Putting your best foot forward: Key lessons from the Federal Court’s interpretation of ‘reasonable steps’

Key Takeaways

The judgment distils a number of key learnings for AFSL holders regarding compliance with section 963F of the Corporations Act. These include:

1. ‘Reasonable steps’ is a question of fact that depends on all the circumstances of the business and the activities carried on by the AFSL holder and its representatives. Notably, it is for the AFSL holder to determine what steps it should take, provided those steps are reasonable. This construction affords licensees a degree of latitude in determining how to comply with the obligation, albeit at the expense of hard and sharp rules as to what constitutes reasonable steps.

2. AFSL holders should adopt policies and procedures prohibiting the acceptance of conflicted remuneration. These policies and procedures should spell out what is required to be done, who is responsible for doing what and the specific actions to be taken.

3. However, written policies and procedures are redundant unless carried out in practice. Steps must be taken to give effect to an AFSL holder’s policies and procedures for prohibiting conflicted remuneration. This includes actively monitoring and supervising representatives for compliance.

4. If in doubt, seek legal advice. In cases of doubt, AFSL holders should seek legal advice as to whether an arrangement involves conflicted remuneration. In most circumstances the cost of obtaining legal advice will be reasonable given the importance of the ban on conflicted remuneration, as well as the importance of enforcing it at the time that a financial product arrangement is first proposed.

5. AFSL holders should maintain a record of the steps taken to comply with their obligations. Perhaps an obvious one… but essential for demonstrating compliance if ASIC comes knocking.

Facts

RM Capital held an AFSL authorising it to provide financial product advice for classes of financial product that included superannuation, and to deal in superannuation products. SMSF Club was an authorised representative of RM Capital and carried on a business of providing financial product advice and accounting and administrative services for self-managed superannuation funds (SMSF). ASIC alleged that between December 2013 and July 2016 and pursuant to referral agreements, Positive RealEstate Pty Ltd (PRE) paid SMSF Club around $5,000 each time a client bought a property through them using their SMSF. ASIC alleged that SMSF Club contravened section 963G of the Corporations Act by accepting payments from PRE, and RM Capital contravened section 963F of the Corporations Act by failing to take reasonable steps to ensure SMSF Club did not accept the payments. Orders in relation to SMSF Club will be made separately.

Bright lines for interpreting the obligation to take ‘reasonable steps’

This is the first case to consider in detail the interpretation of section 963F of the Corporations Act. Interpretive principles that emerged are set out below.

Jackson J observed that the interpretation of the equivalently worded obligation in section 961L of the Corporations Act, which requires AFSL holders to take reasonable steps to ensure that representatives comply with the best interests obligations, is relevant to the interpretation of section 963F.[1]
Section 963F of the Corporations Act does not require AFSL holders to take every reasonable step that could be taken. Nor is there one true path of steps that must be followed. Rather, it is for the AFSL holder to determine what steps it should take, provided they are reasonable.[2]
What constitutes reasonable steps is a question of fact that depends on all the circumstances of the business and the activities carried on by the AFSL holder and its representatives.[3]
It is the steps taken by the AFSL holder in totality that must be reasonable. It will not be sufficient for the AFSL holder to point to one or two reasonable steps.[4]
Circumstances that an AFSL holder may have regard to in determining what reasonable steps to take include the degree of difficulty and practicality of any given steps as well as the costs associated with them and the characteristics of the representative.[5]
A breach of section 963G of the Corporations Act by a representative is not a necessary precondition to establishing a breach of section 963F. However, it may be relevant to shedding light on the extent of the steps that could have been taken.[6]
A provision such as section 963F of the Corporations Act is not susceptible to being reduced to hard and sharp rules.[7]

In construing section 963F of the Corporations Act, Jackson J had particular regard to the relative importance of preventing the acceptance of conflicted remuneration. A “goal”[8] which Jackson J concluded was an “an important one”[9] as informed by the operative text of section 963F (the word ‘ensure’ amplifying the seriousness of the obligation) and its contextual surroundings (including the policy objectives of Chapter 7 of the Corporations Act generally). The importance of section 963F was further reinforced by the existence of significant civil penalties for non-compliance and its application to retail clients, which implies a certain level of vulnerability in the class of consumers to which the prohibition is intended to protect. The corollary of Jackson J’s interpretation is that certain steps that a licensee would otherwise regard as costly or onerous may nevertheless be reasonable given the relative importance of the provision.

Application to RM Capital

Jackson J held that an AFSL holder in RM Capital’s circumstances, taking reasonable steps to ensure that its representatives did not accept conflicted remuneration, would have at least:[10]

Formally adopted a clear written policy prohibiting the acceptance of conflicted remuneration.
Informed new representatives of that policy and its contents at induction and training sessions.
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.
If there was room for reasonable doubt about whether any such arrangements constituted conflicted remuneration, obtained legal advice on the subject.
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.
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.
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.

Jackson J observed that whilst steps 1 to 7 above may be considered unduly onerous for a small business such as RM Capital, he did not consider this to be the case given the relative importance of the ban on conflicted remuneration.[11]

Turning specifically to SMSF Club, Jackson J noted that the risks presented by SMSF Club would have prompted an AFSL holder to monitor SMSF Club “more intensively”[12] than other representatives. This should have included auditing a random selection of SMSF Club files for the acceptance of conflicted remuneration every six months.[13] Moreover, for each financial product SMSF Club gave advice, SMSF Club should have been asked at the time of each audit for details of all payments and other benefits received from the promoters of the products.[14]

Notably, ASIC submitted that RM Capital should have monitored representatives’ compliance with section 963F of the Corporations Act by auditing the advice of its representatives on a regular basis. Jackson J rejected this on the basis that it is not clear how monitoring advice would reveal that representatives may be accepting conflicted remuneration. The key takeaway here is that monitoring will not be ‘reasonable’ if it is not directed towards the intended goal; which in the case of section 963F of the Corporations Act is preventing representatives from accepting conflicted remuneration.

Broader implications

Beyond section 963F of the Corporations Act, ASIC v RM Capital is relevant to the interpretation of the ‘reasonable steps’ test generally. The ‘reasonable steps’ test is a statutory standard of broad application and can be found in provisions such as:

the general conduct obligation under subsection 912A(ca) of the Corporations Act and subsection 47(e) of the National Consumer Credit Protection Act 2009 (Cth) to take ‘reasonable steps’ to ensure a licensee’s representatives comply with the financial services laws and the credit legislation, respectively.
section 994E of the Corporations Act which requires a person who makes a target market determination (TMD) to take ‘reasonable steps’ that will, or are reasonably likely to, result in retail product distribution conduct being consistent with the TMD.
Australian Privacy Principle (APP) 11 of the Privacy Act 1988 (Cth) which requires an APP entity to take ‘reasonable steps’ to protect personal information it holds from misuse, interference and loss, as well as unauthorised access, modification or disclosure.

As this case demonstrates, the obligation to take ‘reasonable steps’ is not expressed as an obligation to take all reasonable steps. Even in circumstances where an obligation is expressed as requiring ‘all reasonable steps’ it is unlikely to require the identification of the “universe of possible reasonable steps”[15]. Rather, the standard leaves open the possibility of multiple paths, provided the steps taken are reasonable.