Retail investors: Allow choice or prohibit products

This article by ASIC Chairman Tony D'Aloisio originally appeared in The Age on 13 July 2010

At the recent ASIC Summer School Paul Clitheroe, in answer to a question on whether complex retail investment products should be prohibited and retail investors not given a choice to assume risk in those products replied: 'I don't like prohibition. It didn't work for alcohol and I am not sure it will work for investment'. Other commentators have advocated the banning of certain products (e.g. CFDs and CDOs) and a wider role for ASIC to 'red flag' certain products.

The current approach of the Corporations Act in protecting retail investors is in line with the body of economic thought around the 'efficient markets hypothesis'. Namely, the Act allows markets to operate with a minimum of regulation and oversight (essentially around disclosure and prohibiting certain conduct which is misleading or deceiving).

ASIC's role as an oversight body can be likened to a road traffic authority (RTA) or police force. Basically, ASIC oversees and enforces the laws and couples that with extensive work to ensure investors receive clear disclosure and have the knowledge to make informed choices. We do this, for example, through our recent work developing shorter Product Disclosure Statements and through our financial literacy initiatives such as the FIDO website which received over 2 million unique visitors this year. The relevant laws are self executing, in the sense that those operating in these markets need to make sure they comply with those laws and ASIC is not a guarantor of last resort.

ASIC's oversight and enforcement work is important and ASIC has achieved a great deal in assisting and protecting investors within its regulatory remit:

On disclosure: ASIC has pushed the disclosure regime to the limit. Examples include our work on unlisted and unrated debentures, unlisted property and mortgage trusts where ASIC introduced the 'if not why not' disclosure regime to push for clear benchmarks so that retail investors can make more risk informed choices.

On guidance: Through the use of initiatives such as 'Investing between the flags' and product risks analysis using our FIDO website, we have provided important guidance to retail investors. This includes guidance on many complex products. This guidance is backed up with a range of calculators that allow investors to compare managed products and scenarios to help optimise choices.

On law reform. While this is a role for government not ASIC, we have seen the problems which the current conflicted remuneration structures for financial advice have caused and made strong recommendations to government about removing the sources of these conflicts and clarifying the advisers fiduciary duty. The government is now acting on that advice.

On enforcement: ASIC takes numerous proceedings to deter illegal conduct. These range from bannings and winding up unregistered managed investment schemes through to recent record numbers of criminal proceedings against those involved in market manipulation offences, such as insider trading, which prejudice the interests of retail investors.

On compensation: Where retail investors have lost their money through collapses, ASIC has made recovering losses our top priority. For example, through the efforts of ASIC and the liquidators, Westpoint investors will see a potential return of some $100 million of the $388 million invested and $250 million returned to investors in with Opus Prime. We've also significantly expanded access to free and independent dispute resolution such as the Financial Ombudsman Scheme – especially for complaints involving financial advisers.

But this doesn't alter the fact that in the recent crisis we have seen retail investor losses from the falls in the markets and from collapses such as Storm Financial. Nor does it alter the fact that we are increasingly seeing extremely complex products, such CDOs, CFDs and even hedge funds, marketed to retail investors, who often borrowing to invest, but who lack the knowledge and skills to invest in them with any safety or in an informed way. Not surprisingly, these have resulted in some significant losses.

These losses have prompted calls for ASIC to be more active in preventing losses and for the possible banning of products or the application of suitability tests or warnings on certain products.

In terms of being more proactive ASIC has reviewed these losses to see where it could improve as it is clear that educating investors and taking actions after the problem will not of themselves be sufficient to prevent significant losses.

In the end, however, the existing regime is one where risk taking will mean retail investor losses will occur from time to time. They are inevitable and retail investors cannot expect ASIC, like the RTA, to be at every intersection or dangerous bend in the road. The question remains though whether ASIC and government can do more to prevent such dangerous bends existing in the first place or, if bends remain, prevent inexperienced drivers getting anywhere near them.

Our current system of retail investor protection has fared better than many of its overseas counterparts. Whether further protection should be given in the form of prohibition of products or 'red flagging' is a policy matter for government and the community. It is an important debate. At present, the view prevailing is that expressed by Paul Clitheroe – retail investors should be allowed to make their own choices. ASIC's job is to push the regulatory remit to the limit, as we have been doing, to arm retail investors to make those choices. It is not to prohibit or 'red flag' products. This debate, however, should continue particularly as we move into the new cycle which will inevitably be new products and new risks for retail investors.

Tony D'Aloisio is Chairman of the Australian Securities and Investments Commission.

Last updated: 13/07/2010 12:00