Charmian Holmes

Equity based crowdfunding platforms may look to existing Australian Financial Services Licensees (AFSLs) for a ‘temporary home’ until they can get their own licence or expected regulatory changes become law, according to Charmian Holmes, Solicitor Director at The Fold Legal (The Fold).

Crowdfunding platforms through which the funder receives shares in the funded company currently need an Australian Financial Services (AFS) licence (or authorisation) to deal in securities. Offering other types of interests in a company or units in a trust is also likely to require an AFS licence and possibly a responsible entity and/or registration of a managed investment scheme.

“ASIC views crowdfunding as a financial service if the offer has a financial product purpose and it involves fundraising through a corporate structure and/or other facility that pools investor contributions,” Ms Holmes says. “In other words, if it involves issuing shares in a company or interests in a managed investment scheme, it’s definitely on their radar.”

The recently released CAMAC report proposes to simplify the regulation of crowdfunding, including how promoters and intermediaries are licensed. “The development of a simplified licence for crowdfunding facilities is definitely on the Australian Securities and Investments Commission (ASIC)’s agenda, however it may take some time,” Ms Holmes says. “In the meantime, crowdfunding platforms may need to look to AFS licensees for a temporary home.”

Before agreeing, Ms Holmes urges licensees to be aware of the risks and responsibilities of appointing a crowdfunding platform, including ensuring their authorised representative agreement and management systems address each of the following areas and conducting a thorough risk-based assessment on the following issues:

• Limiting users to those who are legitimate promoters – Non-legitimate offers could damage your reputation as an AFS licensee and attract ASIC scrutiny. Ensure the crowdfunding platform has effective processes for preventing the platform being used by scammers or ‘conmen’.
• Licence authorisations – Check that you have the necessary licence authorisations for the product and client types of crowd funding activities – e.g. retail clients, securities, unregistered or registered managed investment schemes. It’s illegal to provide services that you’re not authorised to provide.
• Legally compliant offer documentation – Investment disclosure documents for small scale offers should be signed off by a reputable and experienced lawyer to ensure compliance with the Corporations Act and correction of potentially false, misleading or deceptive statements.
• Payment collection facilities – The capital raised must either be paid into a section 981B trust account or be collected by a licensed custody service provider.
• Advertising restrictions may apply – Advertising restrictions can apply to small scale offers – for example, certain investor warnings have to be given in advertising or promotional statements if the disclosure document for the offer has to be lodged with ASIC and this hasn’t yet occurred.
• Assess the level of investment advice that can be given – If the platform will provide investment advice, its operator will need to have the required experience and qualifications to provide the advice.
• Remuneration disclosure for retail client offers – Remuneration earned by the platform will need to be disclosed to retail clients in the FSG and elsewhere on the website.
• Cross-border crowdfunding – As overseas offers could be risky and trigger overseas regulation; consider whether to restrict offers to Australian investors.
• Monitoring and supervision – Do you have the capacity to monitor the platform’s  compliance and outsourcing arrangements – you will be as responsible for their financial services activities as you would be if you were providing them.
• Professional indemnity insurance and EDR arrangements – If offers will be made to retail clients, PI insurance and EDR membership is necessary. This may involve additional cost.

“Licensees may also need to seek legal advice on any areas they are not sure about,” Ms Holmes says.

Crowdfunding is an innovative avenue for entrepreneurs to raise capital without going down the path of venture capital or public offer funding, but Australian regulation of crowdfunding is still in its infancy. “It’s taken off overseas, especially in the US where a considerable number of crowdfunding websites provide platforms for investors to fund corporate, creative and philanthropic projects,” Ms Holmes says.

Crowdfunding sites in Australia include venturecrowd, ozfund, pozible, thinkable, thunderfunds, jumpstartz and stagelabel.

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Claire Wivell Plater

The Australian Securities and Investments Commission (ASIC) is reminding Australian Financial Services (AFS) licensees that significant or likely breaches of their obligations must be notified within 10 days.

Managing Director of The Fold Legal (The Fold), Claire Wivell Plater says in ASIC’s view, AFS licensees become aware of a breach when the person responsible for compliance becomes aware of it. “However, they are often reluctant to report breaches until they have been considered by their directors or lawyers; they have rectified the breach; or, in the case of likely breaches, the breach has actually occurred.”

Ms Wivell Plater says ASIC is concerned that lengthy efforts to rectify a breach, even if well-intentioned, can compromise the regulator’s ability to take action. “Licensees should not panic when faced with a breach, because ASIC has indicated a strong willingness to work with licensees who take their breach reporting obligations seriously,” she says.

The industry received a heads up that ASIC is reviewing breach reports and licensees considered to be at high risk of non-compliance, in a speech made by ASIC Deputy Chairman Peter Kell to the Risk Management Association of Australia CRO Forum this week.

Ms Wivell Plater says ASIC makes decisions about what matters to prioritise for investigation from industry intelligence. “ASIC does not take action in relation to every breach but does look for patterns of misconduct within individual firms or across a market sector. ASIC also considers whether AFS licensees have robust systems for identifying and reporting problems.”

ASIC may consider an inadequate or late notification to mean that breach identification and reporting systems of the AFS licensee are not robust and/or that they have poor compliance culture, she says. “Failure to report a significant breach in itself is a breach. Not reporting until the problem is fixed can get licensees into more trouble than the underlying breach.”

If a licensee is already working on or has rectified a breach and it’s not serious or systemic, ASIC may decide not to make any further enquiries. “If the breach has not negatively impacted a consumer and no market harm has been done, ASIC may be willing to provide technical relief from the law or a no-action position. But the bottom line is, when in doubt, report.”

The Fold has extensive experience and a good track record in working with licensees and ASIC to efficiently minimise the impact of breaches.

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Lesley Thorne

Financial advisers and accountants who provide certificates for limited recourse borrowing arrangements may inadvertently provide credit advice in breach of the National Consumer Credit Protection Act 2009 and for which they may not be insured. 

Senior lawyer at The Fold Legal (The Fold), Lesley Thorne says SMSF clients seeking to enter a limited recourse borrowing arrangement are frequently asking their adviser or accountant to complete a certificate from the lender in order to confirm they have advised the client about the terms, risks, impact or effect of the loan, as well as its suitability for them and their ability to meet repayments. 

“Unless the adviser or accountant holds an Australian Credit Licence or is a Credit Representative of a licensee, it is an offence to provide ‘credit assistance’ or ‘act as an intermediary’ in relation to consumer credit,” Ms Thorne says. “This means that if the client’s loan is consumer credit and the adviser or accountant isn’t licensed or authorised, they can only provide the client and their lender with factual information.” 

Ms Thorne says where the trustees of an SMSF are individuals, a limited recourse borrowing arrangement will be consumer credit if it is to purchase, renovate or improve residential property for investment purposes. “Because the objective of an SMSF is to provide retirement funds for members, a property purchase or renovation by the SMSF will always be for investment purposes,” she says. “This means that a loan provided to SMSF trustees who are individuals intending to purchase/renovate property will be consumer credit.” 

Where a loan is to purchase a different type of asset or the SMSF has a corporate trustee it won’t be considered consumer credit, Ms Thorne says. “Advisers and accountants still need to be wary in this area though as providing advice on the loan or a certificate to the lender could still overstep their professional boundaries, leaving them vulnerable to claims by a client or a lender that aren’t covered by their professional indemnity insurance.” 

Ms Thorne’s tips for advisers and accountants when they are asked to provide an advice certificate for a client are:

• Do read the certificate carefully – understand what you are being ask to certify
• Don’t certify that you have provided advice that you are not authorised or qualified to provide, or haven’t in fact provided
• Don’t provide certification as to the suitability of a loan or a client’s ability to repay it – it is the lender’s responsibility to assess this
• Do strike through any sections that contain anything other than factual information 

Ms Thorne says it is a complex area, so if in doubt, advisers and accountants should speak to their compliance officer or seek legal advice.

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The Institute of Managed Account Providers (IMAP) has welcomed ASIC clarifying its interpretation of the circumstances in which an SMSF trustee can be treated as a wholesale client.  The general test which can now apply means that an SMSF trustee is wholesale client if a certificate is available from a qualifying accountant that the trustee has net assets of $2.5m or income of over $250,000 for two years.

In their announcement released on 8 August 2014, ASIC states that its “…revised approach means that … if the person providing the advice determines… the trustee is (personally) a wholesale client based on the general test…” then the adviser can treat the SMSF trustee as a wholesale client.

Toby Potter, Chairman of IMAP said “The general tests include an income test – $250,000 for the past two years- or a net assets test, $2.5m (not including superannuation). Many trustees will meet one of these tests, enabling them to be classified as wholesale clients. They can therefore be offered a wholesale MDA service. ”

“This will substantially reduce the compliance burden for advisers who have previously hesitated about offering MDA’s. The result is likely to be a significant improvement to the quality of portfolio management offered to this type of investor.” said Potter

In September, IMAP and The Fold Legal are holding a Masterclass on the obligations for Responsible Managers of AFSLs with MDA authorisation.

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Lesley Thorne

Advisers sometimes refer to their clients as sophisticated clients, but this term is often misunderstood according to The Fold Legal.

Senior Lawyer at The Fold Legal, Lesley Thorne says there is no such thing as a sophisticated client, only a sophisticated investor. “A sophisticated investor is a person with sufficient experience in using financial products and services,” she said. “Their experience means they don’t need the information usually contained in a product disclosure statement or the standard protection available to retail clients.”

Ms Thorne says for financial advisers to treat someone as a sophisticated investor, an Australian Financial Services (AFS) licensee must be satisfied that their knowledge and experience makes them sophisticated. “To call someone a sophisticated investor is a big call, as the client might later claim that they weren’t that experienced,” she said. This can put the licensee at risk if they didn’t comply with all the retail client obligations.

People often confuse the sophisticated investor test with other wholesale client tests such as the asset and income test or the product value test, Ms Thorne says. “It’s confusing because for corporate fundraising, the sophisticated investor tests mirror the wholesale client tests that apply to financial services.”

As a general rule, Ms Thorne says advisers should remember that for financial services (i.e not fundraising), the sophisticated investor test only applies to financially experienced clients and can only be used by an AFS licensee (i.e. not an authorised representative). Clients who meet the asset and income tests aren’t necessarily sophisticated investors, but they will be wholesale clients.

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Claire Wivell Plater

The Future of Financial Advice (FoFA) deadlines are upon us and financial advisers should by now have taken several steps to ensure they meet their new obligations, according to the Fold Legal’s managing director, Claire Wivell Plater.

“By 30 June, advisers should have completed their first round of Fee Disclosure Statements,” Ms Wivell Plater said. “This is the only imminent deadline that will be affected by the proposed FoFA amendments.”

Ms Wivell Plater said if the amendments proceed, FDSs will only need to be provided to clients who were first advised after 1 July 2013. “But, by 30 June 2014, advisers would have already provided an FDS to their pre 1 July 2013 clients if they’ve complied with the current requirement. Go figure!”

Advisers must also ensure that they have non-conflicted fee arrangements in place for clients who first join a platform after 30 June 2014 and for all new investments by non-platform clients made after 30 June 2014.

“What this means is that, unless it’s grandfathered, after 30 June 2014 remuneration can’t be received from a product provider without the client’s clear consent and direction,” she said. “And all employee remuneration arrangements must be un-conflicted, regardless of when the employee began working for you.”

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Jaime Lumsden Kelly

Many financial services businesses offer services through a number of different entities, sometimes supported by a service company – but this does not necessarily mean each of the entities needs to hold its own Australian Financial Services (AFS) licence, according to Senior Lawyer at The Fold, Jaime Lumsden Kelly.

“Essentially, there are two options,” Ms Lumsden Kelly says. “Certainly one of those options is for each entity providing a financial service to hold its own licence. This can make it easier to sell parts of the business, but it will multiply compliance tasks.”

The other option is for one entity to hold the licence and appoint the other entities that service clients as authorised representatives (AR)s. The service company shouldn’t need an AFS licence as it doesn’t provide financial services to clients.

“The thing to consider with this option is which company should hold the licence,” Ms Lumsden Kelly says. “A holding company that does not itself provide financial services may be a good choice, but it’s not the only alternative. When making a decision, you need to be mindful of the fact that the entity that holds the licence will need to undertake monthly cash flow forecasts. They also need to obtain all the authorisations needed for all the financial services offered throughout the group.”

Licensing arrangements like these can complicate the issue of  which employees need to be appointed as authorised representatives .  “The thing to remember is that the only employees who need to be formally appointed are employees of companies who are unrelated to the AFS licensee,” Ms Lumsden Kelly says. “Employees of the AFS licensee, (even if they are seconded to work for an affiliated but unrelated company) or employees of companies related to the AFS licensee do not need to be formally appointed.

A company will be ‘related’ to an AFS licensee if the licensee owns more than 50 per cent of its issued share capital; it owns more than 50 per cent of the licensee’s issued share capital; or a third company owns more than 50 per cent of the issued share capital of both the company and the licensee. But confusingly, companies owned by the same individuals are not ‘related’.

“This can be a complicated area, so when in doubt, seek legal advice,” Ms Lumsden Kelly says.

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Claire Wivell Plater

Ancillary or ‘add-on’ insurance, sold at the point of sale, is a new focus for ASIC in 2014, with all businesses selling general or life insurance, or offering credit as an ancillary offering, likely to be affected according to The Fold Legal (The Fold).

The Fold’s managing director, Claire Wivell Plater said ASIC has already spent considerable time looking at motor, consumer credit and travel insurance and it’s clear that they’re not liking a lot of what they’ve seen.

“ASIC has devoted two sessions to this issue at its 2014 Annual Forum, bringing the CEO of the UK Financial Conduct Authority, Martin Wheatley, over to Australia to speak about the UK experience,” she said. “Mr Wheatley let slip a few tips about how they do it in the UK; they follow the money and look at areas such as business model, speed of growth, comparative gross margins, customer base and culture.”

While not all add-on insurance is problematic, potential remedies are under consideration in the UK and Australia. “Many insurance products sold at the point of sale offer a convenient means of purchasing coverage which in some cases is not readily available through conventional channels,” Ms Wivell Plater said. “The underpinning philosophy seems to be that the more obstacles that are put in the way of people’s buying decisions, the better the quality of the decision and the less opportunity for mis-selling and overselling. Regulators are now using behavioural economics to analyse financial services selling practices – with alarming potential consequences for distributors of ancillary insurance and credit products.”

Insurance advisers should be reviewing the following processes within their business:

• Product design- are products giving value for money?
• Sales processes and collateral – are customers fully aware of what they are buying?
• Remuneration structures – minimise incentives to oversell or missell.
• Sales practices in the field – just because you haven’t asked your staff to, doesn’t mean they aren’t!

“If a sales process includes pre-ticked boxes, bundling of costs into another product, misrepresenting the need for cover, opaque selling practices or remuneration practices that encourage aggressive sales – that is, commissions and volume bonuses – advisers could be singled out for special attention,” Ms Wivell Plater said.

Key indicators of trouble include:

• Narrow coverage, e.g. the policy only insures extreme events that are unlikely to occur
• Coverage of existing rights, e.g. most of the rights to refund, repair or replace provided by the warranty are available under the existing consumer guarantees
• Exclusion of common loss circumstances,  e.g. loan protection insurance which excludes claims arising from the two most common causes of inability to work: bad backs and heart attacks
• Low claims ratios
• High denial rates

Ms Wivell Plater warned that the focus will not just be on existing businesses. “It’s also likely that the licensing division will look at these issues when considering licensing applications, so a review of ‘add-on’ or ‘point of sale’ products must be a priority in order to stay out of the regulators’ sights.”

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Claire Wivell Plater

With the Australian Securities and Investments Commission (ASIC)’s 2013 proposal to change requirements around limited managed discretionary account (MDA) platforms appearing to be on hold for some considerable time, the time could be right for advisers to start including them in their suite of service offerings, according to The Fold Legal (the Fold).

The Fold’s managing director, Claire Wivell Plater, says MDAs enable advisers to quickly rebalance their clients’ portfolios, allowing them to, for example, quickly take advantage of a momentary over or under valuation of a stock or exercise a corporate action such as a rights issue or share buyback.

“The attraction of MDAs for advisers is the operational efficiencies they offer,” Ms Wivell Plater says. “There is no need to obtain a client’s consent in advance to simply rebalance a portfolio. Provided advisers can operate them efficiently, MDA services can be an excellent way for advisers to add value.”

Unlike full service MDAs, limited MDA services are provided through an investor directed portfolio service (a platform), which takes care of administration, custody and reporting.

“Advisers can only invest client funds via the platform and can only contribute to or withdraw funds from the platform with the client’s prior authority,” she says. “Currently, advisers who provide a limited MDA service must also obtain a Power of Attorney from the client authorising them to manage the investments within the agreed parameters. However, they don’t need any specific MDA authorisation on their AFS licence.”

In 2013, ASIC proposed changing the law relating to limited MDAs to require operators to:

• Hold a specific limited MDA authorisation on their AFS licence, and
• Hold minimum net tangible assets (NTA) of the greater of $150,000, 10% of MDA operator revenue or 0.5% of the value of MDA assets managed – with a ceiling of $5m NTA

Ms Wivell Plater says that businesses intending to offer a limited MDA service which provides only the advice and investment management components of an MDA service, could be fairly comfortable that they can operate under the existing regime until 2016 when the current Class Order (and No Action Letter) may lapse.

“Even if formal changes do occur before 2016, there would need to be a reasonable transition period for limited MDA operators to obtain ASIC authorisation,” she speculated. “This could be up to two years. So it’s a reasonable bet that advisers who start now would have the required 3 years’ experience by the time they need to apply to be Responsible Managers a ‘limited’ MDA licence – if and when the mooted changes proceed.”

Ms Wivell Plater has warned, however, that there are no guarantees. “ASIC has made it clear that it’s worried about MDAs, because of the potential for fraud and overtrading. So advisers would be well advised to have a fall back position in case the limited MDA regime came to an abrupt halt.”

The Fold has released a comprehensive ‘Limited MDA Kit’, which contains all the documentation and procedures required for advisers who offer a limited MDA service. Available for purchase online, it contains the following, each of which may be purchased separately.

• FSG material
• SoA material including MDA Contract and Investment Program
• Power of Attorney
• Annual Review SoA/RoA material
• ‘Limited’ MDA Policies and Procedures.

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Claire Wivell Plater

The removal of the ban on conflicted remuneration for general advice in the proposed changes to the Future of Financial Advice (FoFA) legislation may provide new opportunities for financial advice businesses who want to provide scaled advice, according to Claire Wivell Plater, managing director of The Fold Legal.

“General advice is another form of scaled advice. We see an opportunity for financial planning businesses to offer general advice – for example, to clients who want to make their own investment decisions or who don’t want to pay for a full advisory service,” Ms Wivell Plater says. “This would allow financial advice businesses to introduce a general advice model for this type of client.”

Ms Wivell Plater says there are many ways this type of advice can be provided – via the internet, by telephone or in person.  If the business then arranges for the client to acquire the financial product, they can be remunerated by commission for the services.

However, Ms Wivell Plater warns that in full service and ongoing advice relationships, where a financial adviser has undertaken a detailed needs analysis and the client expects and pays for the adviser to recommend strategies and investments that will achieve their personal goals, advice will be personal.

“Businesses that want to provide general advice need to have a detailed understanding of when advice is considered general and when it is considered personal. In the early days of the AFS regime, there was some uncertainty over where to draw the line,” she says. “But we’re pretty clear about it now – and we’ve got pretty good at developing sales process and training that ensure the adviser stays on the general side of the advice spectrum.”

Ms Wivell Plater says care should be taken to consider what relationship the client believes is in play. “If a client reasonably believes they have been provided with personal advice, then the advice will be considered personal, even if the adviser intended to give general advice and even if the adviser thought it was general,” she says.

Ms Wivell Plater also says that Statements of Advice (SOA)s aren’t required when general advice is given. “Instead, a ‘general advice warning’ needs to be provided,” she says. “Full service financial planners and their authorising licensees are unlikely to rely on this, because they know the obligation to provide an SOA is a core part of the AFS regime and they won’t want to run the risk of breaching it.”

There is a place for general advice, according to Ms Wivell Plater, in particular, where all the client wants is a product to fulfill a specific need. “This happens a lot with general insurance and some life insurance. It is rarer in financial advice relationships,” she says. “We expect product providers to make the most use of the removal of the ban on commissions for general advice because it will allow them to remunerate on the basis of sales.”

Staff need to be carefully trained on how not to provide personal advice – but she says this is not new. “The Fold has helped many, many general and life insurance business do this over the past 10 years.”

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