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].