Banking Bad

by Adele Ferguson

  With the idea of dismantling the four pillars now on the back burner, vertical integration was about to be put on steroids.

  Chapter 4

  Bigger is better?

  Incentives, targets – and deception

  LESS THAN THREE MONTHS after taking over as chairman at CBA, John Ralph strode into Melbourne’s prestigious Grand Hyatt, in the upmarket Paris end of Collins Street, with the company’s CEO, David Murray, for a dinner that would change the course of Australian corporate history.

  It was 10 February 2000 and Ralph and Murray had booked a private room in the swank hotel to discuss a friendly takeover of Colonial Mutual, the Melbourne-based company that had hit the headlines almost a decade before for its systemic mis-selling of life insurance products to vulnerable consumers. Over an eight-year period, Colonial Mutual’s boss, Peter Smedley, had turned an old-fashioned, non-performing life insurance institution into a modern financial services powerhouse. Under Smedley’s leadership Colonial had demutualised, listed on the stock market, spent billions of dollars snapping up small banks and life insurers, and pushed into the Asian market to create a sprawling empire. During that time, following its move into banking and the bolstering of its presence in superannuation, life insurance and investment products, Colonial had seen its customer base swell from 350,000 to more than three million. Smedley had been a trailblazer in the art of cross-selling financial products to customers. And he had built an empire that Murray now wanted.

  Since becoming chief executive of CBA, Murray had gained the respect of the investment community for his cost-cutting. But he knew that if he was to keep growing the bank, its profit and its share price, he needed to make a spectacular and transformative acquisition. Six months earlier, he had hired corporate advisers to do the numbers on Colonial. Now it was time to strike.

  The timing of the dinner was no accident. Days earlier, Smedley had indicated at a press conference that Colonial was interested in making a takeover bid for Bankwest. Murray believed that if Smedley bought Bankwest it would kill any chances he had of buying Colonial, an acquisition that would create the biggest financial services giant in the country and be the biggest corporate takeover in Australian history, with a likely offer price north of $8 billion.

  Murray and Ralph waited patiently for the arrival of their dinner guests – the brash and confident Smedley, and Colonial’s chairman, David Adam. They knew their offer for the insurance giant had to be generous enough that Smedley and Adam would find it hard to refuse. Still, they were aware it wouldn’t be easy to win over Smedley, who had earned a reputation as a pugnacious and fierce negotiator and was likely to fight hard to keep Colonial in his grip.

  Murray and Ralph’s message to their dinner companions was clear: the two organisations together would create a financial leviathan that would dominate the Australian landscape. They promised that if CBA took over Colonial they would give Smedley a generous exit package from executive duties but allow him to stay on the new board.

  By the end of the dinner Smedley and Adam had agreed to take a formal offer to the Colonial board the following week. When they did so, the board put the offer from CBA to one side and put out feelers for a better one, approaching NAB, ANZ and others who had expressed interest in buying Colonial. But the offers from the other banks were hastily put together and less attractive. CBA had offered seven of its shares, which were trading at $22, for twenty Colonial shares, which were trading at about $6. The offer was set at a healthy premium of more than 40 per cent, valuing the bid at $10 billion. Realising CBA’s bid was the best, Smedley hopped on a plane to Sydney to close the deal.

  The next step would be winning approval from the competition tsar Allan Fels. Murray and Smedley set up a meeting with Fels for 6 March 2000. Fels recalls Murray and Smedley walking into his office and both being fairly aggressive, particularly Murray. ‘They wanted an urgent decision and I wasn’t going to give it to them.’

  Fels was familiar with Colonial and CBA. He was also familiar with the various leaks in the newspapers about an impending announcement. ‘I knew the merger wouldn’t raise any competition issues, but I made it clear I wasn’t going to rush it,’ he says. This was one of the biggest mergers ever and he didn’t want to mess it up. The ACCC’s decision would depend on whether merging CBA and Colonial would substantially reduce competition. It didn’t have a mandate to go any further than that. That meant it couldn’t look at whether the merger would result in inherent conflicts of interest that would be to the detriment of customers. Fels told Murray he would wait for CBA’s official submission then make a decision eight weeks after that.

  On the morning of 10 March 2000, Smedley and Murray held a press conference to unveil the deal. CBA’s takeover of Colonial would displace NAB as Australia’s biggest bank and AMP as Australia’s biggest fund manager. Smiling like the cat that has just eaten the cream, Murray told the large gathering of journalists and banking analysts, ‘The scale and breadth of the merged entity will result in strong growth in all aspects of financial services, increased choice for customers, expanded distribution channels and growth of international revenue.’1

  He went on to pitch the merger as CBA becoming a ‘full service’ behemoth offering everything from retail banking to insurance and financial planning. He outlined what the impact of the transaction would be on the makeup of the bank. Traditional banking, including deposits and loans, in the newly merged group would account for about half of its activities, compared with 92 per cent previously. Insurance and funds management would account for about one-third of business, compared with 3 per cent previously.

  ‘Over recent years, the Commonwealth Bank has been building towards these objectives, but the merger will help us to achieve that vision far more quickly than by organic growth,’ he told the assembled journalists. ‘We believe the imperative for stronger savings in Australia implies very strong growth prospects for funds management and superannuation.’

  The message Murray was sending to the nation through the press was: ‘If we sit here and do nothing, the Australian financial services industry will be a branch office of the rest of the world, and that is not acceptable.’

  Murray was hailed as a hero. The Australian’s business commentator Mark Westfield wrote, ‘Two men, two banks and too clever for their rivals.’2 Another article in The Australian, headlined ‘The Mega bank “good for the nation”: Jobs to go, but chief defends deal’, pitched the merger as being in the national interest because the combined group would have ‘scale, efficiencies and scope of activities to provide more choice to more customers on a more cost-effective basis’.3

  Other media and banking analysts wrote reports lauding Murray for his cost-cutting initiatives, which would make the new entity even more profitable: 2500 jobs were expected to go and there would be 450 branch closures. Warnings by the union that it would be devastating to rural jobs and services were barely acknowledged in media reports. If the banks could boost profits through cost-cutting or acquisitions, it would translate into share price gains. That, in turn, would feed into the burgeoning salary packages of senior executives, who were increasingly being judged on shareholder returns.

  Three months after the bid was announced CBA’s shares had jumped almost $6 to $28 a share. The apparent success of the CBA-Colonial merger opened the floodgates for other acquisitions as the investment community put pressure on ANZ, NAB and Westpac to follow suit. A month after CBA’s deal with Colonial was completed, NAB announced a $4.5 billion merger with MLC. AMP was also on the prowl for major purchases, as were Westpac and ANZ.

  *

  Smedley wasn’t about to play second fiddle to Murray. After the CBA deal, he picked up a $15 million payout and an annual life pension of $840,000. He decided not to take a seat on the board.

  Peter Beck, an actuary who was head of strategy at Colonial and part of the team that had sold Colonial to CBA, stayed on and headed the life insurance division newly rebranded as CommInsure. Beck recalls being s
urprised when CBA’s head of human resources asked him whether he was ‘crafty’. ‘I’m South African, and crafty has a certain meaning and connotation of being dishonest, underhanded, even deceitful. I said if you’re asking me am I smart, the answer is yes. But it struck me as a very unusual question to put to someone,’ he remembers.

  Beck saw a lot of ‘craftiness’ at CBA during his five-year stint, and was particularly struck by the focus of executives on the fortunes of CBA’s share price, shattering any illusions that the selection of appropriate products for customers factored into their decision-making. ‘They would take a lot of costs out of the business just to grow the share price,’ he says. Often that meant reducing the numbers of risk-assessment and compliance staff. ‘Everything was about the impact on the share price.’ The reward system for senior executives at CBA also heavily influenced the culture: ‘They became “crafty” at finding ways to enhance profits to the detriment of customers and staff.’

  According to Beck, CBA lawyers had a lot of power and influence. ‘I remember the head of legal telling me how close he was to Murray, which was essentially a message not to mess with him because it would get right back to Murray, Beck recalls. ‘It was a very litigious culture.’

  Consequently, CommInsure was always ready to fight insurance claims. Says Beck, ‘They were [often] just small claims that customers believed they were covered for, but there were technical angles in the contract we could use to avoid paying.’ In particular, home and contents insurance claims were frequently referred to the legal department.

  In 2005, Beck was ushered into a meeting and told his position had been terminated, after twenty-four years with Colonial and CommInsure. The way a company treats its staff on the way out says a lot about its culture. CBA offered Beck a resignation benefit equivalent to his own 5 per cent contribution with interest, as opposed to the 10 per cent contribution the company had made all those years. In dollar terms, he would receive $1.5 million instead of $4.5 million. CBA did this on the basis that Beck was fifty-three when he was terminated, and he would only officially become eligible for his entitlements when he reached fifty-five – despite the fact it was standard practice to grant full entitlements after ten years’ service.

  Gutted at what CommInsure had done, Beck wrote to the head of human resources, then the fund trustees, then the external complaints body the Superannuation Complaints Tribunal – all without success. He then wrote to the new chief executive of CBA, Ralph Norris, asking him to pay his due benefits and saying, ‘It is hard for me to understand how after twenty-four years of service I am expected to be content with around one-third of my full entitlement.’ Norris wrote back, replying that while he had ‘carefully considered’ Beck’s letter he was unable to meet his request.

  Beck eventually launched action in the NSW Supreme Court and won his case in 2015. But before he could pop the champagne, CBA lodged an appeal, which Beck lost in April 2016. APRA had – to Beck’s astonishment – backed him by writing a letter of support that set out how CBA had incorrectly interpreted ‘accrued benefits’. But it turned out to be useless, because APRA failed to follow up by giving evidence or joining the case, which meant that the court wouldn’t let Beck use the APRA letter.

  The battle cost Beck $600,000 in legal fees. Now in his sixties, Beck is still negotiating a cost settlement with CBA. He has to pay the bank’s estimated $1.2 million court costs.

  *

  One of the first things CBA did was merge its funds management business, Commonwealth Investment Management, with Colonial First State, which manufactured financial products such as property funds, managed share funds and super funds. Colonial First State was run by funds management guru Chris Cuffe, who after joining Colonial First State in 1993 had built it into one of the top three entities in the investment industry, boosting funds under management from $100 million to more than $50 billion.

  With its newly expanded base of ten million customers and a greater range of products, CBA began installing commission-driven life insurance brokers and financial planners inside bank branches. This vertical integration enabled the aggressive cross-selling of financial products to millions of loyal banking customers. Fees were based on funds under management rather than how much value was added to the funds, and were charged at every stage of every process. More than ever, the mantra was sell, sell, sell.

  While Colonial was already renowned for its entrenched sales-driven culture based on commissions, fees and incentives – Smedley prided himself on measuring the number of products per customer that the business could sell – what was less well known was that CBA had also been working towards a similar culture from as far back as 1995. Intent on increasing sales and cutting costs to make bigger profits, Murray had introduced a sales system developed by US consultancy Cohen Brown, which pitched itself as providing the banking industry with a ‘new’ way to sell customers more financial products.

  Staff were coached in the Cohen Brown method via extensive video training and manuals. They were told that selling wasn’t something to switch on or off, it had to be all-pervasive. Tellers were encouraged to spend more time with customers, spruiking them as many new products as they could. One Cohen Brown manual stipulated: ‘Always discover and sell to unknown needs. Simply asking a client “Is there anything else I can do for you?” is totally insufficient as a mechanism of helping clients and increasing cross-sells. Nine out of ten times the answer is no. Rarely will [clients] call you if anything changes in their financial lives even though they promised to do so. Leave nothing to chance. Practice the Cohen Brown rule on an ongoing and continuous basis . . . [and] become a financial missionary for your markets.’4

  The strategy caught on at other banks. Andrew J. Macey, who runs specialist finance services at Westpac, worked at NAB in the mid-1990s when the Cohen Brown method was introduced there too. In August 2017 in a LinkedIn article titled ‘When incentives go wrong’ he discussed the impact of Cohen Brown on the culture inside NAB. He recalled regular gatherings around a TV for training videos. ‘I remember Cohen [Brown] exhorting that “I had the power and the responsibility!” It felt, so . . . foreign . . . so . . . um . . . American?’5 In 2003, Cohen Brown’s website featured a review from Trevor Eddy, then head of sales development at NAB, saying: ‘Referrals increased by 1000 per week, with a 42 per cent increase in lending sales, a 19 per cent increase in deposit sales, in a very tough market, and a 36 per cent increase in insurance and risk sales.’6

  Few disputed the impact of Cohen Brown on improving sales and increasing profits. But in the hands of Australia’s big banks, it was used to create a culture of aggressive selling that too often resulted in poor outcomes for customers. Such single-minded focus could lead to a lack of oversight elsewhere. In 2003, it was revealed that a CBA branch manager in Karratha, WA, Kim David Faithfull, had systematically stolen $20 million from the branch’s general ledger account between 1998 and August 2003.

  Every two weeks representatives from the bank’s area office had visited the branch to check that the sales and service techniques were being implemented. But they were so concerned with sales that they completely missed the fraud. Justice Kevin Hammond, the chief judge of the WA District Court told the court he found it ‘curious’ that CBA hadn’t noticed the money missing until a suicidal Faithfull left a note for staff members, admitting his crimes.7

  Another branch manager, who quit after CBA bought Colonial, recalls how CBA rewarded a bank teller who beat sales targets each week, unaware that this was being achieved through deception. ‘She received awards and movie tickets because she consistently opened twenty-plus new accounts each week,’ the former manager says. ‘She might have a brief conversation with clients to ask if they wanted whatever new style of account that was being flogged at the time. The customers would politely decline, but this woman would open the accounts anyway without a signature and deposit her own funds. Sales targets were exceeded, and she was the sales hero. It all unravelled when a client receive
d their first statements and came into the branch to advise they had never opened the account and asked who put the $2 in to open it.’8

  While high-flying executives drew massive salaries thanks to the huge inflows of funds from compulsory superannuation, bank tellers not only struggled to meet monthly sales targets, but also faced the constant threat of job cuts. CBA’s ‘Which New Bank’ program closed yet more branches and slashed 3700 jobs, to achieve savings of $1.5 billion. One of those who lost her job was branch manager Ann O’Farrell. In a controversial cover story in BRW, she described the culture. ‘Every bank has customer service targets; they are part of the business,’ O’Farrell said. ‘But I would say in the Commonwealth Bank they are being grossly misused. People in the bank think about targets, not the service.’9

  The branch closures resulted in a series of staff strikes, but Murray was defiant, telling BRW, ‘This is the most important change at the bank since privatisation a decade ago. If we deliver on this, we will be the most competitive bank in the country.’ When Murray stepped down as CEO in 2005, the company’s shares were trading at a record high of $42. In just over a decade he had taken CBA ‘from a partly privatised company with a market capitalisation of $6 billion in 1992 to a fully integrated financial services provider with a market capitalisation of around $50 billion in 2005. Shareholder value has grown . . . with Total Shareholder Returns (including gross dividend payments) of more than 24 per cent per annum (compound annual growth).’10 Hawke and Keating would no doubt have seen CBA’s spectacular growth as a vindication of their decision to turn the people’s bank over to the private sector.11

  By now the banks not only dominated the wealth management industry but their massively increased market values meant they also ruled the Australian stock market, accounting for a third of a typical balanced Australian equities portfolio. The banks’ power was supreme, and the rising batch of executives and boards knew it and thrived on it. Arrogance and a sense of infallibility ran riot.