FSR GPS: Efficiently, honestly and fairly in practice (Part II)

Our “FSR GPS” (Guidelines, Principles and Strategies) series is designed to assist financial institutions navigate often complex and sometimes opaque or ambiguous legal provisions, with a view to assisting institutions formulate practical and strategic legal and business solutions.

This edition aims to provides further practical guidance to in-house lawyers and businesses on how to navigate the obligation to take all necessary steps to act efficiently, honestly and fairly in section 912A of the Corporations Act. Our first edition can be read here.

Historical examples

The courts have held that EHF:

• is a compendious phrase: ‘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^[1]’;
• is an ethical obligation:
  • ‘the word ‘honestly’ may comprehend conduct which is not criminal but which is morally wrong in the commercial sense’ and that ‘[i]t comprehends conduct which is not straightforward’ and ‘may comprehend such conduct viewed objectively’^[2];
  • ‘[t]he words ‘efficiently, honestly and fairly’ … so 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’^[3];
  • ‘[i]t is not necessary to establish dishonesty in the criminal sense. The word ‘honestly’ may comprehend conduct which is not criminal but which is morally wrong in the commercial sense’^[4];and
  • ‘[t]he word ‘honestly’ when used in conjunction with the word ‘fairly’ tends to give the flavour of a person who not only is not dishonest, but also a person who is ethically sound’^[5];
• requires competence and a standard of performance:
  • ‘[t]he words ‘efficiently, honestly and fairly’ connote a requirement of competence in providing advice and in complying with relevant statutory obligations’^[6];
  • ‘[t]he word ‘efficient’ refers to a person who performs his duties efficiently, meaning the person is adequate in performance, produces the desired effect, is capable, competent and adequate. Inefficiency may be established by demonstrating that the performance of a licensee’s functions falls short of the reasonable standard of performance by a dealer that the public is entitled to expect’^[7]; and
  • ‘[t]he expression [includes] an assessment of reasonable expectations of performance and reasonable standards of performance’^[8].

The courts have held that the following conduct has breached EHF:

• a misrepresentation that there was another active bidder for a company when there was not^[9];
• acting carelessly on advice from another director that the defendant could give investment advice in relation securities of an associated company despite not being authorised to do so^[10];
• inducing clients to trade in options to secure brokerage commissions^[11];
• permitting inappropriate advice to be given to investors^[12];
• offending the related party dealings prohibitions under Part 5C.7 of the Corporations Act^[13];
• an adviser disclaiming that they cannot give advice about a dealing of a particular kind and referring the client to an entity that is likely to promote those types of dealings without being licenced to do so^[14]; and
• a financial institution providing general advice about a superannuation rollover service where the provider did not know and did not seek to know all matters that were relevant to whether the rollover recommendation was in the customers’ best interests nor did it know whether customers were aware of all of the relevant issues or had considered them^[15].

Five principles “drill-down”

Principle 1: Provision of a financial service

We have written quite a lot about this first principle (see FSR GPS: Efficiently, honestly and fairly in practice). For that reason, we will simply restate some core concepts: The relevant starting point is the definition of financial service contained in section 766A of the Corporation Act.

The most commonly discussed financial services include dealing, advising or arranging activity. The ambit of each of these concepts has been discussed in previous guidance material issued by ASIC (see for example RG 36).

The more interesting aspect of the equation is rather, apart from the core activity, what elements are integral to this core activity such that they can be said to also be comprised in the financial service?

We provided some examples in our previous edition. For example, a dealing would include as an integral element, the issue and content of a Product Disclosure Statement (PDS) as this is a required step in issuing a financial product as mandated generally by the Corporations Act. Moreover the PDS will usually contain the terms of issue of the financial product. This suggests that the terms of the PDS could be part of the EHF obligation.

This seems to us to be the case notwithstanding that the terms of the PDS will normally also be regulated by the other statutory provisions, such as the unfair terms provisions of the ASIC Act and the misleading and deceptive conduct provisions of the Corporations Act and the ASIC Act.

But what about activities that precede or follow the issue of the relevant financial product?

What about administration activities?

On the one hand, activities concerning the administration of the relevant financial product, once issued, would not seem to be subject to the EHF obligation.

What about remediation activities?

On the other hand, the process of remedying a defective issue of a financial product would seem to be captured. This is because the remediation of a defective issue is one side of the issue process. You cannot properly issue a product in a meaningful way without having responsibility for remediation.

It is also totally realistic to see some distribution activities as integral to the issue of a financial product. So the concept of “making available” could be seen as part of issuing. Clearly, the activities of advising on the product or arranging for the issue of the product are not part of the issue of the product, rather they are financial services in their own right and therefore, subject to the EHF obligation.

A distribution activity to be captured as part of the issue of the product would presumably need to have some nexus, interface with, or, at least, impact on the client.

And advertising?

It is submitted that advertising or marketing a financial product will not be part of the issue of the financial product. For a start, the Corporations Act distinguishes clearly between the issue of a financial product and the advertising of a financial product (see for example section 1018A of the Corporations Act).

And dealing with complaints?

Although the concept of dealing is included as a financial service (under section 766A), it is suggested that the areas of complaints handling is not a financial service.

Our view is that handling/dealing with a complaint is not a financial service. Rather it would require a specific amendment to the definition of financial service (as indeed is the case with the inclusion of claims handling as a new financial service).

And advising?

We have previously suggested that remediation of defective advice is also an integral part of the financial service of providing advice.

An obvious follow on question is the extent to which an omission to give advice is also part of the advice financial service. This may be an obvious question but it is not necessarily an easy one. It is hard to generalise in this regard. But certainly in an adviser-client relationship scenario, it is conceivable that the omission to give advice could be seen to be captured by the EHF obligation.

And arranging?

Again, difficult issues may arise as to whether certain activities which precede or follow an arranging activity are part of the financial service. The arranging activity can occur either on behalf of the product issuer or on behalf of the client.

Where an arranging is conducted on behalf of a product issuer, it is submitted that activities which precede the actual giving effect to the arranging, such as training of the persons engaged by the product issuer to effect the arranging would not be part of the financial service of arranging.

Principle 2: Effect of relevant conduct on the client

We formulated this principle in our previous GPS edition as:

“Does the conduct have an disproportionate harsh, unfair effect on customers?”

A key point here is that the EHF obligation does not preclude the relevant licensee from pursuing its own interests. What it does do, however, is prevent the licensee from unduly impacting on the legitimate interests of the client. These are often fine lines which need to be drawn and evaluated.

As a general rule of thumb, a licensee carrying out activities which it is authorised to do by virtue of statute or contractual provisions agreed with the client will be on the right side of the line. For example, charging advice fees which the agreement with the client permits, or relying on the terms of issue of the relevant financial products; for example only providing insurance cover in certain circumstances (i.e. imposing cover exclusions within the terms of issue of the insurance). But there are both substantive and procedural exceptions to this general rule, discussed in principle below.

In addition, as we discuss in more detail in our previous edition FSR GPS: Efficiently, honestly and fairly in practice, when considering how a licensee’s conduct impacts on the interests of clients, the starting point is an examination of the interests of the client conferred by and existing under the terms of the relevant financial product. So, for example, providing in an advice contract that advice is limited in scope will not be a breach of EHF.

However, additional circumstances may be present to render the provision of general advice only inappropriate or unfair.

Procedural exceptions would involve situations where the conduct of a licensee, even when relying on a contractual (or trust) term, may be a breach of EHF because of the way the term is administered. For example, in the way a fact find which is used for the purposes of investigating the circumstances of a client is conducted.

It follows from the above discussion one must have regard to all the relevant circumstances surrounding the relevant conduct of the licensee.

As we discuss in more detail in Principle 4 below, the conduct of the licensee may involve bad faith or acting for an improper purpose or beyond these, engaging in misleading or unconscionable conduct. These factors may push conduct which is within the scope of conduct authorised under the terms of the contract or least into a breach of EHF. For example, pressure selling; a client may have agreed to be contacted and to receive financial product advice but the manner in which the advice is given represents an unfair treatment of the client.

Another example might involve inappropriately corralling a client into a limited advice scenario where this is contrary to their stated instructions and/or needs and objectives.

Principle 3: Materiality of the conduct

As we have discussed in one of our previous EHF edition FSR GPS: Efficiently, honestly and fairly in practice, neither the EHF obligation or relevant case law offers any real sense of whether a materiality threshold applies.

There are three possible axes of materiality.

The first is whether the EHF obligation is only breached if the licensee’s financial services (plural) are not conducted consistently with the EHF obligation.

This position cannot strictly be correct as if it were, the obligation would have no real bite. Moreover, the reference in section 912A(1) to the “financial services” must be subject to the Acts Interpretation Act rule of interpretation that plural includes the singular (and vice versa). Certainly, no case or decision we are aware of has explicitly taken this view.

The Saxby case (commented upon in our previous EHF edition) is rather opaque in its reasoning and whether it relied on materiality for its conclusion that the EHF obligation was not breached. This decision possibly had at least some regard to the second type of materiality, namely whether the relevant conduct was small or trivial in terms of its impact.

Again there are no real judicial (or statutory) guidelines to give any sense of whether and how this type of materiality could be taken into effect.

It does stand to reason however that some degree of materiality should apply. For example, if in the context of providing financial advice, the vast bulk of statements of advice were issued correctly but only a handful were not, it seems fairly uncontroversial that this would not constitute a breach of EHF, subject to the application of the second principle discussed above – namely in this case, was there a very severe impact on the handful of customers affected?

A possible third type of materiality is the severity of the conduct which is related to the next principle. It is likely that some degree of severity would be required to be present in order for the EHF obligation to be triggered. We attempt to define this aspect with more precision in the next paragraph.

Principle 4: Does the conduct have an “aggravation factor”?

We described this principle in our previous EHF edition in the following terms:

“…Does the conduct have an “aggravation” element, which would be more likely to be interpreted by a court as a breach of the fairness criterion; such as whether either a harsh outcome of a bad motivation/purpose (e.g. bad faith) can be seen to characterise/taint the incident?”

The relevance of this principle is essentially to do with the prominent role of the fairness component of the EHF obligation. We have clearly noted that the recent AGM Markets case repositioned the EHF obligation as a compendious obligation.

This said, however, it is fairly clear that the fairness element is much more powerful an agent in the EHF obligation than its siblings.

It follows that if various types of aggravated conduct are present, it is far more likely that the EHF obligation will be seen to be breached.

Some examples of aggravated conduct in ascending order of magnitude are:

1. innocent (but negligent) misleading or deceptive conduct (e.g. incorrect fee information in a statement of advice);
2. breach of good faith; for example, to use the example cited above, corralling clients into an artificially limited scope of advice;
3. acting for an improper purpose, for example, deliberately delaying payment of insurance claims in order to profit financially (once claims handling becomes a financial service);
4. conduct which is “sharp” practice but falling short of the higher unconscionable test of pressure selling; and
5. acting unconscionably; the previous example in (c) may fit this description, depending on the circumstances.

Principle 5: Were there ways to prevent the conduct?

The reason we have relegated this principle to last is because, as observed in our previous EHF edition, the EHF obligation is not one of strict liability.

Non-compliance is dependent on whether all necessary steps were taken to ensure the relevant financial services were provided efficiently, honestly and fairly. In the vast, vast majority of cases, there will of course be steps that could have been taken to avoid the conduct.

So in this sense, the use of this principle to de-identify conduct from being a breach of the EHF obligation is not going to happen very often.

It might occur where the necessary controls were in place to avoid a breach of the EHF obligations but some uncontrollable or unforeseeable event occurred which thwarted those controls.

But in our view, applying the principles has another more practical purpose; namely it assists in identifying the nature of the breach including many aspects of the previous four principles. For example, if the relevant breach was poor (i.e. substandard) financial advice, the steps that could have been taken to avoid such outcome (such as better training, file reviews etc.) can indicate whether the deficiencies identified fall within the ambit of the other four principles. For example, was the conduct not of a sufficient severity? Was there any aggravated conduct involved?

[1]              Story v National Companies and Securities Commission (1988) 13 NSWLR 661 and see also Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 and Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[2]              R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[3]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[4]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[5]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70].

[6]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[7]              Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206 at [69]-[70] and see also Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497 at [191].

[8]              Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023; (2016) 336 ALR 209 at [673].

[9]              Story v National Companies and Securities Commission (1988) 13 NSWLR 661 and Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[10]             R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) [1989] SASC 1941; (1989) 1 ACSR 93.

[11]             Australian Securities and Investments Commission v Camelot Derivatives Pty Ltd (In Liq) [2012] FCA 414; (2012) 88 ACSR 206.

[12]             Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023; (2016) 336 ALR 209.

[13]             Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liq) [2017] FCA 497.

[14]             Re Hres and Australian Securities and Investments Commission [2008] AATA 707; (2008) 105 ALD 124.

[15]             Australian Securities and Investments Commission v Westpac Securities Administration Limited, in the matter of Westpac Securities Administration Limited [2018] FCA 2078.