code of Conduct for Finance Brokers. Finance Brokers Maximum Remuneration Schedule. No legislation Financial Services Reform Act 2001 covers pooled mortgage practice which otherwise constitutes a managed investment scheme. Qld Working Party Current Bill before Parliament Two meetings two years ago. Registration Yes Difficult issue Criteria over 18 merit in concept Fit and proper of licensing. Good character & repute Needs more Prescribed educational consideration. qualifications Specific provisions for firms and body corps. seeking licence Provision for classes of licence Currently Board licenses brokers. Bill will abolishes Board and Commissioner N/A

101 for Fair Trading becomes licensing authority Contract requirements written signed client copy amount term repayment interval repayment arrangements max interest date required potential lenders Broker name & address Company details Bus Name details Commission amount or method When commission payable Any benefits from credit provider broker receives Credit regulated Contract requirements listed are those in the NSW legislation. Consumer credit within meaning of Yes Yes Yes Yes Yes No No Yes (interest) Yes (duration of appointment only) No No No No Yes(plus agreed max. amount for application and valuation fees) No No Consumer credit within meaning of Yes Yes No Yes Yes No No Yes No No Yes Yes Yes Yes No No Consumer credit Yes Yes Yes Yes Yes Yes No amount payable Yes No Yes Yes Yes yes Yes Yes disclosure Consumer and commercial credit Yes Yes - Most agreed consumer and 101

102 Up-front commission Commission depends on being same as agreed terms Commission no greater than contract May charge commission if client declines credit Must keep records 7 years Valuation, application, establishment fees Disciplinary Action Consumer Credit (NSW) Code Consumer Credit (Vic) Code Prohibited Prohibited Yes Prohibited Yes Yes Yes (includes where credit is reasonably comparable) Yes No but not to exceed maximum prescribed Yes Yes Yes No but must not act unfairly or unconscionably Yes Yes No Yes Yes Must not demand, receive or accept. Pay directly to provider. Application to tribunal for noncompliance with contract, engaging in unjust conduct, or charging excessive commission to seek order to take or refrain from specific action, order payment of Yes, but only the actual broker agreement Same as NSW Application to court or tribunal for accepting fees to which broker is not entitled. Apply to court for interest. Business Licensing Authority can revoke a permission given to a disqualified broker if the broker contravenes any Must keep records 3 years Valuation fees held in trust On conviction for contravention of Act, Court may order refund and payment of interest. Commissioner may cancel registration if FB becomes a prohibited person or 6 yrs from repayment of loan Must pay into trust account Complaints investigated by Registrar/Inspector. Prosecution in Court of Petty Sessions for offences. Registrar/Inspector can take disciplinary action before Board for breach of Act/Regs/Code. Appeal from Board to District Court. commercial credit but difficult to justify extending protection to large business. Yes not total agreement on challenging excessive fees. 102

103 Prohibited persons specified amount or order amount not due or owing to fin. Broker. Application to court for refund and interest on refund. conditions imposed by the BLA. No Under 18 Bankrupt/insolve nt Disqualified and no current BLA permission Disqualified: Guilty of fraud, dishonesty etc in past 10 yrs Disqualified under FB or credit legislation Interstate licence application refused in preceding 2 years mentally infirm. Commissioner may show cause, reprimand, disqualify or suspend. Under 18 Bankrupt Convicted of fraud, dishonesty in last 5 years. Refused/dis qualified from occupational licence Appeals to District Court (NOTE: Bill abolishes board and Commissioner will licence/investigate breaches and commence disciplinary proceedings. Discipline by new State Admin. Tribunal) See criteria above Note: Disqualified person may make application to authority for permission to operate Misrepresentation No Offence for misleading & deceptive statements or wilful concealment of a material fact. False or misleading statements. Yes Yes - with specific examples in the legislation 103

104 Advertising No Not specifically, but see under Misrepresentation above Must include business details in any advertising Must include name of broker, interest rate shown must be for stated amount and calculated in accordance with the Act. Yes name of broker address, licence number; statement that they are a broker not a lender. Definition Acts or purports to act as an intermediary to negotiate and obtain consumer credit. Negotiating or acting as an intermediary for a fee in obtaining consumer credit. NB: fee includes commission, reward or other remuneration, whether monetary or otherwise. Negotiating or acting as an intermediary to obtain consumer credit. Existing definition: Acts as agent to negotiate or arrange loans on behalf of others. New definition will exclude persons whose only business is to neg. or arrange pooled mortgages Covers mortgage originators or single loan mortgage arrangements. Codes of Conduct NIL Power of Board to make code of Conduct under Finance Brokers. Proposed that Code by prescribed by regulation. Insurance NIL Not mandatory. But Board requires as a matter of practice by condition on licence. Yes - professional indemnity insurance. Western Australia has amended current Act to abolish Board. Commissioner will become licensing authority and be responsible for compliance Discipline by proposed State Admin Tribunal. Code of Conduct to be prescribed by regulation. Current definition to stay but persons arranging/negotiating pooled mortgages only not required to be licensed. Majority of other existing provisions to be retained. 104