Remediation Round-Up: Regulatory and implementation issues

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

  • Treat a remediation program like any other project. Start planning early, divide responsibilities between business units and have a clear project owner.
  • Designing and implementing a remediation program is a balancing act between what is desirable in theory, and what is possible in practice. Client benefits such as making timely payments to clients need to be balanced against practical factors such as taking the time to ensure those payments are accurate.
  • Resolving the practical issues above involves making judgment calls and agreeing on approaches. Document decisions and take legal advice on these decisions where appropriate. Keeping records of decisions will allow a licensee to justify why it chose an approach if it is ever questioned.

 

Designing a remediation program

ASIC Regulatory Guide 256

ASIC’s initial views on designing and implementing a remediation program are set out in ASIC Regulatory Guide 256: Client review and remediation by advice licensees (RG 256). RG 256 is a useful guide of ASIC’s expectations, but it should be followed only when it is appropriate to do so.

RG 256 is focused narrowly, being aimed at remediation by advice licensees for issues with personal advice. While the principles may also be relevant in other remediation contexts outside of personal advice, there will also be situations where RG 256 will not apply or will not be appropriate. In this chapter we have given a general outline of design and implementation issues as a whole, and not specific to personal advice.

The initial breach

The initial trigger for a remediation program is often a licensee identifying and potentially reporting a breach of relevant law. The first step in any remediation program is to scope the initial breach and ensure that this breach will not occur for new customer.

Example

If a licensee has a defective process which is producing inappropriate advice, that process will need to be scrutinised and additional controls will need to be put in place to ensure that appropriate advice is provided going forward, before designing a remediation program

Scoping and resolving the initial breach creates an effective end date for which clients may need to be remediated up to. Once the initial breach is resolved and is no longer occurring, remediation of clients is no longer required for clients beyond that point.

Scoping and resourcing the program

A remediation program is unique, but is also in some ways like any other significant legal project which a financial services business may undertake. Clear parameters around how the program will be developed, with clear ownership, appropriate separation from other business areas, and set responsibilities at the outset ensures that the remediation is managed effectively across its life cycle. Confirming third party providers, internal resources, and indicative timelines all at the outset are also all valuable to manage the program.

 

Identifying affected members

Scoping

The first substantive step of a remediation program is to determine which clients have been affected and are potentially in scope. The initial breach which triggered the program is an indicative guide of which clients will be in scope (e.g. all clients in a specific product, or clients who received advice from an adviser). But this initial scope is not always definitive. A wider scope may be required if the breach related to an underlying, widespread issue .

Example

In the case of financial advice remediation, it may be relevant to consider whether the breach was a result of inappropriate conduct by an adviser in a scenario, or was a result of a wider issue of inappropriate adviser training on how to handle that scenario?

 

There is an inherent tension between scoping a remediation program too narrowly and potentially missing affected clients, and potentially scoping too wide and delaying a remediation program.

In our experience, remediation programs which initially start with a wide initial scope have some advantages, as they are able to determine for a wider cohort of clients that no remediation action is required. The scope can then be subsequently narrowed. In contrast, with a narrow initial scope, clients are excluded at the outset, and their status is never formally determined. Keeping clients in scope at the start gives certainty to the outcomes of the remediation, and helps ensure that all potentially relevant clients are considered, avoiding the potential for surprises at a later date.

Timing

The extent to which clients are in scope is also informed by how far back in terms of timing the remediation program needs to extend. There is no definitive position on how far back in time a remediation program should reach. Statutes of limitation, ASIC guidance, potentially equitable principles, and a client-centric approach all factor in to this decision (see Chapter 3).

Records and documentation

What clients will be in scope will also be at least partially informed by what client records the licensee has. If there are no records for any clients before a specific date, this can be an indicator that the remediation program could (at least practically) be limited in scope to that date (although it is difficult to offer a definitive view on this topic as much will depend on individual circumstances). If a licensee is confident that it has accurate records going back for the entire period, easy access to records may be a factor justifying a potentially longer remediation scoping period.

 

Identifying the quantum of remediation for each client

After identifying all the potentially affected clients, the next step is to determine what action is required for each customer. Our experience has demonstrated that it is not possible to set out in this chapter a process for every potential permutation of a remediation program.

ASIC’s formulation of the extent of remediation required as a high level statement in the context of financial advice is set out in RG 256:

“The aim is generally to place the client in the position they would have been in if the misconduct or other compliance failure had not occurred.”

This is a sound theoretical basis, but putting this in to practice immediately runs into practical issues that will need to be resolved when designing the program.

For example, when does an entity determine the client’s position; is it at the date of the remediation program, is at the earlier date they stopped holding the relevant product, or is it a future date where you may need to forecast potential fees and returns in the future? Or what type compensation is required, is it purely monetary compensation or does the client require fresh advice as well?

All these questions need to be resolved on a case by case basis.

 

Designing and implementing the process

A number of practical issues all come in to play in translating a potential legal obligation to remediate into a real world remediation program in practice. All of these issues involve judgment calls and stakeholders making decisions. Documenting these decisions, the rationales for these decisions, and supporting legal advice, is a key part of the remediation program. Some of these key practical issues set out in the table below:

 

Issue Considerations
Balancing timely payments against accurate payments A recent industry trend has been to focus on making timely compensation payments to clients. In some scenarios an approach is adopted to use an estimate of the payment required, instead of a detailed analysis. This approach has been viewed as potentially more client centric customer-centric, as clients receive compensation faster. This benefit to clients needs to be balanced against taking the time to make accurate calculations and being confident that correct amounts are paid.
Conflicts between group entities The entity engaged in the initial legal breach may have limited resources on its own account, but may be part of a wider group. For example, a superannuation trustee with limited corporate moneys but which receives services from group members. The superannuation trustee has the obligation to remediate, but may depend on group members for the operational and financial resources to meet that legal obligation. This raises a range of conflicts issues which need to be considered as part of any program.
Having adequate resources to remediate Remediation programs often requires specialist operational skills in a business. An advice remediation might require a large number of skilled advisers to provide new advice. There is a balancing act between carrying out a timely and effective remediation, and managing the resourcing burden of having sufficient skilled staff to put the program into practice.
Opt-in remediation ASIC has a strong preference against opt-in remediation programs as they can be viewed as not client centric, placing a burden on a client for a licensee’s own breach. But there may be certain circumstances where opt-in is appropriate. For example, in widespread general advice disclosure issue across tens of thousands customers, it may not be appropriate to individually remediate every client as a starting point.
Governance and ownership Different businesses might have different business units with responsibility for remediation. Remediation might be a responsibility of the legal team, it may sit within a broader risk team, or there might be an entirely independent remediation unit. When decisions eventually need to be made about an issue clearly delineated responsibilities allows those decisions to be made confidently, and clearly documented.

The new BEAR/FAR accountability regime may be relevant in this regard as it will require a single accountable person to be appointed in respect of financial product management.

Role of external providers ASIC has stated that external review can be valuable to a remediation program. See an external review is required for every remediation program. See in Chapter 5.
Contacting the customer Contacting the customer to let them know the outcome of the program, and obtaining details for payment, often takes significant operational resources. The first contact may rarely be effective and repeated engagement can be necessary. See Chapter 4.
Engaging with the regulator Our experience has shown that engaging with the regulator early and keeping them up to date is an effective approach. While it is not a regulator’s role to “approve” a remediation program, making sure that the regulator is aware of the approach reduces the potential for later disagreement.

 

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
+61 2 9225 5160

Hartley Spring

Hartley Spring
Solicitor
+61 2 9322 4656

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