Dr Alex T Magaisa & Tapiwa Muzvondiwa
AT the outset let us pose a few questions: What would you do if an insurance company refused to pay your claim after burglars break into your house
and steal your insured property? What would you do if you discover that your bank has been failing to pay your cheques although your account has sufficient funds? And what would you do if you discover that an investment company has failed to explain the risks inherent in the product that they have sold to you and you have consequently suffered losses?
Theoretically, you would take legal action through the courts. Yet practically, for many consumers going to court may not be the most viable option given the procedural and economic barriers present in the traditional litigation arena.
In response to these questions, the purpose of this week’s article is to highlight the second pillar of the dispute resolution mechanisms that may be employed to enhance transparency and fairness in the financial markets. While last week we argued for the establishment of a special financial tribunal to resolve disputes between the regulator and the regulated entities, this week we complement this by arguing for the establishment of a financial ombudsman whose principal role is to resolve disputes between consumers and financial institutions.
We submit that if such mechanisms were available consumers would be better-protected and consequently the lack of trust and confidence in the financial sector could be reduced. Indeed, a lot of problems that occurred in the last few years could have been reduced if measures to enhance accountability to consumers were established and followed.
We begin by observing that some of the problems that consumers face in connection with financial institutions are not pursued through the traditional legal channels. This is because the costs of pursuing such actions in terms of time and money may be too high for most small consumers. Additionally, the legal and procedural requirements act as barriers to most consumers who lack the expertise and resources required to hire such expertise. Therefore, in most cases consumers whose rights have been violated by financial institutions fail to pursue their claims.
In our view, this lack of action has the effect of promoting a culture of poor consumer care in the industry at both individual and institutional levels. A mechanism that allows consumers to actively pursue their claims not only helps in the protection of consumer rights but also assists in developing a culture of accountability and fairness within the industry. Arguably, the high objectives of promoting fairness and transparency in the industry can best be achieved by addressing this system of accountability to the consumers.
As the protection of the consumer has become one of the key features of regulatory systems across the world, a number of countries have led the way in establishing mechanisms to meet this objective.
The UK provides a useful example of an integrated system for this purpose. The Financial Ombudsman Service established in terms of the Financial Services and Markets Act (2001) provides for a dispute resolution system which is accessible to ordinary individuals and small businesses (turnover of less than £1 million).
The Financial Ombudsman Service was born out of a merger of previously separate sector-based ombudsman schemes. The integrated Financial Ombudsman Service deals with consumer complaints regarding different financial institutions including insurance companies, pension funds, banks, building societies, investment firms, etc. Although it is a system that is still in its infancy, it is widely regarded as a novel system which many countries are likely to learn from in attempting to deal with the regulatory goal of consumer protection.
The primary aspects of this system are that consumer protection is best served by:
* Establishing clear internal avenues by which consumer complaints are handled effectively at the institutional level;
* Establishing effective and accessible dispute resolution mechanisms beyond the institutional structures; and
* Promoting public awareness of rights, responsibilities and remedies through public education programmes.
In order to meet these key elements, it can be observed that there are three key principles at the foundation of the ombudsman service:
* The system places emphasis on the principle of exhaustion of internal remedies at the institutional level. This means that a consumer must first use the internal procedures within the financial institution before bringing his matter to the ombudsman. This helps to reduce the burden that might otherwise be imposed on the ombudsman service when matters could easily be resolved by pursuing the internal channels;
* Secondly, the regulator is responsible for monitoring the internal procedures at the institutional level through disclosure. This means that institutions must establish and maintain internal procedures for dispute settlement according to set standards. They are obliged by the law to disclose these systems, including disclosure of the number and nature of claims by consumers, details of resolution, etc. That way, institutions cannot deliberately delay matters or frustrate consumers within their internal systems; and
* Finally, as further protection, if the consumer is dissatisfied with the handling of his case by the institution, he is entitled to bring the case to the financial ombudsman whose duty is to adjudicate and make determinations according to standards of fairness and reasonableness. The decisions of the ombudsman are binding on financial institutions but consumers who may be dissatisfied have the option of seeking recourse through the courts of law.
However, given that the ombudsman has the power to decide the matter on a wider basis (sometimes beyond the law), it is highly unlikely that a consumer will succeed through the courts if his case has failed at this level. The ombudsman makes decisions on the basis of what is fair and reasonable in the circumstances. What is fair and reasonable at times entails a departure from the strict legal position. For example departure from the operation of the doctrine of utmost good faith and non-disclosure in insurance cases.
This position is based on the recognition that the operation of the law is not always just or reasonable and that one may have to depart from the strict confines of the law to achieve fairness. The desire to have wider scope for decision-making is not new because historically, equitable rules have always existed to deal with issues without necessarily deferring to legal rules.
The ombudsman service has the advantage of being a more practically viable alternative to litigation through the courts of law because it is a cheaper, quicker and less informal way of dispute resolution. The flexibility enables greater accessibility by consumers who would normally shy away from the traditional judicial system with its attendant costs and other barriers.
The costs of setting up this service would normally be funded by the finance industry and possibly the state while limited fees would also be an additional source of income. In the UK, the Financial Ombudsman Service is set up as a company limited by guarantee.
It is run by a board of directors appointed by the Financial Services Authority. It is funded by a case fee that is paid by the institution against whom the complaint has been made. At the moment the fee is £350 per case. The case fee is payable whether or not the ombudsman’s decision is in favour of the institution. In a way this requirement to pay fees provides more incentives for the institutions to have good internal dispute resolution mechanisms to resolve matters in-house.
The company is further funded by a levy paid by the financial institution as part of their contribution towards the regulatory framework. This ensures that the regulatory mechanism is free from the problems such as lack of autonomy that would arise if it was funded by the state.
In the year 2003/4 the turnover of the Financial Ombudsman Service was in excess of £45 million and handled more than 108 000 cases. Significantly, all its revenue is ploughed back into its operations.
The benefit of setting up such an integrated service for the entire finance industry is that there would be enhanced clarity, more coherence and consistency in the regulatory approach as well as decision-making. This may promote a good measure of predictability and efficiency which is necessary in financial markets.
We believe that matters that affect the financial markets ought to be kept away from the traditional courts as much as possible as legal precedents create a less than impressive credit rating not just for the individual institutions but for the country as a whole. In our view, establishing such dispute resolution mechanisms is not only in line with a growing international trend, but it will enable the internal control systems within institutions by placing primary responsibility at their doorsteps.
A key feature of any dispute resolution system is independence of those who make decisions. It is therefore necessary to ensure that the financial ombudsman service operates with a reasonable measure of independence from both the financial regulator and financial institutions. It must also be emphasised that it is not a advocate for consumer rights but an impartial adjudicator whose duty is to decide on the basis of what is fair and reasonable in the circumstances.
All too often good ideas and organs such as the ombudsman are set up but they fail to meet the intended objectives. Therefore, although the Constitution of Zimbabwe provides for the office of the ombudsman, this avenue has hardly been used by most Zimbabweans nor has it been visible to the general populace.
The ombudsman service in its present form has a vague mandate and is plagued by chronic under-funding, staff shortages and quite frankly a lack of leadership. Some years ago, a former ombudsman infamously plagiarised a report written by an ombudsman in another country. Therefore, in the case of the proposed financial ombudsman service it will be very important for the regulator and the finance industry to promote public education programmes that enhance public awareness about its availability.
Besides protecting consumers, it will also go a long way in restoring some measure of public confidence in the finance industry. This is based on the assumption that once consumers realise that there are effective avenues for their protection, they will readily deal with institutions with some assurance.
In conclusion, it is necessary to place the proposals in context so that we can view the bigger picture. Therefore, using ideas from previous articles in this column, we envisage the architecture of financial regulation to appear as follows:
* An independent financial services regulator for the entire financial industry;
* An independent financial tribunal to handle disputes between the financial regulator and the regulated entities; and
* An independent financial ombudsman service to handle disputes between financial institutions and consumers.
We believe that such a structure is likely to enhance efficiency in the financial markets, help in rebuilding a culture of trust and accountability within the industry and increase fairness and transparency within regulation while meeting the concerns of most key stakeholders. After all the problems of the past year, a new, modern, efficient and fair system is what Zimbabwe needs at this stage.
* Dr Alex T Magaisa is the Baker & McKenzie lecturer in corporate law and the University of Nottingham (firstname.lastname@example.org) and Tapiwa Muzvondiwa is an adjudicator at the Financial Ombudsman Service, UK (email@example.com