Reasonable steps and conflicted remuneration

By Adrian Verdnik, Aashray Velhal and Jonathan Taylor

The highly anticipated Federal Court judgment in ASIC v R M Capital provides useful guidance on how the reasonable steps test under section 963F of the Corporations Act 2001 (Cth) operates. That section requires that an Australian financial services (AFS) licensee must take reasonable steps to ensure its representatives do not accept conflicted remuneration. These learnings could be extended to the interpretation of other conduct provisions that adopt a ‘reasonable steps’ test.

Need to know

  • Section 963F of the Corporations Act requires an AFS licensee to take reasonable steps to ensure its representatives do not accept conflicted remuneration.
  • In a recent case, the Federal Court said the obligation is not to take all reasonable steps – what constitutes reasonable steps will be a question of fact that depends on all the circumstances.
  • These learnings could be extended to the interpretation of other conduct provisions that adopt a ‘reasonable steps’ test.
  • Our Funds team can help licensees review their arrangements with representatives.

Background

R M Capital is an AFS licensee and is authorised to provide financial product advice and deal in financial products that include superannuation. SMSF Club is an authorised representative of R M Capital and carries on the business of providing financial product advice and accounting and administrative services for self-managed super funds (SMSFs).

Positive RealEstate (PRE) was in the business of providing property investment services, including education, advice, and 'property mentoring'.

There was a referral agreement between PRE and SMSF Club, which provided PRE would pay SMSF Club a 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. It was common ground between ASIC and R M Capital that R M Capital knew of the referral agreement.

ASIC submitted that SMSF Club contravened s963G of the Corporations Act by accepting conflicted remuneration from PRE under the Referral Agreement, and that R M Capital contravened s963F by failing to take reasonable steps to ensure SMSF Club did not accept conflicted remuneration.

Section 963F requirements

The Court made the following observations about a licensee’s obligation under s963F of the Corporations Act to take reasonable steps to ensure its representatives do not accept conflicted remuneration:

  • a contravention of s963F is not established merely by pointing to particular steps that were reasonable, and which R M Capital could have taken, but did not;
  • the obligation is not to take all reasonable steps, does not require the identification and performance of all possible reasonable steps, or the ‘one true path’ that must be followed;
  • it is the steps taken by a licensee in totality that must be reasonable;
  • the reasonable steps assessment is objective in nature and made on the assumption that the licensee has a correct understanding of the law;
  • an erroneous understanding of the law does not provide a defence to the reasonable steps requirement;
  • the subjective state of the licensee’s knowledge of all the circumstances will inform what steps it could reasonably be expected to take. This may require consideration of the degree of difficulty, practicality, and costs associated with any given steps. However, noting the importance of taking reasonable steps to ‘ensure’ conflicted remuneration is not accepted and that conflicted remuneration provisions only apply in relation to advice to retail clients – thereby operating as a safeguard to the vulnerability of clients – even where steps result in significant cost, inconvenience, or difficulty to a licensee, the steps may nonetheless be considered reasonable; and
  • relevant circumstances to be considered may include characteristics of the representative, including their level of experience and their compliance history.

Steps taken by R M Capital

The Court said the extent to which any steps are necessary to be performed to discharge the licensee’s obligation to take ‘reasonable steps’ to ensure its representatives do not accept conflicted remuneration depends, in part, on the level of risk presented to the licensee by its representative’s activities. Additionally, the Court highlighted that another factor relevant to assessing the reasonableness of any of the steps is the capacity of the licensee to influence its representative’s behaviour.

The Court detailed the risks specific to SMSF Club and held that these risks would have prompted a licensee taking reasonable steps to monitor SMSF Club more closely than would be required in circumstances where no such concerns were presented.

General steps

The Court provided general guidance about the minimum steps a licensee in R M Capital’s circumstances could have been expected to take to satisfy its obligation to take ‘reasonable steps’ to ensure its representatives did not accept conflicted remuneration under s963F of the Corporations Act. These included:

  • adopting a policy that prohibited conflicted remuneration being accepted and identifying details of these arrangements, including procedures to check whether new products the subject of authorisation may constitute such arrangements;
  • documenting and implementing a training program and induction for new representatives which gave representatives ‘at least annual reminders’ of the conflicted remuneration policies, including examples of these arrangements;
  • obtaining legal advice in circumstances where there is reasonable doubt as to whether an arrangement constitutes conflicted remuneration;
  • if a conflicted remuneration arrangement is identified, refusing to authorise the promotion of or advice in relation to the financial product until the conflict was removed; and
  • conducting annual audits of randomly selected client files.

What does it mean for licensees?

This case provides useful guidance about how the reasonable steps test under s963F operates and could potentially be extended to the interpretation of other conduct provisions which adopt a ‘reasonable steps’ test, including:

  • s912A(1)(ca) of the Corporations Act and subsection 47(1)(e) of the National Consumer Credit Protection Act 2009 (Cth), which require licensees to take ‘reasonable steps to ensure that its representatives comply’ with the financial services laws and credit legislation respectively;
  • s994E(1) of the Corporations Act, which requires a person who makes a target market determination for a financial product to ‘take reasonable steps that will, or are reasonably likely to, result in retail product distribution conduct in relation to the product being consistent with the TMD’; and
  • s1021E(3) and 1022B(7) of the Corporations Act, which provide that a person will not breach the relevant provisions in the Corporations Act if the person prepares a defective disclosure document or statement but the person ‘took reasonable steps to ensure the document or statement would not be defective’.

Importantly, this case demonstrates that the obligation is not to take all reasonable steps, nor is there one desired approach to be taken. Rather, what constitutes reasonable steps that a licensee should take to ensure its representatives do not accept conflicted remuneration will be a question of fact that depends on all the circumstances.

Reach out to the HW Funds team who can help review your arrangements with representatives and answer any queries you may have about what this decision means for your business.

Contact

Adrian Verdnik

Adrian’s financial services law practice covers superannuation, managed funds, insurance, and financial advice.

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