Parliamentary Joint Committee on Corporations and Financial Services Inquiry into litigation funding and the regulation of the class action industry
Opening statement by ASIC Deputy Chair, Daniel Crennan QC at the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into litigation funding and the regulation of the class action industry, Wednesday, 29 July 2020, Parliament House, Canberrra
Representing ASIC today are Deputy Chair Karen Chester, Commissioner Cathie Armour and Deputy Chair Daniel Crennan QC.
ASIC has made a submission to this Inquiry, and previously to the Australian Law Reform Commission Inquiry into Class Action Proceedings and Third-Party Litigation Funders.
ASIC’s current priority in relation to litigation funding
Since the announcement by the Treasurer, on 22 May 2020, that litigation funders will be required to hold an Australian financial services licence and comply with the managed investment scheme regime from 22 August 2020, ASIC has been working with Treasury to implement the Government’s policy.
Our current priority is to ensure ASIC is ready and able to administer the new regime when it commences on 22 August 2020.
Our work encompasses:
- preparing to licence operators of the new kind of management investment scheme
- preparing to register litigation funding schemes as managed investment schemes, and
- dealing with transitional arrangements, including considering whether all aspects of the relevant laws can be complied with, in practice, by litigation funding schemes.
Application of the AFS licensing and MIS regimes to litigation funding
The financial services licensing and managed investment scheme regimes focus on conduct and disclosure in relation to financial services and products.
In our submission to this Inquiry, ASIC set out the obligations that follow for entities that hold an Australian financial services licence and that operate a registered managed investment scheme.
These obligations are well established, and many have a clear role to play in the regulation of litigation funding schemes.
However, financial services and managed investment scheme regulation was not specifically designed to regulate litigation funding. Some issues arise from this fact.
We are aware from submissions and earlier hearings that there is considerable interest in the fees and profit margins of litigation funders and the risk of financial default by litigation funders. However, the financial services licensing and managed investment scheme regimes do not extend to price or prudential regulation.
Further, litigation funding schemes may have some difficulties complying with some of the relevant laws.
- The requirement to provide a Product Disclosure Statement does not work easily with open class actions.
- Another challenging example relates to the rules in relation to withdrawal from managed investment schemes. There are specific rules for withdrawal from illiquid schemes that are not necessarily consistent with Court rules in relation to withdrawal from class actions.
In light of these and other issues and as noted in the Government’s Explanatory Statement, ASIC may need to give some relief to apply the managed investment scheme and financial services licensing regimes to litigation funding.
The Commission is currently focused on considering what exemptions or modifications will be needed on Day 1.
Where potential policy issues arise as we consider these transitional matters, we will consult with the Treasury.
ASIC is committed to administering and applying the existing regime to achieve the Government’s stated policy.
Accountability for failure to comply with continuous disclosure obligations
Whilst this inquiry is primarily interested in the regulation of litigation funding, there has also been interest in a specific type of funded class action, namely, security class actions in relation to breaches of Australia’s market disclosure provisions.
Australia’s market disclosure provisions exist to protect shareholders, market integrity and the good reputation of Australia’s financial markets.
Australia’s domestic equity market capitalisation at 15 July 2020 was $2.15 trillion [source: value of ASX listed stocks according to Bloomberg]. In Australia, many investors rely on market information to make their investment decisions, both domestic and international. A report produced by Deloitte Access Economics entitled 'ASX Investor Study' in 2017 found that 37% of Australian adults, or 6.9 million people, hold investments that are available through an Australian financial exchange.
ASIC’s analysis of trading volumes this year (1 Jan 2020 to 20 July 2020) reveals there is about $45bn of turnover on Australian markets per week. A substantial proportion of this is purchases and sales made by Australian investors including superannuation funds and retail investors. It is paramount that these trades occur based on an informed market.
Continuous disclosure and misleading or deceptive provisions anchor many other elements of the regulatory regime for financial markets, including low document capital raisings. The continuous disclosure regime is particularly important during times of market uncertainty and volatility. The number and value of low document secondary capital raisings has increased as a result of the COVID-19 pandemic, as it did during the GFC.
Our capital markets have supported companies with $31.6bn raised by over 150 ASX listed companies from a range of sectors.
On a relative basis, for the size of our economy we have raised considerably more secondary capital than the UK and US markets.
While the low document fund raising regime allows issuers to raise capital efficiently, it is predicated on the market being kept fully informed through continuous disclosure. ASIC legislative instruments facilitating such equity raising without a disclosure document are based on this principle.
Both security class action plaintiffs and ASIC rely on breaches of continuous disclosure provisions in the Corporations Act. On 25 May 2020, the Treasurer, by legislative instrument, introduced the elements of knowledge, recklessness and negligence into the regime on a temporary basis. This currently applies to both regulatory actions and private security class actions.
In both the United Kingdom and United States, the requirement for proof of intention or fault generally only applies to private litigation and not to regulatory actions. In England and Wales for example, a private claimant must establish that the conduct of the directing mind of the issuer was 'reckless' or 'dishonest': s90A of the Financial Services and Markets Act 2000 (UK). The regulator is not required to prove a fault element. In the United States, in like claims, a private litigant must prove 'scienter' or an intention to deceive. In regulatory actions under regulation FD of the Securities Exchange Act 1935 (US), the regulator does not have to prove 'scienter'.
Any changes to the continuous disclosure regime, including whether the current temporary relief from continuous disclosure obligations should be made permanent or extended, are, of course, a policy matter for Government.