THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
CORPORATE LAW ECONOMIC REFORM PROGRAM (AUDIT REFORM AND CORPORATE DISCLOSURE) BILL 2003
EXPLANATORY MEMORANDUM
(Circulated by authority of the Treasurer,
the Hon Peter Costello, MP)
Corporate Law Economic Reforem Program (Audit Reform and Corporate Disclosure) Bill 2003 1
Outline 1
Abbreviations 4
Financial Impact Statement 6
Regulation Impact Statement 8
Notes on Clauses 80
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1.2 The most recent stage in the Government's reform agenda is CLERP 9. A discussion paper -- Corporate Disclosure: Strengthening the financial reporting framework -- was released in September 2002 and proposed a range of measures designed to enhance audit regulation and the general corporate disclosure framework. The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (the Bill) implements the CLERP 9 measures and recommendations contained in the Ramsay report Independence of Australian Company Auditors (Ramsay report). The Bill also takes account of the relevant recommendations of the report of the Joint Committee of Public Accounts and Audit's Report 391 (Review of Independent Auditing by Registered Company Auditors). In addition, the Bill implements a number of recommendations of the HIH and Cole Royal Commissions.
1.3 The Bill was released for public consultation on 8 October 2003 and over 50 submissions were received. The Business Regulation Advisory Group was consulted on both the policy proposals and the provisions of the Bill.
1.4 The underlying objective of the reforms is to improve the operation of the market by promoting transparency, accountability and shareholder activism. To this end, the Bill sets up a framework with the following features:
• Measures designed to improve the reliability and credibility of financial statements through enhanced auditor independence:
- The role of the Financial Reporting Council (FRC) will be expanded to cover oversight of the audit standard setting process and monitoring and advising on auditor independence.
- Auditors will be required to meet a general standard of independence and make an annual declaration that they have maintained their independence.
- Disclosure will be required of certain matters in relation to all non audit services.
- Restrictions on certain employment and financial relationships will be introduced and/or enhanced.
- Auditors will be required to rotate after five years (and up to seven years where ASIC relief has been granted).
- Auditors will be required to attend company Annual General Meetings (AGMs).
- Australian Securities and Investments Commission (ASIC) will be given a power to impose conditions on auditors' registration.
• Improved enforcement arrangements:
- The operational capacity of the Companies Auditors and Liquidators Disciplinary Board (CALDB) will be enhanced by appointing a deputy chair and facilitating concurrent hearings. In addition, the majority of members will be non accountants.
- A Financial Reporting Panel (FRP) will be established to resolve disputes between ASIC and companies regarding the application of accounting standards.
- Auditing standards will be made legislative instruments in the same way as Australian Accounting Standards Board (AASB) accounting standards.
- Protection will be available for employees and others who report suspected breaches of the law to ASIC and internally within the company.
- The obligations for auditors to report suspected breaches of the law to ASIC will be strengthened.
• Measures to better allocate and manage risk:
- Auditors will be able to incorporate and a regime of proportionate liability will be introduced. Incorporation will protect auditors who are not responsible for loss caused by another auditor in the audit firm. Proportionate liability will ensure that liability rests with all defendants in proportion to their contribution to the plaintiff's loss. The proportionate liability reforms are of general application and are not confined to auditors.
• Better disclosure to shareholders and improved shareholder activism:
- The presentation of disclosure documents and the operation of the secondary sale provisions are being improved.
- Disclosure requirements applying to director and executive remuneration will be enhanced and shareholders will be better equipped to hold directors accountable for their decisions regarding remuneration.
- Shareholders will have greater ability to ask auditors questions regarding the conduct of the audit and the content of the audit report.
- Mechanisms for shareholders to participate and vote in general meetings will be improved.
• Better enforcement mechanisms for continuous disclosure:
- The maximum civil penalty for a contravention of the continuous disclosure (and other financial services civil penalty) provisions by a body corporate will be increased.
- Persons involved in a contravention of the continuous disclosure regime by a body corporate will be subject to civil penalties.
- ASIC will be given the power to issue infringement notices specifying payment of a financial penalty in relation to contraventions of the continuous disclosure regime.
• A specific duty on analysts to manage conflicts of interest.
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| HIHRC
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HIH
Royal Commission
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| IAASB
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International
Auditing and Assurance Standards Board
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| IASB
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International
Accounting Standards Board
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| IASC
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International
Accounting Standards Committee
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| ICAA
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The
Institute of Chartered Accountants in Australia
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| IFAC
|
International
Federation of Accountants
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| JCPAA
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Joint
Statutory Committee of Public Accounts and Audit
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| NIA
|
National
Institute of Accountants
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| PDS
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Product
Disclosure Statement
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| Ramsay
report
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Independence
of Australian Company Auditors
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| SEC
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Securities
and Exchange Commission
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| Trade
Practices Act
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Trade
Practices Act 1974
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3.2 In the 2003-04 Budget, it was announced that the Australian Securities and Investments Commission (ASIC) would be provided with funding of $12.3 million over four years for its role in the implementation of CLERP 9. This funding will enable ASIC to conduct surveillance, investigate and take enforcement action in relation to alleged contraventions of the CLERP 9 provisions. Further funding will be subject to review.
3.3 It was also announced in the 2003-04 Budget that $4 million would be provided over four years to support the expanded role of the Financial Reporting Council, which will include oversight of audit standard setting and auditor independence issues.
3.4 These allocations for ASIC and the Financial Reporting Council total $16.3 million over four years, or $4.1 million per annum.
3.5 Funds will be expended in the establishment of the Financial Reporting Panel (FRP). There will also be ongoing costs associated with the running of the FRP. Funding will be administered along similar lines to the arrangements that apply to the Takeovers Panel, which falls within the Treasury portfolio. The introduction of referral fees will provide a mechanism for some of the running costs to be recouped.
3.6 The Bill will provide a mechanism for ASIC to issue infringement notices for alleged contraventions of the continuous disclosure provisions of the Corporations Act. These notices would contain a financial penalty which would be payable to the Commonwealth.
3.7 The Bill contains provisions that amend the administrative arrangements for the registration of auditors and the lodgement of documents by auditors. While fees will be prescribed for these activities, the low number of transactions involved means that there will be negligible effect on Commonwealth revenue.
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4.2 The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (`the Bill') is the next stage in the Government's reform agenda. It will promote the Government's broad economic objectives of increasing employment and growth by ensuring that regulatory structures remain strong, modern and flexible without burdening business with unnecessary regulation. The proposals in the Bill will implement measures that strengthen, as well as build on, the previous CLERP reforms.
4.4 CLERP 9 was released in September 2002 and over 60 submissions were received by the time the consultation period ended in November. Since then, the Government has met with a broad range of stakeholders to discuss the proposals.
4.5 The Treasurer released the draft Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (the CLERP 9 Bill) for public comment on 8 October 2003. The period for public comment closed on 10 November 2003. Over 50 submissions were received from a broad range of stakeholders.
4.6 The Business Regulation Advisory Group (BRAG) was consulted on both the policy proposal paper and the Bill. BRAG is made up of senior representatives from the business community and was established specifically to advise the Government on proposals arising out of CLERP.
4.7 The Bill also implements recommendations of both the HIH and Cole Royal Commissions and takes account of relevant recommendations of the Joint Committee of Public Accounts and Audit Report 391 (Review of Independent Auditing by Registered Company Auditors).
4.9 The sound operation of Australia's financial markets is dependent upon parties such as auditors providing information or services to investors free from any bias, undue influence or conflict of interest. Auditor independence is concerned with the auditor's capacity, including the perception of that capacity, to exercise objective and impartial judgment in relation to the conduct of an audit.
4.10 The accounting profession has undergone a substantial transformation and the process of change continues. There has been a continuing trend in Australia and overseas for audit firms to merge, resulting in increased size, both domestically and internationally. Accounting firms have established international networks, affiliating under common names. There has also been a significant increase in non-audit services provided by audit firms to their clients, both in terms of the range of services offered and as a proportion of total firm revenue. Accounting firms have become multi-disciplinary service entities and have entered into new forms of business relationships with their clients which can potentially compromise independence.
4.11 The impact on investment levels and efficient operation of the market can be detrimental where shareholders and investors lose confidence in the market as a result of the persons that they rely on not acting independently. Given that a loss of confidence in the market can impact severely on operation of capital markets and the economy more generally, it is essential that broad measures be put in place which will promote independence and ensure that parties operate free from conflicts of interest.
4.12 Over recent years there have been a number of corporate collapses which have called into question the degree of independence of auditors. These cases have demonstrated that while a company's actual financial position may have been poor, the financial statements and the audit report did not reflect the true condition of the company. This has impaired the ability of shareholders and the market more generally to adequately assess the financial health of their investment. The proposals to promote independence will improve the quality and reliability of information provided to the market.
• A general requirement of auditor independence.
• A requirement that auditors make an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct.
• The introduction of restrictions on specific employment and financial relationships between auditors and their clients.
• The imposition of mandatory waiting periods before partners of audit firms, directors of audit companies and audit personnel may join an audit client as a director or in a senior management position.
• A requirement for the compulsory rotation of auditors after a fixed number of years.
• A requirement for an auditor to attend the AGM of a listed company at which the audit report is tabled and to answer reasonable questions about the audit.
• A strengthening of the oversight arrangements of an audit firm's procedures and processes, and the audit standard setting process. In particular the Financial Reporting Council (FRC) will assume responsibilities for overseeing the audit standard setting process and auditor independence.
• A requirement for listed companies to disclose in their annual directors' report the fees paid to the auditor for each non-audit service, as well as a description of each service. In addition, the annual directors' report of each listed company must include a statement by directors whether they are satisfied that the provision of non-audit services does not compromise independence.
4.15 Many of these requirements are contained in rules of professional bodies and apply to members of those bodies only. The majority of the above proposals will apply to all 7075 registered company auditors regardless of membership of professional bodies. The audit committee requirements will apply to all public companies and the fee disclosure requirements will apply to public companies, registered managed investment schemes and large (and certain small) proprietary companies.
4.17 The Bill requires an auditor to give the directors of a company an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct.
4.20 The declaration of independence effectively builds on the general statement of principle and is a means of assuring investors, shareholders and the market more generally that the auditor is complying with the general requirement to be independent.
4.21 The legislative measures will apply a consistent and objective standard of conduct across the auditing profession and thereby promote the credibility and reliability of auditing reports and financial statements. The inclusion of an objective standard in the general auditor independence requirement is critical for enforcement purposes because objectivity, being a state of mind, is not, except in unusual circumstances, subject to direct proof. The difficulties associated with identifying a compromise of independence are also inherent in the nature of the audit process. Accordingly, the perception of auditor independence, as demonstrated by external facts and circumstances, under an objective standard, takes on great importance.
4.22 A legislative requirement in many cases will formalise and reinforce conduct which many auditors are, or should as a matter of best practice be complying with. In this respect the compliance costs that these proposals give rise to are expected to be minimal or at least comparable to costs currently incurred by auditors.
4.23 There are a number of short-term costs that will be incurred by auditors who do not, as a matter of best practice, act independently of their client or who do not follow the rules of the professional bodies. These costs will primarily be in the nature of administrative costs arising as a result of implementing measures that are necessary to comply with the requirements, such as the establishment of quality control systems to detect and prevent threats to auditor independence. It is expected that compliance with the general requirement and declaration of independence will not give rise to any significant compliance burden in the longer term.
4.32 The Ramsay report noted that a particular concern in Australia has been retired audit partners joining the boards of their audit clients. Where this occurs, it is often seen as a particular threat to the independence of the audit firm.
4.35 The HIHRC also recommended that there should be a prohibition on any more than one former partner of an audit firm, at any time, being a director of or taking up a senior management position with the audit client.
4.40 A blanket prohibition on certain non-audit services would provide the maximum assurance to shareholders and regulators that the auditor and its client are not contracting non-audit services that threaten independence.
4.41 When an audit firm provides non-audit services to a client it is serving two different sets of clients: management in the case of non-audit services; and the audit committee, the shareholders and all those who rely on the audited financial statements in the case of the audit. In serving these different clients the audit firm is subject to conflicts of interest.
4.42 A rule prohibiting audit firms from providing non-audit services to their clients would be relatively easy to administer and would not preclude an audit firm from providing non-audit services, as long as those services are not provided to audit clients.
4.43 Such an approach would however place Australia out of step with many jurisdictions and would not recognise that the provision of non audit services per se does not compromise independence but rather it is the possibility of dependence on the financial stream flowing from those services. The HIH Royal Commission report did not propose a blanket prohibition on non-audit services.
4.44 A modification of this approach would be to prohibit only specified non-audit services as in the US. This may give rise to a culture of adherence to rules rather than the underlying principle of ensuring independence. It would be almost impossible to draft legislation specific enough to prohibit non-audit services based on the substance of work to be performed.
4.46 In addition, there is no solid evidence of any specific link between audit failures and the provision of non-audit services, and non-audit services have been provided by audit firms to their clients for many years. A ban should not be imposed in the absence of compelling evidence of a problem.
4.47 Option 2 recognises that audit firms increasingly need specialists to provide critical audit support. Attracting and retaining these specialists, and motivating them to provide direct audit support, may be hampered if they were to be prohibited from providing non-audit services to clients. On some occasions it may be advantageous to the company and shareholders for the auditor to provide non-audit services, particularly where that service benefits from an intimate knowledge of the business. Therefore, an unintended consequence of a prohibition on auditors providing non-audit services to their clients could be to reduce the effectiveness of business advisory services received by the company.
4.48 The mandatory disclosure of non-audit services and the fees attaching to those services will help the market identify the extent of non-audit services provided and the degree of fee dependence. It is not expected that the requirement will give rise to significant compliance costs as the accounting standards already require companies to disclose fees for audit and non-audit services on an aggregate basis. To meet the proposed obligation, companies will be required to keep separate records of fees for audit and non-audit services. It is anticipated that many companies would already keep such records and there would therefore not be any administrative costs in the form of record keeping. In terms of the actual disclosure, it is expected that compliance costs will be negligible.
4.53 Audit partner rotation was considered an appropriate measure to promote independence by ensuring that audit partners do not remain with clients for significant periods which allow inappropriate relationships to develop which may compromise independence. It was considered appropriate that the rotation requirements be limited to the lead engagement and review partners as it is these partners who are responsible for the audit opinion and have the ability to control the work of other members of the engagement team. It is at this level that independence concerns are greatest. It was also consider appropriate to require rotation after five years as a means of enhancing the perceived independence of audit partners.
4.54 As a result of the rotation requirements, audit firms may incur costs as new auditors take time to become familiar with the client, its operations and associated risks. These costs will be present at each new audit engagement however the costs could be minimised through appropriate transitional arrangements between the auditors. Under the Bill's transitional arrangements the rotation requirements will not apply until two years after the Bill comes into effect. This will give auditors and listed companies time to prepare for a change in auditor should one be needed as soon as the requirement takes effect.
4.56 In addition, given the small market for auditors in Australia, especially at the large end of the market which is characterised by only four suppliers of audit services, it was considered that companies should be free to choose their auditor.
4.57 The marginal benefit of rotating audit firms rather than just partners would be minimal and would not justify the significant compliance costs, in terms of disruption and loss of expertise that it would entail.
4.63 The attendance of the auditor at the AGM may give rise to costs for companies to secure the auditor's attendance. It is difficult to quantify such costs as they would be dependent upon individual fees charged by auditors and the length of time the auditor spends at the AGM. The benefits of improved accountability are however considered to outweigh any additional costs.
4.73 Currently there is minimal oversight of the auditing profession by Government agencies. Instead, the professional accounting bodies play a large role in overseeing the profession. Concerns exist that this does not promote independence, nor the perception of independence, as the professional bodies could be expected to champion the interests of their members rather than broader community interests. There is the added concern that auditors who are not members of the professional accounting bodies are subject only to minimal supervision by ASIC (for example, the requirement to lodge a triennial statement). As a means of addressing these concerns the following options were considered.
4.75 Under this option the professional bodies would continue to develop ethical and procedural rules dealing with appropriate standards of behaviour for their members and the manner in which accountancy practices are to be conducted.
4.76 The AISB is a mechanism that could provide that supervisory function and provide an independent analysis of the self-regulatory functions and practices of the profession.
4.77 This option however would see the creation of a separate board with associated costs to the industry of establishing and maintaining the board.
4.78 In addition AISB would not take on any functions relating to audit standards setting.
4.80 The benefits of having the FRC monitor auditor independence would be similar to option 1 however the cost burden would be spread over existing FRC stakeholders, being the Government, accounting profession and business.
4.81 In order to promote greater independence in the auditing profession, responsibility for audit standard setting could be brought within the FRC's functions and thereby complement the FRC's current functions in relation to the setting of accounting standards. This proposal would complement the FRC's current role and would bring under one umbrella responsibility for standard setting within the financial reporting framework thereby achieving synergies in the administration of accounting and auditing standard setting.
4.85 Professional groups have traditionally dealt with their unlimited liability exposure for professional default through professional indemnity insurance, which insures against loss arising from professional services offered by the insured professional.
4.86 Australia is currently experiencing a `hard insurance market' that is, a market characterised by tougher risk selection by insurers. While the Australian experience has been exacerbated by the collapse of a major domestic player in HIH (which held around 35 per cent of the professional indemnity market), globally most classes of insurance have moved into a hard market cycle in the last two years drawn especially by a world-wide downturn in investment returns and losses arising from the terrorist attacks on 11 September 2001. In the case of professional indemnity insurance, this has been compounded by major claims emerging out of the collapse of Enron and other major corporations in the United States of America and elsewhere.
4.87 Specifically, professional groups are reporting that they are experiencing extreme difficulties with the availability and cost of professional indemnity insurance. This is a result of fewer insurers offering the product, while those insurers that do are severely restricting the scope of services they are prepared to cover.
4.88 Exposing professionals to unlimited personal liability could have significant supply side ramifications if it discourages new entrants and leads to the exit of existing players in these occupations.
4.89 There is evidence to suggest that the lack of professional indemnity insurance is leading to a withdrawal of services provided by some occupational groups.
4.90 For example, the Institute of Chartered Accountants reported in a January 2003 survey of members that over half are considering to cease, or have ceased, offering services, particularly audit, because of rising insurance costs. The Association of Consulting Engineers Australia also reported in a January 2003 survey that firms are withdrawing services in areas where insurance is unavailable or unaffordable, such as pollution control, asbestos removal and air-conditioning treatment to combat legionnaires disease.
4.91 Such developments, obviously, have broad economic ramifications.
4.92 The inability of professionals to obtain liability insurance on reasonable terms becomes even more problematic in circumstances where Australian governments increasingly are requiring such cover by law. For example, the Financial Services Reform Act 2001 obliges financial players to have `adequate means of compensating' wronged consumers. This will, in effect, mean that in a large number of cases, professionals will be required to hold professional indemnity insurance.
4.93 From the data available, it is not possible to determine how many professional service providers are operating without insurance cover for a part or all of their business. Clearly, it will not be possible for consumers to access appropriate damages in the case of liability if a professional is operating without insurance or sufficient assets.
4.94 Professional groups report that the greatest impact of the lack of professional indemnity insurance is being felt by small to medium sized businesses and businesses in regional areas. Less impact is being felt by large firms who have sufficient capital to self-insure up to certain levels and insure above these levels on the international reinsurance market. This will cause an impact on competition where only larger firms can continue to provide professional services.
4.95 The primary concern for Government with the lack of appropriate insurance therefore is threefold. Firstly, many professionals may be operating without appropriate insurance cover, and divorcing themselves from assets through discretionary trusts and the like, leaving consumers unable to access appropriate damages in the case of negligence. Secondly, a contraction of supply of professional services is likely to lead to reduced competition. Finally, the withdrawal of professional services, especially in areas critical to public health and the like, will adversely impact on the wellbeing of the community.
4.96 It is likely, moreover, that most, if not all, of the generally higher costs of professional indemnity insurance will ultimately be passed on to consumers.
4.97 The CLERP 9 paper discussed the accounting profession's ongoing concerns about the present unlimited liability regime to which auditors are exposed for professional default. The accounting profession, and other professional groups, have proposed that the current rules of joint and several liability should be replaced with proportionate liability as one of the possible remedial measures to address their concerns about the consequences of unlimited liability.
4.98 The CLERP 9 paper proposed that the Commonwealth should seek the agreement of the States and Territories to introduce proportionate liability for economic loss and property damage on a nationally consistent basis.
4.99 Auditors, and other professional groups, have traditionally dealt with their unlimited liability exposure for professional fault through professional indemnity insurance. Insurance plays an important role in the Australian economy. It provides a mechanism for transferring and pooling the risk of financial loss to entities with the expertise to manage the risks involved. Professional indemnity insurance insures against loss arising from professional services offered by the insured professional.
(a) Prevent the `deep-pocket' syndrome which is synonymous with professionals. The `deep-pocket' syndrome occurs when professionals are the targets of negligence actions not because of culpability but because they are insured and have the capacity to pay large damages awards.
(b) Allow insurers to more accurately price risk. Currently under joint and several liability insurers have to price for the negligent actions of third parties. Proportionate liability enables insurers to insure only against the negligent conduct of the insured.
(c) Assist professionals to obtain suitable cover at more reasonable premiums.
(d) To limit the liability of defendants for the loss suffered by a plaintiff to the extent to which each defendant is responsible for the plaintiff's loss.
4.104 The Review of the Law of Negligence recommended that in cases involving an allegation of negligence on the part of a person holding himself or herself out as possessing a particular skill, the standard of reasonable care should be determined by reference to:
(a) What could reasonably be expected of a person professing that skill?
(b) The relevant circumstances at the date of the alleged negligence and not a later date.
4.105 This rule could, obviously, be applied generally to all professionals.
4.107 The Commonwealth could not implement a professional standards legislation scheme, as such. However, Commonwealth support for such a scheme, by amending the Trade Practices Act 1974, the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001, is essential to ensuring any state and territory professional standards legislation is not undermined.
4.108 The current New South Wales scheme is most likely to form the basis for any national model of professional standards legislation.
4.111 Proportionate liability will overcome the `deep pocket' syndrome inherent in a joint and several liability regime which often sees one party bearing full responsibility for loss or damage despite the fact that a number of parties may have contributed to the loss. Proportionate liability means that liability rests with all defendants in proportion to their contribution to the plaintiff's loss. This is contrasted against joint and several liability where a defendant can be held liable for the total loss sustained, even if they contributed to the loss in a small way.
(a) purchasers of professional services:
(i) `consumer' type purchasers; and
(ii) `business' type purchasers.
(b) providers of professional services.
4.113 There is a strong consensus among all Australian jurisdictions that action is needed to address these two structural issues. In essence, the challenge is to attract a higher proportion of global risk capital back in to the Australian market for liability insurance.
4.114 Relevant too is that professionals are increasingly being required by law to hold professional indemnity insurance. For example, the Financial Services Reform Act 2001 obliges financial players to have `adequate means of compensating' wronged consumers. This will, in effect, mean that in a large number of cases, professionals will be required to hold professional indemnity insurance. Obviously, this becomes problematic when such insurance is simply unattainable or beyond the financial capacity of professionals. It seems, in fact, that there is a body of legal opinion which suggests that the law, and the consumer protection it purports to offer, would be nullified in these circumstances.
4.116 Government intervention in this form also runs the moral hazard risk that it could lead to rapid, significant increases in premium costs as the normal market constraints to pricing would effectively be removed or relaxed. Further, such a moral hazard response would negate the potential benefits of the option.
4.118 Implementing this option would re-balance the interests of defendants and plaintiffs, as was the general objective of the Review of the Law of Negligence.
4.119 This option can be viewed as another element in an overall package of required responses.
4.121 The Insurance Council of Australia has stated that professional standards legislation is one of four pillars to improve the affordability and availability of professional indemnity insurance. The other three pillars are amendments to section 54 of the Insurance Contracts Act 1984, implementing proportionate liability for economic loss and amending the Trade Practices Act 1974.
4.122 This option can be viewed as another element in an overall package of required responses.
4.125 This issue was addressed by the Davis Inquiry into the law of joint and several liability which was established by the then Commonwealth and New South Wales Attorneys-General in February 1994. The Davis Inquiry concluded that proportionate liability reforms should not be confined to professional activities because this would lead to unnecessary anomalies. For example where a builder, an architect and a local authority were found to be concurrently liable in relation to a claim for economic loss, only the architect would normally be regarded as engaging in professional activities. However, the loss caused by the wrongdoing of each is precisely the same, and the Davis Inquiry argued that none should be excluded from consideration simply on the basis of an ill-defined division between professional activities and others. This position in relation to the scope of the proportionate liability reforms has been accepted in the national model that has been endorsed by all governments in 2003.
4.126 It is accepted that while proportionate liability for economic loss limits the exposure of professionals to those matters for which they are personally responsible, it does not prevent other parties who have contributed to the wrongful act being liable for damages. As part of the proportionate liability principle, any contributory negligence on the part of a plaintiff is also taken into account in awarding damages.
4.127 Moving to proportionate liability for economic loss better reflects the responsibilities of professionals to their clients.
4.128 The main benefit, from an economic perspective, of implementing proportionate liability for economic loss is that since insurers are insuring only the risk of a particular professional, and not the risk of other professionals, insurers can be more confident in insuring risk.
4.129 Under this proposal, the costs to plaintiffs of the risk of the insolvency or inability to trace defendants may be transferred from co-defendants to the plaintiff.
• The criticism has been made that proportionate liability for economic loss places an onerous burden on plaintiffs to join all defendants to the action to recover full compensation. This argument can be countered in two ways.
• First, full compensation is a misnomer if defendants are not able to access affordable professional indemnity insurance. In the current climate, professionals are faced with extremely high premiums some with very high deductibles. It is this climate which is forcing some professionals to run `bare', that is, without adequate professional indemnity insurance. Proportionate liability is viewed by the majority of stakeholders as being a fundamental component of the current proposed package aimed at putting downward pressure on professional indemnity insurance premiums.
• Second, procedural rules associated with proportionate liability for economic loss are designed to provide the appropriate balance between the interests of plaintiffs and defendants.
• It operates so that, in applying proportionate liability to a claim, a court should have regard to the responsibility of any potential defendant who is not a party to the proceedings. Further, it requires defendants to notify a plaintiff in writing of the identity and alleged role of any other potential defendants of whom they are aware would also provide protection to plaintiffs. Defendants who fail to co-operate would risk being ordered to pay costs.
4.131 Given these procedural protections, it is highly unlikely that consumers will be materially disadvantaged by these reforms. Fundamentally, they are intended to ensure that professional indemnity insurance can be purchased at reasonable prices and that consumers therefore can have greater confidence that the professionals with whom they deal are in fact covered by such insurance.
4.132 The Commonwealth Department of Prime Minister and Cabinet, Commonwealth Department of Finance and Administration and the Commonwealth Attorney-General's Department have been consulted.
4.134 Although option 2 would achieve the dual objectives of providing protection to professionals and consumers, this would be at a significant cost to Government due to the potential cross-subsidisation between general taxpayers and the providers and users of professional services.
4.135 The Commonwealth supports the implementation of option 3. However, the Commonwealth is unable to directly implement this option. For this reason, the Commonwealth has encouraged the states and territories to implement this, and other, recommendations of the Review of the Law of Negligence. Once again, this option is viewed as one element of a broader set of measures.
4.136 The Government has endorsed option 4, to support any state or territory that implements professional standards legislation, and expects to introduce legislation to this effect into Parliament in the Spring Sittings 2003. This option is considered to be only one element in an overall package of reforms.
4.137 The Commonwealth believes that option 5 does not achieve the stated objectives and may in fact undermine the desired effect of proportionate liability for economic loss.
4.138 On balance, option 6 would appear to achieve the stated objectives better than any of the other options put forward. It would have no financial cost to business.
4.139 It is considered that the national model for proportionate liability when implemented in all jurisdictions, will contribute to an improvement in the professional indemnity insurance market across Australia.
4.142 Incorporation of auditors will address liability concerns arising as a result of accounting firms being structured as partnerships. The partnership structure means that all partners of the firm can be liable for losses caused by one partner despite the fact that they may have had no involvement in the conduct causing the loss. Incorporation will help sheet home liability to those who are actually responsible for loss or damage by quarantining the liability of auditors within audit firms to the particular auditor(s) who have caused the loss. In addition, incorporation will give audit firms a broader range of options in determining how the business is structured and managed.
4.146 In terms of the impact on plaintiffs, a plaintiff could no longer make claims on the assets of the firm and then all individual partners of the firm. The plaintiff in this circumstance would be limited to recovering from the individual negligent auditor and from the assets of the incorporated entity. On balance it is considered that the benefits of auditor liability reform which the market would receive, outweigh any additional costs that might be borne by plaintiffs.
4.148 Analysts may face conflicts of interest that have the potential to undermine their independence and hence the objectivity of research provided to investors. These conflicts are most acute in conglomerate financial services firms that provide services (such as investment banking) to companies they are analysing. In these circumstances, an analyst may be influenced to provide positive research reports about client companies.
4.149 However, the potential for conflicts of interest to arise is not limited to analysts. Financial services licensees and their representatives may also face conflicts of interest that have the potential to undermine their independence, and therefore the objectivity of the service they provide.
4.150 Market failure can result if financial services licensees and their representatives do not manage their conflicts effectively. Therefore it is considered that any new provision requiring the management of conflicts of interest should not apply only to analysts. Rather, it should apply more broadly to financial services licensees, and their representatives.
4.152 Financial services licensees and their representatives are covered by the licensing, conduct and disclosure regime contained in the Corporations Act. Currently licensees are obliged to `do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly'. There is no explicit duty in relation to the management of conflicts of interest. However, certain conflicts must be disclosed in relation to retail clients considering whether to acquire financial services or products or whether to act on personal advice.
4.154 This option could benefit consumers and the community by promoting industry awareness of independence issues. It could also benefit industry, through the flexible and adaptable nature of a voluntary regime, while incurring no additional Government expenditure or regulatory change.
4.155 The main cost of this option is that the standards might not be sufficiently stringent to ensure that investors are adequately protected and have confidence in the advice they receive. Events such as investigations by United States' regulators into the impact of investment banking on research have shown that industry self-regulation may not be adequate. The cost to consumers is that existing industry guidelines are not legally enforceable nor externally monitored for compliance, although compliance costs for industry are lower.
4.156 ASIC's research report into analyst independence, released in August 2003, concluded that Australian industry guidelines had not been adopted as uniformly and closely as is appropriate. Further, ASIC concluded that the industry guidelines are not sufficient to overcome the deficiencies in analyst firm's management and disclosure of conflicts of interest that it identified in its report.
4.157 A consideration of the costs and benefits suggests that while industry initiatives would continue to play a valuable role, government initiatives might further improve outcomes.
4.159 This option could be expected to result in higher standards than relying on industry initiatives alone. In addition, ASIC could link its guidance to the general duty to act `efficiently, honestly and fairly'. This could facilitate enforcement action by ASIC under the licensing regime against licensees. Consumers could benefit from more transparent disclosure of conflicts. A collaborative approach is also a more flexible and less costly means of influencing business practices than additional prescriptive legislative rules.
4.160 There would be costs associated with ASIC developing and administering further guidance, although consultation with industry would help to minimise these costs. Principles-based guidance, which is flexible enough to accommodate different operating structures and overseas developments, is unlikely to impose substantial compliance costs on industry.
4.161 ASIC guidance, developed in consultation with stakeholders, would help to ensure an appropriate response to managing conflicts of interest and this would benefit consumers without imposing unnecessary compliance costs on industry.
4.163 A conflicts management duty would be in addition to the `efficiently, honestly and fairly' duty. Introducing an additional duty would provide a stronger legislative backing for any guidance issued by ASIC, while being consistent with the Government's principles-based approach. This would make it clearer that ASIC could take enforcement action rather than relying on compliance with the general duty. It could promote certainty by making each licensee's responsibility for managing conflicts of interest clearer on the face of the legislation.
4.164 It is unlikely to impose additional obligations on most licensees, because licensees are already expected to manage conflicts (either as part of the general duty or a matter of best practice). Both an additional duty and ASIC guidance may impose a higher cost on licensees not currently managing conflicts of interest adequately. However, ASIC guidance would be worthwhile in terms of enhanced enforcement and investor confidence.
4.165 On balance, an additional duty would clarify and reinforce the overriding obligation to manage conflicts of interest by supplementing the general duty to act `efficiently, honestly and fairly'.
4.167 The CLERP 9 proposal for further ASIC guidance, in conjunction with effective industry initiatives, received strong support from industry. This approach involved general duties and guidance rather than a heavily prescriptive approach. It was considered that stakeholders could actively contribute to ASIC's consultation process to ensure the guidelines effectively address analyst independence and conflict management issues.
4.168 ASIC supported the addition of a specific licensing obligation to manage conflicts as a means of enhancing its capacity to remedy inadequate conflicts management practices.
4.170 The effectiveness of ASIC guidance should be monitored after there has been some experience with its operation. This would provide an opportunity to consider whether any further legislative changes are required.
4.172 These disclosure requirements are intended to address information asymmetries between product issuers and investors. In the absence of these requirements, issuers of financial products may withhold adverse information from investors or selectively disclose materially price sensitive information about their products to particular investors. In addition, the nature of financial products means that investors may be unable to obtain the information that they require to make an informed decision about whether to acquire or dispose of a financial product. Alternatively, the overall cost to investors of compiling this information may greatly exceed the cost to an issuer of obtaining and disseminating the same information.
4.173 Disclosure requirements are intended to facilitate confident investor participation in financial markets (especially in relation to so-called `retail investors') by ensuring that investors have equal and timely access to the information necessary to evaluate investment opportunities (as well as to determine whether a particular investment is suited to their needs).
4.174 Disclosure requirements are also intended to ensure that shareholders are properly informed in relation to their rights to participate in, and exercise voting rights at, company general meetings. This enables shareholders to influence the direction of companies in which they invest.
4.175 It is important to ensure that disclosure requirements are not too burdensome for issuers so that they increase the cost of capital. It is also necessary to ensure that disclosure requirements achieve an appropriate balance between the need to maintain an informed market and the need to safeguard the commercial performance of issuers by allowing them to withhold information whose disclosure might be commercially detrimental.
4.176 CLERP 9 examined three aspects of disclosure by product issuers:
• fundraising provisions that generally apply when financial products are first issued to retail investors (as well as in certain secondary sale situations);
• continuous disclosure provisions (which apply to product issuers that are disclosing entities and require them to disclose materially price sensitive information on an ongoing basis); and
• shareholder disclosure in relation to company meetings and resolutions.
• Difficulties encountered by retail investors in easily comprehending the contents of prospectuses and other disclosure documents.
• Additional compliance costs associated with the need for issuers of continuously quoted managed investment products to disclose information that has already been made publicly available and therefore readily available to investors.
• Excessive limitations on financial institutions that receive wholesale placements of financial products to on-sell these products to retail investors within 12 months without a disclosure document.
4.178 It is considered Government legislative action is needed to correct these problems because they relate to requirements set out in the fundraising provisions of the Corporations Act.
4.180 The fundraising provisions are contained in Chapters 6D and 7 of the Corporations Act and are administered by the Australian Securities and Investments Commission (ASIC). The provisions of Chapter 6D apply to shares and debentures and, with some exceptions, Part 7.9 applies to all other financial products.
4.181 The fundraising provisions require offers of financial products to retail/unsophisticated clients to be accompanied by a disclosure document that contains information relevant to the offer. These clients are unsophisticated in financial markets and receive additional protection under the Act, principally through the disclosure of relevant information to enable the client to make an informed choice about the financial product in question. They specify the information that is required to be contained in disclosure documents and provide penalties and other remedies for inadequate disclosure.
4.182 The fundraising provisions only apply to offers to retail clients. They do not apply to offers made to wholesale clients (such as financial institutions) as these persons are deemed to be able to safeguard their own interests without the need for mandatory disclosure.
4.183 These amendments are intended to improve the practical operation of the fundraising provisions in line with the Government's intention to ensure investors are fully informed when making investment decisions.
4.186 This amendment mirrors provisions introduced by the Financial Services Reform Act (the FSR Act) into the prospectus regime. This does not detract from the content of a disclosure document but ensures that it more effectively conveys the required information to the investing public.
4.190 This approach will have a minimal impact on industry. However, it will result in investors potentially not receiving effective disclosure. Disclosure documents have grown increasing complex. Whilst it is important to disclose the content required under the Act, a tendency to use legally proven or established language has meant that such documents are usually at the expense of clarity and brevity. Given that a disclosure document's main aim is to inform unsophisticated investors of relevant information, a document that does not convey such information in a manner that can be readily understood will be of limited effectiveness as an information source. It is not intended to detract from the content of a disclosure document but ensure it effectively conveys the required information to the investing public.
4.192 This option may involve an increase in compliance costs for product issuers to the extent that new disclosure documents may have to be modified to comply with this requirement. This could involve extra drafting time to ensure a document meets both the content and presentational requirements of the Act. That said, industry may benefit though shorter documents that involve less printing costs and easier marketability to the market.
4.193 Further, it is expected that greater understanding of how this presentational requirement works in practice will develop given the application of the `clear, concise and effective' requirement to both Chapters 6D and 7 of the Act.
4.194 Retail investors and the wider investing market will benefit through access to more useful information when making decisions about financial products.
4.196 These amendments mirror provisions introduced by the FSR Act into the prospectus regime and reduce the overall cost to managed investment scheme operators of preparing a PDS.
4.198 This option would ensure that retail investors continue to receive all relevant information in the PDS accompanying the offer. However, managed investment scheme operators that issue these products would continue to bear the preparation, printing and distribution costs associated with the provision of information that has already been disclosed to the market.
4.200 This option would reduce the cost to managed investment scheme operators of preparing a PDS. Furthermore, that the PDS would inform investors of their right to obtain information that was excluded from the PDS and that retail investors may consider relevant in making a decision to acquire a continuously quoted managed investment product, would reduce the risk that all relevant information may not be accessed before such a decision is made.
4.202 The Bill proposes to improve the operation of these provisions to ensure the placements market can operate efficiently. However, these amendments ensure investors are protected by receiving relevant information to make an informed decision.
4.204 This would provide greatest benefit to issuers and financial institutions. Financial institutions would have few constraints on their capacity to on-sell financial products to retail clients (provided they did not deliberately intend to circumvent the relevant fundraising provisions). This may reduce the cost of capital to issuers, since financial institutions would not require an additional risk premium in relation to constraints on their capacity to dispose of the financial products.
4.205 However, this option moves away from the Government's intention in the FSR Act to strengthen the anti-avoidance intent of the secondary sales provision. Going back to the pre-FSR Act position could mean that retail investors and the wider market do not have access to appropriate information.
4.207 This option ensures that retail investors receive adequate disclosure in relation to financial products on-sold within 12 months of being issued without a disclosure document. However, this option relies on ASIC Class Order relief to enable the practical operation of the placements market. Without relief, the current provisions of the law imposes significant demands on secondary sales as financial institutions accepting share placements would be required to incur the expense of preparing a disclosure document if they wanted to on-sell these securities to retail investors within 12 months of issue. They would therefore demand an additional risk premium from issuers, thereby increasing the cost of equity capital raising.
4.208 Even though ASIC relief could apply, introducing legislative change provides greater certainty of both the legal position and the Government's intention to facilitate the secondary sales market whilst ensuring investors are protected through access to relevant information.
Option 3
4.209 Option 3 is to build on the post-FSR Act amendments to not require further information in relation to secondary sales of securities where:
• prospectus-like information has been disclosed to the market; or
• a prospectus in relation to the same class of securities has been lodged with ASIC.
4.210 This option balances the interests of retail investors on the one hand and those of financial institutions and issuers on the other. It allows financial institutions to on-sell financial products where retail investors have reasonable access to equivalent information to that which would otherwise have been required to be contained in a disclosure document covering the relevant financial products.
4.211 Legislative change also provides a basis for additional ASIC relief where appropriate.
4.213 There was also support for the Bill's proposals in relation to continuously quoted securities and secondary sales. A range of technical queries were raised in submissions and have been largely addressed in the final Bill.
4.215 It is considered that the benefits of improved disclosure to retail investors would exceed any potential increase in compliance costs for the issuers of these products.
4.216 Further, the Bill:
• allows issuers of continuously quoted managed investment products to issue shorter, or transaction specific, PDSs (with other information available on request); and
• provides an exemption from the anti-avoidance provisions for secondary sales in relation to financial products for which retail investors can gain ready access to relevant information through:
- prospectus-like information that has been disclosed to the market; or
- a prospectus in relation to the same class of securities has been lodged with ASIC.
4.217 It is submitted that these two measures will reduce costs for financial institutions through introducing practical reforms to the regime, whilst ensuring that retail investors receive appropriate protection.
4.219 This problem has a significant impact because continuous disclosure is fundamental to the integrity of Australian securities markets. It is important that all investors should have equal and timely access to price sensitive information released by disclosing entities. Inadequate disclosure has the potential to discourage confident investor participation in securities markets. This in turn could reduce the liquidity of these markets and hence the efficiency of the price discovery process.
• This objective is most significant in relation to the most actively traded listed disclosing entities that feature the largest direct and indirect retail shareholder participation.
4.221 Responsibility for ensuring that disclosing entities comply with their continuous disclosure obligations is shared between ASIC and the relevant market operator (in relation to entities that are listed on the ASX, the Bendigo Stock Exchange (BSX) and the Stock Exchange of Newcastle (NSX)).
• ASX accounts for over 99 per cent of Australia's listed disclosing entities.
4.222 The continuous disclosure rules that apply to ASX, BSX and NSX listed entities are contained in the listing rules of the relevant market operator.
• In general, listed disclosing entities are required to immediately disclose materially price sensitive information to the relevant market operator so that it can be made available to investors. Entities are permitted to withhold information from immediate disclosure if it falls into the so-called `carve-out'. This `carve-out' is intended to avoid premature disclosure of potentially misleading or commercially damaging information. However this information may only be withheld so long as it remains confidential.
4.223 Market operators have frontline responsibility for monitoring compliance with their continuous disclosure rules and for maintaining an informed market (including requiring listed entities to remedy inadequate disclosure). They are also responsible for issuing guidance to listed entities in relation to their compliance with these rules.
4.224 In light of the significance of continuous disclosure for market integrity, the continuous disclosure rules of ASX, BSX and NSX have been given statutory backing in Chapter 6CA of the Corporations Act 2001 (the Corporations Act). Inadequate disclosure by a listed entity can result in criminal and civil action by ASIC, which administers the Corporations Act.
• ASIC currently has primary responsibility for enforcement in relation to inadequate disclosure by listed disclosing entities (including by seeking criminal and civil penalties). The penalties are intended to function as a deterrent to contraventions.
4.225 The continuous disclosure requirements that apply to listed disclosing entities are therefore based on a combination of `quasi-regulation' by market operators, reinforced by explicit governmental regulation in the form of criminal and civil penalty provisions contained in the Corporations Act.
4.226 ASIC also has direct responsibility for monitoring and enforcing continuous disclosure by unlisted disclosing entities. The continuous disclosure rules that apply to these entities are contained solely in the Corporations Act.
4.228 This included an examination of:
• the division of responsibility between ASIC and market operators (in relation to continuous disclosure by listed disclosing entities);
• procedures for the dissemination of materially price sensitive information to investors; and
• the operation of the current enforcement framework.
4.229 An examination was also undertaken of the operation of the continuous disclosure frameworks of several other jurisdictions, including the United Kingdom, the United States, Canada (Ontario), New Zealand, Hong Kong and Singapore.
4.230 Four options were considered following examination of the current enforcement framework. It is necessary to consider the impact of these options on the following persons: investors in securities issued by disclosing entities, the disclosing entities themselves, market operators (who have front line responsibility for monitoring compliance with their continuous disclosure rules) and ASIC, which has responsibility for administering the provisions of the Corporations Act which provide statutory backing to these rules and impose similar obligations on unlisted disclosing entities.
• This option involves adopting the UK approach, in which the Listing Authority of the Financial Services Authority has direct responsibility for enforcing compliance with a single set of continuous disclosure obligations that apply to all listed entities.
• ASIC would have added front line responsibility for monitoring disclosure and disseminating information in relation to listed disclosing entities to its current responsibility for penalising non-compliance.
4.233 The main benefit of this option would be to address concerns about potential conflicts of interest between the commercial objectives of market operators and their responsibilities for market supervision (especially administration of their listing rules in relation to listed entities that may be commercial partners or rivals).
4.234 However, this option would involve additional costs for ASIC (including the adoption of more complex arrangements to recover these costs from relevant market operators). In addition, it is not clear that a body such as ASIC would be as well as equipped as the relevant market operator to perform this function (especially if it lacked responsibility for monitoring trading activity).
4.235 Finally, it should be noted that market operators are already required to adopt measures to handle conflicts between their commercial and supervisory responsibilities. There is no evidence that these arrangements are not operating adequately.
4.236 The likely costs associated with this option appeared to exceed any benefits that could be achieved from increasing ASIC's responsibilities in this area.
4.237 As a consequence, it has been decided to retain the current allocation of responsibility between market operators and ASIC. Market operators are best placed to act as front line regulators because of their responsibility for monitoring trading activity as well as for receiving and disseminating price-sensitive information disclosed by market entities. Maintaining adequate disclosure by listed entities is also fundamental to the obligation of market licensees to maintain `fair, orderly and transparent' markets for financial products.
• ASIC should continue to focus on penalising inadequate disclosure (generally in relation to matters referred to it by the relevant market operator).
• It is important to distinguish this from market operators relying on their existing operating rules to impose a range of penalties (ranging from censures to substantial fines) against participants in relation to disciplinary action for contraventions of their trading and conduct of business rules.
4.240 This option would have implications for market operators and for listed entities that had not complied with their continuous disclosure obligations.
4.241 This option would impose some additional costs on market operators, since they would be required to create mechanisms and tribunals for investigating and penalising less serious instances of inadequate disclosure by listed entities.
4.242 It would also impose costs on entities that contravened their continuous disclosure obligations (although these costs would be appropriate as a means of deterring contraventions).
4.243 The main disadvantage of this option is that market operators may not have adequate investigatory powers to punish contraventions. It could also be argued that a requirement for market operators to penalise less serious contraventions of the regime might detract from their responsibility to provide guidance to listed entities and maintain an informed market by remedying inadequate disclosure.
• Market operators argued that they should be responsible for maintaining an informed market and that ASIC should be responsible for penalising breaches.
4.244 The problem with this option is market operators indicated that they would be unwilling to make the necessary amendments to their operating rules.
4.245 It has been decided, therefore, that ASIC should retain primary responsibility for penalising contraventions of the continuous disclosure regime.
4.248 However, consultation with market operators and ASIC revealed a number of potential disadvantages associated with this option.
• It could involve significant administrative costs (deriving from the need for the Government to establish and maintain a peer review body, either on a stand alone basis or as a separate division of the Takeovers Panel);
• It would have significant potential to limit the capacity of market operators and ASIC to respond to contraventions;
• It could lead to inconsistent interpretations of the continuous disclosure obligations of listed entities (which would not assist compliance); and
• It is not clear that a peer review panel would boost levels of disclosure among listed entities.
4.249 On the basis of these considerations it has been decided that the introduction of a peer review panel would not benefit investors and was more likely to reduce the effectiveness of enforcement of the continuous disclosure framework.
4.250 It has also been decided that market operators should be solely responsible for providing guidance to listed entities in relation to complying with their continuous disclosure rules and that the prospect of conflicting interpretations of these requirements was likely to reduce rather than enhance compliance.
4.251 It was noted that the Takeovers Panel has a remedial rather than a punitive role in relation to takeovers disputes. In relation to continuous disclosure, it is considered that this remedial role is best performed by market operators.
4.253 Three measures are proposed:
• an increase in the maximum civil penalty that a court may impose on bodies corporate in relation to a contravention of the continuous disclosure regime from $200,000 to $1 million;
• allowing ASIC to seek civil penalties against individuals directly and knowingly involved in such contraventions; and
• permitting ASIC to issue infringement notices to bodies corporate in relation to less serious contraventions of the continuous disclosure regime.
4.255 The main benefit of this option is its potential to provide improved incentives towards compliance with the continuous disclosure framework by increasing the likelihood that contraventions will be penalised. The proposal for the introduction of an infringement notice mechanism may also benefit ASIC by reducing the costs of pursuing less serious contraventions of the regime. This benefit would accrue if entities e