Australia’s Design and Distribution Obligations Regime turns 3: Progress so far and next phase of development

ASIC v Firstmac: Meeting “reasonable steps” requirements

On 10 July 2024, Downes J handed down the Federal Court’s decision in ASIC v Firstmac. This case considered whether Firstmac, a non-bank lender, had contravened its DDO obligation to take “reasonable steps” under section 994E(3) of the Corporations Act. This is the first time a court has explored the construction of the DDO reasonable steps obligation under section 994E(3).

While the decision relates to distributors, there are important learnings that apply to product issuers with their direct distribution activities, given the reasonable steps obligations are similar. Section 994E(3)(d) requires financial product distributors to take reasonable steps “that would have resulted in, or would have been reasonably likely to have resulted in” a product’s distribution being consistent with its TMD. A similar obligation applies to product issuers under section 994E(1).

In this matter, the product issuer had cross sold units in a new managed investment scheme to investors who had previously invested in a separate secure guaranteed product (a term deposit). The two products had very different investment and risk characteristics which made compliance with the reasonable steps obligation intrinsically a more complex exercise and accentuated the practical need to refine the distribution process in relation to the product and the proposed retail product distribution conduct (RPDC).

In holding in favour of ASIC, Downes J focused on the forward-looking nature of the language in subsection 994E(3)(d) and whether the regulated person had put in place adequate systems, policies, practices, and procedures (including a process of oversight and supervision) to address identified or reasonably identifiable risks of RPDC being inconsistent with the TMD. The decision highlights that reasonable steps taken after the distribution of a retail product cannot be used to cure any failure to take reasonable steps in the course of the RPDC itself. We consider that the required reasonable steps under the DDO regime will vary between product issuers and distributors due to the differences in their products and distribution conduct. However, the Court highlighted that the sequencing of reasonable steps would be key for compliance, and issuers and distributors should have regard to the steps they are taking to comply with the DDO regime before giving a PDS, providing financial advice, or otherwise issuing/dealing in a product.

This is an important decision from a practical perspective, noting that the concept of RPDC under DDO comprises several distinct limbs, including the giving of a PDS. This means that reasonable steps must be taken before each type of distribution conduct occurs; in other words, the reasonable steps taken before a product is issued to a customer (such as questions asked during the onboarding process) cannot qualify as reasonable steps for the giving of a PDS or general advice, where those steps occur before the product is issued. Naturally, what constitutes reasonable steps in each case will vary, based on the nature of the RPDC.

The reasonable steps required for the giving of a PDS should differ from those required before issuing a product to a customer, as the nature of the RPDC, the likelihood that the RPDC would be inconsistent with the TMD, and the nature and degree of potential harm arising from the RPDC (and availability and suitability of ways to eliminate or minimise the likelihood of the harm) are vastly different. Similarly, we consider there would be differences between the reasonable steps required before giving a PDS to a customer, for example, on a website (i.e. giving a PDS to the public at large) versus giving them a PDS in a targeted email.

ASIC v Amex: Knowledge of TMD review triggers

On 19 July 2024, another Federal Court decision was handed down by Jackman J in ASIC v Amex. This decision focused on another important aspect of DDO compliance, being when a product issuer “ought reasonably to know” that a review trigger or an event that would reasonably suggest that a TMD is no longer appropriate has occurred under section 994C(4) of the Corporations Act. In such a case, a product issuer must, as soon as practicable and no later than 10 business days after first knowing of the occurrence (i.e. the TMD no longer being appropriate), not engage in RPDC in relation to the product unless certain conditions are met.

Amex accepted that it ought reasonably to have known that cancelled application rates for the credit cards it distributed via David Jones stores (Cards) reasonably suggested that the TMD for the Cards was no longer appropriate. Accordingly, Amex contravened section 994C(4) by not reviewing the TMDs for the Cards or ceasing its RPDC in relation to them in compliance with the statutory requirements. However, it was an agreed fact that Amex did not know that the relevant circumstance indicated that the TMDs were no longer appropriate.

Jackman J accepted that Amex indeed contravened section 994C(4) in respect of its reasonable constructive knowledge, but not section 994C(5), which applies only to actual knowledge. This resulted in a $8 million penalty for Amex, which was agreed between the parties and ultimately adopted by the Court. This decision is a firm reminder that courts will still scrutinise and opine on principles of law and construction, notwithstanding any joint submissions on such matters from the parties.

While the decision is based on Amex's admissions of contravention, Jackman J’s judgment clarifies the level of knowledge required to enliven each obligation for product issuers under section 994C.

Importantly, the key outcome of this decision is that it clarifies that product issuers are expected to proactively, and on an ongoing basis, monitor and consider a broad range of circumstances in the context of assessing the ongoing appropriateness of their TMDs. This is important judicial guidance as the net of potentially relevant circumstances is wide-ranging, particularly given product issuers typically hold specific product expertise, and have access to a large variety of product metrics, customer data and market data.

The requirement of “reasonable steps” is clearly pivotal. In this context, it is useful to think about what reasonable steps can be taken by the product issuer in terms of distribution of the relevant product, and additionally, what measures can be taken to evidence such steps.

The legal concept of “reasonable steps” has been a staple in financial services law for a long time and is becoming more and more commonplace (think FAR). The concept has been commented upon in case law in other contexts, which are analogous in many ways to the reasonable steps obligation under the DDO regime. Given this, it is helpful to consider some of the existing and recent commentary on other reasonable steps obligations under Chapter 7 of the Corporations Act.

Some of the notable commentary is as follows:

• ASIC v RM Capital³: In this case, the Court considered whether RM Capital, a financial services licensee, had taken reasonable steps to ensure its authorised representative did not receive conflicted remuneration as required under section 963F of the Corporations Act. In finding that RM Capital had been aware of, approved, monitored, and endorsed a referral agreement between the representative and another company, the Court held that the requirement to take reasonable steps under section 963F “leaves the question of precisely what to do [with the] licensee, provided that what is done is reasonable”.
   
• ASIC v Diversa⁴ and ASIC v RI Advice⁵: While these cases highlight ASIC's efforts to hold licensees accountable for the actions of entities in their distribution chain, it is noteworthy that the Court in both cases did not prescriptively set out specific “reasonable steps” that are required to be taken for compliance. Rather, what is clear from these cases is that the “reasonable steps” obligation is objectively tested, and the scope of the required obligation is impacted by the licensee's knowledge, and the factual context of each case.
   
• ASIC v AMP⁶: In this case, it was determined that licensees must be vigilant about potential non-compliance whenever advice is given. The required steps depended on the licensee's awareness of specific risks, whether related to individual representatives or systemic issues.

From these cases, it can be discerned that (1) reasonable steps are not prescriptive and are highly context dependant, (2) a person is required to turn their mind to the steps they are taking and whether they are reasonable in the context, and (3) reasonable steps will be assessed by an objective standard, but which may be couched in the specific subject elements of the relevant person or context.

Section 994E(5) provides some guidance in relation to identifying reasonable steps, providing that all revenant matters should be taken into account including:

• the likelihood of the RPDC being inconsistent with the TMD;
   
• the nature and degree of harm that might result from the issue of the product to retail clients who are not in the target market; or that is inconsistent with the TMD;
   
• what the person knows, or ought reasonably to know, about that likelihood, that nature and degree of harm and ways of eliminating or minimising the likelihood and the harm; and
   
• the availability and suitability of ways to eliminate or minimise the likelihood and the harm.

For DDO purposes, the relevant context will include, at a minimum, the nature of the product and its risk profile and complexity, target market demographics, product performance metrics such as sale and cancellation rates, customer complaints and feedback, the nature of the distributors and distribution channels and the information and data available to the product issuer/distributor.