How can a computer comply with the Best Interests Duty (BID)?
The best interests duty
Section 961B of the Corporations Act 2001 (Cth) (“the Act”) requires a provider of financial product advice to act in the best interests of the client in relation to the advice. This duty will be satisfied if the provider proves that it has met the following safe harbour requirements.
The provider must first identify the objectives, financial situation and needs of the client. Next, they must identify the subject matter of the advice. Then they must identify the client’s relevant circumstances. This refers to the objectives, the financial situation and the needs of the client that would reasonably be considered as relevant to the advice sought on the subject matter. If any of the information relating to the client’s relevant circumstances is incomplete or inaccurate, the provider must make reasonable enquiries to obtain complete and accurate information.
Further, the provider is obliged to assess whether they have the expertise required to provide the client the relevant advice. If they do not possess the necessary expertise, they must decline to provide the advice. If it does seem reasonable to recommend a financial product, the provider must conduct a reasonable investigation into the financial products that might achieve the client’s objectives, and assess the information gathered in this investigation. It is crucial that all judgements in advising the client are based on the client’s relevant circumstances.
Lastly, the provider must take any other step that would reasonably be regarded as being in the best interests of the client, in light of the client’s relevant circumstances, which you will recall are those circumstances relevant to the advice sought on the subject matter.
Section 961(6) of the Act makes it clear that personal financial product advice can be offered through a computer program. The above duty and associated requirements are, therefore, relevant to both traditional providers and automated/digital providers.
What are the compliance challenges facing automated advice providers?
ASIC defines digital advice as the provision of automated financial product advice using algorithms and technology, and without the direct involvement of a human adviser. An automated advice provider is bound to face certain challenges in complying with s961B. This is due to the fact that computers have limited capacity and cannot undertake a conversation with clients. Obtaining and synthesising clients’ information via an artificially constructed algorithm necessarily restricts the extent to which the client can receive personalised and tailored advice.
What does ASIC recommend?
ASIC has made numerous proposals as to how a digital advice provider can ensure compliance with the best interests duty and meet the safe harbour requirements.
A. Scoping or Scaling
Scaling means that personal advice is limited in scope. All personal advice is scaled to some degree. Traditional financial product advice usually involves the adviser limiting the scope of their advice via a conversation with the client. In the context of digital advice, however, conversations will not always take place because no natural person is providing the advice. ASIC has, therefore, outlined specific minimum expectations for digital providers offering scaled advice.
A digital advice provider should explain to the client from the outset what advice is being offered, and what is not being offered. They should require the client to actively demonstrate that they understand the scope of the advice being offered and at various stages inform the client about the limitations and potential consequences of this scope. It is equally important to filter out clients if the advice being offered is not suitable or does not meet their needs. It is integral that potential clients understand that this mode of advice is not, and cannot be, holistic. Early disclosure of the scope of the digital advice can prevent complaints and/or disputes at a later date. Further, information regarding costs, dispute resolution processes and the available processes for withdrawing from advice should be provided. Overall, ASIC suggests that a digital advice provider should think very carefully about the way they communicate with clients and ensure that the communications are user-focused, clear and timely.
In addition to scaling, a digital advice provider must implement a triage process to filter out clients for whom the digital advice is not suitable. This involves testing whether the advice being offered is appropriate and in the best interests of the client. As mentioned above, if a client seeks advice on an area outside the scope of the advice being offered, the client should be filtered out of the digital advice model. Another major component of triage is that if a client provides inconsistent answers in relation to their relevant circumstances, a digital advice provider must respond promptly. A provider must identify the inconsistencies, contact the client, provide them with additional educational information and offer them an opportunity to change their input. Alternatively, the provider must filter the client out of the model.
Reviewing digital advice and testing algorithms
Another key requirement that ASIC addresses is the process of reviewing digital advice. Just as traditional financial product advice must be reviewed, a sample of digital advice provided should be reviewed by a human adviser for compliance with the law. An important aspect of this review process is to monitor and test the algorithms used to provide the digital advice. If problems are detected, immediate steps need to be taken to rectify the issue, and advice should not be provided until the algorithm is functioning properly. Records should be kept of all testing. We offer ‘shadow shopping’ services to our clients where we test digital advice algorithms for flaws or glitches.
ASIC’s RG 255 provide further details on how digital advice providers can best ensure compliance with s961B of the Act.
The compliance challenges faced by digital advice providers extend beyond the best interests duty. Start-ups in the financial services sector often find it difficult to experiment with new ideas and innovations within the current regulatory framework. The process of applying for an AFSL is time-consuming and expensive, and companies that are finding their feet may struggle to satisfy the Responsible Manager requirements.
In response to these issues, ASIC has a regulatory sandbox. This is further explained in RG 257. The exemption constitutes a class-wide licensing waiver for new businesses to run early-stage tests and trials. It includes a twelve-month window for testing of certain financial services conducted without the need for a licence, consumer protections and modified conduct and disclosure obligations that apply to the testing business. The objective of this ‘sandbox’ is to allow innovators to ‘play around’ with their new ideas and to bring better digital financial services to market quicker. To be eligible you must have no more than 100 clients and maximum client exposure of $5,000,000, have adequate compensation arrangements in place and a dispute resolution process. The exemption would assist many of our clients, including our Sydney based FinTech clients. We would be happy to discuss the implications of the regulatory sandbox exemptions at our Melbourne office or at our Sydney office located on Martin Place.
Author: Grant Holley (Partner)