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).