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THE FOLD ADVISES LIMEPAY ON ITS JOINT VENTURE WITH DOMAIN GROUP.

Limepay is Australia’s first enterprise payments fintech to launch a merchant-branded platform that seamlessly integrates online payments and buy now,
pay later (BNPL) functionality to provide a native and frictionless customer experience. Unlike third-party services like Afterpay, Limepay enables
merchants to regain ownership of their customer relationships and control over fees, with a customer experience that increases conversion rates and
lifetime value.
The Fold advised Limepay on its recent joint venture with Australia’s leading property marketplace, Domain (ASX:DHG).
Limepay is joining with Domain to create the venture “MarketNow Payments Pty Ltd” to offer real estate agents and their vendors the ability to finance
property marketing costs using a pay later option. The Fold advised on all aspects of the regulatory requirements for the design of the BNPL product
offering and acted for Limepay on the joint venture. This venture represents Limepay’s first major initiative in the real estate industry.
The Fold’s Domain JV team was led by Charmian Holmes and credit law
and payments specialist, Jaime Lumsden.
Charmian Holmes said, “Having advised Limepay on their recent pre-IPO capital raising, we are delighted to have been able to also support them on this critical deal in their growth trajectory”.

Tim Dwyer, Limepay co-founder and CEO said, “The Limepay platform was built to create a superior and bespoke white-label payments and BNPL solution for all merchants. This native approach has made it quite straightforward to cross over from a retail application to a real estate application. We find it telling that an industry leader like Domain has chosen to bypass third-party BNPL offerings, and decided to use its payments and BNPL offering as a form of competitive advantage. The work that the team at The Fold did during to help us create this venture was absolutely exceptional and helped us achieve and exceed our goals. The speed with which they’ve moved has been crucial to us as a rapidly scaling and agile startup.”

About Limepay

Limepay (www.limepay.com.au) is Australia’s first enterprise payments fintech to launch a merchant-branded
platform that seamlessly integrates online payments and buy now, pay later (BNPL) functionality to provide a native and frictionless customer experience.
Unlike third-party BNPL services, Limepay enables merchants to retain ownership of their customer relationships and data, coupled with a checkout experience
that increases conversion rates and lifetime customer value.
Limepay’s investors, board, advisory and leadership team include current and former C-suite executives from Zip Co, PayPal, Accor, Deputy, Telstra, CBA,
Google, Equifax, and PwC. It has already built native integrations with Adobe’s Magento and WooCommerce platforms and has millions of dollars transacting
through its pipes.
January 2021

CLAIMS AS A FINANCIAL SERVICE: WHAT YOU NEED TO KNOW.

The Financial Sector Reform (Hayne Royal Commission Response) Bill 2020 was passed by Parliament on 10 December 2020.

In our latest blog with Finity Consulting we outline the key points and what you need to do to be compliant.

If you have any queries about the changes, or need help applying for or varying your AFS Licence, get in touch – we’d be happy to help.

Finity is a leading consulting firm with deep domain expertise in the general insurance sector. With actuarial, claims, risk, operations and strategic advisers, along with a cadre of data analytics specialists, the firm has become a trusted adviser to many insurers in the Australian market. Highly regarded for understanding of each client’s business and providing actionable, management-oriented advice. Finity was awarded the Insurance Industry’s Professional Services Firm of the Year in 2018. www.finity.com.au

Lydia Carstensen; Raj Kanhai (Finity)

December 2020

THE FOLD ADVISES LIMEPAY ON ITS PRE-IPO CAPITAL RAISING.

Limepay is Australia’s first enterprise payments fintech to launch a merchant-branded platform that seamlessly integrates online payments and buy now,
pay later (BNPL) functionality to provide a native and frictionless customer experience. Unlike third-party BNPL services, Limepay enables merchants
to retain ownership of their customer relationships and data, coupled with a checkout experience that increases conversion rates and lifetime customer
value.
The Fold Legal advised Limepay on its recent pre-IPO capital raising, together with Herbert Smith Freehills. Limepay raised approximately $21m in what
is considered to be Australia’s biggest pre-IPO raising for 2020. The raise was for the issue of convertible notes to new and existing investors including
institutional investors. It brings Limepay’s total funding to nearly $30 million within one year of its initial seed funding completed in December
2019.
Funds raised will provide Limepay with the balance sheet liquidity and operational flexibility to execute its immediate and short-term business objectives.
Limepay aims to pursue an IPO in the second half of 2021, subject to prevailing market conditions.
The Fold’s pre-IPO team was led by Katie Johnston and Charmian Holmes and the Herbert Smith Freehills team was led by Peter Dunne and Elizabeth Henderson.

Charmian Holmes said, “We are privileged to support Limepay with this significant raise that will help drive their growth plans. Collaborating with fintechs like Limepay allows us to be at the forefront of innovation in financial services.”
Tim Dwyer, co-founder and CEO of Limepay said, “We believe the support and strong interest received from investors in our pre-IPO raise is testament to Limepay’s differentiated offering, which is unique in the global BNPL market. The raise is understood to be one of the largest fintech pre-IPOs completed in the Australian market. It is also anticipated to potentially grow further as we continue discussions with additional institutional and strategic investors. We were extremely grateful to have The Fold advising us towards achieving such a successful capital raise that will be instrumental in helping us to achieve our next phase of growth and expansion.”
About Limepay
Limepay (www.limepay.com.au) is Australia’s first enterprise payments fintech to launch a merchant-branded
platform that seamlessly integrates online payments and buy now, pay later (BNPL) functionality to provide a native and frictionless customer experience.
Unlike third-party BNPL services, Limepay enables merchants to retain ownership of their customer relationships and data, coupled with a checkout experience
that increases conversion rates and lifetime customer value.
Limepay’s investors, board, advisory and leadership team include current and former C-suite executives from Zip Co, PayPal, Accor, Deputy, Telstra, CBA,
Google, Equifax, and PwC. It has already built native integrations with Adobe’s Magento and WooCommerce platforms and has millions of dollars transacting
through its pipes.
December 2020

PROTECTING VULNERABLE INSUREDS – NOT AS STRAIGHTFORWARD AS IT SEEMS.

From 1 July, subscribers to the General Insurance Code of Practice 2020 (Code) must take extra care of small businesses and individuals
who have purchased a retail insurance product and are ‘vulnerable’.
When and who does the Code apply to?

The Code launched on 1 January 2020 but most of its provisions will take effect in 2021. One exception is the vulnerability provisions, which applied from
1 July 2020.
The Code applies to subscribers and their agents. Those agents may deal with insureds at the time the policy is purchased or at other times, like when
a claim is made.
What is vulnerability?

The Code doesn’t define ‘vulnerability’ but it lists factors that may cause or contribute to vulnerability such as:

Age;
Disability;
Mental or physical health conditions;
Family violence;
Language barriers;
Literacy barriers;
Cultural background;
Aboriginal or Torres Strait Islander status;
Remote location; or
Financial distress.

Some of these factors are static and will exist at the time the insurance policy begins, like remote location or a language barrier. Other factors may
crystallize after the policy inception or may be progressive and transpire at the time of making a claim, like if the insured person’s mental health
is deteriorating.
What do you and your employees need to do under the Code?

There are several things you must do when dealing with an insured person or business including:

Recognise that their needs can change over time and in response to particular situations. This may be difficult to identify, particularly
if there is limited contact between you and the insured person or business after the policy has commenced. You can manage this risk by telling
those who are insured about the vulnerability provisions and your vulnerability policies and procedures, both verbally and in writing.
Encourage them to disclose their vulnerability. This can be difficult because it requires a level of self-awareness which the individual
may not have.
Take reasonable steps to identify actual or potential vulnerability. Insurers and their agents can do this by asking specific questions
during the disclosure process.
Provide additional support at all times. Vulnerable insureds may require additional support at any point in the life of the policy,
even where they have not made a claim.

You must also have internal policies and training in place to make sure your employees are aware of and recognise signs of vulnerability and can provide
support to vulnerable insureds as quickly as possible. These must assist employees to:

Understand if an insured person or business is vulnerable;
Decide how and to what extent you can support someone who is vulnerable;
Take an insured’s particular needs and vulnerability into account;
Engage with the insured with sensitivity, dignity, respect, and compassion. This may include having guidelines in place to allow them to arrange additional
support or referring them to people or services with specialist training and experience, like a lawyer, consumer representative, interpreter or
friend;
Work with the insured to find a suitable, sensitive, and compassionate way to proceed as early as practicable;
Protect the right to privacy of the people you insure;
Escalate a case internally to seek a second opinion on whether an insured is vulnerable;
Reach a decision on whether an insured is vulnerable quickly. This includes having timeframes in place and ensuring there are no delays; and
Have their decision challenged. Your internal dispute resolution system must enable an insured to challenge an employee’s decision.

You must also have a publicly available family violence policy.
This is a challenging area as there are many factors that can indicate vulnerability, like a pattern of delayed payments or indications of mental illness.
Each business and insured person must be handled on a case-by-case basis.
If you’d like help developing or reviewing your policies and procedures to ensure they meet the requirements of Code, please get in touch. We’d be happy to help.
Charmian Holmes, Lydia Carstensen

December 2020

ADVISING ON PLATFORMS ISN’T JUST ABOUT PRICE.

Super and investment platforms aren’t all the same, and your advice shouldn’t be either. All too often financial advisers focus solely on price, which means you may not meet your legal obligations and fail to properly address the needs and objectives of your clients.

In this paper we wrote with Netwealth, we discuss how the best interests duty applies to the selection of a superannuation or investment platform for a retail client. There has long been a tendency for advisers to let the price of a platform determine their recommendation, rather than looking at the needs, objectives and preferences of their clients. This pattern of conduct has no doubt been driven by the relentless focus on the financial advice industry by ASIC, the Banking Royal Commission and Treasury.

The issue with focusing on price alone is that platforms are not just technology solutions, they’re financial products. This means that you’re providing financial product advice each time you advise a client on which platform they should invest through. With financial product advice comes a range of legal obligations (in the Corporations Act and, more recently, the FASEA Code of Ethics) that require you to ensure your advice is appropriate and in the best interests of your client.

When recommending a financial product to a retail client you are required to do a range of things including:

Act with integrity and in the best interests of your client;
Capture the client’s needs, objectives and preferences and base your recommendation on those needs, objectives and preferences;
If there is a conflict, prioritise your client’s interests above your own;
Ensure your recommendation is appropriate for, and adequately addresses, your client’s needs, objectives and preferences;
Form a view as to whether the recommendation is likely to leave the client in a better position;
Satisfy yourself that your client understands the benefits, costs and risks of your recommendation; and
Satisfy yourself that the costs of the recommended product are fair and reasonable, and represent value for money for your client.

These adviser obligations make it almost impossible for you to apply a blanket rule to all clients. Every client is different, and you must tailor your platform recommendation to the specific needs, objectives and preferences of each client.

Price will always be a relevant consideration when it comes to choice of platform, but it will rarely be the only consideration. A wide range of factors can affect what is most appropriate for a client including their age, life stage, attitude towards advice, level of financial and digital literacy and desire for specific platform features.

By following a robust advice process, you can ensure that you meet your legal obligations and place your client in the most suitable platform available. We explain what a robust advice process looks like in this paper, including case studies to illustrate how the law is applied in practice.

If you’d like us to review your advice process or you need further guidance on how to meet the best interests duty, get in touch. We’d be happy to help.

Simon Carrodus, Michele Levine

December 2020

INSURANCE PDS OBLIGATIONS – TICKING THE BOX AND THINKING OUTSIDE IT.

Product Disclosure Statements (PDSs) are subject to a range of regulatory obligations but they can also support commercial objectives (for example, a business
that prides itself on speaking in plain English might want to present easy-to-read documents). Below is a short refresher on content vs convenience.

Living documents
PDSs are not ‘set and forget’ documents. They need to be regularly reviewed and updated based on:

Changes to product, insurer or legislation – e.g. design and distribution and unfair contract laws will impact terms and conditions including the information
contained in your PDS;
Changes to other extraneous material included in the PDS – e.g. changes to the Insurance Contracts Act such as the wording of the duty of disclosure
notice or other changes, including privacy disclosures;
Regulatory guidance and instruments such as ASIC instruments, ASIC Regulatory Guides (e.g. Regulatory Guide 271 which includes enforceable provisions),
good disclosure principles and other guidance contained in Regulatory Guides (like RG168 and RG221) or ASIC Information Sheets being developed
or updated;
Product intervention orders issued by ASIC – these may require product issuers to include additional disclosure;
Industry code updates – e.g. the General Insurance Code of Practice was updated in 2020; and
Customer feedback/complaints – e.g. reviewing relevant customer feedback allows you to identify any ongoing systemic issues that are causing customer
complaints. These may need to be addressed in the PDS.

Tip: Staying abreast of regulatory changes and the regular review of your PDS should form part of your risk management and compliance framework. When DDO laws come into effect in October 2021, there is an expectation that all PDSs will be regularly reviewed and updated – start developing the review process now.
Supplementary documents
It is not necessary for a PDS to be a single document. PDS information can be incorporated by reference, i.e. the PDS can refer to other documents or information, provided the information is in writing, publicly available and easily accessible. For example:

Supplementary PDSs: These can be used to correct misleading or deceptive statements, include missing information or update the information in a PDS;
Terms and Conditions: These can be hosted on a website and updated regularly (however every update must be communicated to the insured); and
Product Excess and Discount Guides (PED Guides): These are used for specific insurance products (e.g. motor vehicle and home and contents) to provide information about the costs of the insurance policy (e.g. premiums and excess payable, discounts available, no claims bonus) and the claims process. PED Guides are not required by law but insurers use them to move prescribed content into another document to simplify and shorten the PDS to promote product understanding.

Tip: Any information that is incorporated by reference is still subject to the same rules as a PDS, so make sure that a supplementary document is clear, concise and effective and is not misleading or deceptive. Sanity-check whether more than one document is really necessary – it can be hard to deliver and difficult to maintain.
Combining the FSG and PDS
In some cases, it is possible to combine the FSG and PDS with the policy wording –
effectively creating a one-stop shop for your disclosure document. This can help to ensure there are no problems when the document is delivered because it is one document rather than 2 or 3.
Whether you are using a digital channel for the sale of the insurance or it is a face-to-face sale, it is convenient to have one single document that covers all the required disclosures. Check whether you qualify for the use of a combined FSG and PDS.
If you are a representative of the insurer (for example an authorised representative of the insurer or agent of the insurer) you can combine your FSG with the insurer’s PDS.
Definitions
In order to meet the ‘clear, concise, and effective disclosure’ obligation, most PDSs include defined terms. There are, however, no specific obligations that apply to defined terms. The question of how to balance the flow of reading and consumer understanding with the need to define certain terms in a manner that will make it clear that they are defined, is a tricky one.
As a general principle, words and phrases in a PDS possess their natural and ordinary meaning unless the word or phrase has acquired a special meaning through a definition. Identify defined terms by differentiating them from other words in the document (for example, bolding, italicising or capitalising defined terms). Definitions can be included in a specific ‘Glossary’ or ‘Defined Terms’ section at the beginning or end of a PDS, or terms can be defined as they come up in the document.
Tip: Make sure all defined terms are used in the PDS to avoid confusion and add a warning at the start of the PDS that some terms have been given a special meaning.
Electronic Delivery
A PDS can be provided electronically, provided it is given to a client in a manner that allows them to view the PDS and save it. Normally this means sending the PDS as a PDF attachment or emailing a hyperlink to view the document. However, technology could also be used to innovate insurance products, such as making PDFs interactive or personalising PDS documents as part of an online digital platform.
Tip: Make sure the PDS can be downloaded and saved, regardless of how it is provided.

With technology solutions it is possible to innovate and simplify. Beyond using plain English to make the PDS more understandable and more accessible, you should seize the opportunity offered by the new design and distribution obligations (commencing on 5 October 2021) to:

Modify the design of your products;
Re-draft the documentation accordingly; and
Consider how you can innovate so that a product is unique in the market.
By being the first to seize new opportunities and improve your products (while still meeting your compliance obligations), you will be able to position your business as an industry leader.
If you issue or distribute a financial product that requires a PDS and you are not certain it is compliant, get in touch – we can review the PDS and provide advice on financial services regulatory requirements.

Julie Hartley, Lydia Carstensen
November 2020

CLIENT MONEY RULES – ‘X’ MARKS THE OBLIGATIONS.

Australian Financial Services (AFS) licensees holding client money are on ASIC’s radar, with a particular focus on intermediaries demonstrating high financial
risk or stress. This follows two recent cases where AFS licensees faced criminal prosecution for breaching client money provisions.

In its 2020-24 Corporate Plan, ASIC has
outlined that one of its market focus areas will be safeguarding client money. This includes proactive surveillance to ensure compliance with client
money handling obligations.

ASIC takes the view that these types of offences are serious misconduct. These offences have been legislated to protect investors and enhance confidence and integrity in Australia’s financial markets.

What is client money?

As an AFS licensee, client money is money paid by a client (or a person acting on behalf of the client) to you in connection with a financial product or
service that you have provided, or will provide, to them.

For example, client money may be:

Application money used to acquire or increase an interest in a managed investment scheme (registered or unregistered) from you where
the units in the scheme are not issued to the investor within 24 hours of receiving the money; or
Insurance premiums paid by your client where you are not the insurer or the agent of the insurer, or if you are, no decision has yet
been made to accept the risk.

Client money doesn’t include money paid by a client:

As remuneration for your services;
For expenses that you’ve incurred. For example, reimbursing costs to acquire a financial product for them;
To discharge a liability that you’ve incurred to acquire a financial product for them; or
To acquire a financial product from you (where you are the product issuer or their agent) provided the product is issued within 24 hours of receipt.

What are your client money obligations?

If you deal with client money, there are a number of requirements that apply. These include:

Where the money must be kept: You must separate client money from your own by keeping it in a different bank account (known as a trust
account and designated as a s981B or s1017E account). The bank account must be with an Australian Authorised Deposit-taking Institution, an approved
foreign bank or a cash management trust;
How it can be used: In certain circumstances, you may be able to invest client money. This is a complex area and we recommend seeking
advice before exploring this requirement; and
When it can be moved: Specific rules apply around when you can move client money from the trust account and for what purpose, for
example paying insurance money due to an insurer in connection with an insurance contract. There are also timeframes for moving non-client money
paid into the trust account.

To safeguard client money, you should ensure that you have a solid policy governing these obligations, including who can make withdrawals from the account
and always require two signatories. This ensures that you meet your regulatory obligations and shields client money from fraud or other unauthorised
activity.

You can find more details on these obligations in our AFS Licensee Manual which contains a whole chapter on this topic. Our Broker Manual also contains guidance specific to general insurance brokers.

Who does this apply to?

The client money obligations may apply to a range of financial services intermediaries and financial product providers. This is irrespective of whether
you deal with retail and/or wholesale clients. Common examples include:

Derivatives;
Non-cash payment facilities;
Managed investment schemes; and
Insurance.

What happens when things go wrong?

You will commit an offence if you:

Fail to pay client money into a trust account on time;
Make unauthorised payments out of a client money account; or
Otherwise, breach the client money rules.

If a breach occurs, you will need to consider whether the breach is significant and requires reporting to ASIC. If you’re unsure, it’s best to seek advice
from a lawyer.

Breaching the rules is an offence of strict liability. This means ASIC doesn’t need to prove that you intended to breach the law.

If you have breached your AFS licence, ASIC has the power to:

Request the Court impose civil penalties;
Impose additional licence conditions;
Publish information on your breaches; and
Require you to undertake a client remediation program.

ASIC may also accept an enforceable undertaking as an alternative to civil or licensing action.

Two recent cases show how serious ASIC is:

Pershing Securities Australia was the first company in Australia to face criminal prosecution for breaching client money provisions. This year it was charged with two
counts of failing to pay client money into an account and one count for failing to comply with requirements relating to a client money account. Pershing
Securities Australia was ordered to pay a $40,000 penalty after pleading guilty to breaching its client money obligations.

ASIC also imposed additional licence conditions requiring Pershing Securities Australia to:

Appoint an independent expert to assess and test its controls, systems and processes to ensure they were compliant with the client money requirements
and report back to ASIC; and
Provide ASIC with attestations from a qualified senior executive and a board member to confirm all remedial actions recommended by the independent expert had been adopted and
implemented.

In the case of Societe Generale Securities Australia,
the company pled guilty to four separate offences. Each offence carries a maximum penalty of $45,000. The matter is awaiting sentencing. ASIC also
imposed the same licence conditions which applied to Pershing Securities Australia.

While these penalties aren’t significant, the additional licence conditions can be financially draining and use valuable human resources. They can also
damage your reputation.

Client money requirements are not always straightforward. If you need advice on whether the client money rules apply to you, please get in touch – we’d be happy to help.

Sónia Cruz, Lydia Carstensen

October 2020

REGULATORY RESPONSE: CHANGES TO INTERNAL DISPUTE RESOLUTION REQUIREMENTS.

ASIC released its new Regulatory Guide (RG 271) on complaints handling and dispute resolution standards and requirements on 30 June 2020. RG 271 replaces
the existing RG 165 and takes effect for complaints received from 5 October 2021 on.

In the latest blog in our Regulatory Response series with Finity we explore the key changes, how to foster a proactive complaints handling culture and adopting the changes
to meet IDR requirements.

If you have any queries about the changes to internal dispute resolution procedures, get in touch – we’d be happy to help.

Finity is a leading consulting firm with deep domain expertise in the general insurance sector. With actuarial, claims, risk, operations and strategic advisers, along with a cadre of data analytics specialists, the firm has become a trusted adviser to many insurers in the Australian market. Highly regarded for understanding of each client’s business and providing actionable, management-oriented advice. Finity was awarded the Insurance Industry’s Professional Services Firm of the Year in 2018. www.finity.com.au

Lydia Carstensen; Raj Kanhai (Finity)

September 2020

CREDIT WHERE CREDIT IS DUE – YOUR DESIGN AND DISTRIBUTION OBLIGATIONS.

The Design and Distribution Obligations (DDO) have received a lot of attention lately, but did you know that they apply to credit products? Different obligations apply depending on whether you’re a product issuer or product distributor.

When do the DDO apply?

The DDO were due to commence on 5 April 2020 but they’ve been deferred to 5 October 2021 due to COVID-19.

What products are covered?

Product issuers and product distributors will be required to design and distribute products that are:

Fit for purpose; and
Deliver good consumer outcomes.

DDO apply to:

Credit products such as credit contracts, consumer leases, credit cards, home loans and funeral expenses policies;
Credit facilities under the ASIC Act. This is broader than credit under the National Credit Act. For example, short-term credit is
exempt under the National Credit Act but captured under the ASIC Act; and
Mortgages, guarantees or consumer leases regardless of whether they’re regulated by the National Consumer Credit Protection Act. For example,
this includes buy-now-pay-later credit contracts.

Who is covered?
DDO apply to:

Product issuers: These are the issuers of the product and could include consumer credit providers and consumer lessors;
Product distributors: These are people who engage in ‘retail product distribution conduct’. This covers anyone who gives a disclosure document or provides
financial product advice to a retail client. This means aggregators, the people who exist between mortgage brokers and lenders, wouldn’t be considered
to be product distributors;
Issuer-Distributors: A credit provider or lessor who distributes directly to consumers must comply with the obligations imposed on both issuers and
distributors; and
Intermediaries: This can include a number of people, like credit assistance providers, who take part in the process of securing credit for a consumer
under a consumer contract or consumer lease. They do this by preparing or passing on information at the request of the consumer or another intermediary.
An intermediary would be treated like a product distributor.

The obligations of a product issuer

Product issuers must make a target market determination (TMD). This involves developing a written statement that includes:

The class (or demographic) of customers that the product or service is appropriate for and targeted at. A product is ‘appropriate’ if it’s reasonable
to conclude that it would generally meet the likely objectives, financial situations and needs of the customers in the target market;
Any conditions or restrictions on dealing in the product that would reasonably suggest that the TMD isn’t appropriate for the target market. This should
include what events or circumstances may suggest this and the information that the issuer needs to determine that a product is no longer appropriate
for the target market. If a product is no longer appropriate for the target audience, the issuer must stop distributing or selling it within 10
business days unless they’ve reviewed or updated the TMD;
The period in which the TMD will be reviewed; and
When the distributor should provide the issuer with complaints information about the product.

The issuers must:

Make the TMD available to the public free of charge before the product is offered;
Take reasonable steps to ensure distribution is consistent with the TMD;
Notify ASIC of significant dealings which are inconsistent with the TMD; and
Keep records of decisions made about complying with these obligations.

The obligations of a product distributor

A product distributor must not distribute a product without a TMD. They must also take ‘reasonable steps’ to ensure the product is distributed in a way
that is consistent with the TMD. This includes considering:

The likelihood of any conduct being inconsistent with the TMD;
The nature and degree of harm that might result to consumers from the sale of a product that is inconsistent with the TMD;
How to eliminate or minimise the likelihood of harm when they know or ought to know that the product is inconsistent with the TMD; and
The availability and suitability of ways to eliminate or minimise the likelihood of harm.

A product distributor must also:

Keep records that the issuer requires (including complaints information);
Provide these records to the issuer within a certain timeframe; and
Notify the issuer of any significant dealings in the product that are not consistent with its TMD.

This is a complicated area. If you need help drafting a TMD or reviewing your distribution channels, get in touch. We’d be happy to help.

Jaime Lumsden and Michael Sim

September 2020

PLAYING CHICKEN: THE MYTH OF CONFLICTED REMUNERATION LOOPHOLES.

Conflicted remuneration is currently under the microscope and ASIC is taking action against those who try to use loopholes to avoid the prohibition. In
this blog, we look at a current case study and explain why this is a risky strategy.

The facts of the case

ASIC is suing the Commonwealth Bank of Australia (CBA) and its related party Colonial First State Investments Limited (CFSIL) over an alleged breach of
the conflicted remuneration prohibition. This case was included as a case study in the Final Report on the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Report).

CBA and CFSIL had a Distribution and Administration Services Agreement (the Agreement) in place. Under the Agreement, CBA distributed a superannuation
product called Essential Super in its branch and digital channels in return for CFSIL paying CBA a fee equal to 30% of the total net revenue the trustee
earned from the fund.

ASIC has claimed that Essential Super was the only superannuation fund that CBA staff were trained to sell. It was also the default fund for employees
who didn’t choose a superannuation fund.

Could the fee influence CBAs staff?

CBA and CFSIL have asserted that the fee paid under the Agreement could not reasonably be expected to influence the choice of product recommended by branch
staff or the advice given.

Looking at the fee structure and distribution model in this case, it’s a high-risk play. Let’s look at the law to see why.

Section 963L of the Corporations Act says that volume-based benefits are presumed to be conflicted remuneration. A volume-based benefit is one where access
to or the value of the benefit depends on the number or value of financial products recommended or acquired by clients. The fee paid by CFSIL to CBA
is clearly a volume-based benefit, so it’s presumed to be conflicted remuneration.

Under Section 963A a benefit is conflicted remuneration if it:
a.could reasonably be expected to influence the choice of financial product recommended by the licensee or representative to retail clients; or
b.could reasonably be expected to influence the financial product advice given to retail clients by the licensee or representative .
In order to rebut the presumption that the fee was conflicted remuneration, CBA and CFSIL must demonstrate that the fee could not reasonably be expected
to influence the advice provided by bank staff. The burden of proof sits with CBA and CFSIL, and it is a difficult burden to overcome.

CBA’s position is that branch staff were not directly rewarded for selling Essential Super. Their incentives were based on a balanced scorecard.

Hayne wasn’t having a bar of this argument in his Report. He said that because the fee was based on a percentage of revenue earned, the greater the sales
of Essential Super, the more revenue CBA would receive. In his view, the fee could reasonably be expected to influence which product branch
staff were trained on and expected to recommend.

CBA and CFSIL have admitted that general advice was provided to clients and the fee was volume-based, which doesn’t leave them much wriggle room.

In Regulatory Guide (RG) 246, ASIC says that some benefits
do not influence advice and are not conflicted remuneration. These include:

An adviser’s base salary; and
A licensee paying for an adviser’s business equipment such as telephones, desks and chairs.

Neither of these apply in this case.

What about the Opex exemption?

Probably the best place for CFSIL and CBA to try to mount a defence is through the Opex ‘exemption’. The Opex exemption isn’t really an exemption at all.
It’s more like a loophole. It stems from a few paragraphs in RG 246 where ASIC says they’re less likely to scrutinise a benefit as conflicted remuneration
if:

It isn’t passed on to the individual representatives who provide advice to clients. Instead, the licensee uses the benefit to pay for its operating
expenses; and
There are controls in place to ensure that the benefit doesn’t influence the advice given by representatives of the licensee.

It’s debatable whether the Opex exemption applies in this case. ASIC provides an example in RG 246, with commentary, and it makes for interesting reading.
ASIC says that it’s less likely to scrutinise a benefit if the AFS licensee can show that:

No portion of the benefit is passed onto an individual that provides advice to a client;
The platforms and products advisers recommend to clients aren’t selected based on the potential benefit that the licensee receives from a platform
operator or product issuer;
It does not promote any specific platform or product to its individual advisers or clients; and
It makes available a diverse range of platforms and has an extensive list of products its advisers can potentially recommend to clients.

While CBA and CFSIL may be able to demonstrate that they satisfied the first point, what about the last three points?

So what could CBA and CFSIL have done?

There are a few things that CBA and CFSIL could have done to ensure that the arrangement did not breach the conflicted remuneration prohibition. In particular,
they could have:

Demonstrated that they had implemented and maintained robust policies for platform and product selection;
Provided education that was equally available for all platforms and products its advisers can recommend to clients; and
Had a range of platforms and an extensive product list that advisers could choose from when making recommendations to clients.

Whether or not CBA and CFSIL did these things adequately will be determined by the Court.
However, this whole case could have been avoided had the fee arrangement been structured properly in the first place. CBA and CFSIL claim that the fee
paid to CBA was to reimburse CBA for its share of the costs of Essential Super. So why not structure it that way?
It seems odd, and a little disingenuous, to use a revenue sharing model as a mechanism to reimburse CBA’s costs. Indeed, this revenue sharing model had
the potential to, and probably did, far exceed CBA’s actual costs.
The fee should have been structured as an end-of-quarter or end-of-year reconciliation. This structure would have provided CBA with a fixed dollar payment
at the end of each quarter/year based on the actual costs incurred by CBA with respect to Essential Super.
True labelling beats smoke and mirrors every time. For years we’ve advised our clients not to rely on loopholes like the Opex
exemption. As we are learning, all loopholes eventually get shut down.
Conflicted remuneration is a complex area and one that ASIC is actively monitoring. If you need advice on how to structure your remuneration arrangements,
please get in touch – we’d be happy to help.

Simon Carrodus

September 2020

ISSUING MCI SECURITIES: PRACTICAL LEARNINGS 12 MONTHS ON.

Last year innovative and landmark reforms were introduced that gave companies limited by guarantee the ability to raise capital by issuing mutual capital instruments (
MCIs) without risking their status as a mutual. You can see our earlier blog on the legislative changes here. Now 12 months on, we share our top 3 tips for any mutual looking to streamline the process.

Tip 1: Make sure your constitution is ready

Before you can offer and issue an MCI, your constitution must specifically empower the board with flexibility to issue MCIs and facilitate their issue
in multiple classes.

Key touch points to cover in your constitution include:

Giving the board power to issue and allot MCIs;

Allowing the board the flexibility to determine and approve the class rights of MCIs. At the same time, you should ensure that the proposed MCIs meet
the requirements of the Corporations Act, such as to be issued as fully paid;

Allowing the mutual to accept subscriptions for money for MCIs;

Facilitating payment of dividends to MCIs;

Addressing membership of the MCI holder in the mutual;

Governance points like board composition rights; and

Setting out the terms of issue of the MCIs (Class Rights), including voting and redemption rights and the transfer of MCIs.

If your mutual has already been formed, you will need to change your constitution to include these points.

If you’re forming or planning a new mutual, you should prepare your constitution so that it facilitates the issue of MCIs from day 1. Even if you’re not
planning to issue MCIs, we recommend your constitution is ready to maximise your options and reduce future delays and expense.

Tip 2 – Bed down class rights

It’s important to recognise at the outset that MCI holders are unlikely to be members of the mutual and your class rights should reflect this.

A mutual provides significant financial benefits for members. It offers them the ability to share risk and is designed to promote the interests of the
members by protecting their assets and people.

MCI holders shouldn’t expect significant returns on their investment. This is because their investment is primarily made to support the wider interests
of the community formed by the members. Their capital provides a sustainable model to offer discretionary protection to members.

The class rights should reflect the context of the mutual. It should also reflect that MCIs offered by mutuals are very different from other forms of capital
used by other types of companies to raise funds.

There are 4 key types of class rights that you should consider.

1.   Voting rights  
Mutuals do not have to give MCI holders the right to vote at members’ meetings or sit on the board. It’s up to the mutual to determine this in light of
the rights of its members and its commercial objectives.

Importantly, if a class of MCI does give its holder the right to vote, the investor will only have one vote for that class of MCI regardless of the number
of MCIs they hold in that class.

2.   Dividend rights
The ability to offer and issue MCIs was introduced to accelerate mutual growth and market share. While mutuals can issue MCIs with dividend rights, MCI
investors shouldn’t expect significant returns on their investment. If they do, then MCIs probably aren’t the right investment for them.

That being said, we recommend that the constitution and class rights support payments of dividends to MCI holders so that you have flexibility moving forward.
These rights need to be compliant with the Corporations Act requirements around dealing with surplus assets and profits and any dividend that
is paid being non-cumulative. The point is to maximise flexibility and options for the mutual.

3.   Redemption
The class rights should also set out whether the MCIs in a particular class should be redeemable and what the terms of redemption would be. Redemption
terms could include:

Time: Can they be redeemed at any time or after a set time?

Who: Who has the ability to redeem the MCIs? Are they redeemable only by the company in its absolute discretion or can the MCI holder
redeem them as well?

Price: What price should be paid to the MCI holder on redemption? Will this be the original subscription amount or something else?

How: What is the process for redemption? Does the mutual need to give the MCI holder a redemption notice?

4.   Transfer
Your constitution should also contemplate whether MCIs can be transferred to others. If you want to restrict the transfer of MCIs, the specifics of this
should be covered off in the class rights. For example, is board approval required? Can you transfer to a related party or within the same corporate
group? Are any dealings, such as encumbrances over the MCIs, restricted?

Tip 3 – Streamline your offer and documentation

To have a streamlined process, you need to sort out your constitution and class rights before you set your offer and documentation.

The offer of MCIs is an offer of securities so there are minimum disclosure requirements that you must follow, just like other forms of capital raising.
But MCIs are also their own beast that have their own individual disclosure requirements.

When disclosing your MCI offer you should clearly articulate:

The investment proposition: Investment in MCIs is not about returns. It’s about providing discretionary insurance protection for its
members. Where they have discretion, the board will give priority to providing protection to members. Any return on investment for MCI holders
will be secondary to the interests of members whose claims are being considered. This should be clearly stated so that investors are not misled
about potential returns.

The risks specific to mutuals: These include significant claims by members which will impact the mutual’s ability to fund future claims
and pay distributions. Other risks may include the loss of members which will mean the amount of contributions that may be pooled to pay claims
and fund the purchase of insurance and reinsurance programs will reduce. Market risks may include the availability and appetite of local and global
insurers and reinsurers to support the mutual with insurance and reinsurance programs. Other risks include the detrimental impact of external extenuating
circumstances such as the current global pandemic and regulatory and compliance risks.

Class Rights: These are the rights attached to the class of MCIs being offered. These include those noted above on voting, restrictions
on transfer and redemption.

This list is not exhaustive and will depend on your mutual and business proposition. We can help support your mutual and MCI offering by identifying the
material aspects and preparing the legal documents to wrap around your commercial requirements. Please get in touch, we would love to help.

Katie Johnston and Nicholas Pavouris

September 2020

REGULATORY RESPONSE: PRODUCT INTERVENTION POWER.

ASIC’s Product Intervention Power (PIP) commenced on 6 April 2019 and was intended to reduce the risk of significant detriment to retail clients from financial
products. In the latest blog in our Regulatory Response series with Finity we explore what the scope of PIP is and how ASIC is likely to use it.
If you have any queries about PIP, or you’ve been affected by a product intervention order – get in touch,
we’d be happy to help.

Finity is a leading consulting firm with deep domain expertise in the general insurance sector. With actuarial, claims, risk, operations and strategic advisers, along with a cadre of data analytics specialists, the firm has become a trusted adviser to many insurers in the Australian market. Highly regarded for understanding of each client’s business and providing actionable, management-oriented advice. Finity was awarded the Insurance Industry’s Professional Services Firm of the Year in 2018. www.finity.com.au

Lydia Carstensen;
Raj Kanhai (Finity)

August 2020

START-UPS: TRICKS AND TRAPS FOR STAGE 1 OFFER AND NEGOTIATIONS

The preliminary offer and negotiation stage is pivotal for any start-up in merger or trade sale talks. There are some tricks and traps at this stage but
you can avoid them if you know what to expect.
TRAP: Don’t place undue reliance on the NDA
Often the first step in a deal is signing a confidentiality or non-disclosure agreement (NDA). If you’re the ‘target’ and the acquirer
is in the same industry, disclosing your commercially sensitive business information could be risky.
Whilst the acquirer may argue you’re adequately protected by the NDA, in reality you probably aren’t. The NDA is usually provided by the acquirer and may
be of dubious quality. It could be vague or even ambiguous about its purpose or important legal protections that should support your enforcement rights.
If the acquirer or its associates use the commercially sensitive information you shared at this stage inappropriately, your options are limited. You can
litigate for breach of the NDA but this will be costly and time consuming without an adequate remedy. If the NDA is vague or ambiguous your chance
of getting an injunction or damages will be greatly reduced.
An NDA is also often left unchecked by the target because lawyers aren’t generally engaged until much later in the process. This can leave you unwittingly
exposed. By seeking legal advice early, you can bolster the provisions in the NDA before you sign.
TIP: Determine upfront if there is a match
Ask the proposed acquirer to provide a solid offer to purchase so you know what the transaction may look like (the Offer). You can assess
if there is a potential future together before sharing any sensitive business information.
TIP: If in doubt, leave it out
At this stage, you should be very clear with the acquirer about what high level financial and business information you’re willing to provide confidentially
so the acquirer can construct an Offer. The type of information provided should be sufficient to enable a ballpark Offer to be made, but not specific
enough to be detrimental to your business if misused. It can be a difficult balance to strike but one you should have laser focus on.
All other confidential information about your operations and business plans should remain confidential until due diligence commences or a secure data room
has been established. This is usually after a Heads of Agreement (HOA) or Term Sheet is signed which is in Stage 4.

TRICK: Know what you want and what you’re prepared to accept
The initial Offer should include four aspects:
1.   Ballpark purchase price and calculation
Things to consider include:

How the purchase price will be calculated. There are many ways to do this, such as customer fees x number of customers or a multiple of earnings.

If the purchase price is based on earnings, will it be a multiple of NPAT or EBIT? If so, what multiple will be applied?

TIP: Now is the time to put forward your preferred price/valuation method. If a premium is to be paid, explain why. For example, if the
business is profitable and pre-IPO with no venture capital investors.

2.    The structure of the transaction
Things to consider include:

Will the acquisition be through share purchase or new share issue?

If purchase, will it be 100% or partial?

If new shares are issued, what percentage of holding will be offered? How will that impact control moving forward?

TIP: For anything other than 100% acquisition, key fundamentals should be considered to make sure you and the acquirer will have an amicable and profitable pairing.
This includes considering:

Expectations around board appointments;

Voting rights;

What happens if shares are issued in the future (like anti-dilution protections); and

Desired exit pathway and willingness (or not) of each party to support these. For example, are you planning an ASX listing, a trade sale or 100% acquisition?

Issuing new shares (rather than transferring existing shares) is attractive because it means you have capital that can be used for future growth plans
(like an IPO down the track or to expand internationally).
TRAP: Issuing new shares will effectively dilute the target’s current shareholding. Current shareholders may not be happy about the dilution
and there may be constituent documents that need to be followed, see my earlier blog on capital raising.
3.   Financing
How will the purchase be funded? This could be based on cash at bank, a debt arrangement or something else. If you are the target, you need to be confident
that the acquirer has the funds.
4.    Timing
What are the anticipated timings for the due diligence, transaction negotiations, execution of HOA or Term Sheet, binding transaction document and completion?

TIP: Formulate your position on each of these aspects as early as possible. This makes sure you’re ready to move forward with the acquirer
quickly or shut down negotiations early if you’re not compatible.
Regardless of where you’re at in your business’ lifecycle, if you need assistance with your M&A transaction, please get in touch.
We’d love to help.

Katie Johnston

August 2020

7 STAGES FOR START-UP TRANSACTIONS.

The transaction pathway for start-ups is often protracted, time consuming and costly. So it’s good to map out the process at the outset and stick to it.
Whether your deal is a merger or trade sale, the approach is often the same and can be broken into 7 key stages.
Stage 1: Offer and negotiations
At this stage, the parties discuss and agree what the transaction will look like at a high level (the Offer). These discussions are not
binding and generally involve:

The target sharing high-level figures on its earnings, number of customers etc. More commercially sensitive business information isn’t usually shared
until Stage 4.

Depending on what information is shared and the parties involved (for example, if the two parties are competitors), a binding confidentiality or non-disclosure
agreement (NDA) should be signed.

Stage 2: In-principle acceptance of Offer
The target determines whether the Offer is worthy of further discussions with the acquirer.

Stage 3: Heads of Agreement or Term Sheet
If the target says ‘yes’ at Stage 2, a Term Sheet or Heads of Agreement (Term Sheet) will be negotiated and signed by the parties. This
documents the key features of the Offer and fleshes out most of the conditions for the transaction.

Term Sheets are generally non-binding. They’re often subject to various conditions like:

Due diligence

Finance

Board approvals

Foreign investment review approvals (if necessary)

However, some provisions in the Term Sheet may be binding such as:

Exclusivity: This is a standard ‘no shop, no talk’ provision. Both parties agree to stay committed to negotiating the transaction
for an agreed period (for example, 3 months).

Confidentiality: Even if you already have an NDA, we recommend that your Term Sheet includes a binding confidentiality provision.
This should be clear and give the target enforcement rights if there is a breach by the acquirer. All negotiations should also remain confidential
until the parties agree to make a public announcement (usually after settlement).

Costs: To test how serious the acquirer is, the target may impose a non-refundable transaction fee if the acquirer terminates discussions
and doesn’t proceed with the transaction. This fee is usually an estimate of the reasonable transaction costs that the target may incur if the
deal is terminated before binding agreement. For more general information on Term Sheets, see my earlier blog.

Stage 4: Due diligence
The acquirer will undertake due diligence on the target. We recommend that the target also undertake their own due diligence on the acquirer or the entity
issuing shares for a scrip deal and its associates. This is particularly important if there is a partial sale (i.e. merger) or where scrip or shares
will be part of the consideration.

Stage 5: Negotiate and draft transaction documents
Transaction documents are usually drafted by the acquirer’s lawyer. If senior management are to stay in their roles and shares are being transferred or
issued, additional documents may be required, including:

Executive employment agreements

Shareholders agreement

Plus other ancillary agreements

To protect and improve their position, the target should engage their own lawyers to review and advise on proposed amendments.

Stage 6: Execution of the transaction documents
The parties execute and exchange. After this, there are numerous documents that need to be prepared to complete the transaction. Completion often occurs
30 days after signing but depends on what conditions need to be satisfied. For example, the acquirer may need to arrange finance or third-party approvals
may be required.

Stage 7: Completion
Completion includes:

Settlement of the transaction;

Execution of any ancillary documents; and

Payment of the purchase price.

What happens after completion will depend on a number of factors including the future plans and ultimate desired exit of the parties and their willingness
to support a particular exit plan. For example, the exit plan may be listing on the ASX or another liquidity event like a trade sale or full acquisition
by the acquirer.
In our next blog in this series we’ll take a deep dive into Stage 1. This will include explaining how a target can mitigate the risk of confidential or
business sensitive information being misappropriated by the acquirer.  
If you need assistance with your M&A transaction or want some tips on how to be ‘match fit’, please get in touch. We’d love to help.

Katie Johnston

July 2020

HISTORY REPEATS – THE RISKS OF INADEQUATE DUE DILIGENCE.

Exposure to historical non-compliance can be fatal for purchasers but many don’t include it in their due diligence. ASIC is on the warpath and you can
be liable even if you weren’t operating the business at the time of the non-compliance. So before you purchase a business that holds an Australian
Financial Services Licence or Australian Credit Licence you need to make sure the compliance records and policies are up to standard.

What is due diligence good for?

Due diligence is crucial to any transaction. As a buyer, it gives you comfort that:

The value of the business is appropriate;
You have the appetite for the risks associated with the business; and
The share sale agreement addresses these risks and exposures in exchange for due consideration.

If you don’t perform due diligence you won’t know what potential exposures you have in the business you’re purchasing.

What are the risks of historical non-compliance?

If you purchase a business with a history of non-compliance, ASIC may hold you accountable for regulatory non-compliance. This is possible even if the
acts or omissions that led to non-compliance took place under the previous owner.

If ASIC finds the business guilty of non-compliance, they can impose a range of remedies including:

Additional licence conditions;
Requiring you to undertake a client remediation program;
Publishing a ‘name and shame’ media release. This may tarnish the business’ reputation and cause clients to panic;
Suspending the licence. During this time the business and its representatives cannot provide financial services or generate income;
Cancelling the licence; or
Imposing civil penalties for corporates and financial service licensees for breaching their licence conditions.

Even if the licence isn’t cancelled, you could face significant financial strain or insolvency. This could be caused by:

Paying the purchase price;
Incurring additional legal and compliance costs to defend and remediate non-compliance;
Representatives deciding to transfer to another licensee with a better compliance record and reputation. Operating with a reduced number of representatives
may severely impact the business’ ability to generate revenue; and
Reputational damage and business disruption that stagnates the business.

There is also no guarantee the non-compliance is purely historical – it might be an ongoing issue that needs to be addressed at significant cost.

You can protect yourself in the share sale contract by including specific indemnities, for example. But if these protections haven’t been drafted appropriately,
the cost of defending the business may be prohibitive and impossible for you to recover from the seller.

Minimise your compliance risk
As a buyer, once you’ve completed your financial due diligence, there are 4 steps you should take to minimise your compliance risk:

Step 1: Undertake compliance due diligence

Ask for details of any ASIC investigations or surveillances in the last 5 years.
Ask for audit reports for each representative over the last 5 years.

Red flag: The business doesn’t regularly audit their representatives.

Request details of any client compensation paid over the last 5 years.
Review the business’ breach register.

Red flag: The business doesn’t have a breach register.

Review the business’ key policies and procedures.
Conduct sample testing to check the quality of the business’ record-keeping practices.

If you find any issues you can require the seller to update their compliance framework and address specific issues (like client compensation) prior to
purchase.

Step 2: Protect yourself contractually

When drafting the contract, include:

Warranties that you can rely on and indemnities you can enforce.

TIP: Draft specific indemnities for any particular issues identified during your compliance due diligence that aren’t deal breakers.

A remediation clause that covers any costs including fines, client compensation and legal expenses. Also include requirements for the seller to produce
records and information and promise to work collaboratively and in good faith to negotiate and achieve the most favourable outcome possible for
you.
Guarantees that can be enforced against the seller on a corporate and individual level. Obviously, these will only be as strong as the financial resources
of the party giving them.

TIP: Ask for guarantees from owner directors.

Structuring the purchase price payment so that part of the purchase price is held in escrow for a set period of time. If compliance issues arise during
that time this amount can be used to address the issue. Once the escrow period has lapsed, the amount can be paid to the seller. The length of
the escrow period is a commercial point of negotiation between the parties. The longest we’ve seen them run for is 2 to 3 years.

TIP: This arrangement works best if the exposure you’re protecting against has a set ceiling. If not, indemnities are optimal contractual protection.

Step 3: Be vigilant when running the business

If your due diligence has identified gaps in compliance, you should address these immediately. Your compliance framework should be sufficient to prevent
recurrence.
Consider engaging an external compliance consultant to help you determine the extent of a compliance issue and how best to fix it.
If clients need to be compensated for historical compliance breaches, you should expedite this program and notify the seller as early as possible.

Step 4: Review the representatives of the business

If you’re retaining representatives, you should review their individual compliance history. You may need to terminate a representative if they have
a poor compliance history or require the seller to do so as a condition precedent.
You may need some employees or representatives to stay on after the purchase to assist with remediation or oversee improvements to the compliance framework.
You will need to identify them and make sure they aren’t planning to terminate their employment or authorisation upon sale as this may impact your
valuation of the business.

We have a lot of experience advising on the sale and purchase of financial services and credit businesses. If you’re considering purchasing a business
and are concerned about compliance risk, please get in touch. We’re here to help.

Simon Carrodus, Katie Johnston and Lydia Carstensen

July 2020

ARE MANAGED ACCOUNTS IN CONFLICT WITH STANDARD 3?

Standard 3 of the FASEA Code of Ethics (Standard 3) purports to eliminate conflicts. But for advisers who use managed accounts, it creates a whole new conflict – a conflict between Standard 3 and established law and regulatory policy.
Standard 3 and managed accounts

Standard 3 is drafted in absolute terms, which is where the trouble starts. It reads: “You must not advise, refer or act in any other manner where you
have a conflict of interest or duty.”

The majority of managed accounts are white-labelled by, or associated with, financial advice licensees. This means they are in-house products, because
advisers who recommend them to clients will generally receive a direct or indirect benefit. This creates a conflict of interest.
Despite the potential conflict, managed accounts do benefit clients in several ways by offering:

An investment account managed on a discretionary basis by a professional investment manager;
Transparency over the assets they hold;
Assets held in their own name; and
A portfolio that can be rebalanced without requiring a Statement of Advice or Record of Advice every time.

Can AFS licensees manage the conflict?
Conflicts can and do arise between the interests of financial services providers and their clients, but the law and regulatory guidance does not require
licensees to avoid all conflicts. Under the Corporations Act, licensees have an obligation to have adequate arrangements in place to manage conflicts of interest.
ASIC Regulatory Guide 181 “Managing Conflicts of Interest” states that adequate conflict management arrangements help to minimise the potential impact
on clients. It clearly indicates that not all conflicts need to be avoided, and it lays out three mechanisms for managing them:

Controlling the conflict;
Disclosing the conflict; and
Avoiding the conflict.

Depending on the circumstances, financial services providers will generally use a combination of all the three mechanisms.

What’s an adviser to do?
It’s possible that FASEA may actually be in broad agreement with ASIC and the Corporations Act without realising it.

In consultation sessions last year, FASEA stressed that Standard 3 only prohibits advisers acting in the face of actual conflicts. This means
that it doesn’t apply to potential or perceived conflicts. The rationale is that by managing a potential conflict so that
it does not influence your advice, you ensure that it does not become an actual conflict.
FASEA’s guidance also puts forward a ‘disinterested person test’ – would a disinterested person reasonably conclude that the potential conflict could induce
the adviser to act other than in the client’s best interests? An arrangement that passes this test should be permitted – irrespective of the form and
features of the arrangement.

The problem is that the Code itself contains no such language or qualification. Hence the confusion remains.

What is a conflict?
A conflict is a divergence of interests between an adviser and their client. If a client pays a fee to an adviser and the adviser provides appropriate
advice that is in the client’s best interests, is there really a conflict? Without attempting to speak for FASEA, I believe the answer in this situation
would be ‘no’.

RG 181 provides two examples of actual conflicts:

Example 1: An adviser will receive a higher commission by recommending a higher risk product. This is inconsistent with the client’s
desire to obtain a lower risk product.
Example 2: An adviser will increase brokerage revenue by maximising trading volume. This is inconsistent with the client’s objective
of minimising investment costs.

While this is not articulated in the Code, it is consistent with FAESA’s guidance and commentary. It stresses the importance of advisers managing any potential
conflicts by ensuring that the advice they provide is in the client’s best interests.

Acting in the client’s best interests
When recommending a managed account, advisers need to look at each client individually in order to determine whether a managed account is appropriate for
that client. This involves considering the relative costs, taxation implications and the client’s preference for certain product features.

If an adviser is thinking about recommending a managed account to a client, they should consider:

How the managed account is likely to satisfy the client’s needs, objectives and preferences; and
Whether the client is likely to be in a better position if they follow the recommendation.

Many advisers have some form of ownership interest in the business that operates the managed accounts they recommend. According to FASEA, sharing in profits
generated by the provision of ancillary products and services (like managed accounts) doesn’t breach Standard 3 provided that the ancillary products
and services are:

Merely incidental to the adviser’s dominant purpose in providing advice; and
In the best interests of clients.

An adviser will breach Standard 3 if the dominant purpose for providing advice is to derive profits from ancillary products and services.

A robust advice process
Based on current law, guidance and the Code, financial advisers can still recommend managed accounts provided they follow a robust advice process.
A robust advice process looks like this:

Identify the client’s needs and objectives. Ask questions to draw out the client’s preferences and priorities. Find out which product features and
benefits (if any) are important to them;
Research investment solutions that are capable of satisfying the client’s needs, objectives and preferences. Learn about the benefits, risks and costs
of each option;
Investigate the client’s existing investment solution and conduct a detailed comparison of that solution compared to the managed account;
Benchmark the fees and costs of the managed account you’re considering against the broader market. This is to ensure that the fees and costs are reasonable
and represent value for money for the client;
Tailor advice to the client’s circumstances. Link each recommendation back to the client’s needs, objectives and preferences;
Explain how the managed account satisfies the client’s needs and objectives and why it’s likely to leave the client in a better position; and
Take steps to ensure the client understands the benefits, costs and risks of your recommendation.

We expect that advisers who recommend related-party managed accounts will attract more regulatory scrutiny in future. But Standard 3 isn’t a death knell
for managed accounts. There will always be a place for advice and investment solutions that are appropriate and in the client’s best interests.

If you need advice on managed accounts and managing conflicts – get in touch.
We’d be happy to help.

Simon Carrodus

July 2020

IN A BIND? – TRAPS IN BINDER AGREEMENTS.

Binder agreements are regularly entered into by insurance agents or brokers who are seeking to offer insurance on behalf of the insurer.
A party that holds a binder will perform certain functions for and on behalf of the insurer including issuing policies and handling administration including
variations, endorsements, cancellations, and claims.
Beyond the operational considerations of rating the risk, pricing premiums, issuing the policies and handling claims, there may be traps for the unwary.
So what are our top five commercial tips for negotiating binder agreements?
1.   Servicing Rights, Client Data and Intellectual Property
Where you are servicing clients under a binder, the binder agreement needs to be clear about who owns the client servicing rights. Specifically:

Who owns the goodwill in the client portfolio;
Who can service the clients during the term of the agreement; and
(Most importantly) what happens with the clients when the binder agreement terminates or expires.

If this is left unclear or ambiguous, the insurer may attempt to keep the clients and seek to invite renewal from the client portfolio even though you
have brought them into the relationship (and the goodwill in the client base should remain with you). Imposing reasonable commercial constraints which
prevent the insurer from directly contacting the clients is important.
You also need to ensure that you have permission to use the client’s personal information and any other data which allows you to provide services to them.
It’s important to make sure that:

You’re able to use personal information in accordance with the privacy laws while acting under binder; and
When the binder terminates, you are able to continue to use personal information you have collected, if you have ownership of the client servicing
rights.

If you are developing or creating intellectual property under the binder agreement (e.g. you have drafted the policy wording), you have developed trade
marks (registered or unregistered), or you have invested in customer transaction portals or risk management initiatives which are unique, the binder
terms should:

Protect your intellectual property rights; and
Be clear on how your intellectual property can be used by the other party (during the term or after).

2.   Profit share
Many binder agreements have a ‘profit share’ component. Ensure that you understand the profit share commission under the binder and that you have access
to all of the information you need to confirm your profit share. This is an area where there are often disputes about what has been agreed and it is
worth having a lawyer review the drafting of the profit share calculation to make sure it accords with your commercial understanding.
The binder agreement needs to:

Detail accurately how the profit share will be calculated;
Include dispute resolution clauses and protections specifically tailored for the profit share arrangement (including the use of an insurance expert
for profit share disputes); and
Oblige the insurer to share information such as loss ratios and other actuarial assessments that go towards the calculation of the profit share.

3.   Scope of the authority
The scope of the authority under the binder must be appropriate for the services that the binder holder will provide.

Ensure you know what your rights are in relation to:

Communicating with clients;
Using the insurer’s branding and trademarks;
Communicating with the regulator and supplying information to the regulator including mandatory data breach reporting;
Individuals who are authorised to make underwriting decisions and settle claims; and
Sub-delegating the binder or appointing sub-agents to carry out tasks under the binder.

Generally it is the insurer’s obligation to make sure a binder holder acts within the scope of their authority so there is incentive for both parties to
make the scope clear, precise, and covers all of the necessary services.

4.   Representations and warranties
When entering into any agreement, you will have to rely on the other party’s representations, which is why these are expressly included in the relevant
contract.

At a minimum, each party should be required to make representations and warranties that:

They have the appropriate Australian financial services licence authorisations to provide the services (this will be particularly important when claims
handling becomes a regulated financial service);
They have the power to carry on their business as contemplated for the performance of the obligations under the binder;
They are not aware of any previous or future investigation or disciplinary activity by any regulatory body; and
Entry into the agreement will not conflict with any law, regulation or other document, instrument or agreement.

5.   Termination
Do some groundwork at the beginning of the relationship to make sure that when things end, there is an orderly end to the relationship which minimises
the impact on clients and your business.

You should consider:

When will the binder terminate? What conditions trigger early termination? Make sure you have the ability to exit the binder quickly if you need to
for defaults involving the insurer. For example, if the insurer breaches the law, or their actions may result in serious reputational damage (though
there may need to be a delay to give the insurer a chance to rectify any breach);
What are the timeframes for giving notice for termination? Realistically, how long would you need to find another underwriter and how much notice must
be given for termination without cause?
Are there changes to the terms which can be made unilaterally by the insurer and might ‘constructively’ terminate the relationship? For example, changes
to approved premium rates and policy terms and conditions made by the insurer. How quickly can you terminate when that happens?
Will the binder terminate upon change of control of a party, or upon the resignation of a Key Employee (underwriter/director) of the binder holder?
If so you may need to build clauses into other agreements (such as employment contracts) to ensure you don’t trigger termination of the binder
inadvertently.

Once the binder has been terminated:

Is your appointment automatically revoked?
Who retains the rights to service the clients?
Who is responsible for ensuring clients continue to be serviced (e.g. variations/cancellations)?
Is there a transition period until the expiry of the insurance policies?

The easiest way to manage these issues is to ensure that a ‘run off period’ is built into the contract, to allow the binder holder to continue acting under
the binder until the policies expire. This avoids the risk that the clients will be left exposed. However any run off period must take into account
things like the insurer or the binder holder losing their authorisations or other events like insolvency that may impact the ability to continue servicing
clients.

If you need support reviewing, drafting or negotiating binder agreements, get in touch – we’d be happy to help.

Lydia Carstensen

July 2020
 

AN AFS LICENSING EXEMPTION FOR PRODUCT ISSUERS – INTERMEDIARY AUTHORISATION.

Providing financial products to retail clients in Australia is almost impossible unless you hold an Australian financial services (AFS) licence. The intermediary
authorisation exemption is virtually the only way product issuers can avoid licensing provided it’s used correctly.

What is an intermediary authorisation?

An intermediary authorisation allows an unlicensed product provider to operate by entering into an arrangement with a local AFS licensee. There are no
restrictions on the type of clients you may service under this exemption – it’s available for both wholesale and retail clients.

For example, this arrangement can be used by:

Insurers who enter the Australian market by granting a binding authority to an agent;
Non-cash payment products as long as customers don’t have direct access to their services.

This is not an authorised representative arrangement, it’s a different type of agreement between an unlicensed product provider and an AFS licensee. A
product provider cannot act as the authorised representative of another licensee. This is because an authorised representative always “acts on behalf
of” its authorising licensee to provide the financial services. If a product provider did genuinely act on behalf of the licensee to provide its own
products, then those products would no longer be its products – they would be the products of the authorising licensee.

The financial service that is provided under the authorisation must be the “issue, variation, or disposal” of a financial product (in accordance with the
terms of that intermediary authorisation). It does not exempt any advice activities but product issuers may be able to access a separate exemption
for general advice.

To be a valid intermediary authorisation, the arrangement must include a written agreement that:

Authorises the AFS licensee to make offers to arrange for the product issuer to issue, vary or dispose of the financial products;
Specifies that the product issuer will actually issue, vary or dispose of the products in accordance with any offers made by the licensee; and
Only involves offers made by the licensee that are covered by the authorisations on that licensee’s AFS licence.

What you can’t do with an intermediary authorisation

Under an intermediary authorisation a product issuer cannot deal directly with customers under any circumstances.

The AFS licensee cannot deal in a financial product unless they’re issuing, varying or disposing for the product issuer. This means you can’t:

Make a market for the financial product;
Operate a registered scheme;
Provide a custodial or depository service; or
Provide a crowd-funding service.

This means the exemption can never be used by:

The trustee of a registered scheme (including peer-to-peer lenders);
The trustee of an unregistered scheme that has the custodial and depository services authorisation. In this arrangement, the only option available
to the trustee is to hold its own AFS licence. But it can be used by the trustee of an unregistered scheme that does not hold any financial products
in custody, like a property scheme which only holds real property, provided the trustee only deals with investors through the licensee; and
Non-cash payment providers that allow direct access to their services.

If you think an intermediary authorisation could be the solution for your situation, or you would like help setting one up, please contact us.
We’d be happy to help.

Jaime Lumsden

June 2020

3 TIPS TO RAISE FUNDS EFFICIENTLY IN A TOUGH MARKET.

To commercialise and grow, your business needs capital. But the ongoing fallout from COVID-19 means this may be easier said than done. For a variety of
reasons debt may also not be affordable or attainable. Waiting it out may not be viable for your cashflow, could be detrimental to your strategy or
put your first to market position at risk. In this blog we share 3 tips to raise funds efficiently in a tough market.

1.   Structure your raising right
There needs to be a balance between raising the amount you need to thrive and giving away too much equity cheaply. Strike a balance by considering:

How much cash you have in the bank;
What you need to do next in your business plan; and
How much runway you need to achieve your next significant business milestone.

Other key things to consider include:

Any capital raising requirements or limitations your business has. For example, you may have pre-existing contractual obligations like pre-emptive
rights or anti-dilution protections.
What legal limitations you may have. For example, if you’ve already exhausted the ‘personal offers’ disclosure exemption under the Corporations Act,
you will not be able to rely on that when making your capital raising offer.
Your target investor. You will need to decide if you want to raise from current shareholders or new investors. Now may be a good time to bring on board
a strategic cornerstone investor but you may also want to keep your current support network confident and content. You could do this by including
a rights issue component, for example.
Whether you can explain your structure. The structure of your raise needs to be simple. Overcomplicated structures are likely to stifle investment
and add to the costs of the raising.
Alternatives to your existing investors. There may be other options you could explore like crowd-sourced equity funding.

2.   Get your documentation ready
With the structure set you need to have your documentation ready before you go to market. This will help you net interested investors without losing momentum
or experiencing unnecessary delays. Your documentation should:

Consider any requisite disclosures that apply;
Consider what disclosure exemptions you’re relying on for the raising. This will dictate the minimum documentation you need; and
Clearly and concisely articulate what your business does, how you intend to use the funds and the risks to investment.

3.   Think about your timing
While COVID-19 restrictions are easing, the economic fallout continues. Given the uncertainty around economic recovery, whether government support will
continue and the possibility of second wave infection, there may never be a ‘good time’ to raise funds in the short to medium term. But if your business
is well prepared before you go to market it will have the best prospects for success.
There is no time like the present to get prepared and ready to launch. We can help you raise capital efficiently in these tough times with pragmatic advice
and a streamlined approach to investor documentation. Get in touch, we’d love to help.

Katie Johnston

June 2020

FAIRNESS, VULNERABILITY AND FINTECHS…

Regulators have a laser focus on ‘fairness’ following the numerous scandals involving overcharging, underservicing and poor customer outcomes that were
laid bare in the Royal Commission into Banking. For fintechs, this means making sure fairness is embedded at every customer touch point. This is no
simple task as fairness is contextual and needs to address any customer vulnerabilities. In the midst of the COVID-19 global pandemic, identifying
and responding to your vulnerable customers fairly is more important than ever!
What is fairness?

What is fair isn’t universal – it depends on the context, your product or service and the consumer’s circumstances.
When it comes to fairness, fintechs fair better than most. Why? Because they want to challenge the status quo, address a consumer gap or need and foster
deeper customer trust.
Some fintechs are using features like greater transparency, improved comparability, better rates, lower fees, increased personalisation and greater customer
control. These features help create fairer products and services but alone will not ensure consumer fairness. Why? Because fairness needs to be embedded
in all touch points in the customer journey. This is no small feat.
Catering to vulnerable consumers is a good place to start

A good litmus test for fairness is how you cater to your most vulnerable consumers. Vulnerability is the next frontier in the consumer space but it’s yet
to be defined by regulators in Australia.
Who is a vulnerable customer?

In the UK, the Financial Conduct Authority (FCA) defines a vulnerable customer as “someone who, due to their personal circumstances, is especially susceptible
to detriment, particularly when a firm is not acting with appropriate levels of care”.
This is a broad definition and doesn’t differentiate between potential vs actual vulnerability and permanent vs transient vulnerability. In our view, this
is because the FCA wants vulnerable characteristics to be considered at all stages of the customer journey.
In the context of the COVID-19 global pandemic, fintechs may find that a significantly larger percentage of their customer base may be vulnerable – whether
due to lost/reduced income, health issues (physical or mental), or additional caring responsibilities, just to name a few.
This is certainly in line with the FCA’s guidance, which has identified 4 key drivers of vulnerability:

Health – health conditions or illnesses that affect the ability to carry out day to day tasks;
Life events – major life events such as bereavement or relationship breakdown;
Resilience – low ability to withstand financial or emotional shocks;
Capability – low knowledge of financial matters or low confidence in managing money.

The FCA has also issued draft guidance on what is required to drive better outcomes for vulnerable customers. Key to this is embedding a lifecycle approach
to vulnerability that:

Understands the needs of vulnerable customers. This includes drivers, impacts and effects of vulnerability;
Ensures staff have the requisite skills and capacity;
Takes practical action like product and service design, customer service and communications; and
Fosters continuous improvement including monitoring and evaluation.

While this provides a strong framework for you to consider vulnerability, what it means in practice will vary depending on your products or services and
your potential and actual customer base. It will also need to consider any specific challenges customers are facing due to the COVID-19 global pandemic.
Australia’s position on vulnerability…

Vulnerability is not specifically regulated in Australia but there are a range of regulatory requirements/interactions that are relevant to vulnerability
or touch upon vulnerability.
Competition

The Australian Competition and Consumer Commission (ACCC) issued a compliance guide for businesses dealing with disadvantaged or vulnerable customers in
2011. The guide doesn’t define who is a vulnerable customer but it does identify a range of characteristics and includes some high level principles
and examples based on actual cases. These characteristics include:

have a low income;
are from a non-English speaking background;
have a disability—intellectual, psychiatric, physical, sensory, neurological or a learning disability;
have a serious or chronic illness;
have poor reading, writing and numerical skills;
are homeless;
are very young;
are old;
come from a remote area; and/or
have an Indigenous background.

While useful, the guidance is framed in the context of unconscionable conduct and misleading and deceptive conduct. It doesn’t take into account the broader
concepts of fairness that underpin financial services and credit activities.
It is also worth noting that the ACCC has listed vulnerable and disadvantaged customers as an enduring priority in their Compliance & Enforcement policy
& Priorities 2020. It will be interesting to see how this plays out in the context of COVID-19 and ASIC’s focus post-Royal Commission.
Design and distribution

ASIC’s new design and distribution obligations go some way towards addressing vulnerable customers of financial products. This is because it requires product designers to identify the target market
for a product and ensure distribution (directly or indirectly) is limited to them. When determining the target market, product designers should identify
any vulnerable customers and how the product caters to them. Implemented as intended, these obligations should ensure that products are fit for purpose
and target the appropriate customers. This should shrink the potential vulnerable population somewhat but is not a cure all. Why? Because the right
customers may acquire the product but nonetheless be vulnerable. It also doesn’t address the servicing of vulnerable customers.
ASIC priorities

In light of COVID-19, ASIC has changed its priorities and will (amongst other things) “heighten its support for consumers who may be vulnerable to scams
and sharp practices, receive poor advice, or need assistance in finding information and support should they fall into hardship”.
ASIC’s focus on consumer vulnerability has now been captured in its Interim Corporate Plan 2020-21, which was released on 11 June 2020. In this report,
ASIC acknowledges the increased risk and impact of consumer vulnerability in the context of the COVID-19 pandemic given:

heightened economic uncertainty and widespread job losses;
increased scam activity and misleading advertising targeting susceptible consumers;
reliance on temporary relief from Government assistance, hardship arrangements and mortgage payment deferral;
the widespread use and proliferation of credit;
the risk of under insurance given the concurrent increase in insurance premiums and reduction in wages; and
early access to superannuation.

While ASIC’s focus on vulnerability is contextual and targeted, it does indicate ASIC has vulnerability considerations front of mind in its supervision
of financial services and credit more broadly. It will be interesting to see what ASIC does in the space post pandemic and if they will build on any
lessons learned.
Complaints

The Australian Financial Complaints Authority (AFCA) has, since inception, been assessing complaints from a fairness and vulnerability perspective, particularly
in the credit space. From what we have seen, AFCA are applying industry codes as best practice, even if the provider is not a member and not required
to be a member. This is an interesting development and, in our view, AFCA is likely to drive much of Australia’s approach to vulnerability.
Best interests

Financial advisers have a duty to act in their clients’ best interests. If a client is vulnerable and a financial adviser doesn’t ask the right questions
or appropriately act on their client’s responses, it will be difficult for them to demonstrate they discharged the best interests duty. Financial advisers
are generally in a sound position to uncover vulnerability – given the nature of their relationship, service scope and contact points. The fact find
and review process present an opportune time for financial advisers to identify relevant vulnerabilities for clients.
Responsible lending

Responsible lending obligations require credit providers to consider any known vulnerabilities identified in the application process. It doesn’t prevent
them from lending to vulnerable customers. Providers should have robust processes in place to identify relevant vulnerabilities. However, these processes
may not identify customer vulnerability. Why? Because it requires full and transparent disclosure about matters consumers may not think relevant or
want to discuss.
Industry codes

We have also seen industry develop its own codes of practice. For example, the draft Buy Now Pay Later Code, General Insurance Code of Practice (aiming
to be operative 1 July 2020) and Banking Code of Practice (commenced 1 March 2020). These codes all list common vulnerability characteristics and build
in a range of protections for vulnerable customers. Most require identification of vulnerable customers, adequate training of staff and customer support
(guidance, referrals or product / service changes). While a great step forward, these protections are high-level commitments. You will need to flesh
out what it means for your product or service and broader customer journey.
This will be an interesting exercise for fintechs as many have frictionless customer onboarding and often have minimal human-to-human touch points in the
customer journey. What this means for fintechs in the context of a global pandemic is also untested and unchartered. Key will be having processes in
place that identify vulnerable customers early on and respond appropriately.
How can you identify vulnerability in the customer journey?

Think about your:

Product features: Are they fair? Can they be customised? What levers can be used for different customers?
Service touch points: Are there key touchpoints where you should ask customers to give you information? Will customer answers, behaviours
or data raise red flags for you?
Data: What data do you collect? What inferences can be made from that data? Can you incorporate AI?
Assessments: Do you conduct any customer pre-vetting, risk or suitability assessment? Do you assess customers on an ongoing basis?
How can you extend these to cover vulnerability?
Training: How will you empower your staff to identify and respond to vulnerability?
Recourse: What measures do you have in place for vulnerable customers?
Review: What processes do you have in place to review your practices and build a culture of continuous improvement?

Vulnerability practices are still at an early stage. It will take time and many iterations before businesses can better cater and respond to customer vulnerability.
COVID-19 provides fintechs with a greenfield opportunity to design and test vulnerability measures in a heightened environment with a potentially significant
vulnerable customer population. If you haven’t thought about it yet, it is important that you consider vulnerability now in terms of your product/service
design, distribution and broader customer journey.
We’re experts in helping fintechs design and distribute their products and can help you navigate vulnerability. Get in touch, we’d be happy to help.
Michele Levine

June 2020