ETHICS AND FINANCIAL SERVICES

ETHICS AND FINANCIAL SERVICES

QUESTION ONE

The Interim report of the Royal Commission provides several cases that demonstrate various aspects of greed in today’s business environment considering the perspective of agency theory. It is evident that a culture of greed was the result of various cases of remuneration mis-incentives. The first case study pits a company called NAB whose employees earned various incentives based on erroneous agency relationships (Commonwealth of Australia, 2018). The company’s employees remain tasked with various roles as part of the company’s duties to the stakeholders. Its shareholders would have been especially interested in any business incentives systems in place because of the effects such systems have on their profit margins and dividends. Agency theory dictates that the principal and agent’s objectives and modus operandi must be aligned in order to prevent conflict of interest and liability or trust issues (Bottomley, 2016). However, when the employees used financial matters to calculate their incentives as opposed to compliance ones, this demonstrates a keenness to financial gain at the expense of compliance and the principal’s bottom-line.

Another case presented in the Interim report of the Royal Commission presented CBA’s management and various cases of using incentives to boost company image and performance. The company processes mortgages from various sources and earns commissions from these activities. However, when the management began to issue upfront and tail commissions intended to influence the company’s volume of mortgages handled with little consideration for compliance or customer welfare, it was evident that greed has taken over (Commonwealth of Australia, 2018). In this case, the management began using tactically designed commission to influence the volume of mortgage business it handled. Concurrently, much of the customers benefitting from these mortgages had issues that may have compromised their position but the management at CBA ignored this in favor of the lucrative gains. According to the agency theory, the agent is allowed to negate a business deal when the principal’s interests are at stake (Bottomley, 2016). However, CBA management ignored this theoretical premise and continued cultivating a culture of greed based on remuneration misincentives.

The third case study in the Royal Commission’s interim report presented the financial misbehavior of ANZ. As a company deeply involved in advancing home loans to individuals and organizations, ANZ relied heavily on investigations into the financial position and legality of the borrowers using statements of financial position. However, when one dubious customer called Mr. Regan borrowed a loan and his financial details proved sketchy, the company still advanced a 30-year-old loan against his house (Commonwealth of Australia, 2018). Seemingly, ANZ was not concerned about the customer’s financial dealing even when preliminary investigations showed him using the cash for purposes other than what was indicated at the time of taking out the loan. Unfortunately, the borrower was involved in an international scam that defrauded such borrowers huge amounts of money. The agency theory states that the agent must protect the interests of his or her principals’ interests, more so from unlawful and fraudulent activity that could lead to loss or liability (Bottomley, 2016). It seemed that ANZ was not concerned about the borrower’s financial dealing as long as he took out the loan and had substantive security. Therefore, ANZ does not care about its customers; rather it does about the financial gains from interest and security in case of default. Once more, this ruthless company demonstrated how a culture of greed could be cultivated through crafty remuneration misincentives.

QUESTION TWO

Australia is battling a rising number of cases of financial misconduct in its banking, mortgage, and financial advisory sectors due to several reasons. Even after the Royal Commission’s harsh report and Treasurer’s Josh Frydenburg’s stern warning, the vices seem to be steadfast. The first reason for this phenomenon is a continued culture of greed among major stakeholders in the financial and mortgage sectors (Kehoe et al., 2018). Since the renowned Lehman Brothers scandal paralyzed much of the American financial sector, most banks were found to have been engaging in selfish interests. The report highlights several organizations engaged in questionable behavior with regards to financial prudence and agency theory. Banks would lend borrowers loans even while their financial engagements are undefined, while mortgage brokers did not care about homeowner welfare as long as business volume increases through upfront and tail commissions, are some of the ugly examples.

Competition in the banking, financial management, and asset financing sectors has also been stiff due to the effects of major economies such as the United States and the EU suffering deflation. Consequently, many companies in the Australian financial sector seem to have resorted to recklessness and fraudulent behavior that is both non-compliant and unaligned with agency theory (Welsh and Morabito, 2014). In order to stay afloat, many businesses engaged in mortgage brokerage, house loans, and asset financing started ignoring the warning signals in borrower’s financial affairs in favor of their business gains (Sossin, 2011). The results reflected in many cases of legal liability where aggrieved principals reported the selfish financial policies and remuneration practices of these companies.

A relatively weak regulatory and oversight framework was also to blame in the Australian cases mentioned the Frydenburg. Before the Lehman Brothers scandal and other subsequent financial meltdowns, Australia’s government had begun relaxing its oversight and regulation of financial instructions paving the way for fraud and misconduct. While the ASX and in deed the government have both reacted to these worrying circumstances, the damage has already occurred as highlighted in the interim report. Perhaps the recent changes at the leadership of Australia’s financial services watchdog were indicative of the government’s realization that its oversight capability was weak.

Mr. Frydenburg’s call for businesses in the financial sector to uplift their standards and start putting people first is achievable. However, all the stakeholders would have to come together in perfect concern and with clear goals to achieve this difficult objective (Kehoe et al., 2018). First, the businesses themselves must change their operational attitude from one drive purely by profit to one that considers the welfare of their principals. Such a move would enable them cater to the welfare of their customers before considering profits. Secondly, the government would need to implement revised oversight and punitive measures to deter any unscrupulous businesses from continued operation. Finally, the customer would require demanding the best services and full disclosure from their agents. That would involve reporting suspicious financial activity from their financial services partners.

QUESTION THREE

Comparing the behavior of institutions involved in the American financial mismanagement scandal that caused the global economic meltdown with Australia’s exposes several worrying similarities. The first similarity emanates from the financial institutions segment where borrowing was uncontrolled and lacked fiscal oversight (Worthington, 2013). It is impossible to speak about the American case without mentioning Lehmann Brothers, one of the largest investment banks to fall due to financial mismanagement (Adu-Gyamfi, 2015). Many financial reporting practices this particular institution used were non-compliant and served to encourage shareholders about its financial position. Similarly, several Australian financial institutions were involved with ‘cooking books’ in order to maintain a positive image.

Both the American and Australian financial scenarios also involved mishandled mortgage practices. The Americans used a technique called ‘short selling’ which involved financing homes while the financial security attached to repayment was not fully verified (Beccar-Varela et al., 2017). Some Australian home loan companies and mortgage brokers would finance such assets without carrying out the proper due diligence thus encumbering borrowers in unclear circumstances, which is very risky in such volatile industries.

The use and abuse of incentive systems also seems to feature in both the American and Australian financial misbehavior scenarios. America’s financial oversight and regulatory organization had relaxed its stance on financial misconduct leading to lenders as big as Lehman Brother engaging in cooking accounts (Beccar-Varela et al., 2017). Australia’s oversight and regulatory body also seemed to relax as depicted by the sheer brazenness of companies such as CBA to engage in misincentives to propel business volumes. Such laxity by the two countries’ oversight and regulatory bodies created the best environment for financial recklessness and misconduct.

A repeat of the Royal Commission’s interim findings can be avoided if the business organizations involved heed to Mr. Frydenburg’s advice. Considering the events preceding this report’s publication and its subsequent establishment in the financial services environment, most stakeholders will adhere to the treasurer’s advice (Kehoe et al., 2018). Although Mr. Frydenburg issues one stern warning, it was accompanied by several policy-based structural changes. These changes would serve to punish any defaulters. They also demonstrated the Australian government’s dedication to revamping its financial and banking services sectors like the United States.

The first national policy was the enactment of the Banking Executive Accountability Regime. This policy sought to bring all executive banking and financial services business managers under scrutiny for remuneration changes. Any unwarranted or dubious incentive-based changes would be scrutinized at the company level to prevent using remuneration misincentives to cultivate greed in the industry.

Another structural change that was intended to correct financial recklessness in the banking and financial services sectors in Australia was changes at the ASIC. The Australian Securities and Investment Commission is responsible for oversight and regulating all business activities in financial services and banking businesses (Sossin, 2011). Previously, the commission had allowed all manner of financial and professional misconduct to occur while not taking much action. Such laxity led to the deterioration of the entire industry to a level where even mortgage handlers seemed content with financing international fraud. However, the new leaders at ASIC are proven business, financial management, and legal experts keen to turn the entire Australian financial services industry around.

The tough stance taken by Australia’s Treasurer Josh Frydenburg also contributes to the policy enforcement initiative the Australian government has invested in the matter. As the head of Australia’s financial prudence effort, his stern warning to all the stakeholders in the Australian financial services sector should suffice in changing the minds of all agents and their principals. He used references to the rule of law and its enforcement while making his statement on the matter. This move is a clear indication that Australia’s tough financial misconduct laws were ready for any defaulters (Welsh and Morabito, 2014). Such a statement from the country’s treasurer must have boosted the existent deterrent mechanisms.

REFERENCES

Adu-Gyamfi, M. (2015). The Analysis of the Collapse of Lehman Brothers. SSRN Electronic Journal.

Beccar-Varela, M., Mariani, M., Tweneboah, O. and Florescu, I. (2017). Analysis of the Lehman Brothers collapse and the Flash Crash event by applying wavelets methodologies. Physica A: Statistical Mechanics and its Applications, 474, pp.162-171.

Bottomley, S. (2016). The constitutional corporation. London: Routledge.

Commonwealth of Australia (2018). Interim Report: Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Interim Report. [online] Sydney: Royal Commission into Misconduct in the Banking and Financial Services Industry, pp.151-239. Available at: https://financialservices.royalcommission.gov.au/Documents/interim-report/interim-report-volume-2.pdf [Accessed 4 Dec. 2018].

Kehoe, J., Eyers, J., Turner, S., McInnes, W. and Frost, J. (2018). Josh Frydenberg wary of banking royal commission rules hurting economy. [online] Australian Financial Review. Available at: https://www.afr.com/business/banking-and-finance/josh-frydenberg-wary-of-royal-commission-rules-hurting-economy-20180930-h161xd [Accessed 4 Dec. 2018].

Sossin, L. (2011). Revisiting Class Actions Against the Crown: Balancing Public and Private Legal Accountability for Government Action. SSRN Electronic Journal.

Welsh, M. and Morabito, V. (2014). Public V Private Enforcement of Securities Laws: An Australian Empirical Study. Journal of Corporate Law Studies, 14(1), pp.39-78.

Worthington, A. (2013). Financial literacy and financial literacy programmes in Australia. Journal of Financial Services Marketing, 18(3), pp.227-240.