Regulatory "Rinkles": Spotlight on disclosure

By Michael Vrisakis

This column in our FSR Updates will deal with areas of financial services regulation which are either often misunderstood or are otherwise difficult to navigate.

The first of our Regulatory Rinkles deals with further disclosure issues arising under Part 7.9 of the Corporations Act, and follows on our COVID disclosure module.

 

The PDS provisions – furphies and myths

The PDS disclosure provisions (contained primarily in sections 1013C, 1013D, 1013E and 1013F) are somewhat dense, turgid and not necessarily clear, concise and effective).

There are quite a few instances of this.

The current COVID climate presents a great opportunity to co-ordinate industry thinking on this area and it should deliver efficiencies to the industry if greater clarity exists in this space.

 

Rinkle 1:

The PDS content is not rigid.

At first blush, one might think that the specific content  requirements contained in section 1013D(1) are mandatory in all circumstances. As we know, this section sets out a range of prescribed content items such as information about significant benefits, information about significant risks and many other specific items.

However, the Corporations Act provides certain leeway for relevant issuers to limit the disclosure requirements in relation to certain prescribed items.

This is possible in four ways.

Firstly, the information required by sections 1013D and 1013E need only be included in a PDS to the extent actually known to a specified class of persons which includes obviously the product issuer (section 1013C(2)).

Technically, some information in the section 1013D(1) checklist may not be known to the class of persons but given that the information mainly relates to product features, this is probably going to be unusual.

Secondly, the prescribed information set out in section 1013D(1) need only be disclosed to the extent a person would reasonably require the information for the purposes of making a decision whether to acquire the financial product. Some of the prescribed information may not be required – although again in practice most of the specified information does seem to have some significance for an acquisition decision.

Thirdly, the specified information is only required to the extent the required information is applicable to the relevant financial product.

This requirement may obviously have relevance as with some items, such as a fixed rate return product, the requirement to disclose commission under section 1013D(1)(e) would not be relevant if that did not impact the return.

Fourthly, there is a general excluding provision (contained in section 1013F) which allows the exclusion of any information otherwise required if it would not be reasonable for a retail client to expect to find the information in the statement.

As a practical matter, this last requirement has always raised the issue of whether an investor would reasonably expect to find information in a PDS where that information has been otherwise provided. This is likely to be the case where the relevance of the information to the subject matter of the PDS was self-evident and this fact would be known to prospective investors including where there has been so much independent publicity around the matter that the investor should be taken to be aware of the particular matter.

In a COVID context, we have touched on this issue in our disclosure module, when we discussed the usefulness of the ASIC Class Order relief.

There may be circumstances where in the current COVID context it may be possible to not update a PDS for an event which is materially adverse from a disclosure perspective, (and where the use of the class order would not be possible through reliance on this provision).

For example, events which come out of COVID but which have been well publicised generally could well be matters which need not be disclosed in a PDS.

For completeness, we note that in addition to the above provisions which allow the omission of information from the PDS, there is also a general inclusionary provision (contained in section 1013E) which requires the PDS to contain additional information if it reasonably could be expected to have a material influence on the acquisition decision of a reasonable investor.

 

Rinkle 2:

Significant event reporting is not so straightforward and contains various regulatory nuances.

As we know section 1017B(1) requires ongoing disclosure of various changes and events.

More specifically, it requires disclosure of material changes to a matter or a significant event that affects a matter which is a matter that would have been required to be specified in a PDS "for the financial product prepared on the day before the change or event occurs" (section 1017B(1A)).

This last stipulation makes it clear that disclosure of a material change to a matter or a significant event (neither of these underlined words is defined) is linked to the content requirements of a PDS (as discussed above).

Because of this link, it is possible to argue that if a matter was not required to be contained in a PDS (because of one of the four grounds discussed above), it would not be necessary to disclose the matter as a significant event unless of course there was a change of circumstance that resulted in the matter becoming significant.

One of the confusing elements of the significant event reporting regime is the central timing requirement. The regime prescribes a period of mandated disclosure within 30 days for disclosure of an increase in fees or charges.

So much is clear.

But what exactly is a fee or charge?

Are amounts charged at the level of an underlying investment, a fee or charge?

Quite legitimately, they are often not. In other words what is required to be disclosed is a fee or charge of the relevant top financial product.

This analysis accords with other uses of these terms, fees and charges elsewhere in the Corporations Act. It also meshes with the indirect cost disclosure regime provided for in RG97.

If not a fee or charge, then the disclosure is required:

• before the change or event occurs or soon as practicable after, but not more than three months after the change or event occurs (section 1017B(5);
• however, somewhat confusingly, this provision is expressed to be subject to section 1017B(6) which allows up to 12 months for disclosure of a change or event which is not an increase in fees or charges where the product issuer reasonably believes that the event is not adverse to the holder's interests (first limb) and accordingly the holder would not be expected to be concerned about the delay in receiving the information (second limb).

This regime is complex enough as it is.

However, then Schedule 10A of the Corporations Regulation sets out additional requirements relating to superannuation products.

Two interesting elements of this supplementary regime which are caught are:

1. decisions of the issuer of the superannuation entity;
2. winding up or termination of the superannuation entity;

which if the product holder would reasonably expect to be informed before such an event, then the product issuer must give the information as soon as practicable after it becomes reasonable for the product issuer to expect that the event will happen – provided that it does not need to be disclosed more than three months before the expected date of the event.

Importantly, Schedule10A specifically includes as an event for the purposes of section 1017B(5), (6) and (7) a transfer of a member to a different category of membership or to a different fund.

This means that a successor fund transfer is captured by the disclosure regime in section 1017B.

 

Rinkle 3:

Perhaps however the greatest mystery and the greatest regulatory rinkle lies in the area of periodic statements.

Section 1017D requires the giving of a periodic statement for various types of financial products including a managed investment product, a superannuation product and an investment life insurance product.

There are two quite confusing and central provisions of this section.

The central provision is section 1017D(5) which is entitled “Contents”.

It requires the inclusion of certain specified matters such as opening and closing balances, termination value and details of terminations.

Confusingly, however, section 1017D(4) which is entitled “Information required” stipulates that:

“The periodic statement must give the holder the information that the issuer reasonably believes the holder needs to understand his or her interest in the financial product”.

At first blush and even after much consideration, the relationship between these provisions is not clear.

It seems that the work to be done by sub-section (4) is somewhat strange insofar as it only requires additional information to be disclosed if the product issuer reasonably believes additional information is required in order for the holder to understand his or her investment in the financial product. Ordinarily the product issuer would presumably believe that the information prescribed by sub-section would (5) be sufficient for the holder to understand his or her investment.

So section 1017D(4) is primarily a subjective test, starting with what did the product issuer believe.

Only then do you ask was the belief reasonable?

There is no explicit duty on the product issuer to form a belief and there are case law principles in similar contexts which might go against a positive duty on the product issuer to form a belief. There may be additional fiduciary or equitable factors which go towards the product issuer forming such a belief. If the product issuer considers the issue, did they consider that additional information was required?

If they considered that no other information was required or that some additional information was required, then only then does one consider if their belief was reasonable.