How To Write A Letter To The Credit Ombudsman Service Of Australia

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1 Inquiry into Consumer Credit and Investment The Economic and Finance Committee Of The Parliament of South Australia Credit Ombudsman Service Submission By Credit Ombudsman Service Limited July 2007 SUBMISSION

2 EXECUTIVE SUMMARY Submission 1: Mandate credit providers and finance brokers to join external dispute resolution schemes approved by ASIC under its Policy Statement 139. Submission 2: The establishment of a statutory dispute resolution scheme for financial services would be a retrograde step in the development of the consumer policy framework in Australia. Submission 3: Any licensing requirement for finance brokers must include minimum standards for training and on-going professional development. Submission 4: Self-regulatory industry Codes are the best way to achieve most industry specific regulation provided: 1. all stakeholders are involved in the development of the relevant Code; 2. the Code has mandated industry coverage; 3. all industry participants are members of an appropriate dispute resolution scheme. Submission 5: Industry-specific regulation of financial services is necessary in combination with generic legislation to form a complete matrix of consumer protection. Page 2

3 1. Introduction 1.1 About the Credit Ombudsman Service Limited ( COSL ) COSL is an external dispute resolution (EDR) scheme approved by the Australian Securities and Investments Commission (ASIC). As a condition of ASIC s approval, COSL is required to meet the stringent conditions prescribed by ASIC s Policy Statement 139. These are summarised in the attached schedule. COSL is a not-for-profit company. It is required to be impartial, accessible and independent, as well as absolutely free of charge to consumers. It provides consumers with an alternative to legal proceedings for resolving disputes with its members. The key objects of COSL (as set out in its Constitution) are to: (a) (b) act as the primary complaints resolution body for the credit industry; and ensure the timely, efficient and effective resolution of complaints against members, having regard to the criteria of relevant legal requirements, recognised industry Codes of Practice, good practice in the credit industry, and fairness in all circumstances. Importantly, COSL is able to award compensation in an amount of up to $250,000 for direct and indirect loss. It is also able to make orders compelling a member to do or refrain from doing specified acts. COSL has more than 8,000 members, mostly mortgage brokers with some mortgage originators, non-bank lenders, aggregators, mortgage managers and some finance brokers. An estimated 75% of loan writers who would not otherwise be covered by an ASICapproved EDR scheme, are covered by COSL, and this benefits consumers enormously. In the June 2007 quarter alone, COSL received over 590 inquiries and complaints and finalised 42 complaints. About 95% of COSL inquiries and complaints are resolved by nonadjudicative means, that is by mediation and conciliation, though the Credit Ombudsman does exercise his power to make determinations, the terms of which are then published on its website 1 Like all ASIC PS139 approved schemes, determinations made by the Credit Ombudsman bind members but not consumers. COSL s services are funded by a combination of membership fees and case management fees paid by the members. It is free for consumers and is controlled by a Board with equal representation from industry and consumer organisations and an independent chair. 1 Page 3

4 1.2 This submission COSL is uniquely placed to monitor and comment on consumer credit and investment schemes. COSL has made submissions recently to the Productivity Commission Inquiry into the Consumer Policy Framework in Australia, the Queensland Department Fair Trading on the Regulation of Finance Brokers, with particular reference to its proposed mandatory code of conduct, and to the Ministerial Council for Consumer Affairs on such topics as regulation of Finance Brokers. This submission will not address every issue raised in the Terms of Reference (TOR) for the Inquiry. COSL will focus on those areas where it has particular knowledge and expertise, starting, obviously, with the questions raised about alternative dispute resolution for consumer disputes. COSL submits that mandated membership for all credit providers and finance brokers of an independent industry-based consumer dispute resolution scheme will address many of the access to justice issues facing consumers of credit and investment schemes. This specifically addresses item 8 in the TOR for the Inquiry, but is relevant to all the other items as the old Latin expression says ubi jus ubi remedium: There is no right without a remedy. The submission will then go on to: refer to the experience of COSL with some of the financial products identified in Item 1 of the TOR and on reverse mortgages in Item 2; comment particularly on the roles of brokers as raised in Item 3 of the TOR; note the role of COSL in investment products raised in Item 4 when linked to credit; discuss the necessity for independent dispute resolution and an industry code of conduct for all credit providers, including the so-called fringe providers discussed in Item 5; address Item 7 in the TOR in relation to levels of consumer financial literacy; argue for the role of industry-based Codes of Conduct as part of the regulatory regime addressing Item 8 of the TOR; and argue for a combination of generic and product-specific regulation, again addressing Item 8 and Item 9 of the TOR. Page 4

5 2. Dispute resolution 2.1 The current situation incomplete coverage COSL plays an important role in dispute resolution in financial services, particularly in the area of intermediaries in mortgage lending. These intermediaries generally do not engage in dealing or advising on financial products and are not therefore required by the Corporations Act to hold Australian Financial Services (AFS) licences, or become a member of an ASIC approved EDR scheme. 2 However, if a non-bank lender or intermediary is a member of the Mortgage and Finance Association of Australia (MFAA), they are generally required to become a member of an ASIC-approved EDR scheme such as COSL. The MFAA claims 80% coverage of the relevant industry. Banks and non-bank lenders such as building societies and credit unions are covered by their own respective approved EDR schemes because they are also authorised deposit taking institutions requiring an AFS licence. This submission is therefore primarily concerned with lenders and intermediaries that are neither holders of an AFS licence nor members of the MFAA. These bodies are under no obligation to join an approved EDR scheme. The absence of EDR coverage for these types of lenders and intermediaries represents a gaping hole in the coverage, and therefore the effectiveness, of the consumer dispute resolution regime in Australia. 2 Corporations Act A Page 5

6 2.2 Finance companies It is interesting to note that ten years ago in the Financial Systems Inquiry Final Report, the Wallis Commission recommended that coverage of dispute resolution schemes should be broader. Specifically, the Wallis Report said: The States and Territories should facilitate the creation of a nationally uniform dispute resolution scheme for finance companies.3 Ten years on, finance companies, whether large or fringe, are still not required to join an approved EDR scheme. A very few, such as GE Money, have voluntarily joined the BFSO, but most have not. Some of the reasons for this may be: 2.3 Fringe lenders fear of being submerged in a large institution dominated by banks; a lack of a cultural and operational fit between banks and finance companies; or avoiding the issue because it is not a legislative compliance requirement. Small amount lending by non-mainstream lenders is an area where there is a significant volume of lending to vulnerable consumers. Having regard to its own experience, COSL agrees with the assertion of the Consumer Credit Legal Centre (NSW) 4 that there is a small group of lenders, brokers, and associated parties such as solicitors and accountants, who participate in what it refers to as predatory lending. According to CCLC (NSW), these industry participants offer expensive loans to vulnerable borrowers with little hope of repaying the debt with a view recovering the loan and considerable fees and charges from the security property. These loans are highly damaging to borrowers, who often lose their home, or significant further equity where loss of the home was already inevitable. In terms of pay day lenders, the Consumer Law Centre (ACT) cites an example of a client of their service who presented with several credit contracts and a promissory note with various pay-day lenders in South Australia. The interest rates applied ranged from 230% 3 Financial Systems Inquiry Final Report, 1997, Report/Recommendation 26 Note: ASIC PS139 which sets the benchmarks for all approved EDR schemes for AFS licence holders requires that the dispute resolution is free for consumers. 4 at page 7. Page 6

7 to 855% plus additional fees and charges. (The same contracts in the ACT would have been illegal and may have resulted in the revocation of the credit provider s license.) 5 COSL, with its non-bank membership, can provide the EDR solution for both finance companies and fringe lenders. It is not surprising that representatives of the micro-finance industry have already approached COSL to consider joining its scheme. 2.4 Finance brokers Despite the continued increase in COSL membership over the years, COSL still receives a large number of complaints about finance brokers who are not members of COSL. In the period , for example, almost 20% of complaint-related inquiries received by COSL (that is, 1 out of every 5) were about persons who were not members of COSL. Until all finance brokers are required to become a member of an ASIC-approved EDR scheme, there will be a significant gap in the regulation of the credit industry. Submission 1: Regulation of credit providers and finance brokers should mandate membership of an external dispute resolution scheme approved by ASIC under its PS A Statutory Scheme? There are some in Australia who suggest the establishment of a statutory scheme along the lines of the UK Financial Services Ombudsman ( FSO ) which is a statutory scheme funded by levies imposed by the Financial Services Markets Act 1999 (UK) on industry. This organisation has over 950 staff and a budget of over 43,5000,000 Admittedly, in its last Annual Report, it dealt with 110,000 complaints. 6 There are several arguments against adopting the UK approach in Australia: 1. The benefits of consolidation of schemes are being achieved voluntarily and incrementally through the work of the existing non-statutory schemes in Australia. 2. The ASIC PS139 benchmarks which are applied to schemes in Australia seeking approval and which are regularly reviewed, promote standards of accountability, independence, effectiveness, access and fairness in ways that were not achieved by the balkanised and often industry-controlled EDR sector in the UK prior to the establishment of their FSO FOS Annual Report 2005/2006 p 12 Page 7

8 3. A statutory scheme would create a large bureaucracy that would: not have the multiplicity of access points for consumer representation that the current structure affords; not have the sense of involvement and, therefore, support by the relevant industry groups; be substantially more inflexible; and not be capable of responding quickly to changes in relevant markets. 4. Most significantly, however, a statutory scheme would be more susceptible to judicial review on broader grounds than are available at present. A new legalism may creep into scheme processes and decision-making as they look over their shoulders at the courts 7. The UK Financial Services Chief Ombudsman was sanguine about this prospect in In Norwich & Peterborough Building Society v Financial Services Ombudsman 9, however, one of his decisions was effectively overturned. He was less sanguine in November of 2004 but said that but if we merely said we ve taken account of the way the law runs in this area without trying to specify the view exactly where the law stands then I think in many cases we can avoid getting into serious trouble with the courts 10 Unfortunately, the FSO has been in the courts more than a dozen times since then. In Australia, however, the very few attempts at judicial review of industry-based consumer dispute resolution schemes have, for the most part, been unsuccessful. 11 The vast majority of industry members accept the decisions of the various schemes. This may change for the worse, however, if they are replaced by a statutory scheme subject to full judicial review. Submission 2: The establishment of a statutory dispute resolution scheme for financial services including consumer credit and finance brokers would be a retrograde step. 7 This is a fear expressed in relation to the UK Financial Services Ombudsman by James R and Morris P, The new Financial Ombudsman Service in the United Kingdom: has the second generation got it right in Rickett C and Telfer T International Perspectives on Consumers Access to Justice (Cambridge University Press, 2003). at p As reported by James and Morris see above. 9 [2003] 1 All ER 6 10 Personal Interview with Walter Merricks, Melbourne, November For a more thorough discussion of this problem see O Shea P and Rickett, C In Defence of Consumer Law: The Resolution of Consumer Disputes (2005) 28:1 Sydney Law Review See O Shea above. Page 8

9 3. Experiences with specific products 3.1 Ponzi Item 1 TOR COSL has not received any complaints about Ponzi. A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business, and is named after Charles Ponzi. However, COSL has significant experience in what has become known as Ponzi loans. These types of loans were considered in a recent decision of the NSW Supreme Court. 12 Under section 70 of the Uniform Consumer Credit Code, public interest is one of the matters that the Court must have regard to when deciding whether to re-open an unjust contract or mortgage. Justice Patten in the Cook case admitted evidence by Dr Steve Keen, Associate Professor of Economics and Finance at the University of Western Sydney. After reviewing the debtor s borrowings, Professor Keen categorised the subject mortgage as evidencing a Ponzi loan, namely one which can only be repaid by either taking out a larger subsequent loan, or by selling the asset that was financed using the loan. He also described it as a low doc loan, that is, one where borrowers self verify their income in the application process. He said that such loans are designed mainly for the self-employed or those with irregular income who do not have the documentation required to obtain a conventional housing loan. As to the public interest involved in low doc and Ponzi loans, Professor Keen said: (a) Standard home loans are limited in size by the need for the borrower to establish that he/she can repay the loan out of income. (b) Legitimate Low Doc Loans are a necessary development of incomebased loans in light of the changing composition of the Australian workforce. (c) Ponzi Loans are loans that can only be repaid by either taking out a larger subsequent loan, or by selling the asset that was financed using the loan. 12 Permanent Mortgages Pty Ltd v Michael Robert Cook and Karen Cook [2006] NSWSC 1104 Page 9

10 (d) Ponzi Lending can occur in Low Doc Loans because the loosening of income-verification standards enables loans to substantially exceed the size that could be met out of borrower s actual income. COSL has received and considered numerous complaints involving Ponzi loans. Most of these have been resolved by COSL by non-adjudicative means. However, one such complaint was the subject of a recent Determination by the Credit Ombudsman. The Credit Ombudsman found against the broker member under several heads of law and awarded that an amount be paid to the borrower representing the broker s commission, lender s legal fees and other disbursements associated with setting up the loan. In finding that the broker had acted unconscionably within the meaning of the provisions of the ASIC Act, he said as follows: I consider that [the broker] would have been aware that the Complainants (a) were not sophisticated in financial affairs; (b) had defaulted on their [previous mortgagee] loan; and (c) were anxious, if not desperate, to avoid losing their home. [The Broker] was also aware, despite their subsequent protestations, that the Complainants were unemployed and in receipt of Centrelink payments. I consider that [the broker] took unconscientious advantage of its position as their agent by arranging a loan for the Complainants that (a) required repayments of more than double those of their existing [previous mortgagee] loan; (b) that was significantly larger than the [previous] loan, primarily because of the excessive broker commissions and lenders fees charged; (c) that significantly reduced the equity in the value of their home; and (d) that was secured over their only asset, their home. 13 According to the NSW Consumer Credit Legal Centre, this is the description of an archetypal predatory loan. 14 Unfortunately, the lenders financing the Ponzi loan were not COSL members and full recovery of the consumers losses was not achievable. This would not have been the case if membership of an approved EDR scheme for all credit providers was compulsory. 13 Credit Ombudsman Scheme Limited, Determination 003,May 2007 at Page 10

11 Furthermore, the broker has not to date paid the amount awarded and until there is adequate regulation of brokers in place, he will be able to continue trading despite nonpayment in accordance with the Credit Ombudsman s Determination. 3.2 Reverse mortgages Item 2 TOR Reverse mortgages allow consumers to borrow cash against the value of their home but they don t have to make regular repayments until they leave and move into care, sell the home or die. When the loan ends the consumer s estate, must repay what is owing, usually out of the proceeds of the sale of the home. Each year the fees and interest which the consumer would ordinarily pay are added to the loan balance. Over time, consumers are charged interest on the interest (or compound interest) and that builds up the total amount they owe. There is a risk that the amount of the loan may increase to a point where it is more than the value of the home. This is called 'negative equity'. Some, but not all, reverse mortgage products guarantee that if this happens, the consumer will not have to repay more than the value of the home (a no negative equity guarantee). But the consumer may lose this protection if they don't meet the terms and conditions of the loan for example, if they don't repair and maintain your home to a standard set by the lender. COSL has some experience with this type of lending as it is emerging as a product provided by COSL members. Some of the relevant issues include: misunderstandings by consumers on the limitations on what they can do with their home; allegations of inadequate disclosure to consumers of the costs of the loan; complaints about the interest rates and charges, which are usually more than those for conventional mortgages; and situations where the consumer thought they were taking a reverse mortgage when the documents indicate they were not. As this is a relatively new product in the Australian market, COSL has not issued any determinations or policy guidelines on reverse mortgages, and the complaints it has received so far have not even reached the conciliation phase of the COSL process. Considering the complexity of this product and the potential for misunderstanding the essential features, COSL s position on this issue is that a broker should insist that a potential borrower obtain both financial as well as legal advice before entering into such agreements. Page 11

12 4. Disclosure Issues Item 3 TOR 4.1 Lenders COSL frequently resolves complaints which turn on disclosure issues including: adequate information about the progress of loan applications; inadequate disclosure of the details of particular mortgage products COSL finds the MFAA and other industry codes of conduct which apply to members of these industry bodies useful tools in helping to resolve these complaints, frequently in favour of consumers. 4.2 Brokers Most of the complaints received by COSL about disclosure, or the lack thereof, by brokers include those relating to their fees and commissions, the progress of loan applications and the costs associated with applications which do not proceed. Such complaints against COSL members are resolved reasonably satisfactorily in those States with legislation for the regulation of finance brokers, such as New South Wales, Victoria and Western Australia. However, none of these require brokers to be members of an independent recognised external dispute resolution scheme such as COSL, and it is anyone s guess how effectively such complaints are resolved where the broker is not a member of COSL or another approved EDR scheme. 5. COSL and investment products Item 4 TOR Although COSL is not aimed specifically at investment advisers or brokers, (hence the name Credit Ombudsman ), frequently in the market a financial intermediary will perform both roles in the same transaction. When that occurs, the COSL Rules permit the Credit Ombudsman to make determinations on complaints from consumers about the entire transaction. Member services are defined in Rule 142 to include financial products and financial services provided, made available, suggested or proposed by a Member or otherwise incidental to the Credit negotiated, arranged, provided or managed by the Member. Thus, although the ultimate purpose of the funds may well be investment, if the member, be it broker or credit provider, is involved in raising those funds on credit, then COSL has jurisdiction over the conduct of the entire transaction. At the moment, of course, regulation of credit and investment is very different. Indeed, it is the responsibility of two different levels of government and two different regulatory agencies ASIC and State Offices of Fair Trading. Mandatory membership of a dispute resolution scheme for all credit providers and all brokers, whether dealing in investment or credit or mortgage finance, would alleviate the balkanising effects of this regime and give consumers access to cheap, efficient remedies. Page 12

13 6. Product knowledge Item 7 TOR COSL frequently sees complaints arising out of complex transactions involving credit arrangements. Consumers are often confused and there is clearly a case for increased financial literacy in the community. Conversely, there should also be minimum training and on-going professional development of brokers. Brokers, however, have no legislatively enforceable training requirements although those that join the MFAA must satisfy minimum standards of training and experience. 15 Submission 3: Any licensing requirement for finance brokers must include minimum standards for training and on-going professional development 15 MFAA Code of Practice Clause 10 Page 13

14 7. Industry based Codes of Conduct Item 8 TOR 7.1 Specific interests and knowledge One of the best ways, in the experience of COSL, to develop and enforce industry-specific regulation is for it to be in the form of an industry code developed by the industry in consultation with its stakeholders. The level of ownership of the Code provisions and its character, which such a level of selfregulation affords, leads to greater voluntary compliance and generally improves industry standards. COSL has been involved in processes with the MFAA in the further refinement of its Code of Conduct. At this level, with the Ombudsman, the industry representatives and the consumer representatives engaged, good consumer protection policy can be developed. 7.2 Co-regulation not self-regulation There must be, however, in the experience of COSL, a base-level of industry regulation which is coercive and administered by the regulator. This should mostly involve entry level requirements and, as said above, ground rules. They are, in COSL s view, best dealt with in the context of a licensing requirement. Key to these are: 7.3 Content of Codes the requirement to subscribe to the relevant industry code, thus creating and incentive for greater participation in industry policy development and compliance; and mandated membership of an industry based dispute resolution scheme. While training, education and some prudential matters may well be appropriate subjects for regulations attached to licensing, a code of conduct can deal with: transactional matters such as: o disclosure obligations to consumers in relation to: o fees and commissions product features progress of the consumer s application and the transaction in general. obligations to act honourably and in good faith an obligation to make due inquiries about the consumer s situation an obligation to take reasonable care to find the most appropriate product for the consumer s situation Page 14

15 structural matters such as: o o o obligations to other members of the industry obligations to regulators appropriate notifications of personnel, contacts and locations complaints handling o o establish internal dispute resolution system co-operate with the recognised external dispute resolution scheme for the relevant industry. The content of a code of conduct helps define the scope of obligations and duties owed by subscribers to the code. COSL and other ASIC-approved EDR schemes are required to have regard to relevant codes of conduct that apply to their scheme members. Page 15

16 Submission 4: Self-regulatory industry Codes are the best way to achieve most industry specific regulation provided: 1. all stakeholders are involved in the development of the relevant Code; 2. the Code has mandated industry coverage; and 3. all industry participants are members of an appropriate dispute resolution scheme. 8. Generic and specific industry regulation Items 8 and 9 TOR 8.1 Generic and specific The financial services industry is governed by generic regulation such as the ASIC Act and the State Fair Trading Acts and the common law. It is also affected, in part, by specific industry regulation such as the Consumer Credit Code and the various industry codes of practice. 8.2 Which is better? COSL submits that both are necessary in most industries. Generic prohibitions on misleading and deceptive conduct, for instance, are vital to any functioning market but tend to operate best after the event. They provide means of redress and their effectiveness for consumers is limited by consumer s access to justice. They are most frequently used, not by private consumers, but by regulators such as the State Offices of Fair Trading and ASIC. Industry-specific regulation performs two different tasks. Firstly, they set the ground rules for participation in a particular industry. One of these rules is the requirement to belong to an industry-based dispute resolution scheme such as COSL. Secondly, there are certain types of activities which have unique characteristics which can only be addressed on an industry basis. In credit, for instance, as long ago as 1972 in the Molomby Report, it has been recognised that some measure is required for the relief from payments due to temporary hardship during the life of a loan. Molomby concluded that such variations were usually obtained from reputable credit providers and that the practice of the reputable credit provider should be imposed on all. 16 This is the policy basis for section 66 of the Consumer Credit Code which has its predecessors 16 Molomby Committee Report para Page 16

17 in the earlier Credit Acts which, following Molomby, provided for a process of court ordered variations for hardship. 17 No generic law prescribing relief from hardship in contracts could work across all industries and all situations. It would be difficult for consumers to use, for regulators to administer, for courts, tribunals or ombudsmen to interpret or business to accommodate in its costs structures. Yet, in credit, it works. Submission 5: Industry-specific regulation of financial services is necessary in combination with generic legislation to form a complete matrix of consumer protection. 17 Section 74(1) of the Credit Acts of Vic, NSW, WA and the ACT. Page 17

18 SCHEDULE ASIC POLICY STATEMENT 139 Under PS an EDR scheme must meet the following criteria before it will be approved by ASIC. It must: (a) not permit a complaint or dispute to be considered unless it has first been lodged with the relevant scheme member and: (i) has been resolved by the scheme member, but not to the satisfaction of the complainant; or (ii) has not been resolved by the scheme member and 90 days have elapsed since the complaint or dispute was lodged; (b) (c) (d) provide for any systemic, persistent or deliberate conduct to be reported to ASIC; operate free of charge to the complainant; cover a sufficiently broad range of complaints, with the terms of reference of the scheme to be determined after consultation with consumer organisations and ASIC; (e) (f) provide for independence from the parties to the complaint; be overseen by a Board which includes an equal number of consumer directors and an independent Chairman; (g) accord with the principles of natural justice (including that information used by the decision-maker is provided to the complainant unless prohibited by law, and that reasons for decisions are given in writing); (h) provide for decisions to be made by reference to what is fair in all the circumstances, observing applicable law and relevant judicial authority and having regard to good practice in the relevant industry; (i) (j) (k) have appropriate published procedures, including suitable standards of timeliness; include arrangements for appropriate promotion of the procedures; be supported by adequate resources, including staff whose responsibility is to assist consumers in making their complaints, if necessary by investigating the conduct of a financial services provider; (l) require that decisions made under the procedures will be observed by the relevant scheme members; (m) provide adequate remedies; Page 18

19 (n) provide for the maintenance and publication of appropriate statistics on its operations; and (o) provide for the provision to ASIC and the relevant industry associations, details of the decisions made in respect of all complaints, or a representative selection of complaints, including the reasons for the decisions but excluding any information that would identify any of the parties to the complaint. Page 19