#7361 - How Do We Regulate Retail Clients - Securities and Financial Services Regulation

Not all instruments acquired/traded on financial markets are securities ftpo Ch 6D – the offer and issue of other instruments are subject to a separate regulatory regime in Pt 7.8 which includes mandatory disclosure requirements which arise when FPs are offered to retail clients.

The regulatory regime in Pt 7.9 aims to protect members of the public who acquire FPs and other securities by requiring the disclosure of certain material information in connection with the issue/sale of FPs, and ensuring as far as possible that the information is provided in written form before the decision to acquire a product is made. It also:

• Encourages the presentation of that information in a way enabling those acquiring FPs to compare functionally similar products

• Provides ongoing disclosure to holders of products

• Restricts advertising and ‘hawking’

• Allows cooling off in connection with the acquisition of certain FPs

Though there are parallels in the two securities disclosure regimes, the required disclosure is different – this may reflect the greater emphasis in Pt 7.9 on the use of disclosure to facilitate individual product selection rather than providing corporate information to enable markets to be informed

• In many respects acquirers of products within Pt 7.8 are consumers rather than investors.

• The EM says that this part “seeks to balance the need for the purchaser to have sufficient information to make an informed decision and compare products against the concern that they may be provided with more information than they can comprehend”. It thus takes a middle ground between full due diligence in the fundraising provisions and the ‘Key Features Statement’ approach in superannuation. It takes a directed disclosure approach supplemented by other information known to the issuer/seller that may materially influence a retail client’s decision to acquire the product

[Scope] The product disclosure regime applies to offers of all types of FPs other than securities and government bonds

• FPs are defined through the functional definition in s 763B-E and have a wide-ranging breadth and include products with little or no functional equivalence.

• [Limitations] There are two significant limitations:

  • It doesn’t apply to securities (as defined in s 761A) or government bonds

  • It only applies to FPs issued in the course of business of issuing financial products

[Complexity] The disclosure requirements in Pt 7.9 are complex and highly specific in their application. They vary depending on the type of financial product on offer and the principal statutory requirements have been extensively modified through regulations and ASICCOs (which sometimes include substantive amendments to the principal law)

• Requirements for offers of financial products include requirements as to:

  • PDS

  • Additional and Continuous Disclosure

  • Periodic reporting

  • Dealing with application moneys, Transaction confirmation, Dispute Resolution, Advertising and Cooling off

The two abovementioned regimes are quite different – different conduct triggers obligations to disclose, different exemptions from the disclosure requirements exist, the form and content of the required disclosure is different and the process in accordance with which offers are made is different (Woodcroft v Timbercorp)

• Due to the issues faced in differentiating between instruments in either regimes in the LEPO Case (SFE v ASX), CASAC recommended a ‘core regulatory approach’ for all financial markets and instruments traded on them ftpo clarifying the law and reducing uncertainty/compliance costs, reducing gaps, facilitating development of new products etc.

  • Though this recommendation was adopted in spirit to the regulation of financial intermediaries and provision of financial advice, it didn’t do so in relation to disclosure in connection with offers of financial products.

Some options and warrants are securities and therefore fall within Ch 6 – others are derivatives and therefore fall within Pt 7.9.

• [Scope] Generally speaking, exchange-traded options and other options are derivatives except

  • Options to acquire shares/debentures by way of issue which are within the defn of security

  • Options over tangible property and other options prescribed by the regs

• [Options over issued shares] can be securities or derivatives

  • To fall within s 761A(c) the instrument has to confer L&E interest in issued shares or debentures. Thus covered warrants may fall within this categories.

    • But some warrants are expressly excluded by Ch 6D and may therefore fall within this?

  • Offers of options over FPs other than securities is governed by s 1011C which states that ftpo PDS requirements, an offer of an option over an FP isn't taken to be an offer of the underlying FP.

    • Further, the grant of an option without an offer of it is taken to be an offer of the option and an offer to grant an option is taken to be an offer to issue an FP constituted by the option.

This is a limitation on Pt 7.9 in s 1010B(1) in relation to: “a financial product that is not or was not issued, or that will not be issued, in the course of business of issuing financial products”

• S 19: A reference to a business of a particular kind includes a reference to a business of that kind that is part of, or carried in conjunction with, any other business.

• It is likely that there must be elements of system, repetition and continuity

FPs can consist of separate components of parts (even provided by different providers)

• Sometimes different components will be aggregated to form a financial product

  • S 761B provides that if it is reasonable to assume that the parties to a series of separate arrangements regard them as constituting a single scheme, and together those separate arrangements would constitute an FP, they should be viewed as such

• Others may have a financial product as a component of a broader facility

  • S 762B: if an FP is a component of a facility with other components, Ch 7 only applies in relation to the facility to the extent it consists of the component that is a financial product (for e.g. a loan to acquire derivatives would be required to comply with Ch 7 only irt the offer of derivatives)

  • S 763E: Where the component in the nature of a financial product is only incidental to the broader facility, Ch 7 may be excluded. Consider International Litigation Partners where an LFA was considered to be an FP and considered by the majority not to be incidental to the FP purpose

Pt 7.9 Div 2 requires a PDS be provided to a person who before they acquire a financial product where that person is a retail client. The circumstances in which a retail client must be given a PDS before acquiring a financial product are:

• Recommendation situation – where, in the course of providing personal financial advice to the client, a regulated person has recommended that the client acquire the FP, and the acquisition is either by way of issue to the client, or by way of transfer to the client under a regulated secondary sale to which the PDS requirements apply (s 1012A)

• Issue situation – where a regulated person offers to issue, or arrange the issue of, or issues a FP to the client (s 1012B)

• Sale situation where a regulated person offers to sell, or sells an FP to a client in circumstances amounting to an off-market sale by a controller of the issuer, a sale amounting to an indirect issue of the FP or a sale amounting to an indirect off-market sale by the controller of the issuer (s 1012C)

[Scope] The obligation to provide a PDS is triggered where the conduct is engaged in by a regulated person which includes (s 1011B):

• The issuer of the FP

• The seller of the FP (in a sale amounting to an off-market sale by a controller of the issuer, a sale amounting to an indirect issue of the FP or a sale amounting to an indirect off-market sale by the controller of the issuer)

• Certain financial intermediaries who may be involved in the transaction (Any AFSL or AR of AFSL)

[Who must provide]

• In a recommendation situation the obligation to provide rests on the person providing the advice

• In an issue situation the obligation can fall on:

  • A regulated person offering to issue a FP

  • A regulated person offering to arrange the issue of FP or issuing the FP

• In a sale situation the obligation arises

  • where a regulated person offers to sell the FP; or

  • Where a client makes an offer to a regulated person to acquire the FP that the regulated person proposes to accept

S 1012A imposes an obligation to provide a PDS when the person provides personal advice to a retail client that includes a recommendation that the client acquire a particular FP

• This is primarily directed at ensuring that, when a financial adviser recommends particular products to clients, those clients receive the PDSs for the products as part of the advice process.

• The PDS will be prepared and supplied by the issuer/seller of the products and given to the adviser

S 1012B imposes an obligation on a regulated person to provide a PDS in connection with a primary offer/issue of an FP to a retail client. The obligation arises where the person:

• Offers to issue the financial product to the...