Funds Update - 12 July 2024

In this Funds Update for 12 July 2024:

1. Court finds breach of DDO reasonable steps obligation
2. First tranche of Quality of Advice reforms passed
3. ASIC makes minor changes to IDPS instrument

 

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Court finds breach of DDO reasonable steps obligation

On 10 July 2024, the Federal Court found that a financial product distributor had contravened its reasonable steps obligation under the design and distribution obligations (DDO) regime under section 994E(3)(d) of the Corporations Act 2001 (Cth) (the Act) to take reasonable steps “that would have resulted in, or would have been reasonably likely to have resulted in” the retail product distribution conduct (RPDC) being consistent with the target market determination (TMD) for the product.

The distributor had cross-sold units in a managed investment scheme (units) to customers who held existing term deposits, which had very different investment characteristics to the units. The Court found that the distributor had sent PDSs and marketing collateral for the units to the investors without first taking reasonable steps to ensure that that RPDC was consistent with the TMD for the units.

In finding there was a civil penalty provision contravention of the distributor’s reasonable steps obligation, Justice Downes observed (at paragraph 55) that:

“…the focus of these provisions is primarily forward-looking, and concerns whether the regulated person had (at the relevant time) put in place adequate systems, policies, practices, and procedures – including a process of oversight and supervision – to address identified or reasonably identifiable risks of retail product distribution conduct which was inconsistent with the TMD”

Timing of the reasonable steps

Her Honour also noted that the relevant reasonable steps to ensure consistency with the TMD must be “antecedent” to the RPDC, and cannot be taken concurrently with or after the RPDC (paragraph 56). In other words, the relevant reasonable steps must precede the RPDC and while steps taken concurrently with (or after) the RPDC could impact the likelihood of a person outside of the target market acquiring the product, this is not relevant to the reasonable steps obligation.

This underscores that reasonable steps taken after the RPDC cannot be used to remedy or solve for any failure in relation to the reasonable steps obligation and that the timing or sequencing of the reasonable steps is critical. For example, before giving a PDS to a potential investor or issuing a product to an applicant, what reasonable steps could have been taken and were in fact taken?

Other general observations

Her Honour noted that:

• What constitutes “reasonable steps” requires a consideration of “all relevant matters” including the matters referred to in subsections 994E(5)(a)-(d) and that systems, policies, practices or procedures that a distributor puts in place prior to the RPDC are not relevant matters within section 994E(5) where an action taken under or pursuant to those systems, policies, practices or procedures will only be taken after the RPDC.
• Whether the “reasonable steps” requirement has been met is to be determined objectively, by reference to the standard of behaviour expected of a reasonable person in the distributor’s position distributing the same product, and subject to the same legal obligations.
• Judicial views in relation to other reasonable steps obligations in the Act are applicable to the DDO obligation to take reasonable steps including:
  • what is encompassed by taking all “reasonable steps” will differ depending on the entity, the complexity of the entity’s business and the procedures within the entity;
  • it is necessary to undertake a holistic analysis, considering the full framework of the entity’s contracts, policies and procedures;
  • the reasonable steps obligation does not require a person to “find and to take the optimal steps”;
  • the provision is not expressed as an obligation to take all reasonable steps, and nor does it require identification and performance of either the universe of possible reasonable steps, or the ‘one true path’ that must be followed; and
  • positing steps that could have been taken, but were not taken, can be helpful, as an obvious way of testing the reasonableness of what was (and was not) done.  But the focus of the inquiry must always be on whether the steps that were taken in their totality were reasonable.
• By reference to section 994E(5), “reasonable steps” are steps that the relevant person “is reasonably able to take” and that are directed at a particular result, namely they “will, or are reasonably likely to, result in RPDC in relation to the product being consistent with the TMD for the product” and the reasonable steps must result in a real, not fanciful or remote, chance that the distribution conduct will be consistent with the TMD.

This is the first court finding of a contravention of the reasonable steps obligations under DDO. While the case related to the reasonable steps obligation of distributors, the general observations in relation to reasonable steps will provide useful guidance for issuers. 

The full decision is available here, and ASIC’s media release is available here.

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First tranche of Quality of Advice reforms passed

On 4 July 2024, the government passed the first tranche of reforms in response to the Quality of Advice review, under the Treasury Laws Amendment (Delivering Better Financial Outcomes and Other Measures) Bill 2024. The legislation covers multiple recommendations from the Quality of Advice review, including the deduction of adviser fees from superannuation, ongoing fee arrangements and conflicted remuneration.

We reported on the draft Bill in a previous Funds Update.

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ASIC makes minor changes to IDPS instrument

On 5 July 2024, ASIC issued the ASIC Corporations (Amendment) Instrument 2024/554, which makes minor changes to ASIC Corporations (Investor Directed Portfolio Services) Instrument 2023/669 relating to the apportionment of liability for omissions in the financial services guide.

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