Issues Related to the Financial Consumer Protection Act

Transcription

1 Financial Services Industry Issues Related to the Financial Consumer Protection Act Yoon Mo Chung, Research Fellow* In response to the global trend of strengthening financial consumer protection, Korea is now trying to enact the Financial Consumer Protection Act. In financial transactions, there are two common problems: information asymmetry between a financial company and a financial consumer, and conflicts of interest because a financial company seeks its own interests. The financial company as an expert and the financial consumer as a non-expert have different trading capabilities and information. For these reasons, special legislative consideration for protecting a financial consumer is necessary to ensure that financial consumers have fair and equal trading capability. Hereafter I analyze important issues on functional regulation, sales regulation, ex-post sanctions, regulatory system for customer protection, and financial consumer education, mainly focusing on the financial investment business. I. Introduction All over the world, there is recognition that financial consumers, as counterparts, should be protected efficiently. In financial transactions, there is an asymmetry of information between a financial company as an expert and a financial consumer as a non-expert. On the other hand, there are conflicts of interest when a financial company seeks its own selfish interests. For these reasons, special legislative consideration for protecting financial consumers as the economically weak is required to ensure * All opinions expressed in this paper represent the author s personal views and thus should not be interpreted as the Korea Capital Market Institute s official position. Tel: , cym@kcmi.re.kr Vol. 4, No. 1

2 Issues Related to the Financial Consumer Protection Act substantially fair and equal trading in financial transactions. The Dodd-Frank Wall Street Reform and Consumer Protection Act in the US and the Financial Services Bill 1) in the UK are the best examples of this trend. As finance becomes more important to a country s economy, this legislative trend aims at establishing a foundation for fair trading by taking care of financial consumers, and eventually promoting economic development. Korea is trying to enact the Financial Consumer Protection Act, in response to the global trend of stronger consumer protection in the financial sector. The bill has been submitted to the National Assembly and is waiting for review. It will be revealed through the legislative process and the actual enforcement process whether the consumer protection provisions included in the bill are faithful, and whether it will contribute to consumer protection. However, it could be seen positively in that the consumer protection provisions are improved and strengthened compared with the previous consumer protection system. The bill is an integrated law in the form of legislation, and a comprehensive consumer protection law in the content of legislation. First, the bill can be considered to be a financial integration law because financial investment products in the Financial Investment Services and Capital Markets Act, deposits and savings products in the Banking Act, insurance products in the Insurance Business Act, and credit card products in the Specialized Credit Financial Business Act are integrated into this single law. The integrated legislation approach taken by the Financial Investment Services and Capital Markets Act can be seen in various finance laws. However, the bill shows that the scope of integration does not cover overall financial transactions but is restricted to the sales of financial products. In this regard, even if the bill is consistent with the UK s Financial Services and Markets Act of 2000 (FSMA) and Australia s Financial Services Reform Act of 2001 in pursuit of the integration law, it is closer to Japan s Financial Products Sales Act, considering its limited range of integration. 1) The Bill is to amend the Bank of England Act 1998, the Financial Services and Markets Act 2000, and the Banking Act 2009, and to make other provision about financial services and markets. 33

3 Capital Market PERSPECTIVE It can also be characterized as a general law for consumer protection because it enhances the effectiveness of consumer protection by combining the ex-ante provision of information on a financial product, product sales, and ex-post damage relief synthetically. This bill integrates the existing financial consumer protection provisions which are scattered into a single act. In this regard, the bill extends the various consumer protection regulations of the Financial Investment Services and Capital Markets Act into other financial areas such as banking and insurance. This means that the Financial Investment Services and Capital Markets Act is innovative and universally valid and the sales regulation already established in the Financial Investment Services and Capital Markets Act can serve as a guide to regulations on product sales in other financial areas. Hereafter I will review main issues with the bill by mainly focusing on financial investment business. II. Background According to the trend of in-house delivery of various financial businesses, a hybrid product that is a combination of various financial products emerged. However, the current financial regulatory system is insufficient for the protection of financial consumers in response to this trend. The bill is intended to overcome the limits of current regulatory system, and to provide the foundation for promoting the interests of financial consumer and for fostering the financial products sales business. Hereinafter I will look into the limits of the current regulatory system. First, it was difficult to respond effectively to the need for financial consumer protection, because of revealed limits of the current regulatory system under which different supervision and regulation are applied to different financial sectors. Some financial sectors were not subject to product sales regulations. In some cases, different regulations were applied to similar products. In addition, as the sector-based regulations focus only on financial instruments in that sector, there was no ex-ante regulatory system with respect to value-added services linked to products in other financial areas. Accordingly, even though there were incomplete sales problems, the Vol. 4, No. 1

4 Issues Related to the Financial Consumer Protection Act regulator was not prepared for the problems in advance. In particular, as the complex and hybrid products appeared in the market due to the recent trend of the in-house delivery of financial businesses, these problems with the sector-based regulatory system were deepened. Second, there was no general law on the financial consumer protection. Financial consumer protection provisions regarding financial education, information offering, dispute resolution, etc., were scattered across various acts. Accordingly, consumer protection issues were treated in a fragmented ad-hoc manner whenever a problem occurred. And various financial education institutes provided finance training individually without a control tower. The financial dispute resolution system operated by the Financial Supervisory Service (FSS) had no conclusive binding force, and did not have a feedback system so that the result of dispute resolution was not reflected in the policy. Third, the role of supervisory bodies in financial consumer protection was weak. Many people criticized the supervisory system, saying that it was difficult for the system to efficiently control conflicts of interest between the prudential regulation of financial companies and the regulation for consumer protection. Accordingly, there was a growing need to achieve the check and balance between both functions by strengthening the independence of the consumer protection function. III. Analysis of Key Issues 1. Introduction of functional regulations From the perspective of financial consumers, the bill introduced the same functionsame regulation principle through reclassifying and organizing financial products and sales activities. First, based on the characteristics of financial products, the bill reclassified all financial products and services, which financial companies such as commercial banks, investment banks, insurances, savings banks, credit unions and 35

5 Capital Market PERSPECTIVE so on deal with deposit products, investment products, insurance products, and loan products. Next, according to types of sales activity, financial companies and sales agentsbrokers of financial products in the acts related to the financial companies were reclassified into three types: direct sales persons, sales agents-brokers, and advisers. They are allowed to do business under registration requirements, and only a new type of person such as a financial products advisor and a lending promotion person has to be registered newly. As a result, the provisions of the bill to regulate the entry of financial business entities will require new registration only for financial products advisors and lending promoters who are placed in a blind spot of the regulation. This functional regulation framework was adopted in the legislative process of the Financial Investment Services and Capital Markets Act. This Capital Markets Act first reclassified financial investment businesses, financial investment instruments, and customers according to economic substance, divided financial functions based on the combination of these three factors, and applied business regulation to the financial functions. The Capital Markets Act tried to eliminate the dead zone of regulation and regulatory arbitrage by using this innovative regulation method. While the Capital Markets Act is a capital market integration act incorporating laws related to the capital markets, the Financial Consumer Protection Act is a financial integration act, in that it is applied only to financial products sales, but it covers all kinds of financial companies. As a result, the Financial Consumer Protection Act is expected to equally regulate the financial products sales having the same function by reclassifying financial products and sales activities for customers, and to build a tight regulation framework by removing the dead zone of the regulation about all kinds of financial products. 2. Strengthening of the sales activities regulation The bill sets forth sales activities rules according to the types of financial products and financial products sales businesses such as the duty to explain important factors of financial products, the advertisement rules for sales, and the duty to disclose Vol. 4, No. 1

6 Issues Related to the Financial Consumer Protection Act important information of financial sales agents-brokers. It encompasses all sales activity regulations in individual financial acts such as the duty to explain, the suitability rule, the advertisement rule, conflicts of interests, and differentiates the regulation in consideration of the risk and characteristics of each financial product type. On the other hand, it builds a regulatory system to prevent incomplete sales for protecting consumers in areas where regulation is insufficient. First, the bill applies such regulations as the duty to explain, the suitability and adequacy rules, the prohibition on unfair recommendation, the advertisement regulations, and the prohibition on making a binding contract according to the characteristics of financial products. It differentiates the applicability of sales activity regulations and specific regulations for each financial product by considering the risks and characteristics of product types. Meanwhile, the bill applies such regulations as the prohibition of entrustment, the duty to notice, the duty to prevent conflicts of interest, as for the characteristics of sales activities. The sales activities regulation that was prescribed in the Financial Consumer Protection Act will be deleted from individual financial acts to avoid duplication between the Financial Consumer Protection Act and the individual financial acts. Second, the bill integrates the rules on the conduct of sales into a single act, and hence will resolve the problems of regulatory arbitrage and regulatory blind zones. The scope of applicable financial products will be expanded, in principle, into all financial products, as the investment recommendations regulation stipulated in the Capital Markets Act will be transferred into the Financial Consumer Protection Act. As a result, while the sales regulation s intensity in the financial investment business wouldn t have any significant differences in comparison with the previous regulation, the sales regulation s intensity in other financial business sectors such as banks and insurance companies would be strengthened. This means that the legislative intent of the investment recommendations in the Capital Markets Act is expanded to the overall financial sector. As a result of these legislative efforts, a financial consumer can choose proper products for himself after listening to the full explanation about financial products, and thus the act can minimize the customer s damage. 37

7 Capital Market PERSPECTIVE 3. Strengthening of post-anti remedy First, the bill strengthens liability for damage of direct sellers of financial instruments. It adopts vicarious liability as a general principle of damage recovery between a financial company and an agent-broker. It stipulates a financial company s responsibility for agent-broker management and the relationships of supervision between a financial company and an agent-broker, and applies vicarious liability, which is prescribed in some financial laws, as a general principle to all sales channels. When the sales channel causes harm to the consumer because of misconduct in the process of sales, the bill is intended to protect the financial consumer fully by imposing damage liability on the financial company as well as the sales channel. Vicarious liability means the liability that a supervisory party (such as a financial company) bears for the actionable conduct of a subordinate or associate (such as a sales channel) because of the relationship between the two parties. Vicarious liability is a negligence liability, meaning that a supervisory party is responsible only for neglecting the supervisory duty to the associate. Nevertheless, the burden of proof about fulfilling or failing the duty of care lies with not the victim but the supervisory party. For a financial investment business entity, the application of vicarious liability is the same even after the enactment of the Financial Consumer Protection Act because vicarious liability is already applied to an investment solicitor as a sales agent-broker. When a financial products sales agent-broker causes harm to financial consumers through misconduct in the course of selling financial products, the bill imposes damage liability to the financial products direct sales entity that has relatively sufficient reimbursement ability, thereby strengthening consumer protection. Second, the bill improves the financial dispute resolution system. Under the current dispute mediation system in the Act on the Establishment of Financial Services Commission, the procedure must be stopped if one party launches a legal action before mediation application or during the mediation. If the financial company expects an adverse decision, it can render the mediation system obsolete by bringing a suit prior to the consumer s mediation application or the notice of the mediation result to ensure Vol. 4, No. 1

8 Issues Related to the Financial Consumer Protection Act that there is no obligation. The bill transfers the current financial dispute mediation system set forth in the Act on the Establishment of Financial Services Commission to the Financial Consumer Protection Act, and it allows the court to stop the suit with its decision in the case that the litigation and the dispute mediation conflict with each other. It also prohibits the financial company from suing the consumer until the mediation procedure is finished, once the mediation procedure is initiated for smallsized dispute cases involving less than 5 million won. Though litigation is the surest means of dispute resolution, it has limitation as a means to recover the rights of the victims because of the economic and time costs, and the weaker legal capabilities of the financial consumer as an economically weak person. Accordingly, the alternative dispute resolution (ADR) is attracting attention as an effective means of dispute resolution for a victim s damage recovery. ADR is a very useful mean for the dispute resolution in that it is less costly and secures the fairness of the judgment by the financial expert. The bill is expected to reduce the burden of cost and time for the consumers, by introducing the temporary restrictions system related to the litigation stop procedure and small amounts dispute cases. However, the recognition of unilateral binding, which prohibits a financial company to make a suit to appeal the dispute mediation decision, was excluded because it was considered as being unconstitutional because of an infringement of rights of access to the court. Meanwhile, it is necessary to review whether or not we should introduce arbitration, which is used actively in the US. However, the introduction of arbitration as an alternative resolution mechanism to replace litigation needs more careful consideration since the financial consumer is deprived of the right to a trial and the fairness of the arbitrator is not assured compared with the mediation system aimed to compliment the litigation. Third, the bill imposes monetary penalties on the financial company within the scope of 30% of profits in the case that the financial products sales entity violates the regulatory requirements of business conduct such as failing to fulfill the duty to explain, engaging in unfair solicitation, or forcing binding contract of products. This is to remove the incentive to violate the regulations by depriving unjust enrichment originated in the breach of sales regulations. Current financial laws have low effectiveness of 39

9 Capital Market PERSPECTIVE sanctions as they impose only slight fines against the violation of the sales regulation, except in the Insurance Business Act. In the first draft of the bill, a monetary penalty limited to three times the business profits caused by such violations by the financial products sales entity as a corporation, and later it was reduced to 30% of profits. The introduction of monetary penalty is supposed to secure the effectiveness of sanctions against regulatory breaches by depriving unjust enrichment obtained by them. 4. Improvement of the supervisory system for financial consumer protection Following the recent global financial crisis, developed countries drove to reform their supervisory systems as financial consumer protection was exposed as a weakness by the crisis. The developed countries such as the US and the UK strengthened the function and organization of consumer protection by, for example, establishing separate institutions. This change was initiated because the importance of financial consumer protection was newly appreciated. As a result, the UK and the US introduced the twin peaks system which separates prudential supervision from business conduct supervision. In the US, the Consumer Financial Protection Bureau (CFPB) under the Federal Reserve Bank (FRB) was established, and it is responsible for the consumer protection of banks and non-bank financial institutions. The independence of the CFPB is to be guaranteed. For example, it can establish its budget independently. However, consumer protection related to securities and insurance will still be performed by the SEC and state insurance agencies. The UK abolished the Financial Services Authority (FSA) which was an integrated supervisory body, and split its supervisory function into prudential supervision and consumer protection supervision. The Prudential Regulatory Authority (PRA), a subsidiary of the Bank of England, will take over prudential supervision, while the Financial Conduct Authority (FCA) established as an independent body will assume the consumer protection role. The FCA is responsible for the prudential regulation of firms that do not fall within the scope of the PRA as Vol. 4, No. 1

10 Issues Related to the Financial Consumer Protection Act well as for regulating conduct of all financial companies. Australia split the supervisory function into prudential supervision and consumer protection supervision. The Australian Prudential Regulation Authority (APRA) took over prudential supervision, while the Australian Securities and Investments Commission (ASIC) took over consumer protection supervision. The ASIC s areas of responsibility include consumer protection, financial literacy, corporate governance, financial services, securities and derivatives, and insurance. In 2011, the G-20 summit also approved Principles on Financial Consumer Protection prepared by the OECD. In Korea, numerous problems have emerged because of incomplete sales related to KIKO (kick-in and kick-out) currency options and subordinated debt of savings banks in spite of the various improvements made for consumer protection. Accordingly, it was pointed out that financial supervision was mainly performed with the chief aim of ensuring prudential supervision, and thus consumer protection was relatively neglected. Critics noted the conflict of interests caused by a single supervisory body regulating both prudential supervision and consumer protection. Prudential supervision is likely to neglect business conduct supervision for protecting financial consumers, because it has a tendency to prioritize the profitability of financial companies. Though the bill proposed to establish the Financial Consumer Protection Agency (FCPA) in the FSS, it intended to make the Agency a quasi-independent body by strengthening its independence of personnel, budget, and mission. Whether the FCPA should be fully separated will be determined after reviewing the side effects thoroughly and considering the progress of the US, the UK, etc., that adopted the twin-peaks model, which separates completely prudential supervision and consumer protection supervision. The FCPA makes its budget in cooperation with the FSS, and then the budget is to be approved by the Financial Services Commission (FSC). Meanwhile, the bill stipulated financial dispute mediation, financial education, and compliance as its exclusive tasks. With regard to the exclusive tasks, the bill secured the independence of the FCPA by excluding the instruction and supervision of the FSS s president. By granting the power to investigate and recommend sanctions, the bill strengthened the independence of the FCPA. In the course of carrying out its role, FCPA has the power 41

11 Capital Market PERSPECTIVE to investigate a financial company and recommend proper measures to the FSC and the FSS, if necessary. Because there is no global standard for the financial supervision system to protect financial consumers, each country tries to find a proper supervision system depending on its historical path. Though the bill suggests the conflict of interests between prudential supervision and conduct supervision of the financial company as the rationale for the FCPA, the separation of two supervisory roles is not necessarily the only method for controlling the conflict of interests. The bill provided an alternative that builds the FCPA within the FSS and gives it a quasi-independent status. Even though Australia and the US have adopted the system separating the two supervisory roles, the US SEC still covers both roles in the securities arena. Even in the UK, there are criticisms of the new financial regulatory change from a single peak to twin-peaks. It is therefore still debatable how the relationship of both functions should be set up, and though the bill is considered to adopt the separation of supervisory roles, the level of separation is not high. First, even if the bill acknowledged the independent status of the FCPA, the functional separation is limited as it is enacted within the FSS. Furthermore, although the supervisory functions are nominally split between the FSS and the FCPA, both functions are likely to be integrated at the level of the FSC, which holds the comprehensive power to operate both roles under the double-layer regulatory system. In addition, because the FCPA has only the authority to recommend sanctions, if necessary, due to the limitations of its quasi-independent status, it is not easy for the FCPA to check perfectly the conflict of interests between prudential supervision and business conduct supervision. Finally, it is very desirable to participate in the global trend for the protection of financial consumers, but how to accept it in our supervisory system should be determined after reviewing comprehensively the existing supervisory system, financial market circumstances, consumer protection conditions, etc. It is not desirable that we simply follow the reforms in developed countries Vol. 4, No. 1

12 Issues Related to the Financial Consumer Protection Act 5. Improving financial consumer education In developed countries, as financial trading has become more important, the need for financial education has been increasingly emphasized to reinforce the financial capability of consumers. The US, the UK, and Canada established public institutions dedicated to consumer education. Canada is a typical country educating consumers systematically through the Financial Consumer Agency of Canada (FCAC), which is dedicated to financial consumer protection. The US established the CFPB as an independent entity housed within the FRB and bestowed it with a significant role for financial education. The CFPB is responsible for conducting rule-making, supervision, and enforcement for federal consumer financial protection laws; restricting unfair, deceptive, or abusive acts or practices; taking consumer complaints; promoting financial education; researching consumer behavior; monitoring financial markets for new risks to consumers; and enforcing laws that prohibit discrimination and other unfair treatment in consumer finance. The Consumer Financial Education Body (CFEB) in the UK was established as an independent entity by the FSA under the FSMA in April 2010, entrusted with the task of heightening the financial capability of consumers and improving their financial management skills. By strengthening consumers access to information and knowledge about financial products, financial education can enhance their financial capability, eliminate the asymmetry of information, and improve their defense capability. Financial consumer protection cannot be promoted simply by enacting legislative regulation, but is to be accompanied with consumers increased financial capability. Financial education not only eliminates the asymmetry of information between the consumer and the financial company, but it also prevents financial disputes in advance. Recently, financial education has been recognized as an important issue in Korea, and its importance has been even more strongly emphasized especially after the financial crisis of It is pointed out that there is still some room for improvement as to ensuring cooperation between financial education institutions and the contents of education. 43

13 Capital Market PERSPECTIVE The bill expressed explicitly the duty of the FSC to provide for financial consumer education. According to the bill, the FSC should promote financial consumer education to improve consumers understanding of financial products, the proper exercise of their rights, and the self-judgment and self-liability principle protecting them. In addition, the bill requires the FSC to develop a variety of financial education programs corresponding to the rapidly changing financial environments, granting its status as the control tower for financial education. The bill prescribes that the FSC should install and operate a financial education council in its body for the efficient execution of financial consumer education. Financial consumer education should lead consumers to engage in informed and reasonable financial behavior rather simply delivering financial knowledge. For this purpose, an appropriate system should offer education by differentiated standards and contents for various types of financial consumers. Though investor education has increased substantially both in importance and availability compared to the past, there is still a lingering problem with the absence of a unified dedicated organization or a well-organized system. While there are consumer education programs operated by financial companies, financial associations, training institutions, and non-profit consumer organizations, the role of public organizations dedicated to consumer education is weak. And because there is no explicit provision stipulating financial education as a legal duty of the financial supervisory body, only self regulatory education exists. It is regarded as necessary for Korea to prepare a well-organized financial consumer education system operated by a single public authority. In most countries such as Canada, the US, and the UK, a single authority is responsible for education in all aspects of financial consumers rather than limited to investors. In Korea, the education body needs to cover all financial areas comprehensively, considering the rising trend of the cross-selling of financial products and their complexity. Investor education through various channels and methods is not bad in itself, but a unified education system providing a comprehensive range of financial education by a more reliable public body is needed. To achieve this, the bill is preferable because it has Vol. 4, No. 1

14 Issues Related to the Financial Consumer Protection Act explicit provisions related to the establishment of a financial education authority and its legal responsibilities. IV. Conclusion The bill tries to promote the interests of financial consumers across the financial markets, and at the same time make the financial products sales and advisory businesses healthier by enhancing the credibility of the financial markets. The bill improves various ex-ante and ex-post measures as well as the regulation of sales, to strengthen the priority of financial consumer protection and prevent it from being subordinated to prudential supervision, and to ensure the effectiveness of consumer protection. The aim of the bill is to establish a fundamental law to protect financial consumers. The Financial Consumer Protection Act could be considered an extension of the Financial Investment Services and Capital Markets Act in its legislative method and contents because the regulations of sales in the bill are derived from the recommendation regulations of the Capital Markets Act, considering the characteristics of each financial product. Accordingly, for financial investment companies and investors, it is unlikely to introduce big changes in the existing sales regulations, as the bill is not beyond the limits of the Capital Markets Act. In the future the bill should not be limited as simply an improvement of the system, but should aim to foster fair sales practices to perform faithfully financial consumer protection as a legislation purpose. 45

15 Capital Market PERSPECTIVE References Eilis Ferran, 2011, The Reorganisation of Financial Services Supervision in the UK: An Interim Progress Report. Financial Services Act 2010 Explanatory Notes, Financial Services Commission, 2011, Main Issues on the Financial Consumer Protection Bill. Government, 2012, The Financial Consumer Protection Bill. Kim, H.M., 2011, Discussions and Implications on Strengthening the Financial Consumer Protection. Ministry of Strategy and Finance, 2006, Explanatory Notes on the Financial Investment Services and Capital Markets Bill. Oh, Y.S. et al., 2011, Improvement of the Financial Consumer Protection System. Websites Financial Services Agency Financial Services Commission Financial Supervisory Service FSA SEC Vol. 4, No. 1