$7.125m penalty for DDO breaches: takeaways for financial product issuers

The Federal Court recently ordered Australian Unity Funds Management Limited (AUFM) to pay a $7.125 million pecuniary penalty for contraventions of its design and distribution obligations (DDOs). It found that it had failed to take reasonable steps as the responsible entity to ensure that interests in one of its funds were distributed only to investors who met the criteria set out in the fund's Target Market Determinations (TMDs). This finding is the latest in ASIC's ongoing enforcement of the DDO regime.

For issuers, this emphasises that simply issuing a questionnaire is not enough to discharge their reasonable steps obligations – instead, issuers need to review and assess the responses being provided as against, the target market for the relevant fund. In particular, issuers should consider:

• If default responses are provided in questionnaires, how does this impact the outcome (and is it appropriate)?

• To the extent that issuers rely upon questionnaires, are all applications (whether they are electronic or hard copy) accompanied by such questionnaires?

• Are responses to questionnaires provided by investors in fact tested and considered as part of the application process?

• Has the issuer's DDO process been implemented, and is it being monitored, by an appropriately skilled person?

As ASIC continues its focus on private markets, we expect it will examine the appropriate distribution of financial products which expose retail clients to private markets. This extends to the internal governance and compliance systems of financial product issuers and their practices to ensure the appropriate distribution of financial products to potentially vulnerable clients.

ASIC v Australian Unity Funds Management Limited

AUFM operated the Australian Unity Select Income Fund, a registered managed investment scheme and a contributory mortgage scheme. Eligible clients could invest in a range of syndicate-funds, each of which provided exposure to a specific registered first mortgage loan procured by Australian Unity’s Wealth & Capital Markets mortgages team.

The Federal Court found, and AUFM admitted, that:

• on 89 occasions, AUFM issued interests in the Fund to retail clients without requiring them to submit, as part of their application, a completed questionnaire with answers to questions to determine whether they were within the target market described in the Fund TMDs; and

• on 239 occasions, AUFM issued interests in the Fund to retail clients without reviewing submitted questionnaires that had been completed by them to determine whether they were within the target market described in the Fund TMDs.

In addition to the $7.125 million pecuniary penalty ordered by the Federal Court, AUFM was also instructed to publish and issue a written adverse publicity notice to impacted investors, and pay ASIC’s cost of the court proceedings.

Further guidance on "reasonable steps" for issuers

The Federal Court's findings provide some further guidance to issuers on the practices they implement to ensure the suitability of investors.

His Honour Justice Moshinsky noted the following practices of AUFM which led to the breaches:

• To acquire an interest in the Fund, prospective investors were required to submit an online or paper application. The online application featured a questionnaire intended to elicit information about whether a prospective investor met the TMD. However, during the relevant period, if the applicant did not answer a question, default responses would automatically populate the online questionnaire with responses that would assume the investor's suitability, meaning an investor would be assumed to meet the target market of the Fund. Further, for a period of time before 30 September 2022, the paper application did not include a questionnaire assessing whether an investor fell within the Fund's target market at all.

• Despite receiving responses to questionnaires about the prospective investors' suitability, AUFM did not review any of the responses between 5 October 2021 and 21 August 2023. AUFM explained this was caused by the lack of training and experience of the Project Manager responsible for the establishment AUFM's DDO compliance.

As a result of its deficient practices, a significant number of investors were exposed to the risk that they might have obtained a financial product that was not appropriate to their objectives, financial situation or needs, and to a risk of financial loss.

Justice Moshinsky stated, "These failings are serious. Moreover, there is no satisfactory explanation for how they came about", and that AUFM's explanation that the person tasked with ensuring compliance with the DDO regime did not have appropriate experience or training "suggests that AUFM did not take its regulatory obligations sufficiently seriously; otherwise, it would have ensured that an appropriately qualified person was tasked with implementing the DDO regime."

Further, Justice Moshinsky considered that ensuring that the questionnaires completed by applicants which formed part of the application was a matter of common sense.