The first ‘best interest test’ court decision – let down or learnings?

The recent court decision against NSG Services Pty Ltd may not have clarified what constitutes ‘best interest’ but it highlighted the ‘reasonable steps’ an AFSL must take to ensure it complies with obligations, Fiona McCord writes.

We are almost three years into a world with Future of Financial Advice (FOFA) reforms and the first court decision in relation to the reforms has been handed down.  While many in the financial services industry have been eagerly waiting for the decision in the Australian Securities and Investments Commission (ASIC) in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd¹ (the decision), does it provide the clarity being sought? 

Whereas the decision provides no clarification on the question of what is the ‘best interest’ test, it provides significant guidance on the ‘reasonable steps’ an Australian financial services (AFS) licensee must take to ensure its representatives comply with their obligations.

What was the decision?

The matter arises from facts agreed upon between NSG Services Pty Ltd (NSG) and ASIC.  NSG holds an AFS license with an authorisation to provide financial advice to retail clients, and deal in life risk insurance and superannuation². NSG provided advice through both employees and authorised representatives who, it agreed had contravened the ‘best interest’ duties contained in section 961B of the Corporations Act 2001 (the act) and the obligation to provide “appropriate advice” contained in section 961G of the act (advice obligations).  

The Federal Court made a declaration that NSG contravened sections 961K and 961L of the act for failing in its supervision of its representatives³. These findings attract civil penalties, submissions on which have yet to be considered.

What does the decision say about the best interest test?

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ASIC accepted the submission of NSG that the best interests’ duty in s961B (1) of the act can be satisfied even if the advice provider does not satisfy the elements in s961B(d) (the safe harbour)⁴.  

While this appears to afford advice providers with an alternative best interest test, ASIC’s contention was that the elements of the safe harbour provision are, from a practical perspective, the ways that a provider would show that s961B(1) has been complied with, and therefore compliance with the safe harbour elements is highly relevant to the assessment of whether the best interests duty had been complied with⁵.

ASIC’s contention indicates that its approach to assessing compliance with the best interest obligations is likely to involve, at a minimum, consideration of whether the safe harbour elements have been satisfied.  This would appear to be a departure from its position in RG 175 that:

“…advice providers must carry out the steps in s961B(2)(a)-(g) – or other steps that would, at a minimum, produce at least the same standard of advice for the client as if s961B(2) had been complied with…”⁶ 

Since NSG agreed that its representatives had breached s961B, there was no cause for the court to consider the appropriate test, and so the interaction of the safe harbour provision with the best interests’ test remains unsettled.

Liability of the AFS licensee for its representatives

An AFS licensee will commit a contravention automatically, when its employee representatives contravene the advice obligations , which is what occurred with NSG.  In contrast, the liability of an AFS licensee with respect to its authorised representatives’ compliance⁷ with the advice obligations arises from the obligation to “take reasonable steps to ensure that representatives of the licensee comply with sections 961B, 961G, 91H and 91J.⁸”

ASIC contended that NSG breached s961L of the act because there was a causal nexus between the fact that its authorised representatives breached the advice obligations and NSG’s failure to take reasonable steps to prevent them from doing so⁹.  

In contrast, NSG submitted that 961L of the act only requires consideration of whether the licensee had taken reasonable steps to ensure compliance, a test which did not require a contravention of another provision¹⁰.

While ASIC indicated that it was not advocating a firm position on the point¹¹, unfortunately it was deemed unnecessary to be considered further for the purposes of the decision, and the issue remains unresolved¹².

The licensee as an “enabler”

The case considered NSG’s liability under s.961L of the act, the extent to which NSG, as the AFS licensee ‘enabled’ the contraventions by representatives.  This included a consideration of whether through its processes, systems, and procedures, NSG ‘enabled’ the contraventions by its authorised representatives and whether NSG “failed to ensure that the contraventions did not occur”.

NSG was on notice of potential breaches committed by its authorised representatives but despite the knowledge, NSG did not review its own practices, systems or policies for deficiencies.  The court found that this led to the implication that NSG failed to ensure its systems, policies and procedures were not enabling contraventions by its representatives¹³.

Policies and procedures as evidence

NSG admitted that it failed to take reasonable steps as required by s.961L because of the procedures and policies that it had implemented, or failed to implement in the business¹⁴. Also, of relevance was the fact that NSG was aware of problems with the advice provided by its representatives, and failed to adequately address systemic issues with its practices and policies which enabled the representatives to contravene the advice provisions.  This extended to failing to implement and disseminate advice obtained from external parties¹⁵.

The court assessed the adequacy of the content of NSG’s written policies and procedures and the extent to which they were followed and enforced by NSG.This consideration took place in the context of the business model and culture of the organisation, including the structure of client interaction with advisers, and the practices that had developed within a heavily sales driven environment¹⁶. The court found that the sales culture of NSG led to practices where advisers were likely to (and did) overlook their advice obligations¹⁷.

The court also considered the extent to which NSG had provided training to advisers as relevant to whether it took ‘reasonable steps’ to ensure its representatives’ compliance with the advice obligations, because inadequate training from the licensee meant the representatives were not made adequately aware of their personal responsibility for the obligations or the consequence of non-compliance¹⁸.

Learnings for licensees

The decision highlights the need for licensees to have adequate written policies that show the steps it takes to ensure its representatives comply with their advice obligations. The test of how reasonable the steps taken by the licensee are will include consideration of the culture of the organisation and the business model under which the advice is provided. Licensees should avoid ‘enabling’ contraventions through inadequate systems, policies, training and supervision.

Fiona McCord is senior lawyer at Holley Nethercote.

Footnotes

1.  [2017] FCA 345
2.  Ibid, [1]
3.  Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345, [1] to [20]
4.  As above, [18]
5.  Ibid
6.  Australian Securities & Investments Commission Regulatory Guide 175: Licensing: Financial product advisers-conduct and disclosure, p67 [175.241]
7.  S.961K Corporations Act 2001
8.  S.961L Corporations Act 2001
9.  Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345 [36]
10.  Ibid, 37
11.  Ibid, 38
12.  Ibid, 39
13. 54 14  Ibid,41
15.  Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345, [4]
16.  Ibid, [73-74]
17.  Ibid, [46-47; 73-74]
18.  51