EHF in Focus: Dissecting the efficiently, honestly and fairly obligation with a governance lens

This article addresses the integration of the efficiently, honestly and fairly (EHF) obligation into the risk assessment and breach reporting frameworks of financial institutions that hold an AFSL. Central to this exercise is the integration of the EHF obligation into operational processes, procedures, decision-making and, last but not least, organisational culture.

The role of fairness is particularly important in this last context. But at the same time, the efficiency element of the obligation also warrants close consideration.

EHF as a new standard of conduct

A central tenet of the approach suggested in this article is that the EHF obligation be treated as a primordial standard of conduct for AFSL holders, on a like footing to the role of the best (financial) interests duty for superannuation trustees.

We at HSF envisage that the evolution and primacy of this duty will mean that in key areas of client interface that involve a financial service (e.g. manufacturing, distribution, remediation), the EHF obligation will be a standing matter to be considered by management, to be elevated to the Board where appropriate, and to be the subject of genuine consideration and deliberation before the particular financial service involving a client interface is implemented.

EHF in operational, risk assessment and breach reporting contexts

The EHF obligation is rapidly becoming a crucial standard of conduct for financial institutions.

Since the Royal Commission, it is a vehicle for the “community expectations” phenomenon and is also emerging as an important element of “customer culture”, which the regulators and the courts are increasingly focussing on.

In a recent life insurance merger case, Allsop CJ observed during the course of the hearing that (in reference to claims handling):

And different companies have different approaches and different cultures, and I’m not suggesting any form of criticism in this, but I’m not sure how ultimately this is dealt with. Because the terms can remain the same, the underlying strength of the company can remain the same, but a very different claims handling approach can be manifested by policy, by which I mean company policy as opposed to policy terms, which can make a very big difference to policyholders.

The EHF obligation can therefore be an important element of the way a financial institution develops and implements its customer culture; that is, the way it deals with customers beyond the strict terms of the life insurance contract. This position is consistent with Allsop CJ’s observation in ASIC v Westpac that:

“The provision is part of the statute’s legislative policy to require social and commercial norms or standards of behaviour to be adhered to.[1]

Optimally, the obligation should be enshrined into an organisation’s key operational policies which deal with customer interactions. For example, claims handling has recently been elevated into a financial service under the Corporations Act and is therefore specifically subject to the EHF obligation. This has important implications for the fair treatment of policy holders generally and more specifically, the need to apply procedural fairness to claims in a more intense and concentrated way.

This need for integration of the EHF obligation into policies and procedures raises the need to more precisely map the legal requirements of the obligation, which this article undertakes in the following sections.

As far as breach reporting is concerned, under the new breach reporting regime, a breach of certain obligations is deemed to be a significant breach and therefore reportable. A key category in this regard is a breach of a civil penalty provision. The EHF obligation has recently been placed into this category of civil penalty provision. This means that if a breach occurs, one does not evaluate the extent and nature of the breach under the significance criteria but rather, such breach is automatically reportable. Hence it becomes very important to understand the legal dimensions of this obligation.

Relevant assessment criteria

Composite or singular obligations

The courts have been grappling with this issue in the context of the EHF obligation, the current state of play which can be summarised as follows:

  • the traditional position is that it is a collective or compendious obligation and on this basis, a breach would involve a breach of all 3 elements;
  • in ASIC v Westpac, the role of fairness and the possibility of singular obligations became a live issue;
  • in ASIC v AGM Markets, Beach J declined to adopt the singular approach;
  • in the 2 subsequent cases of MobiSuper and RI Advice Group,[2] the court flirted with the singular approach while keeping the compendious approach alive;
  • the courts have struggled with this approach recently and have in practice adopted a flexible approach of focussing on breaches of the individual components;
  • in this judicial process, the element of fairness has assumed more focus. To adopt the concept of equality articulated by George Orwell in Animal Farm, each of the 3 components are equal but some components are more equal than others. In the present discussion, the fairness component is more equal than the others. This was essentially the approach adopted by Allsop CJ and O’Bryan J in the ASIC v Westpac decision;[3] and
  • a difficulty with this approach is whether and when a breach of the efficiency component can constitute a breach of the overall obligation. We address this point below.

The Courts have said the collective obligation:

“connote[s] an element not just of even handedness in dealing with clients but a less readily defined concept of sound ethical values and judgment in matters relevant to a client’s affairs.” [4]

Role of efficiency

One of the arguments against the obligation comprising individual singular obligations is that this would logically mean a breach of the efficiency component would mean there is a breach of the total obligation.

This efficiency element has not received a lot of attention. In the early influential case of Story, Young J first raised the conundrum of the difficulty the role of efficiency would play if the test were singular:[5]

“Thus I turn to the phrase “efficiently, honestly and fairly”. In one sense it is impossible to carry out all three tasks concurrently. To illustrate, a police officer may very well be the most efficient in control of crime if he just shot every suspected criminal on sight. It would save a lot of time in arresting, preparing for trial, tying and convicting the offender. However, that would hardly be fair. Likewise a judge could get through his list most efficiently by finding for the plaintiff or the defendant as a matter of course, or declining to listen to counsel, but again that would hardly be the most fair way to proceed. Considerations of this nature incline my mind to think that the group of words “efficiently, honest and fairly” must be read as a compendious indication meaning a person who goes about their duties efficiently having regard to the dictates of honestly and fairness, honestly having regard to the dictates of efficiency and fairness, and fairly having regard to the dictates of efficiency and honesty.”[6]

“The “efficiently, honestly and fairly” standard applies as a single, composite concept, rather than three discrete behavioural norms.”[7]

“The word ‘efficient’ refers to a person who performs his duties efficiently, meaning the person is adequate in performance, produces the desired effect, is capable, competent and adequate. Inefficiency may be established by demonstrating that the performance of a licensee’s functions falls short of the reasonable standard of performance by a dealer that the public is entitled to expect.”[8]

Recently, despite adopting the composite, collective interpretation of the duty, the Court in the case of Australian Securities and Investments Commission v RI Advice Group Pty Ltd (No 2)[9] seemingly focussed heavily on the efficiency component when it found that a licensee had breached the EHF obligation by failing to have in place adequate compliance, monitoring and supervision frameworks and to take reasonable steps to ensure that the relevant adviser did not breach the best interest obligations owed to clients.

It appears therefore that a breach of the efficiency component may be sufficient to establish a breach of the EHF obligation but it is strongly suggested that a qualification be adopted as follows:

  • the efficiency breach must be of such an extent that it leads to unfairness to customers; or
  • it is sufficient magnitude that it can be characterised as systemic or results in material loss to customers.

Role of fairness

The concept of fairness can capture both substantive fairness as well as procedural fairness. As R P Austin stated extracurially, the concept of fairness can capture:[10]

at least four potential criteria, which could be seen as cumulative or alternative:

    • the substantive fairness or justice of the conduct (substantive fairness);
    • impartiality/lack of bias of those engaged in the conduct (impartiality);
    • the legitimacy of their participation in the conduct (legitimacy); and
    • the procedural fairness concerning how they engaged in conduct (for example, whether they gave relevant parties the opportunity to be heard) (procedural fairness).”

The concept is well understood as designating an outcome vis-à-vis customers which damages, detracts from or dilutes their rights or otherwise prejudices them.

The recent Mobisuper decision, like the earlier ASIC v Westpac decision, also canvassed superannuation consolidation and importantly implicated the trustee in conduct which was unfair in terms of the issue of the product through the trustee’s failure to adequately monitor how the product was distributed. This last point is very significant as the financial service of issuing interests was seen to extend to the distribution activity of advisers who were seen as delegates of the trustee.

Other instances of unfairness can be considered in the context of case law examples canvassed below.

Role of honesty

The role of honesty is the least contentious. Its purview is not confined to concepts of criminal liability but also extends to unethical conduct “which is not criminal but which is morally wrong in the commercial sense”;[11] it also adopts an objective standard.[12]

Specific guidelines and guardrails

Case law examples

The courts have held that the following conduct breached the EHF obligation:

  • a misrepresentation that there was another active bidder for a company when there was not;[13]
  • acting carelessly on advice from another director that the defendant could give investment advice in relation securities of an associated company despite not being authorised to do so;[14]
  • inducing clients to trade in options to secure brokerage commissions;[15]
  • permitting inappropriate advice to be given to investors;[16]
  • offending the related party dealings prohibitions under Part 5C.7 of the Corporations Act;[17]
  • an adviser disclaiming that they cannot give advice about a dealing of a particular kind and referring the client to an entity that is likely to promote those types of dealings without being licenced to do so;[18] and
  • a financial institution providing general advice about a superannuation rollover service where the provider did not know and did not seek to know all matters that were relevant to whether the rollover recommendation was in the customers’ best interests nor did it know whether customers were aware of all of the relevant issues or had considered them.[19]

Fairness as a benchmark obligation and conduct regulator

This has been touched upon earlier. The contemporaneous challenge for financial services institutions in the face of these recent developments is to integrate fairness as a standard of conduct in its operations, procedures, processes, customer interfaces and decision-making.

Integration of EHF into decision-making and risk assessment

A suggested approach based on a balance of efficiency and outcome would be to leverage the EHF obligation into existing, similarly client-centric general law and statutory obligations.

For example, in the life insurance context, this approach would involve building on the existing obligations of utmost good faith under the Insurance Contracts Act and duty of priority under the Life Act.

The utmost good faith obligation is essentially one which currently regulates interactions with customers in relation to key areas such as disclosure and claims.

The priority obligation is a wider one relating to the investment, administration and management of the assets of a statutory fund.

To best integrate fairness as a standard of conduct into interfaces with customers, the following measures are suggested:

  • it be factored into the key areas of product development, product manufacturing and product distribution (including advice);
  • it also be factored into claims handling and other after-sales interactions such as complaints handling and internal dispute resolution; and
  • it be factored into management conduct and decision-making, such that when proposals from management reach the Board, the role of fairness will have been required to be articulated by management in the Board submission for consideration by the Board.

This will manifest itself in a standing agenda item of consideration of EHF for Board meetings where a product manufacturing, distribution, or other customer interface situations are being proposed or discussed.

To implement this suggestion, a sub-committee of the Board could be appointed to work with management on the implementation of this process.

Breach assessment and reporting

It is beyond the purview of this article to canvass the full dimensions of the new breach reporting regime. Rather for present purposes, an approach is suggested to formulate a proposal for:

  • how the EHF obligation can be integrated into operations and decision-making (as described above) so that as far as possible, breaches of the EHF obligation will not occur; however
  • if slippage occurs, how we can best evaluate whether there has been a breach.

In this regard, due to the complex and evolving legal nature of the EHF obligation, where a potential EHF breach is identified, the following protocols could be applied:

  • in accordance with ASIC recent guidance on breach reporting, knowledge of the potential breach will arise when Compliance is aware of the potential breach (although it would also arise in other circumstances, such as knowledge of the Legal or Risk teams);
  • while a breach of the EHF obligation is a deemed significant breach, it will still be necessary to consider whether a breach of the EHF obligation has occurred (as this may or may not be readily ascertainable);
  • due to the complexity of the issue, Legal and Compliance will work together to produce a set of assessment/evaluation guidelines for management, the breach reporting committee and the Board;
  • bespoke criteria should be adopted in relation to breach reporting committee; in particular, a legal opinion from Legal should be a pre-requisite to a determination by the breach reporting committee that a breach of the EHF obligation exists; in part this flows from the fact that there is no need/opportunity to consider significance. If a breach of EHF is determined, then legal consequences of a significant breach flow automatically, requiring an initial careful consideration by Compliance and Legal; and
  • due to the new breach reporting obligations also being triggered by an investigation being conducted for longer than 30 days, the actual initiation of an investigation into a breach of EHF should also be subject to notification to, and consensus of, Legal and Compliance.

Integration into culture

Relevant for present purposes are the concepts of “customer culture” and “community culture”. What Allsop CJ was discussing was really the way the actions and decisions of a life insurer impact on customer (and community) outcomes,[20] often in ways which organisations might not traditionally measure, or which organisations might not be aware of or commonly register and place value on. The EHF obligation is one way an organisation can be conscious of, and take steps to enshrine, customer outcomes into the organisation’s culture.

This is not just an important initiative to pre-empt what is clearly a legal reality but which is also turning into an increased focus on the cultural scorecard of an organisation by regulators, including representing a potential extension of directors’ duties. It is also entirely consistent with the duties of directors to act in the best interests of the company, as this type of focus on the 2 external aspects of culture mentioned earlier, namely customer culture and community culture, should result in better business volumes and retention, not to mention an enhancement to the reputation of the organisation more holistically.

If you are interested in the current landscape on the EHF obligation and how to build this obligation into existing governance frameworks, get in touch with one of our experts below.

 

[1] Australian Securities and Investment Commission v Westpac Securities Administration Limited [2019] FCAFC 187, 174.

[2] Australian Securities and Investments Commission v MobiSuper Pty Ltd [2021] FCA 855; Australian Securities and Investments Commission v RI Advice Group Pty Ltd (No 2) [2021] FCA 877.

[3] Australian Securities and Investment Commission v Westpac Securities Administration Limited [2019] FCAFC 187.

[4] Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[5] Ibid, [69]–[70]. See also Australian Securities and Investments Commission v Avestra Asset Management Ltd (In Liq) (2017) 348 ALR 525, 561.

[6] Story v National Companies & Securities Commission (1988) 13 NSWLR 661, 672 (Young J).

[7] Australia Securities and Investments Commission v Avestra Asset Management Ltd (In Liq) (2017) 348 ALR 525, 561 (Beach J).

[8] Australian Securities and Investments Commission v Cassimatis (No 8) (2016) 336 ALR 209, 338 (Edelman J) citing Story v National Companies & Securities Commission (1988) 13 NSWLR 661, 672 and 679. See also general discussion of the obligation as cited above in footnote 3.

[9] [2021] FCA 877.

[10] R P Austin, The Concept and Role of Fairness in Superannuation Law (2016), 11-12.

[11] Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[12] R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[13] Story v National Companies and Securities Commission (1988) 13 NSWLR 661 and Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[14] R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[15] Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[16] Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023; (2016) 336 ALR 209.

[17] Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497.

[18] Re Hres and Australian Securities and Investments Commission [2008] AATA 707; (2008) 105 ALD 124.

[19] Australian Securities and Investments Commission v Westpac Securities Administration Limited, in the matter of Westpac Securities Administration Limited [2018] FCA 2078.

[20] See section 2 above.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160
Shan-Verne Liew
Shan-Verne Liew
Solicitor
+61 2 9225 5210

ACTING EFFICIENTLY, HONESTLY & FAIRLY IN FINANCIAL SERVICES – SOME RECENT DEVELOPMENTS

Two recent cases have shed new light on the scope of the obligation on AFS licensees to do all things necessary to act efficiently, honestly and fairly in the provision of financial services (EHF obligation). The cases also give some illustration of how the EHF obligation can apply to product issuers. Both cases illustrate, in our view, a strong evolutionary trend towards the EHF obligation being seen as comprising separate concurrent obligations, rather than a single compendious obligation.

In ASIC v Mobisuper Pty Ltd [2021] FCA 855, the facts involved the conduct of the promoter of a superannuation offering, Mobisuper, through a superannuation fund of which Tidswell Financial Services Ltd was the trustee.

The relevant conduct by Mobisuper involved online advertising, and inbound and outbound telephone sales activity of interests in the fund through, primarily, the identification of lost superannuation and the invitation to consumers to consolidate any such amounts into the fund. This was achieved through the provision of financial advice designed to influence the consumer to dispose of their existing superannuation interests and apply the proceeds to an interest in the fund, including an insurance interest.

Tidswell was found to have failed to discharge a number of statutory obligations, including the proper monitoring of an outsourced activity (being relevant activities of Mobisuper, including the provision of financial advice).

It is discussion, however, of the EHF obligation which is central to this decision.

The Court found that the lack of oversight by Tidswell constituted a breach of the EHF obligation. More specifically:

  • the EHF obligation applies to the provision of a financial service;
  • a financial service includes the issue of a financial product;
  • the EHF obligation is a stringent one; it is not an obligation to take reasonable steps or undertake reasonable endeavours but to do “all things necessary to ensure” that the relevant financial services are provided efficiently honestly and fairly; and
  • the core mischief was described, interestingly, in quasi misleading or deceptive conduct terms:

“In short, there was a risk in the circumstances known to Tidswell that MobiSuper, through its CSOs, would create an impression that the natural outcome of locating and, perhaps, consolidating lost superannuation accounts was to roll those accounts and other existing accounts into the MobiSuper Fund, and that this impression would be created because it was in Mobi’s interests, and would be given without proper regard to the interests of each individual consumer.” (at [49])

A key take-out for our clients is that while Jackson J did not see the need to adjudicate on whether the EHF obligation was a compendious obligation or three separate obligations, his Honour described the breach, significantly, in terms of the fairness and honesty elements of the EHF obligation, following the approach taken by Allsop CJ in the ASIC v Westpac case:

“The issue of interests in the MobiSuper Fund in those circumstances would not have been provided ‘efficiently, honestly and fairly’, considered as a compendious term and (at least) not honestly and not fairly, considered as separate concepts…But his Honour’s words do capture the essence of the lack of honesty, fairness and sound ethical dealing which would have occurred in the present case if the risks I have described had come to pass.” (at [49])

It is noteworthy that even on the singular test, his Honour did not pay attention to the efficiency element of the obligation.

It is also noteworthy that Jackson J adopted a “hybrid” approach, by making an assessment of the EHF obligation both as a compendious obligation and as three separate obligations. This is in contrast to previous Federal Court decisions which have applied the case law precedent on the compendious obligation strictly.

In ASIC v RI Advice Group Pty Ltd (No 2) [2021] FCA 877, this same trend can be discerned.

The case involved an action brought by ASIC in relation to alleged non-compliance by the RI Advice Group to take reasonable steps to ensure that its representative, Mr Doyle, complied with sections 961B, 961G, 961H and 961J of the Corporations Act (the Best Interests Obligations), as well as, relevantly for this present discussion, the EHF obligation.

The broad outline of ASIC’s case involved the retention of Mr Doyle as an authorised representative when the RI Advice Group knew that there was a substantial risk that he would breach the Best Interests Obligations.

Moshinsky J in his judgment, again in similar vein to the Mobisuper case, commences his analysis of the EHF obligation by noting that it was unnecessary to resolve whether the EHF obligation was compendious or not. However, his Honour does note the broad scope of the EHF obligation:

“I adopt the statements of principle concerning s 912A(1)(a) in those passages and note that they emphasise the breadth of the expression “efficiently, honestly and fairly”. To the extent that different views have been expressed as to whether “efficiently, honestly and fairly” is a compendious expression, it is unnecessary to resolve that issue for present purposes. Insofar as RI submits that s 912A(1)(a) comprehends conduct of the licensee that is morally wrong in the commercial sense, I do not consider the provision to be limited to such conduct.” (at [377])

Moshinsky J proceeded to find breaches of both the Best Interests Obligations and the EHF obligation on the basis that RI Advice did not have adequate compliance, monitoring and supervision frameworks in place to ensure financial advice was being provided appropriately.

In respect of the EHF obligation, the breach seems to be premised on a failure of the “efficiency” limb (due to the failure to implement adequate frameworks), rather than the “honesty” or “fairness” limbs (which are traditionally associated with the concept of morally culpable conduct).

The above developments are indicative of a judicial trend whereby the Federal Court is prepared to apply the EHF obligation in a malleable way to a variety of disparate circumstances, which is not limited by a compendious interpretation. While this trend is not yet widespread across the Federal Court, it is certainly gaining traction.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Crystal Sanders
Crystal Sanders
Special Counsel
+61 2 9225 5146
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160

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
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160

 

FSR GPS: Efficiently, honestly and fairly in practice (Part II)

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 provides further 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. Our first edition can be read here.

Historical examples

The courts have held that EHF:

  • is a compendious phrase: ‘a compendious indication meaning a person who goes about their duties efficiently having regard to the dictates of honesty and fairness, honestly having regard to the dictates of efficiency and fairness, and fairly having regard to the dictates of efficiency and honesty[1]’;
  • is an ethical obligation:
    • ‘the word ‘honestly’ may comprehend conduct which is not criminal but which is morally wrong in the commercial sense’ and that ‘[i]t comprehends conduct which is not straightforward’ and ‘may comprehend such conduct viewed objectively’[2];
    • ‘[t]he words ‘efficiently, honestly and fairly’ … so connote an element not just of even handedness in dealing with clients but a less readily defined concept of sound ethical values and judgment in matters relevant to a client’s affairs’[3];
    • ‘[i]t is not necessary to establish dishonesty in the criminal sense. The word ‘honestly’ may comprehend conduct which is not criminal but which is morally wrong in the commercial sense’[4];and
    • ‘[t]he word ‘honestly’ when used in conjunction with the word ‘fairly’ tends to give the flavour of a person who not only is not dishonest, but also a person who is ethically sound’[5];
  • requires competence and a standard of performance:
    • ‘[t]he words ‘efficiently, honestly and fairly’ connote a requirement of competence in providing advice and in complying with relevant statutory obligations’[6];
    • ‘[t]he word ‘efficient’ refers to a person who performs his duties efficiently, meaning the person is adequate in performance, produces the desired effect, is capable, competent and adequate. Inefficiency may be established by demonstrating that the performance of a licensee’s functions falls short of the reasonable standard of performance by a dealer that the public is entitled to expect’[7]; and
    • ‘[t]he expression [includes] an assessment of reasonable expectations of performance and reasonable standards of performance’[8].

The courts have held that the following conduct has breached EHF:

  • a misrepresentation that there was another active bidder for a company when there was not[9];
  • acting carelessly on advice from another director that the defendant could give investment advice in relation securities of an associated company despite not being authorised to do so[10];
  • inducing clients to trade in options to secure brokerage commissions[11];
  • permitting inappropriate advice to be given to investors[12];
  • offending the related party dealings prohibitions under Part 5C.7 of the Corporations Act[13];
  • an adviser disclaiming that they cannot give advice about a dealing of a particular kind and referring the client to an entity that is likely to promote those types of dealings without being licenced to do so[14]; and
  • a financial institution providing general advice about a superannuation rollover service where the provider did not know and did not seek to know all matters that were relevant to whether the rollover recommendation was in the customers’ best interests nor did it know whether customers were aware of all of the relevant issues or had considered them[15].

Five principles “drill-down”

Principle 1: Provision of a financial service

We have written quite a lot about this first principle (see FSR GPS: Efficiently, honestly and fairly in practice). For that reason, we will simply restate some core concepts: The relevant starting point is the definition of financial service contained in section 766A of the Corporation Act.

The most commonly discussed financial services include dealing, advising or arranging activity. The ambit of each of these concepts has been discussed in previous guidance material issued by ASIC (see for example RG 36).

The more interesting aspect of the equation is rather, apart from the core activity, what elements are integral to this core activity such that they can be said to also be comprised in the financial service?

We provided some examples in our previous edition. For example, a dealing would include as an integral element, the issue and content of a Product Disclosure Statement (PDS) as this is a required step in issuing a financial product as mandated generally by the Corporations Act. Moreover the PDS will usually contain the terms of issue of the financial product. This suggests that the terms of the PDS could be part of the EHF obligation.

This seems to us to be the case notwithstanding that the terms of the PDS will normally also be regulated by the other statutory provisions, such as the unfair terms provisions of the ASIC Act and the misleading and deceptive conduct provisions of the Corporations Act and the ASIC Act.

But what about activities that precede or follow the issue of the relevant financial product?

What about administration activities?

On the one hand, activities concerning the administration of the relevant financial product, once issued, would not seem to be subject to the EHF obligation.

What about remediation activities?

On the other hand, the process of remedying a defective issue of a financial product would seem to be captured. This is because the remediation of a defective issue is one side of the issue process. You cannot properly issue a product in a meaningful way without having responsibility for remediation.

It is also totally realistic to see some distribution activities as integral to the issue of a financial product. So the concept of “making available” could be seen as part of issuing. Clearly, the activities of advising on the product or arranging for the issue of the product are not part of the issue of the product, rather they are financial services in their own right and therefore, subject to the EHF obligation.

A distribution activity to be captured as part of the issue of the product would presumably need to have some nexus, interface with, or, at least, impact on the client.

And advertising?

It is submitted that advertising or marketing a financial product will not be part of the issue of the financial product. For a start, the Corporations Act distinguishes clearly between the issue of a financial product and the advertising of a financial product (see for example section 1018A of the Corporations Act).

And dealing with complaints?

Although the concept of dealing is included as a financial service (under section 766A), it is suggested that the areas of complaints handling is not a financial service.

Our view is that handling/dealing with a complaint is not a financial service. Rather it would require a specific amendment to the definition of financial service (as indeed is the case with the inclusion of claims handling as a new financial service).

And advising?

We have previously suggested that remediation of defective advice is also an integral part of the financial service of providing advice.

An obvious follow on question is the extent to which an omission to give advice is also part of the advice financial service. This may be an obvious question but it is not necessarily an easy one. It is hard to generalise in this regard. But certainly in an adviser-client relationship scenario, it is conceivable that the omission to give advice could be seen to be captured by the EHF obligation.

And arranging?

Again, difficult issues may arise as to whether certain activities which precede or follow an arranging activity are part of the financial service. The arranging activity can occur either on behalf of the product issuer or on behalf of the client.

Where an arranging is conducted on behalf of a product issuer, it is submitted that activities which precede the actual giving effect to the arranging, such as training of the persons engaged by the product issuer to effect the arranging would not be part of the financial service of arranging.

Principle 2: Effect of relevant conduct on the client

We formulated this principle in our previous GPS edition as:

“Does the conduct have an disproportionate harsh, unfair effect on customers?”

A key point here is that the EHF obligation does not preclude the relevant licensee from pursuing its own interests. What it does do, however, is prevent the licensee from unduly impacting on the legitimate interests of the client. These are often fine lines which need to be drawn and evaluated.

As a general rule of thumb, a licensee carrying out activities which it is authorised to do by virtue of statute or contractual provisions agreed with the client will be on the right side of the line. For example, charging advice fees which the agreement with the client permits, or relying on the terms of issue of the relevant financial products; for example only providing insurance cover in certain circumstances (i.e. imposing cover exclusions within the terms of issue of the insurance). But there are both substantive and procedural exceptions to this general rule, discussed in principle below.

In addition, as we discuss in more detail in our previous edition FSR GPS: Efficiently, honestly and fairly in practice, when considering how a licensee’s conduct impacts on the interests of clients, the starting point is an examination of the interests of the client conferred by and existing under the terms of the relevant financial product. So, for example, providing in an advice contract that advice is limited in scope will not be a breach of EHF.

However, additional circumstances may be present to render the provision of general advice only inappropriate or unfair.

Procedural exceptions would involve situations where the conduct of a licensee, even when relying on a contractual (or trust) term, may be a breach of EHF because of the way the term is administered. For example, in the way a fact find which is used for the purposes of investigating the circumstances of a client is conducted.

It follows from the above discussion one must have regard to all the relevant circumstances surrounding the relevant conduct of the licensee.

As we discuss in more detail in Principle 4 below, the conduct of the licensee may involve bad faith or acting for an improper purpose or beyond these, engaging in misleading or unconscionable conduct. These factors may push conduct which is within the scope of conduct authorised under the terms of the contract or least into a breach of EHF. For example, pressure selling; a client may have agreed to be contacted and to receive financial product advice but the manner in which the advice is given represents an unfair treatment of the client.

Another example might involve inappropriately corralling a client into a limited advice scenario where this is contrary to their stated instructions and/or needs and objectives.

Principle 3: Materiality of the conduct

As we have discussed in one of our previous EHF edition FSR GPS: Efficiently, honestly and fairly in practice, neither the EHF obligation or relevant case law offers any real sense of whether a materiality threshold applies.

There are three possible axes of materiality.

The first is whether the EHF obligation is only breached if the licensee’s financial services (plural) are not conducted consistently with the EHF obligation.

This position cannot strictly be correct as if it were, the obligation would have no real bite. Moreover, the reference in section 912A(1) to the “financial services” must be subject to the Acts Interpretation Act rule of interpretation that plural includes the singular (and vice versa). Certainly, no case or decision we are aware of has explicitly taken this view.

The Saxby case (commented upon in our previous EHF edition) is rather opaque in its reasoning and whether it relied on materiality for its conclusion that the EHF obligation was not breached. This decision possibly had at least some regard to the second type of materiality, namely whether the relevant conduct was small or trivial in terms of its impact.

Again there are no real judicial (or statutory) guidelines to give any sense of whether and how this type of materiality could be taken into effect.

It does stand to reason however that some degree of materiality should apply. For example, if in the context of providing financial advice, the vast bulk of statements of advice were issued correctly but only a handful were not, it seems fairly uncontroversial that this would not constitute a breach of EHF, subject to the application of the second principle discussed above – namely in this case, was there a very severe impact on the handful of customers affected?

A possible third type of materiality is the severity of the conduct which is related to the next principle. It is likely that some degree of severity would be required to be present in order for the EHF obligation to be triggered. We attempt to define this aspect with more precision in the next paragraph.

Principle 4: Does the conduct have an “aggravation factor”?

We described this principle in our previous EHF edition in the following terms:

“…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 whether either a harsh outcome of a bad motivation/purpose (e.g. bad faith) can be seen to characterise/taint the incident?”

The relevance of this principle is essentially to do with the prominent role of the fairness component of the EHF obligation. We have clearly noted that the recent AGM Markets case repositioned the EHF obligation as a compendious obligation.

This said, however, it is fairly clear that the fairness element is much more powerful an agent in the EHF obligation than its siblings.

It follows that if various types of aggravated conduct are present, it is far more likely that the EHF obligation will be seen to be breached.

Some examples of aggravated conduct in ascending order of magnitude are:

  1. innocent (but negligent) misleading or deceptive conduct (e.g. incorrect fee information in a statement of advice);
  2. breach of good faith; for example, to use the example cited above, corralling clients into an artificially limited scope of advice;
  3. acting for an improper purpose, for example, deliberately delaying payment of insurance claims in order to profit financially (once claims handling becomes a financial service);
  4. conduct which is “sharp” practice but falling short of the higher unconscionable test of pressure selling; and
  5. acting unconscionably; the previous example in (c) may fit this description, depending on the circumstances.

Principle 5: Were there ways to prevent the conduct?

The reason we have relegated this principle to last is because, as observed in our previous EHF edition, the EHF obligation is not one of strict liability.

Non-compliance is dependent on whether all necessary steps were taken to ensure the relevant financial services were provided efficiently, honestly and fairly. In the vast, vast majority of cases, there will of course be steps that could have been taken to avoid the conduct.

So in this sense, the use of this principle to de-identify conduct from being a breach of the EHF obligation is not going to happen very often.

It might occur where the necessary controls were in place to avoid a breach of the EHF obligations but some uncontrollable or unforeseeable event occurred which thwarted those controls.

But in our view, applying the principles has another more practical purpose; namely it assists in identifying the nature of the breach including many aspects of the previous four principles. For example, if the relevant breach was poor (i.e. substandard) financial advice, the steps that could have been taken to avoid such outcome (such as better training, file reviews etc.) can indicate whether the deficiencies identified fall within the ambit of the other four principles. For example, was the conduct not of a sufficient severity? Was there any aggravated conduct involved?

[1]              Story v National Companies and Securities Commission (1988) 13 NSWLR 661 and see also Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 and Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[2]              R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[3]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[4]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[5]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[6]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[7]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[8]              Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023; (2016) 336 ALR 209 at [673].

[9]              Story v National Companies and Securities Commission (1988) 13 NSWLR 661 and Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[10]             R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[11]             Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[12]             Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023; (2016) 336 ALR 209.

[13]             Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497.

[14]             Re Hres and Australian Securities and Investments Commission [2008] AATA 707; (2008) 105 ALD 124.

[15]             Australian Securities and Investments Commission v Westpac Securities Administration Limited, in the matter of Westpac Securities Administration Limited [2018] FCA 2078.

 

Michael Vrisakis
Michael Vrisakis
Partner
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Fiona Smedley
Fiona Smedley
Partner
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Charlotte Henry
Charlotte Henry
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Steven Rice
Steven Rice
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Tamanna Islam
Tamanna Islam
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Remediation Round-Up: Legal basis for remediation

This article is a part of our Remediation Round-Up series which explores potential issues for financial services licensees when conducting remediation and ways to optimise the design of remediation programs.

 

Issues to consider
Is your potential remediation program:

  • sufficient to cover any statutory, contractual, tortious or equitable claims that customers could bring in respect of the conduct sought to be addressed by the remediation?
  • tailored to address the risk of further litigation or ASIC regulatory action, including potential enforcement action or the use of ASIC’s proposed directions power?

Please get in touch with our experts on remediation issues in respect of financial and credit services if you have any questions.

 

Introduction

Prior to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), remediation for misconduct played a cornerstone role in ASIC’s regulatory strategy. While the Royal Commission has prompted a regulatory pivot towards enforcement, remediation continues to be a central tenet of regulation in financial services.

The obligation to remediate usually arises in the context of a legal liability, deriving from a potential cause of action against a licensee. Effective remediation is important in ensuring protection of consumer interests. But it can also play a crucial role in managing legal and regulatory and reputational risk faced by a licensee (including the potential to reduce future compensation claims and enforcement).

Remediation is also important from the perspective of a licensee doing all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly. In some cases, remediation where it forms part of the financial service might be seen as a necessary step towards negating the relevant defect or misconduct, so as to ensure that the overall service has been provided efficiently, honestly and fairly.

This chapter covers the key legal reasons why licensees may need to consider remediation. It is important for a licensee to consider the source of potential liability as this will impact on the nature and quantum of any remediation.

Remediation is relevant to many different regulatory settings, including statutory regimes governed by ASIC, APRA, the ACCC and AUSTRAC. Unless the context otherwise requires, references in this guidebook to ASIC should be interpreted as extending to these other agencies.

 

Contract, equity and tort

Remediation may arise due to a need to discharge potential liability for:

  • contractual damages;
  • account of profits or breach of trust, where the financial service provider is a fiduciary;
  • equitable compensation for fraud, mistake, unconscionable dealing or any other categories of unconscionable conduct; or
  • tortious damages for negligence or misrepresentation.

 

Statutory causes of action

Remediation of an affected customer may be required where there has been a breach of a legislative obligations, such as:

  • contravention of a civil penalty provision in the Corporations Act 2001 (Cth) (Corporations Act);
  • contravention of a provision of Sub-division C or Sub-division D of the ASIC Act 2001 (Cth) (ASIC Act); or
  • as a superannuation trustee, breach of a statutory covenant under the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act).

In all cases, there must be some loss or damage to the customer that needs to be remedied. In some cases, this will not be immediately apparent. For example, where a customer has made a decision based on defective disclosure, what is the quantifiable loss to the customer that must be remedied?

In some cases, it is either not possible to definitively assess what quantum of loss has occurred or whether certain customers have in fact been impacted, or alternatively, it is prohibitively expensive to investigate and ascertain the exact parameters of customer loss.

 

Case study – remediation reduces liability in litigation

A customer class action was filed against a major bank in relation to the sale of financial products. The class action alleged, among other things, breaches of ASIC Act sections 12CB and 12DA and Corporations Act sections 961B and 961G. With engagement from ASIC, the bank had proactively completed a remediation program to provide refunds for the affected clients, before proceedings were filed. In the class action, the claims would be reduced by the value of the remediation, thereby demonstrating how remediation can be used to mitigate against potential litigation.

 

AFCA systemic issue remediation

The Australian Financial Complaints Authority (AFCA) has broad power to investigate issues that it considers to be systemic in nature. As part of this process, the AFCA Rules empower AFCA to unilaterally require member firms to do or refrain from doing anything to resolve the systemic issue, which specifically includes requiring member firms to remedy loss or disadvantage suffered by a consumer or small business:

“whether or not the recipient of the remedy has complained.

The likelihood that AFCA will investigate a systemic issue may depend on a number of factors such as the nature of the alleged conduct, the volume of customer complaints to EDR and the nature of regulator involvement.

Given this risk, and depending on the circumstances, a remediation program may need to take into account the position that AFCA may take on the approach and scope for remediation, if AFCA were to become involved.

AFCA is also required to report certain matters to ASIC, APRA, the ATO or in some circumstances, any other appropriate body. A mandatory reporting obligation with respect to a particular complaint or issue arises if AFCA:

  • identifies a systemic issue;
  • becomes aware that a serious contravention of any law has occurred;
  • becomes aware of a contravention or breach of the governing rules of a regulated superannuation fund or approved deposit fund, or the terms of an annuity policy, life policy or retirement savings account;
  • becomes aware that a financial services provider may have refused or failed to give effect to a determination made by AFCA; or
  • considers that a complaint that has been settled may require investigation.

AFCA is not specifically required to notify the financial services provider when it intends to report or has reported any of these matters to a regulator. Additionally, these reporting obligations arise when AFCA forms the relevant view about the matter, and in this regard ASIC has indicated that AFCA should not necessarily wait until a matter has been finalised.

 

AFCA external dispute resolution

Individual complaints to AFCA about particular conduct can also result in a member firm being required to provide a greater amount of compensation than that which a customer may be entitled to under the law, and greater than what is offered under a remediation program.

This is because AFCA is not required to make a determination that adheres to the law. Rather, AFCA is required to make a determination primarily by reference to what it considers to be fair in all the circumstances.

In this regard, it may be appropriate to consider whether remediation is warranted to proactively address this risk.

 

Breach reporting and ASIC directions

On 31 January 2020, the Government released exposure draft legislation which will enable ASIC to give binding directions to financial services licensees to address suspected prior or future contraventions of a financial services law.

This will give ASIC a far-reaching new power to give directions, including a direction on a licensee to establish and implement a specified customer compensation program as prescribed by ASIC.

The directions power is expected to give ASIC a tool to mandate particular aspects of a remediation program, without a need for lengthy negotiation. For example, it may be possible that a direction could be given to require remediation to occur:

  • to specified classes of affected customers;
  • through specified methods (e.g. with specified requirements around the format, timing and content of communications with customers); and
  • of a specified amount to each affected customer.

These powers have not yet been enacted, and it remains to be seen how intrusive they may be and how ASIC will use them.

 

Ex gratia remediation

In some cases, a licensee may determine to implement an ex gratia remediation program. This could be for reputational reasons, as well as to avoid having to undertake a costly and time consuming review to determine whether remediation is legally required.

In such cases, the licensee will need to give careful consideration to the proposed remediation approach, including the quantum of remediation and whether the remediation should be used to seek a discharge from potential future claims.

 

Determining whether the remediation exercise is ex-gratia or is in satisfaction of a legal obligation

This is an important issue as it is often not clear whether the relevant financial institution has a strict legal obligation to compensate or is rather offering payments on an ex-gratia basis. In some cases, there may be a legal obligation but the financial institution is knowingly paying above the required level of compensation because it is too difficult or too costly to determine the exact quantum of compensation.

 

‘Efficiently, honestly and fairly’

The Corporations Act 2001 (Cth) (Corporations Act) imposes a statutory obligation on financial services licensees to:

“do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly”

Although customers do not have standing to make a claim for compensation for a breach of this obligation, ASIC has expressed a view that the obligation itself requires licensees to remediate customers ‘if things go wrong when financial services are provided and clients suffer loss or detriment’.[1]

This view does assume that remediation is a material part of a financial service (noting that above obligation applies to financial services covered by the Insurer’s AFSL).

From one perspective, in a situation where a financial service has not been provided efficiently, honestly and fairly, remediation might be seen as a necessary step towards negating the relevant defect so as to ensure that the overall service has been provided efficiently, honestly and fairly.

For example, it could be said that a customer who is charged an incorrect fee for a financial service will still have been provided the service efficiently, honestly and fairly if they are appropriately compensated for any excess fee.

Less clear is ASIC’s position that affected customers should be identified and compensated in an ‘efficient, honest and fair manner’. This has not been tested in court, and in any case the actual extent to which licensees would be required by this obligation to conduct remediate customers in a particular manner will depend significantly on the particular facts of a situation. such as:

  • the practicality, cost and time requirements of taking one possible remediation approach over another;
  • the quantum of remediation that affected customers are legally entitled to receive, weighed against the cost of a particular remediation approach; and
  • the number and proportion of affected customers that are likely to receive compensation.

 

Sources of compensation funds

An integral part of remediation is to consider where funding for remediation will emanate from. Issues of insurance cover, the right of indemnification for trustees, third party redress, as well as whether shareholder funding is necessitated may be relevant to a particular remediation exercise. These issues will be addressed in a future article of the Remediation Round-Up series.

 

To keep up to date with the Remediation Round-Up series and our latest regulatory updates see our blog FSR Australia Notes.

 

[1] RG 256.14

 

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
Philip Hopley
Philip Hopley
Special Counsel
+61 2 9225 5988
Steven Rice
Steven Rice
Special Counsel
+61 2 9225 5584
Lesley Symons
Lesley Symons
Executive Counsel
+61 7 3258 6704
Tamanna Islam
Tamanna Islam
Senior Associate
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Shan-Verne Liew
Shan-Verne Liew
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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

Regulatory “Rinkles”: Spotlight on efficiently, honestly and fairly

By Michael Vrisakis

This edition of Regulatory Rinkles deals with the scope of the concept of “financial services” for the purposes of assessing the obligations of an Australian financial services licensee under Division 3 of Part 7.6 of the Corporations Act, primarily section 912A.

The issue is of particular relevance in the context of the obligation of a financial services licensee to “do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly”.

It is also particularly important because the obligation to act efficiently, honestly and fairly is viewed by industry protagonists as an overriding general obligation.

In reality, the obligation only attaches to the provision of a “financial service”.

Hence, the concept and ambit of a financial service are very important matters to elucidate, particularly given:

  • the recent case law focus on the concept; and
  • the recent elevation of the obligation.

 

The starting point

The starting point to understand the concept of a “financial service” is, of course, the definition in the Corporations Act.

Section 766A(1) of the Act contains 7 manifestations of a financial service, namely:

  1. providing financial product advice;
  2. dealing in a financial product;
  3. making a market for a financial product;
  4. operating a registered scheme;
  5. providing a custodial or depository service;
  6. providing a crowd-funding service; and
  7. engaging in conduct of a kind prescribed by the Corporations Regulations.

For present purposes, our focus will be on the first 2 limbs: providing financial product advice and dealing in a financial product.

In one sense, these concepts are straight-forward as they are specifically defined in the Corporations Act.

Starting with the former, “financial product advice” is defined as a recommendation or statement of opinion, or a report of either of those things which:

  • is intended to influence a person or persons in making a decision in relation to a particular financial product or class of financial product or an interest in a particular financial product or class of financial product; or
  • could reasonably be regarded as being intended to have such an influence.

It is not necessary for present purposes to explore the distinction between general advice and personal advice.

The Corporations Act excludes certain matters from this definition, such as the giving of an exempt document or statement (see section 766B(1A)).

Turning to the latter, the concept of “dealing in a financial product” is addressed in section 766C and contains the following 5 points:

  1. applying for or acquiring a financial product;
  2. issuing a financial product;
  3. underwriting securities and interests in managed investment schemes;
  4. varying or disposing of a financial product; and
  5. disposing of a financial product.

Arranging for a person to engage in any of these activities is also a dealing, unless the actions concerned amount to providing financial product advice.

Again, certain exclusions apply under the Corporations Regulations.

 

The tail of the tiger

The real challenge in this space is to determine how broad or otherwise the concept of financial service is for the purposes of section 912A of the Corporations Act. This will determine how pervasive the obligation of efficiency, fairness and honesty is.

Take the area of financial product advice. Clearly, it is easy enough to determine what constitutes advice. But the real issue is what ancillary or related matters might be captured by the primary concept.

For example, remediation in the context of financial product advice. The concept of financial advice covers the provision of the advice (ie the giving of the advice), but also activities which are either part of the provision of the advice or are integral to it (see below).

So for example, remediation of defective advice would logically seem to be part of the provision of the advice (and therefore, the financial service). In this regard, it would be curious if the obligations in section 912A did not extend to remedying any defective advice. ASIC is also of this view in ASIC Regulatory Guide 256 Client review and remediation conducted by advice licensees (RG 256), where it states at RG 256.13 and RG 256.14:

“All AFS licensees have an obligation to ensure that their financial services are provided efficiently, honestly and fairly: s912A(1)(a) of the Corporations Act 2001 (Corporations Act).

Complying with this obligation includes AFS licensees taking responsibility for the consequences of their actions if things go wrong when financial services are provided and clients suffer loss or detriment. This includes remediating clients who have suffered loss or detriment as a result of misconduct or other compliance failure by the licensee or its current or former representatives.”

It is more difficult to enunciate the relevant legal principle at work here. Probably a good enunciation is that the concept of financial product advice covers elements which are either part of the core concept (ie the actual giving of the advice) or are integral to its proper delivery, which would include the remediation in respect of the advice.

Turning to the concept of issuing a financial product (as part of the financial service of dealing), the same test could be applied. In other words:

  • what is encompassed within the core of the concept; and
  • what is essential or integral to the concept?

The concept of “issue” is defined in section 9 to include:

  • in relation to interests in a managed investment scheme, making available; or
  • otherwise, circulating, distributing and disseminating.

The second limb which refers to distribution is interesting.

This reference seems more relevant to the giving of documents such as a product disclosure statement, rather than the issue of an interest in a financial product.

This seems the right interpretation, as where the issue of a financial product means distribution of a financial product, the concept could extend to the whole distribution chain.

However, this does not appear to be the preferred interpretation, noting that:

  • the note to the definition of “issue” uncontroversially states that the meaning of issue is affected by section 761E (discussed above); and
  • the concept of distribution of a product would overlap significantly with the concept of “financial product advice”.

In order to triangulate the reach of the concept of “issue” for the purposes of section 912A of the Corporations Act, it is useful to look at the other occurrences of the term in the Corporations Act (and in particular, in Part 7.9).

In section 1018A of the Corporations Act, relating to the advertising of financial products, the distinction is made between, on one hand, advertising and publishing a statement likely to induce acquisition (sub-sections 1018A(1)(a) and (b)) and on the other hand, the concept of “issue” used in section 1018A(1)(c).

Similarly, in section 1041H of the Corporations Act dealing with misleading or deceptive conduct:

  • sub-paragraph (b)(i) refers to issuing; and
  • sub-paragraph (b)(ii) refers to publishing a notice in relation to a financial product.

The term “notice” in section 9 of the Corporations Act is defined to include a circular and an advertisement.

Contrast the term “statement” in section 1018A, which is defined (also in section 9) to include, in the context of Chapter 7, “matter that is not written but conveys a message.”

It is submitted that the above variety of usages of the term support the concept of “issue” meaning the actual vesting of the relevant financial product in the relevant client; rather than, say, the prior distribution process and activities in relation to the financial product.

On the basis of the above, it would appear therefore that the concept of “issue” would encompass:

  • the actual vesting of the financial product in the client; this would normally involve the creation of legal rights in the product and the client obtaining those rights. So for example, in the case of the issue of a life insurance product, it would capture the entering of the client into the register of life policies. Clearly however, the concept must have a wider catchment for the purposes of section 912A;
  • integral aspects, such as the acceptance and treatment of application monies, which form part of the “issue” would seem captured (noting the specific requirements of other relevant provisions of the Corporations Act, such as section 1017E) (on this general point, see commentary below); and
  • rectification of a defective issue of a financial product.

In the last 2 instances, whilst it seems incontrovertible that these elements are integral to the concept of “issue”, it must be remembered that the Corporations Act contains specific provisions dealing, to some extent, with those elements. We have mentioned section 1017E in the context of the processing of application monies. In relation to a defective issue of a financial product, caused by a defective PDS, specific provisions apply under sections 1016E and 1016F.

The obligation of efficiency, honesty and fairness in section 912A should not however be used as a substitute or “filler” for specific regulatory provisions of the type just canvassed.

Another relevant financial service will be the concept of “arranging” for a person to deal in a financial product. It is beyond the scope of this article to traverse in full detail the parameters of this concept.

Suffice to say that the process of arranging for a client to deal in a financial product, by say, the acquisition of the product or the varying of the financial product is almost certainly going to be captured by the efficient, honest and fair obligations in section 912A.

As such, it would capture activities by licensees and representatives who arrange the issue of a financial product (or its variation) through a facilitation of that process. which amounts to an arranging (ASIC Regulatory Guide 36 Licensing: Financial product advice and dealing is relevant in this regard).

No doubt there will be many other activities in dealing, advising and arranging, which financial service licenses will focus on in the context of the obligations contained in section 912A, especially in relation to the efficient, honest and fair obligation.

Furthermore, the concept of financial services continues to expand, most notably having regard to proposed reforms to include insurance claims handling and providing a superannuation trustee service as specific financial services under section 766A(1) of the Corporations Act. This would certainly expand the application of the efficient, honest and fair obligations to what are traditionally administrative or ancillary aspects of providing another financial service (such as dealing in insurance or superannuation products).

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411