05 Mar 2013

Upcoming changes affecting liability of AFS licensees and directors for their representatives' actions

by Randal Dennings, Mark Teys

Actions of rogue employees and representatives can in some extreme circumstances lead to directors of Australian Financial Services Licensee companies being found personally liable for their representatives’ conduct. Personal director liability in general terms has been highlighted by the Corporations and Markets Advisory Committee (“CAMAC”) as an area in need of reform. The area of law imposing personal liability on directors could see two changes affecting the financial planning industry in the medium term.

The first change will be seen in the Future of Financial Advice (“FoFA”) reforms. These reforms look to create further obligations on the financial planning industry to better protect customers.

The second round of reforms are the proposed Council of Australian Governments (“COAG”) director liability for corporate fault reforms (“COAG reforms”). These are being developed in an attempt to streamline the numerous State and Commonwealth laws which currently overlap on these issue of director liability for corporate fault.

This article will look at how these two reforms could impact upon the liability of directors and financial services licensees for the actions of their representatives. This will be done through:

  • looking at the current situation facing financial services licensees;
  • then looking at how the FoFA reforms will alter the responsibilities of financial planners and licensees; and
  • finally looking how at the proposed COAG reforms may help directors avoid liability for the actions of their employees.

Current situation facing directors of financial licensee companies

As you are aware, financial services licensees have a number of general obligations which may be breached through a lack of monitoring and supervision of financial planning representatives. These include but are not limited to the following duties under section 912A of the Corporations Act 2001:

  • a duty to do all things necessary to ensure that a financial services covered by the licence are provided fairly, efficiently, honestly and fairly;[1]
  • to have adequate arrangements in place for the management of conflicts of interest;[2]
  • to comply with the financial services laws;[3]
  • a duty to take reasonable steps to ensure their representatives comply with financial services laws;[4] and
  • a duty to ensure that its representatives are adequately trained, and are competent, to provide the financial services covered by the licence.[5]

Banning orders can and have been made by ASIC against directors of financial services licensees where they are found to have, amongst other things, not complied with their obligations under section 912A and ASIC has reason to believe that they would not comply with their obligations under section 912A.[6]

Further to this, a director can be found personally liable under the Corporations Act where they fail to act with due care, skill and diligence when exercising their duties.[7]

There are some protections offered to directors in the imposition of these current duties. For example, in regards to the duty to discharge their duties with the degree of care and diligence, a director may rely on the statutory business judgement rule of section 180(2) of the Corporations Act. Further, there are some protections offered by section 189 of the Corporations Act where the director has the right to rely on information provided by others where the reliance was made:

  • in good faith; and
  • after making an independent assessment of the advice, having regard to the director’s knowledge of the corporation and the complexity and structure and operations of the corporation.

Directors are then in effect charged with the responsibility of ensuring that their companies that hold an Australian Financial Services Licence have robust governance risk and compliance arrangements to ensure that they and their representatives comply with the law. In general terms, should they have actual knowledge or act recklessly concerning non-compliant behaviour by licensees or representatives, then they do so at their peril.

The upcoming FoFA reforms, if accepted in their current form, will place further obligations on directors to ensure their compliance systems and programs are strong if they are to prevent themselves being potentially liable for the conduct of their representatives.

FoFA reforms — The bad news, an increase in risk profile

In response to the collapse of Opes Prime and Storm Financial the Government has begun developing stricter guidelines for financial advisers and the financial planning industry, the FoFA reforms. The draft legislation for this was first seen last year and in March 2012 it passed another milestone. Some amendments were made since the draft legislation was released and it passed through the House of Representatives on 23 March 2012. It is still awaiting Senate approval.

Possibly the most significant change that may be brought about in the FoFA legislation reform will be the proposed imposition of a duty on financial planners to at all times act in the best interests of the client.

The FoFA reforms in their current form make it clear that this obligation will be imposed on the individual financial planner themselves rather than the licence holder. This of itself provides by default some protection for directors of licensee companies.

However, the current Corporations Act supervisory obligations (listed earlier) of a licensee director remain. For example, if a rogue financial planner decides to ignore the law and not act in the best interests of the client, the licensee company will be found liable if it does not take reasonable steps to ensure its representatives remain compliant. Directors will need to exercise care to ensure they will not be found liable for the actions of the licensee company if they, as directors, have not acted with due care and diligence in the discharge of their duties.

Directors will potentially need then to place greater emphasis on ensuring that the licensee company has robust business models and compliance programs in place to protect themselves from being found personally liable for the actions of any rogue representatives not acting in the best interests of their clients.

Whatever the final outcomes of the FoFA reform process, a director’s liability profile in the area could potentially increase. However, relief from this could be just around the corner with the introduction of the Personal Liability for Corporate Fault Reform Bill 2012.

Director liability for corporate fault reform — good news ahead?

On 27 January 2012 COAG released the exposure draft of the “Personal Liability for Corporate Fault Reform Bill 2012” for public comment. This is the first look at how COAG intend to address directors’ liability reform.

Directors’ liability reform is aimed at reforming the way personal liability is imposed for corporate fault of directors across all jurisdictions in Australia. It was highlighted by one commentator that there are “currently over 600-plus pieces of legislation (Commonwealth, State and Territory) in which either a reversal of the onus of proof regime or a strict liability regime had been adopted”[8] in the imposition of corporate fault on directors.

Senator Nick Sherry said in 2009:

"We need corporate laws that create strong incentives for directors to act honestly, carefully and diligently. As part of this, we need a balance in our corporate laws between promoting accountability and ensuring suitable people are willing to serve as directors and take appropriate business risks."[9]

In order to address these issues, a set of principles were devised in order to guide the changes. These principles state that criminal liability should only be imposed when a number of conditions are satisfied. Some of these conditions are:

  • where possible, the corporations themselves should be held liable at first instance;
  • director personal liability should not be imposed by a blanket imposition in legislation;
  • directors' personal liability should only be imposed where there are compelling public policy reasons to do so, the liability of a corporation is not sufficient to promote compliance, and there are steps a reasonable director could have taken to ensure the corporation’s compliance; and
  • a director can be absolved of personal liability where they can show they have taken reasonable steps to ensure compliance.

As can be seen from the last principle, a director will have a defence to the actions of the corporation where they can show that they have taken reasonable steps to prevent the offence occurring.

Conclusion and suggestions

It will be a busy year for the regulation of the financial planning industry. Whatever the final results of the law changes are, the FoFA reforms will undoubtedly place an increased pressure on directors of licensee companies. Directors will need to ensure that their business models and control measures are robust to ensure compliance with the law.

Further protection could be on the horizon if the recommended COAG reforms are enacted. The CAMAC reforms, if accepted, could further entrench the due diligence defence within the Ch 7 provisions of the Corporations Act.

In any event, to assisted with risk minimisation we suggest that directors should consider seeking the following:

  • feedback and assurance from management as to the “health” of breach reporting, incident management and the monitoring and supervision framework for representatives (both employees and authorised representatives concerning the provision of quality advice);
  • trend lines and analysis on quality of advice related complaints and identified issues and incidences — what are the problematic issues, what is the root cause of these issues and are they being robustly addressed?;
  • an update on the steps taken or proposed to be taken to deal with the change to the “best interest duty” and monitoring and supervision aspects of the FoFA reforms and the impact that this may have the risk tolerance statement of the licensee; and
  • a briefing of the transitional arrangements for the FoFA reforms and the relevant opt-in strategy to be adopted by the licensee.

We trust that the directors' engagement in the licensees' response to these two rounds of reforms will strengthen the protection currently in place for them and other officers of the licensee whilst ensuring that the directors continue to ask the correct, pertinent questions to seek to strengthen the licensees' business.

This article was published in Australian Banking and Finance Law Bulletin May 2012


[1] Corporations Act 2001 (Cth), section 912A(1)(a) (go back to article)
[2] Corporations Act 2001 (Cth), section 912A(1)(b) (go back to article)
[3] Corporations Act 2001 (Cth), section 912A(1)(c) (go back to article)
[4] Corporations Act 2001 (Cth), section 912A(1)(ca) (go back to article)
[5] Corporations Act 2001 (Cth), section 912A(1)(f) (go back to article)
[6] Corporations Act 2001 (Cth), section 920A (go back to article)
[7] Corporations Act 2001 (Cth), section 180(1) (go back to article)
[8] Baxt R, “Director liability for corporate fault — innocent until proven guilty: Why is this not the law?” 28 C&SLJ 59. (go back to article)
[9]Sherry N, “Minister Welcomes COAG Decision on Directors’ Liability”, Press Release, http://ministers.treasury.gov.au/ (go back to article)

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.