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National Finance Broking Regulation RIS Discussion Paper

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National Finance Broking Regulation RIS Discussion Paper Powered By Docstoc
					    ATIONAL INANCE ROKING
           EGULATION


          REGULATORY IMPACT STATEMENT


              DISCUSSION PAPER




The contents of this Regulatory Impact Statement Discussion Paper
are for discussion only and do not represent the views of any State
       or Territory Government or the Australian Government
Comments are invited on any aspect of the paper. Details of costs to the industry of any
proposed option are sought, as well as comment on any assumptions made in the paper.

Submissions may be sent electronically or in hard copy.

Enquiries to: Lucas Kolenberg
              (02) 9338 8937

The e-mail address for submissions is:

 broking@oft.commerce.nsw.gov.au


Submissions by post should be sent to:

National Finance Broking Regulation 2004
Policy & Strategy Division
Office of Fair Trading
PO Box 972
PARRAMATTA NSW 2124

Final date for submissions:
15 February 2005

                                                                                      2
CONTENTS PAGE

1      INTRODUCTION ............................................................................................................................ 5
    1.1        OVERVIEW ............................................................................................................................... 5
    1.2        REGULATORY IMPACT STATEMENT REQUIREMENTS ................................................................... 5
2      INDUSTRY OVERVIEW ................................................................................................................. 7
    2.1     THE FINANCE AND MORTGAGE BROKING INDUSTRY ..................................................................... 7
       2.1.1 Size and value of the broker industry .................................................................................7
       2.1.2 Value of Broker Transactions .............................................................................................7
       2.1.3 Categories of industry players ............................................................................................9
       2.1.4 Role of Mortgage and finance brokers ...............................................................................9
       2.1.5 Mortgage managers..........................................................................................................10
       2.1.6 Intermediaries who provide loan-reduction services ........................................................10
       2.1.7 Remuneration within the broker industry ..........................................................................11
    2.2     FEATURES OF THE BROKER INDUSTRY WHICH MAY IMPACT NEGATIVELY ON CONSUMERS ............ 13
       2.2.1 Increased reliance by lenders on brokers.........................................................................13
       2.2.2 Minimal barriers to entry ...................................................................................................13
       2.2.3 Conduct engaged in by fringe operators ..........................................................................14
       2.2.4 Financial consequences of accessing credit or advice from fringe players .....................18
    2.3     MAINSTREAM PLAYERS—QUALITY OF ADVICE ........................................................................... 19
       2.3.1 Financial cost of poor recommendations ..........................................................................20
    2.4     EFFECTS OF A COMMISSION BASED REMUNERATION STRUCTURE ............................................... 20
       2.4.1 Reverse competition .........................................................................................................20
       2.4.2 Practices which flow from these arrangements ................................................................20
       2.4.3 Limited capacity of consumers to differentiate between brokers..................21
       2.4.4 Fees issues.......................................................................................................................21
    2.5     DISCLOSURE OBLIGATIONS ..................................................................................................... 22
    2.6     USE OF “COLD CALLING” TO SOLICIT CLIENTS ........................................................................... 23
    2.7     FACTORS WHICH ACT AGAINST THE PROVISION OF QUALITY SERVICES ....................................... 24
       2.7.1 No ongoing relationship with clients .................................................................................24
       2.7.2 Lack of accountability .......................................................................................................24
       2.7.3 Inability of lenders to discipline “bad” brokers ..................................................................24
3      REGULATION AND REMEDIES ................................................................................................. 26
    3.1 REGULATION OF BROKERS IN AUSTRALIA........................................................................................ 26
       3.1.1 Legislation Regulating Brokers .........................................................................................26
       3.1.2 General Regulation of Brokers .........................................................................................29
       3.1.3 State/Territory Fair Trading Agencies...............................................................................30
       3.1.4 Self-Regulation .................................................................................................................30
       3.1.5 Liability of lenders for conduct of brokers .........................................................................31
       3.1.6 Accreditation of brokers by lenders ..................................................................................32
    3.2     REGULATION IN OTHER COUNTRIES ........................................................................................ 33
    3.3     CONSUMER REMEDIES............................................................................................................ 33
       3.3.1 Difficulties in accessing redress mechanisms ..................................................................33
       3.3.2 Legal Redress...................................................................................................................35
       3.3.3 Tribunal Access ................................................................................................................36
       3.3.4 Access to alternative dispute resolution ...........................................................................37
    3.4     SUMMARY OF IDENTIFIED PROBLEMS AND THE CONSEQUENCES FOR CONSUMERS ...................... 37
    3.5     LEVEL OF CONSUMER DETRIMENT ........................................................................................... 38
4      REASONS FOR GOVERNMENT INTERVENTION..................................................................... 45
    4.1     MARKET FAILURE IN RELATION TO CONSUMERS ........................................................................ 45
       4.1.1 Imperfect or costly information..........................................................................................45
       4.1.2 Fraudulent, unconscionable or misleading conduct .........................................................46
    4.2     MARKET FAILURE IN RELATION TO LENDERS ............................................................................. 47

                                                                                                                                                       3
5       OBJECTIVES OF GOVERNMENT INTERVENTION .................................................................. 49

6       POLICY OPTIONS ....................................................................................................................... 50
     6.1     RETAIN THE STATUS QUO ....................................................................................................... 50
        6.1.1 Benefits/Advantages .........................................................................................................51
        6.1.2 Costs/Disadvantages ........................................................................................................51
     6.2     SELF-REGULATION MODEL ..................................................................................................... 52
        6.2.1 Benefits/Advantages .........................................................................................................53
        6.2.2 Costs/Disadvantages ........................................................................................................53
     6.3     CONSUMER EDUCATION.......................................................................................................... 53
        6.3.1 Benefits/Advantages .........................................................................................................55
        6.3.2 Costs/Disadvantages ........................................................................................................55
     6.4     MANDATORY CODE OF CONDUCT ............................................................................................ 56
        6.4.1 Benefits/Advantages .........................................................................................................57
        6.4.2 Costs/Disadvantages ........................................................................................................57
     6.5     BROKER SPECIFIC REGULATION .............................................................................................. 58
7       PROPOSALS TO REGULATE THE BROKING INDUSTRY....................................................... 60
     7.1     SCOPE OF FINANCE BROKING LEGISLATION .............................................................................. 60
        7.1.1 Benefits/Advantages .........................................................................................................62
        7.1.2 Costs/ Disadvantages .......................................................................................................62
     7.2     HOW IS A BROKER TO BE DEFINED? ......................................................................................... 63
8       HOW WILL LEGISLATION MEET GOVERNMENT OBJECTIVES?.......................................... 65
     8.1     OBJECTIVES 1 AND 5 .............................................................................................................. 65
     8.2     LICENSING/REGISTRATION/NEGATIVE LICENSING ..................................................................... 66
        8.2.1 Benefits/Advantages .........................................................................................................69
        8.2.2 Costs/Disadvantages ........................................................................................................69
     8.3     COMPETENCY OF BROKERS..................................................................................................... 70
        8.3.1 Benefits/Advantages .........................................................................................................71
        8.3.2 Costs/Disadvantages ........................................................................................................71
     8.4     OBJECTIVES 2 AND 3 .............................................................................................................. 72
     •     PROVIDE CONSUMERS WITH SUFFICIENT INFORMATION TO CHOOSE A SUITABLE BROKER................. 72
     •     REQUIRE BROKERS TO DEMONSTRATE THAT THEIR RECOMMENDATION IS APPROPRIATE FOR THE
     CONSUMER’S CIRCUMSTANCES AND, WHERE POSSIBLE, THE BEST AVAILABLE ......................................... 72
        8.4.1 Benefits/ Advantages ........................................................................................................73
        8.4.2 Costs/ Disadvantages .......................................................................................................73
        8.4.3 Benefits/ Advantages ........................................................................................................75
        8.4.4 Costs/Disadvantages ........................................................................................................76
        8.4.5 Benefits/Advantages .........................................................................................................77
        8.4.6 Costs/ Disadvantages .......................................................................................................77
     8.5     OBJECTIVE 4 .......................................................................................................................... 78
     •     PROVIDE A MEANS OF EMPOWERING CONSUMERS TO INFLUENCE BROKER BEHAVIOUR BY PROVIDING
     CONSUMERS WITH EFFECTIVE REMEDIES AGAINST BROKERS WHO DO NOT ACT FAIRLY OR COMPETENTLY. 78
        8.5.1 Benefits/Advantages .........................................................................................................79
        8.5.2 Costs/Disadvantages ........................................................................................................80
     8.6     STAY OF ENFORCEMENT PROCEEDINGS ................................................................................... 80
        8.6.1 Benefits/Advantages .........................................................................................................81
        8.6.2 Costs/Disadvantages ........................................................................................................82
     8.7     COMPENSATION FOR CONSUMERS ........................................................................................... 82
        8.7.1 Benefits/Advantages .........................................................................................................83
        8.7.2 Costs/ Disadvantages .......................................................................................................84
     8.8     ACCESS TO AFFORDABLE REMEDIES ........................................................................................ 84
        8.8.1 Benefits/advantages .........................................................................................................87
        8.8.2 Costs/Disadvantages ........................................................................................................87
9       IMPACT ON COMPETITION........................................................................................................ 89

10      CONSULTATION ......................................................................................................................... 90
Attachment A

Attachment B

                                                                                                                                                   4
1 Introduction

1.1   Overview
Deregulation of the finance market in the late 1980s provided a major impetus to changes in
both the volume of credit products offered and also in the structure and composition of the
industry.

As new players entered the market, the competition for market share became intense. One
of the ways in which credit providers could reach more customers without a branch presence
was through intermediaries such as finance and mortgage brokers. At the same time, more
consumers were able to access credit, and the products evolved to meet demand and to
provide a differentiation between products which would provide a basis for competition.

The broking market in turn has grown to meet the demand. As products became more
complex, consumers turned to brokers to assist them in their choices. However, as has been
seen with other intermediaries who occupy a position of some power, consumers have not
always been well served and their lack of expertise has been, in many cases, exploited.

The growth in the industry has been mirrored by growth in consumer problems. State fair
trading agencies have become aware of rising levels of consumer detriment and this has
been reinforced by reports from financial counsellors and credit legal centres.

The broking market has been subject to a minimum level of regulation, but as a result of the
increasing levels of consumer detriment there have been calls by both consumer advocates
and the industry itself for governments to address the problem.

This Regulatory Impact Statement Discussion Paper details proposals to address the
problems identified.

1.2   Regulatory Impact Statement Requirements
Finance and mortgage broking issues are relevant to all jurisdictions. The Ministerial Council
on Consumer Affairs has acknowledged the importance of this issue by including it on the
strategic agenda and has agreed to progress as a matter of urgency proposals to address
the problems raised.

Proposals for standard setting and regulatory initiatives which are made at a national level
and which have the potential to restrict competition are required to include evidence that the
competitive effects of the regulation have been considered; that the benefits outweigh the
likely costs; and that the restriction is no more restrictive than necessary in the public
interest.

This document sets out the problems reported in the marketplace and identifies those
structural elements which are considered to be an impediment to effective marketplace
solutions.

Possible regulatory approaches are canvassed and proposals for a national regime are set
out, with analysis of the potential costs and benefits to the community.

Acknowledgement
Parts 2 and 3 of this paper incorporate material from the “Report to ASIC on the finance and
mortgage broker industry” compiled by the Consumer Credit Legal Centre and commissioned
by the Australian Securities and Investments Commission. The information in those parts
has been updated where appropriate and some minor changes made. Case studies in those
parts are taken from the original report, and were supplied by caseworkers. The information
in that report was obtained from surveys undertaken as part of the research, or from material
sourced elsewhere. References are provided.




                                                                                           6
2 Industry Overview

2.1     The finance and mortgage broking industry
The broker industry in Australia is relatively new, and has experienced a rapid growth in the
last ten years. This growth has resulted from the substantial increase in the variety of
mortgage products offered, strong credit growth to finance the acquisition of mortgage assets
and the recent boom in the residential property market. Industry sources suggest that the use
of brokers is as cheap or cheaper than traditional distribution methods. Their assistance can
also provide value to consumers by saving them time and money.

2.1.1 Size and value of the broker industry
IBIS World estimates that, in 2002-03, mortgage brokers generated around $630 million in
revenue. Industry gross domestic product is estimated to be approximately $271 million (see
Table 1).

Over the five-year period to 2002-2003, industry revenue increased from $332 million to
$629 million, representing an average annual growth rate of 11%. The mortgage broking
industry has also been growing at a significantly faster rate than national gross domestic
product (GDP). Industry GDP grew to $271 million in 2002-2003, and grew at an annual rate
of 9.4% in the five-year period to 2002-2003.

Higher demand for mortgage brokers' services over recent years has also led to increasing
industry profitability. The large variety of mortgage products has brought about increased
complexity for consumers in finding a suitable home loan.

2.1.2 Value of Broker Transactions
The last ten years have seen a transformation of the Australian housing finance market. In
1986–87, Australians borrowed $15 billion in housing finance from lenders (who were then
almost exclusively banks, building societies and credit unions).

The Reserve Bank of Australia data shows that total housing lending was approximately
$452.6 billion in March 20041. Current estimates of broker-introduced loans are around 30%
to 33% of total new housing loans. Based on these estimates, the total value of broker-
introduced housing loans can be approximated to between $136 and $150 billion.

Precise figures on the number and value of the loans that brokers are responsible for are not
available; estimates of these figures can vary significantly. Solomon Smith Barney estimated
that the value of the Australian broker home loan market was $29.5 billion for the calendar
year to December 2001.2 However, APRA reported in January 2003 that brokers accounted
for 23% ($76 billion) of home loans with banks, credit unions and building societies, and
$86.6 billion of credit with these institutions in total.3

Table 1: Size of Industry – Key Statistics (IBIS World, Mortgage Brokers in Australia, April 2004)
                             1997-98    1998-99     1999-00     2000-01     2001-02      2002-03
       Industry Turnover      332.0      365.0       410.0       474.0       568.8        628.5       $m
    Industry Gross Product    154.2      170.6       188.9       211.5       250.0        271.3       $m
          Employment         1,584.0    1,740.0     1,845.0     2,011.0     2,212.0      2,389.0     Units
          Total Wages         107.9      119.7       131.7       144.9       160.0        174.4       $m


1
  Reserve Bank of Australia, Bulletin Statistical Table D02, Lending and Credit Aggregates, March 2004
2
  Solomon Smith Barney, “Australia’s Mortgage Market”, 2 May 2001.
3
  Australian Prudential Regulation Authority (APRA), Report on Broker Originated Lending, Jan. 2003, p. 2.


                                                                                                         7
Mortgage originators provided many of these loans. The bulk of these originators are small in
scale, and have no branch network or existing distribution channels. They have relied on
brokers to negotiate credit between consumers and third parties, and have given a huge
impetus to the growth of the finance broker industry.

Brokers do not deal only with mortgage products. They provide access to all products,
although some will deal exclusively with mortgage finance.

All types of lenders have become dependent on brokers for market share. Banks have
compensated for the loss of business resulting from branch closures by utilising applications
through brokers. On average, each bank has been using brokers for almost ten years, and
currently receives loan applications from 740 brokers.4 It is estimated that the four major
banks received 60% of all broker loan applications in the March 2002 quarter. Credit unions
and building societies have been slower to establish relationships with brokers, with these
institutions using, on average, only 13 brokers and having dealt with them for only three to
four years.5

The use made of brokers by banks, credit unions and building societies has undergone rapid
expansion, with 38% of these institutions planning to increase their rate of broker usage, and
25 individual lenders arranging to use brokers for the first time when surveyed in 2002.6 One
high profile example of this trend in the market was the announcement by three credit unions
- Australian Central Credit Union, Australian National Credit Union and Credit Union
Australia—that they had secured an 8.2% share in Mortgage Choice, one of the nation’s
leading mortgage broker organisations. The move was designed to increase the percentage
of future broker-written credit union home loans, with these three credit unions being
included on Mortgage Choice’s panel of lenders. It is noted, however, that following the
recent downturn in mortgage lending, some of the banks are reported to have imposed a
ceiling on the proportion of mortgages written through brokers.7

The resultant increase in broker numbers has been enormous. Solomon Smith Barney, in a
2001 report into the Australian mortgage industry, estimated that there could be more than
10,000 individuals operating in the Australian broker market, with 50 new brokers entering
the market each week.8 Seventeen per cent of respondents to the “Broker Survey” had been
operating for two years or less.9 Data from the Market Intelligence Strategy Centre, while not
measuring individual brokers, estimates that there are currently 2000 broker firms operating
Australia wide.10

In addition, while there is significant concentration at the upper end of the broker market (a
rough estimate from senior industry sources suggested that, prior to the entry of Aussie
Home Loans into the marketplace, the top three players had around 40% of the market, while
the top ten had around 55%), the industry has a long “tail” of small operators.




4
 APRA, op.cit, p. 6.
5 Ibid.
6 Ibid., p. 2.
7 Business Review Weekly June 10-16 2004, p38.
8 Solomon Smith Barney, op.cit.
9
   Consumer Credit Legal Centre, “Report to ASIC on the finance and mortgage broker industry”, March
2003, Appendix B, Table B4, p.100.
10
   Market Intelligence Strategy Centre, “Mortgage Broking”, Media Release. 17 April 2002.


                                                                                                  8
2.1.3 Categories of industry players
The expansion of the finance broker industry has seen the development of a number of
different types of participants, with three broad categories of intermediaries:11
• mortgage and finance brokers;
• mortgage managers; and
• intermediaries who promote “loan or debt reduction” schemes (in which the borrower
     refinances an existing home loan).

While all three types of intermediaries act as a link between the consumer and credit
providers, they do so in different ways, outlined below.

There is a fourth category of brokers, those who are active in soliciting funds from investors
and making these available as loans to the public. Historically there have been problems with
the conduct of brokers in this area, particularly in Western Australia, where the government
held a number of inquiries into the conduct of brokers in the 1990s, resulting in criminal
charges against approximately 20 brokers involved in fund-raising activities. This type of
fund-raising is now more strictly regulated by ASIC, following amendments to the Managed
Investments Act 1998. An examination of this part of the industry is outside the scope of this
report.

Consumers are relatively inexperienced when using brokers and they can be dependent on
them for advice because of the confusing range of loans and providers; some brokers are
prepared to exploit that dependency. This section of the paper examines the current nature,
structure and operation of the broker industry in Australia, and the way in which this can
operate to both the benefit and disadvantage of consumers.

2.1.4 Role of Mortgage and finance brokers
A key issue in this area is that there are vastly different views of the role and responsibilities
of the broker. Possible variations of the role of the broker are:
• To advise the consumer about the best option or options available, from a broad range of
    products, following a careful analysis of their personal circumstances;
• To present a range of options (with no express or implied recommendation) and allowing
    the consumer to select the product they consider most appropriate for their own
    circumstances; or
• To simply arrange credit for the borrower (usually from a preferred lender), without regard
    to whether a cheaper or more appropriate product is available.

At a practical level these views translate into significantly different methods of operating. The
large player end of the market is dominated by a number of “aggregators”. These are
organisations that provide infrastructure and administrative support to brokers who agree to
become members. The aggregator organises a panel of lenders, facilitates the processing of
loan applications and enters into commission-sharing arrangements with broker members.
Typically, aggregators have panels of 40 lenders or more (and a greater number of
products). The range of products available, and the infrastructure support mean that brokers
in these organisations are readily able to review a broad range of credit products. It does not
necessarily follow that this will result in recommendations with a greater match between the
needs of the consumer and the product selected. One broking firm in a recent edition of their
on-line newsletter stated:




11
   It should be noted that the nomenclature used to designate the different types of broker can vary
significantly from state to state. For example, in Western Australia the term “mortgage broker” appears to be
rarely used.


                                                                                                           9
      “..our view is that brokers should be seen as essentially agents of lenders like
      salespeople in department stores. They have access to a range of products and
      knowledge of the market, so they are useful. But their ‘advice’ should be taken
      with a grain of salt.”12

At the other end of the market are brokers who, while they may represent that they can
'arrange finance', forward virtually all loan applications to a few selected lenders (or, indeed,
may channel all applications to one particular lender), and operate as de facto agents for
those lenders.13

At present there is no general obligation on brokers to provide upfront disclosure on their
role, and there is therefore potential for brokers and consumers to have different
expectations in relation to the desired outcome.

It is likely that many consumers would assume the broker is undertaking a broad review on
their behalf and may not be advised, or otherwise realise, that the functions being carried out
by the broker are much narrower.

The consumer is also generally not provided with a written recommendation which they can
use to test the broker's decision, or assess the extent to which their individual circumstances
have been considered. In the absence of any such recommendation the consumer can
assume, wrongly in some cases, that the broker has undertaken a detailed review when this
is not the case.

2.1.5 Mortgage managers
Mortgage managers are linked to the wave of new non-mainstream mortgage financiers. The
mortgage managers have arrangements with a wholesale lender to distribute the funds,
usually through individually packaged home loans. The mortgage manager will arrange for
the completion of a loan application, and the collation of documents supporting such
applications.

Once the loan is approved and disbursed, the mortgage manager will continue to administer
the loan on behalf of the lender, by accepting payments, issuing statements, monitoring
defaults and responding to any inquiries by the borrower. Despite this close relationship, they
are not agents of the lenders but have established an identity which does not fit the generally
understood categorisations. Some mortgage managers also operate as brokers, in that they
will solicit loan applications, which are forwarded to lenders other than those for whom they
manage the loans.

The distinction between brokers and mortgage managers is one that will not necessarily be
apparent or easily understood by the consumer. In other words, consumers can easily
believe that the mortgage manager is selecting the loan from a pool of products when this is
not the case.

2.1.6 Intermediaries who provide loan-reduction services
The third category of intermediary promotes credit products indirectly, in that they advertise
themselves as offering services that, it is claimed, will result in consumers being able to pay
off their home loan more quickly than at present. These intermediaries therefore emphasise
their advice services (as providing the key to paying off your home loan more quickly) rather
than the credit product. There is a broad range in the level of sophistication of these


12
  See http://www.peachhomeloans.com.au/newsletters/newsletter15rippedoff.htm.
13
  They are likely, nevertheless, to be treated in law as agents of the borrower and not the lender; see Custom
Credit Corporation Ltd v Lynch [1993] 2 VR 469.


                                                                                                          10
intermediaries, with some doing little more than arranging refinances or debt consolidations
at a cheaper interest rate.

However, other bodies promoting loan-reduction services arrange for the borrower to
refinance their existing home loan to a different credit product which, it is represented, will
allow the borrower to achieve savings through maximising the use of their money. These
operations usually:
• charge a significant upfront fee to give the borrower details of the methodology of their
    loan-reduction services;
• advise the borrower to refinance their home loan (and may earn commissions from the
    lender they recommend);
• arrange for the new loan to be connected with an offset account (so that living expenses
    are purchased by way of credit card, and the consumer’s salary is offset against the
    home loan balance during the interest-free period on the card); and
• provide the borrower with budgeting advice, and encourage them to make increased
    repayments.

2.1.7 Remuneration within the broker industry
Brokers receive remuneration in three main ways:
• fees charged to the client;
• upfront commissions; and
• trail commissions.

Generally, most brokers derive their revenue from commissions, or a combination of fees
and commissions. Responses to the “Broker Survey”14 indicated that:
• 97% of respondents received commissions or financial benefits from credit providers;
• 57% of respondents did not charge their clients fees; and
• 40% of respondents charged their clients fees and also received commissions.

There is currently no regulation of remuneration in Australia, with the exception of fees
charged to clients in the Australian Capital Territory and in Western Australia. Individual
brokers can therefore determine how they will be remunerated.
The following matters are noted about commissions:
• the average initial commission paid by lenders was approximately 0.5% to 0.7% of the
   amount borrowed;
• the survey recorded one instance of a lender who paid an upfront commission of 4% of
   the amount borrowed;
• most lenders pay an average trail commission of approximately 0.3% of the outstanding
   balance of the loan. This amount is usually paid on a monthly basis;
• the highest trail commission noted in the “Broker Survey” was calculated at 1.7% of the
   outstanding loan amount; and
• bonuses can also be earned where the volume of business placed with a lender over a
   period of time meets or exceeds specified targets.

The recent APRA survey of Australian authorised deposit-taking institutions (ADIs) noted that
banks, credit unions and building societies paid, on average, an upfront commission of
0.51% for commercial loans, 0.77% for personal loans and 0.57% for housing loans. The
average trail commission paid by these institutions was 0.17% for commercial loans, 0.06%
for personal loans and 0.23% for housing loans.

These figures suggest that some lenders, presumably non-mainstream operators, are paying
commissions that are significantly above industry averages. Assuming that the cost of these

14
     CCLC Report, op.cit., Section B.4 in Appendix B.


                                                                                            11
commissions is recouped from the borrower, and that at least some of these borrowers could
qualify for loans elsewhere, this raises at a general level, the issue of whether or not reverse
competition leads these brokers to place loans with a lender who is more expensive but who
pays a higher rate of commission.

The APRA survey also stated:

         “Over half of the institutions (53%) base the broker’s remuneration solely on the
         volume of business generated, providing brokers with an incentive to generate
         loan volume without appropriate regard for risk. With such an incentive structure,
         it is critical that ADIs have procedures in place to ensure their own credit
         assessment standards are rigorously applied to broker-introduced loans.”15

As with other industries, some lenders also provide soft dollar payments, through offering a
range of financial benefits to selected intermediaries. These benefits can include marketing
subsidies, assistance with office equipment, and profit-sharing arrangements. Where
legislation imposes disclosure obligations on brokers, it generally excludes any requirement
to disclose these types of financial benefits. Exceptions are the recently commenced New
South Wales legislation in that it requires “soft dollar” benefits to be disclosed16, while
Victoria’s legislation, the Consumer Credit (Victoria) Act 1995, defines fees to include
“reward…whether monetary or otherwise”.

The prevalence of commission-based remuneration creates the possibility of conflicts of
interest between the interests of the broker and their client. However, some of the broker
firms, usually the larger ones or the aggregators, seek to mitigate the effect of commissions
on the choice of product by rebating part of the payment to the borrower, or by paying fixed
salaries to their employee brokers.

Similarly, the aggregators generally have commission-splitting arrangements with individual
brokers. These may vary with the identity of the lender and/or the volume of business placed.
To the extent that broker remuneration is based purely on volume (rather than the identity of
the lenders or the value of commissions offered), this may remove conflicts of interest that
might otherwise arise in relation to the advice being offered. It does not, however, remove
any conflicts of interest in relation to the size of the loans generated.

Finally, it is worth noting another form of payment common in the broker industry, namely
payments by brokers to third parties for referring potential clients to them. These fees are
widespread in the industry. The “Broker Survey” found that 65% of respondents promoted
their services though a range of third parties, including real estate agents, accountants,
lawyers, collection agencies, car dealers, building contractors and financial planners.17

In the majority of these cases, the brokers offered commissions or other financial incentives
for these referrals. Where legislation imposes disclosure obligations on brokers, it only
requires them to disclose payments that they will receive, not payments they make to third
parties. Again, the New South Wales legislation is an exception18. Consumers will generally
therefore be unaware of the existence of these payments, and of the fact that they are not
being given a personal recommendation to a broker.




15
     APRA, op.cit., p.9.
16
     Consumer Credit Administration Regulation 2002, Clause 2D.
17
     CCLC. Op.cit., Table B.16 in Appendix B, p.114.
18
     Op.cit., 2E


                                                                                              12
2.2      Features of the broker industry which may impact negatively on
         consumers
This section of the paper seeks to analyse the structural features of the industry and
suggests the consequences in terms of risks and outcomes for consumers that arise out of
those structural features.

2.2.1 Increased reliance by lenders on brokers
As noted above, reliance by lenders on brokers for market share is increasing. As well, the
Australian Banking Industry Ombudsman (now the Financial Services and Banking Industry
Ombudsman) has also noted “an apparent increase in the delegation to brokers by banks of
the responsibility of explaining the loan offer or security documents or both, including an
apparent refusal by banks in some cases to have direct contact with the borrower, instead
referring all questions to the broker.”19

The shift by major lenders in distribution channels from branch networks to brokers has also
seen at least some of those lenders reduce their internal risk checks and credit assessment
criteria. For example, APRA has noted that some credit unions and building societies were
providing loan advance-to-valuation ratios of up to 100%, and that they were also accepting
applications where the only deposit was provided through the Commonwealth Government’s
First Home Owners Grant (without the borrower therefore having any established savings
history).20

The use of brokers can leave lenders exposed to a higher risk of defaulting borrowers, and
can also make them more susceptible to mortgage fraud, although the extent of this may
vary depending on the stringency of any accreditation checks carried out by the lender
before accepting applications from the broker, and on the type of loans (with some lenders
having in place stricter requirements in respect of mortgage loans as opposed to unsecured
loans).

Where the credit provider’s primary goal is market exposure and not the quality of the loan
portfolio, this impacts also on consumers as brokers sell products which are either
inappropriate to their needs or are unaffordable.

2.2.2 Minimal barriers to entry
In the absence of a uniform or national occupational licensing regime, there are minimal
barriers to entry to the industry. Currently, except in Western Australia, a person is not
required to be licensed or to have training or educational qualifications before being able to
practise as a broker. ACT requires registration, but this is not attached to any conditions.
There are also minimal capital requirements since brokers can easily operate without
premises or overheads, without employees and without personal indemnity insurance,
encouraging “fly-by-night” operators.

Some brokers have run significant practices without ever meeting clients, operating solely
through telephone and facsimile contact.

This leaves the market wide open to operators who may have no intention of providing a
bona fide consumer service, but seek only to defraud or exploit the more vulnerable or
unsuspecting consumer. This is demonstrated in case studies supplied and also by
practices identified in the successful action against rogue “brokers” such as Credit



19
     ABIO Bulletin, Dec. 2002, p.3.
20
     Media Release [MR 02/37], 19 September 2002.


                                                                                           13
Accounting Consultants in New South Wales21, where some hundreds of consumers are
thought to have been affected.

A graphic example of one such scam is a broker who attracts clientele through newspaper
advertisements with statements such as: “No credit checks. Finance OK if not working.”
When consumers approach the broker, they are told they need to pay a $600 application fee.
If they cannot afford the fee upfront, the broker tells them to apply for a credit card and then
pay the fee through a cash advance. The broker then may or may not arrange a loan for the
consumer, depending on the person’s circumstances.

The conduct identified through case studies includes:
• brokers recommending interest only loans in inappropriate circumstances;
• brokers misrepresenting the savings available from changing a home loan;
• brokers charging excessive fees, or fees in circumstances where the broker is aware that
   there is little prospect of the borrower being approved for a loan;
• brokers arranging for borrowers to declare, incorrectly, that a loan is for investment rather
   than personal use (with the result that the consumer loses statutory protections provided
   under the Uniform Consumer Credit Code);
• borrowers being placed into a loan where they could only afford the repayments with
   substantial hardship (81% of the caseworkers surveyed by the CCLC (NSW) who dealt
   with broker complaints indicated that they often saw problems of this type); and
• brokers arranging finance for an amount less than that requested by the customer
   (particularly where the funds were required to complete a property purchase).

These practices result in higher costs to consumers, an increased risk of default by the
borrower, and exposure of their home where this was used as security for the debt.

2.2.3 Conduct engaged in by fringe operators
Business purpose test
Consumers can unknowingly sign away their rights in relation to credit regulated by the
Consumer Credit Code by signing a “business purpose declaration.” Under section 11 of the
Code, the Code is presumed to apply to a transaction unless the debtor declares before
entering into the contract that the credit is to be applied predominantly for business or
investment purposes.

Unscrupulous brokers may ask or require a consumer to sign such a declaration before they
will provide access to any credit. Those consumers who either do not understand the
implications or are too desperate to consider the effect of signing away their rights may be
persuaded to sign the declaration and as a consequence do not have access to any of the
redress mechanisms under the Code.

Fraudulent applications
The following is a case study of a fraudulent application:

A broker previously worked for a particular lender. He then left the lender and began
contacting some of its clients, telling them that he had left because “that lender is stealing
your money” and offering to help them refinance. Mr H was one of the clients approached by
the broker. Mr H had recently been retrenched, and had income from a part-time job only. Mr


21
   Commissioner for Fair Trading v Rowland Thomas & Ors [2004] NSWSC 479. The case concerned a ‘scam’
finance broker operation involving non-provision of services, excessive commissions, misleading and
unconscionable conduct.




                                                                                                    14
H had purchased an investment unit off the plan sometime previously. The unit was nearly
completed, with settlement approaching.

The broker told Mr H that he could arrange for him to refinance his existing loan, and get
finance for the purchase price of the investment unit. The broker arranged for false
documents to accompany Mr H’s loan application, including doctored bank statements, and a
false reference from an employer, suggesting that Mr H was employed in sales, and earning
over $80,000 in commission annually. The loan application was approved.

It should be noted that the nature of the fraud in these types of transactions often makes
enforcement actions problematic. Applications for credit that contain false information about
the borrower’s financial position are invariably signed by the consumer. Establishing that the
false details were included without the borrower’s consent or knowledge can be extremely
difficult. Other complicating factors can be the existence of oral representations by the
broker, the complex nature of the transaction, and, potentially, significant time lapses
between the conduct of the broker and its discovery by the borrower. When added to the
relatively small amounts of money involved, these factors mean that there are considerable
difficulties in having a significant number of these matters investigated and prosecuted by the
police.

“Interest only” loans
The case studies indicate that brokers are making widespread use of “interest only” loans.
The repayments on these loans only meet the interest charged on the credit, so that at the
expiration of the term of the loan (commonly one or two years only), the capital must be
repaid. The repayments may be lower than a mainstream home loan, as they only meet
interest rather than also reducing the outstanding capital (although this depends on the
interest rate charged). Interest only loans are therefore generally of benefit only to small and
specialist categories of borrowers, such as those experiencing short-term cash flow problems
(where the short time frame means that the consumer will have to bear the costs of
refinancing their home loan within a short period of time) or professional property investors
seeking enhanced tax benefits.

A review of the conduct of some brokers who arrange “interest only” loans suggests that they
are being used in asset based lending, and that they are associated with patterns of
behaviour which include:

(a)    Brokers targeting financially vulnerable consumers through advertisements containing
       statements such as “Pensioners welcome. Can’t get finance elsewhere? Need
       finance in a hurry?
(b)    Brokers charging borrowers large establishment fees as well as legal fees or
       valuation fees where the broker has not made any payment to a third party for these
       fees.
(c)    Brokers and lenders being unconcerned about the capacity of the borrower to make
       repayments, and lending on the basis that there is sufficient equity in the property to
       cover enforcement expenses should there be a default in payments.
(d)    Lenders protect themselves from actions by borrowers under the Uniform Consumer
       Credit Code by:
       (i)     requiring the borrower to execute a Business Purpose Declaration irrespective
               of the actual purpose of the loan;
       (ii)    obtaining a certificate from an accountant advising that the borrower can
               afford the loan.
       Brokers assist with the execution of these documents and often are aware that these
       documents are incorrect.
(e)    Brokers will sometimes arrange a second refinance for the borrower if they are
       unable to make the repayments on the first refinance.


                                                                                             15
This practice is known as “equity skimming” in that there is little value for the borrower from
these refinances and the effect is to skim the equity from the property to the broker (through
high fees) and the lender (through high interest rates, application and exit fees, and, if
necessary, enforcement costs). As is evident from the newspaper advertisements this
conduct is deliberate and systemic, and designed to exploit, rather than assist, consumers in
a vulnerable situation.

The following case study demonstrates the consequences for an individual borrower as a
result of this practice.

Case study
Mrs M is an aged pensioner. As her only income is the pension, she was struggling to meet
even her basic living requirements. She is poorly educated and has difficulty reading and
writing. She owned her own home in country Victoria, a property valued at $40,000. Mrs M
decided to consolidate her debts, primarily a debt owed to Legal Aid (incurred for divorce and
custody proceedings). Legal Aid was not demanding payments from Mrs M, but she felt she
should pay off the debt. Mrs M found an advertisement for a finance broker in a newspaper.
The advertisement stated “no credit checks” and “loans up to 90% of valuation”. Mrs M rang
the broker and gave some initial details over the phone. She then attended an appointment
at the broker’s office with a friend.

The finance broker advised at this meeting that he could arrange a loan of $24,000 for her,
although it would have to be secured with a mortgage over Mrs M’s property. The broker
provided her with a loan document and mortgage. Due to her literacy problems, which would
have been evident to the broker, she was unable to understand them. Her friend suggested
she take them to a solicitor, but the finance broker told her she could not do so, and that if
she wanted the loan, she would have to sign immediately. Mrs M asked how long the loan
was for, but an evasive answer was given. The broker did not explain that the loan was
“interest only” in nature, and that the principal had to be repaid in 12 months. The interest
rate on the loan was 13% and the contract provided for the broker to receive a procuration
fee of $1500 (or 6.25% of the amount of the loan).

Mrs M felt she had no choice except to sign the documents. She was able to meet the
monthly repayments, although with some difficulty. When the term of the loan expired, Mrs M
was unable to repay the capital sum of $24,000. She sought legal assistance and was
advised to sell her home as otherwise she risked losing her outstanding equity in the
property in legal action that was likely to be unsuccessful.

There is a variation to this practice, whereby brokers recommend home loans (often with
mainstream lenders) where the repayments cover interest only for the first few years. The
amount of the repayments can then increase significantly to cover both principal and interest.
The highly leveraged/geared nature of these loan means the borrower will have to change
established spending habits in order to meet repayments that can increase by up to 40%
(without taking into account any additional amounts payable due to rises in interest rates).
Accordingly, loans of this type have greater risks for consumers than traditional principal and
interest loans, as the initial "interest only" nature of the repayments means that they are
paying significantly more overall, and that - during the period when repayments are only
covering interest - any equity is only being accrued through increases in the value of any
property purchased with the funds. Brokers recommending these products without carefully
explaining to borrowers the way in which they operate and ensuring that the consumer is
comfortable with the increase in repayments place borrowers at risk of being overcommitted,
possibly not at present, but when repayments increase.



                                                                                            16
Misrepresenting the financial benefits available
Some intermediaries market themselves on the basis that, where the consumer has an
existing home loan, they are able to offer the consumer a more competitive product that will
enable their mortgage to be paid off more quickly. This approach uses as a marketing tool
the confusion created in consumers by the proliferation of products in the marketplace. It is
likely that most consumers believe that there are home loans that are cheaper or better than
their own, but that they also find the task of searching the marketplace to identify these loans
too daunting.

These debt reduction schemes often recommend that the consumer refinance from their
existing home loan to a line of credit. The interest rate charged under a line of credit is
usually higher than that charged for a standard variable rate loan (even one with offset and
redraw options). Lines of credit allow the borrower to make offset savings by making the
bulk of their purchases through a credit card and having their salary/income deposited in the
loan in the period between the date of purchase and the date of payment, thereby reducing
the interest accruing on their home loan. In practice the extent to which the loan can be
repaid more quickly depends to a far greater extent on the capacity of the borrower to make
additional repayments, rather than offset savings.

However debt reduction schemes are providing advice rather than a product. It follows that
the advice may be able to be applied to a consumer’s existing home loan and that in order to
justify a refinance to a line of credit the scheme will represent that the product it recommends
has some unique characteristics not applicable to the consumer’s existing home loan.

The recommendation by the debt reduction scheme may be supported by a graph or a
comparison in which it is assumed that the consumer:
(a)   does not make additional repayments to their existing home loan; and
(b)   does make additional repayments to the replacement home loan.

This assumption may not be explicit and the scheme may suggest that the loan can be
repaid more quickly due to offset savings.

There are, therefore, three significant risks inherent in the operation of debt reduction
schemes:
(1)   Where the scheme has not properly investigated the capacity of the consumer to
      make additional repayments it will not have a proper basis for representing the extent
      of any future repayments savings (“a future repayments risk”).
(2)   The scheme may advise the client that they need to refinance their existing home
      loan in order to achieve savings of time and money, when the advice could be applied
      to their existing home loan, without the consumer incurring transaction costs (“an
      unnecessary refinance risk”)
(3)   Where the mortgage reduction scheme produces a comparison between the
      consumer’s existing home loan and the replacement loan in which additional
      repayments are attributed to the replacement loan but not the existing loan, there is a
      risk that this comparison will be misleading or deceptive (“a misleading comparison
      risk”).

The extent to which these risks occur in practice will vary from broker to broker. However
they are inherent in the operation of these schemes. Consumers can suffer financial loss by
refinancing. These losses include:
       - any early repayment penalties charged by their existing lender;
       - fees charged by the scheme (typically$3-5,000), and application fees and
           disbursements charged by the lender; and




                                                                                             17
       -   where the consumer is unable to make any, or any significant additional
           repayments, the additional interest charged due to being refinanced at a higher
           interest rate.

Case study
Ms J had a standard variable interest rate home loan with an outstanding balance of
$114,000. Ms J was cold called by a telemarketer offering to talk to her about how she could
save money on her mortgage. Ms J was interested in increasing her loan to buy a computer
(to work from home) and agreed to a visit.

The person who visited Ms J only discussed finance with one particular lender, and did not
disclose that he was a broker. He led Ms J to believe he acted for that lender, and that she
would only have to pay the lender’s application and loan fees. The broker gave Ms J a series
of documents to sign. These included a broker agreement (which was not explained to her)
and an application for a loan of $120,000. In fact, the loan was to be provided through a line
of credit. This type of finance was completely inappropriate and unnecessary for Ms J, while
the interest rate was more expensive than on her existing loan.

When the loan settled, Ms J paid around $4000 in fees, including nearly $3000 to the broker,
as well as the lender’s application fees and solicitors costs. This meant there were
insufficient additional funds available for her to buy a computer.

The justification for switching loans may be problematic for a number of reasons. First, as the
bulk of the savings derive from increased repayments, there may not be any economic
advantage in the consumer switching home loans (given the transaction costs they will
incur). Secondly, assessing the capacity of the consumer to adhere to a revised budget is
difficult and time-consuming and rarely done thoroughly (by, for example, reviewing their
spending habits over a period of time). No provision may be made for cash reserves for
contingencies (such as the unexpected need to replace a car). Thirdly, if the borrower is
unable to repay the amount outstanding on the credit card in full each month, they become
liable for interest on that sum at credit card rates. As a result, the representation that the
borrower may save years on their home loan can easily result in them being switched into a
more expensive product, and one that has high-risk consequences if they are unable to
maintain a budget.

Responses by caseworkers and the case studies provide some instances of consumers
agreeing to refinance their home loan in circumstances where the economic benefits of doing
so were questionable at best, either because of the high fees charged by the broker or
because the refinanced home loan was at a higher interest rate. These transactions suggest
that there was either reliance by the consumer on oral statements by the broker, or an
implicit understanding by the consumer that the broker is acting in the interests of the
consumer to obtain the “best” loan, or, at a minimum, a loan that reasonably meets their
needs. This means that the broker and the client may have completely different views of the
transaction, which allows the broker to charge high fees.

2.2.4 Financial consequences of accessing credit or advice from fringe players
The greatest risk for consumers who receive recommendations or advice from fringe players
is that the conflicts of interest will be greater. The economic consequences for the consumer
are therefore also likely to be more detrimental and may result, for example, in the possible
loss of the home rather than a refinance at a slightly higher interest rate. At a time when the
need for Australians to make provision for their financial security on retirement is becoming
increasingly important unscrupulous brokers have the capacity to cause large numbers of
people to enter into transactions that are potentially hazardous, and that may result in the
transfer of wealth (through home equity) from the consumer to the broker or to a third party.


                                                                                            18
2.3   Mainstream players—quality of advice
As well as failing to discourage an operator who is clearly dishonest from practising as a
broker, the lack of entry requirements may result in brokers whose intentions are to act
honestly, but are simply lacking in appropriate skills or knowledge. Western Australia is the
only jurisdiction which requires a broker to receive training. This impacts on the quality of
service provided and the suitability of the credit product recommended to the consumer.

Currently, brokers are under no statutory obligation to undertake inquiries and research in
order to have a reasonable basis for recommending a particular credit product. If such an
obligation existed in law, brokers would have to consider a range of factors, including:
• the capacity of the borrower to meet repayments, both currently and taking into account
    reasonably foreseeable circumstances (eg possible increases in interest rates);
• a comparison of the cost of different products available from a pool of credit products;
• consideration of the terms and conditions of the loan, including matters such as whether
    interest rates can be varied under the credit contract, whether the loan is principal and
    interest, interest only, or a line of credit, the extent to which redraws of credit are
    available, the consequence of any default by the borrower, and the penalties, if any, for
    repaying the loan early;
• where the recommendation involves refinancing an existing credit product, such as a
    home loan, an analysis of the advantages and disadvantages of proceeding with the
    refinance (eg a comparison of interest rates and fees and charges between the loans and
    an assessment of the effect of transaction costs);
• the loan amount requested by the consumer, the use of those funds and any time frame
    within which the funds are required (eg settlement of a property purchase – this is now
    addressed in NSW following commencement of its new legislation, the Consumer Credit
    Administration Amendment (Finance Brokers) Act 2003, on 1 August 2004) ; and
• the extent to which the individual needs a buffer of funds in order to meet unexpected
    contingencies.

Brokers are also not currently required by law to provide consumers with a written statement
setting out the reasons for recommending a particular product. In the research for the CCLC
report to ASIC, caseworkers did not come across any instances or examples where
consumers were provided with a recommendation setting out these matters.

The extent to which brokers review the range of factors listed above in determining which
credit product to recommend is unknown, and presumably varies significantly between
brokers. However, the range of problems identified in the case studies and the responses by
brokers to surveys provide evidence of a failure by some brokers to address the consumer’s
personal circumstances or research the range of products available.

For example, 11% of the brokers surveyed advised that they did not compare credit
products. It should be noted that of more than 1100 surveys sent out, 166 responded and
that those brokers who responded were members of the major industry associations.
Similarly, only 54% of those brokers had a written agreement with their client, setting out the
type of credit sought by the client. Of this figure of 54%, only 73% advised that the
agreement addressed the amount of credit and type of loan being sought, and only 51%
advised that the agreement specified the interest rate requested by the client. These results
suggest that some brokers either do not obtain clear instructions from the consumer about
the finance required, or that they do not record or communicate these instructions in a
manner that ensures borrowers have a clear appreciation of the terms of the broker’s
engagement.

In practice, this can result in brokers channelling clients to the same credit provider, or same
few credit providers, without adequately considering the consumer’s circumstances or the


                                                                                             19
price of competing products. In extreme cases, the broker agreement can be completed in
terms that are self-serving and designed to secure the broker’s fees irrespective of the
quality of the service provided by the broker. An example of such self-serving conduct is
broker agreements (sighted by caseworkers) stating that the credit to be arranged should
have an interest rate of between 6% and 20%, which allows the broker to fulfil the terms of
their engagement even if arranging finance that is disadvantageous to the borrower.

APRA has recently expressed concerns about credit unions and building societies adopting
an overly aggressive approach to residential property lending due in part to an increased
reliance on brokers to originate business and a lack of due diligence by the lenders in
assessing the creditworthiness of applicants. This is consistent with some brokers both
failing to adequately consider the capacity of their clients to meet repayments under the
credit arrangements they are recommending, and arranging for their clients to borrow the
maximum amount possible.

2.3.1 Financial cost of poor recommendations
The potential costs of poor recommendations can be very high in that even a small
differential in the interest rate applicable to a 25-year home loan can produce very different
results.

The effect is illustrated in the following examples of a refinance to a less competitive product:
• Loan A—a loan of $175,000 at 5% repaid over 25 years with fortnightly repayments will
   have repayments of $469.94; and
• Loan B—a loan of $175,000 at 5.5% repaid over 25 years with fortnightly repayments will
   have repayments of $493.72, resulting in an additional $15,547 being paid by the
   consumer over the life of Loan B.

2.4      Effects of a commission based remuneration structure

2.4.1 Reverse competition
The fluid nature of the housing market indicates that a degree of reverse competition is
taking place, with lenders competing against each other to gain access to broker distribution
channels, either through increasing the commission they are prepared to pay brokers, or
through the lenders offering volume bonuses to brokers (to ensure they receive the bulk of
their loan applications).

Brokers are therefore in a strong bargaining position, with lenders seeking to gain access to
their client base. Many lenders, especially mainstream institutions, have implemented
accreditation processes for brokers, assessing such matters as their experience,
management capacity, professional indemnity insurance status, and tracking the outcomes
of the loans submitted. However, these measures are by no means uniform, with APRA
reporting that 32% of banks, credit unions and building societies will accept loan applications
from non-contracted brokers.22

2.4.2 Practices which flow from these arrangements
The effect of these arrangements varies across the industry. However, they can increase
rather than decrease the cost of the credit obtained by the consumer, in that, in some
instances, the loan arranged through the broker will be more expensive than one arranged
directly with the lender, and consumers may not be directed towards cheaper or competitive
loans where no commission is paid.



22
     APRA, op. cit., pp. 7–8.


                                                                                              20
Instances of inappropriate sales and pressure selling are typical of industries dominated by
commission-based sales. This is true of the broker industry as intermediaries seek to
maximise both the number of loans granted and the value of those loans. Most home loans
are expected to have a life of seven years or less, so that the size of the upfront commission
is likely to be the major influence on the broker’s choice of loan. Trail commissions create
only marginal incentives for brokers to place the borrower in a loan where they can afford the
repayments.

2.4.3 Limited capacity of consumers to differentiate between brokers
There are a number of reasons why consumers are unable to readily differentiate between
brokers, or to judge the quality and cost-effectiveness of the services they are offering.

The broking industry is relatively new, which means that many consumers have had only
limited dealings with brokers. This relative inexperience means that they are not necessarily
equipped to be able to evaluate the information they are given by the broker, or to compare it
with previous dealings with other brokers.

Depending on the jurisdiction brokers may be under no obligation or under only a limited
obligation to disclose upfront the fees they will charge and the commissions they will receive.
It is the experience of caseworkers (and some regulators, including ASIC) that this
information asymmetry is exploited by some brokers, by, for example, charging fees
according to the amount of credit obtained by the borrower. In these instances, the broker
does not advise the borrower of its fees upfront, but adjusts the amount it charges according
to the amount of surplus credit obtained available to meet its fees.

Also, brokers are under no obligation to disclose to borrowers the reasons for recommending
a particular credit product. Where consumers are only provided with either limited information
or no information it is difficult for them to assess the quality and cost-effectiveness of the
services the broker is providing.

2.4.4 Fees issues
Case studies involving disputes about fees raise the following issues:
• brokers charging fees that are excessive—46% of the caseworkers who dealt with broker
    complaints indicated that they often saw problems about brokers charging excessive or
    undisclosed fees;
• brokers charging fees that appear to be calculated according to the bargaining capacity
    of the individual consumer, and not according to the work to be undertaken. The broker
    survey showed that, in relation to brokers who varied the fee they charged to the client,
    only 8% varied the fee according to the amount of work done to arrange the finance
    (other responses indicated the fee was varied according to the amount of the loan, the
    type of finance, and the outcome of negotiations with the client);
• brokers not disclosing to consumers the amount of the fees that they would charge (with
    this figure only becoming apparent on settlement of the loan, when the broker deducts
    their payment from the loan proceeds);
• brokers refusing to leave a consumer’s home until they have signed an agreement
    committing them to paying a significant fee to the broker;
• brokers charging either the full amount of their fees, or a significant proportion of them,
    even where the broker was unable to arrange a loan or the consumer was dissatisfied
    with the product recommended by the broker and did not proceed with the
    recommendation; and
• brokers using unfair tactics to enforce payment of their fees.




                                                                                            21
Case studies
Mr and Ms J had experienced difficulties in obtaining a loan from a mainstream lender. They
contacted a broker who had placed newspaper advertisement offering loans with “no credit
checks”. They paid an initial fee of $200 to the broker to arrange them a home loan. The
broker did not provide them with a written broker agreement, in breach of the requirements of
the Consumer Credit (Victoria) Act 1995. Before the broker had been able to arrange a loan,
Mr and Ms J changed their mind about going through with the transaction, as they
considered they would be unable to afford the repayments under a home loan.

The broker then demanded fees of $2000 from Mr and Ms J, who then approached the
Consumer Credit Legal Service (CCLS) for assistance. CCLS wrote to the broker stating that
no fees were payable as he had failed to provide them with a written agreement. The broker
wrote back stating that the reason he did not provide Mr and Ms J with any documents was
because they told him they wanted to purchase a property as an investment, as they were
unable to afford finance for a residential property. Mr and Ms J advised CCLS that they had
told the broker the finance was only for a home they would live in themselves. CCLS was
able to get the broker to drop his claim for the $2000 brokerage fee, and to refund the $200
fee paid to the broker by Mr and Ms J.

Ms O and her partner arranged for a broker to visit them at home to discuss options for
refinancing her home loan. The broker advised Ms O that he would be able to find them a
cheaper loan, and, as a result, Ms O and her partner signed a broker agreement that day.
They did not read it before signing it, and the broker did not explain it to them.

The broker subsequently contacted Ms O and sent her documents to sign to enter into a new
loan, to refinance her home loan. However, when Ms O examined the agreement she
decided not to go ahead with it, as it was not cheaper and she believed she would not be
able to afford the higher repayments. She is now being pursued for a $6000 brokerage fee
referred to in the broker agreement, even though the finance arranged by the broker did not
meet her needs.

The following case study (reported in the Sydney Morning Herald on 22 May 2004) shows
the way in which unscrupulous brokers will charge exorbitant fees according to the needs of
the borrower.

The borrowers owned a number of properties and required bridging finance in order to
complete settlement of a Sydney unit they had bought off the plan. Mainstream lenders
rejected their application for finance. They arranged a short-term loan through AAA Law
Mortgages. The loan cost them $10,000 in fees and charges, and interest was charged at
6% a month (rising to 8.5% a month on default). Unbeknown to the borrowers, the loan was
provided by the broker's wife. The broker said he would be able to arrange a permanent loan
on more favourable terms. The terms of this later loan included charges of $70,000 for loan
expenses and brokerage, and interest was charged at 9%. The borrowers rejected the
second loan, and the broker's wife is now suing them for possession of their three properties.

2.5   Disclosure Obligations
In general terms, the statutory requirements on brokers to disclose their fees vary but are
comprehensive only in New South Wales. Nor has self-regulation led to universally high
levels of disclosure. The broker survey results showed that 25% of brokers who charged fees
to their clients provided that information to their clients in an oral form only, and not in a
formal document. Similarly, 35% of brokers who received commissions from the lender only
advised their clients of this orally, while 5% stated that they did not inform their clients about
commissions at all.



                                                                                               22
Payments by brokers to third parties for referring potential clients to them are widespread in
the industry. As noted in Section 2.1.7, the broker survey found that 65% of respondents
promoted their services though a range of third parties. In the majority of cases, the brokers
offered commissions or other financial incentives for these referrals. The types of third
parties who received commissions included real estate agents, accountants, lawyers,
collection agencies, car dealers and building contractors, where the consumer would not
ordinarily assume or consider a commission might be paid. Jon Denovan, Chairman of the
MIAA Legislative Committee, has described these payments as “among the most
objectionable of practices in the industry.”

It is the experience of caseworkers that these commissions or payments are never disclosed
to the consumer, and that the referral to the broker is therefore seen by the consumer as
personal and reflecting a positive experience by the third party. In fact, the payment of the
commission means that the referral is not impartial, and the failure to disclose this payment
means the consumer is not in a position to objectively assess the value of the referral. It also
suggests that the standards applying to disclosure of fees and commissions within the
industry are generally poor.

Many brokers charge a significant percentage of their fee if the borrower decides not to
proceed with the loan. This, combined with the absence of any explicit obligation on the
broker to make a recommendation that is reasonably suitable (or any sanction on the broker
when they fail to do so), inhibits the capacity of consumers to negotiate with brokers, or to
select a cheaper loan than that recommended by the broker. The European Union prohibits
brokerage fees in circumstances where the broker is remunerated by commission from the
lender, or where no finance is actually arranged.

There is also evidence that some brokers flout the law by charging fees in advance of
securing credit for their clients, in direct contravention of legislative prohibitions in some
States.23 The existence of fraudulent conduct by brokers and disregard for legislation is
consistent with some of the extreme conduct identified in the case studies—behaviour that is
driven solely by profit motives rather than acting in the best interests of the client—and
suggests that some brokers are able to exploit both the significant existing weaknesses in
the regulatory framework and the trust placed in them by their clients for their own ends. The
structural factors driving this conduct (as identified in Section 2.2) suggest that this conduct
will continue unabated, in the absence of stringent and robust government intervention.24

Other matters about which the consumer would ordinarily be unaware include the range of
loans reviewed by the broker, the range of commissions offered to the broker by those credit
providers, and the different interest rates and fees charged in respect of those loans. Most
consumers would also be unaware that by signing a declaration that the loan is for
investment purposes (and therefore outside the UCCC regime), they make it significantly
easier for the lender to take possession of any security, such as the their home, in the event
of default.

2.6   Use of “cold calling” to solicit clients
Many consumers make contact with brokers, either as a result of advertising or in response
to a direct approach by the broker. Neither of these methods is necessarily an effective way
of identifying a broker who will provide efficient or cost-effective services. The difficulties in
comparing the services offered by brokers are exacerbated where the initial approach is
made through the broker “cold calling” on the consumer in their own home.


23
   Final Report of the NSW National Competition Policy Review of the Credit (Finance Brokers) Act 1984, p.
16.
24
   Industry efforts to deal with fraud and other improper practices are detailed in Section 4.2 of this paper.


                                                                                                           23
The finance intermediary industry is an area where “cold calling” (or an unsolicited approach
to potential customers) takes place on a regular basis. For example, the “Broker Survey”
indicated that 22% of brokers employed cold calling as a marketing strategy, with brokers
using telephone contact and visits to consumers’ homes and workplaces to initiate contact.

Consumers in their own home are particularly vulnerable to making uninformed decisions
due to a variety of factors, including:
• the inability to walk away from a sale;
• an inherent politeness towards a person who is a guest in their own home;
• the nature of the sales staff who are often trained to exploit this sense of obligation and
   who may refuse to leave until the sale is complete; and
• logistical difficulties comparing prices, often resulting in the consumer committing
   themselves to paying excessive fees.

Door to door sales of credit are prohibited under the Consumer Credit Code, however,
broking is not prohibited. In most jurisdictions there is some protection from telephone or
door to door sales in the form of a cooling off period.

2.7   Factors which act against the provision of quality services

2.7.1 No ongoing relationship with clients
Most brokers (as distinct from mortgage managers) will have only limited contact with the
borrower once they have been placed in a loan. Once the loan or credit has been arranged,
the broker has little reason to continue to be involved. The relationship is different from other
intermediaries, such as insurance brokers or financial planners, where there is a need to
provide ongoing advice in relation to the investment or insurance product initially
recommended.

While some brokers do provide a continuing service to their clients after they have arranged
the loan for them, the results of the survey of brokers suggest this is limited to a small
minority. The absence of any ongoing relationship means that the broker has minimal
financial incentives (through earning ongoing fees or business from the borrower) to ensure
their initial advice and choice of product is sound and reasonable.

2.7.2 Lack of accountability
Where consumers have suffered damage or loss as a result of the conduct of a broker, they
are usually unable to access timely and effective remedies. Brokers, unlike other
intermediaries in the financial services industry, are not required to be members of an
alternative dispute resolution scheme, so that consumers have few options for obtaining
redress apart from instigating legal action, with its attendant uncertainty and expense.

The lack of accountability by brokers means that they can refuse to respond to complaints,
even where a community advocate helps the consumer, because the difficulties and cost in
taking Court action means the consumer is unlikely to pursue the complaint. A further
complicating factor for consumers is that generally they will not have any redress against the
lender for the conduct of the broker; in other words, the development of the broker industry
has seen responsibility at the point of sale shift from lenders to brokers, who are in practice
often unaccountable.


2.7.3 Inability of lenders to discipline “bad” brokers
It is also possible for brokers to manipulate the competition between lenders to avoid
stringent supervision of their activities. Brokers are in a position where they can respond to
attempts by credit providers to scrutinise their business by switching to different lenders.


                                                                                              24
Ultimately the only sanction a lender can impose is to refuse to have further dealings with a
broker (where, for example, they consistently submit poor or even fraudulent loan
applications). However, this has no effect on whether or not the broker remains in the
marketplace, as they can easily direct their credit applications to a new financier. The
position is similar to that of life agents in the early 1990s, where “bad” agents (who had their
employment terminated by one insurer) were able to rotate between different insurers.

APRA’s “Report on Broker-originated Lending” noted that, since first utilising brokers, the
average bank has ceased dealing with 70 brokers.25 The three most common reasons for
ceasing business with a broker are:
• poor quality of loan applications (59%);
• lack of volume of business (59%); and
• fraud (24%).26

The report also found that, if a loan becomes impaired (through default by the borrower), only
25% of institutions have recourse to the broker, usually through ceasing to pay trail
commissions, rather than being able to claw back the upfront commission.27

Lenders are liable to the borrower for the conduct of brokers only in extremely limited
circumstances. Accordingly, they have minimal incentives to impose standards of conduct on
brokers. Attempts at improving industry standards through self-regulation are relatively
undeveloped and, for a variety of reasons, have generally had at best a limited impact on the
industry overall.




25
   Ibid., p. 6.
26
   Ibid. p. 8.
27
   Ibid.


                                                                                             25
3 Regulation and Remedies

3.1 Regulation of Brokers in Australia

3.1.1 Legislation Regulating Brokers
The level of statutory regulation of finance brokers varies from jurisdiction to jurisdiction
within Australia. South Australia, Tasmania, the Northern Territory and Queensland do not
currently have broker-specific legislation. The other four jurisdictions do have legislation
directly regulating brokers.

New South Wales
The main features of the NSW Consumer Credit Administration Amendment (Finance
Brokers) Act 2003 are set out below:

Coverage:
Only brokers who negotiate or obtain credit covered by the Consumer Credit Code are
regulated. That is, only credit provided for personal, domestic or household use.

A finance broker must enter into a written contract with a consumer before commencing
finance broking. The contract must be signed by the consumer and a copy must be given to
the consumer.

The contract must contain:
• particulars of the amount of credit to be obtained;
• the term over which the credit is to be repaid;
• the maximum periodic payment the consumer is prepared to pay;
• repayment arrangements if a regular repayment is not acceptable to the consumer;
• the maximum interest rate payable;
• the date by which the credit is to be secured;
• a statement that the finance broker’s recommendations will not necessarily be drawn
   from all lenders that offer credit of the nature being sought;
• the name and address of the finance broker;
• the ACN if the broker is a company;
• the name and address of the principals of the relevant business if the broker trades under
   a business name;
• the amount of commission (if any) payable by the consumer, or if the amount is not
   known, the method of calculating it and an estimate of the amount payable;
• when and how the commission will be payable;
• if a financial or other benefit will be received by the broker from a person other than the
   consumer, a statement of that fact in the terms prescribed by regulation;
• any other matter that may be prescribed: the regulation will prescribe
   • a description of any special loan features required by the consumer
   • if any financial or other benefit will be paid to any referring source.

The regulation also requires that the broker:
• give a statement identifying each credit provider on the broker’s panel of lenders;
• give a statement that these credit providers do not necessarily represent all the credit
   providers who offer credit of the nature sought be the consumer;
• make a statement to the effect that the credit provider will receive a financial or other
   benefit from a person other than the consumer;
• indicate the range of the benefit (highest and lowest amounts);


                                                                                          26
•    disclose to the consumer before the credit contract is entered into the actual amount of
     commission that the broker will receive from the credit provider;
•    whether or not the broker can determine or recommend conditions of the credit contract
     (for example, the interest rate or the term of the loan), and if so, the effect of any such
     condition on the level of commission payable;
•    state whether he or she is authorised to set such rate, term or fee;
•    disclose any benefit that will be received by the broker’s firm from the credit provider;
•    disclose any interests or relationships of the finance broker that could be expected to
     influence the broker’s recommendation;

The broker must not demand commission from the consumer before the credit is secured.

The right to claim the commission depends on the terms of the finance broking contract
being met and must not exceed the amount stated or estimated in the finance broking
contract.

The broker may charge commission if the consumer declines the credit, if the credit secured
meets the terms of the finance broking contract and the contract has not been validly
terminated before the credit is secured. This right to claim commission must be stated in the
finance broking contract.

The finance broker must keep records of the broking transaction and the broking contract for
7 years.

The broker must not accept valuation fees, credit application fees or credit establishment
fees except in the circumstances specified in the Act.

Victoria and Australian Capital Territory
These jurisdictions adopt a similar approach to New South Wales, however the requirements
are less comprehensive. The legislation is not detailed in full in this paper but may be
referred to in the summary at attachment “B”.

In both Victoria and the Australian Capital Territory the legislation encourages brokers to
have written agreements with their clients by providing that if the broker does not have a
formal agreement, a civil penalty applies in that they are prohibited from demanding or
receiving any fee from the client. Where the broker has a written agreement with their clients,
that document must include a number of specified matters, such as the amount of credit
required and, in Victoria, the agreement must set out the fee or how to calculate the fee. The
list of specified items does not include matters such as disclosure of commissions or
“spotters fees” paid by brokers to third parties, or any time limits within which the credit must
be arranged.28

Western Australia
Finance brokers in Western Australia are regulated by the Finance Brokers Control Act 1975
(the FBCA). The Finance Brokers Control Amendment Bill 2003 (the Bill) passed both
Houses of the Parliament on 10 November 2004 and will amend the FBCA when assent is
given.

Brokers are also subject to a mandatory code of conduct prescribed by Regulation under the
FBCA.

Coverage:

28
   See s37J of the Consumer Credit (Victoria) Act 1995 and s35 of the Consumer Credit
(Administration) Act 1996.


                                                                                              27
The FBCA applies to a person who, as an intermediary and in the course of business,
negotiates or arranges loans of money for others, or, who in the course of business manages
loans of money arranged or negotiated for or on behalf of others.

The purpose of the loan is irrelevant and, subject to the consent of all parties to a
transaction, a finance broker can act for either a lender or borrower.

Exemptions:
The following persons and classes of persons are exempted from the FBCA:
• Insurance companies;
• Authorised deposit taking institutions;
• Australian Financial Services licensees authorised to deal in securities within the
   meaning of the Corporations Act 2001;
• Legal practitioners;
• Housing societies registered under the Housing Societies Act 1976;
• Suppliers of goods and services arranging loans for payment of goods and services;
• Corporate bodies authorised by law to accepts grants of probate of letters of
   administration on behalf of deceased estates; and
• Persons and classes of persons exempted from the Act by Regulation.

Entry requirements:
Unless otherwise exempt, persons seeking to carry on business as a finance broker must
hold a licence. The licensing authority is the Commissioner for Fair Trading.

The term of a licence is three years (cost $350).

The prerequisites for the grant of a licence to a natural person are:
• Over 18 years of age;
• Possession of prescribed educational qualifications;
• Ordinarily resident in Western Australia;
• Fit and proper person of good character and repute;
• Sufficient financial resources; and
• An understanding of the requirements of the Act.

Body corporates and partnerships can also be licensed provided a minimum number of
directors/partners are personally licensed.

Fees and remuneration:
Brokers fees and remuneration are regulated by the Minister.

Other controls and requirements:
• Mandatory professional indemnity insurance;
• Maintenance of and annual auditing of trust accounts;
• Bond or guarantee in an approved amount to secure obligation to account for monies
   received on behalf of others;
• Business and all branch offices to be effectively managed by a licensed person;
• Prohibition on holding multiple licences and operating multiple businesses under a single
   licence;
• Prohibition against subcontracting with unlicensed persons;
• Disclosure requirements;
• Appointment by court of supervisor to broker’s business;
• Written appointment to act; and
• Prohibition against receiving fees before loan negotiated.


                                                                                        28
Summary
Only Western Australia has an occupational licensing regime, under which a finance broker
must satisfy certain requirements before they can practise as a broker. The ACT requires a
person to be registered as a finance broker before they can practice, and some categories of
people are excluded from being registered as brokers. Both New South Wales and Victoria
have “negative licensing”, i.e. a capacity to prohibit brokers from trading.

There are two significant limitations in the application of the broker-specific legislation to the
activities of brokers or broking transactions:

First, in New South Wales, Victoria and the ACT the legislation only applies to those
transactions regulated by the Uniform Consumer Credit Code (UCCC), which regulates credit
which is predominantly for personal, domestic or household use. It has been noted by
consumer advocates and fair trading agencies that some fringe brokers regularly utilise
Section 11 Declarations to oust the jurisdiction of the UCCC, irrespective of the actual
purpose of the credit.

Secondly, the legislation only applies to intermediaries where they negotiate or obtain credit
for consumers. It does not extend to people who provide advice in relation to mortgages.
This is an issue particularly in the area of debt reduction services. Intermediaries in this area
regularly split themselves into two entities, to limit the application of broker-specific
legislation. One entity cold-calls consumers and represents that significant savings can be
achieved through refinancing; in undertaking these activities it does not need to comply with
the broker legislation. If the consumer agrees the loan application will be arranged, often by
the same person, but acting on behalf of a second entity, who will comply with any legislative
requirements (but at a time when the consumer is already committed to the transaction).

There are some significant limitations in the matters brokers are required to disclose to
consumers, both in relation to the terms of their broking contract and the credit product
recommended. These limitations include:
   • disclosure of financial benefits received from lenders is required only in NSW and
      Victoria;
   • no obligation to disclose the range of lenders and products that the broker can
      arrange, or to disclose whether the broker offers independent advice or merely
      channels loan applications to one or a few selected lenders (except in NSW);
   • no obligation to advise how the broker has assessed the borrower’s capacity to meet
      repayments under the recommended credit product; and
   • no obligation to provide clients with any analysis of the advantages or disadvantages
      of refinancing an existing credit contract.

It will be noted from the description of broker specific legislation set out above that there are
major differences between jurisdictions in what is required of brokers in order to comply.
This is a major impost on those broking firms that have a national market. This is examined
further in the discussion of regulatory options.

3.1.2 General Regulation of Brokers
ASIC has had the federal regulatory role in relation to credit, including the conduct of
brokers, since 11 March 2002. ASIC’s responsibility for credit and finance brokers arises
under the ASIC Act 2001 (the ASIC Act). The ASIC Act does not prescribe detailed
disclosure or contractual requirements in relation to credit. Rather, the ASIC Act sets out a
number of broad standards of conduct in relation to credit facilities, including:
• prohibiting unconscionable conduct and misleading or deceptive conduct;
• prohibiting making false or misleading representations; and



                                                                                               29
•     implied warranties of due care and skill and fitness for purpose into contracts for the
      provision of financial services.

ASIC’s current position is that it “will generally focus on issues that are national in scope
and/or have a clear systemic aspect”.29 ASIC does not usually seek to intervene or mediate
with lenders on behalf of individual consumers who may need immediate assistance about a
problem with a loan or other credit product. ASIC has stated that “because [it] can often not
help directly in these cases, [it] will have an important referral role to play”.30

The level of regulation of brokers under the ASIC Act is therefore responsive, in that action
can only be taken where unfair conduct has already occurred.

3.1.3 State/Territory Fair Trading Agencies
ASIC shares the credit jurisdiction with State/Territory fair trading agencies (or their
equivalent), as analogous prohibitions exist in some Fair Trading Acts. In addition, these
agencies are also responsible for monitoring compliance with the UCCC. Some jurisdictions
take a similar response to ASIC in relation to individual complaints, while some will negotiate
with a broker on the consumer’s behalf as well as conducting targeted enforcement action.
They also usually have dedicated resources to negotiate hardship variations in repayments
with the credit provider, where the credit contract is regulated by the UCCC.

3.1.4 Self-Regulation
There are two main industry bodies representing brokers: the Finance Brokers Association of
Australia (FBAA) and the Mortgage Industry Association of Australasia (MIAA). These bodies
require their members to comply with internal codes of conduct.

The MIAA Code of Practice is currently under review. The current Code is binding on every
MIAA member and specifies minimum standards of professional conduct and good industry
practice to be adhered to by members. It also specifies minimum requirements of
professional qualifications and/or experience as well as professional indemnity insurance that
are required to be a member of the MIAA. The Code sets out procedures for consumer
complaints handling, which include informing the consumer about the Credit Ombudsman
Service Limited, an independent dispute resolution scheme approved by ASIC.

The Code requires full disclosure of fees and commissions paid by or to the broker as well as
requiring the broker to inform the consumer if they are acting as agent of the credit provider
and of any conflicts of interest they may have. The Code requires the broker to act with due
care and diligence and to establish and maintain honest and honourable dealings with the
consumer.

The FBAA also requires its members to comply with its Code of Practice, which was
upgraded in October 2003. Members are required to discharge their duties competently and
with integrity and honesty; to avoid conflicts of interest but, if they arise, to disclose such
conflict as soon as practicable.

FBAA members must disclose fees and commissions paid or received. Members must
assist the client to understand their contractual benefits and obligations with the finance
broker and credit provider and maintain written reasons for recommendations made to
clients.

Members are required to make all reasonable inquiries of the client as to their income, assets
and liabilities and also supply details of their credit history.
29
     See www.asic.gov.au/asic/asic_polprac.nsf/byheadline/Credit+homepage
30
     Ibid.


                                                                                            30
Members are required to comply with the Australian Standard AS4269 for complaints
handling and, if any complaint is not resolved, to refer the complaint to a Referee for
determination.

The limitations of the self-regulatory regime established by the FBAA and the MIAA have
been publicly acknowledged across the broker industry, with both peak industry bodies
calling for a greater degree of government regulation. Phil Naylor, chief executive of the
MIAA, has said:

       “Brokers in any sector will always have some propensity for fraud and improper
       practice. Two years ago, we set up a framework for self-regulation of our
       membership. At that time, our preference was for self-regulation of our
       membership but things have changed; the mortgage market has heated up and
       there has been a lot more scrutiny of brokers. The community’s perception is that
       self-regulation is not enough.”31
Similarly, in February 2003, the FBAA publicly adopted a goal of uniform national legislative
registration of brokers within three years, with mandatory training requirements for entrants.32

3.1.5 Liability of lenders for conduct of brokers
Generally, brokers are characterised in law as an agent for the borrower and not the lender.
Where there is a written agreement between the lender and the broker this usually stipulates
that the broker is not an agent of the lender. Prima facie, therefore, the lender will generally
not be held responsible for any unfair conduct by the broker towards the borrower. Where the
broker has acted unfairly and yet is not an agent of the lender, the borrower cannot rely on
the broker's conduct as a defence to any Court action brought against them by the lender.
For example, if the broker misrepresented the interest rate charged by the lender, the
borrower would not be able to take the lender to Court and argue that the lender had to
charge the lower (misrepresented) interest rate. The borrower’s remedy would be against the
broker, seeking compensation for the additional interest charged.
However, there are three exceptions to this general rule, where the borrower may be able to
seek relief directly against the lender for the conduct of the broker:

1    the first exception is where there are unusual facts that lead to the conclusion that the
     broker has either actual or ostensible authority to act as the agent of the lender, not the
     borrower. The fact that the broker receives a commission from the lender, and that the
     broker has been supplied with credit applications by the lender and been instructed how
     to complete them, will in themselves not usually be sufficient circumstances to establish
     actual or ostensible authority.33 This approach is outmoded and does not adequately
     address the situation where the broker regularly or invariably channels credit applications
     to only one lender, or to a small number of lenders (and where volume-based
     commission arrangements are designed by the lender to create financial incentives for
     this to happen);
2    the second exception is where the credit is regulated by the UCCC and the broker is a
     linked supplier with the lender. In this case, the lender will be responsible for statements
     made by the broker, under s118 of the UCCC. There are a number of preconditions that
     must be satisfied before this section will apply which inhibit the extent to which
     consumers can rely on it; and


31
   Quoted in “Bridle the Brokers”, Business Review Weekly, 28 November 2002, pp. 63–4.
32
   “FBAA chief seeks national registration”, February 2003 at www.mortgagemagazine.com.au.
33
   See, for example, Morlend Finance v Westendorp [1993] 2 VR 284; Custom Credit Corporation Ltd v
Lynch [1993] 2 VR 469.


                                                                                               31
3    borrowers can seek relief from unjust credit contracts under s70 of the UCCC and, in
     New South Wales, under the Contracts Review Act 1980. Under the Contracts Review
     Act 1980, a credit contract can be found to be unjust because of the conduct of a third
     party (such as a broker), even where the lender was ignorant of that conduct. However,
     the state of knowledge of the lender will be relevant in determining whether or not to
     grant relief, as the competing claims of the lender and the borrower need to be
     considered.34 The issue has not been considered in relation to the interpretation of s70 of
     the UCCC, but it is possible that the Courts will find that a similar two-stage inquiry
     should be undertaken. If this is the case, then in extreme or exceptional circumstances,
     the Courts may grant relief to a borrower with respect to the lender, even though the
     lender was unaware of the conduct of the broker.
In general terms, lenders have minimal incentives to maintain vigorous and regular
supervision of the conduct of brokers given their limited legal liability for the conduct of the
brokers, and the additional expense and cost that would be incurred in doing so. Lenders,
where confronted by a wayward broker, can adopt the straightforward, cost-effective
approach of refusing to deal with that broker.

3.1.6 Accreditation of brokers by lenders
APRA released the results of a survey of use of brokers by ADIs (ie banks, credit unions and
building societies). The survey found that approximately 60% of these institutions had in
place an accreditation process for brokers. The process could include:35
• only accepting business from approved, contracted brokers;
• identifying and tracking broker-introduced loans;
• internal review of loan applications;
• maintaining records of rejected broker-introduced applications; and
• regular reviews of the broker.

APRA commented that “there is a high proportion of ADIs doing business with brokers about
whom they have relatively little knowledge.”36 It can be speculated that the level of
supervision of brokers by non-ADIs is generally less rigorous.

Before releasing the report, APRA had publicly called on lenders to review or improve the
due diligence assessments they make of brokers who submit applications to them. Charles
Littrell, APRA’s Executive General Manager of Policy Research and Consulting, said:

       “One hopes lenders are keeping track of the quality of the loans that brokers are
       sending them. It is the broker’s role to maximise the size of the loan that it can
       secure for the client and to present the client to the lender in the most favourable
       light. To that extent, loan broker intermediation has the ingredients for higher
       default rates.”37
This statement urges lenders to actively supervise brokers. Consistent with this approach,
Wizard Financial Services and RESI Mortgage Corporation jointly released ten ethical
guidelines for brokers. The guidelines were a response to their concerns about the extent to
which the conduct of some mortgage brokers were seen to be damaging the industry as a
whole. They made public calls for the guidelines to be imposed nationally, as representing
minimum standards of conduct for brokers. The release of those guidelines was, in itself,
recognition of deficiencies in the standard of behaviour within the broker industry, and the
inability of lenders to regulate or properly supervise brokers.

34
   Nguyen v Taylor (1992) 27 NSWLR 48.
35
   APRA, op. cit., p. 8.
36
   Ibid.
37
   Quoted in “Bridle the brokers”, Business Review Weekly, 28 November 2002, p. 65.



                                                                                              32
3.2   Regulation in Other Countries
This section of the report reviews the nature of the broker industry in a number of other
countries, and the models of regulation in those countries. It should be noted that regulation
is generally restricted to broking in relation to lending secured by way of mortgage over real
estate. Detail of that regulation is to be found in Appendix A, and an overview is set out
below.

The UK and European Union have now harmonised their regulation of brokers or credit
intermediaries and require:
• Licensing or registration;
• Broker to advise whether they are acting on an execution only basis or providing advice
    and, if the latter, provide details of the number of lenders and credit products reviewed
    prior to making a recommendation;
• Broker must assess whether or not a loan is appropriate for the borrower and further
    consider what type of loan is suitable and which product best meets the consumer’s
    needs and financial circumstances;
• Brokers are subject to the compulsory jurisdiction of the Financial Services Ombudsman,
    the complaint handling scheme for financial services in the UK.
• A higher level of regulation applies to mortgages identified as inherently more risky for
    the borrower, such as “equity release” mortgages for older borrowers.

In the US the mortgage broker industry is regulated by ten Federal laws, five Federal
enforcement agencies and over 45 state laws or licensing boards. The main Federal act is
the Real Estate Settlement Procedures Act 1974. The regulatory agency’s Statement of
Policy on broker fees is that:
• Broker payments must be commensurate with the amount normally charged for similar
    services; and
• The broker fee disclosure must be accompanied by a description of what services the
    broker will perform, as well as the broker’s total compensation for performing those
    services.

State laws generally require surety bonds, some require licensing or registration, some have
educational requirements and some require experience. Individual states may have
additional requirements for example, New York, which has requirements for broking high cost
or “predatory” loans.

Similarly Canada regulates on a state by state basis and generally requires registration,
written agreements with full disclosure and educational requirements.

In New Zealand, brokers are not specifically regulated but the peak industry association
requires members to comply with a Code of Ethics and Standards. Some regulation of the
industry is provided through general fair trading legislation and credit legislation.


3.3   Consumer Remedies

3.3.1 Difficulties in accessing redress mechanisms
The current mechanisms for obtaining redress against brokers are generally inadequate to
provide timely and effective remedies for consumers. There are a number of reasons for this.
The first reason is that consumers have few options for obtaining redress apart from
instigating Court action, with its attendant uncertainty and expense.

Brokers, unlike other intermediaries in the financial service industry, are not required to be
members of an alternative dispute resolution (ADR) scheme, giving consumers a choice


                                                                                           33
apart from Court action. The “Broker Survey” indicated that only 51% of brokers had in place
a formal procedure for responding to customer complaints. It should be noted in respect of
the broker survey that nearly all responses were from MIAA and FBAA members, and that
these organisations are unlikely to attract members from the “fringe” broking industry.

As well, 26% of the caseworkers surveyed by CCLC (NSW) who dealt with broker complaints
indicated that direct negotiations with the broker were never successful in resolving
complaints.38 These responses are consistent with a lack of accountability by brokers, and
the lack of any incentives for them to adopt effective complaints handling procedures. They
reflect the fact that brokers, if they are so minded, can ignore complaints, even where the
consumer is assisted by a community advocate, because of the difficulties for the consumer
in taking action elsewhere.

The second reason why redress is difficult to obtain is that commonly the loss suffered by a
consumer will be the amount they are required to pay a third party. Usually the third party will
be the credit provider, but it may also be, for example, the vendor of a property when the
consumer cannot pay the purchase price because the broker failed to arrange finance. The
consumer will be under financial pressure because of the third party either having received or
demanded payment, and the focus of their attention will be on resolving the dispute with the
third party. The fact that a third party is involved inhibits the capacity of the borrower to
contemplate or bear the cost of any legal action.

The following case studies illustrate the problems that can arise for a consumer.

Case study
Mr B is a single father with a young child, working four days a week. He was living in his own
(mortgaged) home, and was interested in buying an investment property, as a way of
becoming more financially secure. Mr B approached a broker for advice, initially to determine
whether or not he could borrow money to purchase an investment property, and, if so, how
much. The broker informed him that he would be able to borrow over $300,000, with the
precise figure depending on the rental income received from the investment property to be
purchased. Relying on this advice, Mr B found a property for about $250,000.

The broker then lodged an application for finance for Mr B with a bank, which was approved.
However, when Mr B began budgeting to meet the repayments, he realised he could not
afford them. He contacted the bank and the broker, and discovered that the broker had
misrepresented his financial situation on the application form to the bank, by suggesting that
he would be getting additional rental income from the property in which he and his child were
living.

Mr B was advised that if he did not proceed with the purchase of the investment property, he
would lose his deposit. He therefore has had to move out of his home, and live with his
parents. Despite this, he still finds it difficult to meet repayments on both loans and is
considering selling one of the properties.

Case Study
Karl Suleman Enterprizes Pty Ltd was a high-profile company which promised investors high
rates of return (through what was essentially a pyramid scheme). Some consumers obtained
large sums for investment in the scheme through mortgaging their homes. Many of these
loans were arranged by an intermediary, Boushra Gadallah, through Perfect Loans Pty Ltd
(trading as Sunline Home Loans) and Xclent Accountants Pty Ltd (trading as Gadallah & Co).


38
     CCLC Report, op.cit.,Section C.5 in Appendix C.


                                                                                             34
In May 2004 ASIC banned Gadallah from acting as an investment adviser for a period of 10
years39. ASIC found that Gadallah:
• failed to exercise reasonable care in compiling and verifying information in home loan
    applications and taxation returns used to obtain loans for investors
• failed to exercise reasonable care in assisting borrowers to invest in high risk investments
    even though he knew they were likely to collapse.

It is noted that Gadallah was only banned from acting as an investment adviser and that
under current legislation he cannot be banned, by either State or Federal agencies, from
working as a broker.

3.3.2 Legal Redress
Consumers considering taking legal action against brokers face a number of barriers
including the inaccessibility, delays, daunting formality and high costs of the Court system. In
addition, it is the nature of broker disputes that they tend to be either about fees (where the
amount of money involved is relatively small compared to the costs of legal action), or arise
in circumstances where a third party is involved and demanding payment from the consumer
(commonly the lender or the vendor of a property if a sale does not proceed). In some cases,
the consumer can be left with a dispute with a lender that is the direct result of the actions of
the broker, and where the broker may not be able to be located, or where enforcement of any
judgement against the broker is problematic, and the lender refuses liability on the basis that
the broker was the borrower’s agent.

As discussed above, brokers are often characterised in law as agents for the borrower and
not the lender (even where the broker has received a commission from the lender and that
the broker has been supplied with credit applications by the lender and been instructed how
to complete them). Practical examples of the difficulties this characterisation creates for
borrowers include:

•     misrepresentations by the broker about a break cost or the availability of features such as
      redraws are unlikely to be attributed to the credit provider;
•     unconscionable behaviour such as the broker misrepresenting the nature or terms of the
      finance to third parties who do not benefit from the loan, but become parties to the
      transaction (either as guarantors or borrowers) will not be attributed to the credit provider
      where there is nothing on the face of the application to suggest that this has occurred.
      The unjust contract provisions of the UCCC may not provide relief as the court will have
      to decide between the competing interests of two “innocent” parties, the third party
      borrower/guarantor and the credit provider.
•     similar limitations apply where the broker misrepresents the borrower’s financial or
      personal circumstances, without the knowledge of the borrower. Relief that may have
      been available against the credit provider for knowingly overcommitting the consumer will
      not be available unless the consumer can somehow demonstrate knowledge of the
      misrepresentation by the credit provider.

Other problems for consumers in taking action directly against the broker include an absence
of corroborating evidence (where the consumer relied on oral statements contrary to written
documents), lack of access to documents held by the lender, and possible time delays. It is
also not easy to evaluate the prospects of success of any Court action, given the lack of
clear standards within the industry, as to what constitutes acceptable behaviour.

A particular problem arises for borrowers where they have signed an effective declaration
that the loan is for business purposes, under s11(2) of the UCCC, even though the money is

39
     ASIC Media Release 2004-145, 18 May 2004.


                                                                                                35
in fact for personal use. In these circumstances, the borrower will be unable to access the
statutory remedies in the UCCC, including redress for breach of disclosure requirements and
relief from unjust contracts in s70 of the UCCC. These remedies are generally broader than
other actions.

It should also be noted that s70(2)(l) of the UCCC directs the Court, in determining whether
or not a transaction is unjust, to consider:

      “whether at the time the contract, mortgage or guarantee was entered into or
      changed, the credit provider knew, or could have ascertained by reasonable
      inquiry of the debtor at the time, that the debtor could not pay in accordance with
      its terms or not without substantial hardship…”

This provision was included, in part, because of the reluctance of the Courts to acknowledge
that over-commitment of borrowers might, in itself, constitute grounds for relief. CCLC
(NSW), and other caseworkers, have noted that some non-mainstream and fringe lenders
(particularly those providing “interest only” loans) systematically use the business purposes
declaration to avoid the jurisdiction of the UCCC. Borrowers using such lenders tend to be
financially desperate, so that one specific consequence of the use of these declarations is to
deny them access to the sole statutory remedy available for redress (and when any non-
statutory remedy is legally problematic).

Disempowered consumers are rarely in a position where they are able to commence
proceedings regardless of the actions of the broker. They either attempt to withdraw from the
relationship with the broker, or they proceed with the transaction and problems arise when
they are unable to meet their commitments under the loan contract. In the former case,
typically it is the broker who commences legal action in order to recover their fees, usually on
the basis of a written document that is difficult to refute in a court of law. In the latter case,
the consumer is in dispute with the credit provider and the broker’s fees, while often
substantial, pale into insignificance against the costs and consequences of an expensive and
unsuitable loan.

The range of difficulties confronting consumers contemplating taking legal action against
brokers means this is rarely pursued as an option, even where the conduct of the broker has
been extreme and may have caused the loss of the family home.

Case study
Mr K had been sick and working part-time. He was behind in his home loan repayments and
had outstanding credit card debts. He received a default notice from the mortgagor. The
bank declined his application for a loan to meet the arrears. As a result, he contacted a
broker advertising in the newspaper as being able to find finance for people rejected by other
lenders. The broker told Mr K he could organize a loan, but that he would have to refinance
his existing home loan. Mr K’s original lender charged a break fee of several thousand
dollars. The broker arranged an interest only loan, and charged a fee of $2600. The lender
charged an establishment fee of over $3000. Mr K soon fell into arrears on the new loan, and
Court proceedings were commenced. The lawyer examined the documents he had signed
when applying for the loan. These included documents outlining the fees charged, and a
business purposes declaration. The lawyer advised Mr K that the costs of fighting the Court
case would be significant, and he was unlikely to succeed in arguing that the loan was
regulated by the UCCC, or therefore that the loan was unjust.

3.3.3 Tribunal Access
In New South Wales and Victoria consumers may apply to a tribunal for relief in certain
limited circumstances. In Victoria, the consumer can apply to a court or tribunal where the


                                                                                               36
broker accepts fees to which he or she is not entitled. In New South Wales, under the
recently commenced legislation, applications may be made to the Consumer Trader and
Tenancy Tribunal in respect of a broker’s non-compliance with the contract, engaging in
unjust conduct, or charging excessive commission.

While this option is less expensive than court action, it is still a daunting prospect for many
consumers who are intimidated by the quasi-legal environment and the formal hearings.
More particularly, those consumers who are the least sophisticated and who fall prey to
“rogue” brokers are the least likely to use this system. As well, only limited issues can be
dealt with in such a forum and the credit contract itself cannot be affected by any action
taken. Where the credit obtained is not covered by the Consumer Credit Code the Tribunal
does not have jurisdiction.


3.3.4 Access to alternative dispute resolution
Unlike other intermediaries or product providers in the financial services area, there is no
alternative dispute resolution (ADR) scheme with comprehensive coverage of brokers.40 In
fact, consumers can only have a dispute in relation to the conduct of a broker heard by an
ADR scheme in the following limited circumstances:
• where the intermediary is a member of the Credit Ombudsman Service Limited, originally
    Mortgage Industry Ombudsman Scheme (MIOS). Membership of this scheme is
    voluntary. Complaints to the scheme were up 31% for the year to June 30, however,
    37% related to non-members. The scheme’s shortcomings were detailed in a recent
    newspaper article.41
• where the intermediary or their employer is a member of the Financial Industry
    Complaints Service, usually because the intermediary is a financial planner and has
    recommended or assisted the borrower to take out credit as part of an overall investment
    plan;
• where the intermediary is a related corporation to a bank. In these cases, the consumer
    can complain to the Banking and Financial Services Ombudsman (BFSO),(previously
    the Australian Banking Industry Ombudsman) about the conduct of the broker. The BFSO
    extended its coverage on 13 August 2003 to brokers who join the scheme. There are
    currently 19 broker members.
• where the lender is a bank or a credit union and the consumer may be able to claim relief
    against the lender rather than the broker (see for example, CCLC Report, p. 53). In these
    cases, the consumer can complain to either the BFSO or the Credit Union Dispute
    Resolution Centre. However, even where the broker may be found to have acted as an
    agent of the credit provider, these two schemes may still be unable to hear complaints
    about matters such as the fees charged by a broker, or where the broker failed to obtain
    a loan for the client, or failed to do so within any time limits specified by the consumer.

The limited access to an ADR scheme means that many consumers have little option but to
go to Court, particularly when dealing with the smaller or fringe brokers. Perversely, these
brokers are those most likely to adopt unfair practices and therefore to have dealings with
consumers who are most likely to need redress.

3.4   Summary of identified problems and the consequences for consumers
The preceding chapters outline in detail the consumer detriment seen by both financial
counselling caseworkers and legal centre staff, and the industry practices thought to be
causing the problems. These are summarised below:

40
   Only 37% of respondents to the “Broker Survey” were members of an ADR scheme; CCLC Report,
op.cit. see Table B.18 in Appendix B.
41
   “Rights issue”, Sydney Morning Herald, 11 August, 2004, p.8.


                                                                                            37
Problems:
• Brokers are not obliged to disclose details of their functions and operations so that
   consumers’ expectations of the role of the broker may not be realistic;
• There is nothing on which consumers can base an assessment of the quality or cost
   effectiveness of broking services;
• Brokers are not uniformly required to enter into a contract with the consumer for their
   services;
• Brokers are not uniformly required to tell the consumer the number and identity of lenders
   on their panel;
• Brokers are not uniformly required to disclose the costs that will be borne by the
   consumer;
• Brokers are not uniformly required to disclose the factors, financial and other, that may
   influence their recommendations;
• Brokers are not required to give consumers reasons for recommending a particular loan;
• Brokers are not required to support any representation of the benefits the consumer will
   receive in switching loans or refinancing;
• There is no uniformly applied system of accountability for brokers, especially at the fringe
   broker level;
• The lack of a continuing relationship between broker and client does not provide an
   incentive for a broker to provide a good service;
• There are limited avenues for accessible consumer redress;
• Brokers’ misrepresentations are difficult to prove.

Consequences:
• Consumers may enter into credit contracts that they cannot afford to repay without
  substantial hardship;
• Consumers may be locked into an uncompetitive credit product;
• Consumers may enter into contracts for credit which are inappropriate for their credit
  needs;
• Consumers may enter into loans which they believe will be cheaper but which cost them
  more in the long run;
• Consumers may not get access to credit in time to complete a purchase;
• Consumers may be charged exorbitantly high fees and commissions;
• Consumers may be charged unrefundable commissions upfront and may not gain access
  to the credit they need;
• Consumers may lose their homes or suffer substantial financial loss;
• Consumers have very limited access to redress.

3.5   Level of Consumer Detriment
It is difficult to establish even a rough estimate of the extent of consumer financial detriment.
The number of complaints received by fair trading agencies is one indicator, although such
data is more useful in identifying trends rather than the size of a problem. A benchmarking
survey conducted in 1997 found that of the consumers surveyed who had experienced a
consumer problem, only 13% had approached a government agency such as the (then)
Department of Fair Trading seeking assistance. This is consistent with a 1995 study
undertaken by the Society of Consumer Affairs Professionals in Business Australia
(SOCAP), where less than 15% of consumers had approached government or community
organisations with a complaint.42

In more recent times, during 2003 – 2004, only 4 people out of several hundred consumers
who were victims of a broking scam had contacted the New South Wales Office of Fair
42
   Keys Young, Benchmark Study of Consumer Protection and Marketplace Issues in New South Wales,
Final Report, 1997, p27.


                                                                                              38
Trading to make a complaint, while in another matter, 23 people out of a potential 100+ had
made a complaint to the same office.

It is clear, therefore, that complaints data will not reflect the magnitude of the problem in the
community at large. Not all inquiries proceed to a complaint. When inquiry and complaint
data is reviewed, it seems that the practices which are the subject of an inquiry or complaint
are in similar proportions to the whole. It may be the case that when making an inquiry,
consumers are advised to approach the trader about the issue in the first instance. Many
consumers lack confidence in their capacity to negotiate a solution and those who will
approach a trader are likely to be in the higher income brackets and with a higher level of
education.43 Again, it is the most vulnerable consumer who will not achieve a satisfactory
resolution.
While it is not possible to draw firm conclusions from complaint data in the various States as
to the effect of the legislation in that jurisdiction, some tentative suggestions may be made.
Western Australia is the only jurisdiction with a licensing regime. It should be noted, however,
that the licensing regime applies to brokers of commercial credit as well as consumer credit,
so that the number of complaints would not be directly comparable. In the financial year
2002-2003, 88 complaints were received against brokers. Complaints fell mainly into the
following categories: channelling consumers to lenders whose products may not be in the
best interests of consumers; charging fees in excess of the Maximum Remuneration
Schedule; consumers complaining about debt reduction schemes and those brokers claiming
that their debt reduction schemes are not broking and should not therefore make then
subject to the regulatory regime; and cold calling in contravention of the Door to Door
Trading Act.

Western Australia makes the point that they have a high profile in relation to broking and are
therefore likely to attract more complaints because of that fact.

Western Australia does not have any recent recorded incidence of “fraudulent” behaviour or
major misleading, deceptive or unconscionable practices. This could be attributed to their
licensing regime and both the screening or compliance activity that accompanies such a
regime. This can be, at best, a tentative interpretation.

Victorian data registers 702 inquiries and 63 complaints for 2003-2004. The largest category
of complaints comes under the general term of unfair conduct, which includes non-supply of
service, required documentation not issued or is defective, unfair contract terms and unfair or
unjust trader. Non-supply of service and unfair trader are the largest sub-categories. The
largest single number of complaints otherwise relates to overcharging, or undisclosed or
unreasonable charges. Substandard services caused the second largest number of
complaints.

Inquiries differed in composition only in respect of substandard services, which were much
lower in the list of complaints.

Because data collection at this time is not harmonised between jurisdictions, it is difficult to
draw firm conclusions about the effect of any regulatory regime. The lack of a screening
process in Victoria could be related to the large proportion of unfair conduct issues and non-
supply of service, which could reflect fraudulent activity. Since Western Australia appears
not to have a comparable data collection system, comparisons are not possible.

In New South Wales for the period 2003 – 2004, there were 149 complaints registered.



43
     Ibid, p27.


                                                                                              39
Misleading and deceptive conduct, unconscionable conduct and unsatisfactory/non-
performance of service constituted the largest proportion of complaints by far. The largest
single category outside of that grouping was for complaints about commissions that have
been charged before any credit is obtained. At the time of this data collection, the new
legislation had not commenced and requirements were simply that commissions should not
be demanded or accepted before credit was obtained, as well as rules for dealing with third
party fees and retaining records of transactions.

The smaller number of complaints in Victoria compared to NSW could be related to their
more comprehensive regime at that time, but both jurisdictions share the high proportion of
unfair conduct complaints. Like Victoria, New South Wales has no licensing or registration
requirements.

With respect to level of consumer detriment, this takes many forms. In the Credit Accounting
Consultants matter, which was the subject of NSW legal action referred to previously,
consumers paid between $2,000 and $18,000 for a service which would constitute “non-
supply” or “unfair conduct” in complaints data. The Supreme Court of NSW ordered
$1,300,000 to be paid in compensation to victims of this broking firm in 2004. One consumer
recently signed up (with an “X”) for a broker to obtain a $30,000 loan for a $10,000 fee. The
case studies have detailed the losses that can result from refinancing when this is not in the
best interest of the consumer. Many consumers have lost their homes by being persuaded
to take out inappropriate high cost products.

The financial impact on consumers of these practices is demonstrated by the following
studies.

Study 1 Debt Reduction Schemes
One of the problem areas in relation to finance brokers is debt reduction schemes where the
broker targets consumers through promising to refinance the consumer into a facility that can
be paid off in a much shorter period of time. Section 2.2.3 of the paper sets out in detail the
reasons why these claims are spurious, and why they result in consumers being refinanced
to a line of credit at a higher interest rate.

One agency has conducted a detailed examination of one of these schemes. It is possible to
quantify the costs to consumers.

During a recent five month period the debt reduction schemes arranged:

   (a) 374 refinances of consumers to credit facilities provided by a related corporation; and

   (b) 87 additional loans to mainstream lenders.

The average loan size was $246,400. Where the lender was a related corporation it charged
an interest rate above the level charged by mainstream lenders, usually by 0.5%.

The involvement of the debt reduction scheme meant that the consumer paid refinancing
costs of a minimum of $4285, made up of:

   1. Fees charged by the broker, usually $3300;

   2. Application fees of $865; and

   3. Solicitors fees of a minimum of $120.




                                                                                            40
Consumers incurred two types of loss as a result of the refinance: additional interest charges
and transaction costs. It is possible to quantify these losses.

Additional Interest Charges

It is possible to calculate the additional interest charges paid by the consumer using the
following information:

   1. The average loan size was $246,400 (and this includes refinancing costs of $4285).

   2. In relation to the 374 refinances to credit facilities provided by a related corporation a
      review of the files suggests that the average interest rate on the consumer's existing
      loan was 6.5%, and the interest rate on refinance was 7.5%. However, a conservative
      estimate of 0.5% as the average difference between the loans is used.

   3. In relation to the 87 refinances to credit facilities provided by mainstream lenders a
      review of the files suggests that the average interest rate on the consumer's existing
      loan was 6.5%, and the interest rate on refinance was 7.0%. However, a conservative
      estimate of 0.2% as the average difference between the loans is used.

   4. The debt will be paid out in an average of 15 years (that is, although the loan itself
      may be refinanced prior to this time, it is assumed that the liability incurred by the
      consumer will take 15 years to discharge).

Additional Interest Paid Where Lender Was A Related Corporation

Interest payable for loan of $246,400 @ 7% over 15 years:             $152,248.31

Interest payable for loan of $241,840 @ 6.5% over 15 years:           $137,519.69

Difference                                                            $14,728.62

Additional Interest Paid Where Lender Was A Mainstream Lender

Interest payable for loan of $246,400 @ 6.7% over 15 years:           $144,846.59

Interest payable for loan of $241,840 @ 6.5% over 15 years:           $137,519.69

Difference                                                            $7,326.90

Transaction Costs

The loss to consumers from refinancing is a minimum of $4285, as set out previously. This is
a conservative estimate as it does not include additional fees or costs such as stamp duty,
nor any penalties or discharge costs charged by the lender whose facility is being refinanced.

Total Losses

It is possible to quantify the overall losses for consumers:

Losses Where Lender Was A Related Corporation

Individual Losses:     $4160 + $14,728.62 =           $18,888.62

Total Losses:          $18,888.62 x 374       =       $7,064,343.88


                                                                                             41
Losses Where Lender Was A Mainstream Lender

Individual Losses:    $4160 + $7,326.90      =      $11,486.90

Total Losses:         $11,486.90 x 87        =      $999,360.30

Overall Losses        $7,064,343.88 + $999,360.30 = $8,063,704.18

These losses are over a 5 month period. The company has been operating in similar fashion
since 1999, and its business has expanded rapidly since that time.

Reviews of websites and the operation of other brokers has identified a minimum of another
20 companies operating debt reduction schemes, at least three of whom have large scale
operations.

Study 2        Brokers Arranging Interest Only Loans
Another problem area in relation to finance brokers is where brokers arrange 'interest only'
loans for consumers in financial difficulties, and who may be in arrears on their existing home
loan. Section 2.2.3 of the paper sets out in detail the way in which these brokers
systematically target and exploit financially vulnerable consumers by arranging refinancing
where the consumer is having difficulty in meeting the repayments on their existing loans.

One agency has conducted a detailed examination of one of these schemes. The costs to
consumers are variable and include:

Brokerage fees of between $2000 and $4000.

Lender's application fee and expenses of between $2000 and $7000.

Fees charged by borrower's solicitor and existing lender of $1400.

Additional interest through interest being charged at rates, of between 8% and 18.75%

A review of 41 files showed that 18 borrowers failed to make payments on time within first 3
months. This level of default is considered typical by the agency. The lenders involved in
these matters will usually commence enforcement action following an initial default and
failure to remedy the default following service of a letter of demand (rather than negotiate
with the borrower or arrange a revised payment schedule, as is the usual method of
operation of mainstream lenders).

It is estimated that between 10% and 25% of the borrowers in default to these types of
lenders will lose their home as a result of court action by the lender. These consumers suffer
additional losses:

Enforcement costs of a minimum of $3000, where court action commenced.

Loss of equity in their home through sale of their property at an auction price, or through
additional transaction costs where the consumer is able to refinance to a mainstream lender.

Study 3       Broker Has Conflict of Interests
The decision of the NSW Supreme Court in Investmentsource Corporation Pty Ltd v Knox
Street Apartments Pty Ltd & Others [2002] NSWSC 710 provides evidence of the losses
consumers can suffer due to a failure by the broker to identify conflicts of interest.



                                                                                            42
The case concerned the marketing and promotion of inner city units by a Henry Kaye
company, Investmentsource Corporation Pty Ltd ("Investmentsource"). It is understood that,
consistent with his usual method of operation, Henry Kaye used his wealth creation seminars
to encourage consumers to purchase these units and that Investmentsource assisted
consumers to arrange finance (in order to ensure that consumers proceeded with the sale).

In fact, Investmentsource had negotiated with the owner of the units to obtain exclusive rights
to market them. Investmentsource had negotiated to receive a commission from the owner
for the sale of each unit; the amount of commission received by Investmentsource was not
fixed but was the amount by which the purchase price exceeded a minimum sale price set by
the owner. There was no evidence that the consumers were told about these arrangements
and it can be presumed that they were unlikely to have agreed to purchase the units if this
was the case.

Investmentsource sold 31 units and earned commission of $1,330,589. This equates to a
profit of $42,922 on each sale through inflation of the property price. Assuming that the
consumers borrowed money to finance the purchase of a unit with a loan at an interest rate
of 6.5% and that the liability was discharged over a period of 15 years, the additional interest
paid by a consumer on the sum of $42,922 would be $24,379.41.

The total loss to consumers can be estimated as:

(42,922 + $24,379.41) x 31    = $67,301.41 x 31      =   $2,086,343.70

Study 4. Broker Arranges Less Finance Than Borrower Required to Complete
Purchase
One agency has examined the conduct of a broker that arranged finance for consumers to
purchase homes. The broker had a practice of assuring the borrower he could arrange a loan
for sufficient money to enable the borrower to complete the purchase, even where this was
not the case. Borrowers suffered damage as a result, including costs resulting from
postponing or defaulting on settlement (such as additional charges, penalties and loss of
deposit).

The losses resulting to consumers where they lost the deposit could be significant. In one
instance, where the conduct of the broker was reviewed in detail the loss to the consumer
was over $50,000.

Study 5 Broker Charges Borrower Fee Irrespective of Whether Able to Arrange
Finance
Some brokers will charge the borrower an upfront fee to arrange finance, and will demand
payment of this fee even where they may be unable to arrange finance for the borrower.

This creates particular problems where the borrower is a business, as in these
circumstances the amount of credit required may be quite high, and the failure to obtain
credit can impact significantly on the cashflow of the business, and its capacity to continue
trading.

One agency had two complaints about a broker where the broker charged upfront fees of
$15,000 and $25,000 to obtain credit. In neither case was the broker able to arrange finance,
and in one case it demanded (but did not receive) an additional fee in order to 'get the money
through'.

In both cases the business was under financial pressure due to both payment of the fee and
the failure of the broker to arrange credit.



                                                                                             43
While there can be no accurate estimate of costs to the community, it is clear from the
studies presented that the costs are significant.




                                                                                    44
4 Reasons for Government Intervention

4.1   Market failure in relation to consumers
Markets can be an effective mechanism for resource and product allocation provided that (a)
consumers are armed with full, or at least adequate, knowledge about the nature of goods
and services and the terms of the transaction with the supplier, and that (b) traders compete
fairly with each other. However, this may not occur because of asymmetrical information and
dissimilar bargaining positions.

The underlying principle is that well-informed consumers know best what goods and services
will satisfy their needs and wants. In economic terms, society achieves its optimal “welfare”
outcome when individuals are free to pursue their own best consumption options. The
efficient allocation of productive resources in a market economy relies on the informed
choices made by consumers and the competitive behaviour of market participants. Where
this optimal outcome is not achieved, “market failure” is said to occur.

The problems demonstrated in the preceding chapters appear to flow from two main
categories of market failure, that of imperfect or costly information and unfair competition
resulting from fraudulent or unfair conduct of “fringe” brokers. This is addressed in more
detail below.

4.1.1 Imperfect or costly information
The range of consumer credit products offered by the various financial institutions is too
complex to allow consumers to make rational selections of products that are best suited to
their needs.

The Caseworker Survey referred to in previous chapters has demonstrated that a large
percentage of caseworkers reported that their client had sought broking services because
they believed they could secure a better deal, and a substantial percentage that the client
either had no time or desire to compare different products themselves.

In order to make a rational choice of product the consumer asks a broker, who can limit the
cost of the transaction to the consumer by accessing information in a cost efficient way, to
assist in that choice.

The broker is then in the position of agent of the consumer in searching for the product, while
being also the agent of the credit provider in informing the consumer about the product in
such a way that will allow the consumer to make a rational choice. Remuneration for this
service may come from either party or both parties. Remuneration may vary between credit
providers and lead to a bias in favour of the credit provider providing a higher commission,
thereby subverting the potential for the consumer to make a rational choice.

Large numbers of brokers have entered the market in recent years. This should theoretically
benefit the consumer by reducing the “opportunity cost loss” of potential borrowers either
spending valuable time researching products themselves, or going into the branch of a credit
provider and being sold only that credit provider’s products. In view of the “time poorness” of
consumers, it is unlikely that the consumer will have had sufficient resources or capacity to
research the whole market and they may not therefore be accepting the most appropriate
loan for their purposes.

A UK study of consumer behaviour in accessing a home mortgage reports that consumers
have difficulty in comparing different mortgage products and that the largest percentage


                                                                                            45
(23%) stay with the lender they have previously used, while the second largest percentage
(20%) chose the mortgage product recommended by an intermediary.44

While there may be significant numbers of consumers who have benefited from a broking
service, that by no means is the case for all consumers. The background information
suggests that a significant number of brokers demonstrate unethical or fraudulent practices
while others are lacking the knowledge and expertise required to provide adequate broking
services. In a market with perfect information and perfect competition, the market would
have corrected this situation by consumers avoiding brokers who are unethical or
incompetent. However, in the finance broking market, most consumers do not have the
information or expertise to judge whether a broker is going to act honestly and in their best
interests and provide a quality service. The broker service provided is not one that is
regularly used and therefore the consumer is not likely to have developed skills in assessing
broker performance.

The complexity of the credit market also means that the consumer does not have the
expertise to judge the quality of the advice provided by the broker. This lack of expertise is
precisely the reason why a broker (who is presumed to possess specialist knowledge) is
being employed. The consumer is in a position where they are dependent on the broker's
skill and expertise, and where that skill and expertise is the reason they have chosen to
employ the broker. This dependency leaves them vulnerable in their dealings where the
broker does not act scrupulously.

There are other aspects of finance broking of which consumers would be unaware. Many
brokers have access to a very limited number of lenders, so that they are not necessarily
sourcing the best loan available for the consumer. The access to lenders may reflect a
number of factors: whether the lender has rejected the broker because there is insufficient
volume of business; or the broker has not met the lender’s accreditation criteria; or the broker
has proven to be engaging in fraudulent activity or some other activity with which the lender
prefers not to be associated. Also, the broker may have rejected the lender because they do
not pay commission.

These are matters of considerable importance, and the consumer would have no way of
accessing that information.

4.1.2 Fraudulent, unconscionable or misleading conduct
The background material contains descriptions and case studies of fraudulent activity by
brokers, as well as conduct which demonstrates an unwillingness to act in accordance with
the law. The activities described are able to be carried on because of the trust placed in a
broker by the consumer and consumers’ relative inexperience or naivity in financial matters.

Professor Jeffrey Carmichael, one of the members of the Financial System Inquiry, and
formerly Chairman of the Australian Financial Institutions Commission and Chief Manager of
the Markets Group of the Reserve Bank, has commented on the role of market misconduct in
producing market failure as follows:

“Financial markets cannot operate efficiently and effectively unless participants act with
integrity and unless there is adequate information on which to base informed judgements…

The two areas of misconduct that are most common in financial markets are:
• Unfair or fraudulent conduct by market participants; and
• Inadequate disclosure of information on which to base investment decisions.


44
     Financial Services Authority, “Choosing a Mortgage”, table 3.3.


                                                                                             46
Regulation to address these sources of market failure is usually referred to as market
integrity regulation…… By protecting markets in this way, market integrity regulation seeks to
promote confidence in the efficiency and fairness of markets.

Market integrity regulation typically focuses on:

•      Disclosure of information
•      Conduct of business rules
•      Entry requirements through licensing
•      Governance and fiduciary responsibilities;
•      Some minimal financial strength conditions……“45

Professor Carmichael goes on to describe the functional split of the four regulators each
aligned with correcting one of the sources of market failure. At the Federal level the
regulators with the major responsibility for market integrity are the Australian Competition
and Consumer Commission and the Australian Securities and Investments Commission.
The Fair Trading agencies would be the State Government equivalent.

This commentary underlines the importance of dealing with market misconduct with the goal
of encouraging an efficient and effective financial marketplace. It recognises that it is
unrealistic to expect that sufficient numbers of the most disadvantaged consumers will
acquire enough expertise to identify and avoid operators who act unfairly. These “fringe”
operators target those people in the community who are easy targets because of their
financial or social situations. Changes in this demographic are slow and are not likely to
occur because of education programmes or because of experience gained in using a service
on a regular basis.

Currently, remedies against unethical and incompetent brokers are difficult for consumers to
access and therefore do not provide an effective incentive for brokers to behave ethically and
to provide a quality service. Brokers know that a consumer will often have no recourse
against the broker.

In summary, market failure in respect of consumers accessing credit through brokers is
demonstrated by:

•      Consumers being unable to readily distinguish between unscrupulous brokers and those
       who will act in the consumer’s best interests;
•      Consumers entering into inappropriate or uncompetitive credit products;
•      Consumers being unable to access remedies for financial loss.

4.2      Market failure in relation to lenders
A significant and, from a regulatory viewpoint, disturbing trend in the broker industry is the
incidence of fraudulent mortgage applications. The shift in responsibility for the preparation of
the loan application from persons such as bank employees to brokers has seen a shift in the
interests of that person, from applying proper risk assessment techniques to earning
commissions through having the loan approved. Increased reliance on brokers therefore
creates an increased risk of this type of mortgage fraud.

At the soft end, mortgage fraud can involve the broker misrepresenting the consumer’s
personal or financial information in order for the lender to finance a marginal application for
credit. Because brokers have ongoing contact with a credit provider, they become familiar
with its lending criteria and can manipulate the content of applications to ensure the loan will

45
     Carmichael J, The Australian Model of Integrated Regulation


                                                                                              47
be approved. There are a number of ways in which the broker can camouflage the
borrower’s circumstances, such as not disclosing all liabilities, reducing the number of
dependants, or inflating the value of assets.

More sophisticated mortgage frauds can involve “identity theft”, where the application is
made on behalf of a non-existent or reconstructed individual, the security offered is illusory or
vastly inflated in value, and the funds advanced by the lender are simply stolen. According to
a newspaper report, mortgage fraud is a “thriving suburban industry” in Sydney, with finance
brokers manufacturing false identities for customers and then arranging loans of up to
$50,000.46

Mortgage fraud practices have undoubtedly taken advantage of the search for increased
market share by lenders. John Kavanagh, a financial services journalist, writes:

      “Among police and fraud experts, there is a belief that in the fiercely competitive
      home loan market, some big banks—in their effort to secure market share—were
      prepared to deal with almost any broker who brought them business. This meant
      that, in the past, they have lent money to home buyers through brokers who had
      no relevant qualifications or experience in the industry, no business record, who
      were not members of the industry association, and who were known to use
      heavy-pressure sales tactics on consumers.”47

Precise figures on the scale of mortgage fraud are not available, but it has been estimated
that this type of fraud accounts for 3.2% of all frauds committed against financial institutions,
and for 12.9% of the value of all financial institution losses.48 The extent of the problem is
such that some professional indemnity insurers have identified those lenders who are known
to have particularly lax lending practices (leading to an increased risk of fraud), and have
refused to provide insurance cover to valuers in transactions involving those lenders. The
cost of these frauds is passed on to all consumers through increased interest rates, to cover
the losses incurred by lending institutions.

The prevalence of mortgage fraud is an additional reason why there have been calls for
national regulation of the broker industry. Simon Purcell is the Legal Director of Latrobe
Capital and Mortgage Corporation Ltd, part of the Latrobe Group, which has a mortgage
book of $1.2 billion. He has stated:

      “The undisputed existence of mortgage fraud has prompted moves to more tightly
      regulate the industry, especially at broker level. Hopefully, this intent to weed out
      mortgage fraud will result in industry support for a single national regulator for all
      secured loans; and broker licensing requirements along the lines of those
      applying to stockbrokers and financial advisors. Meanwhile the Mortgage Industry
      Association is intent on weeding out fraud and is working on its own self-
      regulatory regime. However this appears likely to fail unless it can force the
      national registration and licensing of every mortgage broker within the next two
      years.”49




46
   Daily Telegraph, 24 February 2003, p.11.
47
   “Bridle the brokers”, Business Review Weekly, 28 November 2002, p. 64.
48
   Simon Purcell, Legal Director of Latrobe Capital and Mortgage Corporation Ltd, “Warning: Mortgage fraud
on the rise”, Money Management, 27 June 2002, p. 26.
49
   Simon Purcell, Legal Director of Latrobe Capital and Mortgage Corporation Ltd, “Defrauding the great
Australian dream”, Journal of Banking and Financial Services, 116, August 2002, p. 7.


                                                                                                       48
5 Objectives of Government Intervention
A perfectly competitive and fair finance broking market would provide consumers with
sufficient information to be able to purchase the cheapest available finance broking advice
which also fulfils the purpose for which it was sought, that purpose being to help the
consumer to choose the best available loan for their circumstances.

The finance broking market does not currently operate in this fashion and the role of
government intervention in the market is, where possible, to assist in bringing about these
conditions of operation. This will require government action to:
• Provide consumers with the opportunity of choosing a finance broker who will act in the
   consumer’s best interests, and who is competent to recommend a suitable loan;
• Provide consumers with sufficient information to choose a suitable broker;
• Require brokers to demonstrate that their recommendation is appropriate for the
   consumer’s circumstances, and, where possible, is the best available;
• Provide a means of empowering consumers to influence broker behaviour by providing
   consumers with effective remedies against brokers who do not act fairly or competently;
   and
• Provide credit providers with confidence that the incidence of mortgage fraud by brokers
   will decline, and that offending brokers will be excluded from the marketplace.




                                                                                        49
6 Policy Options

6.1   Retain the Status Quo
This option would mean that clients of brokers who wish to access credit for personal,
domestic or household purposes would have certain remedies available to them under the
legislation as outlined in paragraph 2.3 of this paper.

The scope and limitations of current broker-specific legislation are discussed in that section
and include:
• Lack of consistency of regulation between jurisdictions, which disadvantages firms having
   national operations;
• Limited entry requirements, so that in most jurisdictions anyone can set up a broking
   business without experience or expertise;
• Restriction of jurisdiction to those brokers accessing credit covered by the Uniform
   Consumer Credit Code, except in Western Australia;
• Except in New South Wales and Victoria, no requirement to disclose financial or other
   benefits paid by lenders,
• Except in New South Wales no requirement to disclose fees paid by brokers for referrals;
• No requirement to disclose the range of lenders or products a broker can access except
   in New South Wales;
• No requirement that the broker demonstrate that the recommended product is suitable for
   the consumer's circumstances and is the best that broker can access.

General regulation under the Fair Trading and ASIC Acts is limited in scope to
unconscionable conduct; misleading and deceptive conduct; false and misleading
representations and implied warranties of due care and skill and fitness for purpose.

The Consumer Credit Code also covers some aspects of broking behaviour. It applies to
brokers in relation to advertising of credit products, and to representations which are material
to entry to a credit contract. The Code also applies to a person obtaining a business purpose
declaration, however, unethical brokers may deny access to those remedies that exist under
the Code by requiring the consumer to falsely sign a business purpose declaration.

The Code does not deal with the entire range of functions performed by a broker so that
there is, currently, a gap in accessing remedies for those clients, both with regard to the
credit contract itself and to broker behaviour.

While legislation currently in place provides a range of enforcement and redress options,
most consumer remedies provided would require court action to access, except in those
states where jurisdiction is vested in tribunals. Court action is prohibitive for most
consumers, and could only be undertaken by the few who had the financial resources and a
willingness to negotiate that process. In any event, the remedies do not affect the credit
contract itself, which may be totally unsuitable for the consumer who may then not be in a
position to refinance. As well, experience has demonstrated that the most disadvantaged
consumers are unlikely to approach a Tribunal even if they have been made aware of the
possibility of application and have the kind of documentary evidence required in that forum.

While state fair trading agencies may take action under the fair trading laws, the time and
resources involved would require that only the major scams were pursued, leaving the
majority of consumers to fend for themselves.




                                                                                             50
There are currently few remedies available to broking clients who obtain credit for business
or investment purposes, except general contract law, state fair trading acts (depending on
jurisdiction) and the ASIC Act.     This legislation may provide remedies in certain
circumstances, generally misleading and deceptive conduct, false representations and
unconscionable conduct. However, as with consumer transactions, these remedies rely on
court action and the expense involved may also be prohibitive to most small business or
investor broking clients.

All the general legislation which might possibly be used for enforcement and redress requires
action to be taken after the misdemeanour occurs, which means that many consumers may
suffer major detriment before any possibility of relief is achieved.

The rapid expansion of the finance broking industry in recent years, and the range of
problems identified, has led to calls for a consistent and comprehensive approach in
addressing the problems identified in dealing with the broking industry. The nature of the
industry, which is essentially to assist consumers to deal with a very complex financial
market, does not lend itself to improvement through competition. Certainly, the increased
numbers of brokers operating in the market has not led to improvements across the board,
but rather to increased incidence of consumer detriment.

6.1.1 Benefits/Advantages
For finance brokers
Brokers would not incur any additional costs from changes to the regulatory environment.
Those brokers who do not act in the best interests of the consumer would continue to benefit
from excessive commissions and fees.

For consumers
None identified.

For government
None identified.

For credit providers
Fringe credit providers would continue to benefit from exposure to the market through fringe
brokers. They would be shielded from action by government or the consumer by their status
as third party to any disputes.

6.1.2   Costs/Disadvantages

For industry
Industry would continue to bear the costs of four different broking regulatory regimes.
Broking businesses can involve writing loans for customers over state and territory borders.
Therefore, any differences in the regulatory environment between jurisdictions will impede
brokers’ operations and act against the efficiency of the service provided to the consumer. A
further feature of the industry is that a large proportion of brokers are involved in either
franchise or aggregator groups which are usually nationwide in their operations. A regulatory
environment which differs from jurisdiction to jurisdiction militates against the efficiency of
such groups, and individuals.

The costs imposed by such a system put brokers at a competitive disadvantage with credit
providers who operate under a uniform regulatory scheme. Brokers who operate across
boundaries would have in place compliance systems for four regulatory regimes. This
obligation imposes costs in time, human and financial resources. Such costs would inevitably
be passed on to the consumer.



                                                                                            51
For consumers
Consumers would continue to be disadvantaged in jurisdictions which do not have broking
legislation and from the lack of comprehensive protections in the other jurisdictions.

Those costs incurred by brokers in dealing with differing regulatory regimes would be
ultimately borne by the consumer.

For government
Government would be subject to increasing criticism for failing to address problems in the
broking industry.

Government would also continue to bear the cost of major enforcement action. The costs of
one recent action taken in relation to CAC were estimated to be between $122,000 and
$140,000. In another action, where costs were minimised because the defendants agreed to
consent orders, costs were capped at $12,000. Significant cases where injunctive orders are
sought face costs of application to the Supreme Court of a minimum of $5,000.

The costs set out above relate to action against two firms over a period of one year incurred
by one agency, so that if applied Australia-wide over a period of time, some millions of
dollars would be expended.

For credit providers
Credit providers would continue to suffer losses from poor quality loans and from the
fraudulent activities of some elements of the industry.

In summary, the status quo appears inadequate in addressing the market failure. There is
little in the current regulatory framework to assist consumers to make an informed choice of
either broker or product, and little in the way of accessible remedies to encourage brokers to
act in the best interests of consumers.

In addition, the status quo does not provide consistency between jurisdictions so that
national businesses are required to deal with several different sets of legislation. This acts
against an efficient marketplace and increases costs both to business and consumers.

Maintaining the status quo is not, therefore, the proposed option.

6.2   Self-Regulation Model
This option would rely on brokers’ peak industry organisations developing comprehensive
rules of conduct and process, as well as developing effective dispute resolution mechanisms.

While there are currently two main industry associations, the Mortgage Industry Association
of Australia, and the Finance Broking Association of Australia, which provide professional
services to their members and have codes of conduct and dispute resolution schemes, these
associations do not by any means represent the whole market. While the MIAA estimates its
membership at 75% of the market, this is limited to “serious” mortgage brokers. The problem
with any voluntary membership scheme is that it cannot affect the conduct of non-members.
Rogue operators are most unlikely to join any such association.

Without complete coverage of the market, there is little that can be done to influence
behaviour and provide feedback and sanctions which might bring about change. The most
that can be done is to expel rogue operators from being members of the association. This
would merely swell the ranks of those brokers who do not act in the consumer’s interests.




                                                                                           52
The success of self regulation relies to a great extent on there being a relatively
homogeneous industry with few major problems. As noted previously, the broker industry is
very diverse, with a large number of players and a range of brokers of different size, market
segments and structure. The market is multi-layered, in that there are aggregators as well as
mortgage managers and mortgage/finance brokers. There are some large national operators
as well as some franchised operations. Some operators are closely aligned with a very
limited number of credit providers while others are essentially independent. The concerns
and interests of these operators may be quite different and the problems encountered by
consumers would reflect those concerns and interests.

The problems outlined previously in this paper are numerous and varied, and can be
relatively severe in their impact on broking clients.

6.2.1 Benefits/Advantages
Since a degree of self regulation is currently in place and industry has acknowledged the
limitations of their capacity to expand their activities, it is unlikely that there would be
significant difference in the benefits from those outlined for the “status quo” above under this
option.

6.2.2 Costs/Disadvantages
See comments under 6.2.1.

In summary, the fractured nature of the industry militates against effective self-regulation,
which, as a general principle, has the greatest influence in industries with a relatively small
number of players, where those players are relatively homogenous, and where there is a
single strong industry body. In these circumstances, the interests of the players tend to
converge, giving them a similar commitment to improving standards of conduct through self-
regulation.

In effect, self regulation has been in place for some years and, while some benefits may
have flowed to consumers from the efforts of the major industry associations and their codes
of conduct, this has not and could not have any impact on non-members.

Self-regulation, therefore, is not likely to achieve the government’s regulatory objectives and
is not a proposed option.

6.3     Consumer Education
One model of regulation would be status quo or self-regulation with improved education of
consumers. Educational material might encompass information as to what a consumer
should ask a broker; advice on the consumer’s rights under the law, and how to access the
redress mechanisms available.

There are a number of matters to be considered in assessing the effectiveness of any model
that relies solely on education to deliver information (and, implicitly, bargaining power to
consumers):

      1. Educational materials will usually not be received by the consumer when they are
         most likely to be receptive to that information.

         Research indicates that consumers are most likely to be engaged by educational
         information if the delivery of that information is targeted or made available when most
         likely to be receptive to that information. In the case of finance brokers, consumers
         are most likely to be receptive in the period between deciding to use a finance broker
         and entering into a contract with that broker to arrange finance. In most instances this


                                                                                              53
   will only provide a relatively small opportunity for government to provide information,
   and there will be considerable impediments to timing delivery of information
   appropriately. Consideration must also be given to whether consumers would know
   how and where to access information at this time.

   Information about redress mechanisms if provided at point of sale or earlier is not
   likely to be of interest to the consumer. Most consumers do not contemplate
   problems at that stage and with the amount of paper that is generated by credit
   transactions generally, it is unlikely to be useful. Most consumers seek advice and
   assistance only when they are under extreme pressure and sometimes when it is too
   late in the process to be very effective.

2. Educational information is unlikely to be received or acted upon by those most in
   need of the information.

   Research shows that different groups within the community respond best to
   education programs that are specifically targeted to their needs. For educational
   materials to be effective a broad range of different programs addressing these
   various needs is necessary. The Consumer and Financial Literacy Taskforce
   sponsored by the Commonwealth has noted that people with higher levels of
   consumer and financial literacy (and less need for consumer education) tend to be
   the larger users of consumer education programs.

   One subset of people who use brokers is those people who cannot obtain credit from
   mainstream lenders. These people are by definition financially vulnerable, and are
   often seeking credit that will be secured by a mortgage over the family home. Even
   where these people may have received and absorbed educational materials, their
   capacity to negotiate with the broker is extremely limited (i.e. because they are in an
   extremely weak bargaining position). It is the experience of regulators that, in many
   instances, the broker will offer to arrange finance on onerous terms, and with the
   consumer having no capacity to negotiate with the agreement offered on a 'take it or
   leave it' basis. In the absence of specific legislative obligations (as is the current
   position), these consumers enter into agreements under which brokers can charge
   high fees and refinance consumers into loans they are in fact unlikely to be able to
   afford. The options available to them at that stage are inadequate as described in
   Section 3 above.

3. Educational materials must compete with information provided by brokers.

   Many medium or large brokers have financial resources that enable them to
   disseminate information (principally through websites and advertising) that is likely to
   have as much impact on consumers as government sponsored materials. Websites
   with enticing graphics and modern displays, or advertisements with snappy slogans
   are also more likely to be accessed by consumers at the time when they are seeking
   finance (that is, when the information presented by the broker is of more immediate
   interest, and therefore more compelling).

   The information presented through websites and advertising is designed to promote
   the broker's activities and interest the consumer in using the broker. The extent to
   which this information may not be accurate is indicated by a recent action by ASIC. In
   September 2004 ASIC took action in relation to a website calculator which produced
   a comparison between the borrower's existing loan and an alternative loan. However,
   the assumptions embedded in the calculator meant that additional repayments were
   attributed to the alternative loan, but not to the borrower's existing loan. This
   produced a distorted comparison which suggested that the consumer would always


                                                                                        54
        be better off financially by refinancing to the alternative loan. The calculator appeared
        on over 100 websites.

   4. For educational materials to be effective, they must be long term and are, therefore,
      reliant on ongoing government funding.

        The Commonwealth Government has recently established a financial literacy
        taskforce. However it is clear that the task of improving financial literacy is long-term
        and requires a sustained effort. Education in relation to the use of brokers is only one
        small aspect of this project and it is not clear that government funding (at both a
        Commonwealth and State level) in the financial services area will be directed towards
        materials in relation to the use of brokers.

        As noted above, different programs are necessary to meet the different needs of
        various groups in the community, increasing the expense to government.

It would appear self evident that improved financial literacy, as well as the provision of
information on a consumer’s rights under the law would assist consumers in conducting
financial transactions. Fair Trading agencies and other community organisations currently
provide a range of materials for consumers to assist them in their choices and in accessing
redress. As stated above, this strategy, while useful, is likely to benefit only a relatively small
proportion of the market and would be unlikely to assist those most in need.

6.3.1   Benefits/Advantages

For industry
Fringe brokers would continue to attract the more disadvantaged consumer and also those
who are “time poor” and unable to access appropriate materials at the time needed.
Reputable brokers could expect to deal with a larger percentage of knowledgeable
consumers.

For consumers
The more financially literate consumer would have greater access to relevant material which
could improve their bargaining position.

For government
Some consumers would have enhanced financial literacy and therefore less need for
complaint and enforcement services.

For credit providers
Fringe credit providers would continue to make available high cost loans. Some borrowers
would be more financially literate and better able to select a reputable broker, which would
benefit credit providers offering products through such brokers.


6.3.2   Costs/Disadvantages

For industry
Reputable brokers would continue to be subject to unfair competition from fringe brokers.
The image of the broking industry would not be improved.

For consumers




                                                                                                55
The disadvantaged and “time poor” consumer would continue to be subject to fraudulent or
misleading behaviour and would pay an unnecessary financial premium for both the broking
service and the credit product. This would contribute to market inefficiencies.

For government
Government resources would be directed to operations which are unlikely to deliver benefit
to the target demographic. Government would continue to be subject to criticism for failing to
address market problems.

For credit providers
Mainstream credit providers would continue to run the risk of poor quality loan portfolios.

In summary, it is unlikely that educational materials will, in themselves, deliver any effective
outcomes for consumers. Any educational campaign needs to be viewed in the broader
context of ongoing discussions about financial literacy and as an adjunct to other regulatory
mechanisms.

This is not a proposed option.

6.4   Mandatory Code of Conduct
A mandatory code of conduct is a regulation prescribed under legislation which usually
makes specific to an industry those general principles outlined in the head legislation. A
mandatory code is generally considered more flexible than legislation in that it is not subject
to parliamentary scrutiny and therefore may be able to react more quickly to events in the
marketplace and be changed to reflect new practices

It is not clear that this would be the case with any scheme such as that being called for in
relation to the broking industry. Brokers, credit providers and consumer advocates are
united in their opinions that any broking scheme should be uniform in nature. With any
uniform scheme, agreement between jurisdictions must be achieved, and this is time
consuming. As well, most parliaments are concerned to ensure that regulations do not
exceed their statutory function and have systems in place for scrutinising regulations as well
as legislation.

The COAG requirements for consultation and cost benefit analysis apply equally to proposals
in the form of a regulation, so that a stringent consultation process is required in certain
circumstances, depending on the effect of the regulatory proposal.

It is likely, therefore, that the flexibility, or timeliness, which is considered to be a benefit of
mandatory codes, may not apply in this case.

Another benefit that is sometimes claimed for mandatory codes is that they can clarify the
application of laws in respect of certain industry practices. One reason for this is that they
are generally written in language that is less “legalistic” than the legislation itself. This has
sometimes proved difficult in situations where legal interpretation is necessary, as the
language of codes may be less legally precise. If mandatory compliance is needed this may
be a disadvantage rather than a benefit.

A related issue is the enforcement of mandatory codes. As a regulation, only low level
enforcement mechanisms are appropriate. Indeed, there is a perception in the market that a
code is “less compulsory” than legislation.

It is instructive to note that in NSW, the provisions in the Fair Trading Act permitting the
development of mandatory codes, have been repealed. Over time the three mandatory


                                                                                                 56
codes under that legislation have been incorporated into legislation, this having been
recommended by a series of reviews where it was considered that any marketplace failure
was best addressed by relevant legislative provisions rather than the making of a potentially
unenforceable code of conduct. The repeal of the enabling provisions in the Fair Trading Act
followed a NSW Court of Appeal decision which confirmed the predominance of contractual
rights over the Retirement Village Code of Practice, ruling that the Code did not override
specific contractual obligations with which it conflicted.

6.4.1   Benefits/Advantages

For industry
The language of a mandatory code of practice may clarify the requirements of the legislation
and assist compliance.

For consumers
In those jurisdictions where there is currently no broker specific legislation, the mainstream
broker may provide a better service.

For government
Mandatory codes usually include alternative dispute resolution procedures which would
mean less need for government to provide complaint handling services.

For credit providers
 A mandatory code which aims to raise industry standards would have a positive effect on
some brokers, which would benefit credit providers offering products through such brokers.

6.4.2   Costs/Disadvantages

For industry
Reputable brokers would continue to face unfair competition from fringe brokers and may
suffer loss of business from a consumer perception that the industry as a whole should not
be trusted because of lack of effective enforcement options. Mandatory codes usually
require industry involvement in administration, review and dispute resolution which can be
costly.

For consumers
Consumers would continue to be subject to unfair practices from fringe brokers and a sub-
optimal service from mainstream brokers resulting from a lack of enforcement possibilities.

For government
Government would continue to be subject to criticism that the problems in the industry were
not being addressed.

For credit providers
Mainstream credit providers would continue to subject to the risk of poor quality loan
portfolios.
In summary, it is likely that the objective of providing effective remedies in order to provide
an incentive for brokers to act in the consumer’s best interests and provide a quality service,
would be subverted by a mandatory code’s low level enforcement capacity and potential for
imprecise legal interpretation.




                                                                                            57
It is considered, therefore, that a mandatory code of practice would not satisfy the
Governments’ objectives in respect of finance broking and would further enshrine the
inconsistencies in regulation between jurisdictions.
A mandatory code of practice is not the proposed option.

6.5   Broker Specific Regulation
Section 3.1 notes the piecemeal nature of broker specific legislation in Australia. It is also
noted that the legislation which could be used on a national basis, such as the ASIC Act and
the various Fair Trading Acts, cover broad categories of misdemeanour such as misleading
and deceptive conduct and false representations, or unconscionable conduct, and that this is
responsive legislation. The limitations of that legislation and the inaccessibility of remedies
to consumers are also discussed.

That section also refers to the Uniform Consumer Credit Code. Its coverage of broking
transactions is minimal, and the Consumer Credit Legal Centre in its report for ASIC, has
noted the very limited capacity for redress under that legislation, as well as the fact that the
Code was drafted when broking was in its infancy and there was no experience of the
practices discussed in this paper.

State based legislation takes different approaches, largely responding to the market at the
time of the legislation’s development, and, in the case of Western Australia that response
was developed to address matters raised in a high profile inquiry that are not relevant to the
industry in other jurisdictions.

There has been significant discussion of the need for regulation of the industry in the public
forum. All industry players as well as consumer advocates seek a national solution, given the
increasing number of brokers who have national operations or franchises, and in view of the
fact that the credit industry is largely national. National solutions, where appropriate, are
considered to enhance the efficiency of the market.

None of the options discussed above appears to have the capacity to address a complex and
fragmented market where problems stem largely from the reliance of the consumer on the
broker to make sense of an even more complex credit market, and where fraud and unfair
conduct are not isolated occurrences.

In summary, national legislation would appear to be the most appropriate means of securing
Government objectives. The Federal Government has declared its position, which is to leave
regulation to the states in view of the fact that the states have jurisdiction over consumer
credit matters.

The option which emerges, therefore, is nationally uniform or consistent legislation which
could incorporate features of existing state-based legislation, where these are seen to
address those problems identified in the industry, and where such features would serve
government objectives.

Nationally uniform or consistent broker specific regulation is therefore the proposed
option.

The costs and benefits of this approach are set out in relation to the proposed components of
the regulation.

National Uniformity
If the regulation of finance broking is to remain with the States and Territories, a means to
apply and maintain uniformity or consistency is essential to the efficient working of the
broking market.


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A number of regulatory schemes operate with a degree of consistency between states
without a formal uniformity agreement. Others, such as the various Travel Agents Acts are
subject to a Participation Agreement which requires certain uniform provisions to be
incorporated into each state Act. In that case each jurisdiction has the carriage of its own
legislation through the Parliament.

Similarly, in respect of Co-operatives, Ministers agreed to “core consistent” elements of
legislation, but without formally signing an agreement. There are now significant differences
between jurisdictions and amendments are introduced by each jurisdiction but not
synchronously. There may be as much as 2 years difference between jurisdictions in
adopting the provisions.

The model which aims to ensure the highest degree of uniformity is one in which one
jurisdiction secures the passage of legislation which has the unanimous support of all
jurisdictions, and the others then adopt that legislation as a law of their jurisdiction “as in
force for the time being”. This means that any future amendments in the state which passed
the original legislation would apply automatically in all other jurisdictions, those amendments
having previously been agreed between the parties. This is generally referred to as a
“template” model.

One example of legislation which is subject to this model is the Uniform Consumer Credit
Code. The rules for achieving and maintaining uniformity are set out in the Australian
Uniform Credit Laws Agreement 1993. That Agreement in fact permits a choice of process
for achieving consistency in regulation. Jurisdictions can either choose the template process
or opt to pass alternative consistent legislation. At the time the Agreement was made in
1993, all jurisdictions except Tasmania and Western Australia chose the template process.
Tasmania chose a modified template process under which the initial legislation and any
amendments are adopted by proclamation. Western Australia originally chose to pass
alternative consistent legislation, which meant that the initial legislation and every
amendment had to undergo the usual parliamentary process, with the risk of amendment by
one of the Houses. In practice, there are problems in achieving synchronicity, and in 2003
Western Australia adopted a model similar to Tasmania.

The Code Uniformity Agreement also permits certain things to be non-uniform, allowing for
differences in structure or policy between jurisdictions. The non-uniform matters are listed in
the Agreement. These are:
(a) the fixing of maximum interest rates payable under consumer credit contracts;
(b) the establishment of trust funds with designated purposes into which forfeited interest
     charges may be paid;
(c) the establishment of a scheme for the licensing or registration of credit providers;
(d) the vesting in a Tribunal of jurisdiction which, under the Initial Legislation is vested in a
     Court;
(e) such other matters as are approved by unanimous resolution of the Ministerial Council.

No additional matters have been added since that Agreement was signed.

The Uniformity Agreement recognises that it cannot interfere with the sovereign powers of
each Parliament, however, jurisdictions are required to not pass conflicting legislation or
legislation which would negate the operation of the Code.

Uniformity of credit laws has been generally maintained since 1996 and the processes
outlined in the Agreement appear to have worked well. It would seem appropriate, therefore,
that a similar scheme apply to any national regulation of finance broking, with similar
provision for specified matters to be non-uniform.


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7 Proposals to Regulate the Broking Industry
This section sets out a regulatory scheme which it is suggested would address the problems
between brokers and consumers which result in market inefficiencies and consumer loss. In
effect, the proposals combine features of the Western Australia and New South Wales
approaches, but these are enhanced to address current practices and problems.

7.1   Scope of finance broking legislation
Issue - should finance broking legislation extend to all finance broking transactions?

Finance broking legislation in NSW, Victoria and ACT only extends to transactions where the
credit to be obtained is covered by the Uniform Consumer Credit Code. This means that the
credit is provided, or intended to be provided, wholly or predominantly for personal, domestic
or household purposes. In Western Australia, there is no “purpose” test and almost all
broking transactions are regulated.

Both consumer and broker representatives argue that finance broking legislation should
extend beyond consumer credit to credit which is to be used for investment and small
business purposes.

Both groups consider that consumers seeking credit for investment and small business
purposes can be just as vulnerable as those whose credit is for domestic or household
purposes. Broker representatives also see little sense in having to comply with different
regulatory requirements for the same consumers, depending on the purpose for which they
are intending to use their loan.

Possible responses
The scope of finance broking legislation could be determined by a test similar to the “retail
client test” used in the Corporations Act 2001.

The retail client test in the Corporations Act determines when a person is to be treated as a
“retail client” and therefore receive the protections offered by the Act. These protections
consist of disclosure requirements relating to the sale of financial products and conduct
requirements applying to sellers of financial products.

This test, contained in section 761G(6) of the Corporations Act, provides that a financial
product (other than general insurance, superannuation and retirement savings accounts), or
a financial service related to such a financial product, is provided to a person as a retail client
except in four instances:
• where the price of the financial product, or the product in relation to which the financial
     service is provided, exceeds the prescribed amount (currently set at $500,000);
• where the business acquiring the product or service is above a certain size;
• where an individual acquiring the product or service provides evidence of a nominated
     level of personal wealth; or
• where the person acquiring the product or service is a professional investor.



Product value exemption
This exemption is based on the assumption that persons who can afford to acquire financial
products or services with a value above the prescribed amount do not require the protections
given to a retail client, as they may be presumed to have either adequate knowledge of the
product or service, or the means to acquire appropriate advice.


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The product value exemption in the retail client test, which in the case of credit products
would focus on the amount of credit a consumer wishes to acquire, would inappropriately
exclude a consumer from the protection of finance broking legislation. This is because there
is a vast difference between having $500,000 to invest and borrowing $500,000. It cannot
be assumed that a person who wishes to obtain a large amount of credit is a sophisticated
consumer or has a certain level of financial resources, particularly if the credit is for a
business. In this context it should be noted that the Consumer Credit Legal Centre has dealt
with cases of vulnerable, low income consumers being provided with large loans.

Further, it would not seem appropriate to make the scope of finance broking legislation more
limited (at least in relation to the amount borrowed) than the coverage of the Uniform
Consumer Credit Code. As the Credit Code covers all consumers who obtain credit for
personal, domestic and household purposes, regardless of the amount of credit being
obtained, it would not be appropriate to limit finance broking legislation to consumers whose
loans are below an amount that might constitute a consumer purchase.

Big business exemption
This exemption excludes businesses above a certain size from being given the protections
available to a retail client, provided the financial product or financial service is used in
connection with that business. A big business is defined as one that employs more than:
• 100 people if it is a manufacturing business; or
• otherwise, 20 people.

A big business exemption would appear to be appropriate for finance broking legislation.
Such businesses do not need the protection of the legislation and the requirement to comply
with the terms of the legislation may unnecessarily restrict competitive business practices.
The exemption would leave small businesses with the protection of the legislation.

There is, however, an issue with regard to businesses which are, essentially, $2 shelf
companies, and which may be set up for the purposes of borrowing large amounts of money
for, say, a securitisation program, and which may be multimillion dollar enterprises.

It is proposed, therefore, that a small business, as defined above, which seeks to borrow
more than $2 million be excluded from the coverage of the finance broking legislation.

Individual wealth exemption
This exemption enables a person to provide evidence that they have:
• net assets of at least $2.5 million; or
• gross income for each of the last two financial years of at least $250,000.

If a person provides a certificate to this effect, they will no longer have the retail client
protections. Wealthy individuals may therefore choose to decline these protections, on the
basis that they have either experience in making investments or the means to seek
appropriate advice.

It is difficult to imagine why someone would want to decline the protections of finance broker
legislation. Further, an individual wealth exemption would not seem to be appropriate for
finance broking legislation, as it would make the scope of broking legislation more limited
than that of the Credit Code. The Code covers all personal, domestic and household credit,
regardless of the consumer’s income.

The professional investor exemption




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The Corporations Act excludes persons who are considered to be professional investors.
These include:
• financial services licensees;
• bodies regulated by the Australian Prudential Regulation Authority;
• bodies registered under the Financial Corporations Act 1974;
• trustees of superannuation funds, approved deposit funds, pooled superannuation trusts
   and certain public sector superannuation schemes;
• persons who control at least $10 million;
• listed entities or related bodies corporate of listed entities;
• exempt public authorities;
• investment companies as defined by the Corporations Regulation; and
• foreign equivalents of the above.

The professional investor exemption was included in the Corporations Act in response to
concern by industry that retail protections would otherwise apply to financial and investment
entities that are not big businesses.

It is not proposed to provide an exemption similar to the professional investor exemption for
finance broking legislation. It is considered that the size of a business is a better measure of
whether it requires the protection of finance broking legislation or has the resources to obtain
its own advice, than the type of activities the business carries out.

Proposed option
That finance broking legislation cover all credit unless the applicant is a business entity which
employs more than:
• 100 people if it is a manufacturing business; or
• otherwise, 20 people; or
• the credit sought is more than $2 million.

7.1.1   Benefits/Advantages

For finance brokers
There will be certainty of application of any national finance broking legislation.

For consumers
All consumers and small businesses will receive the benefits of the legislation. Instances of
fraudulent broker practices in relation to small business loans have been identified and
demonstrate the need for coverage of the legislation beyond consumer credit.

For government
There would be fewer complaints from consumers and small business about broking
problems. Small business could expect access to credit suitable for their needs.

For credit providers
Credit providers could expect better quality loans for a wider range of products.


7.1.2   Costs/ Disadvantages

For finance brokers
Possibly higher compliance costs if more transactions are covered by legislation. However,
brokers have expressed the advantages of one regulatory scheme covering all transactions.



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For consumers
If there are higher compliance costs, these may be passed on to consumers.

For government
Should the proposals in the following sections be adopted, there would be less need for
government enforcement activity. If these are not adopted there may be an increase in the
level of enforcement activity undertaken by governments.

For credit providers
None identified.

7.2   How is a broker to be defined?
The market for credit is very fragmented. Potential borrowers can go directly to a credit
provider, or to intermediaries who they can identify as finance or mortgage brokers, or they
may access credit when making a purchase in a store or a motor dealership.

In all cases except for credit providers, the person who provides access to the credit will
receive a payment or benefit for doing so, whether it is from the consumer or the credit
provider or some other party.

Where a person provides those intermediary services for payment, and they have the
authority to recommend more than one credit product, they are to all intents and purposes
providing a broking service.

It is proposed, therefore that a broker should be defined, widely, as “a person who acts, or
purports to act, as an intermediary to negotiate or obtain credit for a person (other than the
intermediary’s employer, or a principal who is not the client of the intermediary) in return for a
commission or financial benefit, whether payable to the intermediary by the person, the credit
provider or any other person or body.” In this way, it is the function that is being addressed,
which establishes a level playing field for all that provide this service.

This approach has recently been adopted in New South Wales the Consumer Credit
Administration Amendment (Finance Brokers) Act 2003, that legislation having been drafted
in response to a National Competition Policy Review of the Credit (Finance Brokers) Act
1984. The definition of broker in that legislation may provide a useful basis for any national
scheme. While the New South Wales legislation regulates only brokers who access
consumer credit as defined in the Consumer Credit Code, the definition would need to be
extended to encompass the proposed scope of any national scheme.

Should any intermediaries that are caught by this definition be exempt?
The New South Wales legislation exempts “second tier” intermediaries, such as document
handlers who are, in fact, intermediaries between the broker and the consumer in certain
circumstances and between the broker and the credit provider. These intermediaries are not
those with the responsibility for negotiating and obtaining credit and have therefore been
exempted.

Others currently caught but who will be exempt are those intermediaries who are obliged by
their agreements with the credit provider to offer only one brand of credit. This issue is
referred to earlier in this paper in the context of mortgage managers who are, in the
consumer’s perception, offering credit as a lender, not a broker. In such cases, it is
considered that no useful protection would be provided to the consumer by issuing a finance
broking contract and making the disclosures required by the legislation.




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The possibility of commercial lease broking being exempted has been raised by that section
of the industry, as that type of broking is considered not to be comparable with the focus of
this paper. Further comment on this issue is welcome.




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8 How will legislation meet Government objectives?

8.1    Objectives 1 and 5
•     Provide consumers with the opportunity of choosing a finance broker who will act
      in the consumer’s best interests, and who is competent to recommend a suitable
      loan.
•     Provide credit providers with confidence that the incidence of mortgage fraud by
      brokers will decline, and that offending brokers will be excluded from the
      marketplace

Problem to be addressed
Brokers who do not set out to act in the consumer’s interests may be described as
fraudulent, recognising that not all the practices identified would constitute fraud for the
purposes of the law. These are “brokers” who enter the market, act fraudulently or unfairly
and with a clear intention to take clients’ money without providing a legitimate service.

It is impossible to quantify the numbers of such brokers, or traders who hold themselves out
as brokers, as a percentage of the whole. The APRA report noted that the third most
common reason for ADIs ceasing to deal with certain brokers was fraud (at 24%). Poor
quality of loan applications (which may include a high incidence of unfair, misleading and
deceptive conduct) was equal first at 59%. It is likely that credit providers other than ADIs
would have similar experiences. While no data is available, it is likely that the non-
conforming lender would attract a higher percentage of fraudulent and unfair brokers.

In New South Wales, one recent case against a firm of “brokers“, Credit Accounting
Consultancy (CAC), resulted in Supreme Court orders that the defendants involved in the
case pay $1.3 million to compensate the victims of their practices. These individuals have
been banned from offering or arranging credit for consumers in New South Wales and are
now subject to criminal charges in respect of their practices. The NSW Office of Fair Trading
was involved in two years of investigation and eighteen months in the Court in bringing their
operations to a halt. However, there is nothing to prevent these operators from starting up in
another jurisdiction where there are no probity checks and the process could be repeated.

While the number of such brokers may be relatively small compared to the whole, it can be
seen from this one example that the impact on consumers is high. The $1.3 million in the
case cited above is by no means expected to cover all consumers’ losses in dealing with
CAC.

The migration of these fraudulent brokers following a prohibition from trading is by no means
unusual, and New South Wales has been informed that another such operator who was
prohibited from trading in New South Wales has been operating in Queensland.

Traders such as those referred to above are competing unfairly with those brokers who are
acting lawfully and providing a bona fide broking service. They also are the cause of
considerable consumer detriment, much of which will not be compensated. They not only are
the cause of financial losses to consumers but they also tarnish the public image of all
brokers and may make the public less willing to use a broking service.

An appropriate response to this sort of problem may be to prevent people with a history of
unfair or fraudulent conduct from operating as a finance broker. The usual process
undertaken by Government to screen industry entrants is that of probity inquiries as a
condition of granting a licence.


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The type of entry requirement chosen in any regulatory scheme would depend on the degree
of detriment suffered by consumers, and how the market may be affected by any barriers to
entry. It also depends on the objectives of regulatory authorities. The various entry
mechanisms are outlined below.

8.2   Licensing/Registration/Negative Licensing

Negative Licensing
While negative licensing is not actually an entry requirement, a discussion of its merits is
included as it is the regulatory scheme in force in Victoria and New South Wales. Of the
systems currently in place, negative licensing is the least burdensome on industry. Negative
licensing is the term applied to a system where there is no formal requirement to be licensed,
but where a trader who contravenes the law can be required to comply with certain
conditions, and, in extreme cases, be prohibited from trading. In essence, negative licensing
places no obligations on the finance broker, except an implicit obligation to act in accordance
with any legislation that may be in place, or to suffer the consequence that they may be
prevented from continuing in that business. The obligation is on the government agency to
investigate complaints about broker behaviour and, where appropriate, to take administrative
or legal action against that broker.

The power to prohibit a trader from operating in a particular jurisdiction is usually an
administrative one, with appeals to an independent authority.

Negative licensing may be the regulatory option of choice in situations where there are few
complaints about industry behaviour and the participants are easily identified and contacted.
Those jurisdictions which currently have this system have seen the broking industry grow at
a rapid rate, and significant consumer detriment occur. Negative licensing cannot prevent
the entry of undesirable elements, nor can it provide access to industry participants. It is
difficult to undertake regular compliance activity when the industry participants cannot be
identified and their location is unknown. To pursue and prosecute illegal broker behaviour
may take many months of activity. It is, therefore, a significant burden on government
resources and neither prevents nor discourages consumer detriment.

In respect of consumer identification of legitimate traders, there is no way of checking a
broker’s bona fides. This is not to say that a licensed trader will never contravene the laws,
but it is less likely that a person who is willing to undergo probity checks and pay license
fees, as well as fulfilling other requirements for a licence to be issued, will set out to defraud
a consumer.

Registration
Registration requires simply that a trader register their trading operations with a regulatory
authority and is required only in the Australian Capital Territory. This system can provide
greater protection than negative licensing by attaching a number of operating requirements,
such as requiring education to be undertaken or that a broker must obtain professional
indemnity insurance. It can also facilitate communication and provide for disciplinary action
by “deregistering” a broker and thereby prevent them from trading.

Registration does not, however, screen those wishing to operate in the industry. People with
poor trading records, or criminal records, can operate even if it is only until they are
investigated and deregistered. There may be significant consumer detriment before this can
happen.




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In respect of those who operate outside the law, and depending on the requirements of the
scheme for proof of identity, registration does not provide certainty that the person who
registers does so with their real name, nor that they can be found when required. This is a
circumstance commonly encountered by fair trading agencies when pursuing rogue brokers.

Registration, therefore, would seem appropriate in an industry where there is generally an
intention to comply with the law, but where the standard of service needs to be improved. It
will not prevent unscrupulous brokers from entering the market, nor will it ensure that they
can be contacted when complaints are received. It will not prevent major consumer
detriment or unfair competition.

Licensing
Licensing can prevent entry by checking a person’s record and excluding undesirable
individuals from legitimately entering the market.

Currently licensing is required only in Western Australia.

In New South Wales, prior to 1996, licences were required for finance broking and for non-
bank credit providers. However, when the Consumer Credit Administration Act was being
developed to commence synchronously with the Consumer Credit Code, that regime was
replaced by a negative licensing scheme. One reason for this was that the Consumer Credit
Administration Act provided the same disciplinary regime for credit providers as well as
finance brokers. Because banks could not be licensed by the States, to apply a licensing
requirement only to credit providers who were not ADIs was thought to be discriminatory and
potentially anti-competitive. In order that the Act should not require two kinds of disciplinary
regimes, and because the finance broking industry had not yet developed the practices now
evident, a negative licensing regime was applied to both industries.

This essentially means that in most jurisdictions anyone at all can hold themselves out to be
a finance broker, without any knowledge of the industry and without capital. Some “brokers”
operate entirely by telephone or electronic means. The proliferation of brokers who
fraudulently exploit the client may reflect the lack of entry requirements and probity checks.
Those who operate fraudulently generally target those consumers who are naïve in financial
matters or who are desperate for access to credit.

Purpose of entry requirements
Entry requirements have traditionally been used to:
• Keep individuals with a history of unfair or unlawful trading or conduct out of the market;
• Facilitate more effective and responsive disciplinary action
• Facilitate effective communication with the sector
• Allow consumers to identify a trader who has satisfied certain entry criteria
• Place entry conditions on participants
• Require a level of competency to trade in the industry
• Require traders to comply with ongoing requirements in order to remain in the industry

Proposal
In view of the experiences of consumers in unlicensed markets, and the financial
consequences of those transactions, many of which flow from fraudulent behaviour, it is
proposed that a reasonably high level of screening would be appropriate for participants in
this industry and that a licensing scheme be introduced.

Should the Code uniformity scheme be adopted, consideration may be given to making the
licensing of brokers one of those matters permitted to be non-uniform. While this would be
consistent with current practices, it should be recognised that those states which chose to


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lower any barriers to entry would face the prospect of a large migration of fraudulent traders,
with the consequential impact on the regulatory agency’s resources and the likely increased
detriment to consumers in that jurisdiction.

Any licensing/registration cost should be determined in relation to the cost to the regulatory
authority. This would establish that any applicant for a broking licence had sufficient
commitment to that project to be prepared to outlay a small amount in the form of a licence
fee. It would also relieve the government of any additional cost in establishing and
maintaining a licensing system.

Any licensing scheme would:
• Require an applicant to be a “fit and proper” person
• Impose probity checks to include:
   • convictions for offences involving dishonesty
   • cancellation of any licence, registration or permission to trade in a regulated
        occupation, profession or business
   • undischarged bankrupts
   • a person who has breached any undertaking in relation to fair trading legislation
• Exclude a person from being a director of a finance broking business if they have been
   disqualified from trading
• Exclude persons under 18
• Exclude any mentally incapacitated person

Who should hold a licence in any broking business
One function of any licensing regime is to ensure that a designated person is responsible for
carrying out the requirements of applicable legislation and is accountable for any deficiencies
in the performance of those requirements.

Clearly, sole traders would need to hold a licence.

If a business was set up as a partnership, it is unlikely that one partner would want to take
responsibility for another and risk losing their broking licence because of the other’s
wrongdoing, so that all trading partners should be separately licensed.

Where a company has a small number of employees or contractors who are subject to the
control and supervision of the employer, then only the employer need be licensed.

With larger businesses which have numerous branches or a web of operations, and whose
brokers are employees, contractors or franchisees, it is unlikely that the employer could be
considered to control and supervise the broker on a day to day basis. The larger the
business, the less likely it is that a person will be closely supervised. However, if one of the
functions of licensing is to ensure that someone is responsible under the law, it is a major
incentive for the licensee to ensure that brokers in their employ, or under contract, are of
good character and reputation, and that they are properly trained and supervised. Office
bearers in such large business entities with appropriate line responsibilities should hold a
licence on the business’s behalf. They need not be directors.

Nevertheless, where the employer is geographically distant, and there are a large number of
branches with broking business being carried on by one or more brokers, then each branch
should have at least one licensed broker on the premises who has an appropriate
supervisory capacity in respect of other brokers on the premises. All those carrying out
broking functions must be authorised by a licensee to do so, whether the employer or the
person on the premises, depending on the corporate structure and the devolution of
responsibilities.


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Membership of an ADR scheme, as proposed later in this paper, should follow the licensing
regime. A licensee should also be responsible for ensuring that all brokers and other
employees who carry out functions which require expert knowledge are appropriately trained.

In proposing such a scheme, it is recognised that many brokers, whether they are to be
“licensed” or “authorised”, and who are currently operating throughout Australia would be
required to make application to remain in the industry. The MIAA has pointed out that the
requirements listed above for obtaining a licence are almost identical to their membership
criteria, and that their membership comprises a significant percentage of the industry. For
others, the requirements would not pose a problem for those with a good trading history, and
it would achieve the goal of excluding those currently in the industry who would not meet
probity requirements. Appropriate lead time would be required for government to establish
licensing systems and process applications, and for industry participants to apply for a
licence. It is not suggested that there be any break in continuity of trading during this time.

Should any broker already trading be unable to obtain a licence, it would be possible to make
application to a relevant appeal body if they could demonstrate an acceptable trading history.

8.2.1   Benefits/Advantages

For brokers
Brokers generally would experience increased public confidence and an opportunity to
expand their businesses. There has been a significant amount of negative media coverage
in the last two years which may cause consumers to avoid using a broker to access credit.
Brokers currently express concerns that their image is being tarnished by unscrupulous
operators. Brokers would also not face unfair competition from those elements currently
operating who mislead consumers into believing they are offering legitimate services, and
who appear to be able to offer what legitimate brokers cannot offer if they are acting
honestly.

For consumers
Consumers could have confidence that brokers do not have an established record of
dishonesty. They could check whether a broker was licensed. The risk of being defrauded
by a broker would be significantly diminished. Major financial losses may be avoided.

For government
Government would receive positive community support for screening out fraudulent persons
from the industry. A reduction in protracted legal actions against disreputable brokers would
result in there being a reduced demand on compliance and enforcement resources. The
cost of administering the scheme would be funded by licence fees.


For credit providers
Credit providers would have increased confidence in using broker services. The background
information shows that 24% of cancelled bank/broker relationships are due to fraud. The risk
of bad loans would be reduced. Smaller credit providers could enter the market by using
broker intermediaries who had undergone probity checks. All credit providers could increase
their exposure to consumers.

8.2.2   Costs/Disadvantages

For brokers



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The broker would face the cost of a licence. This may vary from one jurisdiction to another
according to the overheads of the agency and the nature and cost of checks performed by
that agency. The only agency which currently licenses finance brokers is Western Australia.
The cost of a licence is $350, renewable every three years. That fee is not set with any
relationship to the costs to the licensing agency, but it is estimated that “self funding” would
not result in higher licence fees.

By comparison, the licence fee for financial services advisers is $270 or $230.

For consumers
If the cost of the licence is reflected in the cost of a service to consumers, this may represent
a marginal increase in commissions charged. It is likely that the cost to consumers would be
negligible.

For government
A cost recovery scheme would not impose costs on government. The cost of establishing
the scheme could be averaged out over a period of time and included in the licence fee.

For credit providers
No costs identified.

8.3   Competency of brokers
A number of the problems experienced by consumers may result from the brokers’ lack of
appropriate skills or knowledge. Apart from the skills required to run a small business,
brokers should be aware of legislative requirements that impact on their operations. Brokers
also need to have considerable knowledge of the finance market and of the products that are
available as well as the art of communication with a client in order to best assess their needs.

While training is currently a requirement in Western Australia, no other jurisdiction requires it.
There is a requirement for certain education qualifications for membership of the Mortgage
Industry Association of Australia (MIAA), unless the person can demonstrate sufficient
practical experience. The Finance Brokers Association of Australia (FBAA) also requires
completion of a course or sufficient relevant experience before membership is available.
Training is also provided by some of the franchised groups. There is, however, no common
standard in either the training or the experience required.

Experience alone does not guarantee appropriate skill or knowledge. Brokers who do not
have the benefit of an active industry association may be unaware of new developments,
both product and regulatory. Therefore, there should be some formalised training, even for
people who have been in the industry for a while. Certainly, if new legislation is introduced,
knowledge of that legislation plus other legislative requirements such as under the Uniform
Consumer Credit Code and state fair trading acts should be a required training component.

To date, there has been little in the way of broker-specific training available. Non-specific
financial services competency training has been available, and this is currently under review.
It will, when completed, have a specific broking component. This is a package developed by
the National Finance Industry Training Advisory Board, which in turn is subject to the
Australian National Training Authority. Whether this is considered appropriate cannot be
determined until the review is finalised in late September 2004.

The provision of financial product advice, regulated under the Corporations Act 2001,
requires advisers to be licensed and for the licensee to ensure that advisers are
appropriately trained. The training package referred to above will overlap with finance
broking training and it is envisaged that similar requirements to those prescribed for financial


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advisers could also apply to finance brokers, but tailored to the functions of the industry.
Again, this is subject to the final form of courses currently being developed, and the fine
detail is not yet available.

Financial services advisers meet the training standards required by the legislation if they
satisfactorily complete approved training course relevant to their activities. Those courses
must be assessed by an authorised assessor meeting the relevant requirements for
knowledge and skills, if appropriate, and listed on the ASIC training register. Courses on
basic deposit products and non-cash payment products do not need to comply with these
requirements but can, instead, be assessed by the licensee. As an alternative, advisers with
at least 5 years relevant experience over the immediate past 8 years may demonstrate their
competence by being individually assessed.

Proposed option
A scheme which operates similarly to the ASIC scheme outlined above in targeting the
required skills, but is flexible with respect to the knowledge and skills of brokers making the
transition from the unregulated market to a regulated market, is envisaged as a model for the
national finance broking scheme.

8.3.1   Benefits/Advantages

For brokers
A skilled broker would be expected to generate significant consumer confidence and the
expectation of repeat business. There would be a reduction in complaints by consumers.

For consumers
There would be an increased likelihood that consumers would be placed in appropriate loans
and that the relationship between the consumer and broker would be transacted with due
regard to the relevant laws. Consumers could expect to benefit financially from being placed
in an appropriate loan.

For government
There would be fewer complaints about brokers and a reduced impact on resources.

For credit providers
The quality of loans would be improved. There would be greater consumer satisfaction with
the loans they were placed in which would result in a greater retention rate of customers and
less use of credit providers’ internal complaints systems.


8.3.2   Costs/Disadvantages

For brokers
There would be a cost to the broker of fees for undertaking the required courses. The
Mortgage Industry Association of Australia charges $165 for its Initial Compliance Pack on
line, which includes Uniform Consumer Credit Code, Privacy and Compliance essentials.
Where loan writers do not have at least two years broking or lending experience they are
required to successfully complete the TAFE Certificate III in Mortgage Lending, available on
line via MIAA at a cost of $900, subject to some reductions where the broker has completed
the MIAA Initial Compliance Pack, or another equivalent course recognised by MIAA. A
large number of existing brokers therefore already pay the cost of education. While the new
courses would contain more comprehensive education requirements, some reductions would
be expected for those who could demonstrate an appropriate level of training.



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For consumers
Any cost outlaid by the broker may be passed on to the consumer. This would be minimal.

For government
None identified

For credit providers
None identified

8.4    Objectives 2 and 3

•     Provide consumers with sufficient information to choose a suitable broker

•     Require brokers to demonstrate that their recommendation is appropriate
      for the consumer’s circumstances and, where possible, the best available

Problem to be addressed
Most consumers currently have no way of assessing the value of any broking service. For
example, knowing how many lenders are on the broker’s panel, or whether the lending panel
comprises mainstream, non-conforming or non-retail credit providers is an important issue in
deciding whether a broker is going to access a competitive product. Also, it is important for
consumers to know the influences to which the broker is subject and, in fact, whether the
broker is likely to be acting in their own interests or the client’s.

Brokers may currently place consumers in loans which the consumer cannot afford or which
are inappropriate for the consumer’s needs. Even if the loan is affordable or reasonably
appropriate for the consumer, it may not be the best loan which the broker can access for the
consumer.

Proposed option
Require the finance broker to enter into a written contract with a consumer before
commencing finance broking and that the contract contain details of the broker’s access to
credit providers as well as details of the credit required by the consumer.

This would mirror a requirement in the NSW Consumer Credit Administration Amendment
(Finance Brokers) Act 2003.

The New South Wales legislative requirements are outlined in Section 3.1.1. It is proposed
that Part 1A Divisions 2,3 and 4 would be used as a basis for disclosure requirements in the
national scheme, but that consumer remedies would be available as detailed in this paper.

Other practices which come to light between the time the New South Wales legislation is
enacted and the time any national regulatory scheme commences may also need to be
addressed. For example, it has been noted that unscrupulous brokers are taking a caveat
over any property held by the small business applicant and, knowing the applicant is
desperate for the loan, do not find finance assuming that the applicant will go elsewhere.
The broker then demands payment to remove the caveat. The practicalities of removing the
caveat through an objection to the Land Titles Office and court action usually render this
course of action impractical. Practices such as these should be expressly prohibited.

There may be other businesses or practices which are structured to avoid regulation, such as
advice or mortgage reduction schemes. These should be specifically captured by any
definition of intermediary.


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8.4.1   Benefits/ Advantages

For finance brokers
Requiring the details of the credit required to be set out in the broking contract will assist the
broker to gain a picture of the consumer’s needs before finance broking commences. This
should help to prevent the broker obtaining credit which does not match the consumer’s
needs. A written contract will also assist brokers to prove that they have met the consumer’s
requirements in the event of any dispute.

For consumers
The consumer will be able to judge whether the broker can add value in sourcing a credit
product and whether the broker appears to be acting impartially.

Requiring the details of the credit required to be set out in the broking contract will encourage
the consumer to apply their minds to the issue of the type of credit sought before finance
broking commences. This should help to prevent the problem of brokers securing credit
which does not match the consumer’s needs, and the requirement for a written contract is
important in the event of any dispute about the consumer’s stated needs.

The inclusion in the broking contract of the maximum periodic repayment that the consumer
is prepared to pay should help to prevent consumers entering into loans which they cannot
afford. Expressing the amount the consumer can afford to pay in terms of the periodic
repayment amount as well as the maximum interest rate or fees and charges should give a
consumer a realistic idea of the cost of the loan, as looking at the interest rate or fees and
charges alone does not give an idea of the dollar amount involved. The repayment amount
is the consumer’s main yardstick of affordability for credit purchases, but without other
specifications such as the term of the loan or type of credit provided, this can be
manipulated.

For credit providers
Fewer consumers being placed in loans which do not meet their needs should result in fewer
consumers being dissatisfied with their credit product and deciding to refinance.

For government
Fewer consumers being placed in credit contracts which do not match their needs should
result in fewer complaints to Government and fewer cases being brought to courts and
tribunals.

8.4.2   Costs/ Disadvantages

For finance brokers
Preparing computer systems to accommodate the requirements for a contract would require
some initial outlay but this would be minimal when averaged over a number of years.
Including the information on the consumer’s credit requirements in the broking contract would
involve some work for the finance broker but this should be part of their normal broking
practice in determining the client’s needs.

For consumers
While specifying the type of credit required in the broking contract is likely to assist many
consumers to obtain credit which meets their needs, it will not necessarily always ensure that
a consumer is placed in the best loan which the broker can access for the consumer, or even
an appropriate loan.




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There are several reasons for this:
• Firstly, the consumer may sign a broking contract in which the credit specifications are
   not affordable or appropriate for the consumer. This may be because the broker has
   persuaded the consumer to obtain credit which is unaffordable or inappropriate. Some
   brokers have a tendency to inappropriately recommend interest only loans. This can
   mean that, although the consumer can afford the regular repayments, they will not be
   able to afford to pay off the principal at the end of the loan term.
• Lines of credit have become increasingly popular with brokers, especially those
   marketing debt reduction schemes. The increased level of promotion of lines of credit is
   indicated by ASIC’s recent action in removing calculators providing simulations between
   a standard loan and a line of credit from 100 websites.
• Requiring a loan to match the contract specifications requires only that. If a number of
   loans match the specifications there is no requirement that the broker recommend the
   best or most suitable of these loans, whether in terms of price or other features.
• In the case of refinancing, matching the contract specifications does not require a
   comparison of whether the consumer will be better off entering into the new loan than
   remaining with their existing loan. Termination fees can be considerable, sometimes
   amounting to two or three months additional repayments.

For credit providers
For the reasons outlined above, the requirement to specify the details of the credit required in
the broking contract will help many consumers but will not always ensure that a consumer is
satisfied with their loan, nor prevent default on a loan or refinancing to another loan.

For government
The requirement to specify the credit details in the broking contract will not always ensure
that a consumer is satisfied with their loan. Vulnerable consumers may still complain to
Government and bring cases to courts and tribunals.

Additional proposals to address these limitations
Require the finance broker to enter into a written contract as outlined above and provide the
consumer with a statement of reasons setting out why the credit product recommended by
the broker is the most appropriate product for the consumer’s circumstances.

The statement of reasons could be required to address how the credit product recommended
by the broker meets the specifications in the finance broking contract and why the particular
features of the loan make it the most appropriate product for the consumer’s circumstances.
If cheaper finance is available the statement of reasons could explain why this has not been
recommended.

If the broker recommends that the consumer refinance an existing credit facility, the
statement of reasons could also address:
• why the new product is more beneficial for the consumer than the existing product;
• any charges the borrower will or may incur in relation to the disposal of the existing
    product;
• any charges the borrower will or may incur in relation to the acquisition of the
    recommended product;
• any pecuniary or other benefits the borrower will or may lose (temporarily or otherwise)
    as a result of taking the recommended action;
• any other significant consequences for the borrower of taking the recommended action;
• where a change in credit product is recommended because of features other than price,
    whether or not those features are available under the borrower’s existing credit contract
    (and at what cost).



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Where the capacity of the borrower to make repayments greater than the borrower’s existing
repayments is relevant to the recommendation, the statement of reasons should contain:
• a statement of what the repayments will be, and
• a comparison of the savings which would be achieved with the borrower’s existing credit
   facility, if the consumer were to make the increased repayments to that facility.

Where the broker recommends that the consumer refinance to a line of credit facility, the
statement of reasons should address why the consumer requires the extra credit provided by
this facility, and what the repayments would be if the borrower draws down the full amount of
credit available.

Where the broker recommends an interest-only loan, the statement of reasons should
clearly state why this is better for the consumer than a principal and interest loan, and
how the broker and consumer have agreed that the consumer will pay off the principal
when it is due.

8.4.3   Benefits/ Advantages

For finance brokers
Providing a statement of reasons would help the broker to clearly articulate to a consumer
why a particular loan is the most suitable loan for the consumer’s circumstances.

For consumers
A statement of reasons would help to clarify to a consumer exactly how a particular loan will
meet their needs. Where the broker provides a number of choices, a statement of reasons
would help the consumer to decide which loan is the best available loan for their
circumstances, rather than simply one of a number of loans which fits the criteria specified in
the broking contract.

Requiring a broker to justify a refinancing recommendation by explaining why the
recommended loan is superior and what costs the consumer will incur in switching loans
should help a consumer to decide whether they will gain by refinancing.

Where refinancing recommendations are based on the consumer needing to make larger
repayments, providing the consumer with an analysis of the savings which would be
achieved if these repayments were applied to their existing loan will give the consumer a
clear picture of whether refinancing will actually provide any benefits.

Explaining why an interest-only loan is beneficial for the consumer and how the consumer
will pay off the principal should alert the consumer to the potential problems with such loans.

For credit providers
A statement of reasons such as that proposed would help consumers to find the best loan for
their circumstances, and should reduce the number of consumers who are unhappy with
their loans and either default or refinance.


For government
A statement of reasons would help consumers to find the best loan for their circumstances,
and should reduce the number of consumers who complain to Government or bring cases to
courts or tribunals.




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8.4.4   Costs/Disadvantages

For finance brokers
Providing a detailed statement of reasons will involve extra time and paperwork for brokers
but could be considered to be a normal part of a broker’s role. One industry association
considers that this would amount to less than one hour’s work.

For consumers
While a broker can provide in a statement of reasons a number of arguments why a loan is
the most suitable one for a consumer, this will not always ensure that the loan is actually the
best one for the consumer. There may be another loan which the broker has failed to
mention which would be better for the consumer.

A statement of reasons also does not necessarily ensure that the recommended loan is even
appropriate for the consumer, if the consumer has signed a broking contract with credit
specifications which are not actually suitable for the consumer’s needs.

For government
While a statement of reasons should increase the number of consumers who are satisfied
with their loans, it will not ensure that all consumers are placed in optimal or even
appropriate loans. These consumers may still complain to Government and bring cases to
courts and tribunals.

For credit providers
While a statement of reasons should increase the number of consumers who are happy with
their loans, it will not ensure that all consumers are placed in optimal or even appropriate
loans. These consumers may still default or refinance.

Additional proposal
Require brokers to enter into a written contract, provide a statement of reasons and have a
reasonable basis for recommending or obtaining a particular loan for a consumer.

This requirement would go beyond the statement of reasons by requiring a loan to actually
be suitable for a consumer rather than just requiring the broker to present arguments why the
loan is suitable.

A third party can usually only judge whether a broker’s recommendations are reasonable and
a legislative requirement, which will be assessed by an independent third party, should not
go beyond requiring reasonable recommendations.

The reasonableness of a broker’s recommendations can only be judged in the context of the
information to which the broker has access in making those recommendations. It would be
unfair to judge a broker for not taking into account information of which the broker was
unaware. In order to provide a consumer with useful advice about credit products, a finance
broker should collect information about the consumer’s income, assets, liabilities,
expenditure patterns and the purpose for which the consumer needs the credit.

It is not proposed that a legislative requirement of reasonableness should attempt to give a
general definition of when a recommendation will be reasonable, as this will vary according
to the circumstances of each case. However, given that recommending a loan which is
unaffordable for a consumer will never be reasonable, it is proposed that the legislation
should state that a reasonable recommendation will need to take into account, among other
things, whether a consumer can afford to repay the loan without substantial hardship.



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The ASIC guide PS175 provides useful guidance for financial product advisers on what is
appropriate advice in respect of financial products. The relevant sections of that document
could be adapted for use by finance brokers in assisting their understanding of
“reasonableness”.

8.4.5   Benefits/Advantages

For finance brokers
Requiring a broker to have a reasonable basis for recommending or obtaining a credit
product will improve consumer confidence in the broking industry and encourage industry
growth.

For consumers
A requirement that the broker have a reasonable basis for their recommendations should
help to prevent consumers being placed in unaffordable or inappropriate loans.

This requirement would greatly improve on the requirement that a broker provide a statement
of reasons, as the statement of reasons, although it may help many consumers, will not
necessarily prevent a consumer being placed in a loan which is actually inappropriate and/or
unaffordable.

For government
The requirement should help to reduce the number of complaints to Government and cases
being brought to courts and tribunals. Should these statements initially not be satisfactory,
and be challenged by consumers, this is a matter that could be dealt with by an alternative
dispute resolution scheme.

For credit providers
This requirement should help to reduce the number of consumers defaulting on their loans
and/or refinancing.

8.4.6   Costs/ Disadvantages

For finance brokers
For those providing a genuine statement of reasons, the requirement that the product be
appropriate would not impose any additional cost. The requirement will require the finance
broker to carefully consider the recommendations they make to a consumer, but this should
be part of the finance broker’s usual function. For those who may try to “work back” from
their choice of product to justify it when in fact it is not appropriate, the requirement that the
product be appropriate may result in action by the consumer to remedy the situation.

For consumers
Brokers may be reluctant to recommend or obtain loans which the broker considers to be
unsuitable. However, while a consumer may not like this, it is clearly beneficial for a
consumer to be aware that a loan may not be appropriate for their circumstances.

For government
Should any alternative dispute resolution scheme not be able to satisfy the consumer in its
decisions, deciding whether a broker has a reasonable basis for recommending or obtaining
a loan may be a more time consuming task for a court, or tribunal than simply checking
whether a loan matches the specifications in the broking contract or whether the broker has
prepared an adequate statement of reasons. However this is likely to be balanced against
the fact that fewer cases are likely to be brought to courts and tribunals.


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For credit providers
Brokers may submit fewer inappropriate loan applications to credit providers. However,
credit providers should not be approving loans which consumers cannot afford or are not
suited to the consumer’s needs, and granting fewer loans which are otherwise unsuitable
should lead to fewer defaults and refinances.

8.5    Objective 4

•     Provide a means of empowering consumers to influence broker behaviour
      by providing consumers with effective remedies against brokers who do not
      act fairly or competently.

Problem to be addressed
As discussed elsewhere in this paper, the inaccessibility of consumer remedies is seen as a
contributing factor to market failure in respect of this industry, with the result that there is no
effective incentive for brokers to behave ethically and provide a quality service. As well,
consumers accessing credit which falls within the scope of the Consumer Credit Code may
be denied access to remedies in respect of the credit contract by virtue of using a broker
intermediary. This is because the broker is not an employee of the credit provider, nor in
many cases an agent of the credit provider, and in the absence of such a link the Code can
not be accessed for any remedy that may have been available if the consumer went directly
to the credit provider.

Possible responses
While some remedies in respect of broker conduct may be available under the Consumer
Credit Code, that legislation does not attempt to deal with all broker practices. Indeed, there
was a very small broking industry when the Code was developed. In any event, the proposed
regulatory scheme would cover broking activities which are not within the jurisdiction of the
Code. It would not seem appropriate for clients who access consumer credit through brokers
operating under a comprehensive regulatory scheme to have to go to the Consumer Credit
Code for those remedies that may be available in respect of broker behaviour, nor to have
less protection with respect to the credit contract itself than consumers who obtain credit
directly from the credit provider. This in itself could encourage unfair practices by credit
providers.

Broker specific legislation should therefore:
• ensure that consumers are not disadvantaged with respect to remedies available under
   the Consumer Credit Code by accessing consumer credit through a broker rather than
   directly from a credit provider;
• provide remedies with respect to broker behaviour.

Since any broker legislation would not attempt to establish agency, any remedies should not
affect the credit contract itself, except in very limited circumstances. Where both broker and
credit provider are involved in any unfair conduct, there should be an opportunity for the
parties to be joined, or for one to be able to claim compensation from the other, if
appropriate.

The need for remedies appears to stem from the following main sources of broker
misconduct: failure to enter into a finance broking contract; breaching the requirements of the
finance broking contract; failure to provide a statement of reasons; recommendation of an
inappropriate product; accessing credit not covered by the Consumer Credit Code (by
misuse of the business purpose declaration); falsifying consumer details in order to obtain
credit; misrepresenting the nature, cost or details of the credit to the consumer.



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Proposals to deal with such conduct as well as for contraventions of the administrative
scheme are set out below.

Proposed option
• Offences (criminal or monetary penalties consistent with the severity of the offence)
   would be created where certain requirements are contravened;
• Compensation would be available to consumers where the contraventions result in
   consumer detriment. The broker would be required to compensate the consumer for any
   loss suffered from the broker’s actions, including loss resulting from not having the
   protection of the Code. There could be a requirement for any dispute resolution scheme
   to consider:
   • costs involved in entering the credit contract
   • fees/commissions paid by the consumer to the broker or any other party
   • price of the product compared to an appropriate product
   • cost of refinancing to an appropriate loan
   • value of any other loss suffered by the debtor as a result of being denied the
       remedies under the Code
• In the event of consumer detriment a broker would not be entitled to be paid by the
   consumer for any broking services;
• Administrative sanctions would be provided for breach of any licensing/registration
   requirements.

Remedies exist in some jurisdictions in relation to excessive commissions. Remedies should
also be provided in any national broking legislation. While it is not intended to mandate the
level of fees, consideration could be given to referring to a standard, or accepted level of fees
in the legislation or regulations in the same way that the Commonwealth Bank standard
variable interest rate is used as a benchmark for various purposes in the credit industry. This
would provide some guidance to consumers and brokers, and may assist in reducing the
incidence of fees being charged that are significantly higher than industry standards (for
example, fees of 20% or more of the amount borrowed as identified in some of the case
studies in the ASIC broker report)

8.5.1   Benefits/Advantages

For finance brokers
Remedies which impact on a broker would be likely to discourage disreputable traders from
entering the market and encourage the use of broker services by both credit providers and
consumers. Public perception of brokers would be improved.

For consumers
Consumers would have greater confidence in using a broker service. They would not be
financially disadvantaged by using a broker service instead of a credit provider and they
would be compensated for any loss resulting from non-compliance with broking legislation.
Fair competition could reduce the cost of broker services.



For government
Government would have fewer complaints from consumers about broker conduct. Fewer
compliance resources would be expended on broker misconduct. There would be less public
criticism about the lack of government action.

For credit providers



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Remedies which are attached to broker conduct would weed out dishonest brokers. This
would give credit providers confidence in using brokers as a means of reaching a wider
market. This could encourage smaller lenders to enter the market.

8.5.2    Costs/Disadvantages

For brokers
Those brokers unable or unwilling to provide the quality of service required by the legislation
may be required to make significant payments of compensation to consumers as well as
penalties if offences are committed.

For consumers
None identified.

For Government
Cost of administrative sanctions and disciplinary procedures. However, these are likely to be
offset by a reduction in court action currently undertaken against rogue brokers.

For credit providers
Possible cost of reviewing arrangements with brokers who are found to be in contravention of
broking legislation. However, this is already done by lenders in respect of fraudulent brokers,
and it is likely that these numbers would be reduced.

8.6     Stay of enforcement proceedings
Problem to be addressed
Section 86 of the Consumer Credit Code permits a consumer who has been given a default
notice or a demand for payment, to negotiate with the credit provider a postponement of the
enforcement proceedings. If the consumer is unable to negotiate such a stay, application
may be made to the Court for a postponement.

In such cases, the Court would consider whether to grant the postponement on the merits of
the case, which would include the capacity of the debtor to put the contract back on foot.

One of the effects of obtaining credit through a broker has been that some broker clients
have lost their homes through inappropriate loans that they have agreed to on the broker’s
recommendation without a clear understanding of the financial consequences.

Credit providers may not negotiate a stay if they can not see that a debtor’s circumstances
will change in the forseeable future. The Court is also unlikely to order a stay on the same
basis.

Proposals outlined above in respect of remedies (section 8.5) require a court or ADR scheme
to consider certain factors in assessing any damages. Where a consumer has a claim
against a broker that may result in damages or compensation that could allow the home to
be saved, the consumer should be permitted to apply to a court for a stay of proceedings and
the legislation should require the court to take certain matters into consideration.

The Court currently has powers to grant injunctive relief in appropriate cases, however, in the
past courts have been extremely conservative in their assessment of damages and in their
application of contract law. While the Court will necessarily have discretion to consider the
circumstances of each case, the quantum of damages will also be guided by the legislation,
as set out in the Remedies section of this paper.




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Proposed option
• Where a consumer has a claim against a broker for compensation or damages (whether
   in the court or under an ADR scheme) which is in respect of conduct by the broker that
   the consumer claims has caused the mortgagee to embark on the forced sale of their
   home, the Court may order a stay of enforcement proceedings.
• In determining whether a stay is appropriate, the Court will have regard to:
   • whether the home is the primary residence of the debtor;
   • whether it is likely that the home could be saved if a stay is granted;
   • whether the case against the broker is likely to result in damages which could be
       applied to reduce the amount of the loan due to the credit provider to such extent that
       the debtor could afford to make repayments; and
   • whether the consumer can make a reasonable repayment arrangement during the
       hearing of the dispute
• The Court will have a power to compel documents and other evidence to be produced by
   the broker and credit provider
• The Court will have power to compel the credit provider to participate in any negotiations
• Any ADR scheme must also have the scope to deal with such matters, depending on the
   circumstances of the case and the Rules of the ADR scheme.
• The Court will have power to direct that damages due from the broker be paid to the
   credit provider to reduce the outstanding balance, if this will make the contract viable.

The right to apply to the Court for a stay under broking legislation would be a more
sophisticated and developed version of the borrower’s right to apply for a stay under the
Consumer Credit Code, since the rights under the Code are very limited. While there are
some novel aspects to this right (including joinder of the broker as a third party, and referral
to the ADR scheme as a mediator) this approach is broadly consistent with current
approaches to the use of mediation to resolve court proceedings. For example, in NSW Part
7B of the Supreme Court Rules gives the Supreme Court discretion to refer a matter to a
mediator irrespective of the consent of the parties. If necessary, the broker legislation would
recognise ADR schemes as appropriate vehicles to mediate in these types of disputes.

Note: While the term “consumer” is used, it should be noted that it is not proposed that any
distinction be drawn between a “consumer” loan or any other loan to which the broking
legislation will apply. The stay of enforcement provisions will, therefore, apply equally to
small business loans for which a mortgage is taken over the debtor’s home as security.

8.6.1   Benefits/Advantages

For finance brokers
Minimal, except that some complaints may be resolved more quickly (due to pressure of
court action) than would otherwise be the case.

For consumers
Enhanced opportunity, in appropriate cases, to retain possession of real property.

For government
Reduction in the number of evictions, and consequent claims by borrowers on government
services. Greater accountability of brokers for poor or misleading advice (as once property is
sold borrowers are less likely to complain). Reduced demand on court services due to
capacity to refer cases for mediation through the ADR schemes.

For credit providers
Reduction in the number of evictions , and greater accountability of brokers.



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8.6.2    Costs/Disadvantages

For finance brokers
May become involved in court/mediation actions (although impact may be minor given that
intention is for these matters to be resolved quickly).

For consumers
Small increase in amount owing to credit provider where stay does not prevent sale of
property.

For governments
None identified.

For credit providers
While credit providers are likely to claim this as a cost, it is noted that the circumstances in
which the criteria for a stay will be met are very limited and should not give credit providers
any grounds for concern, given that the debt will still be secured over real property, and the
court can, in appropriate cases, require the borrower to maintain repayments when ordering
the stay.

If the other parts of the legislative proposal, such as entry requirements, broker/client
contracts, statements of reasons etc are implemented, the number of applications for a stay
should be so few as to have no impact on the credit industry.

8.7     Compensation for consumers
Even if a consumer obtains an order requiring the broker to pay the consumer a sum of
money, the broker may not have enough money to pay the consumer.

Possible responses
This could be dealt with in two ways, which are:
• requiring a broker to hold professional indemnity insurance; or
• requiring that the broker contribute to a fidelity fund administered by the Government or
   an independent body.

The latter possibility is thought to possibly discriminate against smaller brokers and is not a
proposal at this time.

Require broker to hold professional indemnity insurance
Many finance and mortgage brokers currently hold some sort of professional indemnity
insurance. Members of the Mortgage Industry Association of Australia and the Finance
Brokers Association of Australia are required to hold professional indemnity insurance as a
condition of membership.

Affordable professional indemnity insurance is becoming easier for brokers to obtain, as
insurers are being educated about the risks involved in insuring brokers and are lowering
premiums as a result. There are currently about six underwriters offering PI insurance for
brokers and for one-person brokers a PI insurance policy currently costs around $800 p.a.
The following can be said about the usual scope of PI insurance policies in the finance
broking industry:
• Generally policies will cover negligent activity in the ordinary course of conducting a
    broking business. The cover will usually apply even if the liability arises under contract,
    the Trade Practices Act, or the ASIC Act, but only if the claim would have been
    successful if made in negligence. If the damages assessed under a claim for breach of



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    contract, trade practices or fair trading legislation are larger than the damages that would
    be payable under a claim for negligence, the policy will normally only pay out the lower
    amount that would have been paid if the claim was for negligence. Some policies have
    specific extensions for trade practices/fair trading liability, but that is not a standard
    feature.
•   There is no cover for acts, errors or omissions by the insured themselves that are done
    with the intention of causing a third party loss, damage or injury, or with reckless
    disregard for the consequences. These include fraud, forgery or dishonesty. However
    some policies cover dishonest, fraudulent, criminal or malicious acts or omissions by an
    employee of the insured, but not a sub-contractor. A broker would not ordinarily be liable
    for the dishonest acts of subcontractors, but often aggregators are made liable for the
    dishonest acts of their sub-originators pursuant to the head origination agreement.
•   There is a dollar limit on the amount of cover. The policy will usually specify the limit of
    cover that applies for any one claim and the limit that applies to the total of claims made
    during the policy period.
•   Other limits on cover might include a limit on legal costs (though this is rare),
    investigation costs, and specified risks (for example advising in relation to interest rates).
•   Most policies are “claims made” policies (which means that claims are covered by the
    policy in place at the time the claim is made, and will not be covered if there is no policy
    in place at that time). These policies usually provide that a broker will not be covered for
    claims which were known about when the policy was taken out. Therefore if the cover is
    allowed to lapse, the broker will not be covered for any claims made during the period of
    the lapse.

Proposed option
In order to ensure that compulsory PI insurance provides consumers with the maximum
possible protection, it is proposed that brokers be required to hold professional indemnity
insurance which:
• Covers risks which arise from the work which the broker actually undertakes, regardless
    of what name the broker gives to that work. For example, a broker may call him or
    herself a mortgage broker, but actually undertake the functions of a mortgage manager.
    Unless the policy takes account of the nature of the work the broker undertakes, the
    broker may not be insured for liabilities incurred in the course of that work.
• Covers conduct which can result in a claim for breach of contract and/or breach of the
    Trade Practices Act, the ASIC Act or fair trading legislation, where such a claim could
    also be made in negligence.
• Provides continuous coverage for consumers. This means that the broker must be
    required to maintain continuous cover, with no gaps. If the policy is a “claims made”
    policy, the broker must also be required to maintain run-off cover for a suitable period
    after the broker ceases to trade (probably at least 6 years).
• Provides for a monetary limit for claims of not less than $1 million.
• Is provided by an insurer that is APRA regulated, and has a Standard and Poors rating of
    “A” or higher.
• Covers decisions of any accredited alternative dispute resolution scheme to which
    brokers are required to belong.

In view of the volatile nature of the insurance market, the requirement to hold professional
indemnity insurance could be located somewhere other than in legislation (for example, in a
regulation) so that it could be removed quickly if such insurance suddenly ceased to be
available.

8.7.1   Benefits/Advantages

For finance brokers


                                                                                               83
Costs of claims are spread out over time (through payment of PI premiums) rather than being
required to be met through a lump sum payment.

For consumers
The major benefit of PI insurance for consumers is the assurance of being paid any money
owed to the consumer as a result of negligence, breach of contract or breach of fair trading
or trade practices legislation by the broker.

For credit providers
Limited impact given that some credit providers already require brokers to hold PI cover in
order to obtain accreditation for that lender.

For Government
Assists in effective running of ADR scheme as a means of providing compensation to
borrowers. PI insurers who refuse to offer cover to brokers on the grounds of poor business
practices assist in excluding marginal players from the marketplace.

8.7.2    Costs/ Disadvantages

For finance brokers
While it is arguable that the requirement to hold satisfactory PI insurance cover may be a
barrier to entry to the industry this would not appear to be the case in practice, given that the
cost of PI cover appears to be falling, and that this requirement already exists informally
(given that some PI insurance is required by the MIAA as a condition of membership, and
that it is also required by some lenders in order for the broker to obtain accreditation from
that lender).

For consumers
In some instances the cost of PI insurance may be recouped through increased costs passed
onto the consumer. However, this would be limited for two reasons. First, many brokers
already have PI cover. Secondly, where the broker’s income is derived from the commission
paid by the lender, any increase in commission will depend on the broker-lender relationship
and not the cost of PI cover.

For credit providers
None identified.

For Government
None identified

8.8     Access to affordable remedies
The capacity to access effective remedies is essential in ensuring that a market functions
efficiently. Industry has no incentive to provide a reputable service if consumers are unable
to enforce their rights. The cost of legal action is prohibitive given that disputes are frequently
in respect of relatively small amounts of money. In any event, for many of the most
vulnerable consumers the prospect of approaching a court or tribunal is a daunting one.

Broker clients must be able to access remedies that are cost efficient and, in this way,
influence the way that brokers perform their functions. If consumers are able to compare
between brokers who are trading efficiently and fairly, the market will operate more
efficiently.




                                                                                                84
Proposed option
Alternative dispute resolution schemes would appear to be the most cost efficient way of
ensuring affordable access to remedies and enforcement. However, consistent application
of such schemes across all industry members would be necessary in order to be effective.
Licensing or registration is necessary in order to impose a requirement for membership of a
scheme which fulfils this need, but that does not require membership of an industry body in
order that a consumer has access to remedies.

The financial services industry has established a number of reputable alternative dispute
resolutions systems which provide affordable and independent dispute resolution that
consumers find easier to deal with than court or tribunal systems.

Any ADR scheme should have a wide scope to deal with complaints in order that the need
for legal action be avoided wherever possible.

Proposed option
That brokers be required to be a member of an ADR scheme approved by ASIC. This could
operate in a relatively straightforward way, and would have a number of advantages.

This approach would take advantage of the already existing ASIC standards for ADR
schemes in the finance sector. Membership of an ASIC approved scheme is now compulsory
under the FSRA regime. These standards are rigorous and well-understood in the financial
services industry and consumer bodies, as they have been the subject of extensive
consultation with stakeholders.

Requiring membership of an ASIC approved scheme would ensure consistency in the way
that ADR schemes work across the finance sector, as nearly all other financial services
providers are subject to this requirement.

ASIC already has experience and resources to assess and monitor ADR schemes (thereby
avoiding a duplication of resources in other agencies).

It is worth noting that the Credit Ombudsman Service Limited and the other scheme covering
this area, the FSBO (formerly ABIO), are already approved by ASIC. It is highly likely that
there will only be these two schemes in this sector.

ASIC has developed expertise in evaluating ADR schemes, and issued detailed public
guidelines setting out how it assesses a scheme against six key benchmarks: accessibility,
independence, fairness, accountability, efficiency and effectiveness. The guidelines are set
out in Policy Statement 139 Approval of external complaints resolution schemes (issued on 8
July 1999) and Policy Statement 165 Licensing: Internal and external dispute resolution
(issued on 28 Nov 2001).

While ASIC involvement has the advantages outlined above, it may be prudent to include in
any regulatory scheme a power to prescribe an acceptable ADR scheme by regulation.
There may be circumstances where ASIC is unable, for reasons not currently forseen, to
approve schemes which might be acceptable in certain circumstances. This regulatory
power should be included in any national broking legislation as a failsafe mechanism.

Operation of ADR schemes
ADR schemes operate in accordance with Membership Rules. As part of the approval
process ASIC reviews these Rules and tests them against the six benchmarks and the
guidelines in Policy Statements 139 and 165. Where necessary, ASIC will recommend
changes to the Rules before approving the scheme. All schemes so far approved in the



                                                                                         85
finance sector have had to make significant improvements to their structure and operations
to meet approval standards.

The Rules determine what types of complaints the scheme can hear, and what complaints
are outside its jurisdiction. It is usual for ADR schemes to exclude some types of complaints:
• complaints above a specified monetary limit;
• complaints relating to conduct beyond a specified time limit;
• complaints that have not been through a member's internal complaints handling
    procedure; and
• complaints relating to particular matters of commercial judgement (usually limited to
    particular areas eg insurance underwriting decisions).

Schemes approved by ASIC usually have the following features:
• the ADR scheme is responsible for enforcement of payment of successful claims
   (including through the threat of loss of membership and consequent loss of licence).
• the ADR scheme acts as a source of market information in that it is required to report
   complaints statistics and trends on a quarterly basis, and also instances of “serious
   misconduct” and “systemic problems”. These reports could, in the case of mortgage
   brokers, be distributed via ASIC to state and territory agencies or directly to state and
   territory agencies.
• the ADR scheme acts as an informal method of improving industry standards through
   providing feedback to members, attending conferences and issuing practice notes
   addressing common issues.

Mechanism for ensuring membership
The introduction of a licensing or registration mechanism would be the most obvious and
straightforward "hook" for ensuring compliance with this requirement. In ASIC's experience
compulsory membership cannot be achieved through industry bodies as they do not have
universal coverage. This is especially the case in industries with a large number of smaller
players. An advantage of this approach is that it means the ADR schemes in effect have a
tool to help enforce compliance, in that failure to comply with a scheme decision will mean
that membership is terminated (subject to an appropriate process). This then becomes a
relatively straightforward breach of the licence or registration condition that the government
agency can then enforce.

The alternative to a licensing/simple registration mechanism is a "stand alone" legislative
provision stipulating that brokers are required to be members of an ADR scheme. However,
the disadvantages of this approach are that enforcement of this requirement is likely to be
more resource-intensive than through taking action for removal or suspension of a licence.

Requirement for an internal dispute resolution procedure
The usual method of operation of ADR schemes is that they require members to pay a fee
for each complaint. One of the implicit consequences of this approach is that it creates a
financial incentive for brokers to develop or improve their internal dispute resolution or
complaints handling procedures. Consideration could be given to making this requirement
explicit by creating a specific statutory obligation that the member have in place internal
dispute resolution procedures that comply with appropriate standards.

Interaction with other ADR schemes
It can be anticipated that any broker-specific scheme will develop informal referral
mechanisms with other ADR schemes, particularly those in relation to credit providers (such
as the FSBO and the credit union schemes). These links may assist, in appropriate cases, in
the credit provider agreeing to a stay of any court action until the broker-specific ADR




                                                                                           86
scheme has made a determination in relation to a complaint. This may only assist borrowers
with credit facilities through banks and credit unions.

It should be noted also that any decision under an ADR scheme would generally bind only
the industry member and not the broker client, who would be free to refuse to accept the
scheme’s ruling and take action through the court or tribunal system.

8.8.1   Benefits/advantages

For brokers
The ADR scheme(s) effectively imposes a form of discipline on the industry by ensuring that
firms meet certain standards in dealing with customers, resulting in greater consumer
confidence in the industry.

For consumers
Consumers can have their complaints handled in a fair, efficient and low cost manner.

For government
ADR schemes have an informal role in supervising the industry in two ways. They can help
identify systemic trends or problems that can then be addressed by industry, regulators
and/or governments, and they are also likely to be a point through which brokers who are not
members of the ADR scheme will be identified.

For credit providers
Issues that affect the consumer’s repayment capacity can be resolved more quickly.

8.8.2   Costs/Disadvantages

For brokers
The costs are primarily borne by industry rather than regulatory authorities.

Indicative costs are available from schemes already operating. The Financial Services and
Banking Ombudsman annual membership fees are $550 for two writers, plus $275 for each
additional writer, up to $5,500. Additional fees are charged on the basis of complaints
received.

The Credit Ombudsman Service Limited (formerly Mortgage Industry Obudsman Scheme)
have a membership fee scale which is graded according to the number of writers ranging
from $165. Fees are also charged for individual complaints.

Cost comparisons may be made with the Financial Industry Complaints Service (FICS), an
ADR scheme for financial planners. Where there are less than 50 advisers, a minimum fee
of $550 is charged. With larger organisations where there are more than 400 advisers, there
is a maximum fee of $10,740.

Insurance Brokers Disputes Ltd charges $400 plus $60 per broker per annum.

For consumers
None identified.

For government
None identified.




                                                                                         87
For credit providers
None identified.




                       88
9 Impact on Competition

The proposals outlined above are considered to have a positive impact on competition.
Although some traders would be prevented by the probity checks of any licensing regime
from entering the market, these are traders who would be unlikely to compete fairly with
brokers who offer a legitimate service.

The only reasons that prospective market entrants might be deterred, other than being
unable to pass the probity checks, are the costs that might be associated with licensing or
registration fees, gaining educational requirements and professional indemnity insurance.
While these may amount to $2-3,000, depending on the cost of educational requirements,
this is a relatively small outlay for any small business to make, and would not be inconsistent
with entering any other similar occupation. Again, the only potential traders this is likely to
deter are those who are not committed to a bona fide business.

Similarly, the costs involved in providing contractual documentation and the time required to
provide the statutory disclosures and the statement of reasons are costs that may be
considered to be normal costs associated with a business enterprise for which fees are
charged. Commissions paid to the industry from credit providers are quite substantial and
brokers are not precluded in these proposals from charging the consumer.

Cost should not therefore be a barrier to entry to the market.

The proposals are intended to enhance competition in the industry by redressing the
imbalance in power and information between consumers and brokers. The information
required to be provided in the finance broking contract will assist consumers to choose a
broker who can provide access to the sort of credit they need and at a price they can afford.
Educational requirements should encourage greater efficiency of the broking service and
increase the possibility of the broker accessing an appropriate and affordable credit product.
This should have a positive impact on market efficiency.

The requirements for membership of an ADR scheme, as well as appropriate redress
provisions, will allow consumers to enforce their rights in a cost efficient manner, thereby
proving an incentive to brokers to act lawfully and efficiently. Professional indemnity
insurance should ensure that compensation is available to the consumer.




                                                                                            89
10 Consultation

In developing these regulatory proposals, preliminary papers were circulated for comment to
the following organisations:

•    Mortgage Industry Association of Australia
•    Finance Brokers Association of Australia
•    Gadens Lawyers (legal advisers to MIAA)
•    Australian Bankers Association
•    Credit Unions Services Corporation (Australia) Limited
•    Australian Finance Conference
•    Australian Association of Permanent Building Societies
•    Consumer Credit Legal Centre Inc

Proposals for further consultation
This Regulatory Impact Statement will be made widely available from government websites
and through mailout on request.

It is intended that its availability will be advertised in national newspapers.

The paper will be sent directly to those organisations listed above, and to those who have
expressed interest.

Comments are invited on any aspect of the paper. Details of costs to the industry of any
proposed option are sought, as well as comment on any assumptions made in the paper.

Submissions may be sent electronically or in hard copy.

Enquiries to: Lucas Kolenberg
              (02) 9338 8937

The e-mail address for submissions is:

    broking@oft.commerce.nsw.gov.au


Submissions by post should be sent to:

National Finance Broking Regulation 2004
Policy & Strategy Division
Office of Fair Trading
PO Box 972
PARRAMATTA NSW 2124

Final date for submissions:
15 February 2005




                                                                                        90
                                                                               Attachment A
United Kingdom
In the United Kingdom, it is estimated that brokers are responsible for approximately 60% of
mortgages.50 In order to have lenders accept applications, brokers usually have to be
registered with the Mortgage Code Compliance Board; in 2000, there were 10,470 broker
firms, representing 43,569 mortgage advisers.

The main industry body for the mortgage lending industry is the Council of Mortgage Lenders
(CML). It has 145 members who provide over 98% of the first mortgages on residential
property in the United Kingdom. The CML also sponsors a voluntary Mortgage Code that
covers the activities of both lenders and mortgage intermediaries. Generally, lenders who
subscribe to the Code do not accept business from brokers who have not also agreed to
adopt the Code.

The Code obliges brokers to:
• disclose their status with respect to the lender and the borrower;
• disclose at the outset whether they receive a fee for arranging the client’s mortgage;
• provide clients with fair terms and conditions, setting these out clearly and in plain
   language;
• have internal procedures for handling complaints fairly and speedily; and
• be a member of an alternative dispute resolution scheme (typically the Mortgage Code
   Arbitration Scheme).

Government regulation of broker activities in the United Kingdom currently takes place
through the Consumer Credit Act 1974, the Office of Fair Trading Guidelines for Non-Status
Lenders and Brokers, and precedents under the Unfair Contract Terms Regulations 1999.

The Consumer Credit Act 1974 encompasses all forms of consumer credit and hire purchase
and prohibits false or misleading advertising. The “Non-Status Lending Guidelines for
Lenders and Brokers” is a series of guidelines issued by the Office of Fair Trading (OFT).
They are specifically directed at enhancing the protection provided to consumers whose
credit rating made it difficult for them to obtain finance.

The guidelines apply to both lenders and brokers and provide that:
• there should be transparency in all dealings with potential and actual borrowers, with full
   and early disclosure and explanation of all contract terms and conditions, and all fees and
   charges payable;
• contract terms and conditions should be fair, and should be written in plain English to
   ensure that borrowers understand the nature of the loan agreement and their rights and
   responsibilities;
• there should be no high pressure selling, and adequate time should be allowed for the
   borrower to reflect on the terms and conditions of the loan and to obtain independent
   advice before signing;
• advertising and other promotional material should not mislead, and there should be no
   cold-calling or canvassing of trade premises without the borrower’s prior consent;
• brokers should disclose at the outset their status with regard to the borrower and the
   lender, the extent of the service offered to the borrower, together with any brokerage fee
   or commission payable by the lender;



50
   See www.cml.org.uk. See also Jason Clout, “Mortgage broking looks set to expand”, The Australian
Financial Review, 12 April 2002, p. 70.


                                                                                                91
•    lenders should take all reasonable steps to ensure that brokers and other intermediaries
     regularly marketing their products do not engage in unfair business practices, or act
     unlawfully, and that they serve the best interests of the borrower; and
•    there should be responsible lending, with all underwriting decisions subject to a proper
     assessment of the borrower’s ability to repay.

However, from mid-2004, the Financial Services Authority (FSA)51 will be responsible for
regulating mortgage lending, and brokers to the extent that they arrange mortgage loans.52
This change has been triggered by the need for the UK to meet standards set by the
European Union.

To avoid dual regulation, mortgages entered into after the FSA assumes responsibility for
mortgage lending will be carved out of the jurisdiction of the Consumer Credit Act 1974 and
will be regulated solely by the FSA. The FSA proposals include:
• brokers will either be licensed by the FSA directly, or authorised to operate by an entity
     that is itself licensed by the FSA;
• brokers must advise borrowers whether or not they are acting on an execution only basis,
     or providing advice, and, if the latter, provide details of the number of lenders and credit
     products reviewed prior to making the recommendation;
• the broker must assess whether or not a loan secured by mortgage is appropriate for the
     borrower, and, if so, further consider what type of loan is suitable and which product best
     meets the consumer’s needs and financial circumstances;
• a higher level of regulation applies to mortgages identified as inherently more risky for the
     borrower (such as “equity release” mortgages for older borrowers); and
• brokers will be subject to the compulsory jurisdiction of the Financial Services
     Ombudsman (the complaint scheme for financial services in the UK). They will also be
     required to meet internal complaint-handling benchmarks.

European Union
In the European Union, brokers (or “credit intermediaries”) are subject to limited regulation by
European Union (EU) legislation under Consumer Credit Directive 87/120/EEC.53 The
legislation has recently been redrafted with brokers now subject to the following obligations:
• brokers must be registered within each Member State in which they operate;
• brokers must offer or arrange the most appropriate type of credit, taking into account the
    financial situation of the consumer, the advantages and disadvantages of the
    recommended product, and the purpose of the credit;
• brokers must indicate, in advertising and documents provided to clients, whether or not
    they work exclusively with a limited number of lenders, or whether they operate
    independently; and
• brokers cannot demand or receive brokerage fees from clients where they are
    remunerated by commission from the lender, or where they do not arrange finance for the
    client.

United States of America
In 2000, there were approximately 30,000 mortgage broker companies in the USA,
employing an estimated 240,000 brokers. Mortgage brokers are the biggest source of
mortgage lending and are responsible for approximately 72% of home loans originated in the
United States.54

51
   An independent, industry-funded body that regulates the financial services industry in the UK. See
www.fsa.gov.uk
52
   CP146:The FSA’s approach to regulating mortgage sales, FSA, August 2002.
53
   See www.europa.eu.int/comm/consumers/index_en.html.
54
   See www.namb.org. See also Jason Clout, “Mortgage broking looks set to expand”, The Australian
Financial Review, 12 April 2002, p. 70.


                                                                                                  92
The National Association of Mortgage Brokers (NAMB) is the only national trade association
representing the US mortgage broker industry. It currently has only 13,000 members who are
obliged to subscribe to a Code of Ethics and to “Best Business Guidelines”. These are
significantly less detailed than the UK Mortgage Code.

The code and the guidelines stipulate that members must:
• conduct business in a manner reflecting honesty, honour and integrity;
• conduct their business activities in a professional manner;
• endeavour to be accurate in all advertisements and solicitations;
• avoid unauthorised disclosure of confidential information;
• conduct their business with all applicable laws and regulations;
• disclose any equity or financial interest they may have in the collateral being offered to
   secure a loan; and
• provide written disclosure of fees, and thoroughly explain the loan process to their clients.

The NAMB also provides members with a model borrower–broker disclosure agreement,
which explains to clients the relationship their broker has with lenders. The mortgage broker
industry in the United States is currently regulated by ten Federal laws, five Federal
enforcement agencies and over 45 State laws or licensing boards.55

A table of selected requirements is set out below.

State Licensing Rules – United States

        State               Regulator                            Selected Requirements
      Alabama             State Banking          Must show a net worth of $25,000. Submit three letters
                           Department             of character reference and three letters of reference
                                                    concerning experience. Initial license fee of $500.
       Alaska            Department of               The state of Alaska does not regulate mortgage
                        Community and               lending or mortgage brokering, regardless of lien
                     Economic Development                                position.
      Arizona            State Banking              Required to maintain a surety bond for $10,000 to
                          Department                 $15,000. Must have three years of experience in
                                                            lending and pass a written exam.
      Arkansas        Securities Department      Company required to maintain a net worth of $25,000
                                                  and surety bond of $35,000. No specific education or
                                                                   experience required.
      California       Department of Real          Most brokers register under the Department of Real
                      Estate; Department of           Estate. They must have two years' of industry
                          Corporations               experience during the last 5 years or a four-year
                                                           college degree and pass an exam.
      Colorado        Division of Securities,          Pay a license fee of $75 and take a required
                          Department of                                examination.
                      Regulatory Agencies
     Connecticut     Department of Banking,        Required to maintain a surety bond for $40,000. No
                         Consumer Credit             specific education or experience requirements.
                             Division
      Delaware       Office of the State Bank      Mortgage brokers must maintain a bond of $25,000
                          Commissioner             and provide references from companies that have
                                                   done business with them. No specific education or
                                                               experience requirements.



55
        Details    of    individual       licensing     requirements     can      be      found     at:
http://www.namb.org/gov_affairs/state_licensing.htm.


                                                                                                    93
    State              Regulator                                  Selected Requirements
  District of    Office of Banking and       Brokers are required to maintain a surety bond ranging
  Columbia       Financial Institutions          from $12,500 to $50,000. No specific education or
                                                                experience requirements.
   Florida      Office of the Comptroller,        Mortgage brokers are not subject to any specific
                 Department of Banking             financial requirements. Applicants for a broker's
                       and Finance            license must receive classroom education and pass a
                                                                        written test.
   Georgia       Department of Banking       Mortgage brokers are required to maintain a net worth
                     and Finance             of $25,000 or surety bond for $50,000. They must also
                                               have two years of lending experience or complete 40
                                                             hours of coursework in the field.
   Hawaii          Department of             Maintain a surety bond for $15,000. Mortgage brokers
                   Commerce and                         have no specific education or experience
                  Consumer Affairs                                    requirements.
    Idaho       Department Of Finance               A surety bond for $10,000 for home office and
                                                additional $10,000 for each office outside of Idaho.
                                                 Applicants for mortgage broker license must have
                                             three years experience in residential mortgage lending
                                                     if they are in charge of the place of business.
   Illinois     Office of Banks and Real        Mortgage brokers must have a net worth of $35,000
                    Estate, Bureau of            and a surety bond for $20,000. Licensees are also
                  Residential Finance        required to have three years' experience in real estate
                                                     financing or attend mortgage lending classes.
   Indiana         Secretary of State,              Registered loan brokers are required to post a
                   Securities Division             $50,000 bond. They also must take 24 hours of
                                                                classes on loan brokering.
    Iowa           Division of Banking         Must maintain a surety bond for $15,000. No specific
                                                          education or experience requirements.
   Kansas       Office of the State Bank            Mortgage brokers are required to meet specific
                Commissioner, Division                                requirements.
                   of Consumer and
                   Mortgage Lending
  Kentucky      Department of Financial        Must maintain a surety bond for $50,000. Applicants
                       Institutions            for a mortgage loan broker license must complete a
                                                                30-hour training course.
  Louisiana        Office of Financial         Must have net worth of $50,000 or a surety bond of
                       Institutions               the same amount. Brokers are also required to
                                               complete 10 hours of education and pass a lending
                                                                         exam.
   Maine          Office of Consumer             Registered credit services organizations, which
                   Credit Regulation         include mortgage brokers, must maintain a bond in the
                                                    amount of $10,000. No specific education or
                                                               experience requirements.
  Maryland        Division of Financial         Mortgage brokers are required to maintain a surety
                       Regulation               bond ranging from $15,000 to $75,000. They must
                                                             have three years' experience.
Massachusetts       Division of Banks              Mortgage brokers must demonstrate financial
                                                   responsibility but are not required any specific
                                              requirements. Brokers must show a year's experience
                                                    in the field; related course work can trim the
                                                                experience requirement.
  Michigan        Division of Financial      Mortgage brokers are required to maintain a net worth
                       Institutions              of $25,000 and a bond for $25,000. No specific
                                                       education or experience requirements.
  Minnesota          Department of                 No specific financial, education or experience
                      Commerce                                        requirements.




                                                                                                 94
    State              Regulator                              Selected Requirements
  Mississippi    Department of Banking         Mortgage brokers are required to maintain a surety
                 and Consumer Finance           bond for $25,000. They must also have two years'
                                                       lending experience or pass an exam.
   Missouri         Division of Finance       Mortgage brokers are required to maintain a net worth
                                              of $25,000 and a surety bond for $20,000. No specific
                                                     educational or experience requirements.
   Montana            Department of               Mortgage brokers are required to pay a license
                  Administration Banking         application of $500 and loan originators $400. A
                 and Financial Institutions      broker applicant must have minimum of 3 years
                         Division              experience as a loan originator and take an exam to
                                                test experience. Surety bond of $25,000 required.
  Nebraska       Department of Banking            Surety bond for $50,000 required. No specific
                 and Finance, Financial              educational or experience requirements.
                   Institutions Division
   Nevada        Department of Business             Brokers must have or work in an office with a
                 and Industry, Financial          supervisor who has two years' mortgage lending
                   Institutions Division                              experience.
New Hampshire     Banking Department             Mortgage brokers must maintain a surety bond for
                                                   $20,000. No specific educational or experience
                                                                     requirements.
 New Jersey      Department of Banking          Brokers are required to have a net worth of $50,000
                    and Insurance             and a bond for $50,000. They also must pass a written
                                                                         exam.
 New Mexico          Regulations and          Must maintain a $25,000 surety bond, and pay a $400
                  Licensing Department,        initial license application fee. No specific educational
                   Financial Institutions                     or experience requirements.
                         Division
  New York         Banking Department          Mortgage brokers are required to have two years of
                                                               experience in the field.
North Carolina         Office of the             Must maintain a $25,000 surety bond. No specific
                 Commissioner of Banks               educational or experience requirements.
 North Dakota     Department Of Banking        Must maintain a surety bond for $25,000. No specific
                 and Financial Institutions          educational or experience requirements.
     Ohio             Department Of              Mortgage brokers must maintain a surety bond of
                  Commerce, Division of         $25,000 for their main office, plus $5,000 for each
                   Financial Institutions           branch office. They must also have 3 years'
                                                  experience in the lending field or an associate's
                                              degree in finance, banking or business administration.
  Oklahoma            Department of           Brokers must have three years continuous experience
                     Consumer Credit           in the residential mortgage loan industry, real estate
                                                  sales or lending industry. There is a $750 initial
                                                        application fee and a $150 test fee.
   Oregon            Department of            Licensed mortgage brokers are required to maintain a
                 Consumer and Business         surety bond for $25,000 to $50,000. They must also
                  Services, Division of       have at least 3 years' experience in mortgage lending
                 Finance and Corporate                         or a related business.
                       Securities
 Pennsylvania    Department of Banking        Mortgage brokers must maintain a bond for $100,000.
                                               No specific educational or experience requirements.
 Rhode Island    Department of Business         Licensed brokers must have a net worth of $10,000
                       Regulation                  and post a $10,000 bond, plus $5,000 for each
                                                additional office. They are also required to have five
                                                            years' experience in the field.
South Carolina       Department of            Must maintain a surety bond for $10,000. To obtain a
                    Consumer Affairs          license, brokers must have worked for two years as a
                                                  loan originator. They can substitute six hours of
                                                       academic study for one of those years.




                                                                                                    95
        State                 Regulator                             Selected Requirements
     South Dakota        Division of Banking            No minimum financial requirements, no specific
                                                           educational or experience requirements.
      Tennessee        Department of Financial        Mortgage brokers must maintain a surety bond for
                             Institutions           $90,000, pay a nonrefundable $100 investigation fee,
                                                     have a tangible networth of $25,000 and pay a $500
                                                      license fee. No specific educational or experience
                                                                         requirements.
        Texas          Finance Commission of            Mortgage brokers must maintain a net worth of
                         Texas, Savings and         $25,000 or a surety bond of $50,000. They must also
                          Loan Department               have a bachelor's degree in finance, banking or
                                                    business administration and 18 months' experience in
                                                          lending or three years' lending experience.
         Utah          Department of Financial          Must have surety bond for $25,000. No specific
                             Institutions             educational or experience requirements. All broker
                                                                   apps must take an exam.
       Vermont         Department of Banking,       Brokers must maintain a bond for $10,000. No specific
                       Insurance, Securities &             educational or experience requirements.
                              Health Care
                             Administration
       Virginia            State Corporation        Brokers must maintain a surety bond for $25,000 with
                       Commission, Bureau of                      a $500 application fee.
                         Financial Institutions
     Washington        Department of Financial        Mortgage brokers must maintain a surety bond for
                        Institutions, Division of   $20,000 to $60,000. Applicants must pass an exam or
                          Consumer Services            demonstrate two years' experience in the field.
     West Virginia        Division of Banking        Must maintain a net worth of $10,000 and a bond for
                                                       $25,000. No specific educational or experience
                                                                         requirements.
      Wisconsin        Department of Financial      Mortgage brokers must maintain a bond for $10,000 or
                             Institutions             net worth of $100,000. No specific educational or
                                                                    experience requirements.
      Wyoming            Division of Banking              File a license application and a $150 fee.
Source: Mortgage Academy

The main Federal Act regulating the activities of mortgage brokers is the Real Estate
Settlement Procedures Act 1974, which is administered by the US Department of Housing
and Urban Development (HUD). On 5 October 2001, HUD issued Statement of Policy 2001–
1, which detailed HUD’s position on broker fees. HUD stated that:
• broker payments must be commensurate with the amount normally charged for similar
    services; and
• in order for broker fee disclosure to be meaningful, it must specify what services a
    mortgage broker will perform and the broker’s total compensation for performing those
    services (including any commission paid by the lender). This information must be
    disclosed as early as possible in the broker–consumer transaction.

There is considerable variation in the regulation of brokers at a state level in the United
States. New York State provides an example of an interventionist regulatory model. In New
York State, mortgage brokers are required to be registered under Article 12–D of the Banking
Law and Superintendent’s Regulation Part 410. Broker conduct is regulated chiefly by the
General Regulations of the Banking Board Part 38 and Part 41, both of which are
administered by the State of New York Banking Department.56




56
     A summary of Part 41 can be found at: www.banking.state.ny.us/41ov.html


                                                                                                      96
Part 38 prohibits fraudulent, deceitful or misleading broker advertising. Advertisements that
promise immediate loan application approval fall into this category. Brokers are required to
disclose, either in writing or via electronic media, a number of specified matters including:
• that the broker cannot guarantee acceptance into any particular loan program, nor
    promise any specific loan term or conditions;
• whether the broker places loans primarily with any three or fewer lenders;
• the maximum commission and/or any premiums or bonuses payable by the lender to the
    broker;
• fees to be paid by the borrower directly to the broker (with a prohibition on these fees
    being calculated as a percentage of the principal amount of the loan or amount financed);
    and
• whether or not a loan imposes a pre-payment penalty on the borrower.

The legislation also contains a number of measures designed to protect consumers from
brokers who regularly place their customers in high cost or “predatory” home loans.57

These measures include requirements that:
• brokers must not publish fraudulent, deceitful or misleading broker advertisements, such
   as those promising immediate approval of loan applications;
• borrowers must sign a statement, in a minimum 12-point type, advising them to shop
   around and determine comparative interest rates and other fees and charges; and
• brokers must not offer repayment terms that exceed the borrower’s capacity to repay the
   loan.

Recent amendments to the legislation have placed additional obligations on brokers who
organise high cost home loans, including that:
• borrowers receive certification from a financial counsellor that the borrower has received
   counselling on the advisability of the loan transaction; and
• brokers arrange refinance only when the new home loan has tangible net benefit to the
   borrower.

Canada
The leading industry body is the Canadian Institute of Mortgage Brokers and Lenders
(CIMBL). It currently has over 2500 members and it estimates that 25% of all new mortgage
business is written by brokers, although there are significant variations between provinces.58
In Ontario, for example, brokers are said to generate some 70% of new mortgage business.

Members of CIMBL are obliged to abide by the Institute’s Code of Ethics, which is
administered by internal committees. The main thrust of the provisions in the code relate to
disclosure, conflict of interest and advertising.59 The committees can impose significant
penalties for violations of these provisions, including compensation to clients, fines and
termination or suspension of membership.

The activities of Canadian finance brokers are regulated by the individual provinces, rather
than nationally. In Ontario, mortgage broker activities are governed by the Mortgage Brokers
Act 1990. Mortgage brokers are required to be registered, and the Superintendent of


57
   For first mortgage to be characterised as a high cost loan, the loan must have an annual percentage rate
that exceeds by more than eight percentage points the yield on US Treasury securities having comparable
periods of maturity or the fees associated with the loan must exceed 5% of the total loan amount.
58
   Canadian Institute of Mortgage Brokers and Lenders,“Blueprint for change in the Canadian mortgage
broker industry:Recommendations for effective mortgage broker regulation”,28 Sep 2001, p.5. See
www.cimbl.ca/journal.html
59
   See Code of Ethics at http://www.cimbl.ca/ethics.html.


                                                                                                        97
Financial Services has the power to refuse registration of a mortgage broker who makes
false, misleading or deceptive statements in any advertising material.

In order to be registered, an applicant must successfully complete an educational program
approved by the Superintendent. The program takes two semesters to complete on a full
time basis.

In June 2004, the Financial Services Commission of Ontario published a Consultation Paper
titled “Improving the Mortgage Brokers Act” which canvasses submissions on improvements
to the legislation, recognising that broking is an ”ever growing” industry and that brokers are
not adequately regulated.

In British Columbia, mortgage brokers are regulated under the Mortgage Brokers Act 1996
and must be registered. Brokers are prohibited from arranging a mortgage on behalf of a
borrower unless the broker has a written agreement specifying the remuneration of both the
mortgage broker and any other person for all services related to arranging the mortgage.
Brokers must also provide a written disclosure statement, which outlines any direct or indirect
interest the broker (or any associate or related party of the broker) has or may acquire as a
result of the transaction.

British Columbia also requires brokers to undergo specified courses as a condition of
registration.

New Zealand
It is estimated that 25% of all mortgage business in New Zealand is sourced through
mortgage brokers.60 The peak mortgage broker industry body is the New Zealand Mortgage
Brokers Association (NZMBA), which currently has over 320 members.

To become a member of the NZMBA, a broker must have:
• a proven history of relevant experience;
• an acceptable personal record;
• no ratified public objection to their membership;
• mortgage broking as their principal activity;
• approval from at least six major financial institutions;
• at least $1 million in professional indemnity insurance cover; and
• a full range of product types and options on offer.

All members must also have completed (and passed) an approved training and accreditation
program. The NZMBA requires members to adhere to a Code of Ethics and Standards,
which contains a number of general obligations.

For example, it requires member brokers not to misrepresent, conceal or exaggerate any
pertinent facts relating to any transaction in which they are involved. Additionally, the NZMBA
code places a duty on brokers to maintain their knowledge and skills at a level required to
ensure that their clients receive competent service based on up-to-date knowledge and
practice.

A recent article on the New Zealand broking experience has commented on the influence of
commissions on market share:

        “In 1999, ANZ was the only New Zealand bank to offer trailer commissions to
        brokers and they received a larger share of their business from this channel than
        other banks. In 2000, the National Bank and Westpac instigated similar
60
     See www.nzmba.co.nz/entry.html.


                                                                                            98
      commission structures and were rewarded with an increased share of business
      through brokers, and ANZ’s share decreased."61

There is currently no specific regulation of finance broker activities in New Zealand. Similar to
some jurisdictions in Australia, the activities of finance brokers are regulated by more generic
fair trading legislation, as well as the credit legislation where the broker arranges a credit
contract, which is subject to that legislation.




61
  Shaun Drylie and Claire Matthews, “Going for Broker”, Journal of Banking and Financial Services, 117
February 2003, p. 37.




                                                                                                   99
                                                                                                                                    Attachment “B”
                                       COMPARISON OF INTERSTATE FINANCE BROKER LEGISLATION

PROVISION        NSW                  VIC                    ACT              WA                              TAS,SA,NT        Commonwe         Qld Working
                                                                                                                               alth             Party
                                                                                                                               Corporation
                                                                                                                               s Act 2001
Legislation      Repealing Credit     Repealed Finance       Consumer         New Bill to amend Finance       No legislation   Financial        N/A
                 (Finance Brokers)    Brokers Act 1969 in    Credit           Brokers Control Act 1975                         Services
                 Act 1984.            1998 and inserted      Administration   introduced into Parliament                       Reform Act
                 Amends               new part into          Act 1996         3 December 03.                                   2001 – covers
                 Consumer Credit      Consumer Credit                                                                          pooled
                 Administration Act   (Victoria) Act 1995                     Code of Conduct for                              mortgage
                 1995                                                         Finance Brokers.                                 practice which
                                                                                                                               otherwise
                                                                              Finance Brokers Maximum                          constitutes a
                                                                              Remuneration Schedule.                           managed
                                                                                                                               investment
                                                                                                                               scheme.
Current status   Awaiting             Commenced 1 July       Current          Bill before Parliament                                            Two meetings
                 commencement         1999                                                                                                      two years ago.
Licensing/       Negative licensing   No – disqualifying     Registration     Yes – –                                                           “Difficult issue”
Registration                          provisions may apply                    Criteria over 18                                                  merit in concept
                                      ie – negative                           Fit and proper                                                    of licensing.
                                      licensing                               Good character & repute                                           Needs more
                                                                              Prescribed educational                                            consideration.
                                                                              qualifications
                                                                              Specific provisions for firms
                                                                              and body corps. seeking
                                                                              licence

                                                                              Provision for classes of
                                                                              licence

                                                                              Currently Board licenses
                                                                              brokers. Bill will abolishes
                                                                              Board and Commissioner
                                                                               for Fair Trading becomes
                                                                               licensing authority


Contract           Contract
requirements       requirements
• written          listed are those in   Yes                 Yes               Yes                        Yes
• signed           the NSW               Yes                 Yes               Yes
• client copy      legislation.          Yes                 No                Yes
• amount                                 Yes                 Yes               Yes
• term                                   Yes                 Yes               Yes
• repayment                              No                  No                Yes
    interval
• repayment                              No                  No                No
    arrangements
                                         Yes (interest)
• max interest
                                         Yes (duration of    Yes               amount payable
• date required
                                         appointment only)   No                Yes
• potential                              No                  No                No
    lenders
• Broker name                            No                  Yes               Yes
    & address
• Company                                No                  Yes               Yes
    details
• Bus Name                               No                  Yes               Yes
    details                                                                                               Yes -
• Commission                             Yes(plus agreed     Yes               yes
    amount or                            max. amount for
    method                               application and
• When                                   valuation fees)     No                Yes
    commission
    payable
• Any benefits                           No                  No                Yes disclosure
    from credit
    provider
    broker                               No
    receives
Credit regulated   Consumer credit       Consumer credit     Consumer credit   Consumer and commercial    Most agreed
                   within meaning of     within meaning of                     credit                     consumer and


                                                                                                                  101
                   Consumer Credit      Consumer Credit                                                           commercial
                   (NSW) Code           (Vic) Code                                                                credit but
                                                                                                                  difficult to justify
                                                                                                                  extending
                                                                                                                  protection to
                                                                                                                  large business.
Up-front           Prohibited           Prohibited              Yes                Prohibited                     Yes
commission
Commission         Yes                  Yes (includes where     Yes                No but not to exceed
depends on being                        credit is “reasonably                      maximum prescribed
same as agreed                          comparable)
terms
Commission no      Yes                  Yes                     Yes                No but must not act unfairly
greater than                                                                       or unconscionably
contract
May charge         Yes                  Yes                     No                 Yes
commission if
client declines
credit
Must keep          Yes                  Yes, but only the       Must keep          6 yrs from repayment of
records 7 years                         actual broker           records 3 years    loan
                                        agreement
Valuation,         Must not demand,     Same as NSW             Valuation fees     Must pay into trust account
application,       receive or accept.                           held in trust
establishment      Pay directly to
fees               provider.
Disciplinary       Application to       Application to court    On conviction      Complaints investigated by     Yes – not total
Action             tribunal for non-    or tribunal for         for                Registrar/Inspector.           agreement on
                   compliance with      accepting fees to       contravention of   Prosecution in Court of        challenging
                   contract,            which broker is not     Act, Court may     Petty Sessions for             excessive fees.
                   engaging in unjust   entitled. Apply to      order refund and   offences.
                   conduct, or          court for interest.     payment of
                   charging                                     interest.          Registrar/Inspector can
                   excessive            Business Licensing      Commissioner       take disciplinary action
                   commission to        Authority can revoke    may cancel         before Board for breach of
                   seek order to take   a “permission” given    registration if    Act/Regs/Code. Appeal
                   or refrain from      to a disqualified       FB becomes a       from Board to District
                   specific action,     broker if the broker    prohibited         Court.
                   order payment of     contravenes any         person or


                                                                                                                          102
                    specified amount   conditions imposed       mentally infirm.   (NOTE: Bill abolishes board
                    or order amount    by the BLA.              Commissioner       and Commissioner will
                    not due or owing                            may show           licence/investigate
                    to fin. Broker.                             cause,             breaches and commence
                    Application to                              reprimand,         disciplinary proceedings.
                    court for refund                            disqualify or
                    and interest on                             suspend.           Discipline by new State
                    refund.                                                        Admin. Tribunal)
Prohibited          No                 •   Under 18             •   Under 18       • See criteria above
persons                                •   Bankrupt/insolve     •   Bankrupt
                                           nt                   •   Convicted of
                                       • “Disqualified”             fraud,
                                           and no current           dishonesty
                                           BLA permission           in last 5
                                       Disqualified:                years.
                                       • Guilty of fraud,       • Refused/dis
                                           dishonesty etc in        qualified
                                           past 10 yrs              from
                                       • Disqualified               occupational
                                           under FB or              licence
                                           credit legislation   Appeals to
                                       • Interstate licence     District Court
                                           application
                                           refused in
                                           preceding 2
                                           years

                                       Note: Disqualified
                                       person may make
                                       application to
                                       authority for
                                       permission to
                                       operate
Misrepresentation   No                 Offence for              False or           Yes                           Yes - with
                                       misleading &             misleading                                       specific
                                       deceptive statements     statements.                                      examples in the
                                       or wilful concealment                                                     legislation
                                       of a material fact.



                                                                                                                       103
Advertising        No                 Not specifically, but    Must include       Must include name of                                   Yes – name of
                                      see under                business details   broker, interest rate shown                            broker address,
                                      “Misrepresentation”      in any             must be for stated amount                              licence number;
                                      above                    advertising        and calculated in                                      statement that
                                                                                  accordance with the Act.                               they are a
                                                                                                                                         broker not a
                                                                                                                                         lender.

Definition         Acts or purports   Negotiating or acting    Negotiating or     Existing definition: Acts as
                   to act as an       as an intermediary       acting as an       agent to negotiate or
                   intermediary to    for a fee in obtaining   intermediary to    arrange loans on behalf of
                   negotiate and      consumer credit.         obtain consumer    others. New definition will
                   obtain consumer                             credit.            exclude persons whose
                   credit.            NB: “fee” includes                          only business is to neg. or
                                      “commission, reward                         arrange pooled mortgages
                                      or other
                                      remuneration,                               Covers mortgage
                                      whether monetary or                         originators or single loan
                                      otherwise”.                                 mortgage arrangements.
Codes of Conduct                      NIL                                         Power of Board to make
                                                                                  code of Conduct under
                                                                                  Finance Brokers.

                                                                                  Proposed that Code by
                                                                                  prescribed by regulation.

Insurance                             NIL                                         Not mandatory. But Board                               Yes -
                                                                                  requires as a matter of                                professional
                                                                                  practice by condition on                               indemnity
                                                                                  licence.                                               insurance.

   Western Australia – has amended current Act to abolish Board.

                         Commissioner will become licensing authority and be responsible for compliance
                         Discipline by proposed State Admin Tribunal.
                         Code of Conduct to be prescribed by regulation.
                         Current definition to stay – but persons arranging/negotiating pooled mortgages only not required to be licensed.
                         Majority of other existing provisions to be retained.


                                                                                                                                                104

				
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Description: National Finance Broking Regulation RIS Discussion Paper