Efficient honest and fair - SSRN

Providing financial services “efficiently, honestly and fairly” Paul Latimer* Australia’s national securities commission - the Australian Securities and Investments Commission (ASIC) - sees the stockbroker’s or investment adviser’s obligation to act efficiently, honestly and fairly in s 912A(1)(a) of Australia’s Corporations Act as both a stand-alone obligation that a broker or adviser (an Australian Financial Services (AFS) licensee) must satisfy, and an obligation that encompasses other obligations under their AFS licence. A licensee may be in breach of its statutory obligation to provide services efficiently, honestly and fairly even if it is complying with all of its other specified obligations. This general obligation includes personal competencies, and imposes continuing obligations on the licensee and its representatives when providing financial services from the beginning of the relationship to its end. Included in the licensee’s obligations are its duties as an employer to its employees, even if intermingled with other obligations regarding financial services. The obligation of acting efficiently, honestly and fairly parallels legal action under other sections in the Corporations Act. The importance of the test is that it triggers ASIC’s administrative procedure of suspending, cancelling or banning an offender for breach of the obligation to act efficiently, honesty and fairly. This can present potential problems because it allows ASIC to bypass specific provisions in the Corporations Act, avoid the decision whether to pursue civil or criminal proceedings, avoid briefing prosecutors and allows it to deal with the matter by means of the administrative process of suspending, cancelling or banning a licensee for breach of the obligation to act efficiently, honestly and fairly. Even criminal activity such as false transfers, false entries, illegal trading and manipulation – which ASIC may classify as gross misconduct – can be dealt with administratively for failure to provide financial services efficiently, honestly and fairly. The test of whether financial services are provided efficiently, honestly and fairly is written in plain English. It is not encumbered with existing interpretations and its scope is not fixed, so it cannot become obsolete, and like the evolution of Trade Practices Act 1974 (Cth) s 52, the expected standard of the financial services licensee of efficiency, honesty and fairness will continue to evolve to meet new situations in the marketplace for financial services.

REGULATION OF FINANCIAL MARKETS The regulation of financial services and markets aims to bring about confident and informed decision making by investors,1 fairness, honesty and professionalism by providers of financial services and

*

Associate Professor, Department of Business Law and Taxation, Monash University, Melbourne. Early research for this article was undertaken while the author was a Visiting Scholar at the law school at the University of Nice in 2004 and a Visiting Fellow in the School of Accountancy at the Queensland University of Technology (QUT) in Brisbane in 2005.

Electronic copy available at: http://ssrn.com/abstract=1326181

Latimer

fair, orderly and transparent markets. 2 These aims are consistent with IOSCO‟s principles of securities regulation to promote fairness, efficiency and transparency in financial markets, 3 and they are common around the financial services world. These aims fit within the Australian Securities and Investments Commission‟s (ASIC) broader objects set out in s 1(2) of the Australian Securities and Investments Commission Act 2001 (Commonwealth of Australia - Cth) (ASIC Act): „In performing its functions and exercising its powers, ASIC must strive to: (a) maintain, facilitate and improve the performance of the financial system and the entities within that system in the interests of commercial certainty, reducing business costs, and the efficiency and development of the economy; and (b) promote the confident and informed participation of investors and consumers in the financial system.‟

ASIC stresses that its vision includes “fair and efficient markets and confident, informed consumers”,4 including making company information available efficiently, and assisting business transactions and applications for relief to proceed efficiently and fairly.

COMPETENCE IN THE FINANCIAL SERVICES INDUSTRY – LICENSING Licensing of those in the financial services industry is the foundation for the promotion of competence and high standards of conduct.5 Licensing as a method of occupational regulation makes the regulator the gatekeeper of those who may enter the financial services industry, and provides investor protection by control of the conduct of those operating in the market. 6 Licensing is seen to promote honesty and fairness, professional competence and financial soundness, 7 although there is evidence that licensing leads to the promotion of the interests of the producer group rather than those of the public.8 Therefore an effective licensing system can fulfil investors‟ expectation of competence and high standards by intermediaries, comparable to: „some of the oldest and most traditional of American values. Similar in concept to the original Bill of Rights that amended [the US] Constitution in 1791, investors‟ interests must be protected through mechanisms that promote fair capital markets, honest managers and full and fair disclosure. I call these basic investor rights, which are vitally important if our markets are to be efficient, “The Investor‟s Bill of Rights”.‟9

1

For the purposes of Corporations Act 2001 (Cth) Ch 7 (Financial services and markets), investors are described in s 760A(a) as “consumers of financial products and services”. Corporations Act 2001 (Cth), s 760A. Section 760A(d) includes “the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities”. 2

3

International Organization of Securities Commissions (IOSCO), Objectives and Principles of Securities Regulation (May 2003) [4.2.2], available at http://www.iosco.org. 4 For example, ASIC, Patrolling a broad territory, ASIC Annual Report 2004-2005, p 1. 5 Alternatives to licensing include: (1) registration, with qualification prerequisites to go on the register. Registration amounts to de facto licensing. (2) certification of those with the relevant qualifications by a recognised authority (government or private sector) such as the accounting bodies. (3) negative licensing – an authority is able to issue or obtain an order prohibiting persons from engaging in an occupation for specified reasons: National Companies and Securities Commission (NCSC), A Review of the Licensing Provisions of the Securities Industry Act and Codes (Australian Government Publishing Service, Canberra, 1985) [5.4]-[5.8]. 6 NCSC, n 5, p 37; Latimer P, “Regulation of Securities Industry Intermediaries – Australian Proposals” (1986) 9 University of Pennsylvania Journal of International Business Law 1. 7 NCSC, n 5 at [5.9]-[5.28]. 8 Maurizi A, “Occupational Licensing and the Public Interest” (1974) 82(2) Journal of Political Economy 399. 9 Lynn E Turner, Chief Accountant, US SEC, Speech by SEC Staff, “The Investor‟s Bill of Rights: A Commitment for the Ages” (SEC Institute, Washington, DC, 18 June 2001), available at http://www.sec.gov/news/speech/spch505.htm.

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Providing financial services “efficiently, honestly and fairly”

LICENSING IN AUSTRALIA – EFFICIENTLY, HONESTLY AND FAIRLY FROM 1980 Section 911A(1) of the Corporations Act 2001 (Cth) provides that those who carry on a “financial services business” must have an Australian financial services licence (AFSL) issued by ASIC. The Act does not set any requirements for this licence and instead focuses on the “general obligations” of a licensee once an AFSL is granted – of which the first is the general obligation “to do all things … efficiently, honestly and fairly” (s 912A(1)(a)). In contrast to the traditional static and historic “fit and proper” test to assess a person at a particular point in time, the efficient, honest and fair test has an operational flavour and sets an ongoing standard of conduct expected of a licence holder. Moreover, the obligations of efficiency, honesty and fairness are different from the “fit and proper” licensing criteria as they include conduct in the future as well as past conduct. 10 The efficient, honest and fair test has the advantage of flexibility and the ability to adequately reflect changing industry standards in relation to conduct.

OLD LICENSING TEST OF “FIT AND PROPER” The NCSC stated that the criterion of efficient, honest and fair, or provisions of similar effect such as fit and proper, are well established in other professions such as in the legal profession and in financial services regulation in countries such as the United Kingdom, United States and Canada. 11 The fit and proper test refers to a person‟s past record which can be proven as a fact 12 – has the defendant done something in the pursuit of their profession which would be reasonably regarded as disgraceful and dishonourable by their professional peers of good repute and competency? 13 This traditional test was used in the former Securities Industry Acts of 1970 in New South Wales, Victoria and Western Australia, and 1971 in Queensland. The fit and proper test was carried forward in ss 37 (for dealers and investment advisers) and 38 (representatives) of the uniform Securities Industry Acts of the four ICAC States in 1975, 14 which empowered the then Corporate Affairs Commission to “grant” a licence if in the opinion of the Commission the applicant were a “fit and proper” person. 15 This same fit and proper test was carried forward in the Commonwealth Government‟s “Murphy Bill” in 1974, which lapsed on change of government in November 1975.16

10

NCSC, n 5 at [7.31]. NCSC, n 5 at [7.34]. 12 This past record, such as for example, “good character”, refers to the enduring moral qualities of a person (an objective assessment) which can be proved as a fact with no subjective public element. It does not refer to a person‟s good standing, fame or repute in the community (the latter a subjective assessment): Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [220], citing the Full Court of the Federal Court in Irving v Minister for Immigration, Local Government and Ethnic Affairs (1996) 68 FCR 422 at 431-432; 139 ALR 84 at 94; later proceedings reported as Australian Securities Commission v Kippe at (1996) 137 ALR 423. 13 Paraphrased from Allinson v General Council of Medical Education [1894] 1 QB 750 at 761, 763 and 766, cited by Young J in the leading case of Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at 669-670; 6 ACLC 560 at 569. 14 ICAC, the Interstate Corporate Affairs Commission (1972-1975), comprising the four then non-Labor States of NSW, Vic, Qld, and later WA, was an important State-initiated move towards creating greater uniformity in interstate corporate regulation, aiming at common standards and coordination. The uniform Securities Industry Act 1975 was an ICAC achievement: NSW Hansard, 11 November 1975, pp 2790-2793, cited by Young J in Story’s Case (1988) 13 NSWLR 661 at 670-671; 6 ACLC 560 at 569. 15 Securities Industry Act 1975 (NSW), (Vic), (Qld), (WA), ss 46 and 47 (revocation and suspension of licences), the prototype for ss 915B and 915C (suspension or cancellation) and s 920A (ban) provided for revocation and suspension if a licensee fails to comply with a condition or restriction of the licence. 16 Corporations and Securities Industry Bill 1974 (Cth), s 71(1)(b)(ii) (grant of licence). This first ahead-of-its time and forward looking Commonwealth attempt at securities market regulation was led by former Attorney-General and High Court judge, Senator Lionel Murphy QC. 11

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DEBUT OF EFFICIENT HONEST AND FAIR IN 1980 There was no celebration for the arrival of and little recognition of the likely impact of the new test of efficient, honest and fair when it was first launched in Australian financial services law in 1980. It followed the half-mention of efficient, honest and fair in the Rae Report in 1976 – “The stock exchanges should be doing their utmost to ensure that … their members are providing honest, skilled, unbiased and efficient service”.17 Driven by national business and political pressures towards national financial services industry regulation (called securities regulation in those days), these uniform Securities Industry Acts of four States were replaced by the first Commonwealth legislation in the form of the Securities Industry Act 1980 (Cth), which was mirrored by the equivalent State legislation and was called the Co-operative scheme.18 The new test of “efficient, honest and fair” first appeared in the 1980 Act and Codes in s 48(a)(v), alongside the “good fame and character” test in s 48(a)(iv). An early mystery was that the efficient, honest and fair test was not in the original s 48(a) of the Securities Industry Bill 1980 (Cth), which only used the “fit and proper person” as the test for the Commission to grant a licence. It was inserted between the release of the Securities Industry Bill and the Explanatory Memorandum, as the Explanatory Memorandum paraphrased what became the later test of good fame and character and efficient, honest and fair. Section 48 was revised and replaced in 1981 when the efficient, honest and fair test in s 48(a)(v) was renumbered s 48(2)(e). 19 Another mystery was that the tests in s 48 for granting a licence were not parallelled in s 60 dealing with revocation and suspension of licences, which was limited to the licensee not being a “fit and proper person”. This was harmonised in 1981 when the “fit and proper person” test was removed from s 60(1)(b), and was replaced with the test of whether the licensee has performed its duties efficiently, honestly and fairly on the basis that this is “both fairer and more goal-oriented than „fit and proper‟”.20 This new test focused on how a person carries on financial services business – the actions, process or method of working of the financial services licensee – rather than their historic status as the “fit and proper person”. It did change the law, and as Young J pointed out in the Story Case, if the legislature repeals a phrase in a section and re-enacts the section using a substitute phrase, the court must prima facie conclude that the legislature intended to make a change to the existing law.21 This major change in 1989 was introduced with no explanation in Parliament beyond the sentence that the Commission “will be given power to ban undesirable persons from acting as participants in the securities or futures industries”.22 Presumably there was neither expectation nor prediction of its later importance and the potential problems it might create.

17

Senate Select Committee on Securities and Exchange (Chairman: Senator Peter Rae), Australian Securities Markets and their Regulation (AGPS, 1974) [15.6]. 18

For example, Securities Industry (South Australia) Code and Securities Industry (Application of Laws) Act 1981 (SA); Securities Industry (Tasmania) Code and Securities Industry (Application of Laws) Act 1981 (Tas). 19 Co-operative Scheme Legislation Amendment Act 1981 (Cth) s 46. 20 NCSC Licensing Review, n 5 at [7.35]. The amendment was in Securities Industry Amendment Act (No 2) 1981 (Cth), s 20. The NCSC Review in 1985 stated that the amendment was “partly in response” to Boyd v Carah Coaches Pty Ltd (1979) 145 CLR 78; [1979] HCA 56, in which the High Court considered that permitting only licensed persons to carry on a business of a travel agent in interstate commerce would be in breach of the Constitution s 92 if the regulatory authority had a wide discretion regarding the issue of a licence. Mason J, in the majority, had pointed out that restrictions on the grant of a licence would not be in breach of s 92 if there were definite criteria such as a minimum age requirement or that there were provisions which prescribed reasonable standards of efficient service (at [33]-[36]). Young J did not “find any attraction in this argument”: Story’s Case (1988) 13 NSWLR 661 at 670; 6 ACLC 560 at 569. 21 Young J in Story’s Case (1988) 13 NSWLR 661 at 670-671; 6 ACLC 560 at 569-570, citing Goldsbrough Mort & Co Ltd v Larcombe (1907) 5 CLR 263; [1907] HCA 58 and stating that the new provision should therefore not be construed the same as the old: Ioannou v Fowell (1982) 63 FLR 170 at 184; 43 ALR 415 at 427 (Federal Court), upheld (1984) 156 CLR 328 at 335; [1984] HCA 24 at [11] (High Court). 22 Lionel Bowen, MHR, Attorney-General, Second Reading Speech, Co-operative Scheme Legislation Amendment Bill, Parliamentary Debates (Hansard), House of Representatives, Canberra, 12 April 1989, p 1474.

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This new test was paraphrased in the 1989 Explanatory Memorandum without comment.23 The then Liberal/National Party Opposition concurred with the changes, and its representative did pick up the importance of the operational test when he said: “It is just not feasible for a securities commission … to say, „You are satisfactory but that guy is not‟. On asking why the other guy is not, one might find that his background and criteria are not worse than those of the one approved but the one approved happens to come with a better introduction, which is common in the securities industry.” 24 Section 60 was replaced in 1989 by new s 62C, which was noted in the Explanatory Memorandum to contain “a number of additional grounds for revocation of a licence” including in s 62C(1)(k) “the Commission has reason to believe that the licensee will not perform those duties efficiently, honestly and fairly”.25 By the time of the Corporations Act 1989 (Cth), passed by the Commonwealth to apply in the ACT and mirrored by State legislation under the name of the Corporations Law, the efficient, honest and fair test had been established for both licensing, disclipline and delicensing. 26 It was carried forward when the Corporations Law was replaced by the first Commonwealth Corporations Act in 2001, and when the Act was restructured with changes brought about by the Financial Services Reform Act 2001 (Cth) by the merging of the securities industry and the futures industry sections and its application to the merged concept of “financial services”. 27

THE LICENSEE’S OBLIGATION TO ACT EFFICIENTLY, HONESTLY AND FAIRLY The first-listed “general obligation” of a financial services licensee is set out in s 912A(1): „A financial services licensee must: (a)

do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly.‟

These plain English words provide the general obligations expected by ASIC of financial services licensees. They are not encumbered by existing interpretations, their scope is not fixed and they cannot become obsolete. Like the evolution of Trade Practices Act 1974 (Cth) s 52, the expected standard of the financial services licensee will continue to evolve to meet new situations in the marketplace for financial services. These words encompass the standard of qualifications, competence and integrity by a licensee, including integrity at a personal level and in regard to professional conduct.

23

Explanatory Memorandum, Co-operative Scheme Legislation Amendment Bill 1989 (Parliament of the Commonwealth of Australia, Canberra) p 625. 24 Hon John Moore, Parliamentary Debates (Hansard), House of Representatives, Canberra, 24 May 1989, p 2741. 25

Explanatory Memorandum, n 23 at [337].

26

The licensing section became ss 780 (dealer) and 781 (investment adviser), if the Commission has no reason to believe inter alia that the person will not perform their duties efficiently, honestly and fairly (s 783(2)(e)) (duplicated with s 784(2)(d) for a body corporate). The Corporations Act 1989 (Cth) carried forward the Commission‟s power to revoke a licence if the Commission has reason to believe the licensee has not performed efficiently, honestly and fairly (s 826(1)(j)) or will not perform efficiently, honestly and fairly (s 826(1)(k)), backed up with a banning order under s 828(b). These securities industry sections were parallelled for the futures industry – licensing of futures brokers and futures advisers (s 1145(2)(f), 1145(4)(d)), revoking a licence (s 1191(1)(h), (j)), suspending a licence (s 1192(1)(b)) and banning a licensee (s 1193(f), (g)). 27

Amendments to the Corporations Act 2001 (Cth) by the Financial Services Reform Act 2001 (Cth), s 3, Sch 1, Pt 1 resulted in the merger of Chs 7 and 8, with the former licensing sections of ss 780, 781 (securities), and ss 1142, 1143 (futures) becoming ss 911A-911C. Former ss 783(2)(e), 784(2)(d), 1145(2)(f) became s 913B(1)(b). The power to revoke or suspend in s 826(1)(j)/1191(1)(j)/827(1)(b)/1192(1)(b) became s 915C(1)(a). The power to ban in s 828(b)/1193(f) and (g) became s 920A(1)(a). The changes are based on Treasury‟s Financial Markets and Investment Products, December 1997 (Corporate Law Economic Reform Program (CLERP 6)).

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Efficient There are many aspects and meanings of the test of “efficiently” as called for in s 912A(1)(a), and the related words efficient or efficiency. The lay meaning of “efficient” stresses being “productive with minimum waste or effort … (of a person) capable, acting effectively”.28 Justice Young added to this lay definition in Story’s case when he said that: „So far as “efficient” is concerned, someone is an efficient person or performs his duties efficiently if he is adequate in performance, produces the desired effect, is capable, competent and adequate, see eg Spotts v Baltimore & Ohio Railroad Co [102 F (2d) 160 at 162 (1939)]. Although that definition comes from a case dealing with handbrakes on railway cars, it seems to me that it can be applied to the word used in the current statute.‟29

For example, ASX removing the need for signed transfer forms for shares in 1989 assisted in the development of “a more efficient securities market”.30 Referring to efficiency by travel agents, the High Court has said that: „The conduct of the business of travel agent calls for knowledge and an ability to handle with efficiency communications and financial transactions … I use the word “efficiently” advisedly because the legislature is entitled to prescribe such reasonable standards as will promote an efficient service to the public in the course of regulating the travel agents industry. It is not to be thought that the concept of permissible regulation is confined to protecting the public from harm, fraud or malpractice. It extends also to the promotion of efficiency or other similar ends the Parliament sees as appropriate to ensure that the service which the public receives is of a reasonable standard.‟31

If the focus is on productivity and effectiveness, “laws to promote „efficiency‟ in the carrying on of a business are not in their nature, in my opinion, regulatory in the relevant sense”. 32 Referring to expectations in the financial services industry, the United Kingdom Gower Report commented that “the financial services industry … should be able to provide services to industry and commerce, private investors and services to industry and commerce, private investors and Government in the most efficient and economic way”. 33 A person cannot provide financial services without knowing the relevant law and regulation. The AAT has said that “(a) person cannot be said to operate efficiently if he or she has no knowledge, or only a very limited knowledge of the laws which must be followed and which may circumscribe his or her actions”.34 Therefore a person does not act efficiently “notwithstanding the absence of any finding of dishonesty” if there is evidence of “demonstrably inadequate securities advice practices” and contravention of the law. 35 Operating a managed investment without an AFS licence or in breach of ASIC relief is illegal under the Corporations Act. Corporate personnel would fail to satisfy the

28

Oxford Australian Dictionary (Oxford University Press, South Melbourne, 1999) p 633. This meaning is used in s 1(2)(e) of the ASIC Act, which provides that ASIC is to receive, process and store information given to ASIC “efficiently and quickly”. Story’s case (1988) 13 NSWLR 661 at 672; 6 ACLC 560 at 571, applied in, eg, Farley v Australian Securities Commission (1998) 16 ACLC 1,502 at [148]; Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [166]; Re Felden and Australian Securities and Investments Commission (2003) 45 ACSR 111; [2003] AATA 301 at [374]-[376]; Re Campbell and Australian Securities and Investments Commission (2001) 37 ACSR 238; [2001] AATA 205 at [98]; Re Saxby Bridge Financial Planning Pty Ltd and Australian Securities and Investments Commission (2003) 46 ACSR 286; [2003] AATA 480 at [293]. 29

30

Securities Exchanges Guarantee Corporation Ltd v Aird [2001] NSWSC 379 at [31].

31

Boyd v Carah Coaches (1979) 145 CLR 78; [1979] HCA 56 at [35]-[36] per Mason J.

32

Boyd v Carah Coaches (1979) 145 CLR 78; [1979] HCA 56 at [9] per Barwick CJ.

33

Department of Trade and Industry, Financial Services in the United Kingdom: A New Framework for Investor Protection (HMSO,1986), cited in NCSC, n 5, p 36. 34

Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [209], cited in, eg, Re Saxby Bridge Financial Planning Pty Ltd and Australian Securities and Investments Commission (2003) 46 ACSR 286; [2003] AATA 480 at [294]. 35

Re Campbell and ASIC (2001) 37 ACSR 238; [2001] AATA 205 at [117] (resulting in a banning order), cited in Saxby Bridge Financial Planning Pty Ltd and Australian Securities and Investments Commission (2003) 46 ACSR 286; [2003] AATA 480 at [295].

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efficiency criterion, and this would reflect on the honesty and fairness of the relevant officers, and it may authorise ASIC to refuse to grant a licence under s 913B.36 “Efficient” and “effective” have the same root, but they are not the same because efficiency can be measured and determined quantitively by the ratio of actual output to maximum possible output, while “effectiveness” is a non-quantitative concept to do with achieving objectives. The lay sense of efficient is the basis of the economic concept of operational efficiency – where there is more output from the current input, which in turn connects with the efficiency ratio in business, where expenses can be calculated as a percentage of revenue (expenses/revenue). An economic ratio with a lower percentage means that expenses are lower and earnings are higher. In addition, efficiency in economics refers to efficiency in the allocation of resources. 37 ASIC aims to promote a fair and efficient market characterised by integrity and transparency and supporting confident and informed participation of investors and consumers. 38 Economics aims to maximise the use of resources, so that scarce resources should be allocated to those who value them the highest. There is operational efficiency, with more output from less input. Under allocative efficiency, goods and services are produced that are most highly valued by society. With informational efficiency, prices reflect the available information and no information is wasted.

“Efficient” compared to “competent” The equivalent licensing section in Hong Kong provides that in determining whether a person is a “fit and proper person for the purposes of any provision of this Part”, the regulator “shall … have regard to – (c) the ability to carry on the regulated activity competently, honestly and fairly”.39 The dictionary traces the word “competent” to the present participle of the Latin competere – to “be fit or proper”.40 The use of the test “competent” overcomes the problem of what is efficient, and picks up the tone of efficient in the sense of capable, meaning “adequately qualified or capable” or “(of a person) having legal capacity and qualification”. 41 For example, “the person carrying out the operation is competent, by virtue of his training and substantial practical experience”.42

Honest “Honest” is an everyday word and, as with “misleading or deceptive”, attempts to define it remind us that we know what is honest and what is dishonest. The helpful and detailed analysis of “honest” given by Deputy President Forgie in Kippe’s Case started with the dictionary:43 „The ordinary meaning of the word is: “1 In an honourable or respectful manner; worthily, decently … 2 Chastely, virtuously…. 3 With upright conduct; without fraud, by honest means; sincerely, fairly, openly ... b Really, genuinely, in truth ...”‟

36

Eg Re Koala Hydroponics Ltd and ASIC (2002) 40 ACSR 529; 20 ACLC 559; [2002] AATA 41; ASIC MR 02/179 “Unregistered scheme wound up”. 37

This meaning is used in s 1(2)(a) of the ASIC Act, which provides that ASIC must strive to maintain, facilitate and improve the financial system in the interests of inter alia “the efficiency and development of the economy”. 38

ASIC, Annual Report 2004/2005, n 4, p 117.

39

Securities and Futures Ordinance 2002 (Hong Kong), s 129(1)(c).

40

Oxford Australian Dictionary (Oxford University Press, South Melbourne, 1999) p 273.

41

Oxford Australian Dictionary, n 40, p 273.

42

Gas Safety (Gas Supply) Regulations (Hong Kong), reg 39.

Kippe v Australian Securities Commission (1998) 16 ACLC 190 at 210, cited in Felden’s Case (2003) 45 ACSR 111; [2003] AATA 301 at [379]. 43

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Latimer (New Shorter Oxford English Dictionary, 1993).

The comments of Bollen J on the meaning of “honestly” in the context of the forebear of s 912A(1)(a) show the sense of the test in modern financial services law: 44 „I think that the word “honestly” may comprehend conduct which is not criminal but which is morally wrong in the commercial sense. It comprehends conduct which is not straightforward. Moreover, I think it may comprehend such conduct viewed objectively. The evidence does not prove that Elrington intended to misrepresent or disregard the advice given him by McNamara nor that he intended to profit by failure to make the position clear. But the truth is that he did do those things. It all amounts to a very serious breach of the conditions of the licence and the statutory obligation to behave “efficiently, honestly and fairly”.‟

Justice Young in Story’s Case (1988) 13 NSWLR 661; 6 ACLC 560 referred to honest as “having regard to the dictates of efficiency and fairness”. As he pointed out, “honestly” used in conjunction with the word “fairly” gives the flavour of a person who not only is not dishonest, but a person who is ethically sound – the sort of person the judge says is reflected in Psalm 15. 45 Deputy President McMahon in Farley’s Case (1998) 16 ACLC 1,502 quoted Psalm 15 in full, saying that being “honest” refers to such qualities as being upright, righteous, truthful, and a person who “nor doeth evil to his neighbour, nor taketh up a reproach against his neighbour”. 46 Forgie DP in Kippe’s Case (1998) 16 ACLC 190 cited the definition of the Court of Appeal that honesty in financial services contrasts with dishonesty in the criminal law in a passage where Callaway JA stated that: „Fraud and dishonesty may be regarded as interchangeable terms in relation to an offence of misappropriating property [R v Glenister [1980] 2 NSWLR 597 at 604-607]. The common law concept of dishonesty, at least in a criminal context, is subjective. If a person has a belief inconsistent with dishonesty, he cannot be convicted of an offence of which that is an element even if his belief is unreasonable. The reasonableness of the belief goes only to its plausibility: “a man may be a stupid, unreasonable, or wrong-headed man, without being a dishonest one” [R v Nundah (1916) 16 SR (NSW) 482 at 489]. That case illustrates the cognate proposition that a genuine belief that one has a lawful claim is a defence in relation to property offences at common law and under statutes to which the common law applies. Such a bona fide claim of right may be both unreasonable and unfounded, although, if it is, it is less likely to be believed or, more correctly, to engender reasonable doubt [R v Lopatta (1983) 35 SASR 101 at 107-108, 119-122]. These propositions are distinct from the defence of honest and reasonable mistake discussed in such cases as He Kaw The v R [[1985] HCA 43; (1985) 157 CLR 523; 60 ALR 449].‟47

“Honestly” in this context imported the notion which was not criminal but rather morally wrong in the commercial sense. As said by Forgie DP, “Whether or not a dealers [sic] representative had a dishonest intent would be relevant but so too is an objective assessment of whether or not his or her conduct satisfies the standard of propriety which may be expected of a dealers [sic] representative.” 48 “Honest” then would include “earn an honest dollar”, an “honest broker” and “honest-to-God” but it has a different sense to an honest witness, honest belief, honest mistake. Where goes “to make an honest woman of”? Fair

RJ Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) (1989) 1 ACSR 93 at 110, cited in Felden’s Case (2003) 45 ACSR 111; [2003] AATA 301 at [378]; Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [212]. 44

45

Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at 672; 6 ACLC 560 at 571.

46

Farley v Australian Securities Commission (1998) 16 ACLC 1,502; [1998] AATA 495 at [149].

47

Forgie DP in Kippe v Australian Secuirites Commission (1998) 16 ACLC 190 at [211], citing R v Lawrence [1997] 1 VR 459 at 466-467; (1996) 138 ALR 487 at 494. 48

Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [213], cited in Saxby Bridge Financial Planning Pty Ltd and Australian Securities and Investments Commission (2003) 46 ACSR 286; [2003] AATA 480 at [294].

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In the words of the Oxford Australian Dictionary, the word “fair” in the current context means “just, unbiased, equitable; in accordance with the rules”.49 “Fair” has currency in legal English in the context fair comment (impartial observation), fair dealing (in copyright), fair trading (eliminate unfair consumer trading practices). In the Australian vernacular, we are all used to “fair and square”, “a fair deal”, “fair play” and even “fair dinkum” and “fair go”. Justice Young in Story’s Case added to the words “fair”/“fairly” “having regard to the dictates of efficiency and honesty”. 50

Reading efficient, honest and fair together As the then NCSC pointed out some 20 years ago, the purpose of the test of efficient, honest and fair is “a way of controlling conduct … [but] … [t]he scope of the test is not altogether clear on the face of the legislation. As such, the test must be applied having regard to current industry standards of conduct”.51 The test imposes a continuing standard of conduct on licence holders, as failure to meet the standard re-appears as one of the criteria for disciplinary action by ASIC through suspension or cancellation of a licence (s 915C(1)(a)) and a banning order (s 920A(1)(b)).52 What then is meant by the threefold test of efficiency, honesty and fairness in s 912A(1)(a)? The purposive principle of interpretation is that “Every statute must be supposed to be „for the public good,‟ at least in intention”.53 Young J in Story v National Companies and Securities Commission (1988) 13 NSWLR 661; 6 ACLC 560 graphically pointed out that it would be impossible to carry out all three tasks concurrently:54 „To illustrate, a police officer may very well be most efficient in control of crime if he just shot every suspected criminal on sight. It would save a lot of time in arresting, preparing for trial, trying and convicting the offender. However, that would hardly be fair. Likewise a judge could get through his list most efficiently by finding for the plaintiff or the defendant as a matter of course, or declining to listen to counsel, but again that would hardly be the most fair way to proceed. Considerations of this nature incline my mind to think that the group of words “efficiently, honestly and fairly” must be read as a compendious indication meaning a person who goes about their duties efficiently having regard to the dictates of honesty and fairness, honestly having regard to the dictates of efficiency and fairness, and fairly having regard to the dictates of efficiency and honesty.‟

This pioneering test of efficient, honest and fair set out by Young J has been confirmed by subsequent authority over almost 20 years, and provides the framework for the current application: Efficient, honest and fair are conjunctive not disjunctive Case law on efficient, honest and fair has moved on from the interpretation by the then NCSC that “and” can be read disjunctively as “or”. Case law no longer accepts the NCSC interpretation that “nor

49

Oxford Australian Dictionary, n 40, p 464.

50

Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at 672; 6 ACLC 560 at 571.

51

NCSC, n 5 at [7.32]-[7.33].

52

NCSC, n 5 at [7.32]-[7.33].

53

Province of Bombay v Municipal Corporation of the City of Bombay [1947] AC 58 at 63.

54

Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at 672; 6 ACLC 560 at 571, cited in Farley and Australian Securities Commission (1998) 16 ACLC 1,502; [1998] AATA 495 at [148]; Saxby Bridge Financial Planning Case (2003) 46 ACSR 286; [2003] AATA 480 at [293]; Re Chapel Road Pty Ltd and Australian Securities and Investments Commission [2003] AATA 660 at [169].

9

Latimer

is it accepted that the words „efficiently, honestly and fairly‟ in the paragraph are cumulative”, 55 and current case law states that the words are to be read conjunctively or cumulatively. 56 A disjunctive interpretation of “and” would run contrary to the usual interpretation that “and” is to be read conjunctively and that “or” is to be read disjunctively. 57 For example, in the words of Mr Hughes QC for the plaintiff: „Another question is what is meant by the collocation, the putting together of the words “efficiently, honestly and fairly”. In our submission it is clear that in order that a ground of revocation under (what is now ss 915C or 920A) can be made out, there must be a conjunction of inefficiency, dishonesty and unfairness. The words are conjunctive. They are, as it were, cumulative. They do not read efficiently or dishonestly or unfairly. Their sense is inefficiently, dishonestly and unfairly.‟58

This confirms the dictum of Blackburn J that “the proposition that „and‟ can sometimes mean „or‟ is true neither in law nor in English usage”. 59 However, every book on statutory interpretation recognises that there may be instances in a statute where “and” and “or” may be interchangeable. A court may be persuaded that the legislature has made a mistake, that the wrong conjunction has been used, that there is an absurdity or unintelligibility in reading “and” as “or”, or that “or” is truly cumulative and the whole class should be read together. In Maxwell‟s words, it is sometimes necessary to read the conjunctions “one for the other”.60 Justice Young said that either way, there is no evidence that one of those exceptions would apply to efficient, honest and fair, and that it would not matter whether one reads the words cumulatively or disjunctively, because the Commission could suspend, cancel or ban a licensee whether for one or the three attributes “whether as one package or as three separate parcels”.

Acting efficiently, honestly and fairly is an obligation of a licensee, not a duty or function The statutory “general obligations” of a licensee set out in s 912A have laid to rest the debate over whether there is a difference in the meaning and significance of the obligations, duties or functions of a licensee. Young J in Story’s Case pointed out that the obligations to do all things efficiently, honestly and fairly do not involve analysis of any of the tasks performed by licensees to see whether these can be classed as “statutory duties, fiduciary duties, duties under the common law of negligence or otherwise”.61 Section 911A requires a person to have an AFSL to carry on a financial services business, leaving the general obligations, duties and functions of the licensee to be detailed in legislation such as Ch 7 of the Corporations Act 2001 (Cth) as appropriate (including the general obligations in

Story’s Case (1988) 13 NSWLR 661 at 671; 6 ACLC 560 at 570. The equivalent section in Singapore uses “or”: see text below at nn 141, 142. 55

56

Eg, Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [217]; Felden and Australian Securities and Investments Commission (2003) 45 ACSR 111; [2003] AATA 301 at [374]. 57

Eg, Bennion FAR, Statutory Interpretation – A Code (4th ed, Butterworths, London, 2002) p 1021.

58

Story’s Case (1988) 13 NSWLR 661 at 671-672; 6 ACLC 560 at 570.

59

Re The Licensing Ordinance (1968) 13 FLR 143 at 147.

60

Eg, Theobald JA, Maxwell on the Interpretation of Statutes (4th ed, Sweet and Maxwell, London, 1905) pp 357-360; also, eg, Pearce DC and Geddes RS, Statutory Interpretation in Australia (4th ed, Butterworths, Sydney, 1996) [2.15]; Bartley R, The Modern Approach to Statutory Construction (Sydney, 2000) pp 62-63. Story’s Case (1988) 13 NSWLR 661 at 672; 6 ACLC 560 at 571; applied Felden’s Case (2003) 45 ACSR 111; [2003] AATA 301 at [377]. His Honour also considered the scope of the word “duties”. He rejected a submission that it meant only the statutory obligations imposed on a licence holder. See also Nisic v Corporate Affairs Commission (1990) 8 ACLC 514 at 525, followed by the AAT in Farley v Australian Securities Commission (1998) 16 ACLC 1,502 at [151]. 61

10


s 912A to provide the financial services covered by the licence efficiently, honestly and fairly), the ASIC Act and other relevant legislation. These statutory licensee obligations do not displace conduct requirements from other sources such as the common law and the rules of the various financial markets. 62 Referring to the common law, Street J said in 1971: „The occupation of sharebroking demands high standards of integrity. In carrying out his occupation a sharebroker acts, not for himself, but for his client … Those clients are entitled to expect from a broker not only competence, but also integrity and absence of conflicting personal interests. His position is one of trust and integrity. By the recognition and pursuit of the high traditions of their occupation, brokers have aspired to the status of an honourable profession. The price they must pay for this status is that they forswear all compromise of their integrity, and that they repudiate the creation of personal interests which could bring them into conflict with their duty to their clients.‟63

Similar sentiments regarding the common law principles were expressed by the Supreme Court of Victoria in the Ali v Hartley Poynton Ltd (2002) 20 ACLC 1,006; [2002] VSC 113 in these words (at [267]-[269]): „Where a stockbroker holds himself out as having an expertise in advising on investments and is approached for advice on investments and undertakes to give it, in circumstances where the stockbroker has a financial interest, a stockbroker‟s duty is: “to furnish the client with all the relevant knowledge, which the adviser possesses, concealing nothing that might reasonably be regarded as relevant to the making of an investment decision including the identity of the buyer or seller of the investment when that identity is relevant, to give the best advice which the adviser could give if he did not have but a third part did have a financial interest in the investment to be offered, to reveal fully the adviser‟s financial interest, and to obtain for the client the best terms which the client would obtain from a third party if the adviser were to exercise due diligence on behalf of his client in such a transaction” [Daly v The Sydney Stock Exchange Limited (1986) 160 CLR 371 at 385 per Brennan J]. The above propositions are, as I understand it, common ground. In addition, and of more immediate relevance, the defendant accepts there was an implied term of the retainer that the stockbroker would, in performing its obligations under the retainer, exercise such reasonable care, skill and diligence as might be expected of a reasonably competent stockbroker. Plainly also stockbrokers who provide professional services to clients owe a common law duty of care to their clients in respect of those services [Presser v Caldwell Estates Pty Ltd [1971] 2 NSWLR 471 per Mason JA at 491]. The duty to exercise reasonable care and the contractual obligation to exercise reasonable care apply to each of the professional activities undertaken for the client and extend to advice and recommendations for buying and selling stock on the share market and any decisions by the broker himself to buy and sell stock on the share market for the client in the exercise of his discretion.‟

ASIC has pointed out that failure by a licensee to comply with these common law obligations may amount to a failure to conduct its financial services business “efficiently, honestly and fairly”. For example, ASIC has stated that advisers who provide financial product advice are under common law obligations, which, depending on the context in which the advice is given, may include “a duty to fully disclose any conflict of interests that may affect the advice they provide” and a duty to “adopt due care, diligence and competence in preparing advice to ensure that it is suitable for the purpose for which the clients to whom it is provided are reasonably likely to use the advice”. 64 The Supreme Court of New South Wales has confirmed ASIC‟s view that it “is entitled to rely upon and consider those parts of the business of the plaintiffs (the licensee)” in licensing matters. 65

62

Such as the operating rules of the Australian Stock Exchange (hereafter ASX).

63

Per Street J in Bonds and Securities (Trading) Pty Ltd v Glomex Mines NL [1971] 1 NSWLR 879 at 891, cited in part in Ali v Hartley Poynton Ltd (2002) 20 ACLC 1,006; [2002] VSC 113 at [266]; see further Latimer P, “Disclosure and Fair Dealing by Stockbrokers” (1989) 18 Anglo-American Law Review 335. 64

ASIC Policy Proposal, Licensing: financial product advisers – conduct and disclosure (ASIC, 2002) at [16]-[17].

65

Nisic’s Case (1990) 8 ACLC 514 at 528 per Enderby J.

11

Latimer

Justice Young in Story’s Case agreed with the then NCSC that the word “duties” does not refer merely to the statutory obligations of a licensee under the legislation, and his definition of “duties” as approximating “functions” holds today. 66 The former NCSC in its decision in Story’s Case had accepted that “duties” in the original s 60(1)(b) were wider than the “obligations” set out in the legislation, because duties arise from many sources such as statute, common law and stock exchange rules whereas “obligations” derive only from the legislation and can only apply to licensees regulated by the legislation. Therefore in the view of the NCSC, “duties” would include “observance of standards applicable where a fiduciary relationship between licensee and client exists as well as due observance of the balance of relevant statutory obligations”. The NCSC had correctly declined to accept the plaintiff‟s argument that “duties” in the paragraph denotes something other than isolated acts.67

Acting efficiently, honestly and fairly imposes a standard of conduct on a licensee Justice Young in Story’s Case (1988) 13 NSWLR 661; 6 ACLC 560 provided meanings to the threefold test of efficiency, fairness and honesty (at 671, 570): „One clue to the meaning is that it is obviously designed to protect the public … The next clue that is given is that the conduct being looked to is something that goes to performance of the duties of the licence holder ... The third clue … permits the Commission in determining whether a licence holder is performing efficiently, honestly and fairly … [to hold] even one failure in the area of making a recommendation to a person without a reasonable basis a contravention of the subsection, and thus the effect of s 60(6) (now s 915C(1)(a)) is to make even one contravention a matter which the Commission may have regard to when revoking a licence. This gives the flavour that in appropriate cases it may be that even one serious offence would warrant the Commission coming to the conclusion that a licensee had not performed his duties efficiently, honestly and fairly.‟

Efficient, honest and fair imposes a “standard of conduct”, and like Trade Practices Act 1974 (Cth) s 52, it is a new missile68 with wide scope able to target what s 912A(1)(a) describes as “all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly fairly”. Like s 52, the test of efficient, honest and fair uses non-technical words and is neither defined nor limited, and it would operate from opening a client account including matters preceding such as advertising, promotion and representations, through broker/client relations to closing an account and the consequences thereof. The requirement in s 912A to do “all things necessary” means that the requirement to act efficiently, honestly and fairly is not limited to matters within the broker/client contract, and would extend to matters incidental but necessary. ASIC states that it sees the obligation of efficient, honest and fair in s 912A(1)(a) as both: (a) a stand-alone obligation that a licensee must satisfy; and (b) an obligation that encompasses other obligations under an AFS licence. So, a licensee may be in breach of its obligations to provide services efficiently, honestly and fairly even though it is complying with all of its other specified obligations. 69

Efficient, honest and fair and ASIC discipline

66

As authority, Young J cited Canadian Pacific Tobacco Company Ltd v Stapleton (1952) 86 CLR 1 at 6, [1952] HCA 32 at [20], per Dixon CJ, and Attorney-General v Cooper [1974] 2 NZLR 713 at 720; applied in Felden’s Case (2003) 45 ACSR 111; [2003] AATA 301 at [377]. See also Nisic’s Case (1990) 8 ACLC 514 at 525, followed by the AAT in Farley v Australian Securities Commission (1998) 16 ACLC 1,502 at [151]. Paragraphs 23, 25 of the NCSC‟s 10 page document containing its reasons dated December 1987, referred to by Young J in Story’s Case (1988) 13 NSWLR 661 at 669; 6 ACLC 560 at 568, and cited at NSWLR 671, ACLC 570. 67

68

Eg, Pengilley W, “Section 52 of the Trade Practices Act: A Plaintiff‟s New Exocet?” (1987) 15 ABLR 247.

69

ASIC Policy Statement (hereafter PS) 164, Licensing: Organisational Capacities (ASIC 2001, reissued 2002) at [164.20][164.21], 2001, often quoted in ASIC releases.

12


The effectiveness of the efficient, honest and fair test is such that ASIC can now state publicly that “[m]ost advisers are efficient, honest and fair”. ASIC points out that poor financial advisers tend to sell only products (not financial plans) and “get rich quick” schemes with little attention paid to investors‟ needs, and that they charge high fees and commissions and apply pressure to make decisions. To promote this standard, ASIC invites the public to report a financial adviser who is “inefficient” or a shady character, with the reminder that ASIC is always seeking to raise the standard, and that it bans about 30 advisers each year out of the 37,000 in the industry. 70 There are many legal consequences for breach of the statutory obligation to act efficiently, honestly and fairly, starting with action by ASIC to suspend, cancel or ban a licensee. If a licensee is in breach of an obligation under s 912A such as not acting efficiently, honestly and fairly, ASIC can respond quickly by suspending or cancelling the AFSL under s 915C(1)(a) after offering a hearing to determine whether the licensee has complied with the section. 71 This is a very effective administrative action by ASIC as the gatekeeper to the financial services industry, as indicated by the statistics. In addition to suspending or cancelling a licence, ASIC can ban a person from the financial services industry under s 920A for more serious misconduct. A banning order is made both to protect the public72 and to maintain confidence in the financial services industry. This was the basis of Story’s Case (1988) 13 NSWLR 661; 6 ACLC 560 discussed above. ASIC can ban a person in advance if it has reason to believe that the person will not comply with their obligations under s 912A: s 920A(1)(ba). This is based on the person‟s record and ASIC‟s belief that it will not change.

Classifying what is efficient, honest and fair The obligations of the holder of an AFSL, including doing all things efficiently, honestly and fairly, is illustrated with many examples given in ASIC releases and in relevant case law, as discussed below. In addition to the obligations of the licensee in Australia, the licensee‟s obligation to act efficiently, honestly and fairly exists extraterritorially, as the operation of the Corporations Act has extraterritorial effect which authorises ASIC to monitor the overseas behaviour of licensees, especially conduct impacting on their activities in Australia. 73 For example, ASIC has said that it will monitor Australian offers to overseas investors on electronic prospectuses, and that it may take action in Australia if the conduct of the issuer is not efficient, honest and fair.74

Providing financial services efficiently, honestly and fairly Personal competencies for licensees ASIC has stated that it sees matters going to integrity – like insolvency, suspension or refusal of membership of any professional or industry association, or convictions – as matters which may influence its view that an applicant can provide financial services efficiently, honestly and fairly.75

ASIC and Financial Planning Association of Australia Ltd, “Don‟t kiss your money goodbye” (2002) p 5, available at http://www.fpa.asn.au. 70

ASIC, Hearings Practice Manual – the principles of, and how we conduct, administrative hearings (ASIC, first ed 1999, updated 2002). To be contrasted with situations where ASIC can suspend or cancel immediately without a hearing in s 915B. 71

Eg, Story’s Case (1988) 13 NSWLR 661 at 685; 6 ACLC 560 at 581; Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [213], cited, eg, Jones v Tax Agents’ Board of New South Wales (2002) 51 ATR 1147; [2002] AATA 1246 at [16]; Christensen v Australian Securities and Investments Commission [2000] AATA 531 at [28]. ASIC statistics show that 39 were banned from financial services in 2002-2003 (ASIC, Fighting fraud and misconduct, Annual Report 2002-2003, p 29); 42 were banned in 2003-2004 (ASIC, Building confidence in financial markets, Annual Report 2003-2004, p 19) and 25 were banned in 2004-2005 (ASIC, n 4, p 21). 72

73

Corporations Act 2001 (Cth), s 5(4).

74

ASIC PS 107, Electronic prospectuses (ASIC, 1996) at [106.107].

75

ASIC PS 138, Investment advisory services: Personal competencies for licensees (ASIC, 1998) at [138.31].

13

Latimer

Those governed by the law are assumed to know the law, so a licensee is expected to know the relevant laws and regulation. A person cannot be said to operate efficiently if he or she has no knowledge, or only a very limited knowledge, of the laws which must be followed and which may circumscribe his or her actions.76 Breach of the law (with or without dishonesty) and “demonstrably inadequate securities advice practices” may be evidence of inefficiency by a licensee, serious enough to warrant the making of a banning order.77 The general obligation of efficiency, honesty and fairness can be expected of financial services licensees in their dealings with their own affairs and the regulation thereof, such as keeping client records in the context of providing financial services. This includes keeping copies of FSGs,78 personal advice79 and SOAs.80 In principle, this obligation should extend to all conduct of business matters such as honouring contractual obligations. The policy of ASIC to include a licensee‟s own affairs as evidence of acting efficiently, honestly and fairly, as confirmed by the AAT in Farley (1998) 16 ACLC 1,502 at [150], supersedes earlier authority which purported to exclude these from the standard of efficient, honest and fair: 81 „But I do not think that efficiency by a dealer in dealing with its own affairs is contemplated by s 60(1)(b) (now s 920A(1)). Efficiency, honesty and fairness there mentioned refer to the duties of a holder of a licence. Those duties must be duties to, with and towards the public.‟

Licensee as employer The licensee‟s obligation to act efficiently, honestly and fairly includes the conduct of the licensee as an employer in the course of providing financial services in matters like recruitment, training and supervision. Failure to meet the licensee‟s obligation in s 912A(1)(f) to ensure that its representatives are adequately trained and are competent to provide financial services, 82 which may also breach the obligation in s 912A(1)(ca) to comply with financial services law, may be evidence of not meeting the obligation to act efficiently, honestly and fairly. Added to this is the usual licence condition to supervise representatives, to provide adequate initial and ongoing training for and supervision of representatives, and to have an adequate compliance system in place – failure to do so may be evidence of not providing financial services efficiently, honestly and fairly. 83 A licensee must have policies, procedures and follow-up in place to promote efficiency, honesty and fairness to give effect to the dictum of the Supreme Court of Victoria that:

76

Kippe v Australian Securities Commission (1998) 16 ACLC 190 at [209], cited by the AAT in Chapel Road Pty Ltd and Australian Securities and Investments Commission [2003] AATA 660 at [170]. 77

Re Campbell and ASIC [2001] 37 ACSR 238 at [117], quoted by the AAT in Chapel Road Pty Ltd and Australian Securities and Investments Commission [2003] AATA 660 at [171]. Financial services guides: ASIC PS 175, Licensing: financial product advisers – conduct and disclosure (ASIC, reissued 2005) at [175.56]. 78

79

ASIC PS 175, n 78 at [175.117].

80

Statements of advice: ASIC PS 175, n 78 at [175.147].

81

RJ Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) (1989) 1 ACSR 93 at 98 per Bollen J.

82

ASIC PS 146, Licensing: Training of financial product advisers (ASIC, reissued 2005) at [146.19].

ASIC, MR 01/140 “Chapel Road has dealers‟ licence cancelled” (1 May 2001); licence reinstated with conditions by AAT in Chapel Road Pty Ltd and Australian Securities and Investments Commission [2003] AATA 660. 83

14

Providing financial services “efficiently, honestly and fairly” „A stockbroker employing brokers cannot supervise each dealing they make as they make it. It can, however, set down policies ... Policies, however, are worthless without systems and people in place to enforce those policies by checking from time to time that they are being applied.‟84

Dishonest financial services business conduct by a licensee fails to meet the obligation of efficiently, honestly and fairly – this would include dishonest conduct by a licensee as an employer towards its representatives such as misconduct in the non financial services area intermingled with conduct as a licensee. In the Nisic Case (1990) 8 ACLC 514 at 525, Enderby J considered the duties of a licensee included: “not only engaging in conduct calculated to impinge adversely on the confidence and trust of clients and investors but also, in relevant cases, of its relations with its employees. The case I am considering has the capacity to be such a case.”85 This intermingled approach has been applied in many cases. For example, in Christensen’s Case [2000] AATA 531 a representative of an established insurance and financial services company as a commission agent promised returns of 50% per annum for investment in a particular scheme. The representative did not have any documentation or research about the scheme and, when it collapsed, ASIC imposed a five year banning order on the representative. The AAT rejected his appeal that his activities regarding the scheme were separate from his activities as the representative of a licensee (at [37]): „In his evidence, the applicant said that he relied on his clients to do their own research, therefore, this indicated to him that they did not rely on him to make the ultimate decision on whether to invest in [the scheme] Wattle. This is irrelevant when considering what is necessary to carry out the duties of a representative “efficiently, honestly and fairly”‟.

Conduct of business Evidence of doing all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly would be found in how the licensee conducts its financial services business, including the licensee‟s conduct in providing financial advice. For example, ASIC has pointed out that if there were non-compliance by a licensee with an ASIC-approved external complaints resolution scheme, one administrative response would be to treat this as the licensee not acting efficiently, honestly and fairly.86 A licensee not using personalised forms acceptable to issuer which are not accepted by issuer, which get rejected by issuer, would not be efficient, honest and fair.87 Evidence of misleading or deceptive conduct under ASIC Act s 12DA, common law negligence and failure to meet standards of due care and diligence including common law obligations would indicate failure to meet the standard of not acting efficiently, honestly and fairly. 88 Disclosure As brokers, licensees (agents) owe a fiduciary duty to their client (their principal), based on the relationship of trust and confidence, derived from agency law and fiduciary principles based on the relationship of ascendancy, influence and trust.89

84

Ali v Hartley Poynton Ltd (2002) 20 ACLC 1,006; [2002] VSC 113 at [365].

Upheld by the AAT in Farley’s Case (1998) 16 ACLC 1,502 at [151] (licensee had misrepresented the terms of employment in advertisements for representatives, the percentage of commission paid, the duration of an investment plan with Australia Eagle and it had instructed employees to promote investments with a high commission return instead of other investments which may have been more appropriate for the clients: breach of the know your client rule, n 97, below). 85

86

ASIC PS 139, Approval of external complaints resolution scheme (ASIC, 1999) at [139.128].

87

ASIC PS 150, Electronic Applications and dealer personalised applications (ASIC, 2000) at [150.55].

88

ASIC PS 175, n 78 at [175.24]-[175.25].

These principles have carried over into online investing, with the electronic broker to act in the client‟s best interests such as dealing with crossings, disclosing of research materials and handling client instructions. 89

15

Latimer

These duties of a licensee to its principal fit within the aims of the regulation of the financial system, including confident and informed participation by consumers and investors. As discussed at the beginning of this article, financial services regulation aims to achieve inter alia fairness, efficiency and transparency in the marketplace, underpinned by disclosure, on the basis that sunlight is the best disinfectant, 90 referring in the context of this article to providing information for the marketplace. ASIC has built on this with its Good Disclosure Principles: „1. Disclosure should be timely 2. Disclosure should be relevant and complete 3. Disclosure should promote product understanding 4. Disclosure should promote comparison 5. Disclosure should highlight important information 6. Disclosure should have regard to consumers‟ needs.‟91

For example, ASIC has said that licensees‟ remuneration practices (including non-monetary benefits) must include disclosure such as disclosure of non monetary remuneration to overcome possible conflicts of interest to ensure that they operate efficiently, honestly and fairly. 92 Failure to give a client a PDS with disclosure of remuneration practices would not be acting efficiently, honestly and fairly.93 Any doubts that disclosure of conflict of interest would not be covered by s 912A(1)(a) have been overcome by amendment with s 912A(1)(aa), which requires licensees to have in place adequate arrangements for the management of conflicts of interest. ASIC has pointed out that failure by a licensee to implement adequate conflicts arrangements would not be efficient, honest and fair.94 To meet the standard, ASIC will require evidence of the relevant arrangements, and evidence that they are monitored. This includes recording actions taken on breaches (the recording of systemic or repeated breaches probably indicates that the arrangements themselves are inadequate). “Arrangements that are not monitored and enforced are unlikely to be adequate.”95 For example, conflict of interest by a dealer dealing in and providing investment advice in relation to the securities of an associate is a serious breach of a licence condition, and has been held to be a breach of its statutory duty to perform its functions efficiently, honestly and fairly, and warranted revocation of the dealer‟s licence.96 Know your client The adviser‟s duty to the client – sometimes called the know your client rule – is based on common law concepts and fiduciary principles and is given statutory effect in the Corporations Act 2001 (Cth).97 Sections 944A-945A provide that a licensee giving personal advice to a retail client must determine the client‟s personal circumstances and must make reasonable inquiries, and that the advice must be appropriate to the client.

ASIC Act 2001 (Cth) s 1(2); Brandeis LD, Other People’s Money, and how the bankers use it (Augustus M Kelley, New Jersey, 1914, reprinted 1986) p 92. 90

91

ASIC PS 168, Disclosure: Product Disclosure Statements (and other disclosure obligations) (ASIC, 2001, reissued 2005) at [168.10]. 92

ASIC PS181, Licensing: Managing conflicts of interest (ASIC, 2004) at [181.38]-[181.39].

93

ASIC PS 175, n 78 at [175.24].

94

ASIC PS 181, n 92 at [181.18].

95

ASIC PS 181, n 92 at [181.17].

96

RJ Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) (1989) 1 ACSR 93.

97

The know your client rule was set out in former Securities Industry Act 1980 (Cth) and State Codes in s 60(6), linked to the former s 65A(1), which is the former version of Corporations Act 2001 (Cth), s 945A.

16


Justice Young pointed out in Story’s Case that making recommendations to clients without a reasonable basis – even one failure – could be evidence of a licensee not performing efficiently, honestly and fairly.98 This “one strike and you‟re out” test has raised the standard set out in – and therefore changed – earlier case law which had held that an isolated or passing departure from proper professional standards does not prove unfitness and in the words of the joint judgment of the High Court, that “mercy might be shown towards a young man who had not understood the error of his ways”.99 The disclosure documents required by the Financial Services Reform Act 2001 (Cth) – financial services guide, statement of advice and product disclosure statement – require client disclosure of inter alia commissions and connections in a manner which is “clear, concise and effective”. 100 For example, a licensee marketing tax schemes to clients where advisers receive hidden high commissions, incentives and kickbacks, with little or no consideration of the individual investment needs of clients, would not be acting efficiently, honestly and fairly.101 In this context, the AAT has stated that “as part of the duties required under (what is now s 920A(1)(a)) the applicant was under an obligation to make certain inquiries prior to advising his clients in relation to the Wattle scheme”. 102 There are many examples of ASIC making banning orders for defective advice in breach of the know your client rule on the basis that the adviser has not acted efficiently, honestly and fairly. For example, ASIC in the Felden Case (2003) 45 ACSR 111; [2003] AATA 30 permanently banned a licensee‟s representative for breaches of financial services law such as not having a reasonable basis for making recommendations, engaging in conduct that was misleading or deceptive or was likely to mislead or deceive, and making representations about the risk of certain investments without first having conducted adequate investigation. There was evidence that the representative had taken unacceptable risks with clients‟ money, including placing investors seeking secure low-risk investments into a number of speculative high-risk investments with little or no regard for their needs and investment objectives. Some of the clients were elderly or retired, and one was the trustee of a 12 year old girl‟s inheritance. In the words of the AAT: „The Tribunal also finds that the Applicant‟s failure to perform the duties of a dealer or investment adviser efficiently, honestly and fairly within the meaning of s 829(f), his reluctance to acknowledge having done so and his reluctance to acknowledge responsibility for having done so afford reason to believe that, if allowed to participate again in the securities industry, the Applicant would not perform the duties of a representative of a dealer or investment adviser efficiently, honestly and fairly, within the meaning of s 829(g) ... Time and again Mr Felden failed to exercise the critical judgement he was required to apply, yet presented his recommendations as based on research that his clients had no reason to believe was inadequate, as it was.‟103

Both subsections are now subsumed into s 920A(1)(b). In Jungstedt’s Case (2003) 73 ALD 105, another example of the failure of the know your client rule, ASIC found that a representative had recommended options trading to clients, which was not in

98

Story’s case (1988) 13 NSWLR 661 at 671; 6 ACLC 560 at 570.

New South Wales Bar Association v Evatt (1968) 117 CLR 177 at 183; [1968] HCA 20 at [12], cited in Story’s Case (1988) 13 NSWLR 661 at 671; 6 ACLC 560 at 570. 99

100

Corporations Act 2001 (Cth), s 947B(2)(d), (e); s 947B(6).

These were the facts in the Saxby Bridge Case: ASIC MR 01/387, “Licences revoked for Saxby Bridge, ABS Securities, managing director banned” (ASIC 2001), which led to Saxby Bridge Financial Planning Pty Ltd and Australian Securities and Investments Commission (2003) 46 ACSR 286; [2003] AATA 480 (licence reinstated); ASIC v Saxby Bridge Financial Planning Pty Ltd (2003) 133 FCR 290; [2003] FCAFC 244 (licence reinstated), discussed Purnell F, “ASIC loses appeal against Saxby Bridge reinstatement”, Money Management.com.au (6 November 2003), available at http://www.moneymanagement.com.au. 101

102

Christensen’s Case [2000] AATA 531 at [31].

ASIC MR 03/112, “AAT upholds life ban for investment adviser” (ASIC, 2 April 2003); Felden and Australian Securities and Investments Commission (2003) 45 ACSR 111; [2003] AATA 30 at [395], [411]. 103

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their best interests; that he failed to properly advise clients of the risks associated with the trading strategies that he recommended to them, and that he operated discretionary accounts for clients without obtaining the required written authorisation. The AAT upheld ASIC‟s decision to ban the representative for five years after finding that he had not performed his duties as a representative efficiently, honestly and fairly.104 Conduct of business – misconduct Misconduct is negative conduct or unprofessional conduct which results in financial services not being provided efficiently, honestly and fairly. New technology and new products will continue to expand the possibilities for misconduct in the conduct of financial services business. As indicated above, misconduct in its many forms may lead to suspension, cancellation or banning by ASIC for failure to meet the general obligation to act efficiently, honestly and fairly. For example, unauthorised discretionary trading without client authority, including failure to issue contract notes in relation to some trades, is evidence of not carrying on business efficiently, honestly and fairly.105 An options trading strategy which led to clients trading far beyond their limits and often well beyond their personal financial means, leading to total client losses of some $15 million, is not efficient, honest and fair.106 In this latter case, there was evidence that the representative conducted an investment advice business without a licence, did not obtain background financial instructions in breach of the know your client requirement, made statements to prospective clients without caring whether they were true or not, and deceived inexperienced clients regarding the nature and consequences of options trading. Further examples of conduct which is not efficient, honest and fair are demonstrated in ASIC‟s banning of high profile broker Gerald Farley, a licensee‟s representative and “deal maker” for four years, for many breaches of the Corporations Act:107 (1) Farley offered credit recklessly and habitually to the detriment of the licensee (the principal, his employer). (2) Farley represented to his family and some of his friends that the licensee would carry any initial financial risk, as eventuated. (3) Farley crossed shares between clients often without instructions, which gave a false impression of commercial reality. In one case, there was a payment of a large sum of money where there had been no real change in beneficial ownership. (4) Farley failed to observe instructions requiring payment to be made promptly and instructions not to deal with certain persons or organisations. (5) Farley accepted loans while amounts were owing to the licensee by entities controlled by the lender without any satisfactory explanation for the taking or repaying of such loans. (6) Farley carried out discretionary trading, contrary to the licensee‟s instructions. The lack of payment in advance of a pool of capital exacerbated, rather than excused, the conduct.

Jungstedt and ASIC (2003) 73 ALD 105; ASIC 03/065, “AAT upholds five-year ban for adviser” (ASIC, 21 February 2003); also Boucher v Australian Securities Commission (1997) 71 FCR 122; 15 ACLC 100. 104

105

ASIC 01/107, “Former client adviser Anthony Wilson offers enforceable undertaking” (ASIC, 26 March 2001).

ASIC 04/316, “Former Performance Plus and Ord Minnett representatives banned” (30 September 2004) (managed funds representative banned for five years); “ASIC bans rogue traders”, Money Management.com.au (30 September 2004). Reference to “efficient, honest and fair” appeared only in the summary of the second case. 106

107

Paraphrased from Farley v Australian Securities Commission (1998) 16 ACLC 1,502 at [143].

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(7) Farley accepted instructions on behalf of new clients in a careless manner. No attempt was made to verify the existence of the client or its credit. (8) When receiving instructions for a new client from an existing associate, Farley did not indicate any connection with those persons on the client introduction form even though there was provision in the form for that purpose, indicating that he attempted to conceal the connection. (9) Crossings were made to postpone liability for payment to the licensee, especially just before balance date. (10) The vagueness of the alleged co-venturing arrangements with certain investors indicated an habitual failure to observe efficiency in the organisation of Farley‟s affairs. (11) Farley breached stock exchange rules on a number of occasions. (12) Farley entered into a deed in which he covenanted to pay more than $5 million to the licensee within seven days, yet he had no intention to honour this obligation and has not honoured it. In the words of the AAT, “These findings establish that Mr Farley has not performed his duties efficiently. The many instances of non disclosure evidence a failure to perform honestly. The conduct towards (the licensee/principal) evidences a failure to perform fairly” (Farley (1998) 16 ACLC 1,502 at [143]). Gross breach of duty by representative ASIC has described conduct considered more serious than misconduct as gross breach of duty, perhaps approaching what is described as “serious misconduct” in other contexts such as conduct that causes serious risk to the reputation of the employer‟s business, theft or fraud.108 For example, ASIC described the conduct in the RetireInvest case by the McLachlan father and son “rogue traders” as gross breach of duty and trust to clients which failed to meet their general obligation to act efficiently, honestly and fairly. 109 Evidence showed that McLachlan senior had for example made false journal entries in client records regarding transfers of funds between client accounts. The case resulted in the two being permanently banned by ASIC from acting as licensee representatives under the forerunner of s 920A(1)(a). Malcolm (father, director of broker) was banned by ASIC for failing to perform his duties as a representative efficiently, honestly and fairly. ASIC had alleged that:110 „1. You engaged in, and allowed others to engage in, conduct which had the effect of concealing from clients of RetireInvest the true position of their accounts with [the stockbroker/ASX member/AFSL]. 2.

You allowed [the broker] to improperly trade on the RetireInvest client accounts.

3.

You failed to establish appropriate procedures to enable [the broker] to comply with the Australian Stock Exchange (ASX) Business Rules.

108

Eg, Workplace Relations Regulations 1996 (Cth), reg 30CA, promulgated for Workplace Relations Act 1996 (Cth) s 170CM(1)(c). Similar to the distinction between “fraud” and “serious fraud” (Corporations Act, s 9), only the latter of which is grounds for immediate suspension or cancellation under s 915B. 109

McLachlan v Australian Securities and Investments Commission (1999) 85 FCR 286; 30 ACSR 418; 17 ACLC 656; [1999] FCA 244, discussed below at n 138. See, eg “RetireInvest saga rolls on”, Money Management.com (10 June 1999) at http://www.bluebook.com.au/articles/6d/0c00476d.asp. RetireInvest paid each investor for their loss. Misconduct involving unauthorised trading – from the managing director down by employees‟ former broker Thompson Brindal in Adelaide – led to some 400 investors losing about $17m. The ASX proceedings are noted in n 138, below. 110

McLachlan (1999) 85 FCR 286; 30 ACSR 418; 17 ACLC 656; [1999] FCA 244 at [13].

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You failed to establish or apply any, or any effective, risk management policy, compliance controls or reporting system in relation to the trading activities of authorised representatives of [the broker].

5.

You failed to take any action in relation to the trading activities of [Hamish, his son] after you became aware of unauthorised transfers of options contracts and journal entries undertaken by [the son].

6.

You allowed [the broker] to breach ASX Business Rules.

7.

You failed to understand and acknowledge that there was a broker/client relationship between [the broker] and the individual RetireInvest clients.‟

Hamish (the son, director of broker) was banned by ASIC for failure to perform his duties as a representative of the broker efficiently, honestly and fairly. ASIC had alleged that:111 „1. You improperly made or caused to be made in the client records of [the broker] four journal entries which had the effect of transferring funds from certain RetireInvest clients to other RetireInvest clients. 2. You improperly transferred numerous options positions from your own trading account and the accounts of your associates to the accounts of RetireInvest clients which resulted in losses being incurred by the RetireInvest clients rather than by you or your associates. 3. You conducted RetireInvest‟s clients accounts in a manner which hid from them the true state of their accounts. 4. You improperly traded on RetireInvest client accounts.‟112

Gross misconduct – false transfers, false entries, illegal trading distort the market mispricing A further example of what is considered “gross” misconduct is illustrated by ASIC banning former Queensland broker Max Kippe under the forerunner of s 920A(1)(a) rather than pursuing him through the civil or criminal courts for specific breaches or offences. As in the misconduct examples above, Kippe had committed many breaches of the law. He had submitted new client forms with assumed names, provided false information concerning himself, and had recorded that information in the dealer‟s books.113 As an employee, he had failed to pay for his share purchases within the time limits established by the employer and therefore forced the providing of credit in breach of the forerunner of Corporations Act 2001 (Cth) s 991F. He had breached the identification requirements of the Financial Transaction Reports Act 1988 (Cth). He had failed to keep a register of his interests under s 881 of the former Corporations Law.114 He had used assumed names to enable him to evade the securities dealer‟s responsibility not to extend him credit and had also enabled him to “spread” the credit the dealer provided to its clients. Kippe had not only acted unfairly in relation to the securities dealer but also had not operated in an open and straightforward manner in his dealings with him. 115 Conduct of business – manipulation One of the aims of financial services regulation is to protect financial markets from activities which may result in artificial or manipulated prices. Sections in the Corporations Act 2001 (Cth) seek (in the words of the High Court):

111

McLachlan (1999) 85 FCR 286; 30 ACSR 418; 17 ACLC 656; [1999] FCA 244 at [15].

112

McLachlan (1999) 85 FCR 286; 30 ACSR 418; 17 ACLC 656; [1999] FCA 244 at [13]-[15]. Hamish McLachlan, a former Australian Olympic rower, was committed for trial on 91 charges brought by ASIC for transferring exchange-traded options from his account to client accounts to divert the risk of loss: ASIC 01/383, “Hamish McLachlan committed for trial” (29 October 2001). He was convicted by the District Court of SA of breach of then Corporations Law s 232(6)/1317FA and a sentence of nine years jail was imposed: “Former Olympic rower jailed for stock market fraud”, ABC South Australia (30 January 2004), available at http://www.abc.net.au/sa/news; appeal dismissed McLachlan v The Queen [2004] SASC 277. Earlier proceedings are reported at R v McLachlan [2003] SADC 100. 113

Under the predecessor of what is now Corporations Act 2001 (Cth) s 1307, dealing with falsification of books.

114

Now subsumed into the provisions dealing with financial services guides. Formerly Securities Industry Act 1980 (Cth) and Codes s 89. 115

Kippe v Australian Securities Commission (1998) 16 ACLC 190, banning order under Corporations Act 2001 (Cth), s 920A(1)(a).

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Providing financial services “efficiently, honestly and fairly” „to ensure that the market reflects the forces of genuine supply and demand. By “genuine supply and demand” I exclude buyers and sellers whose transactions are undertaken for the sole or primary purpose of setting or maintaining the market price. It is in the interests of the community that the market for securities should be real and genuine, free from manipulation. The section is a legislative measure designed to ensure such a market and it should be interpreted accordingly.‟116

In words foreshadowing the fraud on the market theory, 117 Lord Ellenborough CJ said in delivering judgment in the “Great Stock Exchange Fraud of 1814”118 that: „(a) public mischief is stated as the object of this conspiracy; the conspiracy is by false rumours to raise the price of the public funds and securities; and the crime lies in the act of conspiracy and combination to effect that purpose … The purpose itself is mischievous, it strikes at the price of a vendible commodity in the market, and if it gives a fictitious price, by means of false rumours, it is a fraud levelled against all the public, for it is against all such as may possibly have any thing to do with the funds on that particular day.‟119

Breaches by a licensee of any of the market misconduct and prohibited conduct provisions in Pt 7.10 Div 2 such as market manipulation, false trading and market rigging, and false or misleading statements relating to financial products and financial services, would also fail to meet the general obligation of acting efficiently, honestly and fairly. 120 For example, possible breach of the stock market manipulation section (now s 1041A), the false trading and market rigging section (now s 1041B), or share trading possibly considered not efficient, honest and fair led to the signing, without admitting the concerns of ASIC, of an enforceable undertaking by a former authorised financial services representative to withdraw from the financial services industry. 121 In this example, ASIC was concerned that the representative dominated the market in certain shares and that he exercised a wide discretion regarding the timing and the price of clients‟ buy and sell orders. ASIC was concerned that he failed to buy available shares when he had outstanding orders, that he caused trades to be executed at prices higher than the last sale price and that he placed bids within 20 minutes before the close of the market. ASIC was also concerned that he executed trades for clients when there were prior outstanding orders for other clients, placed bids for clients without written orders or in excess of existing orders, had outstanding buy/sell orders at the same time for the same client and failed to execute those orders, failed to complete buy orders for clients and that he bought shares at prices in excess of clients‟ instructions. This administrative procedure of banning an offender for breach of the obligation to act efficiency, honesty and fairness overcomes the need for ASIC to decide whether to pursue a civil or criminal remedy for each breach separately under the relevant specific laws. ASIC can bypass technical provisions in the Corporations Act, avoid the decision whether to pursue civil or criminal proceedings, avoid briefing prosecutors such as the Director of Public Prosecutions and deal with the matter by means of the administrative process of suspending, cancelling or banning a licensee for breach of the obligation to act efficiency, honesty and fairness.

Acting efficiently, honestly and fairly – ASIC licensing discretions and approvals As political scientist Merle Fainsod pointed out in a groundbreaking paper in the 1940s on the nature of the regulatory process: “[t]he growth of administrative discretion has emphasised the creative role

116

North v Marra Developments Ltd (1981) 148 CLR 42 at 59; [1981] HCA 68 at [39] per Mason J; Rae Report, n 17, Ch 8.

Eg, Van De Voorde MH, “The Fraud on the Market Theory and the Efficient Capital Markets Hypothesis: Applying a Consistent Standard” (1988) 14 Journal of Corporate Law 44. 117

118

The Great Stock Exchange Fraud of 1814 involved conspirators providing false information that Naploeon I of France had been killed and that the Napoleonic wars were over. As a result of this good news, share prices on the LSE soared in the morning, and fell in the afternoon when the government confirmed that the news of peace was false. The Committee of the Stock Exchange, suspecting that there had been deliberate stock manipulation, investigated and discovered a purchase the week before and later sale of more than £1.1m of government securities. Those involved were charged, convicted and fined: see the entry in Wikipedia at http://en.wikipedia.org/wiki/Great_Stock_Exchange_Fraud_of_1814. 119

R v De Berenger (1814) 3 M & S 67 at 72-73; 105 ER 536 at 538.

120

ASIC PS 175, n 78 at [175.24].

121

ASIC 01/429, “Levi Mochkin withdraws from securities industry” (ASIC, 3 December 2001).

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which regulatory agencies can play in defining the scope and direction of public policy.” 122 ASIC influences public policy in the exercise of its discretion to exempt from or to modify the operation of the Corporations Act 2001 (Cth) in defined circumstances within the authority of the Act and with regard to the objectives set out in, for example, s 760A, as interpreted by ASIC policy. 123 This regulatory discretion fits within ASIC‟s aims of maintaining, facilitating and improving the performance of the financial system and the reduction of business costs (ASIC Act, s 1(2)(a)). ASIC‟s authority for exemption and modification in the area of licensing of providers of financial services is set out in s 926A:124 Corporations Act s 926A(2) „ASIC may: (a)

exempt a person or class of persons from all or specified provisions to which this section applies; or …

(c) declare that provisions to which this section applies apply in relation to a person or financial product, or a class of persons or financial products, as if specified provisions were omitted, modified or varied as specified in the declaration.‟

There is nothing in the Corporations Act to guide ASIC on the criteria to grant an exemption, but as the High Court has pointed out, that does not mean the power can be exercised “for any reason whatever or for no reason at all. The intention of the legislature is to be ascertained from the words of the statute as applied to the subject matter with which the statute deals”.125 The decision-maker may only exercise a power or discretion under the Act for the purpose for which it was given. 126 Although it has gained many administrative discretions from this authority, ASIC has stated that one of the factors it will consider in using its powers to give relief under s 926A over financial services licensing is to support the regulatory goal of promoting the provision of efficient, honest and fair financial services by all licensees and their representatives.127 For example, and in line with this goal, ASIC has confirmed that it may grant licensing relief to cover atypical, unforeseen circumstances or unintended consequences of the licensing provisions of the Act, in line with PS 167.128 Such unintended consequences were not evident in the Enertrade 129 application for exemption from the need for an Australian Financial Services Licence, rejected by ASIC in line with ASIC policy and confirmed by the AAT130 – which one is to evaluate whether the alternative regime would address the obligation of providing financial services efficiently, honestly and fairly?131

Fainsod M, “Some reflections on the nature of the regulatory process” in Freidrich CJ and Mason ES (eds), Public Policy (Harvard University Press, 1940) p 320. 122

123

As set out by the AAT in Queensland Power Trading Corporation t/a Enertrade and Australian Securities and Investments Commission [2005] AATA 945. For example, ASIC PS 167, Licensing: Discretionary Powers (ASIC, reissued and amended 2005) at [167.3B(b)]; ASIC PS 5, Applications for relief (ASIC, 1996), a pre-FSR policy statement, continues to apply: at [167.16], Sch 1. Section 760A applies to “this Part”, ie Pt 7.6, with the exception of Pt 7.6 Div 4 (important Australian Financial Services Licence matters such as how to get a licence, licence conditions and variation, suspension or cancellation) and Div 8 (banning or disqualifying). 124

125

Water Conservation and Irrigation Commission (New South Wales) v Browning (1947) 74 CLR 492 at 496; [1947] HCA 21 per Latham CJ. 126

Drake v Minister for Immigration and Ethnic Affairs (No 1) (1979) 2 ALD 60 at 70 per Bowen CJ and Deane J, cited in the Enertrade Case [2005] AATA 945 at [85]. 127

Also, relief under ss 911A(2)(l); 951B and 992B. ASIC PS 167, n 123 at [167.3B(b)], cited in the Enertrade Case [2005] AATA 945 at [83]. Also ASIC PS 169, Disclosure: Discretionary Powers (ASIC, reissued 2005) at [169.3B(b)]. 128

ASIC PS 167, n 123.

129

Enertrade, a wholesale electricity trader, is established under the Government Owned Corporations Act 2003 (Qld), was formerly the Queensland Power Trading Corporation. The AAT held that Enertrade was not exempt from licensing under Ch 7 of the Corporations Act 2001 (Cth) as an instrumentality of the Crown and nor did it have Crown immunity. 130

Queensland Power Trading Corporation t/a Enertrade and Australian Securities and Investments Commission [2005] AATA 945. 131

ASIC PS 51, Applications for relief (ASIC, 1996); ASIC PS 167, n 123.

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A further example of ASIC discretions and approvals is in ASIC‟s requirements for the issue of a financial services licence, which may be met either by exact compliance or by fulfilling the equivalent if the applicant can demonstrate that it will operate efficiently, honestly and fairly on a different basis.132 Further, ASIC has the power to license the operators of overseas financial markets under s 795B(2), and part of the information to be provided for assessing the outcomes of the home regulatory regime is evidence of the obligation to act efficiently, honestly and fairly on the part of participants in overseas financial markets.133 As ASIC has said, an overseas regulatory regime will achieve the same outcomes as the Australian regime if it promotes the provision of efficient, honest and fair financial services if it ensures that: „financial services are provided by persons who: (a)

are fair and honest;

(b) are competent to provide the financial service; (c)

have adequate resources; and

(d)

have adequate risk management processes, including in relation to the maintenance of financial records.‟134

The efficient, honest and fair test is also one of the tests for ASIC to give registration relief to permit operators of foreign collective investment schemes to operate in Australia if it is satisfied as to the equivalent regulation in the home jurisdiction. One of the tests of equivalence is evidence that scheme operators and promoters, and their representatives, act efficiently, honestly and fairly. 135 Another example is that when ASIC licenses a public company with an Australian financial services licence to authorise it to operate an investor directed portfolio service (IDPS), it will assess the capacity and expertise of the applicant to operate an IDPS efficiently, honestly and fairly, based on requirements set out in specified ASIC policy statements dealing with managed investments.136 There is much scope for the developments in this marrying of the standard of efficient, honest and fair with the wide discretions open to ASIC. These may involve subjective standards, but standards which are reviewable in administrative proceedings.

Conclusion – efficiently, honestly and fairly in other laws The standard of “efficiency, honesty and fairness” has proven to be so effective that it has become the benchmark in legislation and rules outside the operation of the Corporations Act. It has been used as a standard by ASX, where the test appears in one of the ASX market rules. 137 It did appear in the ASX Constitution,138 but has now been subsumed into ASX‟s clause 4.1.1 “General compliance by market participants”. 139

132

ASIC PS 160, Summary Policy Statement 160 Time Sharing Schemes (ASIC, 2000) at [160.9] (disclosure of prices by responsible entity licensed to run a time-sharing scheme). 133

ASIC PS 177, Australian market Licences: Overseas operators (ASIC, 2003) at [Q3.1(g)].

134

ASIC Policy proposal, Licensing: Discretionary powers – foreign financial services providers (ASIC, 2002) at [A9].

135

ASIC PS 178, Foreign Collective Investment Schemes (ASIC, 2004) at [178.48(a)]; under s 601ED.

136

ASIC PS 148, Investor directed portfolio services (ASIC, 2000) at [148.23].

137

The test of efficient, honest and fair appears in the context of ASX co-regulation, where ASX is authorised to disclose information to any governmental agency or regulatory authority (such as ASIC) in the proper exercise of its powers relating to efficient, honest, fair, competitive and informed trading, clearing and settlement of financial products: ASX Market Rule 1.7.2(h)(ii). Under ASX Constitution former Art 13.2, the then business rules were to “(e) contain provisions calculated to ensure that dealings in securities by participating organisations are engaged in on a basis that is efficient and honest”. The test of efficient, honest and fair also appeared in the former ASX Art 52, which provided for disciplinary procedure for prohibited conduct, defined as conduct “which is not efficient, honest or fair or is otherwise prejudicial to the interests of the Exchange or its members (whether such prohibited conduct constitutes or involves a breach of any of the Articles or Rules or not)”. Cases included Norths Ltd v McCaughan Dyson Capel Cure Ltd (1988) 12 ACLR 739; 6 ACLC 320. In Australian Stock Exchange Ltd v McLachlan [2002] NSWCA 374, McLachlan senior failed to be efficient, honest and fair and engaged in conduct which 138

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The test has also been introduced in the licensing provisions of the Tobacco Products (Licensing) Act 1988 (Cth), requiring a natural person to have inter alia adequate knowledge and experience to undertake the business of selling tobacco in an efficient, honest and fair manner. 140 The Securities and Futures Ordinance 2002 (Hong Kong) Ch 571 contains the traditional test of “fit and proper” for the purposes of the Ordinance, including financial services licensing. Among the matters listed to determine a “fit and proper” person is “the ability to carry on the regulated activity competently, honestly and fairly” (s 129(1)(c)). Similarly, in Singapore, the Monetary Authority of Singapore is authorised to grant a corporation a capital markets services licence, or a representative a representative‟s licence, but one reason not to do so is if the Authority has reason to believe that the applicant, or any of its officers or employees (in the case of a corporation applying for a capital markets service licence), will not perform the functions for which the applicant seeks to be licensed, efficiently, honestly or fairly.141 Equally, the Authority may revoke a capital markets services if the holder of the licence (or any of its officers or employees) or a representative have not performed their “duties” efficiently, honestly or fairly.142 Efficient, honest and fair: the future ASIC sees the obligation of acting efficiently, honestly and fairly in s 912A(1)(a) as both a standalone obligation that a licensee must satisfy and an obligation that encompasses other obligations under an AFS licence. This is important as it raises the problem that a licensee may be in breach of its obligations to provide services efficiently, honestly and fairly even if it is complying with all of its other specified obligations.143 Future research, investigation and commentary must monitor ASIC‟s record to ensure that this approach is not advanced without regard to the substantive provisions found elsewhere in the Corporations Act. “Efficient” is both an everyday word and a technical word in economics with reference to operational efficiency, allocative efficiency and informational efficiency, not to mention dynamic efficiency, distributional efficiency, Pareto efficiency and Kaldor-Hicks efficiency. “Honest” has a moral and ethical overtone, and the word “fair”, the opposite of unfair, is especially familiar to Australians as fair dinkum. Read conjunctively, not disjunctively, the standard of efficiency, honesty and fairness imposes general obligations – not duties or functions – on the financial services licensee and its representatives as set out in, for example, Corporations Act 2001 (Cth), s 912A. The general obligation of acting efficiently, honestly and fairly includes personal competencies, and imposes continuing obligations on the licensee and its representatives in providing financial services from the beginning of the relationship to its end. The general obligation imposes obligations in the adviser/client relationship from courtship, conception and birth through to death and its

breached former ASX Articles of Association Rule 52. In addition, he was charged with prohibited conduct which amounted to “(a) impropriety affecting professional character and which was indicative of a failure either to understand or to practise the precepts of honesty or fair dealing in relation to clients or the public and, or in the alternative, (b) unsatisfactory professional conduct where such conduct involved a substantial or consistent failure to reach reasonable standards of competence and diligence and, or in the alternative, (c) conduct which is or could reasonably be considered as likely to be prejudicial to the interests of ASX or its Members” and was fined $100,000. The ASIC proceedings are noted in n 109, above. In Reynolds and Co v Australian Stock Exchange (2003) 174 FLR 311; 21 ACLC 608; [2003] NSWSC 33, a stock broker failed to implement and enforce adequate compliance systems in breach of then Art 52. Its representative Peter Struk was in breach of the then ASX Business Rules and was later banned for life by ASIC: ASIC MR 02/184, “Stockbroker struk off” (24 May 2002). 139

“A market participant must at all times … not engage in unprofessional conduct”: Market Rule 4.1.1(w).

140

Section 20(2B)(a)(iii). The same test applies to a corporation: s 20(2C)(a)(ii); the equivalent is in, eg, Tobacco Products (Licensing) Act 1988 (Qld), s 20(2B)(a)(iii), (2C)(a)(ii). The test in the Tobacco Products Control Act 2006 (WA) is “honestly and fairly”: s 39(3)(f) (not yet in operation 18/8/2006). 141

Securities and Futures Act Cap 289 1995 (Singapore), ss 86(4)(m), 87(3)(m), respectively. Singapore uses the disjunctive “or”; compare text above at n 55. 142

Securities and Futures Act Cap 289 1995 (Singapore), s 95(2)(a)(iii), (2)(b)(iv), respectively. Singapore uses the disjunctive “or”; compare text above at n 55. 143

ASIC PS 164, n 69.

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aftermath – such as from preliminary advertising and representations to the end of the relationship and after (such as disclosure of trailing commissions). Among the licensee‟s obligations are its duties as an employer to its employees, even if intermingled with other obligations to do with providing financial services. The obligation of acting efficiently, honestly and fairly includes the full range in the providing of financial services, including conduct of business, disclosure, the duties of agent to principal including fiduciary duties, know your client, breach of duty by a representative, misconduct, gross misconduct and manipulation. It is one of the tests in ASIC‟s exercise of its power to grant discretions and approvals. The policy issue raised is that the obligation to act efficiently, honestly and fairly parallels obligations imposed by some of the sections discussed in this article. Are some of the relevant sections now redundant? The administrative procedure of suspending, cancelling or banning an offender for breach of the obligation to act efficiently, honestly and fairly overcomes the need for ASIC to decide whether to pursue a civil or criminal remedy for each breach separately under the relevant specific laws. ASIC can bypass technical provisions in the Corporations Act, avoid the decision whether to pursue civil or criminal proceedings, avoid briefing prosecutors such as the Director of Public Prosecutions and deal with the matter by means of the administrative process of suspending, cancelling or banning a licensee for breach of the obligation to act efficiently, honestly and fairly. It is essential that research is undertaken by ASIC, and by other relevant organisations, to monitor the record of evaluating the concept of efficient, honest and fair behaviour in light of the specific provisions of the legislation. The general obligation provides efficiency for ASIC‟s regulation of financial services, and spares ASIC the expense of civil or criminal action. Even criminal activity such as false transfers, false entries, illegal trading and manipulation – which ASIC may classify as gross misconduct – can be swiftly dealt with under administrative action for failure to provide financial services efficiently, honestly and fairly. The standard necessary to ensure that financial services are provided efficiently, honestly and fairly is written in plain English. It is not encumbered with existing interpretations and its scope is not fixed, so it cannot become obsolete, and like the evolution of Trade Practices Act 1974 (Cth) s 52 (misleading or deceptive conduct), the expected standard of the financial services licensee of efficiency, honesty and fairness will continue to evolve to meet new situations in the marketplace for financial services.

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Latimer

Table: Evolution of the test of efficient, honest and fair: SI Act 1970 (NSW) (Vic) (WA) 1971 (Qld)

Must be licensed

NSW, Vic ss 9,10

SI Act 1975 (NSW) (Vic) (Qld) (WA)

s 37 (principal )

Qld ss 17 , 18

s 38

WA ss 10,11

resent-

SI Act 1980 (Cth) and State Codes (Cooperativ e scheme)

ss 43 - 46

SI Act Amend ment Act

FI Act 1986 (Cth) and State Codes

1983 (Cth)

SI Act Amend

FI Act and

Corporations

Corporations

Act

Act 2001 (Cth)

ment

Codes Amend

1989 (Cth)

after

Act

ment

Financial

1989 (Cth)

1989 (Cth)

(Corporation s Law) and Corporations

Reform

Act

Act 2001 (Cth)

Services

2001 (Cth)

s 61

ss 780, 781;

s 63

ss 1142, 1143

(repative)

if fit and proper. NSW, Vic ss 14,15 Qld ss 21(1), 21(2) WA

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s 911A

Providing financial services “efficiently, honestly and fairly” ss 15(1), 15(2)

Conditions for grant of licence/

s 40

s 48(a)(v)

s 66(2)(f)

s 48(2)(e)

s 66A(2)(e)

s 783(2)(e) s 1145(2)(f) s 1145(4)(d)

s 912A(1)(a)

s 62C

s 80C(1)(k)

s 826(1)(k)

s 915C(1)(a)

s 80D(1)(a)

s 1191(1)(h), s 1191(1)(j)

s 80E(b)

s 828(b)

s 80F(f)

s 1193(f)

s 80F(g)

s 1193(g)

(dealer and invest

general obligations –

ment adviser)

efficient, honest and fair

s 48(b)(v) (corporat ion)

Suspend or cancel licence – if not efficient, honest and fair

NSW, Vic ss 19(1)(a), (b),

ss 46, 47

s 60(1)(b) (revoke) s 60(6)

Qld s 28(1)(a), (b) WA s 22(1)(a), (b) if not fit and proper

Banning order – if not efficient, honest and fair

s 920A(1)(a)

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