One of the Australian Securities and Investment Commission’s (ASIC) top priorities is to ensure compliance with the product design and distribution obligations (DDO) in Pt 7.8A of the Corporations Act 2001 (Cth). These obligations came into force on 5 October 2021.
Since that time, ASIC has issued 11 DDO stop orders. The products covered by these stop orders have been interests in managed funds and shares in investment companies. Seven remain in place and four have been lifted following actions taken by the entities to address ASIC’s concerns.
In this alert we have set out why stop orders have been issued, ASIC’s key areas of DDO focus and key takeaways.
Why have stop orders been issued?
It is clear from ASIC’s media releases that ASIC is willing to take issue with how a product issuer defines a financial product’s target market or determines a product’s distribution conditions. Reasons given by ASIC for issuing the stop orders to date fall within the following categories:
- the target market was too broad
- the target market determination (TMD) did not specify any distribution conditions or the distribution conditions were inadequate
- the TMD did not include required content (eg review periods), and
- investment companies did not prepare TMDs for offerings of shares.
To issue a stop order, ASIC must be satisfied that there has been a contravention of the DDO provisions. Before making a final order, ASIC must hold a hearing and give a reasonable opportunity to any interested person to make oral or written submissions to ASIC on whether an order should be made. However, if ASIC considers that any delay in making such an order pending the holding of a hearing would be prejudicial to the public interest, ASIC may make an interim order which lasts for 21 days unless revoked. Further, at any time during the hearing ASIC can also make an interim stop order which may apply until either ASIC makes a final order or the interim order is revoked.
1. TMDs’ target markets too broad
A TMD must be such that it would be reasonable to conclude that, if the product were to be issued 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. A number of stop orders involved a failure by the issuer to identify what ASIC considered was the appropriate target market for their product. The investor attributes in target markets in TMDs that ASIC considered inappropriate included:
- risk and return profiles
- investment objectives, and
- investors’ intended product use.
Inappropriate risk and return profiles of investors in target market
ASIC has expressed concern that issuers are not appropriately considering the features and risks of their products when determining the target market for their products.
For example, due to the high-risk nature of a fund’s underlying assets (eg secured and unsecured loans) ASIC considered that interests in the fund were inappropriate for investors with a “tolerance for a moderate level of risk” (as described in the fund’s TMD).
ASIC also took a similar approach in respect of TMDs for other funds that invested in asset classes that it considered to be high risk. It issued 3 TMD stop orders for funds that invest in crypto assets (i.e. funds that invested solely in bitcoin, ether and Filecoin respectively). ASIC considered that crypto assets were “very risky and speculative”, and disagreed with the description in TMDs that these single-crypto asset funds were appropriate, even for investors with medium, high or very-high risk and return profile.
Inappropriate investment objectives of investors in target market
ASIC issued a stop order in relation to a property fund TMD that described the target market as including investors who were looking for “capital preservation or potentially a capital guaranteed investment objective” where the fund’s investments were solely in a concentrated portfolio of residential property assets.
Another fund’s TMD stated that investors would not have the right to withdraw their investment during the investment term, and that the investment will have “no ongoing liquidity”. Despite this, ASIC appears to have interpreted the TMD as suggesting that the product was suitable for investors requiring liquidity or needing to make withdrawals during the investment term. Further, ASIC disagreed with the description in the TMD that the fund was suitable for investors seeking “regular monthly income distributions”, but did not provide any indication as to why it adopted this position.
Percentage of investable assets to invest in the product
ASIC has also made stop orders in relation to TMDs that ASIC considered inappropriately described the proportion of an investor’s portfolio to which a financial product would be best-suited. This included 25-75% of an investor’s investment portfolio for a fund that invested in a single loan and up to 25% for crypto funds.
2. Not setting distribution conditions or including inadequate distribution conditions
A TMD must be such that it would be reasonable to conclude that, if the product were to be issued to a retail client in accordance with the distribution conditions - it would be likely that the retail client is in the target market.
One stop order was made for a TMD that did not include any distribution conditions and 3 other stop orders were made for TMDs which ASIC considered had inappropriate distribution conditions. For example, ASIC considered that it was insufficient for an issuer of a TMD to rely solely on self-certification from investors that they fell within the target market.
3. Not including required content
Other stop orders were made for TMDs that failed to satisfy the TMD content requirements (for example, failing to include mandatory review periods in the TMD).
4. Failure to issue TMDs for investment companies
Two of ASIC’s first stop orders were issued to two companies that sought to issue shares to retail investors, without issuing a TMD in circumstances where one was required.
While the general rule is that issuers must make and publish a TMD for a financial product before any retail product distribution conduct, subject to certain exemptions, a TMD is not generally required for a fully paid ordinary share in a company. However, a TMD is required where the company carries on a business of investment in financial products, interests in land or other investments; and in the course of carrying on that business, the company invests funds subscribed, whether directly or indirectly, after an offer or invitation to the public made on terms that the funds subscribed would be invested.
ASIC’s key areas of DDO focus
ASIC’s 2022-26 corporate plan states that it intends to pursue risk-based surveillances and take enforcement action focusing on sectors and products that pose the greatest risks of consumer harm. This includes:
- conducting surveillance on superannuation and managed funds TMDs and superannuation distribution practices
- reviewing product governance in the credit and buy now pay later sectors
- taking enforcement action in relation to poorly designed products
Further, one of ASIC’s enforcement priorities for 2023, announced on 3 November 2022, is enforcement action targeting poor design, pricing and distribution of financial products.
Key takeaways
In light of the above, issuers of financial products should consider:
- reviewing TMDs in light of ASIC stop orders, ASIC's priorities, data and customer information
- ensuring TMDs and advertisements are consistent with the product’s PDS
- ensuring that advertisement checklists and sign offs consider the product’s target market
- the broader implications of not getting DDO right, including:
- negative publicity from receiving a stop order
- having to withdraw a product from market
- the broad orders that a court may make, including returning money paid by the customer and compensating them for any loss.
