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ASIC putting compliance under the microscope

Highlight of ASIC recent enforcement activities

ASIC has undertaken a number of enforcement actions in the last month or so putting compliance under the microscope and subjecting financial service providers under increased scrutiny to get things right. 

It has taken various actions ranging from issuing civil penalty proceedings, placing stop orders on product disclosure statements (PDS) and advertisements extending to placing its first DDO stop orders.  We highlight a few of those enforcement activities below.

 

The Lanterne Enforcement Activity

On 6 July 2022 ASIC commenced civil penalty proceedings in the Federal Court against Lanterne Fund Services Pty Ltd (Lanterne) alleging multiple failures to meet the obligations of its AFSL.  ASIC alleges that Lanterne, under a “licensee for hire” business model, failed to:

  • have in place adequate risk management systems;
  • have adequate resources (including financial, technological, and human resources) to provide the financial services and carry out supervisory arrangements;
  • maintain competence to provide its financial services;
  • ensure that its representatives were adequately trained;
  • take steps to ensure that its representatives complied with the financial services laws, and
  • do all things necessary ensure that the financial services were provided efficiently, honestly, and fairly.

Some interesting information surrounding ASIC enforcement against Lanterne:

  • Lanterne has over 200 authorised representatives (ARs) and over 60 corporate authorised representatives (CARs) operating under its AFSL.  The businesses of its ARs and CARs included venture capital funds, managed investment schemes, agricultural advisory services, wholesale funds management services, corporate advisory services, wholesale property funds, digital asset funds, and climate change advisory services.  These representatives operated in various industries including renewable energy, technology, healthcare, real estate, and biotechnology and agriculture.
  • Lanterne’s ARs and CARs are responsible for over $1 billion in funds and collectively paying monthly fees of around $180,000 to Lanterne.  However, it appears to ASIC that Lanterne operated a wholly deficient business, with no compliance staff and almost no risk management processes in place. 
  • ASIC is seeking declarations, pecuniary penalties from the Court and orders that an independent expert be appointed to review and report on Lanterne’s systems, processes and controls (including relevant implementation).  This is on the basis that ASIC expects all wholesale AFSL holders to reduce risk by ensuring their businesses develop, implement and maintain robust risk and compliance procedures and ASIC views Lanterne’s business to have deficient risk management processes.

On 7 July 2022, ASIC issued a Media Release (22- 174MR) in relation to civil penalty proceedings against Lanterne for risk and compliance failures.

 

The First DDO Enforcement Activity

ASIC has now placed interim stop orders on three financial firms in response to deficiencies in the target market determination (TMD) for their products. These actions are ASIC’s first employment of the stop order powers under the DDO regime.

On 28 July 2022, ASIC issued a Media Release (22- 194MR) in relation to these stop orders.
 

Refresher on the DDO regime

On 5 October 2021, the product design and distribution obligations (DDO) regime commenced.  DDO obligations require issuers and distributors of financial products to consider the design of the product, including its key attributes, and to determine the appropriate “target market” for the product (i.e., a class of consumers for whom the product would likely be consistent with their likely objectives, financial situation and needs).  If an appropriate target market cannot be identified for a product, then the product cannot be offered by the issuer.

On 11 December 2020, ASIC issued Regulatory Guide 274 – Product design and distribution obligations, the purpose of which is to explain ASIC’s interpretation of DDOs, its expectations for compliance, and its general approach to administering the DDO obligations.
 

What is a DDO stop order?

The DDO stop order power is contained in Part 7.8A of the Corporations Act 2001 (Cth) (Act), and is an administrative mechanism that allows ASIC to prohibit entities from engaging in specified conduct when ASIC is satisfied that there has been a breach of Division 2 of Part 7.8A or section 994E of the Act. Examples of breaches include when an entity has:

  • failed to make, review, make public or otherwise satisfy the requirements for a TMD;
  • distributed a financial product when a TMD has not been made for the product or is no longer appropriate; or
  • failed to take reasonable steps that will, or are reasonably likely to, result in distribution of the product being consistent with the TMD.

Before ASIC makes a stop order, it is obliged to hold an administrative hearing and give a reasonable opportunity for any interested persons to make verbal or written submissions to us on whether the order should be made.

However, ASIC has the power to make an interim stop order without a hearing if it considers that a delay would be prejudicial to the public interest.  Such an interim stop order lasts for 21 days, unless revoked earlier by ASIC.  In the below scenarios, ASIC has made interim stop orders, and the relevant issuers will have an opportunity to make submissions before any final stop order is made by ASIC.
 

DDO Case Study:  Responsible Entity Services Limited

ASIC issued an interim stop order preventing Responsible Entity Services Limited (RES) from issuing units in the RES Investment Fund (PPM Units), giving a product disclosure statement (PDS) for PPM Units or providing general advice to retail clients recommending investment in PPM Units.  The stop order is valid for 21 days unless revoked earlier.

ASIC noted that that the sole underlying asset of the PPM Unit class is a loan for development of a sandstone quarry, characterised as a high-risk, illiquid, unlisted single asset investment.  The return of an investor’s funds and any interest payable under the loan is wholly dependent on the ability of the borrower (a related party of RES) to repay the loan.

ASIC considered that, given the product’s features, RES’s TMD included two categories of retail investors for whom investment in PPM Units would not have been consistent with their likely objectives, financial situation and needs.  These categories comprised investors intending to use an investment in PPM Units as a core component of their investment portfolio, and investors with an objective of high capital growth or a mixture of capital growth and income.
 

DDO Case Study:  UGC Global Companies

ASIC made interim stop orders preventing two companies in the UGC Global Group, UGC Global Alpha Limited and UGC Global Alpha Fund Limited, from dealing in shares in relation to retail investors, providing a disclosure document or providing financial product advice in relation to the shares to retail investors.

In May 2022, the two companies lodged prospectuses seeking to raise $100 million each through the offer of ordinary shares, for the purpose of investing in the UGC Alpha Global Fund.  ASIC extended the exposure period for these prospectuses because of concerns that the disclosure was defective and placed interim stop orders on offers made under the prospectuses.

When the prospectuses were made publicly available during the exposure period, a TMD was not made available, and the prospectuses provided that applications to invest would be processed on a “first come, first served “ basis.

ASIC was concerned that the UGC Global Group companies may have engaged in retail product distribution before preparing a TMD for their high risk offers.  Therefore, ASIC also made orders for non-compliance with obligations under DDO in relation to the shares of these companies, which lasted for 21 days.  On 11 July, further DDO orders were made (for an indefinite period) to give the companies additional time to respond to ASIC concerns.
 

DDO compliance is likely to be a focus area for ASIC

According to ASIC Deputy Chair Karen Chester, ASIC’s focus has now shifted to compliance. ASIC believes industry has had sufficient time to bed down its implementation of the DDO regime.   Ms Chester has highlighted that ASIC has targeted surveillance underway to check whether product issuers and distributors are complying with DDOs.  She has also identified the following focus areas for ASIC in relation to DDO:

  • Defective TMDs, and issuers who have failed to make TMDs or to make them publicly available.
  • How product issuers interact with their distributors, to confirm they are not straying beyond their target market. 
  • How product issuers monitor and review consumer outcomes to ensure consumers are receiving products that are consistent with their likely objectives, financial situation and needs.

 

Other disclosure enforcement action

ASIC has demonstrated a heightened scrutiny of PDSs and ancillary marketing material. In this context, ASIC’s concerns have focussed on potentially misleading or deceptive statements in a fund’s marketing disclosure.  ASIC has recently issued several interim stop orders in this respect, including an interim stop order preventing advertisements containing certain misleading or deceptive statements about PPM Units in the RES Investment Fund (prior to the DDO stop order).

ASIC has highlighted the requirement for compliance with the following:

How we can assist

The DDO regime imposes obligations on both product issuers and distributors, and it is clear ASIC intends to scrutinise and enforce compliance with these obligations, including through issuing stop orders and/or enforcement action in court.

Amongst other things, DDO requires consideration of the design of a product (including its key attributes) and to determine an appropriate “target market” for the product, including whether one exists, and preparing an appropriate TMD in relation to it.  This must involve careful and appropriate consideration on the part of the product issuers and distributors, to ensure consumers are receiving products that are likely to be consistent with their likely objectives, financial situation and needs.

Our funds and financial services team can assist product issuers and distributors with their compliance obligations in relation to DDOs, including in relation to implementation, maintenance and documentation of product governance arrangements and preparation of TMDs. 

Further, we are able to assist with ensuring disclosure in PDSs and ancillary marketing material is otherwise in accordance with the Act and ASIC policy.

 


For more information, please contact Erik Setio, Brendan Ivers and James Crinion.