FSR GPS: The efficiency limb of the EHF obligation

This is the third edition in our “FSR GPS” (Guidelines, Principles and Strategies) series relating to the efficiently, honestly and fairly (EHF) obligation in financial services law.

In this third edition, we examine the very specific issue of when a financial service might breach the EHF obligation on the grounds of the service not being provided efficiently.

In our previous editions on EHF (available here and here), we have observed that:

  • the Courts have swung back to treating the EHF obligation as a compendious obligation;
  • of the three compendious elements, fairness is, in our opinion, the most weighty;
  • by the same token, the efficiency element is the least weighty;
  • there is some severity of conduct which will usually activate a breach of the EHF obligation;
  • there is also likely to be some materiality element that is required in relation to a breach; and
  • there is some connectivity between the three elements of efficiency, honesty and fairness in the compendious text; in other words, shortfalls in conduct from an efficiency perspective are likely to require an element of fairness and lack of honesty.

It is this last observation that we propose to scrutinise in this edition.

Spotlight on efficiency

Many of our clients understand how a breach might occur through a fairness deficiency but are less clear about when a lack of efficiency might trigger an EHF breach.

The link between the three elements of the EHF obligation was expressed early on in the peace when Young J noted that the obligation required a person to perform their duties “efficiently having regard to the dictates of efficiency and fairness, and fairly having regard to the dictates of efficiency and honesty”.[1]

In the case where Young J made this pronouncement, there was in fact a breach discerned based on a shortfall in efficiency of performance of the relevant financial service. In that case, the concept of efficiency was equated to conduct which falls short of the reasonable standard of performance that the public is entitled to expect.[2]

Anderson, in his article “Duties of Efficiency, Honesty and Fairness Post-Westpac: A New Beginning for Financial Services Licensees and the Courts”[3] identifies three types of inefficiency which have been seized on by the Courts:

  • the first is inefficiency in the area of advice; illustrative is the case discussed of Re Campbell[4] where the relevant conduct fell within a general rubric of incompetence (e.g. failure to ensure clients were sufficiently briefed in relation to the instant advice);
  • the second is an adviser’s lack of knowledge of the law (citing AAT decision in Kippe v Australian Securities Commission[5]); and
  • the third is described as the “incompetent administration of a licensee’s business and the management of its internal affairs.”

Inefficiency in practice

The real issue is whether inefficiency, in and of itself, will be enough to ground a breach of the EHF obligation.

One difficulty in this context is that many of the examples that have been examined by the Courts, or which one can hypothesise about, often also have an element of unfairness. So pure inefficiency may not be sufficient to ground a breach, particularly where the adverse consequences are “mild” in relation to consumers.

It is possible, therefore, that inefficiency as a foundation for an EHF breach might depend on the magnitude of the inefficiency, or the consequences of the inefficiency. An example we cited previously is in the provision of Statements of Advice or periodic statements, where out of a large volume prepared, only a small number suffered from the relevant inefficiency. However, here, it is relevant to consider the impact of the relevant inefficiency, particularly on consumers.

Another lens that could be adopted is to look at the inefficiency in the context of the totality of the financial services provided under the relevant AFSL. As we know, section 912A(1)(a) of the Corporations Act, which houses the EHF obligation, refers to the provision of financial services in the plural. This phrase has not been interpreted literally but one wonders when it comes to the efficiency criterion, whether a more expansive judicial view could be taken; possibly even by just according less weight to this element.

If such a mitigated approach is not taken, then a wide range of cases of inefficiency could end up in a breach of the EHF. Of course, Young J’s observation links the efficiency element to the other two elements, which is an appropriate mitigation in the context of a compendious obligation.

Some tentative conclusions

It is suggested that:

  1. efficiency is a lesser coefficient of the EHF obligation;
  2. there ought to be some ability to look to the seriousness or magnitude of the conduct in relation to the efficiency element;
  3. there ought to be some ability to link the efficiency element to the honesty and fairness elements; and
  4. despite 1 – 3 above, or perhaps due to it, the greater the inefficiency, the greater the prospect that the conduct will be considered unfair or have fairness implications.

 

[1] Story v National Companies And Securities Commission (1988) 13 NSWLR 661 at [672].

[2] Story v National Companies And Securities Commission (1988) 13 NSWLR 661 at [672].

[3] (2020) 37 C&SLJ 450.

[4] Campbell v Australian Securities and Investments Commission (2001) 37 ACSR 238; [2001] AATA 205.

[5] Kippe v Australian Securities Commission (1998) 16 ACLC 190.

 

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Fiona Smedley
Fiona Smedley
Partner
+61 2 9225 5828
Charlotte Henry
Charlotte Henry
Partner
+61 2 9322 4444
Steven Rice
Steven Rice
Special Counsel
+61 2 9225 5584
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160

 

FSR GPS: Efficiently, honestly and fairly in practice

Our “FSR GPS” (Guidelines, Principles and Strategies) series is designed to assist financial institutions navigate often complex, and sometimes opaque or ambiguous, legal provisions, with a view to assisting institutions formulate practical and strategic legal and business solutions.

This edition aims to provide practical guidance to in-house lawyers and businesses on how to navigate the obligation to take all necessary steps to act efficiently, honestly and fairly in section 912A of the Corporations Act. This area of financial services law continues to evolve, and remains riddled with ambiguities and complexities. Against this backdrop, we offer some guiding principles and a “checklist” that can be applied in practice.

The Guiding Principles

(a) The obligation is an obligation to take all necessary steps; it is not solely focused on outcomes

There is a component of process in the efficiently, honestly and fairly obligation, reflected in the “all necessary steps” language. However, unlike other obligations under financial services law, the steps component is not qualified by a reasonableness standard.

The steps obligation is onerous insofar as it equates the steps required with the net outcome of the overall duty, i.e. to carry out the relevant financial services efficiently, honestly and fairly.

A scenario is possible where all necessary steps have been taken but no breach arises, even though the efficiently, honestly and fairly limbs were not otherwise satisfied (i.e. from a net outcomes perspective), precisely because all necessary steps have been taken. However, in our view, this would not be a commonplace scenario.

(b) The obligation to act efficiently, honestly and fairly is compendious

This is the latest pronouncement of the Federal Court (reflected in the judgment of Beach J in ASIC v AGM Markets[1] – see our discussion on this decision here).

Whether there is still flexibility in how the efficiently, honestly and fairly test is applied is another matter. Allsop CJ chose to primarily focus on the fairness element in ASIC v Westpac[2], because of the seriousness of the conduct in question. We provide some specific commentary on the concept of fairness from a practical perspective here.

Apart from this:

  • the efficiency criterion is likely to be read down in our view; and
  • the overall flavor of the obligation has traditionally been seen as honesty and ethical conduct. This traditional case law interpolation is unlikely to change.

Overarchingly, the efficiency test seems to require the relevant services to be conducted efficiently in a honest and fair way, honestly in an efficient and fair way and fairly in a honest and efficient way. This was the original conceptualisation by Young J in Story v National Companies and Securities Commission.[3]

(c) It is not a catch-all provision capturing all other breaches of specific financial services laws

This is true based on case law dicta. It is similarly true that it is not a filler obligation, which only applies where there is no specific financial services law provision.

It is quite possible that, say, conduct engendering a breach of misleading and deceptive conduct provisions under the Corporation Act or ASIC Act could also be a breach of the efficiently, honestly and fairly obligation – but this is not an automatic or foregone conclusion.

(d) The honesty limb is breached where facts and circumstances suggest that there has been conduct that is morally wrong in a commercial sense or unethically sound. It is not necessary to demonstrate dishonesty to show a failure to act honestly

It follows that the honesty limb adopts a lower standard than the revised definition of dishonesty adopted in section 1041G of the Corporations Act.

(e) The concept of fairness should be judged having regard to the interests of all parties (and should not be used as a proxy for a best interests obligation). A licensee giving undue weight to its own interests over customers may indicate a breach

The duty does not prevent a licensee from pursuing its own interests. The test is more akin to whether the licensee has inappropriately, improperly or inequitably dealt with the interests of the client.

(f) The concept of “efficiently” indicates a reasonable standard of performance that one would expect

This is a useful breakdown of the efficiently component. Although, because of the compendious nature of the obligation, merely acting inefficiently will not activate a breach. Rather, there must be some unethical or unfair outcome associated with the inefficiency or arguably, some moral turpitude.

(g) The incident being considered should not be viewed in isolation. Rather to the extent possible, one needs to consider the licensee’s behaviour more generally

A related issue is whether there is some materiality threshold inherent in the efficiently, honestly and fairly obligation – given that the obligation refers to the financial services covered by the AFS licence broadly. There is little guidance as to whether any conduct at all, no matter how small or trivial, would constitute a breach.

It is suggested that some element of materiality is required in order to adjudge that the relevant financial service has been performed in a manner that is not efficient, honest and fair. This is a different gauge than the significance criteria involved in the breach reporting condition.

It remains unclear as to the extent materiality would allow breaches of one financial service (or one aspect thereof) to be overlooked because of an otherwise compliant business. However, there is some case law to this effect.[4]

What does “all necessary steps” involve?

Undoubtedly, the efficiently, honestly and fairly obligation calls for a compliance framework. This includes training, testing and monitoring in respect of the compliance framework. The key issue is the extent of that compliance framework.

This will, by necessity, differ between different financial services and different scenarios. For example, it is possible the terms of issuing a financial product could breach the efficiently, honestly and fairly obligation. This is conceivable in the area of add-on insurance. In this case, reasonable steps may involve the evaluation of the terms of issuance of the insurance and the deliberations of the bodies who formulated and approved the terms of issue. In our opinion, seeking information concerning governance and compliance checkpoints and protections is a very valid line of inquiry.

But can this aspect be encapsulated in an overarching line of inquiry/criteria? Because the term “necessary” is wider than “reasonable”, we suggest this line of inquiry proceed from the other analytical end – causation.

In other words, the threshold question to ask is what checks and controls could have prevented the breach of the efficiently, honestly and fairly obligation.

For example, in the case of add-on insurance, the answer could be criteria that the decision-making body had in place, which would have identified the issue of the product on unfair terms.

Is the context of providing financial services relevant?

A question often arises as to the relevance of the context in which the financial services are provided. For example, where the licensee has a fiduciary duty to the client, does this affect the standards of fairness and acting honestly?

In our view, this question should be answered in the affirmative.

Aspects such an inequality of bargaining power as between the parties are also likely to affect the content of the duty. A limitation on pursuing one’s own interests, such as is manifest in a fiduciary obligation, can similarly affect the standard of the efficiently, honestly and fairly obligation.

Another relevant factor would be the complexity of the particular financial services or products being provided.

Further, the context of the provision of the relevant financial services is also likely to inform what will constitute “all necessary steps”.

What is the actual scope of the financial services covered by the AFS licence?

We have been vocal on this point, stating that the relevant financial services are those activities referred to in the Corporations Act, such as dealing and the provision of financial product advice, along with the aspects/activities that are integral to the core activity.

For example, in the context of financial advice, the charging of fees and remediation of defective advice would, in our opinion, all be captured within the relevant financial service. Similarly, in the context of dealing, the preparation and issue of product disclosure documents would constitute an integral component of the financial service of dealing. See further commentary on this point here.

Does the fact that the provision is now a civil penalty provision alter the way the obligation should be interpreted as a matter of statutory interpretation?

In our view, there is no relevant principle of statutory interpretation which would either render the efficiently, honestly and fairly obligation more or less onerous. Certainly, a penal provision may engender a narrow interpretation. But we consider that a civil penalty provision is distinguishable.

What other factors should be considered?

Clearly, the moving pendulum of community expectations will play a role. There are forces at work in this context, which are both visible and undeniable.

The following are but a few examples:

  • use of disclosure documents that are dense, turgid, or which the issuer knows or should know that the client will not comprehend;
  • use of disclaimers or hidden away acknowledgements, which the issuer should similarly know will not be, or will be unlikely to be understood;
  • issue of products which do not deliver value, e.g. certain add-on insurance; and
  • issue of products which the issuer should know are unsuitable or not fit for purpose, or otherwise oppressive or harsh.

What are the top 5 principles that could assist in identifying conduct that could infringe the efficiently, honestly and fairly obligation?

  • Is the conduct occurring in the provision of a financial service?
  • Does the conduct have a disproportionately harsh, unfair effect on customers?
  • Is the conduct of a trivial or small nature, or is it beyond this?
  • Does the conduct have an “aggravation” element, which would be more likely to be interpreted by a court as a breach of the fairness criterion; such as where either a harsh outcome or a bad motivation/purpose (e.g. bad faith) can be seen to characterise/taint the incident?
  • Were there ways to prevent the conduct, such as compliance controls or management intervention, and ultimately board deliberations/intervention (directly or through its delegate) which could have been put in place?

 

[1] [2020] FCA 208.

[2] [2019] FCAFC 187.

[3] (1988) 13 NSWLR 661.

[4] Australian Securities and Investments Commission v Saxby Bridge Financial Planning Pty Ltd (2003) 133 FCR 290.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Fiona Smedley
Fiona Smedley
Partner
+61 2 9225 5828
Charlotte Henry
Charlotte Henry
Partner
+61 2 9322 4444
Steven Rice
Steven Rice
Special Counsel
+61 2 9225 5584
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160

“In relation to” a financial service: Federal Court reaffirms wide angle lens

The Federal Court has recently reaffirmed that the phrase “in relation to” a financial service is necessarily of wide import. In this context, it is timely to reiterate the practical consequences of this broad interpretation in the context of financial services.

“in relation to”

In Australian Securities and Investments Commission v Hutchison [2020] FCA 978, the relevant circumstances involved adviser misconduct relating to the improper cashing of payments for the provision of financial advice to retail clients. As a result of this conduct, ASIC imposed a banning order on the adviser for, among other things:

  • engaging in dishonest conduct “in relation to a  financial service” under section 1041G of the Corporations Act; and
  • engaging in conduct, “in relation to a financial service, that is misleading or deceptive or is likely to mislead or deceive” under section 1041H of the Corporations Act.

ASIC’s banning order was overturned by the Administrative Appeals Tribunal (AAT), on the basis that the conduct was not “in relation to” a financial service. The AAT came to the view that the requirement that conduct be “in relation to” a financial service in sections 1041G and 1041H should be understood narrowly as requiring a direct or substantial relationship.

On appeal to the Federal Court, the primary question before Banks-Smith J was whether the relevant conduct was conduct that was “in relation to a financial service” for the purposes of section 1041H of the Corporations Act. Her Honour overturned the AAT decision and concluded that the phrase “in relation to” a financial service requires only “an indirect or less than substantial connection” between the conduct and the financial service. In adopting this approach, Her Honour applied the previous decision in Australian Securities and Investments Commission v Narain [2008] FCAFC 120, which also held that that the relationship contemplated by the words “in relation to” is such that an indirect or less than substantial connection is sufficient.

Provision of a financial service vs “in relation to” a financial service

We have previously commented on the scope of a “financial service” in our article discussing the obligation to do all things necessary to ensure that financial services are provided efficiently, honestly and fairly. In this context, we noted that the scope of a financial service may, in fact, be narrower than is commonly understood. The scope of a financial service is a function of the core of that service, as well as the necessary incidents of such service. For example, dealing does not encompass the administration activities of operating the financial product, unless integral to the dealing itself. By way of counterpoint, the financial service of providing financial product advice would ordinarily encompass the charging of fees in respect of such advice, as this is either core to the provision of the advice (in terms of how it is provided) or a necessary incident of it. Contrast the handling of complaints relating to financial advice; that is not a financial service per se, but it is arguable that it is a necessary incident of providing advice, as is remediation of poor or deficient advice.

This is important, because a number of key obligations in Chapter 7 of the Corporations Act are enlivened only when a financial service is being provided. Most notably, the general licensee obligations in section 912A of the Corporations Act apply in respect of the provision of a financial service.

However, importantly, a number of obligations and prohibitions in financial services law apply in a broader set of circumstances. In particular, market misconduct provisions in the Corporations Act and ASIC Act such as misleading or deceptive conduct, false or misleading representations, dishonest conduct and unconscionable conduct apply when the conduct is either “in relation to” or “in connection with” a financial service. This means that these misconduct provisions may apply, even where the general licensee obligations in 912A of the Corporations Act do not.

As a result, a licensee must always give due regard to the broader administrative and other operations of its financial services business (which may not require a particular AFSL authorisation), to ensure that they do not fall foul of these broad conduct obligations.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160