We examine Australia & New Zealand Banking Group Limited (“ANZ”) in the second instalment of our series on alleged wrongdoings in the Australian financial services sector.

Royal Commission

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the “Royal Commission”) was established on December 14, 2017, by the Governor-General of the Commonwealth of Australia. The Commissioner will submit an interim report by September 30, 2018 and will provide a final report by February 1, 2019.

ANZ has been involved in multiple cases in the Royal Commission thus far:

  • Round 1 – Consumer lending (commenced on March 13, 2018)
    • In her closing address, Senior Counsel Assisting stated that it was open to the Commissioner to make multiple findings of misconduct by ANZ, that ANZ engaged in conduct that fell below community standards and expectations, and that ANZ’s mechanisms for redress have been inadequate to address the detriment suffered by the individual in relation to a single home loan made by ANZ in 2017 (identified in a specific case study). Additionally, Senior Counsel Assisting stated it was open to the Commissioner to make a finding that ANZ’s conduct more generally falls below community standards and expectations because it relies on the Household Expenditure Measure (“HEM”) benchmark when assessing a customer’s ability to service a home loan.
      • ANZ rejected all allegations of misconduct but acknowledged that some of its conduct fell below community standards and expectations.
    • Senior Counsel Assisting also stated it was open to the Commissioner to make multiple findings of misconduct by ANZ in relation to providing overdraft facilities to customers under the ANZ Assured product in 2015 without previously inquiring as to customers’ required credit limits. Senior Counsel Assisting also stated it was open to the Commissioner to find that ANZ engaged in conduct that fell below community standards and expectations in relation to remediation activities of affected customers. Senior Counsel Assisting also stated it was open to the Commissioner to find that the misconduct was the result of the inadequacy of ANZ’s internal systems.
      • ANZ accepted the findings of misconduct but rejected the allegation that its conduct fell below community standards and expectations, because the bank had not identified any customers requiring remediation. ANZ also rejected the allegation that its internal systems were inadequate.
    • Senior Counsel Assisting also stated it was open to the Commissioner to make multiple findings of misconduct by ANZ in relation to incorrectly applying interest rate discounts to home loans, and failing to link offset accounts to home loans from 2003 to around 2014 and again in 2017. Senior Counsel Assisting also stated it was open to the Commissioner to make multiple findings of conduct that fell below community standards and expectations in relation to the length of time it took to appreciate the scope of the problem, inadequate fixes to the problem, poor remediation processes, inadequate systems and processes, and inadequate mechanisms for redress.
      • ANZ rejected all allegations of misconduct but acknowledged that its conduct fell below community standards and expectations.
    • Senior Counsel Assisting also stated it was open to the Commissioner to make multiple findings of misconduct and conduct falling below community standards and expectations by ANZ in relation to car loans made to approximately 320 customers under ANZ’s Esanda consumer car loan brand through third party intermediaries from 2013 to 2015, which was the subject of a 2018 Australian Securities & Investments Commission (“ASIC”) civil penalty proceeding. Senior Counsel Assisting also stated it was open to the Commissioner to make findings of conduct falling below community standards and expectations by ANZ in relation to the financing of the purchase of add-on insurance products sold by third-party intermediaries, and that ANZ had inadequate systems in place to enable it to comply with its responsible lending practices when assessing whether to approve car loans.
      • ANZ and ASIC previously filed a Statement of Agreed Facts and Admissions in which ANZ admitted that it had contravened the law, and ANZ accepted the findings of misconduct and conduct falling below community standards and expectations. However, ANZ rejected other allegations of misconduct and conduct falling below community standards and expectations, allegations that the dishonest conduct by the intermediaries was due to the incentive structures for intermediaries, and allegations of inadequate systems.
  • Round 2 – Financial advice (commenced on April 16, 2018)
    • In her closing address, Senior Counsel Assisting stated that it was open to the Commissioner to make multiple findings of misconduct by three ANZ-affiliated financial advisers providing poor financial advice in 2011, 2015, and 2016. Additionally, Senior Counsel Assisting stated that it was open to the Commissioner to make multiple findings of misconduct and conduct falling below community standards and expectations by RI Advice Group (“RI”) and Millenium3 Financial Services (“M3”), two subsidiaries of ANZ, during the period when the advisers provided the poor advice. Senior Counsel Assisting also stated that it was open to the Commissioner to find that RI and M3’s conduct was attributable to inadequate risk management systems, recruitment processes, internal systems, and responses to potential detriment suffered by customers.
      • M3 and RI rejected all allegations of misconduct regarding the advisers as well as their own conduct. M3 and RI also rejected allegations of inadequacies in their risk management systems and internal systems, and RI rejected allegations of inadequate recruitment processes. However, M3 and RI accepted some of the open findings regarding their conduct falling below community standards and expectations in relation to the advisers.
  • Round 3 – Loans to small and medium-sized enterprises (commenced on May 21, 2018)
    • In his closing address, Counsel Assisting stated that it was open to the Commissioner to find that ANZ had been in breach of the Code of Banking Practice regarding a single small business highlighted as a case study.
      • ANZ rejected all allegations, though ANZ acknowledged that an unacceptable number of data and related errors occurred in the case and, in that limited respect, ANZ may have failed to meet the standards expected under the Code of Banking Practice.
  • Round 4 – Financial services in rural and remote communities (commenced on June 25, 2018)
    • In her closing address, Senior Counsel Assisting stated that it was open to the Commissioner to find that ANZ engaged in misconduct and conduct that fell below community standards and expectations in relation to various customers whose loans ANZ assumed following its acquisition of the loan book of Landmark Financial Services (“Landmark”) in 2010. Senior Counsel Assisting also stated that it was open to the Commissioner to find that ANZ’s conduct was attributable to a lack of preparation by ANZ before the acquisition of the Landmark loan book, and the culture within ANZ’s Lending Services prior to August 2014.
      • ANZ acknowledged that certain of its conduct in relation to some former Landmark customers amounted to misconduct or otherwise fell below community standards and expectations. However, ANZ rejected the open findings regarding the attribution of its conduct.
    • Senior Counsel Assisting also stated it was open to the Commissioner to find that ANZ engaged in misconduct and conduct that fell below community standards and expectations in relation to some Aboriginal and Torres Strait Islander customers, and that ANZ has inadequate internal systems in relation to customers who receive Centrelink payments and have overdrawn account balances.
      • ANZ rejected the allegations of misconduct and some but not all allegations of conduct that fell below community standards and expectations in relation to some Aboriginal and Torres Strait Islander customers. ANZ accepted that its systems and processes do not automatically allow proper arrangements for customers who receive Centrelink payments and have overdrawn account balances.
  • Round 5 – Superannuation (commenced on August 6, 2018)
    • In his closing submission, Counsel Assisting stated that it was open to the Commissioner to find that ANZ engaged in misconduct and conduct that fell below community standards and expectations in relation to the provision of information about Retail Smart Choice Super. Counsel Assisting also stated that it was open to the Commissioner to find that OnePath Custodians (“OPC”), a subsidiary of ANZ, engaged in conduct that fell below community standards and expectations by engaging ANZ to sell Retail Smart Choice Super through ANZ’s distribution network.

Other issues

ANZ has otherwise been under regulatory and legal scrutiny for various practices in the past year:

BBSW manipulation

On November 20, 2017, ASIC announced it had accepted an enforceable undertaking from ANZ in relation to ANZ’s bank bill trading business and their participation in the setting of the Bank Bill Swap Rate (“BBSW”), a key Australian benchmark and reference interest rate. On November 10, 2017, the Australian Federal Court made declarations that ANZ had attempted to engage in unconscionable conduct in connection with the supply of financial services in attempting to seek to change where BBSW was set on certain dates, on ten occasions from 2010 to 2012. The Court also declared that ANZ failed to do all things necessary to ensure that it provided financial services honestly and fairly. The Federal Court imposed pecuniary penalties of A$10 million on ANZ for the attempts to engage in unconscionable conduct in respect of the setting of BBSW. The Court also noted that ANZ will give enforceable undertakings to ASIC which provides for ANZ to take certain steps and to pay A$20 million to be applied to the benefit of the community, and that ANZ will pay $20 million towards ASIC’s investigation and other costs.

Breaching responsible lending laws

On January 18, 2018, ASIC announced a package of regulatory actions against ANZ for loans approved through its former car finance business Esanda (which was a case study in Round 1 in the Royal Commission, as mentioned above). First, ASIC commenced civil penalty proceedings in the Australian Federal Court, in which ANZ admitted 24 contraventions of the responsible lending provisions of the National Consumer Credit Protection Act 2009 for car loans approved by Esanda from three broker businesses from July 2013 to May 2015, by failing to take reasonable steps to verify the information provided by borrowers. The Australian Federal Court later ordered ANZ to pay the negotiated penalty of A$5 million for these breaches. Second, ANZ agreed to remediate approximately 320 car loan customers for loans taken out through the three broker businesses from 2013 to 2015 which are likely to have been affected by fraud. The total remediation will be around A$5 million.

Failure to disclose credit card charges

On February 7, 2018, ASIC announced that ANZ would refund A$10.2 million to 52,135 business credit card accounts, after it had failed to properly disclose fees and interest charges for the product, dating as far back as 2009 in some cases. According to ASIC, many of the ‘Business One’ credit card customers affected by ANZ’s errors and omissions were small businesses.

Poor financial advice

On April 6, 2018, ASIC announced that it had accepted an enforceable undertaking from ANZ after an investigation found that ANZ had failed to provide documented annual reviews to more than 10,000 ‘Prime Access’ customers in the period from 2006 to 2013. The enforceable undertaking requires ANZ, among other things, to:

  1. pay a community benefit payment totaling $3 million;
  2. provide an audited attestation of ‘reasonable assurance’ from ANZ senior management that the bank has, since 2014, provided documented annual reviews to customers who were entitled to such reviews; and
  3. provide further audited attestations from ANZ senior management as to the improvements that the bank has made to its compliance systems and processes, and that the design and implementation of those systems and processes will seek to ensure documented annual reviews are provided in accordance with the ANZ Prime Access package.

In addition to the enforceable undertaking, ANZ has also agreed to compensate its Prime Access customers who, in the period from 2006 to 2013, did not receive the documented annual reviews to which they were entitled.

On August 8, 2018, ASIC announced that ANZ had either paid/offered compensation or estimated future compensation of approximately A$59 million in total remediation for failing to provide financial advice to customers while charging them ongoing advice fees, including the Prime Access-related compensation described above.

Inappropriate distribution of superannuation products

On July 6, 2018, ASIC announced that it had accepted an enforceable undertaking from ANZ in which ANZ had agreed to change the way it distributes superannuation products to its customers. An ASIC investigation found a common practice among ANZ branch staff to offer ANZ’s Smart Choice Super and Pension products to customers at the end of a fact-finding process about customers’ overall banking arrangements (a so-called “A-Z Review”). ASIC was concerned that the proximity between the fact-finding process and the discussion about the superannuation products was leading staff to provide personal advice to customers about their superannuation.  Branch staff for ANZ were only authorised to provide general advice. ASIC was concerned that customers may have thought, due to the proximity of the fact-finding process to the offer of Smart Choice Super, that the ANZ branch staff were considering risks specific to the customer when this was not the case. The court enforceable undertakings prevent ANZ from distributing Smart Choice Super in conjunction with an A-Z Review. They also require ANZ to make a A$1.25 million community benefit payment.

Breaches in continuous disclosure obligations

On September 14, 2018, ASIC commenced civil penalty proceedings against ANZ for an alleged continuous disclosure breach in relation to a A$2.5 billion institutional equity placement undertaken by ANZ in 2015. ASIC alleged that ANZ contravened provisions of the Australian Corporations Act by failing to notify the ASX that approximately A$791 million of the A$2.5 billion of ANZ shares offered in the placement was to be acquired by its underwriters rather than placed with investors.

ANZ has stated it will defend the allegations and claimed it is “not aware of a precedent for a listed entity to disclose the take up of shares by underwriters in an equity placement.” The matter has been listed for an initial hearing on October 26, 2018.

Glass Lewis commentary

In relation to the Royal Commission, we note that the Royal Commission is ongoing and that many of the open findings regarding ANZ are in dispute. However, shareholders may wish to assess the materiality of the open findings that ANZ has accepted.

The BBSW outcome is concerning and, like at Westpac, speaks to the historic acceptable risk tolerance at ANZ’s trading desks.

ANZ’s settlement with ASIC regarding its responsible lending obligations is worth noting because it reflects the risks that arise from banks using intermediaries to sell their financial products, and the importance of effective compliance and risk management frameworks. The penalty and remediation payments, not to mention subsequent investment in enhancing risk management, in effect represent deferred expenditure.

The failure to disclose credit card charges or fees may not have had a material impact on any individual business customer (the average remediation was less than A$200). However, the scale of the customers affected as well as the duration the error persisted in some cases is concerning.

The fees-for-no-service scandal is particularly problematic because of the nature of the infringement as well as the number of customers and the size of the fees taken. We note that this practice artificially inflated revenue in the reporting periods in which the practices occurred.

The inappropriate distribution of superannuation products reflects the inherent risks and potential conflicts presented by a vertically integrated financial services model—the cross-selling opportunities for retail branch staff are fraught with peril. It is no wonder that ANZ has been in the process of de-integrating.

Finally, in relation to ANZ’s alleged breaches in continuous disclosure obligations, we will monitor the developments as they unfold.

As with other Australian financial institutions, investors will want to reflect on these practices and on where accountability should lie when considering how to vote at ANZ’s AGM in December 2018.

Daniel J. Smith is General Manager, CGI Glass Lewis.