Design and Distribution Obligations - Reasonable Steps

As the civil penalty action by the Australian Securities and Investments Commission (ASIC) against an Investment Manager engaged in distribution of a managed investment scheme (Investment Manager) for alleged breaches of the Design and Distribution Obligations (DDO) progresses, the Federal Court asked that ASIC’s pleadings include what ASIC considers constitute “reasonable steps” for a distributor to satisfy itself that the consumers of its product are within its target market as determined by the product’s Target Market Determination (TMD).

In summary, ASIC appears to have defined “reasonable steps” for a distributor to be the preparation and mandatory implementation of a documented DDO policy and procedure which govern how retail product distribution will be conducted and are enforced by supporting materials for relevant staff and regular training, monitoring and reporting.

BACKGROUND

The proceeding against the Investment Manager was ASIC’s first DDO civil penalty action taken against a distributor of financial products.

The Investment Manager distributes term deposits and other investment products, including interests in a registered managed investment scheme (Scheme) and ASIC alleges that under the DDO, the Investment Manager is required to take reasonable steps to ensure that it distributes financial products consistent with the TMD for each product.

ASIC alleges that in marketing and distributing the Scheme to term deposit holders, this cross-selling strategy was likely distribute the Scheme to customers outside its target market, because:

• unlike the term deposits which were guaranteed by the Commonwealth Government in the amount up to $250,000 per account, the Scheme was not a capital guaranteed product. The TMD indicated that customers seeking a capital guarantee were not in the target market; and
• the investment timeframes for term deposits ranged from 30 days to two years whereas the recommended investment timeframe for the Scheme was a minimum of three years up to five years. The TMD indicated that customers seeking an investment timeframe of two years or less were not in the target market.

THE PROCEEDINGS

It’s worth remembering, ASIC’s action is against the Investment Manager as a distributor of a financial product and not the Responsible Entity or Issuer of the relevant product.

In relation to this particular financial product and method of cross-selling distribution, it appears from ASIC’s amended pleadings they consider, for an Investment Manager charged with distribution to retail clients, “reasonable steps” include that they must:

1. prepare and implement appropriate mandatory compliance policies, procedures and processes on DDO as they apply to the distribution of the product and the content and effect of the TMD (DDO Policy) and have in place a process to consistently review and monitor the DDO Policy and its operation;
2. adequately consider and assess (including through analysing customer data) whether any cross-selling strategy of marketing and distributing a product to holders of other products (including any cross-selling strategy which was in place prior to the introduction of the DDO) is consistent with the DDO, the DDO Policy and the TMD and if not, make appropriate changes to the strategy to ensure that it is consistent with the DDO, the DDO Policy and the TMD;
3. provide adequate initial and periodic training to staff in a Sales, Marketing and/or Customer Care team (Relevant Staff), the Executive Team, Legal team and the Audit and Compliance team, about the DDO, the DDO Policy and the TMD (including training on identifying whether a consumer is outside the target market for the product);
4. provide written, mandatory support materials for Relevant Staff consistent with the DDO, DDO Policy and TMD such as sales scripts and operating guidelines to ensure compliance with the DDO Policy;
5. in communications with consumers of other products about the distributed product, require the Relevant Staff to: (i) ask consumers filtering questions (including knockout questions if relevant); and (ii) inform consumers about whether they are within the target market;
6. have in place a process for regular supervision, audit and compliance testing of Relevant Staff and their communications with consumers about the product to ensure that staff were properly trained and their communications with the consumers were consistent with the DDO, the DDO Policy and the TMD;
7. require any mass marketing about the product (e.g. by sending the Product Disclosure Statement, Application Form and any other supporting material via post or email) to be undertaken only after taking the above steps; and
8. require that any invitation to holders of other products to “rollover” or otherwise convert or transfer their existing product into the distributed product to be given only after taking the above steps.

ACTION

Every distributor of financial products to retail clients should have in place a DDO Policy and Procedure and OIG encourages Investment Managers involved in retail product distribution to review their policies and procedures relating to DDO and TMD ensuring that they meet ASIC’s definition of “reasonable steps”.

Investment Managers who are only involved in the distribution to wholesale clients of retail or wholesale products must have in place documented procedures that ensure they don’t stray into retail product distribution and test their compliance with those procedures regularly.