Financial Services Directors’ Survival Kit – Product Disclosure Statements

This edition of the HSF FSR Australia Notes is the first in our Directors’ Survival Kit (DSK) series. This series is designed to identify and address legal issues that have a tendency to register on directors’ radars and in some cases, even keep them awake at night!

We have selected the topic of product disclosure statements (PDSs) as the first in our DSK series as there are a myriad of legal issues that impact on the content and validity of a PDS and therefore, there are potential impacts on directors’ liability.

 

The starting point

Section 1013C of the Corporations Act is a useful starting point.

It requires the inclusion in the PDS of various statements and information (specified by section 1013D, section 1013E and other provisions of the relevant subdivision). Section 1013D contains a checklist of information (specified in paragraphs (a) – (m)). It is qualified, however, by only requiring such of the specified information “as a person would reasonably require for the purpose of making a decision, as a retail client, whether to acquire the financial product”. This core disclosure requirement is subject to two other important provisions.

The first is section 1013E, which operates as an overriding inclusionary provision stipulating a general obligation to include in the PDS “any other information that might reasonably be expected to have a material influence on the decision of a reasonable person, as a retail client, whether to acquire the product”.

The second is section 1013F, which operates as an overriding exclusionary provision negating the need to include any information otherwise required (as indicated above), “if it would not be reasonable for a person considering, as a retail client, whether to acquire the product to expect to find the information in the Statement”.

Section 1013F goes on to specify (in sub-section (2)) matters which can be taken into account when considering whether a retail client could reasonably expect to find particular information in the statement.

These specified matters are:

1. the nature of the product (including its risk profile);
2. the extent to which the product is well understood by the kinds of persons who commonly acquire products of that kind as retail clients;
3. the kinds of things such persons may reasonably be expected to know;
4. certain matters relating to an ED security;
5. the way in which the product is promoted, sold or distributed; and
6. any other matters specified in the regulations.

 

Why is the content of the PDS relevant to directors?

There are three main reasons why the content of the PDS is relevant to directors.

The first is because the information required to be included in the PDS extends to information known to directors of the person who prepares the PDS (most often the issuer of the financial product) (see section 1013C(2)(g)).

The second is due to the application of the general law and other provisions of the Corporations Act, which require a director to exercise a degree of care and prudence.

The third is that inaccurate or omitted material can render the PDS misleading or deceptive and potentially defective.

So directors have a direct impact on the accuracy and compliance of the PDS with the relevant legal requirements.

Moreover, the obverse of the coin is that directors could be liable if they do not meet their relevant duties. One such potential source of liability is by way of civil liabilities attaching to persons involved in the preparation of the PDS who directly or indirectly caused the PDS to be defective or contributed to it being defective.

Some provisions of the Corporations Act impose specific personal liability on directors; for example, section 1016F of the Corporations Act confers a right on clients to return the relevant financial product and to be repaid their acquisition cost in the case of a defective PDS. It also renders directors personally liable to repay the money if the responsible body corporate doesn’t repay that money (section 1016F(2)).

 

So what could go wrong?

We have already mentioned the possibility of the content of a PDS being or becoming misleading or deceptive. This is the most common area of risk in this space.

This can occur through a range of reasons including:

• incorrect or inconsistent description of fees and charges;
• information becoming out of date;
• representations that were made inadvertently in the PDS as to what the product issuer will or will not do; and
• incorrect information about certain product features or activities, such as insurance or investment activities.

 

What standard of care applies to a director?

The decision in Centro still stands as authority and guidance for the standard of care of a director when performing functions which fall to them. In this regard, there are two broad principles which apply.

The first is essentially a negative obligation, according to which directors cannot substitute reliance upon the advice of management or others for their own attention to, and examination of, important matters which fall specifically within the Board’s obligations.

The second is essentially a positive obligation, according to which directors have a positive obligation to acquire sufficient knowledge so that each director is in a position to bring, and does in fact bring, an enquiring and critical mind to bear upon the information, including specialist advice, prepared and provided by others in order to assist the directors in carrying out their functions.

 

How do these principles apply to the PDS preparation process?

First, the PDS preparation must garner relevant knowledge of matters held by the directors which are relevant to the required content of the PDS. This aspect is an important part of a prudent due diligence exercise.

Second, the directors, as part of that due diligence exercise, will need to consider other information relevant to the required content of the PDS which is provided by management. In this last regard, directors cannot simply accept that the information furnished by management is accurate, but must consider that accuracy and completeness of such information having regard to their own knowledge, as well as their own special expertise. Directors must approach that information with an enquiring mind and examine that information in order to understand its probity.

 

Due diligence process                   

It is beyond the ambit of the current edition to comprehensively examine a product due diligence exercise. However it is appropriate to point out some core elements of such a due diligence exercise.

These are as follows:

• Verification of information included

There must be a procedure for verifying not just factual content, but also representations more generally. Verification can be achieved by requiring some proof of accuracy or in some cases, using reliance on opinions provided by third party experts.

• Enquiry as to information potentially missing

In addition to making diligent enquiries relating to the information to be included in the PDS as presented to directors, it will also be equally important to make diligent enquiries about information which might be missing from the PDS.

One clear example of this aspect flows from the requirements of section 1013E (described above), which requires the inclusion of all information material to the investment decision subject to the permissible exclusion of information (under section 1013E).

However, the directors will need to think more broadly about what additional information might be required to be included in the PDS in order for it not to be misleading or deceptive.

• Reliance on third party experts

Clearly, there are elements of the due diligence exercise that will be outside of the directors’ knowledge or skillset. Directors can rely on such opinions of third party experts and in fact, should commission such opinions if the matter lies beyond their skillset, subject to some areas of diligence.

First, the directors should be satisfied as to the competency of the expert.

Second, the directors must not be on notice that any of the input from the expert is inaccurate or inadequate.

Third, the directors must not otherwise be on notice of any issue, having regard to their knowledge or special expertise.

Fourth, in relation to any assumptions underpinning the expert’s opinion, the directors should:

(a)          satisfy themselves of the correctness of the factual basis of the expert’s conclusions;

(b)          obtain appropriate assurances concerning the reasonableness and appropriateness of critical assumptions made or relied upon by the expert; and

(c)          form the view that the reasoning leading to the expert’s conclusions is persuasive.