Corporate 5 Minute Fix 12: financial product issuers, reporting, Ch 6, AI, shareholder communications

ASIC call to action for financial product issuers

ASIC has called on issuers of investment, insurance, and credit products to ensure compliance with their design and distribution obligations (DDO) to prevent financial harm to consumers. Issuers must ensure their distribution aligns with the target market determination (TMD). Poor product design and distribution may result in ASIC issuing stop orders for non-compliance.

ASIC’s Report 795 highlights “better practices” for compliance, including:

• Selection and supervision of distributors: due diligence on distributors and formalised relationships requiring distributors to ensure that distribution of the TMD is consistent with the terms of the TMD. Distributors should also be regularly trained and test on their understanding of DDO’s with monitoring via audits and questionnaires.
• Staff Training: regular DDO training on their practical application and monitoring incentive risks to avoid inconsistent distribution.
• Marketing Materials: aligning marketing with the TMD, considering the target audience, and avoiding mass marketing for high-risk products.
• Consumer Questionnaires: designing effective questionnaires, especially for high-risk products, with “lock-out periods” and follow-ups for changed consumer circumstances.
• Monitoring Outcomes: ensuring that complaint process captures relevant consumer data, , and monitoring product performance to ensure alignment with the TMD.

ASIC restricts licensee's ability to provide independent expert reports on corporate transactions

In light of ASIC’s action against AP Lloyds Pty Ltd, AFS Licensees should be particularly mindful of the following:

• Compliance with Regulatory Guides: when preparing independent expert reports (IERs), to compliance with ASIC Regulatory Guide 111 (Content of Expert Reports) and Regulatory Guide 112 (Independence of Experts). These guides outline the necessary standards for the content, independence, and methodology of IERs, ensuring they meet regulatory expectations and do not mislead stakeholders.
• Independence and Competence: the exclusion of AP Lloyds from providing expert advice stresses the importance for expert to ensure that they have the adequate competence or if required to engaged appropriate specialist before issuing an opinion, and also ensure that they are independent and can provide objective and independent opinions in relation to corporate transactions such as takeovers, schemes, restructures or related party transactions.

Non-compliance with ASIC’s regulatory expectations could lead to reputational damage, loss of the AFSL, and potential exclusion from providing expert advice, which could negatively impact business operations and stakeholder confidence.

Mitigating risks in shareholder communications during schemes of arrangement

The importance of informing courts of communications with shareholders during schemes of arrangement processes has recently been highlighted in the NSW Supreme Court.

In Vonex Limited [2024] NSWSC 1075, the company proposed that its secretary field calls from shareholders without an established call script. While the Court allowed this proposal, which included a register of all inbound calls (requested by ASIC), it required the company to provide evidence of the content of such calls.

In Ansarada Group Limited [2024] NSWSC 1121 the Court criticised that several shareholder communications had not been disclosed at the initial court hearing. The Court stressed that such communications should be brought to their attention at first hearing, to ensure they did not compromise the integrity of the scheme process.

What to watch: If conducting a scheme of arrangement, ensure scheme proponents disclose the nature of intended and actual communications with shareholders to both ASIC and the Court before the first hearing.

Takeovers Panel clarifies timing of Chapter 6 jurisdiction

The Takeovers Panel recently considered a unique situation whether a promise to issue shares by a non-Chapter 6 entity may be performed without relying on a section 611 exception to the prohibition when, at the time of the issuance, the section 606 prohibition applies. For more, see Ringers Western Limited [2024] ATP 8.

The question was answered in the negative, such that Chapter 6 of the Corporations Act cannot be displaced by a contract that was entered into at the time when the entity was not subject to Chapter 6.

To avoid a potential declaration of unacceptable circumstances, parties in similar situations may seek fresh approval under an item 7 resolution.

ASIC’s position is that fresh approval under item 7, section 611 should be sought if:

• a change in circumstances occurs after approval has been obtained but before the acquisition is completed; and
• the change means the transaction is materially different from the one approved by members.

Lodging requirements for significant global entities

ASIC has issued a reminder for significant global entities (SGEs), being entities that are a global parent entity (GPE) with an annual global income of A$1 billion or more; or are either:

• a member of a group of entities consolidated for accounting purposes as a single group; or
• a member of a notional listed company group where another group member is a GPE with an annual global income of A$1 billion or more.

SGEs are required to lodge their annual financial report either with ASIC under Form 388, or if listed, via the market operator.

This is in addition to the requirement for SGE’s to lodge general purpose financial statements with the ATO.

Reminder for companies under external administration who have sought relief

Companies under external administration and relying on relief under ASIC Corporations (Externally-Administered Bodies) Instrument 2015/251 should ensure they are complying with the Instrument’s requirements.

The Instrument provides conditional relief to companies in external administration by:

• extending the time for a company to prepare and lodge financial reports for a minimum of 6 months and maximum of 24 months (deferral relief); and
• extending the time for a public company to hold an AGM until two months after the deferral relief ends.

For companies under voluntary administration which enter a deed of company arrangement, relief will continue up to 24 months after the voluntary administration commenced, so long as the deed administrator exercises all or most of the management functions of the company.

Unless they obtain further deferral relief before the obligations are due, companies still under external administration after the end of the deferral relief period must comply with any previously deferred financial reporting obligations in addition to any upcoming financial reporting obligations.

ASIC may refuse to grant relief from any continuing obligations where an external administrator has failed to monitor compliance with the Instrument’s requirements.

Requirements for submitting certain documents for lodgement with ASIC

Reminder to company officers that the following documents are to be submitted for lodgement with ASIC in final form:

• related party meeting materials under Chapter 2E of the Corporations Act 2001;
• expert reports, valuations and proxy forms with the notice of meeting and explanatory statement included.

Take notice that there should be no “Draft” or “Confidential” watermarks or headers included in the notice of meeting or explanatory material. Once lodged through the ASIC Regulatory Portal, these documents become public documents.

Placeholder text is not to be used for information that is material information

Material information includes:

• date, place and time of the meeting; or
• dollar amounts relevant to the value of the financial benefit and to other information shareholders require to decide if the financial benefit to the related party is in the best interests of the company. This would apply where trading prices and volume-weighted average price (VWAP) calculations are to be provided.

Report 799: ASIC report on financial reporting and audit work program for 2023 to 2024

ASIC’s recent report on financial reporting and audit surveillance describes findings related to disclosure of material business risks in the operating and financial review, impairment of assets, revenue recognition and other financial report disclosures from 1 July 2023 to 30 June 2024.

The key takeaways to consider for companies and auditors are:

• Operating and Financial Review (OFR) Disclosures: ASIC found failures in disclosing material business risks in OFRs. Companies should:

• • have a well-developed risk management and reporting process in place;
  • avoid a generic OFR; and
  • have disclosures appropriate to the entity’s circumstances and business environment.
• Impairment and Asset Valuations: ASIC identified inadequate asset impairment and misclassification of assets as current or non current. Companies should:
  • ensure correct asset classification (current vs. non-current) and valuations; and
  • make timely impairment adjustments based on relevant standards.

Auditors should properly assess assumptions, inputs, and impairment indicators.

• Revenue and Receivables: issues with revenue recognition, including agent vs. principal classification.
  
  Auditors should:
  • test performance obligations to ensure correct revenue recognition;
  • review work on revenue from overseas auditors and understand different revenue streams and design appropriate audit procedures.
    
    
• Audit and Independence: ASIC has taken enforcement actions against auditors for non-compliance and is starting a surveillance review focusing on auditors' independence and conflicts of interest.

ASIC urges licensees to boost governance amid growing use of AI

ASIC recently carried out its first market review of licensees’ AI use in the banking, credit, insurance and financial advice sectors that impacted consumers. The analysis also extended to generative AI and advanced data analytics (ADA) models.

As part of the review, licensees were asked about their risk management and governance arrangements for AI, and how they planned to use AI in the future.

Key takeaways

ASIC has observed a rapid rise in the use of AI, particularly with the growing adoption of complex and opaque technologies like generative AI. While innovation and competition drive this shift, ASIC warns that many licensees are struggling to keep pace with the evolving landscape while ensuring consumer protection. Despite some efforts to update governance frameworks, there is concern that AI adoption is outpacing the development of appropriate governance practices.

To avoid potential risks such as misinformation, bias, consumer manipulation, and data security failures, ASIC advises financial services and credit licensees to update their governance frameworks as AI use accelerates. If governance gaps widen, the risks grow significantly.

ASIC recommends the following best practices to mitigate these risks:

• implement policies focused on consumer fairness, bias, and AI transparency;
• align AI deployment with existing regulatory obligations;
• ensure human oversight and contingency plans for AI failures;
• conduct thorough due diligence on third-party AI suppliers;
• assess whether staff have the necessary skills to understand and review AI-generated outputs; and
• maintain technological resources to ensure data integrity and security.

Updated guidance for auditors

ASIC has updated its Regulatory Guide 26, which governs the resignation, removal, and replacement of auditors for registrable superannuation entities (RSEs), retail CCIVs, public companies, registered schemes, and AFS licensees. These updates align with reforms expanding financial and auditing obligations under Chapter 2M of the Corporations Act to include more RSEs.

The guide outlines the process for auditor resignation or removal, including ASIC's consent powers, required information, and effective dates. It also clarifies disclosure obligations, circumstances for auditor changes, and reasonable application timelines.

ASIC has issued instructional sheets to assist entities in navigating these processes, providing specific guidance for different entities and arrangements. See relevant information sheets: 62, 64, 65, 136 and for RSEs, retail CCIVs and AFS licensees, see 288, 289, 290.

CFO and company secretary fined and disqualified for financial reporting disclosure breaches

Company officers are reminded of their continuous disclosure obligations following the Federal Court judgment against Campbell Nicolas, the former CFO and Company Secretary of Noumi. Mr. Nicolas was fined $100,000 and disqualified for four years after being found to have been knowingly involved in Noumi’ continuous disclosure contraventions, breached his duties as an officer of Noumi and to have given false or misleading information to Noumi’s directors and auditors.

This case highlights the significant legal and ethical responsibilities that company officers bear in ensuring accurate financial reporting. Officers should ensure compliance with disclosure obligations, especially regarding key financial metrics, to avoid severe penalties.

Greater disclosure requirements coming for beneficial ownership of listed entities

Treasury is currently seeking submissions on the Draft Bill for the Treasury Laws Amendment Bill 2024: Enhanced disclosure of ownership of listed entities.

The proposed amendments to Chapters 6 and 6 C of the Corporations Act 2001 seek to include equity derivatives in the calculation of a person’s holding, regardless of settlement method or whether the counterparty has a relevant interest in the underlying securities (i.e. cash settled derivatives will be included). Any changes in the nature of a person’s interest under equity derivatives—such as a greater than 1% change—must be disclosed, including for physically settled and non-physically settled derivatives.

Persons must disclose substantial holdings in a listed entity when it becomes a Chapter 6C body (i.e., when it first lists). ASIC and entities can issue tracing notices to individuals with relevant interests in securities, including those suspected of having such interests. ASIC will be given unfettered powers to issue freezing orders on disclosable securities in listed entities if individuals fail to comply with substantial holding and tracing notice requirements.

This disclosure requirement extends to foreign entities listed on Australian markets, with ASIC able to exempt them if they comply with equivalent disclosure rules in their home jurisdiction. Additionally, tracing notice registers must be publicly accessible.

Submissions close on 13 December 2024.

Company director sentenced for failing to disclose “relevant interest” in listed company

In light of the Treasury Laws Amendment Bill 2024: Enhanced disclosure of ownership of listed entities being the hot topic, it's a timely reminder for shareholders to fulfill their obligations in providing accurate information in their substantial holding notices.

A Melbourne Magistrate’s Court sentenced a former director of Copper Strike to six months in prison (suspended upon payment of a $2,000 fine) and disqualified him from managing corporations for five years. This conviction stemmed from providing misleading information in relation to his shareholding in Copper Strike.

The director had secretly purchased shares through a brokering account linked to an associate and failed to notify the market, breaching the Corporations Act. Under section 205G of the Corporations Act, directors must disclose their interests within 14 days of their appointment or any changes to those interests. Failure to do so, as demonstrated in this case, can lead to severe penalties.

Directors should look out for the changes proposed in the Bill, the influence of equity derivatives will now be recognised across key areas of the Corporations Act, including director disclosure requirements under section 205G, subsections 300(11) and (12), and the takeover provisions in Chapter 6.

ASIC’s Deputy Chair, Sarah Court, mentioned that these legal obligations are important for protecting investors.