This article was co-authored with Emily Almond and Tess Waldron.
Norton Rose Fulbright has assisted the Australian Securities and Investments Commission (ASIC) in a landmark Federal Court of Australia proceeding. ASIC successfully sought penalties totalling $20.4 million against Forex Capital Trading Pty Limited (Forex CT) and its director Shlomo Yoshai, arising from thousands of contraventions of the Corporations Act 2001 (Cth) (Corporations Act) and the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act).1
Notably, this is the first decision regarding contraventions of conflicted remuneration provisions, sections 963F and 963J, of the Corporations Act. The decision provides a cautionary reminder to Australian Financial Services Licence (AFSL) holders, in particular those dealing with retail clients in the OTC derivative market, to be aware of and to adhere to financial service obligations so as to steer clear from regulatory intervention and what could be potentially significant consequences.
This article details key findings in the ASIC v Forex CT decision and highlights:
- circumstances in which a Court will impose significant penalties for breach of duties by AFSL holders;
- conflicted remuneration requirements that the Financial Services Sector and mortgage brokers should be alert to;
- ASIC’s regulatory response towards high-risk retail OTC derivative providers including recent regulatory changes for AFSL holders to be aware of; and
- action items and risk management strategies for consideration by AFSL holders.
ASIC’s pursuit of Forex CT
Forex CT carried on a financial services business providing advice to retail clients in relation to over-the-counter (OTC) derivative products, including margin foreign exchange instruments and contracts-for-difference (CFDs). Forex CT employed acquisition agents, account managers and retention team leaders (together, Representatives) to provide financial services to clients.
Complaints made by Forex CT clients triggered ASIC to launch an investigation. Following the initial investigation, in July 2020, ASIC commenced proceedings against Forex CT and Mr Yoshai. By consent, the parties submitted to the Court a statement of agreed facts, joint submissions and proposed declarations and orders.
The Federal Court of Australia found that Forex CT engaged in thousands of contraventions of the Corporations Act and the ASIC Act.
It was determined during the relevant period that, Forex CT and/or its Representatives:
- provided advice that was not in the best interests of Forex CT’s clients;
- failed to take reasonable steps to ensure that Representatives complied with obligations;
- engaged in conduct in relation to financial services that was misleading or deceptive or was likely to mislead or deceive;
- engaged in unconscionable conduct including the finding of an unconscionable system of conduct and pattern of behaviour; and
- failed to take reasonable steps to ensure that account managers did not accept conflicted remuneration.
It was found that Mr Yoshai:
- contravened section 180 of the Corporations Act by failing to exercise a reasonable degree of care and diligence in the exercise of his powers and the discharge of his duties as Director and Chief Executive Officer of Forex CT; and
- aided, abetted, counselled or procured Forex CT to contravene section 12CB (unconscionable conduct provision) of the ASIC Act.
In the judgment, Justice Middleton describes Forex CT’s processes and systems as being directed towards maximising client deposits and trading volume, including through the implementation of employee remuneration schemes with the purpose of incentivising Forex CT Representatives to encourage clients to deposit funds and to recommend trades or trading strategies that were not necessarily in the client’s best interests.
Hefty penalties imposed
The penalties associated with Forex CT’s and Mr Yoshai’s conduct are significant. However, due to the cooperation of the defendants and the parties’ joint approach to resolving the proceeding, Justice Middleton considered it appropriate to order a penalty of $20 million in respect of Forex CT’s contraventions and $400,000 in respect of Mr Yoshai’s contraventions. Mr Yoshai was also disqualified from managing corporations for eight years.
Justice Middleton noted various factors that supported the determination of a significant penalty including:
- widespread and regular failures by Forex CT and Representatives to adhere to statutory obligations and the obligations of Forex CT as a financial services licensee;2
- the deliberateness of the conduct to encourage clients to deposit funds and be exposed to increased losses, with a direct benefit to Forex CT. The purpose of Forex CT’s interactions with clients was to encourage clients to increase deposits, to increase the volume of trades and to open multiple trading positions;3
- the systemic nature of the conduct including a culture of non-compliance that continued over a period of more than two years. Forex CT adopted a system or business model by which Representatives were encouraged to acquire and retain active traders and to increase net deposits of funds to trading accounts;4
- the vulnerability of clients including clients who had little or no trading experience and clients experiencing financial stress to the extent that clients relied upon credit or superannuation savings to fund trading;5 and
- significant net losses incurred by clients amounting to approximately $77,619,914 which translated to a corresponding net gain to Forex CT.6
The ASIC v Forex CT decision demonstrates that the Court will not shy away from fixing significant penalties to punish and deter AFSL holders who breach their financial services obligations. This show of force impacts the Financial Services Sector and should prompt service providers to be alert to their AFSL responsibilities, to review relevant policies and monitor employee conduct associated with services. A failure to do so could give rise to substantial consequences.
Conflicted remuneration provisions in the Corporations Act
This decision is the first of its kind regarding contraventions of the conflicted remuneration provisions, in particular sections 963F and 963J, of the Corporations Act. Conflicted remuneration as defined in section 963A of the Corporations Act means:
“any benefit, whether monetary or non-monetary, given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients that, because of the nature of the benefit or the circumstances in which it is given:
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.” 7
How Forex CT contravened sections 963F and 963J
The parties submitted and Justice Middleton agreed that Forex CT gave employees conflicted remuneration and failed to take reasonable steps to ensure employees did not accept conflicted remuneration, thereby contravening sections 963J and 963F of the Corporations Act:
|Conflicted remuneration provisions contravened by Forex CT
963F: Licensee must ensure compliance
A financial services licensee must take reasonable steps to ensure that representatives of the licensee do not accept conflicted remuneration.
963J: Employer must not give employees conflicted remuneration
An employer of a financial services licensee, or a representative of a financial services licensee, must not give the licensee or representative conflicted remuneration for work carried out, or to be carried out, by the licensee or representative as an employee of the employer.
|One contravention during the period 1 January 2017 and 1 April 2019.
||116 separate contraventions during the period 1 January 2017 to 1 April 2019 (an instance for each employee who received conflicted remuneration).
The contraventions arose from the following factual circumstances:
- Forex CT paid monthly bonuses to account managers based on a formula heavily weighted by reference to total net deposits to the trading accounts of clients;8
- payments of bonuses were contingent upon account managers achieving specified “prerequisites” or “gate openers” including a requirement that the account manager achieve an “average daily talk time target”;9 and
- it could be reasonably expected that the benefits paid in accordance with bonus structures influenced the financial product advice provided by account managers including recommendations that the client deposit amounts into their trading account or not withdraw amounts, regardless of whether such recommendations were in the client’s best interests.10
The ASIC v Forex CT case illustrates that multiple conflicted remuneration provisions in the Corporations Act can be contravened concurrently and that, in relation to section 963J in particular, multiple occurrences can give rise to separate contraventions.
Impact on the Financial Services Sector
Aspects of the decision relating to conflicted remuneration will be of interest to the Financial Services Sector including financial institutions, investment service providers and insurance brokers. To mitigate the risk of breaching obligations, service providers and their representatives should review remuneration structures and policies to ensure that adequate systems are in place and complied with, so that conflicted remuneration is not provided or accepted.
The decision will also be of interest to mortgage brokers and mortgage intermediaries, who from 1 January 2021 became subject to requirements in the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act), prohibiting acceptance of conflicted remuneration. The definition of conflicted remuneration provided in section 158N of the NCCP Act largely mirrors the definition in section 963A of the Corporations Act. Mortgage brokers and intermediaries need to be aware of and comply with the new requirements so as to avoid future investigative action from regulators.
ASIC’s regulatory response toward high-risk retail OTC derivative providers
ASIC’s approach to high-risk retail OTC derivative providers is not a new phenomenon. This sector has been the subject of ASIC surveillance for some time with Norton Rose Fulbright advising ASIC in another proceeding in which the Federal Court imposed a $75 million penalty (see Australian Securities and Investments Commission v AGM Markets Pty Ltd (in liquidation) (No 4)11 (ASIC v AGM).
In ASIC v AGM, Justice Beach described OTC derivative products as “little more than gambling”.12 Both Justice Beach in ASIC v AGM and Justice Middleton in ASIC v Forex CT identified the need for general deterrence in the retail OTC derivative market as a relevant factor when determining an appropriate penalty. Justice Beach noted that “the size of the market for retail OTC derivatives in Australia, and the risk of loss to clients exposed to the sort of conduct engaged in…supports the fixing of a significant pecuniary penalty to advance the purpose of general deterrence”.13
Both judgments noted the impact of the regulatory changes that would likely reduce the risk of similar conduct in the future by other retail OTC derivative market participants, or at least significantly ameliorate the scope or effect of such conduct. Following an industry-wide review and consultation process, ASIC recently implemented regulatory changes to strengthen protections for retail clients trading CFDs and binary options:
- ASIC made a product intervention order imposing conditions on the issue and distribution of CFDs to retail clients, effective 29 March 2021; and
- ASIC made a product intervention order banning the issuing of binary options (including certain OTC derivative products) to retail clients, effective 3 May 2021.
The significant penalties imposed in ASIC v AGM and ASIC v Forex CT should serve as a reminder to operators within the Financial Services Sector, dealing with retail clients in the OTC derivative market, to comply with their obligations under the ASIC Act and Corporations Act. These cases along with the recent regulatory changes will strengthen consumer protections for these products.
Taking action and managing the risk
AFSL holders operate under the watchful eye of regulators. Risk management strategies may include:
- understanding legal obligations associated with providing financial services;
- reviewing relevant policies and procedures;
- monitoring conduct and compliance with policies and procedures; and
- keeping up to date with legal changes to AFSL holder obligations.
A proactive approach may assist to prevent the substantial consequences that can arise from breaches of financial services obligations.