The Australian Securities and Investments Commission (ASIC) is appealing the Federal Court (Court)’s decision to dismiss proceedings against the Commonwealth Bank of Australia (CBA) and Colonial First State Investments Limited (CFSIL) brought by ASIC for alleged breaches of the conflicted remuneration provisions of the Corporations Act 2001 (Cth) (Corporations Act).
The landmark decision of Anderson J was the first time that the Court has explained, in detail, the Court’s interpretation of the conflicted remuneration provisions of the Corporations Act. In particular, the Court examined the application of the terms “benefit” and “influence” in the case brought by ASIC. Although ASIC has not published its grounds for appeal, ASIC stated that they are appealing the decision due to concerns that the Court’s interpretation will limit the operation of the conflicted remuneration provisions.
CFSIL is a wholly owned subsidiary of CBA. CFSIL and CBA jointly developed Essential Super, a superannuation product designed to comply with the Australian Government’s MySuper reforms. Essential Super is issued by CFSIL and, separately, distributed by CBA. Essential Super was the only superannuation product that CBA distributed. CBA’s representatives sold Essential Super to individuals and small business employers as a default fund for employees who had not nominated a superannuation fund.
CBA and CFSIL entered into a distribution agreement (Distribution Agreement) which included terms requiring that a portion of the net revenue made by the distribution of the Essential Super would be paid to CBA for services that CBA was providing under the Distribution Agreement. These payments were made in the form of both journal entries and cash transfers.
ASIC commenced civil penalty proceedings against CBA and CFSIL in June 2020 after the “Final Report of the Royal Commission into Misconduct in the Banking and Superannuation and Financial Services Industry” raised concerns around conflicted remuneration in respect of CBA’s and CFSIL’s conduct.
In the initial proceedings, ASIC alleged that between 1 July 2013 and 30 June 2019, CBA accepted a benefit in the form of cash transfers and journal entries from CFSIL for the distribution of Essential Super, which influenced the choice of financial product recommended by CBA to its customers and the general product advice provided by CBA.
CBA and CFSIL submitted that the journal entries and cash payments formed part of the usual accounting practices within a corporate group. CBA also submitted that in any event the journal entries and cash sweeps were not known to the employees of CBA who were selling Essential Super and therefore the payments could not influence the recommendation of superannuation products or general product advice provided by CBA.
The Court was asked to determine whether the journal entries and cash payments provided by CFSIL to CBA constituted a benefit and whether the financial product advice provided, or choice of financial product recommended, by CBA to its retail clients could reasonably be expected to be influenced by the alleged benefit.
The Court determined that CBA and CFSIL did not breach the conflicted remuneration provisions, as those provisions were not intended to apply to members of the same corporate group. The Court found that the journal entries and cash payments did not constitute a “benefit” as there was no transfer of value from CFSIL to CBA. Further, the Court found that the journal entries and cash payments could not have reasonably influenced CBA’s product recommendations or general advice, as CBA only offered one super product and frontline staff were unaware of the arrangement between CBA and CFSIL.
Contention on Appeal
ASIC has not released its grounds of appeal, however, there are several key findings of the Court that significantly narrow the application of the conflicted remuneration provisions.
Arm’s Length Dealings
The Court’s decision established that a benefit can only be classified as “conflicted remuneration” if the benefit is provided between unrelated parties in “arm’s length dealings”. CFSIL was a wholly owned subsidiary of CBA and had no employees. All employees who were involved with the development and issue of Essential Super were employed by CBA or other CBA entities (other than CFSIL).
The Court determined that the conflicted remuneration provisions were never intended to operate within business units in the same group of companies or entities within a consolidated group of companies. Even though CFSIL is a separate legal entity, the Court considered that the arrangement between CFSIL and CBA could not be an “arm’s length dealing” as Essential Super was a CBA branded product that was jointly initiated and jointly supported by two business units within the CBA group of entities.
This limitation to the application of the conflicted remuneration provisions was reflected in the Court’s assessment of the alleged benefit. The Court found that the journal entries and cash payments were a standard accounting practice within corporate groups, and did not create a transfer of value as the transactions cancelled out when the books were balanced.
The Court’s determination that the conflicted remuneration provisions do not and can not apply to a single corporate group essentially creates an exemption from the conflicted remuneration provisions for wholly owned subsidiaries. There is the potential for large industry participants (i.e. product providers) to acquire smaller businesses (i.e. advisory firms) to rely on this exemption, which may lead to industry consolidation. It is likely that ASIC will ask the Full Court to reject this interpretation or strictly limit the circumstances in which the conflicted remuneration provisions do not apply to corporate groups.
Choice of Financial Product
The Court determined that in order for a licensee’s choice of product recommendation or product advice to be influenced by a benefit it had received, there must be more than one financial product to provide or recommend.
Anderson J referred to the definition of conflicted remuneration, which requires that the nature of the benefit or circumstances in which its given to reasonably be expected to impact the “choice” of financial product recommended or advice provided to retail clients. The Court found that the inclusion of the term “choice” in this definition required circumstances where one financial product was recommended over another financial product. The Court did not consider that a choice between a financial product or no financial product was a choice between financial products. Essential Super was the only superannuation product distributed by CBA. Therefore, there was no such “choice” for any other financial product and on this basis, the Court found that the conflicted remuneration provisions did not apply.
This interpretation also provides an exclusion from the conflicted remuneration provisions for financial services businesses that only offer one product. There may be uncertainty for advisory firms that only offer a model portfolio solution (i.e. SMA or MDA) to their clients. Even though financial advisers have a duty to act in the best interests of their clients, if the advisory firm only has one product on their approved product list, they could be exempt from the conflicted remuneration provisions. Product distributors may be encouraged to only offer one product in order to avoid the conflicted remuneration provisions. This could reduce the range of financial products and financial advice available to consumers through a centralised entity. This determination effectively limits the application of the conflicted remuneration provisions to financial services providers that recommend or advise on more than one financial product.
Actual Knowledge of Benefit
The Court stated that to determine whether any benefit provided is, or could be expected to, influence the financial product advice or choice of the financial product provided, the parties providing the financial product recommendation or advice must have actual knowledge of the benefit.
The people advising customers to switch their super into Essential Super were CBA’s customer facing staff. CBA and CFSIL submitted that at no point were any of these staff aware of the journal entries and cash payments provided by CFSIL to CBA under the Distribution Agreement. Therefore, the Court reasoned that these staff members could not be influenced by the alleged benefit.
This requirement of actual knowledge of the benefit establishes a new defence to the conflicted remuneration provisions. Frontline staff may be encouraged to recommend a financial product by their managers or superiors without being explicitly told that the licensee is receiving a benefit. In this situation, the licensee may have a defence that their frontline staff did not have actual knowledge of the benefit. ASIC may seek – either through the Courts or legislation – to expand the scope of persons who can be influenced by a benefit to include line managers and supervisors who make decisions about the financial product advice and recommendations provided by frontline staff. ASIC may also seek to reduce the threshold of ‘actual knowledge’ to whether the person knows, reasonably ought to have known or is reckless as to whether a benefit was being provided.
Definition of Benefit
The Court established that any purported “benefit” received by a licensee or adviser, to which the conflicted remuneration provisions refer, must result in a “real commercial advantage”. For the purposes of the conflicted remuneration provisions, a “benefit” must include a transfer of value between legal entities. This transfer of value is more likely to be considered a “real commercial advantage” and therefore a “benefit” if there is a clear and significant financial advantage for the recipient.
The Court found that the journal entries and cash payments made by CFSIL to CBA did not constitute a “real commercial advantage” for three reasons:
- They were a standard accounting practice within a corporate group and cancelled out when the books were balanced, which did not result in a transfer of value;
- The journal entries and cash payments did not reduce the significant costs incurred by CBA when developing and distributing Essential Super, and
- The journal entries and cash payments did not significantly impact CBA’s financial position. The total amount of alleged benefits was $23 million, whereas the net profit after tax of CBA’s Retail Banking Services was in excess of $26 billion over the relevant period.
Notably, the Court clarified that the repayment of costs incurred by one party for services provided in the distribution of a product is not considered a “benefit” for the purposes of the conflicted remuneration provisions.
The Court’s interpretation may limit what is considered a ‘benefit’. Licensees may argue that a remuneration arrangement is not conflicted remuneration if the benefit does not cause the transfer of value to the licensee. It is likely that ASIC will consider that consumers may still be harmed where conflicted remuneration is paid, even if the remuneration does not involve a significant transfer of value to the licensee. It is likely that ASIC will seek to broaden the interpretation of “benefit” so that even poorly constructed conflicted remuneration arrangements are prohibited.
The conflicted remuneration provisions are a significant pillar of financial services regulation. The ban on conflicted remuneration is an important form of consumer protection and a deterrent against incentivising conduct that may cause client detriment. Consumer protection is part of ASIC’s statutory objectives, therefore it is likely that ASIC will seek to ensure that the conflicted remuneration provisions apply broadly in order to protect consumers. The appeal will provide an opportunity to glean how ASIC intends for the conflicted remuneration provisions to operate.
As an AFS licensee, or an authorised representative, it is essential that you ensure you are not paying or receiving any benefit that may be considered conflicted remuneration.
If you would like us to review your distributions agreements, employee remuneration model or third-party arrangements, please get in touch with Simon Carrodus, Erik Setio Glenjon Aligiannis or Annabelle Parmegiani to discuss.