Regulatory “Rinkles”: Efficiently, honestly and fairly (Part 2)

This is the second part on this theme. The first part examined the concept of ‘financial services’ as a key component of the scope of the duty. This continues the analysis by looking at how financial institutions can respond to the duty, particularly at a practical level and also given the increased regulatory sanctions with the obligation now being transformed into a civil penalty provision.

1    The status quo

For many years, the ‘efficiently, honestly and fairly’ obligation was seen as one which involved an aggregate obligation. This interpretation followed from the decision of Young J in Story v National Companies & Securities Commission,[1] a matter involving consideration of whether a securities dealer had acted “efficiently, honestly and fairly” for the purposes of the Securities Industry (New South Wales) Code 1980. Relevantly, his Honour said:

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 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, trying 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, honestly and fairly” must be read as 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.[2]

2    Quo vadis the status quo?

The position in Story was settled law for many years. However, after the discussion in the 2019 case of ASIC v Westpac Securities Administration Limited,[3] there was good reason to doubt that the law from Story should be followed. From reading this decision of the full Federal Court, one could be forgiven for holding the view that the provision is made up of three individual obligations; that is (at the risk of repetition!) to:

  • carry out the relevant financial services efficiently; and
  • carry out the relevant financial services honestly; and
  • carry out the relevant financial services fairly,

with each operating as three separate obligations.

In ASIC v Westpac, the Chief Justice stated:

The phrase [efficiently, honestly and fairly] has been held to be compendious as a single, composite concept, rather than containing three discrete behavioural norms.  That said, if a body of deliberate and carefully planned conduct can be characterised as unfair, even if it cannot be described as dishonest, such may suffice for the proper characterisation to be made.[4]

While the Chief Justice was prepared to focus on fairness as the primary obligation in the circumstances where the financial services licensee “set out for [its] own interests to seek to influence a customer to make a decision on advice of a general character when such decision can only prudently be made having regard to information personal to the customer”, he also suggested this was an issue for examination in proceedings where it was fully argued. Justice O’Bryan, on the other hand, more firmly rejected the “compendious” view:

it seems to me that there is no reason why it cannot carry its ordinary meaning which includes an absence of injustice, even-handedness and reasonableness. As is the case with legislative requirements of a similar kind, such as provisions addressing unfair contract terms, the characterisation of conduct as unfair is evaluative and must be done with close attention to the applicable statutory provision: cf Paciocco v Australia and New Zealand Banking Group Ltd (2015) 236 FCR 199 at [364]. It seems to me that the concepts of efficiently, honestly and fairly are not inherently in conflict with each other and that the ordinary meaning of the words used in s 912A(1)(a) is to impose three concurrent obligations on the financial services licensee: to ensure that the financial services are provided efficiently, and are provided honestly, and are provided fairly.[5]

Justice Jagot did not express such reservations and agreed with the conclusions of the trial judge on this issue.

We note that the High Court has given special leave to Westpac to appeal the full Federal Court decision, however we do not expect that the issues around the interpretation of the efficiently, honestly and fairly obligation will be ventilated.

3    Back to the future?

Since the decision in ASIC v Westpac however, in the subsequent Federal Court decision of Australian Securities and Investments Commission v AGM Markets Pty Ltd (in liquidation) (No 3),[6] Justice Beach was prepared to revert to the previous historical and conventional judicial interpretation where the obligation is seen as an aggregate obligation comprising the three combined limbs and essentially concerned with ethical conduct. His Honour referred to his earlier decision in Australian Securities and Investments Commission v Westpac Banking Corporation (No 2)[7] and said:

First, the words “efficiently, honestly and fairly” are to be read as a compendious indication requiring a licensee to go 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.

Second, the words “efficiently, honestly and fairly” connote a requirement of competence in providing advice and in complying with relevant statutory obligations. They also 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. I have emphasised here the notion of connotation rather than denotation to make the obvious point that the boundaries and content of the phrase or its various elements are incapable of clear or exhaustive definition.[8]

His Honour applied similar principles in the more recent decision in Australian Securities and Investments Commission v Commonwealth Bank of Australia [2020] FCA 790 (5 June 2020) (ASIC v CBA).

As mentioned, in this edition, we will attempt to provide practical guidance for financial institutions in terms of how they can assess and respond to the dimensions of the obligations.

4    Fairness as a lynchpin – practical issues

Given that fairness is a core element of the obligation to act efficiently, honestly and fairly, what does being ‘fair’ mean in this context? In fact, ‘fairness’ can be broken down into six principles.

Principle 1:  Fairness is heavily concerned with outcomes (although it will also capture procedural or process fairness). Even as a compendious obligation, the cornerstone of the obligation is fairness, not least because the concepts of efficiently and honestly are fairly uncontroversial.

Honesty is a well understood concept (although see our comments in Principle 4 below).

Efficiency is a little more complex insofar as various case law such as Story points out, it could operate contrary to the concept of fairness insofar as something might be seen as efficient but might not be seen as fair to the relevant client-base.

The first point to note is that fairness is a concept which applies to not just the relevant clients but also to the licensee. In other words, it requires and justifies consideration of, and allowance for, the interests of the licensee and of the clients.

It would be wrong therefore, to proceed on the basis that fairness is solely about the interests of the relevant clients.

The second point to note is fairness is different to other seemingly similar obligations such as the common law duty of care or the equitable duty to act in the best interests of beneficiaries.

We note that the latter obligation of best interests is concerned with process and the conduct of the trustee in its decision making, not outcomes.

This is the key conclusion of the New South Wales Court of Appeal in the decision in Manglicmot.[9]

So fairness looks to outcomes. As such, it is clear that the obligations must focus on the interests of both the licensee and the client(s).

This leads to the next principle which relates to interests.

Principle 2:  Fairness is about protecting clients’ interests in a broad sense. The interests that the duty of fairness protects includes the interests of clients as conferred by a constituent document such as the relevant contract or trust deed but it also is likely to be construed by a court as extending to general interests of clients going beyond the narrower interests which arise from the relevant “bargain” or arrangement made between the client and the licensee. It is suggested that this position contrasts with specific statutory duties which require the prioritisation of the interests of clients where case law suggests that the relevant interests to be prioritised are those conferred by the relevant constituent document.

So interests of the client are likely to now encompass the way in which the licensee discloses information to the client, the way in which the licensee communicates more generally to the client and the way the licensee deals with the benefit of the client, and other types of similar interactions with the client.

This said, it is only the conduct of the licensee in the provision of a financial service which is captured (see Part 1 of Spotlight on efficiently, honestly and fairly).

Principle 3:  the concept of fairness has a core of reasonableness.

When evaluating the scope of content of the obligation, a useful starting point is whether the licensee is acting reasonably in the provision of the financial service.

In this sense, a useful comparator might be the duty of good faith as it exists in various areas of the common law.

Often this duty is referenced as requiring the holder of the duty to not unreasonably deal with the interests of the counterparty. For instance, in Dillon v Burns Philp Finance,[10] in the context of an superannuation trust deed under which the settlor company was tasked with forming an opinion as a means of determining a fact significant for the rights of the employee and employer sponsor, Justice Bryson stated:

“the parties cannot be supposed to have contracted on any view that the principal company could form an opinion with a view to serving its own interests, to the exclusion of a fair consideration of the interest of the employee and of the rights which the rules purport to confer.”

Principles of unconscionability and other related concepts may also be part of the chemistry of the obligation; for example, Chief Justice Allsop’s observation in Paciocco can be considered:[11]

honesty in behaviour; a rejection of trickery or sharp practice; fairness when dealing with consumers; the central importance of the faithful performance of bargains and promises freely made; the protection of those whose vulnerability as to the protection of their own interests places them in a position that calls for a just legal system to respond for their protection, especially from those who would victimise, predate or take advantage…

Translated into an obligation of fairness, the core of the obligation might be referenced as:

Does the conduct involved in the provision of the financial service unreasonably affect or erode the interests of the client(s)?

So one approach to assessing whether conduct of a licensee is fair, is to consider:

  • What are the consequences of the conduct vis-à-vis the client?
  • As part of that, how does the conduct affect their interests?
  • Have the clients’ interests been dealt with reasonably or unreasonably?

Before proceeding to looking at some examples, the relationship between the fairness element of the total obligation and the elements of honestly and fairly needs to be considered.

As has been commented on above, efficiency stands apart from fairness and honesty.

If the relevant financial service is governed by a contract with the client, if the licensee properly carries out the terms of the contract and provides the relevant consideration required of it, prima facie this would not seem to be able to be characterised as a breach of the obligation.

But if the licensee engages in misfeasance such as misrepresentation or the consideration provided by the licensee is illusory or arguably does not provide real and genuine value, the obligation might be seen to be activated.

One particular way to reconcile these elements as a single composite obligation is to envisage that efficiency could be viewed as operating in tandem with fairness so that a licensee must perform activities not just efficiently, but efficiently in a fair way. This standpoint flows from the dictum from ASIC v Westpac (No 2) cited in section 3 above.

This approach is not too dissimilar to the historical case law interpreting the obligation which sought to see the obligation as essentially one of ethical conduct, first in the tribunal decision of Re Hres and ASIC[12] which was then followed by the Federal Court in ASIC v Camelot Derivatives Pty Limited[13] a decision of Foster J which was supported by Beach J in ASIC v CBA as discussed above.

Principle 4: Whilst the current judicial interpretation might favour the composite nature of the obligation, a court in our opinion is unlikely to require all three elements to be breached in order to find an overall breach.

For example, one criterion might be breached in such a material way that the other elements will be regarded as being breached. This seems to be the approach taken by the Chief Justice in ASIC v Westpac. We also would observe that the criterion of honesty might be treated as more verging on ethical conduct rather than the strict concept involving mens rea.

Principle 5: Is there a specific statutory provision that the deficient conduct breaches, such that the efficiently, honestly and fairly obligation may not have been intended to apply?

We know that the obligation does not require a contravention or breach of a separately existing legal duty or obligation. But, Justice Beach said in ASIC v AGM Markets that the duty “is not a back door into an “act in the [best] interests of” obligation. Other specific provisions of the Act nicely fulfil that role”.[14]

Principle 6:  The extent of the relevant deficient conduct. As we know, the obligation applies to the provision of the relevant financial services.

The Corporations Act does not specify or clarify whether the obligation is breached if a particular financial service is carried out deficiently (although this must be the effect as the plural reference will include the singular) or indeed if there is any materiality or extent of the deficient conduct which acts as a threshold.

In other words, just what extent of deficient conduct in the provision of a financial service activates the provision? Is it activated when only a small element of a financial service or services is deficient or only where some more substantial activity is deficient?

A very minor incident proportionate to the total activity comprised in the relevant financial service might not mean that the financial service has been carried out inefficiently, dishonestly or unfairly.

5    Examples

Some examples serve to illustrate the relevant issues licensees will need to consider:

  1. Out of 10,000 annual statements for a superannuation product, 500 are issued late.
  2. A licensee formulates an approved product list (APL) with some of its own products on the list but the majority are not its products.
    It commissions research for the other products to justify their inclusion on the APL but does not do so for its own products.
  3. A licensee who is a product issuer determines to launch a new financial product.
    The product provides insurance cover for certain events which although represent some real risks of occurrence, could be covered in terms of risk by a simpler, cheaper alternative insurance product, and so lack of value is an issue.

In example A, consider whether mere oversight or negligence would breach the obligation. It is true that courts are probably moving to see negligence as constituting inefficiency. Actual circumstances of the incident will still be very relevant; for example, reckless failure of relevant compliance systems might tip the balance.

In example B, again the actual circumstances may tip the balance; was internal research commissioned and, if so, would that be sufficient validation (by way of general analogy only, cf ASIC Regulatory Guide 256 Client review and remediation conducted by advice licensees, where independent expert input for remediation may or may not be required)? Consider if the licensee did not benchmark its own products because of self-interest (i.e. conflicts of interest played a role).

In example C, an issue here is whether again the licensee deliberately formulated the product with no regard to the value of the product to the customer; i.e. absence of value is the issue.

6    Working through ‘efficiently, honestly and fairly’: a different calculator!

Rather than provide specific answers, it seems to us that one can synthesize an assessment tool which can be used to assist in the evaluation of any given perceived deficiency in the conduct of the licensee.

First, did the conduct/activity occur in the provision of a financial service?

A drill down question here is whether the relevant conduct/activity is either core to the relevant financial service for a licensee or an integral element of the service.

Second, is the conduct unethical or at least unfair?

A drilldown question here is to consider whether the relevant conduct/activity unreasonably affects or erodes the interest of/position of the client.

Refer to the more micro questions set out above under Principle 2.

Third, is there some materiality threshold that could/should be applied?

Note, that this issue is not crystal clear.

Most case law discussions have not had regard, at least not explicit regard, to the extent the relevant deficient conduct impacts on the relevant financial service(s).

It may be that unless the impact is very minor (i.e. de minimis) a court would hold that any deficient conduct of the relevant type in the provision of a financial service means that it has not been provided efficiently, honestly and fairly and since the plural term “financial services” used in section 912A(1)(a) indicates the singular, there has been a breach of the obligation.

[1] (1988) 13 NSWLR 661 (Story).

[2] (1988) 13 NSWLR 661 at 672.

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

[4] [2019] FCAFC 187 at [170].

[5] [2019] FCAFC 187 at [426].

[6] [2020] FCA 208 (ASIC v AGM Markets).

[7] [2018] FCA 751 (ASIC v Westpac (No 2)).

[8] [2020] FCA 208 at [505].

[9] Manglicmot v Commonwealth Bank Officers Superannuation Corporation Pty Ltd [2011] NSWCA 204.

[10] Unreported, Supreme Court of New South Wales, Bryson J, 20 July 1988.

[11] Paciocco v Australia and New Zealand Banking Group Limited [2015] FCAFC 50 at [296].

[12] [2008] AATA 707.

[13] [2012] FCA 414.

[14] [2020] FCA 208 at [522].

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Steven Rice
Steven Rice
Special Counsel
+61 2 9225 5584

FINANCIAL PRODUCT DISCLOSURE IN THE AGE OF COVID-19

By Michael Vrisakis, Tamanna Islam and Sky Kim

 

The way we live, work and socialise have not been the only changes owing to the COVID-19 pandemic – the Government has also been led to introduce a variety of measures affecting the financial services industry, including the reduction of default minimum withdrawal rates for pensions (for 2019-20 and 2020-21) and allowing for temporary early release of superannuation.

The economic impact caused by the pandemic also means that many sections in a product disclosure statement (PDS) may need to be updated, including significant risks, liquidity, distribution policy, asset allocations and valuations, underlying assumptions and fees and costs. This poses important questions for financial product issuers, who have ongoing obligations under the Corporations Act 2001 (Cth) (Corporations Act) to ensure that their PDSs are kept up to date and to notify holders of financial products of material changes and significant events.

Product issuers who are required to, or wish to, update their PDSs in a cost-effective and expeditious manner, are provided some useful practical relief under the ASIC Corporations (Updated Product Disclosure Statements) Instrument 2016/1055 (Instrument). An important regulatory marker to pay attention to is the key restriction on using the Instrument, namely that the updated information cannot be materially adverse. We explore this concept in further detail below as well as what types of changes need to be disclosed and what disclosure options might be available to product issuers, including if and when the Instrument could be relied upon. Greater flexibility exists, in our opinion, to add product changes and deal with COVID-related operational changes than might have been thought to be the case.

 

What types of changes need to be disclosed?

As a starting point, section 1012J of the Corporations Act provides that the information in a PDS must be up to date at the time it is given. A PDS must also not otherwise be “defective” under the Corporations Act.

Updated information may relate to any aspect of the PDS or the product, whether materially adverse or not. A supplementary product disclosure statement (SPDS) containing updated information may be given with a PDS that is out of date (other than in the case of a short-form PDS). Alternatively, the product issuer may issue a new PDS (ie a PDS roll), although this clearly has cost, time, operational and other logistical implications.

Any changes that impact the significant characteristics and features of a financial product, the rights, terms and conditions and obligations attaching to the product or any other information relevant to the acquisition decision must be disclosed via an update to the PDS to prevent the PDS from being out of date or defective.

It should be noted that it would not be necessary to update a PDS in relation to information which, as contemplated by section 1013F of the Corporations Act, is not required to be included in the PDS because it would not be reasonable for a retail client to expect to find this information in the PDS. An example might be the new superannuation access scheme which because of Government, media and regulatory publicity, may not be information that a retail client would reasonably expect to find in the PDS.

 

What can be disclosed without a SPDS or a new PDS?

A SPDS or a new PDS containing updated information may be used to prevent a PDS from becoming non-compliant on the basis of the PDS being outdated or defective. However, not all disclosures will require a SPDS or a new PDS, as the Instrument permits any updates that do not include “materially adverse” information may be disclosed elsewhere, subject to the following conditions being met:

  • The PDS was up to date at the time when it was prepared;
  • the updated information in relation to the PDS does not include any materially adverse information;
  • The issuer has taken reasonable steps to ensure that the PDS clearly and prominently explained that information that is not materially adverse information is subject to change from time to time and may be updated by means described in the PDS, explained how that updated information can be found out at any time, and stated that a paper copy of any updated information will be given, or an electronic copy made available, to a person without charge on request;
  • The issuer has taken reasonable steps to establish and maintain means by which a person may find out any updated information, being means that are simple and involve no charge and little inconvenience to the person, having regard to the kinds of persons likely to consider acquiring the financial product to which the PDS relates; and
  • The issuer has taken reasonable steps to make available any updated information as soon as practicable to each regulated person to whom the PDS has been provided for further distribution and to cause a copy of any updated information to be kept for 7 years after it is prepared.

The effect of the above is that even if the updated information would ordinarily require the issue of a new PDS or a SPDS, this would not be required as long as the information is not materially adverse to the holder, the issuer met the other conditions of the Instrument, including by establishing other simple means by which the holders can access any updated information (such as website disclosure).

From a practical perspective, it is important to remember that the Instrument may only be used for PDSs that become out of date. The Instrument relief cannot be used in respect of defective PDSs as any changes to correct a defective PDS would be materially adverse, as per the definition in section 1021B of the Corporations Act.

Therefore, there must be a change in order for the Instrument to be used. The Instrument is ideally suited to update a PDS for non-materially adverse COVID-19 changes instituted by the product issuer to the product itself or an associated administrative process. In addition, it can also be used for other changes affecting the information in the PDS which are not made by the product issuer, such as regulatory changes (including during COVID-19).

It is always important to bear in mind that the Instrument cannot be used in all cases of an out of date PDS. Where a PDS has become out of date by reason of a materially adverse change (ie the PDS becomes defective), the Instrument cannot be used because, as noted above, the information has become materially adverse and the central condition in the Instrument is therefore not satisfied.

 

What constitutes “materially adverse” information?

There are several ways in which additions to or other modifications to information contained in a PDS could be materially adverse. For example, adding restrictions to withdrawal criteria in superannuation, or increasing the frequency of indexation of fees would constitute materially adverse information. The concept of “materially adverse” information is defined in the Instrument as:

“information of a kind the inclusion of which in, or the omission of which from, a Statement would render the Statement defective within the meaning of section 1021B of the Act”.

This concept of “defective” is, in relation to a disclosure document or statement, defined as:

  1. there is a misleading or deceptive statement in the disclosure document or statement; or
  2. if it is a PDS — there is an omission from the PDS of material required by section 1013C, other than material required by section 1013B or 1013G (content requirements); or
  3. if it is a SPDS that is given for the purposes of section 1014E—there is an omission from the SPDS of material required by that section; or
  4. if it is information required by paragraph 1012G(3)(a)—there is an omission from the information of material required by that paragraph;

being a statement, or an omission, that is or would be materially adverse from the point of view of a reasonable person considering whether to proceed to acquire the financial product concerned.

 

The content requirements include that a PDS must contain information:

  • about the significant characteristics and features of the product, or of the rights, terms and conditions and obligations attaching to the product (section 1013D(1)(f) of the Corporations Act); and
  • that might reasonably be expected to have a material influence on the decision of a reasonable person, as a retail client about whether to acquire the product (section 1013E of the Corporations Act).

Importantly, the concept of “materially adverse” requires the information to be both material and adverse from the perspective of a reasonable person deciding whether to acquire the product. It is not enough that the information is merely “material”, as required under section 1013E of the Corporations Act.

 

What changes can the Instrument be used for?

A key issue relevant to relying on the Instrument to update the contents of a PDS, particularly in the current climate, is just exactly what type of content can be added to, varied or replaced in the PDS.

At first blush, this may seem a trite issue. The reality, however, is a little different. Section 1012J simply stipulates that the information in the PDS must be up to date as at the time it is given. This indicates that changes to any information which is in the current PDS must be updated in the PDS at the time it is given to the retail client. This contextualisation requires one to focus on the types of information which are included in the PDS.

The Corporations Act very clearly states that a PDS contains, or can contain, two categories of information, as follows:

  • statements and information required by the Corporations Act (ie Division 2 of Part 7.9). Information required to be included in the PDS fits into two sub-categories. The first is specific information required by section 1013D. The second is any other information which might be expected to have a material influence on the decision of a reasonable person, as a retail client about whether to acquire the financial product, as required by section 1013E; and
  • any other information which may be included in the PDS but which is not required.

Although differing legal views have been expressed, it remains our unequivocal view that by reason of section 1013C, the Instrument can be used not only to update information required by the Corporations Act (ie as referred to in section 1013C(1)(a)) but to update any other information that has been included voluntarily (ie as referred to in section 1013C(1)(b)).

The implications of this legal position are significant for product issuers who wish to rely on the Instrument to deal with COVID-19 related changes. This is because they will be able to rely on the Instrument to update information in the PDS:

  • where the product features or other information required by section 1013D changes such as information about:
    • fees and costs;
    • significant characteristics or features of the product or of the rights, terms and conditions and obligations attaching to the product; or
    • significant risks associated with the product,

subject to the materially adverse condition; and

  • any other changes to the information contained in the PDS. This is very broad, as it captures voluntary disclosure as flagged above.

The use of the word “update” suggests that the content is being changed which could mean additions, subtractions or modifications to the existing information in the PDS.

To understand how wide the use of the Instrument would be, it is useful to identify some practical examples:

  • Scenario 1: A superannuation trustee lowers the minimum investment amount for its superannuation product due to COVID-19

The trustee may rely on the Instrument and update this information via its website, as the information is unlikely to be materially adverse to a prospective member.

  • Scenario 2: A superannuation trustee issues pensions-based investment products and must disclose the reduction of default withdrawal rates for pensions by 50% for 2019-20 and 2020-21 as a result of COVID-19

The trustee will be able to successfully rely on the Instrument on the basis that the information update is unlikely to be materially adverse to prospective pensioners and instead, is a factual update of statutory changes.

  • Scenario 3: The responsible entity of a managed investment scheme must change its asset allocations disclosed in its PDS due to changed economic conditions as a result of COVID-19

It is likely that the responsible entity will need to make the change through an updated PDS or a SPDS, as the changing asset allocations may constitute materially adverse information.

  • Scenario 4: An insurer is increasing its fees and charges due to changed economic conditions as a result of COVID-19

The insurer will need to issue an updated PDS or a SPDS. This is because an increase in fees and charges is materially adverse information which means the Instrument will not apply.

  • Scenario 5: A superannuation trustee wishes to disclose additional withdrawal options available to members, such as introduction of financial hardship withdrawals during COVID-19

The trustee may rely on the Instrument and update this information via its website, as the information is unlikely to be materially adverse to a prospective member.

Beyond these specific examples, there are a range of disclosure situations in which the Instrument can be relied upon (which in addition to the specific examples above assume that the Instrument conditions are satisfied), such as:

  • Certain changes to product features: This could cover switching restrictions, withdrawal restrictions, changes to indexation and eligibility criteria;
  • Information relating to regulatory matters: This could cover changes to the way the product is legally regulated, for example, changes to legislated withdrawal amounts; and
  • Information relating to operational matters: This type of information will often fall into the reasonably expected information (see discussion on section 1013E above) or information voluntarily disclosed (see discussion relating to section 1013C(2) above). This can include matters such as:
    • application or redemption processes;
    • unit pricing methodology and asset valutions; or
    • hardship withdrawal requirements.

 

Significant Event Notices

Section 1017B of Corporations Act requires ongoing disclosure of material changes and significant events, as well as a significant event notice (SEN) where there is any material change to a matter or significant event that affects a matter that would have been required to be specified in a PDS for the financial product. This updating obligation does not apply to widely held managed investment schemes where 100 or more people hold units in a class where the offers of those units required a PDS (where the units are ‘ED securities’).

If the change is an increase in fees or charges, then the SEN must be issued 30 days before the change takes place. The SEN must include all information that is reasonably necessary for a product holder to understand the nature and effect of the event.

If the change is not an increase in fees or charges, then the SEN should be given before the change or event occurs or as soon as practicable after, but not more than 3 months after the change or event occurs. However in some cases the SEN may be given more than 3 months after the change or event occurs if the issuer reasonably believes that the event is not adverse to the holder’s interests and accordingly, the holder would not be expected to be concerned about the delay in receiving the information. In this case, the information must still be given within the period of 12 months after the change or event occurs. By relying on this provision, issuers can provide updates by other member communications such as annual reports, making it a more cost-effective option with less operational impact.

 

Misleading or deceptive conduct

A PDS is defective if it includes a misleading or deceptive statement that is materially adverse. The term “misleading” is defined at sections 12BA and 12BB of the ASIC Act as where:

  • a person has made a representation to a future matter (including the doing of an act); and
  • the person does not have reasonable grounds for making the representation (but the 12BB definition expressly states (at section 12BB(4)) that it does not limit what is meant by the term misleading.

 

The term “deceptive” is not defined under the ASIC Act or the Corporations Act.

In its paper, ‘The AFCA Approach to Misleading Conduct’, the Australian Financial Complaints Authority outlines misleading conduct as conduct that:

  • leads, or is likely to lead, someone into error or to believe something that is false;
  • can happen when a financial firm says something that is wrong, acts in a way that misleads a complainant or does not say or do something when it should; and
  • can occur even if the financial firm did not mean to mislead or the complainant could have found out the true position by looking into the matter further.

Therefore, it is important to ensure that despite the means by which the update is communicated to the product holders, any updates of the information contained in the PDS will not be rendered misleading as a result of the updated information.

This continues to be an area of regulatory focus by ASIC.

 

Pythia’s wisdom: The Instrument can be used to update for product changes initiated by the product issuer (provided not materially adverse), not just externally caused changes. So there is more flexibility than one might initially imagine.

Who is Pythia?

Pythia was job title given to the original Delphic Oracle. She represents a strong female voice in Ancient Greek times in the role of dispenser of wisdom and sage advice to the population of Delphi.

Our Pythia’s Wisdom feature is in part homage to Pythia, as although the term has not entered the English language day to day lexicon, the phrase “Delphic Oracle” has of course.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160
Sky Kim
Sky Kim
Solicitor
+61 2 9225 5573

Where are we up to again? Insurance regulation over the horizon

By Philip Hopley

The Australian regulatory financial services sector has certainly been giving props to Greek philosophy of late with its channelling of Heraclitus’ statement that “there is nothing permanent except change.”

Now that the dedicated insurance hearings at the Royal Commission have finished, here is a snapshot of the current legislative and regulatory plans for the insurance industry that are in train and coming over the horizon.

  1. Product design and distribution obligations & intervention powers – following the recent consultation by Treasury, draft legislation has now been introduced into parliament (link here).
  2. Unfair contract terms legislation to apply to insurance – Treasury consultation on a proposed model law ended in August (link here).
  3. Life insurance claims reporting – ASIC and APRA are in the process of creating a formal reporting regime for life insurance claims to drive accountability in the sector (link here).
  4. Disclosure regime for general insurance – Treasury is currently reviewing and considering reform of the product disclosure regime for general insurance products (link here).
  5. ASIC oversight of insurance claims handling – work to implement this recommendation from ASIC Report 498 in 2016 was placed on hold by the Royal Commission.  The impetus for change in the law has only increased in the meantime and reform must now be very likely.
  6. Civil penalties for breach of the duty of utmost good faith – the government has agreed to give ASIC the power to impose civil penalties on insurers that breach their duty of utmost good faith, as recommended in ASIC’s Enforcement Review Taskforce Report in December 2017 (link here).
  7. ASIC approval of industry codes – another Taskforce Report recommendation by ASIC that the government has agreed to, pending the Royal Commission’s final report, is to move the general and life insurance codes of conduct to a co-regulatory model where ASIC approves these codes and enforces breaches.

No doubt the above proposals will receive a tailwind from the publication of the interim Royal Commission report at the end of September and the final report at the beginning of February 2019, that will consider insurance and superannuation.

The obvious questions at this stage are whether the planned reforms that pre-date the Royal Commission will be seen to go far enough, whether additional reforms are likely to feature to add to the list, whether the government can legislate in time before next year’s federal election and what difference a change in government may bring.

It seems likely it will take at least the next six to 12 months for a more complete picture of the legislative and regulatory reform programme to emerge.

 

Philip Hopley
Philip Hopley
Special Counsel
+61 2 9225 5988

Consumer Data Right – The Rules Framework is out

Written by Amy Ciolek and Kiara Salvia

On 12 September 2018, the Australian Competition and Consumer Commission (ACCC) released for public consultation the Consumer Data Right (CDR) Rules Framework (Rules Framework) following the release of the exposure draft Treasury Laws Amendment (Consumer Data Right) Bill 2018 (the Bill) which proposes amendments to the Competition and Consumer Act 2010 (Cth), the Australian Information Commissioner Act 2010 (Cth), and the Privacy Act 1988 (Cth). Continue reading

The evolving role of the financial services regulator

By Amy Ciolek and Nicola Greenberg

The ABC news reports today that “for the first time, the Australian Securities and Investments Commission will have enhanced powers to place dedicated staff within the big four banks and wealth manager AMP to directly monitor governance and compliance and fight white-collar crime.” Continue reading

When utmost good faith is not good enough

By Philip Hopley

There is just over a month left for stakeholders to provide views on a proposed model that will implement the government’s policy to apply unfair contract terms legislation to life and general insurance contracts for consumers and small businesses. To find out more, click here.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Philip Hopley
Philip Hopley
Special Counsel
+61 2 9225 5988

ASIC updates its ICO guidance

What this means for you

Initial Coin Offering (ICO) issuers have been placed on notice that from 19 April 2018, the Australian Competition and Consumer Commission (ACCC) has delegated powers to the Australian Securities and Investments Commission (ASIC) to enable ASIC to take action under the Australian Consumer Law (ACL) relating to crypto-assets. See ASIC’s Media Release 18-122MR.

This new power enables ASIC to take action against entities using ICOs to raise funds, for conduct that is misleading and deceptive, including making false or inaccurate statements in white papers.  The new delegated powers are applicable to both crypto ‘currency’ and to crypto ‘tokens’.

Key developments – new delegated power and updated INFO 225

ASIC has released a revised Information Statement 225 (INFO 225).  Revisions to INFO 225 include:

  • introducing ASIC’s new delegated powers, and intention to focus on misleading conduct; and
  • describing the key attributes of certain classes of financial product, and when an ICO may display the characteristics of a regulated financial product.

To clarify some commonly held misperceptions, INFO 225 also confirms that the mere fact that a token is:

  • described as a ‘utility’ token; or
  • accompanied by a statement that the ICO or the token is not a financial product,

does not mean that it is not a financial product.

INFO 255 may need further future updates to explore some more sophisticated considerations, such as whether distributed ledger technology platforms hosting the ICO’s, or the DApp hosts may also be arranging financial products, whether white-paper authors or promoters may be jointly liable for false and misleading statements, how incentive schemes may be governed and whether master nodes may also be ‘arranging’ or have disclosure obligations.

INFO 255 also does not give a precise definition of a ‘crypto-asset’, and whether this is a broad concept (including usage and work tokens), or whether this is limited to the digital tokens sold through an ICO.

Is our current regulation fit for purpose?

Crypto currency is now more widely available in Australia, including in retail outlets such as Australian newsagencies. The industry remains active, even after the first quarter of 2018 ‘crashes’. It appears that crypto is becoming more broadly accepted, or at least understood in Australia.  This does raise questions about the future of crypto in Australia, and elements of our regulatory ecosystem need to adapt at a faster pace.

For example, assume that an ICO issuer obtains an Australian Financial Services Licence (AFSL), and as part of its licensing obligations, is a member of an external dispute resolution scheme (EDR).   EDR schemes provide dispute resolution mechanisms for unresolved disputes with member licensees, and are an essential pillar of consumer protection under the AFSL regime.  If a crypto customer has an unresolved dispute with an AFSL licensee, they are generally entitled to complain to the licensee’s EDR to seek assistance resolving the dispute.

Are our EDR schemes equipped to respond to matters relating to ICOs, particularly in the case of third party fraud or unauthorised intervention? If EDRs are not equipped, the requirement for the ICO issuer to be a member seems redundant, and consumers should be told before acquiring the product that they will have no EDR recourse.

As the AFSL regime provides no separate authorisation category for ICO issuers, existing AFSL holders can potentially issue an ICO if the relevant ICO has the characteristics of the financial products that the AFSL holder is authorised to deal in. But are they appropriately equipped to protect consumers in an ICO?  Are they digitally savvy enough, do they hold adequate capital and does their insurance deal with ICO related risks?  Do we need a new AFSL authorisation category which applies to ICO issuers and promoters, and deals with the risks and protections specifically relevant to ICOs?

Perhaps a low-value exemption or ‘restricted AFSL’ could enable ICO issuers to have a total circulation of up to a “specified amount” to enable them to learn about financial services laws before applying for their full AFSL.

Finally, the retail AFSL licence is focused on consumer and investor protection.  In a particularly complex token arrangement (for example, a multi-token digital hedging arrangement including future options or vesting), the potential complexity of a properly constructed white paper containing a correct and valid economic calculation can baffle the most sophisticated investor who does not hold an honours in advanced computational mathematics.  How useful is a Product Disclosure Document in describing risk to a retail client in a complex ICO?

Regulatory focus is essential

It could be argued that an AFSL is not required if you include in the white paper that “this is not a token of value and must not be sold on an exchange”, or if your initial intent is to design a utility token, as the initial intent is relevant in categorising the nature of the token.

These strategies are not valid exemptions from the AFSL regime.  An issuer or promoter must still consider whether the digital token has the characteristics of a financial product for which a licence may be required. To echo ASIC, a utility token may still be a financial product.

It is clear from ASIC’s new delegated power, updated INFO 225 and roadshows to fintech hubs through Australia that ASIC is beginning to understand and turn its mind to ICOs, and to the conduct of issuers.  Regulatory intervention and focus is critical to the growth of genuine ICOs as potentially innovative and beneficial vehicles.

Get in touch

Contact us for any assistance, including help on what to do next, or to learn more about possible implications for your business.

 

Tony Coburn
Tony Coburn
Consultant
+61 2 9322 4976