Top 5 things you should know about the FOFA reforms
By Diana Young
Draft legislation set to implement the government’s Future of Financial Advice (FOFA) reforms has been released this year in two tranches. The FOFA reforms are a response to a government inquiry into financial services and products that was conducted after several high profile collapses such as Opes Prime, Timbercorp and Storm Financial.
This first tranche of legislation covers a number of key components of the FOFA reforms including an opt-in regime, the best interest duty and the increase in ASIC's powers and was released earlier this year.
The second tranche, which was released in late September, includes the ban on conflicted remuneration (covering commissions and volume payments) and the ban on 'soft dollar' benefits.
In summary, the key reforms that are proposed by the FOFA legislation are as follows:
1. Statutory Fiduciary Duty
When providing financial advice to retail clients after 1 July 2012, financial advisors will have a statutory duty to act ‘in the best interests of the client’. Where a conflict in interest occurs, the advisor must give priority to the interests of the client. In doing so, the advisor must take a number of steps, including:
- Assess whether they have the expertise to provide advice on the subject matter requested,
- Assess whether the client’s objective could be met through means other than the acquisition of financial products,
- Advise the client in writing when it is apparent that their needs could be better met by obtaining advice on another subject matter.
The full list of obligations can be found at section 961(c) of the draft legislation.
2. On-going Remuneration
When charging an on-going fee to a retail client, the adviser must provide:
- a renewal ('opt-in') notice every two years, and
- an annual fee disclosure statement setting out, among other things, the amount of fees paid by the client in the past 12 months and the fees anticipated that the client will incur in the next 12 months.
This will apply to new clients from 1 July 2012.
If the client does not renew the adviser's services by 'opting in' to the renewal notice, they are assumed to have opted out and an ongoing advice fee can no longer be charged.
A client can terminate an on-going fee arrangement at any time.
3. Ban on Conflicted Remuneration Structures
One of the key FOFA reforms will mean that from July 2012, there will be a ban on all commission payments relating to the distribution and provision of advice for retail financial products as well as any form of payments relating to volume of sales targets.
This ban extends to soft dollar benefits or benefits other than monetary commissions or direct client advice fees. Exceptions are made to benefits under $300 that relate to professional development and administrative IT services.
There are some limited carve out of products from the ban.
4. ASIC Powers
The proposed legislation will change ASIC’s licensing and banning powers, giving ASIC the ability to act at an earlier stage if they have concerns about a person. Such changes include:
- ASIC can refuse, cancel or suspend a Australian Financial Services Licence (AFSL) where it has reason to believe that a person is likely to contravene (as opposed to will not comply with) its obligations under the Act, and
- ASIC can ban a person from providing financial services where it has reason to believe that the person is not adequately trained or competent to provide financial services.
5. Restriction of the term ‘Financial Planner’
A public consultation paper will be released by the end of the year covering the restriction of the term ‘financial planner’, and the Treasury will provide the government with recommendations as to whether the term should be defined in the Corporations Act and its use restricted.
The deadline for submissions to Treasury on the draft bill for the second tranche of reforms closed on 19 October 2011.
The bill for the first tranche of reforms has now been referred to the Senate Economics Legislation Committee and the committee is seeking submissions from interested parties. A report is due on the 14th of March 2012.
For more information contact Slater & Gordon on 1800 555 777.
Breaking down barriers to recovering financial loss following negligent financial advice
By Odette McDonald
Slater & Gordon has acted for thousands of investors in individual and representative proceedings to recover compensation for financial loss suffered following the collapse of some of Australia’s biggest financial services companies, including Westpoint, Storm Financial, Opes Prime, Basis Capital and Fincorp. We also regularly act for people who have suffered financial loss as a result of negligent or inappropriate advice in legal claims against the financial service provider in question.
In our experience, the legal causes of action and forums for redress available to consumers of financial services are satisfactory, and will be potentially enhanced through some of the current reforms being considered by the Future of Financial Advice (FOFA) reviews, in particular those that may potentially relax the current financial distinction between retail and wholesale investors.
However, there are still a number of barriers to a consumer obtaining compensation where they have lost money from negligent advice from a licensee. This article addresses some of those barriers.
Consumer perception of the current compensation system
The Australian Securities and Investments Commission (ASIC) Consumer Advisory Panel recently commissioned research into the social impact of monetary loss on consumers. The results of the study indicate that the majority of investors who could seek compensation for their financial loss have not done so, either because they are unaware of available avenues for compensation or are reluctant to consider legal recourse. The report found that:
- 83% of participants in the study had not obtained any compensation for their financial loss at the time of interview
- a staggering 31% of participants had not pursued compensation because they were simply unaware that they were able to do so, and
- 7% of participants actively chose not to pursue compensation.
One of the primary reasons for investors not pursuing legal action, aside from being unaware of their options, was a fear of the costs and risks involved.
The report found that the most popular avenue for compensation was to join a class action because they are largely free, easy and rarely involve risk to the individual. One of the limitations, however, is that a class action is not available for everyone. Even where a number of other investors have suffered similar loss, the circumstances of the case may not be amenable to a class action.
There are, in fact, a number of options available to individuals in these circumstances, which involve minimal cost and risk. Consumers can pursue their loss through the Financial Ombudsman Service (FOS), and be awarded up to $150,000 in compensation if they are successful. Individuals are not required to have legal representation at FOS (although those who opt to have legal representation may have up to $3,000 of their legal costs paid if they are successful). Further, if an individual is unsuccessful at FOS they do not have to pay the defendant’s legal costs of the FOS process, and they preserve their rights to pursue the claim further in Court.
If it is necessary to go to Court, Slater & Gordon offers investors access to its RecoverTM funding options to reduce the cost and risks involved with pursuing their claim as an individual. RecoverTM offers distressed investors a fixed price assessment of the merits of their case before legal action is begun. If legal action proceeds, eligible clients are offered a No Win – No FeeTM arrangement for their own legal costs, and can access insurance to cover the defendant's legal costs and their own disbursements if their case is unsuccessful.
What happens when the advisor is insolvent?
A central issue for anyone contemplating whether to sue their former financial advisor will be whether or not the advisor has the ability to pay them.
The Parliamentary Joint Committee on Corporations and Financial Services (PJC) conducted an inquiry following the collapse of a number of financial services companies that resulted in significant financial loss to investors. In reporting on the inquiry in the Ripoll Report, the PJC recognised that current arrangements largely rely on often deficient professional indemnity insurance as a basis for compensation.
Some of the central factors that limit a consumer’s ability to recover compensation where the licensee is no longer operating include:
- the licensee holds no or inadequate professional indemnity insurance (e.g. cover that is insufficient in amount, or a policy that excludes financial products recommended by the licensee)
- the consumer is unable to access basic information concerning whether a licensee has sufficient professional indemnity insurance to meet their claim, and
- the inadequacy of existing regulations in relation to the amount and scope of insurance that licensees must maintain.
The Government is, as part of the Future of Financial Advice (FOFA) review, investigating existing compensation arrangements for consumers who receive bad financial advice or services, and examining the costs and benefits of introducing a statutory compensation scheme for consumers (the Review).
Slater & Gordon submitted to the Review that the industry should be reformed to ensure improved minimum standards for insurance, better disclosure of insurance policies for consumers, and the ability for consumers to directly access an insurance policy where a licensee has ceased operating.
We also supported the introduction of a last resort compensation fund, to be made available, inter alia, in circumstances where the licensee has become insolvent and there is no professional indemnity insurance policy in place, the policy in place is not sufficient in size to cover the claim, or the claim is rejected because of an exclusion in the policy (e.g. fraud by the advisor).
If you or one of your clients has suffered financial loss after receiving advice from a financial advisor, contact Slater & Gordon on 1800 555 777 to discuss options for recovering your loss.
Investors left in the lurch after court ruled that Timbercorp had met its obligations
By Odette McDonald and Sue Zhang
A recent decision by the Supreme Court of Victoria examines the extent to which information about risks and adverse events affecting a business are required to be provided in a Product Disclosure Statement (PDS).
The proceeding was a class action brought by investors in various agribusiness managed investment schemes (MIS) against a number of Timbercorp entities and directors, including Timbercorp Securities, which operated each scheme. The investors had taken loans from a Timbercorp subsidiary, Timbercorp Finance Pty Ltd, to fund their investments. The Timbercorp Group collapsed in early 2009.
In brief, the plaintiff's case was that Timbercorp Securities failed to disclose particular information in the PDS for each MIS, being:
- the 'structural risk' that the Timbercorp Group may fail due to maintaining insufficient cashflow to operate the schemes, and
- various 'adverse matters' including:
- the 2007 announcement that the Australian Taxation Office would no longer allow certain tax deductions by non-forestry MIS investors, and
- the global financial crisis.
Timbercorp's non-disclosure was said to have breached the Corporations Act, and also constituted misleading and deceptive conduct. The plaintiff asserted that had he been informed of this information, he would not have invested in the schemes, or suffered the consequent loss and damage.
Justice Judd found against the plaintiffs on all arguments.
In relation to the 'structural risk', it was held that a PDS is not required to include detailed financial information contained in Timbercorp's Annual Reports. Investors were required to be informed of the risk that Timbercorp Securities would fail only when there was a material risk of this occurring, namely in late 2008 or early 2009, when bank support for the Timbercorp Group was withdrawn and it became clear that certain asset sales would not take place.
As for the 'adverse matters', it was held that these were properly characterised as events, not risks, and that a PDS need not contain information about the existence and potential impact of events that can be reasonably managed.
The court was also critical of the plaintiff's general conduct of the proceedings, characterising its statement of claim as overly complex, and its laywitness and expert evidence largely unconvincing.
The upshot of the Timbercorp decision is that investors who had taken loans from Timbercorp Finance Pty Ltd will be denied relief from their liability to repay those loans, despite suffering large losses on their investments. It should be remembered that many of these investors are also unable to pursue claims against the financial planners that advised them to enter into Timbercorp investments, due to the planners' often inadequate insurance coverage. The predicament faced by these investors highlights the need for greater investor protection.
The plaintiff has recently appealed Justice Judd's decision.
For more information contact Slater & Gordon on 1800 555 777.
Take care when drafting agreements to reduce the risk of litigation
By Roop Sandhu
The Full Court of the Federal Court of Australia unanimously allowed an appeal by Macquarie Bank Ltd and Leveraged Equities Ltd against Ross Goodridge, a barrister who entered into a margin loan facility with Macquarie in 2003.
A margin loan is a popular way of borrowing to invest in shares or other publicly traded investments. The investor purchases shares with his own money and then uses those shares as collateral for a loan to purchase additional shares. The value of the investment rises and falls in line with the market. If it falls too much, the issuer of the loan can require the investor to top up his collateral to maintain the level of leverage in the loan at a constant rate relative to the current market value of the shares. This call to make a top up is known as a margin call.
Mr Goodridge entered into a margin loan facility with Macquarie in May 2003. The loan services agreement that Mr Goodridge signed contained some important clauses including:
- Margin calls were to be paid by 2pm the following business day,
- Macquarie was entitled to sell securities held under the margin loan facility where there was a shortfall (up to the value of the shortfall),
- The borrower was under obligation to monitor the loan and investment, and pay any shortfall, regardless of whether notice of the shortfall had been given,
- In the event of default, the secured property could be sold,
- Macquarie could vary the terms and conditions of the agreement, and
- Macquarie could assign its rights and novate its obligations under the agreement without the borrower’s consent.
In 2007, Mr Goodridge was notified of a change in the terms of the facility. Macquarie amended the requirement to permit margin calls be paid within three business days instead of the following business day, unless it otherwise notified at its absolute discretion.
In January 2009, Macquarie sold its portfolio of over 18,000 margin loans to Leveraged Equities, of which Mr Goodridge claimed he was not informed. As of February 2009, Mr Goodridge held units in a unit trust through the margin loan facility. These units had dropped in value such that Leveraged Equities made a margin call on Mr Goodridge. The first call was eventually satisfied. But the value of the units fell again and further margin calls were made. Less than three days’ notice was given. The margin calls were not met and the units were sold by Leveraged Equities.
The units subsequently rose in value again, such that Mr Goodridge would have been better off if the forced sale had not occurred. Mr Goodridge initiated legal proceedings, attacking these transactions in two ways. He asserted that the margin calls and forced sales were not lawfully made under the agreement, and that Macquarie’s rights and obligations had not lawfully been passed to Leveraged Equities.
The primary judge found for Mr Goodridge.
Macquarie and Leveraged Equities appealed to the Full Court of the Federal Court.
The Full Court found that the agreement authorised the margin calls and forced sales. In making its decision it found the following:
- The clause that required borrowers to pay margin calls within three working days unless otherwise notified gave discretion to both shorten and lengthen the period for compliance,
- The clause that permitted the sale of securities held under the margin loan facility could be relied on even when a valid margin call had not been made so long as there was a shortfall,
- Mr Goodridge was in default as he had not met his obligation to pay either the margin call or the shortfall that had arisen.
On the issue of the assignment of rights, the Full Court decided that the relevant clause of the agreement that permitted this to occur without the borrower’s consent meant what it said. The Court found the agreement permitted Macquarie to novate its obligations and assign its rights to Leveraged Equities. The Court also found that, although Mr Goodridge claimed not to have received notice of the novation and assignment, he had most likely received it. In any event, it was probably unnecessary to show that he had received it, only that the notice had been sent to him by post and had not been returned to sender.
The case reinforces the importance of carefully drafting agreements. Although the Full Court decided against Mr Goodridge, it was not without criticism of the agreement. Justice Stone described the agreement as lacking in clarity and being incompetently drafted, and commented that litigation could have been avoided completely had Macquarie been less obscure and ambiguous in drafting it.
The purpose of careful drafting is not just to ensure a party’s rights are vindicated in the final result of litigation (as Macquarie’s and Leveraged Equities’ rights were), but also, by removing ambiguity, to decrease the likelihood of costly litigation in the first place.
The decision also underlines the importance of the words of the contract in establishing the rights and duties of parties to it. If a party to a contract agrees in the contract to permit the other party to novate and assign its rights and duties to a third party, this can be legally effective, despite the law being generally wary about such third party dealings.
For more information contact Slater & Gordon on 1800 555 777.
Court rules that vulnerable investors deserve to be protected
By Roop Sandhu
The Supreme Court of New South Wales has endorsed the decision of a trustee of a unit trust to refuse to register transfers entered into between unit-holders and a company specialising in unsolicited share offers.
The Direct Share Purchasing Corporation (DSPC) is one of a number of companies that engages in dealings to acquire shares at below market value. These companies obtain (lawfully) details of registries from share registers or similar databases. They then write to the holders of those investments directly, and make offers to purchase their shares or units at well below market value. Most people reject the offers, but some vulnerable investors, typically those who are elderly or unsophisticated, accept.
This business model is legal and regulated. Although regulations require that the market price for the share or unit be stated when making such an offer, vulnerable investors continue to fall prey to such schemes.
This case concerned the DSPC’s dealings with unit-holders of Perpetual's Monthly Income Fund and Perpetual's Wholesale Monthly Income Fund. Perpetual Investment Management Ltd is the trustee of both funds. DSPC obtained the registry for these funds from Perpetual. It then wrote to unit-holders, offering to buy their units for around half of their value. Sixty-one unit-holders agreed. Perpetual, without being obligated to do so, wrote to those unit-holders to confirm whether they wished for the transfer to occur, of which 42 chose not to proceed, two agreed to proceed and the remainder did not respond.
Section 63 of the Trustee Act 1925 provides that a trustee may apply to the Supreme Court for opinion advice or direction on how it should exercise its powers as trustee. Under this provision, Perpetual asked the Court whether it was justified in refusing to register transfers of units to DSPC.
DSPC contended that it was not appropriate that the Court give advice. This contention was made on a number of bases, one of which was that it said the Court would be pre-judging any dispute that might arise between DSPC and Perpetual as to the registration of the transfers.
The Court held that there was no issue of pre-judging a dispute. It held that any dispute was likely to be between DSPC and the unit-holders who entered into the transfers but later did not wish to proceed. The Court found that the provisions of the Corporations Act 2001 that deal with registration empower registries to refuse to register transfers that might be unenforceable should they wish to do so. It is up to DSPC to bring proceedings against the unit-holders and Perpetual for registration to occur should DSPC wish to contest Perpetual’s refusal.
Accordingly, the Court rejected DSPC’s submissions, and found that it had power to provide advice. The Court advised Perpetual that it was justified to refuse to register the transfers of units for those unit-holders who had indicated they no longer wished to proceed, as well as those who had failed to respond. The Court also advised Perpetual to make payment of distributions to the unit-holders as recorded in the register (that is, not to DSPC).
The decision has uncertain implications. Notably, the Court was at pains to point out that its decision does not affect the rights of DSPC against those unit-holders who entered into transfers with it, but then stated that they did not wish to proceed. DSPC could commence proceedings against unit-holders and Perpetual, seeking an order that the transfers be registered. The Court noted a number of bases on which unit-holders could resist such proceedings, however given the nature of the application before it (which was by the trustee seeking advice), the court did not rule on whether the unit-holders could succeed.
The Court also noted that although registries can refuse to register transfers that might not be enforceable, it does not follow that they have a positive obligation to scrutinise transfers that appear valid. The Court found it doubtful that Perpetual could have been criticised had they not sought the Court’s advice and registered the transfers.
Furthermore, since only trustees are able to seek judicial advice in the way Perpetual did in this case, such proceedings are not available to corporations seeking to counteract the activities of companies specialising in unsolicited share offers. Corporations seemingly could, however, rely on the provisions of the Corporations Act regarding their power to refuse to register transfers of shares.
For more information contact Slater & Gordon on 1800 555 777.