ASIC Opposes Proposed Role as Litigation Funding Regulator
As many readers will know, the Australian Law Reform Commission ("ALRC") is currently conducting an inquiry into the federal class actions regime and the regulation of litigation funders, and have been accepting submissions in response to a Discussion Paper. I was a co-author of both the Levitt Robinson and the NSW Young Lawyers submissions.
The Discussion Paper and the submissions canvassed a number of issues and I would encourage anyone who is interested to read them in full. This post focuses only on one aspect, which is the proposed regulatory regime for litigation funders.
The Proposed Scheme
Commercial litigation funding (that is, where someone funds another person's legal claim in return for a share of whatever is recovered) has been a feature of the Australian legal landscape for over 20 years.
At present, litigation funders are specifically exempted from the managed investment scheme ("MIS") regulatory regime in the Corporations Act 2001 (Cth) by r 5C.11.01 of the Corporations Regulations 2001 (Cth) (and see also, Corporations Amendment Regulation (No. 6) 2012 (Cth)). This became necessary after the Full Federal Court held in Brookfield Multiplex Limited v International Litigation Funding Pte Ltd (2009) 180 FCR 11 that a litigation funding scheme was an MIS as defined under the Corporations Act.
One of the upshots of the exemption from the MIS regime is that litigation funders are not required to hold an Australian Financial Services Licence ("AFSL"). There are some requirements in r 7.6.01AB of the Corporations Regulations for a litigation funder to have a conflicts of interest policy, but otherwise the 25 or so litigation funders active in Australia are more or less unregulated.
The ALRC, however, proposes to change all that. Or at least that was the position until recently.
The Discussion Paper proposed a series of measures to regulate litigation funding. The measures centred around a new proposed "litigation funding licence", which litigation funders would require in order to operate in Australia. The Commission proposed that litigation funding licences should require third-party litigation funders to:
do all things necessary to ensure that their services are provided efficiently, honestly and fairly;
ensure all communications with class members and potential class members are clear, honest and accurate;
have adequate arrangements for managing conflicts of interest;
have sufficient resources (including financial, technological and human resources);
have adequate risk management systems;
have a compliant dispute resolution system; and
be audited annually.
In relation to the "sufficient resources" point, there was a proposal that litigation funders should be required to comply with capital adequacy requirements in order to ensure that they are able to meet their obligations. That is, so that they can pay all of the plaintiff's legal fees and pay security for the defendant's costs in all of the cases they work on.
The thinking is that if a litigation funder fails financially, it could leave both the plaintiff and the defendant exposed—the plaintiff may have to pay any unpaid legal fees to their own lawyers and, if the case is unsuccessful, will have to pay the defendant's costs; and the defendant would probably not be able to recover its costs from the plaintiff if the defendant is successful, as class actions are hugely expensive and no ordinary person would be able to pay an adverse costs order running into the millions or tens of millions of dollars.
A few counter-arguments were made in the submissions I co-authored (see above). I won't go into them all now (and I encourage you to read the submissions), but in summary:
that kind of regulation is prohibitively expensive and would likely shut smaller litigation funders out of the market, thereby denying access to justice for many people;
there is no evidence that there is much risk of the ALRC's concerns actually coming to pass, as there has been only one identified instance of a litigation funder failing in the 22 years that litigation funders have been active in Australia, and the proposed regulations would not have prevented that one instance of failure from happening; and
even in the one instance of a litigation funder failing, the only people who were left out of pocket were the plaintiff's lawyers.
The cornerstone of the proposed scheme was going to be regulation by the Australian Securities and Investments Commission ("ASIC"). ASIC is the regulator responsible for most of the financial industry, including all AFSL-related issues, and it was foreshadowed that the litigation funding licence would be similar in practice to the AFSL. In fact, from what the Commission said in the recent post-submission consultation seminars, it was leaning towards just requiring litigation funders to obtain an AFSL, rather than creating a whole new separate licensing regime.
ASIC Throws a Spanner in the Works
Given the central role that ASIC is proposed to be playing in the new regulatory scheme, you would expect the Commission to have consulted with ASIC before making the proposals. I cannot say for sure whether this was done, but there are definitely some indications that ASIC was inexplicably left out of the whole process.
Having finally been alerted to what the ALRC is proposing for it to be doing, ASIC does not seem too happy about it. In a submission made well after the submissions deadline had theoretically closed, ASIC has come out and said that there is probably no need for a litigation funding licensing scheme, but if one is introduced then ASIC is not the appropriate regulator.
In fact, ASIC makes many of the arguments that we made in the submissions that I was involved in authoring, including that litigation funding is very different from regulated financial service providers, such as lenders, financial planners, and insurers. As ASIC put it, "[t]he AFS licensing regime is focused on the conduct of financial services, and the activities of litigation funders do not sit neatly within the regime".
As ASIC points out, and as we said in the NSW Young Lawyers submission (which I think was the only submission other than ASIC to say this), most of the issues that arise in relation to litigation funding are more closely related to legal services than financial services, and so the appropriate regulator would be the Legal Services Commissioner, not ASIC. The problem of course is that there is no federal Legal Services Commissioner, so in lieu of that option the ALRC has proposed that ASIC should be the regulator for litigation funders, which has a little bit of a "square peg, round hole" problem.
Another issue ASIC raises is that the proposal that litigation funders be required to hold a minimum level of capital buffers in order to ensure that they are able to meet their obligations would effectively be prudential regulation of the kind that is applied by the Australian Prudential Regulation Authority ("APRA"), and not by ASIC.
Prudential regulation is extremely expensive and so is only applied to the largest financial institutions: banks, building societies and credit unions (authorised deposit-taking institutions), life and general insurance and reinsurance companies, private health insurers, friendly societies and superannuation funds (excluding self-managed funds). The reason it is applied to these entities is the huge systemic risk that their failure represents. That is, those entities are "too big to fail", and so there is a system in place to minimise the risk of their failure.
The same is not true of litigation funders. There are about 25 of them in Australia. They have been active for about 22 years and, in that time, only one has failed, and that failure caused very little harm. If the entire litigation funding industry collapsed tomorrow it would be a tragedy for access to justice in Australia, but it would be unlikely to have much impact beyond the few thousand people who are receiving litigation funding services, and the only impact it would have for most of them is that they would be unable to pursue their legal claims for want of funds. Compared with the risk of, say, a large bank collapsing, the risks posed by litigation funders are more or less insignificant. As ASIC says in its submission, "given ASIC’s risk-based approach to regulation, it seems unlikely [regulation of litigation funding] would be a main focus of our work even if we had jurisdiction for it."
In other words, the ALRC is proposing a radical and unprecedented extension of a highly onerous style of regulation to an industry that poses no real systemic risk to Australia's economy. Viewed in those terms, it seems very undesirable to adopt the proposals—and it certainly seems as though the proposed regulator has no appetite for it. It will be interesting to see how ASIC's response affects the ALRC's ultimate report.
On a final upbeat note, this is possibly the first time in history that a regulator has come out publicly and said that it does not want its role to be expanded. Good job ASIC!.