Rotting from the head: We need more than a Royal Commission

Thursday, May 3rd, 2018

The Royal Commission into the Australian banking system has triggered shocking headlines of abuse, particularly around financial advice. But there is a danger that while the inquiry identifies issues and delivers a regulatory response, it doesn’t get to the core of the problem.

It is my view that the core of the problem lies in the sad decline of a culture of service in financial services, and its replacement with a culture of profit and greed. It is a decline that started with the widespread demutualisation of many of Australia’s great service entities.


A problem in the making

The problems highlighted by the Royal Commission have been building for a long time. Australia embarked on a demutualisation and corporate conversion of the financial services sector around 25 years ago. State banks and the Commonwealth Bank were privatised and the co-operative regional banks like Advance and St George, with mutuals like AMP, NRMA and National Mutual were demutualised.

The argument at the time, led by international investment bank advisors and other commissioned paid experts (sound familiar?), was that demutualisation would release embedded value which was “somehow” owned by current members. The contributions of the past and the rights of future members were forgotten, ignored or taken away. The advisors claimed that company structures would create better businesses because they would be profit-focused and would attract better talent through employee profit incentives. They claimed that market place rigours would benefit owners, clients and employees alike. How wrong they were! … but they were very well rewarded for their advice.

As we’ve seen at the Royal Commission, all those arguments have fallen by the wayside – except maybe for employee benefits. There is immense evidence that businesses driven by the profit motive over service motive can destroy themselves.

High salaries and stock incentivised bonuses will not produce better managers today than there were in the past. Instead, we end up with short-term focused management. The Royal Commission has exposed a plethora of senior financial services management that show little interest in sustaining in perpetuity the businesses they are privileged to work for.

The AMP is the best example (or is it the worst example?) of an enterprise that since demutualisation has self-destructed or devalued the power and value of its brand. AMP was formed in 1849 as the Australian Mutual Provident Society, a non-profit life insurance company and mutual society. Now, a national icon is no more, its image seriously tarnished.

The AMP’s problems evolved when it was demutualised. That decision turned the organisation from a service orientated “not-for-profit” well regarded across Australia into a profit-focused enterprise. Over time, the incentives have become more employee focused, well away from the AMP’s heritage of customer focus.


Rotting from the head

The Royal Commission is uncovering the consequences of a profit focused financial services enterprise. But the profit focus is demanded by Australia’s shareholders or investor base – either directly or through pooled investment funds. The need to seek wealth creation is the focus of retirement savers and that is mandated in Australia. However, it requires more than higher profit numbers to create sustainable value and that is the unsavoury lesson being learnt by many public company boards.

Another observation is that many of the leaders of major financial companies were not brought through the business. Very few have any experience in a member or customer focused mutual. Many have resumes that proudly proclaim business school, accounting and legal training but are silent on customer service or ethical business training.

There are too many financial services management teams and boards dominated by people who have no heritage in the businesses or industries they manage or oversee. The consequences are clear – they simply haven’t ensured either valuable or quality services for their customers and they haven’t protected the brand value of their businesses.

At the same time, shareholders have disengaged. The power of shareholders to make change has been stymied by the power of major super fund investors and large offshore index investors. The major institutions being exposed by the Royal Commission are significantly owned by many of their direct competitors which oversee pooled funds management operations. That also leads to an unsavoury outcome: some fund managers may benefit from wounded competitors. They will only seek change when public disquiet – like now – becomes over-bearing. So, the AMP board will finally be held to account by the Industry funds – but it has taken far too long.

Today, companies are more likely to be sued in class actions for misdemeanours than directed by active shareholders to change. That is an unfortunate outcome of poor governance and poor boards. Class actions benefit the legal fraternity more than disaffected investors and the costs are rising across the community at large. There will be a flood of class actions arising from this Royal Commission and that is a very poor outcome.

Away from the legal claims, there is the ethical consequence of excessive payments granted to the management of financial institutions. Excessive executive pay adds to a culture of greed and envy inside those institutions. The Royal Commission may have exposed this consequence, but not its cause.

Lower and middle management look up and see their CEO and (increasingly) Chairman being paid extraordinary amounts of money. Senior executive management are commonly being paid millions of dollars of base salary with the potential to double that with no consequence for destroying value or a brand. A bank CEO can work for five years and make a $25 million turn. A bank chairman is now being paid many hundreds of thousands of dollars annually, ridiculous amounts of money that are not based on performance.

The problem with remuneration of this type is that it doesn’t reward risk or penalise poor management. The business leaders are the custodians of major institutions. They did not build them. Their remuneration should reflect this fact.

The culture of these institutions is driven from the top. It doesn’t start at the bottom and flow up. People are led by example. The focus on short-term gain, on profit, on share price, on a five-year contract, maximising the wealth of the management team creates poor outcomes. Is there really any wonder that staff operate with greed and envy if that is exactly what their senior executives present?


Reflex response

Despite ingrained cultural problems, what we’re likely to see in response to the Royal Commission is a knee-jerk reaction on top of much needed change. The first is greater regulation (akin to a “tighter band aid”). Another will be the enforcement of stronger “internal audit” regimes inside advisory businesses and these are well overdue.

Many advisory firms inside banks will be sold off as senior management and boards panic under the hot glare of public scrutiny. It will be unfortunate if the people that mismanaged these businesses should manage their sale or benefit (a bonus entitlement) from the sale.

By selling out of “wealth advice”, the banks and other institutions are effectively saying that it is not possible to ethically manage a wealth advisory and wealth product business. Society should question why ethical behaviour should be such a hard undertaking; why will unethical behaviour inside an institution improve if it is not directly addressed?

If the institutions being examined by the Royal Commission were mutuals and focused on client services, would we have the cultural and ethical problems that are now presented? The mutual of the late 1980s and early 1990s had few problems in offering client’s multiple financial services, from deposit taking to lending, mortgages, personal finance, into wealth management, advice and insurance products.

The mutual culture has been destroyed by greed. Culture is very hard to build but so easy to lose. Indeed, very few public companies have built or sustained an enduring ethical culture. Across the world, many major companies are being exposed with significant ethical shortcomings.


Who will provide advice?

Today our major banks are declaring that it’s easier to sell off financial advisory businesses than to fix their culture. We predict that in a decade’s time they will be buying those businesses back because high quality financial services do sit well inside a strong and ethical financial institution. People are naturally attracted to strong and enduring service providers.

Rather than the difficult but rewarding endeavour for management to deal with the cancer sitting inside their companies they will take the easy road – cut out the cancer and throw it away. But in doing so, they will neither acknowledge nor take responsibility for the capital lost on a false business premise, simply described as the pushing of product and services via commissions and customer lock-up arrangements.

Shareholders and indeed society should be pressing these entities to fix the problems. They are household trusted brands, and many were built over decades with public trust in their services. The problem with the jettisoning of financial advice by institutions is that it disregards the massive issue facing Australians: their need for financial advice. If our largest 4-5 institutions leave the advice industry, who will fill the void, and can it be properly regulated?

Australia has $3.5 trillion of declared investable assets – $2.4 trillion housed in super and $1 trillion in household investments outside the residence. Overwhelmingly, the beneficiaries of those funds have little financial nous.

Financial, superannuation and tax laws are highly complex, as are estate planning laws and the ongoing management of investment portfolios. For instance, if Labor’s proposed changes to franking credits become law, where will the average person go to seek advice?

Financial advice is as important as legal or medical advice. On a personal level, I recall that when my father, suffering from advanced dementia, needed to move into high-care management, high level financial advice was needed. The financial arrangements were so complex that even an industry “insider” needed planning by a specialist. Our family drew comfort in seeking help from a specialist working for a creditable major institution.

It will be interesting to see if independent financial advisors can fill the void created by the withdrawing of the majors and the increasing demands of an ageing population.


A difficult conversation

The management and boards of major institutions need to behave like custodians, not only of shareholders, but of employees and customers as well.  Great institutions will trade in perpetuity – the banks and insurance companies have been around for decades and some for a hundred years. Westpac was founded in 1817.

This Royal Commission is a wake-up call to Australia. It has uncovered poor and unethical behaviour. However, it won’t investigate the reasons, some of which can be directly traced back to demutualisation.

But can we go back to mutualisation? Probably not.

Therefore, we need to understand the consequences of what our society has created. We also need to have a very direct conversation with our business leaders and tell them that there is more to being a good CEO than driving the business solely for profit.

Being a CEO is also about ensuring that a business is perpetual; that there is life after the leader goes. It is an ethical backbone that creates a sustainable and profitable business, operating within a community, a society. Excessive remuneration and bonuses must be reviewed; that action alone will create a framework for better business ethics and corporate culture. Leadership is critically important for the institutions currently being exposed by the Royal Commission.

Across the country, away from the financial services sector, the Business Council of Australia needs to better entrench ethical standards. Society demands a lot from our politicians ethically, we need to have the same demands upon business leaders.

This is a difficult conversation, but it is worth having. Those managers and business leaders not up for the conversation and the necessary consequences need to be moved on – urgently. Those that stay for the journey need to be rewarded by acknowledgement rather than simply dollars.

32 Responses to “Rotting from the head: We need more than a Royal Commission”

  1. Michael Gearin says:

    Private enterprise has lost the right to manage people’s superannuation. The money should be managed by Govt centrally simular to the Future Fund. Also similar to Singapore. This should be built with minimum cost to manage from when you start paying super until you die. For a select few who are extremely wealthy a few financial planners that are skilled, objective and ethical may be worthwhile. Overall charging people 1 to 2% per annum over 30 years adds to 30 to 60% which is outrageous. Time for a significant rethink on super.

  2. Ric Hingee says:

    Excellent article which mirrors my own view over many years on the state of our financial institutions.

  3. Ross McTaggart says:

    spot on. Some boards should have been shot years ago when they continually agreed to the large fees and bonuses paid to management and themselves as Directors. I remember when Noby Clarke was made banker of the year and NAB wrote off $700M plus AMP paid $34m to its manager they have not stopped yet.

  4. Mutuals can be returned and can compete with our present Bank rogues. Grant new Mutuals the tax advantages given to not-for-profit oganisations. Audit those Mutuals for non-profit and passing benefit to their community. The rogues will not be competitive to those communities, , order may be restored. Sounding off loud noise does nothing (like a Royal Commission)

  5. Henry Ringwood says:

    Hard to argue with this depressing set of observations!

  6. chris jemmett says:

    what a first class article. In short “greed wins”. As a small shareholder i have no hope of influencing boards and over the years have watched the obscene rewards they have paid themselves, with a pitifully small number of directors/CEO’s who reward themselves reasonably–mostly in small companies where they have “skin in the game”

  7. Carolyn Hoban says:

    Thank you to the author of this thoughtful and mature reflection. Obviously written by someone who knows the ethical and mutually beneficial origins of the key financial institutions which helped to build this country. I’m going to print it and post it to friends and advisors, including my stockbroker and accountant whose values and judgement I respect. They will applaud it. I suspect the pen and mind of J A crafted this. Much appreciated. Carolyn Hoban

  8. Henry Rodrigues says:

    Thank you for highlighting the corruption of the financial institutions and the big end of town. Now if you could find a way to publish this so that more people can get to read it. You could also encourage the MSM to feature it on their front pages. I am referring to that bastion of free speech, the Sydney Telegraph, the Sydney Morning Herald and all of Rupert Murdoch’s ‘wonderful’ dynamic publications around Australia. I encourage you to do this as your civic duty. This has got to stop and, and politicians who have ignored it, named and shamed.

  9. Graeme Walker says:

    I have to partly disagree with your comments. After a lifetime, spanning over 80 years, exposed to the life insurance industry, I can state it has ALWAYS been this way with high pressure salespeople with the only object being to make a sale. 60 years ago we used to say “there is no one with endurance like the life insurance salesman”.
    All that has changed is that the life insurance industry took to SELLING investments as well using their old “anything goes” attitude. Stupidly, many banks just bought out these SALES outfits without realising the consequences.

  10. Jim Short says:

    An excellent article, with which I strongly agree. I fear that it is a culture that pervades much of the Western world. It poses a real threat to social cohesion, to Civil Society, and ultimately to our democratic forms of government.

  11. T J Duffy says:

    Excellent article. It really explains the demise of the ‘Financial Institutions’ in the Banking Sector. I would recommend that this article be sent to all those people being investigated by the “Royal Banking Commission” as it would certainly act as ‘Food for thought’ for them and highlight the mistake they would be making by selling off their Financial Advisory divisions, instead of addressing the “Cultural” issue that has evolved.

  12. Brett Keogh says:

    So very well written and highlights so many major issue not only in the financial world but in many of our big businesses. I will NEVER understand a) how any executive can be worth these sums of money and b) how they walk away with bonuses even after major failures but never have to forfeit any of it when they fail. It seems no matter what they do they will be rewarded.
    How can we make this a BIGGER issue and force our politicians to act and not just let these issues be swept under the carpet. We have a unique opportunity while this is front page news to get some REAL action.

  13. John Allan says:

    Meanwhile politicians and public ‘servants’ continue to enjoy the lucrative benefits of defined benefit superannuation, despite overseeing this mess.

  14. Colin Dennett says:

    Excellent article. Thank you. Perhaps the structure of Mutualization ought to be revisited. Why should it not work well again? Food for thought.

    • Colin Dennett says:

      Excellent article. Thank you. Perhaps the structure of Mutualization ought to be revisited. Why should it not work well again? Food for thought.

  15. Geoff Reeves says:

    In my experence, satisfactorily marketing of almost any product implies advise, selling and servicing of customers, (old fashion after sales if you wish)
    Remumeration is a necessary part of sales /marketing,
    Incentive provides the necessary drive for Growth, almost any sales / servicing company worth their salt knows that.
    Managment salaries need seperated to outside organisations who provided professionals advising the board, this decision making must the responsibility of the board.

  16. M Dunn says:

    Sorry, but I find this article disappointing. The old ‘caring’ AMP model involved selling outrageously expensive life insurance products and overpriced super. Let’s not romanticise the past era of rationed credit, commission sales and much higher fees for broking and asset management, while nonetheless being rightly appalled at misconduct. Personal financial advice is costly, and I think genuine ‘fee for service’ only, still rare, is probably the only non-conflicted way to offer personal advice. At least the internet has made general advice, which is what most people need most of the time, much more accessible.

    • Peter C says:

      I went to an Australian Super seminar during the week. Ther seminar was presented by one of their financial advisors. In response to questions he provided the following info. He is paid a salary only, no incentives, no performance fees based on sales or how much he directs into Australian Super products.

      If members seek a financial plan they charge on a per hourly rate only, no up front or trailing commission. If they seek specific advice they are charged on an hourly rate only.
      Before I went to the seminar I compared their fees for the balanced option with the fees charged by AMP for the equivalent option. Australian Super was about 2/3 of the cost of AMP.
      Why can`t the banks, AMP or IOOF operate on this structure? At least I don`t feel like a patsy.

  17. Christine DUCKER says:

    Ah, somebody else who rues the rush to demutualise. This has been bad for most of us. Health funds especially should never be listed companies but look at Medicare Private, which bought our fabulous fund and now it is not fabulous. Thank you for your perspective. It’s not rocket science to understand that returns to shareholders and returns to policy holders are not compatible. There are smarter ways to raise capital.

  18. Bob Miller says:

    While the Royal Commission has caused severe shock waves, it is very likely that only the jailing of some senior executives/ chairmen will
    achieve the necessary change of culture in financial businesses.

  19. Edward Patching says:

    Outstanding article, so a big “well done” to John & the ClimeTeam. Am in furious agreement with almost every point advanced. Wouldn’t wish though to lend credence to the notion that excessive pursuit of profit is somehow spurred by shareholders. More than profits, most shareholders want to be associated with reputable companies that honour the spirit as well as the letter of the law. Company board members who lead by example, and who appreciate the ethical dimension in their duty of care to employees – present, past & future; and to customers, shareholders, and broader society. All of which also happens too to be sound practice for a company that wants to stay in business.
    Amongst AMP’s greatest “crimes” has been to argue that their many failures ought to be viewed simply as them “assigning greater priority to our shareholders’ interests than to those of our customers”. Perhaps the AMP Board could indicate which shareholder-endorsed resolution supports charging dead people? Or helped them to conclude that it was sound business practice to lie systematically to the industry regulator?

  20. Craig Morley says:

    Great article, well written. I couldn’t agree more.
    As an example of the GREED of the ‘Supreme Leaders’ of the banks; my sister worked for NAB in the 90’s as a permanent part time employee. Her annual wage equaled the PER DAY rate of the CEO!! Where’s the ethics/fairness in that?
    A business making profit from exploiting the ignorant masses and hoarding the profits for the upper echelon, need a serious lesson in humility and how to treat others as one would like to be treated themself (thats after a naked trip to the ants nest for an hour or two),

  21. Anthony Gross says:

    reply to the Clime team,
    I wish to pass on to you all my congratulations to you on this well argued piece. I would add that your point on de-mutualisation also applies in my view to the privatization of the former Commonwealth Bank and the various State owned banks as they were…

    I do want to note that Clime as very early on in suggesting that investors need to not “bank” on the level of dividends being available from these major Australian financial institutions…

  22. Trevor says:

    this is a great article and i agree with all of it.this has been a long time coming..I have worked in a commission based job and it is a cancer that needs great care in overseening.

  23. John Thompson says:

    What a wonderful insightful article on the state of financial businesses .It should be compulsory reading for all CEOs and their staff.
    Unfortunately as a small shareholder my voice of protest will be drowned out by the likely response from the Government which will seek to protect the interests of their compatriots rather than the public interest.
    to the detriment of the public interest.

  24. Trevor Russell says:

    Absolutely agree with this article and hope it helps engender a new dawn in the banking and personal investment industry.

  25. Trevor Best says:

    As a retired branch manager of a major bank I well recall the residential courses we were taken to in Melbourne around 1969 when this bank was about the first to embark on the “McKinsey exercise”. As wll as being shown the workings of complex balance sheets etc., I have retained the folder “How to succeed the xxxxxx way”, which is substantially devoted to showing how to take advantage of the 5 different kinds of personalities people have and how to apply the Pareto Principle, the KISS practice, and the Feel/Felt/Found routine and many others. In other words. not genuine advice from a professional people could trust, but psychological trickery. So I am afraid that while I agree totally with the thrust of your article, it all started much earlier than you suggest.
    We need to go back to having at least one government bank, one government insurance company, one energy provider and one oublic transport provider in each state.

  26. Rob M says:

    I view with alarm the various class actions and proposed penalties for the directors. I have no problem with jail terms for the latter, but you can bet that any fines will be paid by the comany – that is the very shareholders who have been dudded in the first place by malpractice and then again in the second place as the value of their stock declined sharply when the Directors/CEOs were found out.

  27. Doug Freeman says:

    Most interesting. I have whinged for years about the excessive salaries people give themselves and now it is proved that the value is not there.

  28. Peter C says:

    There are a lot of myths about defined benefits pensions, one of which is how lucrative they are. Most of these schemes were set up to save money for the Government, but circumstances changed. Defined benefits are not as lucrative as accumulation schemes during periods of high growth/high inflation. When these schemes were set up public servants were expected to be worse off than accumulation schemes, however circumstances changed. Australia is now in a period of low growth and low inflation, so accumulation schemes are not growing as much as in the past. In this climate, defined benefits are more lucrative. If we return to high inflation high growth then accumulation schemes will be more popular. By the way, the Federal government schemes were closed 13 years ago and State Government schemes were closed earlier that that, some 20 years ago. The military super was the last defined benefits scheme. By the way most employed public servants today are in accumulation schemes, like you and I. P.S Some big private sector employers (such as GM Holden) also had defined benefits schemes, it was not just a public sector issue,

  29. Bruce Johnston says:

    I resigned from the executive of westpac in 1994 as the bank was morally currupt and the deciese spread like wildfire through all Financial Institutions. The appointment of Murray to AMP is a huge mistake.

  30. Bob Kendell says:

    Excellent article, should be restriction on number of boards [also chairman] a director
    can hold. Old boys[or girls ] club.

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