ASIC spotlight on client money

In the wake of ASIC’s recent announcement on enforcement in this area, we thought that it would be timely to set out:

• some key points about how the client money provisions operate, particularly with respect to application money;
• the pitfalls to look out for; and
• how some of the more technical provisions interact with each other.

To this end, we adopt a “Ten Point Synthesis” to hone in on the most pertinent points.

Point 1

The client money provisions apply not just to money paid to acquire an interest in a product, but also to client payments that top up an existing investment (see section 1017E(1)(c) of the Corporations Act viz payments to acquire an interest or an increased interest in a financial product).

Point 2

The provision is activated when the product issuer does not immediately issue the relevant interests after receiving the money (section 1017E(1)(d) of the Corporations Act). For these purposes, an issue arises as to what “receiving the money” means. The Corporations Act seems to contemplate that money means the amount paid by the client. For example, where the money is paid as a cheque, the question is whether the issuer can wait until the cheque clears. In this example, this issue is resolved by Corporation Regulation 7.9.61C, which provides that payment equates to when the cheque is honoured.

Point 3

Probably the lynchpin requirement is that which provides that the money must be paid into an account which is held with an Australian ADI (section 1017E(2)(a) of the Corporations Act) and importantly, the only money that can be paid into the account is money to which section 1017E applies. This means it can apply to money attributable to multiple financial products issued by a single product issuer (for example, money with respect to different superannuation and investment products issued by the relevant product issuer). Of course, with the recent proposed reforms requiring separation of RSE functions and other fiduciary functions, separation of the 1017E account is also likely to be required.

It should also be noted that several exemptions to this rule apply under the applicable regulations. In particular, where the money is paid to a life insurer, then a statutory fund may be used as a section 1017E account (Corporations Regulation 7.9.08).

Point 4

Money paid into the account is to be treated as trust money (section 1017E(2A) of the Corporations Act). This is important as such money is impressed with trust characteristics and obligations. Notably, such money is to be held on trust for the person paying the money and hence, any interest on that money would, under ordinary trust principles, also be held on trust for that person. However, the Corporations Regulations modify this usual position by providing that the product issuer "is entitled to the interest on the account" where "the product provider discloses to the person who paid the money that the product provider is keeping the interest (if any) earned on the account." This is often disclosed to investors via a product's disclosure documents.

Point 5

Restrictions apply as to when the account money can be withdrawn (section 1017E(3) of the Corporations Act). Primarily, the money can only be withdrawn to pay back the payer of the money or to issue the product in accordance with the instructions of the payer (or otherwise in accordance with applications of the money provided for in the Corporations Regulations).

Here, it should be noted that there may be money which is received by the product issuer that is not actually being paid to acquire an interest in the product (or an increased interest in the product). Such money may have been paid as inbuilt commission to a third party adviser for example. There is an issue here as to whether this type of money can be paid into a section 1017E account on the basis that it is not paid for the acquisition of a financial product. However, if combined money is paid by a single cheque (ie application money and third party commission), then under Corporations Regulation 7.9.61C, the total amount is deemed to be received by the by the product provider where the cheque is honoured. So the cheque could be banked into a non-1017E account. Under section 1017E(2), the product provider would then have to deposit the application money into the section 1017E account on the day of deemed receipt or the next business day.

Point 6

The Corporations Act provides a strict regime for the permissible period during which account money can remain in the section 1017E account (section 1017E(4) of the Corporations Act). Within one month of the money being received, it must be returned to the payer or applied towards the relevant acquisition. The exception to this is where it is not reasonably practical to return or apply the money by the end of that month. In such a case, it can be maintained in the account until the end of such period as is “reasonable” in the circumstances (see Point 7!).

Point 7

Case law sheds light on what is “reasonable” in the circumstances and has taken a strict view in this regard (see Basis Capital Funds Management Ltd v BT Portfolio Services Ltd [2008] NSWSC 766).

Point 8

A product provider can utilise multiple accounts to comply with the relevant requirements (section 1017E(5) of the Corporations Act).

 Point 9

As noted above, interest on a section 1017E account can only be retained by the product issuer if properly disclosed (see Corporations Regulation 7.9.08A).

 Point 10

There is an interplay between section 981B and section 1017E of the Corporations Act in a number of ways. For example, money received in respect of section 1017E can be paid into a section 981B account (under Corporations Regulation 7.8.01(6)). In this case, it is important to remember that where this is done, Part 7.8 of the Corporations Act applies (Corporations Regulation 7.8.01).

However, if section 1017E money is paid into a section 981B account, then one needs to consider how the money can be applied (see Corporations Regulation 7.8.02(1)), as there is no explicit reference to section 1017E money being applied for the purposes contemplated under section 1017E.