State of Play: Taking ‘reasonable steps’ under financial services law

On 29 February, Jackson J handed down the decision in Australian Securities and Investments Commission v R M Capital Pty Ltd [2024] FCA 151 (ASIC v RM Capital).

The case concerned whether RM Capital Pty Ltd (RM Capital), a financial services licensee, took reasonable steps to ensure its authorised representative, The SMSF Club Pty Ltd (SMSF Club), did not receive conflicted remuneration, as required under section 963F of the Corporations Act.

This is the first time a court has considered the construction of section 963F.

The decision is also relevant to other Chapter 7 obligations, such as the obligation that requires licensees to “take reasonable steps to ensure” their representatives comply with financial services laws under section 912A(1)(ca) and section 961L, which requires licensees to take reasonable steps to ensure that representatives comply with the best interests duty and other personal advice obligations.

In this article, we explore the judicial guidance provided by Jackson J and the state of play in relation to these kinds of “reasonable steps” obligations.

The decision in ASIC v RM Capital

SMSF Club provided financial product advice about self-managed superannuation funds (SMSF) to retail clients as RM Capital’s authorised representative, as well as providing administrative and accounting services for SMSFs.

It was common ground between the parties that RM Capital was aware of – and approved, monitored and endorsed – a referral agreement between SMSF Club and another company, Positive RealEstate Pty Ltd (PRE), under which PRE would pay SMSF Club a referral fee each time a client of PRE used the services of SMSF Club to establish a bare trust within an SMSF to purchase a property through PRE.[1]

Jackson J held (at [343]) that a licensee in RM Capital’s circumstances (which included knowledge of matters that gave rise to a risk that its SMSF Club was accepting conflicted remuneration) taking reasonable steps to ensure its representatives did not accept conflicted remuneration would have at least:

(a) formally adopted a clear written policy prohibiting the acceptance of conflicted remuneration, at least by the time that ban came into effect in July 2013 or soon thereafter (acknowledging the grandfathering that lasted until July 2014);

(b) informed new representatives (individuals and corporations) of that policy and its contents at induction or training sessions;

(c) adopted written procedures to check whether new products proposed to be the subject of authorisation that would or might constitute conflicted remuneration came with arrangements under which the promotors of the products offered monetary or soft dollar benefits to representatives, and if so to ascertain the details of those arrangements;

(d) if there was room for reasonable doubt about whether any such arrangements constituted conflicted remuneration, obtained legal advice on the subject;

(e) if it had determined that the arrangement did involve conflicted remuneration, refused to authorise the promotion of or advice in relation to the product until the aspect of the arrangement that involved conflicted remuneration was removed;

(f) documented and implemented a training program which, as well as the induction session for new representatives already mentioned, gave representatives at least annual reminders of the existence and content of the prohibition on conflicted remuneration, and RM Capital's policy on the subject, preferably with examples; and

(g) annually conducted audits of a random selection of client files, along with annual checks as to what benefits, if any, representatives had received from the promoters of financial products, with any benefits of concern to be further investigated.

More generally, his Honour stated (at [345]):

If steps are to be taken to ensure that something is not done, it seems that an organisation with that role must at least: state clearly its position on the matter; communicate that position to new recruits; not give its authorisation to the promotion of or advice in relation to a product without checking that the product does not involve conflicted remuneration; follow through if the check gives cause for concern; periodically remind representatives about the existence and content of the prohibition; and check to see whether it is being breached.

Jackson J also made a number of statements of principle relevant to what an obligation to “take reasonable steps to ensure…” requires (see [68]-[86]). In summary, these included that:

• The requirement to “take reasonable steps” does not require the licensee to take every reasonable step that could be taken; rather the obligation leaves the question of precisely what to do to the licensee, provided that what is done is objectively reasonable (at [74]; [76]).
• The degree of difficulty and practicability of any given steps, as well as the costs associated with them, are relevant considerations (at [78]).
• However, the seriousness of the obligation and the use of “ensure” means that steps that result in significant cost, inconvenience or difficulty to a licensee may still be reasonable ones (at [83]). This is particularly so where the obligation applies only in relation to retail clients, as this implies a certain level of vulnerability that may require licensee to take greater pains to ensure they are protected from conflicts of interest (at [82]).
• The relevant circumstances may include the licensee’s knowledge of all the circumstances, as well as the characteristics of the representative: an experienced representative with a good track record of compliance might require less intensive supervision than an inexperienced one, or one who has previously demonstrated ignorance or disregard of the requirements of Chapter 7 of the Act (at [78], [79]).

Reasonable steps more generally

While this is the first case considering the construction of section 963F, there are other cases which have considered similar obligations in sections 912A(1)(ca) and 961L of the Corporations Act where ASIC has sought to hold licensees responsible for the conduct of other entities down the distribution chain. These include cases such as ASIC v Diversa Trustees Limited [2023] FCA 1267 (Diversa) and ASIC v RI Advice Group Pty Ltd [2022] FCA 496 (RI Advice), as explored in our recent article on issuer liability.

The Diversa and RI Advice cases are both also indicative of ASIC seeking to hold licensees responsible for the conduct of other entities down the distribution chain, in particular, doing all things necessary to ensure that financial services are provided ‘efficiently, honestly and fairly’. Similarly to the case at hand, they do not prescriptively set out what “take reasonable steps to ensure…” practically looks like but do set out some guiding principles.

What is clear is that while the “reasonable steps” obligation is ostensibly an objective test, the scope of what the obligation will require is impacted by the knowledge of the licensee. In other words, what the licensee is “aware of” or “on notice of” will constitute a part of the relevant circumstances and inform what reasonable steps are required. For example, in the case of ASIC v AMP, it was held section 961L requires:

licensees to be alive to the possibility of non-compliance each and every time a representative provides advice and to calibrate the steps taken having regard to their knowledge of the particular circumstances…For example, if the licensee is aware of the risk of non-compliance by a specific representative, the relevant steps are likely to be specific to that representative. If a risk of systemic non-compliance is identified, then it is likely that the necessary steps must address systems and processes (at [117]).

In ASIC v RM Capital, the reasonable steps set out by Jackson J were directly impacted by the fact that RM Capital was aware of, and approved/endorsed, the relevant referral agreement. Accordingly, what is reasonable will necessarily be affected by what is in the knowledge, as well as control, of the licensee. It goes without saying that the test will also consider what objectively “should” have been within the knowledge and control of the licensee.

It is also important to contrast Jackson J’s statement of principle that the requirement to “take reasonable steps” does not require the licensee to take every reasonable step that could be taken against other conduct obligations that are formulated with a different standard. In particular, the obligation on a licensee to act efficiently, honestly and fairly under section 912A(1)(a) of the Corporations Act requires a licensee to “do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly” (emphasis added). This is clearly a more onerous standard.

These cases demonstrate how broad and malleable the concept of “reasonable steps” is. This is particularly evident when considering the further obligation under section 994E of the Corporations Act requiring distributors and issuers to take reasonable steps to ensure retail product distribution is consistent with the relevant target market determination. The concept of what constitutes “reasonable steps” in a DDO context, will also vary depending on the circumstances, such as the product risk and complexity, distribution channels and customer composition and sector.

Concluding remarks

These cases demonstrate that the conduct of, and relationship with, representatives and other entities down the distribution chain will impact the circumstances in which the licensee provides financial services, and that this can lead the licensee to contravene its own obligations under financial services law, such as the efficiently, honestly and fairly obligation or its obligations to properly supervise representatives.

As a result, we encourage licensees to map the entities and intermediaries that form part of their product and distribution chains and consider how potential liability can be managed and mitigated. In particular, licensees should consider:

• ensuring their risk management procedures are documented and that they accurately reflect the nature, scale and complexity of the licensee;
• having in place procedures to enable the identification and assessment of various risks the business faces;
• developing controls or other measures to manage or mitigate risks and ensure where the risks relate to the appointment of representatives, that the controls are adequate; and
• regularly reviewing and updating the analysis of risks.

[1] RM Capital maintained that this did not involve the provision of financial product advice by SMSF Club. However, Jackson J considered that issue did not need to be resolved because the case did not concern any question of contravention by SMSF Club (see [58]).