Secret commissions and your disclosure obligations

By Vanessa Murphy, James Morvell and Caitlin Byrne

It is not uncommon in the funds industry for issuers to seek to pay distributors a commission for the distribution of their products. While these arrangements have become a thing of the past for retail clients, following the implementation of the conflicted remuneration prohibitions, they are often still put in place for distribution to wholesale clients. However, these arrangements can be legal where the distribution is to wholesale clients if clients are informed that the distributor or referrer is receiving a benefit. Unintended and often serious legal issues may arise if the commission is kept confidential.

Need to know

  • A secret commission is a non-disclosed financial incentive given to a party to distribute interests in a product or to influence customers to acquire goods and services from the supplier.
  • Secret commissions are criminal offences and the consequences can be serious.
  • To avoid paying or receiving secret commissions, disclosure is key.
  • It is important to consider the nature of any benefits provided under distributor, introducer, or referral arrangements, and, where required, appropriately disclose any commissions before clients are issued a product.

What are secret commissions?

Known as ‘secret commissions’, issues generally arise where a non-disclosed financial incentive is given to a party to distribute interests in a product or to influence customers to acquire goods and services from the supplier. The illegality is rooted in the lack of disclosure of the benefit. This can be in the form of a flat fee per client introduced, or as a commission on the application monies/funds under management introduced by the distributor.

The secret commission offences were previously governed in Australia by the Secret Commissions Act 1905 (Cth) before it was repealed in May 2001. Secret commissions are now regulated by state Crimes Act legislation in all state jurisdictions, as well as under the common law. In New South Wales, Queensland, Tasmania, and Victoria, an offence can apply to both the provider and receiver of the gift or benefit.

As secret commissions are criminal offences, the consequences can be serious. For example, contravention can result in up to seven years imprisonment in some states, as well as significant monetary penalties.

The offences in some states are only enlivened where there is a corrupt intention. While this seems a high level of immorality, a corrupt intention can, in some cases, be supported by a simple confidentiality clause in distribution agreements, showing the parties’ intention for the fee arrangements between them not to be disclosed to the underlying clients.

How do issuers and distributors prevent falling foul of the secret commission prohibitions?

To avoid paying or receiving secret commissions, disclosure is key. Disclosure should be made to the client before they are issued the relevant financial product, so that they are aware of the benefit to be received by the distributor or referrer. There is no prescribed form for the disclosure, but it should be in a way that ensures it is made known to the client, such as through specific letters, PDS or IM disclosure, and financial services guides. Disclosure should always be in writing to ensure issuers and distributors can prove the necessary disclosure was given.

Related issues

The secret commission offences are separate from, and operate differently to, the conflicted remuneration prohibitions. Importantly:

  • secret commission offences are not limited to retail clients, so arrangements that are not captured as conflicted remuneration may still be secret commissions; and
  • secret commissions are only an issue if the benefit is in fact ‘secret’, so the issuer and distributor can ‘cleanse’ their arrangements through disclosure to the underlying clients – an option not available for conflicted remuneration.

Contravening the secret commissions prohibitions also raises issues from a breach reporting perspective. The circumstances giving rise to the conduct and contravention of law need to be considered to determine whether they amount to a reportable situation (for example, whether financial services have been provided honestly, efficiently and fairly).

What should you do next?

The law surrounding secret commissions is unforgiving. It is important that you consider the nature of any benefits provided under distributor, introducer, or referral arrangements, and, where required, appropriately disclose any commissions before clients are issued a product. If you need to know more about how best to structure your distribution arrangements to avoid secret commission risk, please get in touch with Vanessa Murphy, James Morvell, or a member of the HW Funds Team.

This article was prepared with the assistance of Keshav Mohan, Law Graduate.

Contact

Vanessa Murphy

Corporate & commercial lawyer Vanessa's experience includes M&A, funds, capital markets transactions and regulatory advice.

James Morvell

James has particular expertise in equity capital markets, corporate transactions, and public and private M&A.

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