By Mark Bland, Partner, Geoff McCarthy, Special Counsel and Angela Wootton, Paralegal.

ASIC’s first successful Court action, enforcing the Design and Distribution Obligation (DDO) regime, has concerning implications. While the outcome is not surprising, the reasoning in the judgment has the potential to considerably increase the regulatory burden on RSE licensees, responsible entities and other financial product issuers and distributors. In this article we analyse how Australian Securities and Investments Commission v Firstmac Limited [2024] FCA 737 (10 July 2024) may change what is accepted industry “distribution” practice under the DDO regime.

Any licensee with obligations under the DDO regime should revisit their distribution conduct, and in particular how it meets the obligation to take reasonable steps before any general advice or product disclosure statement (PDS) to ensure the advice or PDS is provided only to the likely target market.

Licensees may also consider approaching their industry bodies about approaching ASIC for a modification declaration or guidance to prevent excessive compliance costs for no apparent benefit to consumers.

Proceedings

ASIC commenced civil penalty proceedings in the Federal Court against Firstmac Limited (Firstmac), a financial product distributor, for alleged breaches of the design and distribution obligations (DDO).

Firstmac distributed term deposits and other investment products, including interests in Firstmac High Livez (High Livez), a registered managed investment scheme. Under the DDO, Firstmac was required to take reasonable steps to ensure that it distributes financial products consistent with the target market determination (TMD).

ASIC alleged that in marketing and distributing High Livez to term deposit holders, Firstmac failed to take reasonable steps to ensure that the product was distributed in accordance with the TMD.

ASIC’s case was that by adopting a cross-selling strategy of marketing and distributing High Livez to term deposit holders, there was a likelihood of the customers being outside the High Livez target market due to:

• High Livez not being a capital guaranteed product in contrast to Firstmac’s term deposits which were guaranteed by the Commonwealth Government for an amount up to $250,000 per account; and
• the investment timeframes for term deposits ranging from 30 days to two years unlike the recommended investment timeframe for High Livez which was a minimum of three years up to five years.

The TMD indicated that customers seeking a capital guarantee or having an investment timeframe of two years or less were not in the target market.

Firstmac marketed the product to some of its term deposit customers.  ASIC was concerned that Firstmac’s term deposit customers were exposed to the risk that they may obtain a financial product that was inappropriate to their needs and objectives when some of them would not have been in the target market.

ASIC sought declarations and pecuniary penalties from the Court.

The agreed facts included that High Livez was offered to 780 retail clients between October 2021 – September 2022.

Reasons for judgment

In Australian Securities and Investments Commission v Firstmac Limited [2024] FCA 737 (ASIC v Firstmac), Downes J held that Firstmac had breached s 994E(3) of the Corporations Act 2001 by failing to take reasonable steps so that the provision of the PDS for the High Livez product was consistent with its TMD.

The Court found, based on the evidence, that there was a real possibility that some of the recipients of the PDS may have held either or both the objectives of government guarantee or less than 2 years investment.

The Court found that Firstmac’s actions were insufficient to meet the statutory obligations. Firstmac knew or ought to have known that there was a real risk that some recipients of the PDS would be outside the target market.  While Firstmac did take some steps that could be considered as a part of reasonable steps, there remained a real residual risk and there were further steps it could take that were not onerous to meet the requirement of “reasonable steps” – for example, questioning persons interested in the product or sending targeted communications before retail product distribution conduct regulated by the TMD occurred.

Therefore, the recipients were outside of the target market for High Livez and the giving of the PDS was not consistent with the target market.

The case management hearing for the determination of pecuniary penalties is set down for 19 July 2024.

What is conduct “consistent with” the TMD?

Giving a PDS to a retail client in Australia for a financial product on offer for issue is a form of retail product distribution conduct.  There is generally a contravention if the distributor gives a PDS to a retail client without first taking “reasonable steps” that would have “resulted in, or would have been reasonably likely to have resulted in”, the giving of the PDS being “consistent with” the TMD (s 994E(3)(d)).

Downes J appears to have considered that giving a PDS to a retail client in Australia who was outside the target market in the TMD would not be “consistent with” the TMD.  In doing so Her Honour held that “the relevant reasonable step must be antecedent to the retail product distribution conduct itself (in this case, the giving of the PDS) and not be taken concurrently with or after that conduct.” [56]

This view seems to apply equally to the provision of general advice to a retail client outside the target market about the financial product and to prospectuses for securities that are not exempt.

There is a specific requirement to identify conditions and restrictions that apply to a distributor and it is open to consider that consistency merely implies complying with those distribution conditions. Except to the extent that compliance with any conditions and restrictions on distribution in the TMD is concerned, it is not clear in the Act what determines consistency for the purposes of s 994E.

ASIC considers that more may be required than merely compliance with distribution conditions to meet the obligation to take reasonable steps to be consistent with the TMD. In its Regulatory Guide 274 Design and distribution obligations at 274.172 it states:

“ . . . the distributor should consider . . . what distribution method would be appropriate and what additional arrangements need to be put in place that are reasonably likely to result in sale of the product being consistent with the TMD” (emphasis added) and by ‘sale’ ASIC presumably means to include issue.

ASIC does not suggest in RG 274 that the provision of a PDS or general advice to a person outside the target market would necessarily be inconsistent with a TMD.

On its ordinary meaning the term “consistent with” may imply only doing that which is permitted by the TMD and not doing anything that undermines the objects of the TMD.

The statement of the target market in the TMD relates to who is to acquire the financial product, that is the target market of the financial products, not the target market for the receipt of a PDS (or general advice) and this reflects the object of limiting inappropriate issues or sales rather than limiting the provision of information.

What does “likely” mean?

The Court held that for ASIC to succeed it needed to prove (on the balance of probabilities at the Briginshaw standard of proof) that Firstmac had failed to take reasonable steps that either resulted in, or would have been reasonably likely to result in (i.e. there was a real and not remote chance), the distribution conduct being consistent with the High Livez TMD.

It is also relevant in indicating analogously that the term ‘likely’ is to be interpreted as meaning a real possibility, and not more probably than not, when assessing the test for the adequacy of the TMD in s 994(8).  That provision is as follows:

“(8) A target market determination for a financial product must be such that it would be reasonable to conclude that, if the product were to be issued, or sold in a regulated sale:

1. to a retail client in accordance with the distribution conditions—it would be likely that the retail client is in the target market; and
2. to a retail client in the target market—it would likely be consistent with the likely objectives, financial situation and needs of the retail client.”

This implies that to meet this test it need only be reasonably possible that:

1. retail clients acquiring the financial product will be in the target market; and
2. for retail clients in the target market, the acquisition would be consistent with the likely objectives, financial situation and needs (relevant personal circumstances).

Policy considerations

The judgment of Downes J is not necessarily in accord with the object of the DDO as stated in the Revised Explanatory Memorandum is to Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2019 which states:

1. at paragraph 1.5, “These obligations are designed to assist consumers to obtain appropriate financial products…” (emphasis added); and
2. at 1.86 in reference to the obligation relating to not distributing where there is TMD when is it required, “[t]his obligation promotes the effectiveness of the new regime. It ensures the distribution of non-compliant products is minimised; (emphasis added);
3. the absence of an indication of an intent to address any harm arising from distribution of information, such as a PDS, apart from the implications for the distribution of the product which occurs on its issue or sale.

A potential function of the PDS and general advice is the provision of information to a retail client.  The information can help the client to decide about the product’s suitability to their relevant personal circumstances.  That is not to say that it is appropriate for an issuer to rely only on retail client self assessment but it is an important part of reasonable steps to avoid retail clients acquiring inappropriate products.

The provision of the information through the PDS and general advice also helps make more effective attempts by the issuer to obtain information to assess likely relevant personal circumstances.  This is because until they have information about the product and are interested in it, retail clients are unlikely to be willing to provide information about their personal circumstances.  Also, even if willing, retail clients may have difficulty articulating their objectives and needs.  This important function of the PDS and general advice will be undermined if the PDS or general advice can’t be given before filtering to the likely target market.

It is common marketing practice, as Parliament would have known, that general advice about financial products, and PDSs be publicly available, and it would be surprising if it was intended that such practices would be undermined.

Reflecting on the objects of Chapter 7 of the Corporations Act, while requiring steps to be taken to avoid providing general advice or PDSs to clients outside the target market may serve the Chapter 7 object of “provision of suitable financial products to consumers” it is unlikely to serve the object of “informed decision making by consumers”. This is particularly the case where there are adequate safeguards to prevent the issue of the product to retail clients who are outside the target market. Only reasonable steps are required, but what is reasonable should be informed by the later steps in the process, and not only what has occurred before the general advice or provision of a PDS.

Impractical implications

The judgment creates problems such as in the following examples of conduct that reflects industry practice and is not apparently harmful, but may not be permitted.

• An RSE licensee has a pension product PDS available on its website. The TMD for the Fund identifies the target market as persons who have satisfied a condition of release of their superannuation. The RSE licensee implements checks of applicants to confirm they are in the target market before issue but not before making available the PDS. This practice may not be permitted.
• A responsible entity of a registered scheme advertises its managed investment products, and the advertisement contains general advice. The advertisement is broadcast.  The advertisement contains an effective link to the PDS.  Before accepting an application for a product, the responsible entity requires the prospective applicant to complete a questionnaire to determine if they are likely to be in the target market.  In the circumstances the questionnaire means it is not likely that any acquirer will not be in the target market. This approach to marketing may not be permitted.
• A research house rates financial product within a class and includes general advice about the characteristics of the financial products. The information is publicly available.  No attempt is made to limit access to discussions of products to those in the target market.

What AFS licensees can do

It would be prudent for retail financial product issuers and distributors to review their practices. ASIC has a current focus on ensuring distribution is consistent with TMDs.  Heavy civil penalties may apply as well as licensing disciplinary action.

Product issuers may wish to review their TMD promptly to reduce the scope of for successful allegations of inconsistency while remaining mindful of ASIC’s stop order powers and the important underlying objective of reducing consumer harm from acquiring products that are not appropriate.

Licensees may also approach their industry bodies to approach ASIC about the policy implications of this decision and ask ASIC to either use its modification power under s 994L(2)(c) to modify s 994E(3) or alternatively provide guidance about how it will enforce this provision, which may alleviate the arguably unnecessary costs of modifying distribution conduct in response to the ASIC v Firstmac decision.

How we can help

Mills Oakley has strong experience in assisting in the preparation of TMDs and advising on distribution requirements and would be happy to engage in initial no obligation discussions around these issues.

Further information about the DDO requirements is available to subscribers to the ARGOS Reg tech platform for which Mills Oakley is the content providers.  You are welcome to contact us for a free trial.