Defining (narrowing) the parameters of a “financial service” for the purposes of EHF breach reporting

This article is the first of our recently launched "Regulatory Wrangling" client program.

According to the Macquarie Dictionary, the meaning of the term ‘wrangling’ is “to engage in argument, debate or disputation”, “to influence, persuade, or otherwise affect by arguing” or “to deal with or manage expertly”.

Our take on the term is that “regulatory wrangling” involves engagement with a regulator:

• if possible, in a constructive way to reach cooperation and collaborative solutions; and
• if not possible, and where the matter becomes contentious, to continue to engage constructively to achieve optimal outcomes for our clients within the framework of the regulatory theatre of play.

Another key limb of regulatory wrangling, which is needed to effectively underpin the above regulatory engagement piece, is the ability to articulate and synthesise complex legal concepts, including the parameters of such concepts. This can, in some cases, involve seeking to narrow or better define otherwise elusive concepts under financial services law.

Many of the regulatory interactions and actions we see involve consideration of technical and complex provisions, where regulatory outcomes can fluctuate due to different or competing legal interpretations. It is often the case that both the scope of breach reporting and the outcomes of regulatory interactions depend increasingly on the ability to identify, successfully pursue, and if need be, prosecute the correct interpretation to achieve equity for clients (particularly since the ability to obtain the necessary clarity from the court is often limited). An increasing number of  regulatory engagements involve not wilful and bad faith misfeasance, but rather hinge off this difference in technical interpretation. Hence, the increasing relevance and value to our clients of "regulatory wrangling".

We have previously touched on the significance of the statutory construct of financial services, particularly in the context of licensee conduct obligations, as contained in section 912A of the Corporations Act 2001 (Cth) (Corporations Act). In this regard, a central provision (and exemplar) attesting to the importance of this concept in the context of breach reporting is section 912A(1)(a), namely the obligation that a financial services licensee must:

“do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly.”

Note the reference to “financial services”. The term financial service is not synonymous with just any service provided by a licensee. This point emerges emphatically from contrasting uses of the term appearing elsewhere in the Chapter 7 of the Corporations Act and associated regulations (for example, the use of the word “service” otherwise appears in regulation 7.1.31 of the Corporations Regulations 2001 (Cth) to mean more than just a financial service).

The term “financial services” in the plural must, considering the Acts Interpretation Act 1901 (Cth), capture any one financial service as well as the totality of all financial services engaged in by the licensee and covered by the relevant licence. However, the term “financial service” is anchored elsewhere in the Corporations Act (such as section 766A) by reference to specific activities.

The most relevant specific activities spanning the spectrum of financial products are:

• providing financial product advice (section 766A(1)(a)); and
• dealing in a financial product (section 766A(1)(b)).

The parameters of financial product advice are relatively clear, being as they are defined in a specific provision (section 766B) of the Corporations Act and comprising two limbs, namely:

• a recommendation or a statement of opinion (or a report of either) that is intended to influence a person or persons in making a decision in relation to a particular financial product or class of financial products (or an interest in a particular financial product or class of financial products); or
• such a recommendation or statement of opinion which could reasonably be regarded as being intended to have such an influence.

The construct of financial advice is further divided into general advice and personal advice, with the latter also having both a subjective and objective limb.

It is submitted that because the concept of financial product advice is well defined, it should be relatively easy to determine if the service of financial product advice is being provided efficiently, honestly and fairly.

However, from a materiality perspective, the number one issue is whether section 912A(1)(a) can be breached when the financial service (such as financial advice) is provided efficiently, honestly and fairly, measured against the full spectrum of financial product advice provided by the licensee. In other words, can one adopt what we will call the “percentage approach”?

Translated into practical terms, does this mean the financial service (such as financial advice) can still be seen to be provided efficiently, honestly and fairly if a small or moderate portion of the service (for example, advice provided, say by, one representative, is not provided efficiently, honestly and fairly)?

So far, courts (and the regulator) have tended to adopt an enforcement approach whereby, to use a ten-pin bowling analogy, if one skittle falls down, then the obligation will have been breached. No court (or the regulator) has adopted the contrary approach of a breach requiring a multiplicity of the skittles to be down.

Logically, however, one can see how the multiplicity skittle approach has some attraction (and logic).

In the absence of a multiplicity skittle approach, the number two question in terms of the scope of financial services is the meaning of "dealing" in a financial product.

The construct of “dealing in a financial product” is explained in section 766C of the Corporations Act, as essentially comprising the following five activities:

1. applying for or acquiring a financial product;
2. issuing a financial product;
3. underwriting securities or interests in a managed investment scheme;
4. varying a financial product;
5. disposing of a financial product.

A key activity within the current discussion is the scope of the activity of issuing a financial product. In particular, does it encompass more than the narrow issuing of an invitation to participate in the relevant financial product and accepting an application by a customer for participation?

The Corporations Act sheds some light on the concept of "issue" (in section 761E). It equates the issue of a financial product to when the client acquires the financial product. It also equates to the issuer providing the relevant financial product to the person (section 761E(1)). The statutory guidance extends to the proposition that the relevant financial product is issued when it is first issued, granted or made available to the client. This explanation could suggest a very narrow ambit for the construct of ‘issuing’; such that it is only the mechanical process of installing the applicant as a client in the relevant financial product.

It leaves open (to speculation and/or the imagination) whether:

• advertising a financial product;
• distributing the financial product; or
• issuing a product disclosure statement,

in all or part are included in the construct of "issuing". It seems to the authors that:

• the Corporations Act does take a narrow view of the construct of ‘issuing’;
• other activities that precede the “issue” are elsewhere regulated, such as:
  • advice (as described above), which includes the advertising of a financial product (section 1018A);
  • preparing and issuing a product disclosure statement (Part 7.9); and
  • reporting by giving a confirmation of the issuing transaction (section 1017F); and
• a court may, however, seek to impose a more elastic interpretation of the concept. For example, a court may seek to interpret that the concept of issuing includes the prelude to the installation, such as the provision of advice relating to the financial product, the issue of the offer document relating to the financial product and possibly the notification to the client of such installation.

It can be seen that the ambit of the activity of ‘issuing” can make a considerable difference to a licensee’s reporting obligation. For example, if reporting on the issuing of a financial product was defective or at least not carried out with complete accuracy, timeliness or correct destination, the issuing financial service could be held to be in breach of the efficiently, honestly and fairly obligation. As such it would be captured by the breach reporting regime. And yet if it was not caught, it would conversely not be captured by the efficiently, honestly and fairly obligation.

It can be seen that materiality in the context of financial services has several important dimensions which remain unexplored by the courts, but where we think some rational guidelines can nonetheless be developed for breach reporting purposes.

If you have any questions, get in touch with one of our experts below.