Follow My Leader
Total Page：16
File Type：pdf, Size：1020Kb
The Same Yet Different: Australian and US Online Investing Regulation.
Dimity Kingsford Smith * Professor of Law Faculty of Law University of New south Wales Sydney 2052 Australia Ph: 612 9385 2245 Fx: 612 9385 1175. E-mail: [email protected] http://www.law.unsw.edu.au/staff/KingsfordD/
The Same Yet Different: Australian and
* The author is grateful for comments on a previous draft by Camille Blackburn and Joanna Bird, both of the Australian Securities and Investments Commission, and for the comments of two referees. She is also indebted to Scott Calnan, Roslyn Cook and John O’Brien for research assistance.
1 US Online Investing Regulation.
Synopsis: Australian corporations and securities regulation tends to be an amalgam of UK and US influences, with national features developing in response to local historical, constitutional and market conditions. In the area of online investing, the US has been particularly influential in shaping both the operating conditions of online brokerages and some aspects of regulation. However, transplants often grow differently in foreign soil, and local Australian conditions have had their own shaping effects resulting in national innovations in this area. This paper will provide an overview of similarities and differences between the US and Australian regulation of online investing, and offer some insights about the future, given the cross-border nature of cybersecurities markets.
I. Introduction Australian corporations and securities regulation tends to be an amalgam of UK and US influences, with national features developing in response to local historical, constitutional and market conditions. In the area of online investing, the US has been particularly influential in shaping both the operating conditions of online brokerages and some aspects of regulation. However, transplants often grow differently in foreign soil, and local Australian conditions have had their own shaping effects resulting in national innovations in this area. This paper will provide an overview of similarities and differences between the US and Australian regulation of online investing, and offer some insights about the future, given the cross-border nature of cybersecurities markets.
(a) The Australian Market Context. Australian financial markets might be characterized as small, but developed. Australia has 2% of the world’s capitalization, by contrast with the USA providing 56% of global capitalization.1 The Australian financial markets display similar institutional differentiation and perform functions comparable with the various sectors of the US markets. To what degree this is attributable to similarities in political and cultural inheritances, or to the close economic relationships between the two countries in the post-WWII period is difficult to say, but the parallels are real and plain.
1 http://www.asx.com.au/investor/overseas_markets/how/why_invest_overseas.htm
2 The banking sector is dominated by four large national commercial banks with licenses for the full range of banking business,2 and by overseas investment banks, with US institutions prominent amongst them.3 Australia has a thriving and liquid, though by US standards thin, public companies equities market, centered on the Australian Stock Exchange in Sydney.4 The Australian forward and futures markets are centered on the Sydney Futures Exchange,5 and the active inter-dealer markets in derivatives and foreign exchange – also mostly located in Sydney. Australia has what we call a managed investments (in the US, mutual funds) sector, both listed and unlisted. This like life insurance investment products is mainly directed to retirement income provision, though there have been more speculative periods when there has been more active trading evident in managed funds.6
A peculiarity of the Australian financial markets is the effect of compulsory superannuation contributions, on the amount, and pattern of funds available for investment. All employed Australians are entitled to a compulsory superannuation contribution from their employer, at the rate of 9% of gross income.7 In many employment contexts, the negotiated amount is much greater – the University of NSW for example, contributes at a rate more like 17% of gross income. Unlike the US where compulsory social security contributions are invested and administered by the Federal Government,8 most compulsory superannuation in Australia is invested through the private institutions of the financial sector, and in Australian and overseas
2 Commonwealth Bank, National Australia Bank, Westpac Banking Corporation, ANZ Bank Ltd and National Australia Bank. 3 Macquarie Bank is a successful ‘homegrown’ investment bank, in a sector otherwise predominantly a roll-call of international banking names: eg Bankers Trust (BT Australia), Citibank with Salomon Smith Barney, Credit Suisse First Boston, Banque Nationale de Paris, UBS Investment Bank and Deutsche Bank. 4 www.asx.com.au The ASX also conducts markets in Melbourne and Perth. Australia has several licensed stock exchanges: ASX, Bendigo Stock Exchange, Newcastle Stock Exchange, Asian Pacific Exchange. The ASX is the ninth largest stock exchange in the world: http://www.business.nsw.gov.au/factsReports.asp?cid=31&subCid=67 5 www.sfe.com.au 6 Eg the market in listed property trusts in the late 1980s. 7 Superannuation Guarantee (Administration) Act 1992 (Cth) s 19. 8 Jane L. Ross, Social Security Reform: Implications for Women’s Retirement Income (Appendix II, GAO/HEHS-98-42); KL Moore ‘Redistribution Under a Partially Privatised Social Security System’ (1998) 64(3) Brooklyn Law Review 969.
3 assets. Superannuation contributions provide a stream of investment funds which are important in the diversity and prosperity of Australian financial institutions.9
While compulsory superannuation may be considered a prudential strategy for the ageing of the population, there is a particular Australian idiosyncrasy in this system, which is perhaps not so prudent. Instead of requiring funds to continue to manage contributions, and supply superannuants with an income stream or pension in retirement, it is an Australian political ‘sacred cow’ that everyone is entitled to a lump sum pay out of their superannuation on retirement. Although the government has been trying to change this by using tax expenditures to provide rebates for those who take a substantial portion of superannuation as a pension or annuity, there has been mixed success. At the other end, the current government has just introduced investor choice in where the funds will be invested at the contribution stage.10 These features of the Australian financial landscape require Australians to be active in the financial sector in choosing a fund to which their employer makes contributions, and in investing their accumulated lump sum on retirement. Individual investor activity in the financial markets has also been stimulated by a decade of privatizations of government businesses,11 and the demutualization and listing of a number of major Australian businesses, mainly in the insurance sector.12 This has resulted in about half of all adult Australians owning shares directly,13 and of course all employed Australians do so indirectly, through their superannuation funds.
But how many Australians have access to the Internet, and what about online investing? The Australian Government has made a policy, investment and operational priority, the development of online communication and e-commerce. It has led this in getting much of Federal government online,14 and through an office of government 9 In September 2004 there were 297,819 superannuation entities managing $648.9 billion in assets on behalf of 26.9 million member accounts. This is an increase of $17.5 billion from the June 2004 quarter. www.apra.gov.au/statistics/ 10 Superannuation Legislation Amendment (Choice of Superannuation Funds) Act 2004 (Cth). 11 Telstra, Commonwealth Bank, National Railroads. 12 Notably of Australian Mutual Provident Society which became AMP Ltd, and the National Roads and Motorists Association which became NRMA Ltd. 13 ASX, 2003 Australian Share Ownership Study: www.asx.com.au/about/pdf/2003_Australian_Share_Ownership_Study.pdf 14 Eg if any of you are coming to Australia, you can apply for your entry permit over the Internet -www.immi.giv.au/e_visa.htm or www.eta.immi.gov.au/index.html. Australians can apply to renew passports over the Internet, www.passports.gov.au/Web/renewal/index.aspx.
4 dedicated to this task.15 So although it is not correct to suggest that the Australian Government has adopted a ‘technology-forcing’ stance,16 it has certainly been an active promoter of it. The private sector has been active too, and the result is a very considerable take up of digital economy modes by Australian businesses and individuals. In 2003, 66% of Australian households had access to a computer at home (up from 44% in 1998). In 2003 53% of Australian households had Internet access (up from 16% in 1998).17 Although Australian businesses are thought to have been slow to take up broadband connections18 in 2003 Internet commerce in Australia was up 37% from the previous year to $Aus 33 billion.
(b) Regulatory Structure and Approach. The Australian Constitution like the US Constitution, provides for a federal distribution of powers, including sharing the power to legislate for corporations between the state and Commonwealth governments. However, since 1990 Australia has had a single national corporations and securities regime, and a single market integrity regulator with a financial consumer protection mandate, the Australian Securities and Investments Commission (ASIC). This has been accomplished by a number of strategies,19 some rather more successful than others,20 but since 2001 there has been a single Australia-wide statute governing companies, securities, futures and managed funds. In this ASIC enjoys the institutional support of Commonwealth civil courts and administrative law tribunals21 and authorities,22 as well as cross-vesting provisions to allow state courts to assume civil and criminal jurisdiction and enforce orders under this legislation as well.
15 Australian Government Information Management Office: http://www.agimo.gov.au/. 16 J. Grundfest, ‘The Future of United States Securities Regulation in an Age of Technological Uncertainty’ Stanford Law and Economics (December 2000) Working Paper No 210, http://ssrn.com.abstract=253763 17 Australian Bureau of Statistics 81460 – Household Use of Information Technology, Australia (22/09/04). 18 Australian Bureau of Statistics – Australian SME’s Slow on Fast Internet Take-up, (18/03/05). 41% of businesses were using broadband. 19 P Redmond Companies and Securities Law, (LBC 3rd ed, 2000) 47-68. 20 Re Wakim;Ex parte McNally (1999) 163 ALR 270. 21 The Federal court of Australia and the Commonwealth Administrative Appeals Tribunal. 22 The Commonwealth Director of Public Prosecutions and the Australian Federal Police which both assist the Australian Securities and Investments Commission with investigations and prosecutions.
5 In Australia, in financial regulation, there can be neither ‘race to the bottom’ nor indeed any ‘race to the top’, in the regulation of corporations and securities. This extends to the regulation of other financial products and services as well. ASIC has jurisdiction under other legislation over market integrity and regulation of service providers in relation to superannuation, life insurance linked products, general insurance and banking products.23 In short Australia has a primary regulator for most financial products and services, though we have not gone quite as far as Britain towards a single financial sector regulator. As well as a market integrity regulator, Australia also has a prudential regulator of banks and superannuation funds, the Australian Prudential Regulatory Authority (APRA), which deals with capital adequacy and stability of those institutions.24 ASIC and APRA work closely together under Memoranda of Understanding, especially in areas such as fraud which clearly has both market integrity and prudential implications.
One of the benefits of this more or less universal regulatory scheme is that financial services providers may offer financial services, may give advice and deal and broker a wide range of financial products under a single license from a single regulator.25 Of course that license will be endorsed with the kinds of services or products in which the provider has proved itself to ASIC as capable of holding a license. But the single license regime along with a generic definition of ‘financial product’ (including securities), has a centripetal effect on policy making and enforcement, and tends to avoid ‘turf wars’ between regulators. It also means that when there is a cross-cutting development such as online investing, it is easier to develop consistent policy and enforcement activity across the regulation of a number of financial products, which in the past were institutionally regulated. This provides a legal infrastructural reason, for why online investing has taken off in Australia.
23 Australian Securities and Investments Commission Act 2001, Corporations Act 200, Chapter 7. See also www.asic.gov.au 24 http://www.apra.gov.au/. 25 Sections 911A, 911B, 911C and 912A Corporations Act 2001. See also D. Kingsford Smith, ‘Is Due Diligence Dead? Financial Services Disclosure Under the Financial Services Reform Act 2001’ (2004) 22 Company & Securities Law Journal 128-150.
6 In the early 1980s Grabosky and Braithwaite characterized Australian regulators as being of ‘manners gentle’.26 By this they meant that Australian regulators are slow to use formal enforcement powers, and will usually resort to persuasion and negotiation for a long time before resorting to either administrative or judicial proceedings in the regulatory process. ASIC is no exception and has in some periods gone to considerable ends to portray itself as a ‘facilitator’ of business as much as a regulator.27 At other times, it is true, it has been more energetic in prosecutions and other enforcement activity28 but generally ASIC’s modest resources have forced it to rely heavily on regulating in other ways, with formal enforcement as a last resort. This is despite the fact that ASIC has very considerable powers of investigation and enforcement, indeed it has been described as having greater investigation powers than any other Australian regulator. Further, the Corporations Act under which it exercises most of its powers, is undeniably a ‘command and control’ type statute. Naturally, ASIC makes frequent use of these powers, but generally it has shown a marked preference for civil enforcement (including civil penalty) actions by contrast with criminal prosecution. Exceptions to this have occurred when large corporate failures have impelled appropriations from government to support the additional expense of prosecution.29 By contrast US regulatory agencies have been criticized for ‘going by the book’30 and the US legal system more generally for ‘adversarial legalism’.31 The Securities and Exchange Commission itself has been accused of ‘regulation by prosecution’.32
26 Grabosky, P. and Braithwaite, J. (1986), Of Manners Gentle: Enforcement Strategies of Australian Business Regulatory Agencies (Oxford University Press in association with Australian Institute of Criminology, Melbourne). 27 With the change of Chairman in 1993, the Commission described itself as “adding value to commerce” and “facilitating business, ASC, ANNUAL REPORT 1992/93, at 5. ASIC has a statutory obligation to facilitate business: section 1(2) Australian Securities and Investments Commission Act. 28 D Knott (ASIC Chairman) ‘Corporate Governance - Principles, Promotion and Practice’, Monash Governance Research Unit: Inaugural Lecture, 2002 (on file with author). 29 Eg the recent appropriations made to ASIC to conduct prosecutions recommended by The HIH Royal Commission, The Failure of HIH Insurance, 4 April 2003 Vols I-III (Commonwealth of Australia). 30 30 Bardach, E. and Kagan, R. (1982) Going By the Book: the Problem of Regulatory Unreasonableness, Philadelphia: Temple University Press 31 Kagan, R. (2001), Adversarial Legalism: the American Way of Law (Harvard University Press, Cambridge, Massachusetts). 32 Karmel, R.S. (1982), Regulation by Prosecution: the Securities and Exchange Commission vs. Corporate America (Simon and Schuster, New York).
7 These points explain some of the approaches that have been taken in Australia to the regulation of online investing, as it has emerged. Along with this disinclination to use prosecution as an enforcement means, there has been a move towards ‘soft’ regulation approaches, with high expectations placed on codes, guidelines, policy statements and the like, although within a statutory framework. This has been augmented by investor and financial consumer education programs, attention seeking regulatory action involving sham websites, and the excellent FIDO and ‘gull awards’ pages, on ASIC’s website, which contain a lot of material about how investors can avoid being made fools of on the Internet.33
II. Similarities in Australian and US Online Investing Regulation.
(a) Online Investing Sites and Services. Turning now to the online investing market itself. The Australian online trading industry has developed in a similar manner to that in the US. In the start-up phase in the mid to late 1990s, three of the largest US online firms set up subsidiaries or had alliances with Australian online firms. Many practices developed in the US have been adopted by Australian sites.34 In 2005 there are twelve ASIC licensed and ASX participating brokers in Australia which offer discount online non-advisory execution services.35 The largest by far, is CommSec a subsidiary of the Commonwealth Bank, one of the four big locally grown Australian commercial banks.36 Most Australian online investors start with CommSec and then some move on when they become more familiar with the way to trade.37 Half the participating brokers are either owned or affiliated with banks, including E-Trade Australia Securities Limited the large US
33 At www.asic.com.au especially www.fido.asic.gov.au/fido/fido.nsf 34 ASIC Survey of Online Trading Websites (August 2000) at 23: www.asic.gov.au 35 For a list of these go to http://www.asx.com.au/resources/brokers/internet_based.htm (visited 31/03/05). 36 CommSec website is at www.comsec.com.au ; http://about.commbank.com.au/group_display/0,1922,CH2071%255FTS10238,00.html (visited 31/03/05). 37 Kingsford Smith & Williamson, ‘How Do Online Investors Seek Information, And What Does This Mean for Regulation?” 2004 (2) The Journal of Information Law and Technology at 12. http://www2.warwick.ac.uk/fac/soc/law/elj/jilt/2004_2/kingsford-smithandwilliamson/
8 brokerage.38 Half the ASX participating brokers appear to be small substantially or completely locally owned companies.39
In addition there are online sites operated by firms that are not participating brokers at the ASX, and who engage a participating broker to execute and settle transactions on their behalf. Before the year 2000 market crash there were 29 broker sites overall.40 Clearly the market is not very large by US standards, and the prediction made then that it was not large enough to sustain all 29 operators has been shown to be correct. For example, in 2002 Charles Schwab Australia Pty Ltd was forced to retire from a short attempt to establish itself there.41 CommSec has acquired the business of TD Waterhouse the Canadian broker42 and other local operators have left the market. But nonetheless it was recently estimated that Australia has about 20 online brokers overall and 1.5 million online investors,43 in a population of 18.1 million.44 The similarities with US online broker’s sites are immediately obvious. The trading facilities themselves, libraries of financial information and research reports, charting and analysis tools, and the suite of connected products such as margin lending, portfolio and watch lists, price alerts and connections to chat rooms and bulletin boards. And the intense advertising. A quick visit to a few sites45 and the reader will get the picture!
38 E-Trade Australia Securities Limited has affiliations with the large Australian commercial bank, ANZ Bank Ltd and with the Bankers Trust organization through BT Securities Limited. 39 StateOne Broking; Andrew West Stockbroking; Australian Investment Exchange (aka Sanford Securities); Avcol Stockbroking; Webstock Securities. 40 ASIC Survey of Online Trading Websites (August 2000) at 8: www.asic.gov.au 41 http://www.bandt.com.au/news/c1/0c0030c1.asp; http://www.bizjournals.com/sanfrancisco/stories/2001/12/03/daily50.html (visited 31/03/05) 42 http://about.commbank.com.au/group_display/0,1922,CH2071%255FTS9558,00.html 43 R. Kinsky, Online Investing on the Australian Sharemarket (Wrightbooks, 2005) at 63, 84, 69 and 73. The largest broker, Commsec reports 1.1 million customers. 44 It is very difficult to know what percentage of trades are done online in Australia as the ASX does not disaggregate this information. Anecdotally, it is thought to be about 30% of all trades in an equities market which the ASX reports in 2002-03 had a traded value of $535 billion, Australian Stock Exchange (2003), ASX's 2002/2003 Report to Shareholders www.asx.com.au 45 CommSec at www.commsec.com.au; E*Trade at www.etrade.com.au; Dragondirect at www.directshares.com.au; Sanford Securities Ltd at www.sandford.com.au
9 General information portals which include financial information have proliferated, with hyperlinks to brokers.46 For reasons that I will discuss, there are fewer unlicensed publishers of online financial information in Australia than in the US, and for those there are, the law requires that their operations are (or at least should be) quite limited.47 There are many licensed online publishers of financial information, which are not also brokers.48 These are required to hold an Australian Financial Services License for this activity, because Australia takes a broader view of the kind of commercial speech which can be regulated. The broader licensing requirement usually applies to trading software and data analysis providers.49 Internet discussion sites have also developed and as in the US, these are mostly chat rooms and bulletin boards.50 These are not required to be licensed, but as I will show, are subject to ‘soft’ regulation. Though there are differences in regulatory treatment, in general the topography of online investing sites in Australia is very similar to that in the US.
(b) The Leading Regulatory Concerns with Online Investing Sites. In August 2000 the Australian Securities and Investments Commission followed the example of Securities and Exchange Commissioner Laura Unger51 and the New York
46 Eg: http://au.finance.yahoo.com, the Australian version of a portal familiar to US readers; www.money.bigpond.com, a portal sponsored by Australia’s main telecoms corporation, Telstra Limited; www.sharesdaily.com.au, a portal sponsored by the Fairfax group, one of Australia’s two leading newspaper publishers. Visited 31/03/05. 47 Eg www.Cooltrader.net.au; www.australianinvestor.com.au Visited 31/03/05. 48 Building Wealth Through Shares, published by Colin Nicholson (FSL No?); Guppy Traders, published by Daniel Guppy (FSL No?); The StockWatch Report, published by Warranted Financial Solutions Pty Ltd, Australian Financial Services License Number 253906; The Intelligent Investor and the Floattank both published by Intelligent Investor Pty Ltd, Australian Financial Services License Number 282288; Investorweb published by IWL Limited, AFSL241398, all visited 31/03/05. 49 Eg ABC Trader Software sold by Safety in the Market, http://www.sitm.com.au/; Metastock sold be Paritech, http://www.paritech.co.uk/default-uk.asp; Quicken ShareAnalyser sold by Quicken, http://www.quicken.com.au/. See also ASIC, Superseded Policy Statement 118 Investment advisory services: media, computer software and Internet advice now covered by Australian Securities and Investment Commission, FSRB Policy Proposal Paper No 1, Licensing: The scope of the licensing regime: Financial product advice and dealing, 2001, passim. 50 Eg www.comsec.com.au/PublicAccess/default.asp?Page=Chat; www.equitycafe.com.au; www.hotcopper.com.au; all visited 31/03/05. 51 L Unger, On-Line Brokerage: Keeping Apace of Cyberspace (SEC, 1999), pp 21–30. This was followed up by a report from the staff of the Commission covering similar issues, SEC Office of Compliance Inspections and Examinations, ‘Examination of Broker-Dealers Offering Online Trading: summary of Findings and Recommendations’ 25 January 2001: http://www.sec.gov/news/studies/online.htm
10 Attorney General52 and issued a Survey of Online Trading Websites.53 These three inquiries show a considerable degree of similarity in the issues of regulatory concern involving online investing websites. Where there are differences between the US and Australian experience, it is often one of degree or emphasis. In particular the level of sophistication of ‘securities fraud’ seems greater in US online investing, than in Australia.
(c) Insufficient Disclosure. ASIC saw insufficient disclosure by online sites as probably the single most important deficiency in their conduct. These failures ranged from absence of full legal and business details to inadequate explanation of orders ‘at market’ and ‘at limit’ and what happens when an order is received after the market is closed for trading. There was also lack-lustre disclosure in relation to firms’ privacy policies, the nature and availability of ‘straight through processing’ and the risk significance of trading on the credit usually available on becoming a customer.54 By contrast most sites disclosed fees adequately, and nearly every site prominently displayed disclaimers limiting the service provider’s liability!55 ASIC then went on to propose a ‘Good Disclosure Template’ which it asks all sites to adopt, an approach derived from the US regulatory reports mentioned above and the IOSCO Guidelines.56
The US reports indicate similar concerns. The New York Attorney General says ‘The best…protection is to arm investors with the information to make logical and informed decisions.’57 He then continues to discuss desirable disclosure in very much the same areas, to deal with very similar problems, as ASIC has advocated.58 The Report by Commissioner Unger also advocates better disclosure to investors of issues relating to systems capacity and delays.59
52 Office of the NY Attorney General Eliot Spitzer, From Wall Street to Web Street: A Report on the Problems and Promise of the Online Brokerage Industry, 22 November 1999, p 1. Also Blake A Bell, “Online Brokerages Under Siege for Trading Outages and Delays” (April 1999) 2(11) Wallstreetlawyer.com: Securities in the Electronic Age. 53 ASIC Survey of Online Trading Websites (August 2000): www.asic.gov.au passim. 54 ASIC Survey of Online Trading Websites (August 2000):15-19 www.asic.gov.au 55 Id. 56 Id at Appendix A. 57 Office of the NY Attorney General Eliot Spitzer, From Wall Street to Web Street: A Report on the Problems and Promise of the Online Brokerage Industry, 22 November 1999, p 61. 58 Id at 61-76. 59 L Unger, On-Line Brokerage: Keeping Apace of Cyberspace (SEC, 1999), p62.
11 (d) Operating Capacity Problems. Because of the huge volumes of trades in the US markets, the issue of operating capacity problems seems much more severe in the US.60 In Australia the problem is acknowledged as real, but it is difficult to find solid evidence of its scope. The ASIC survey did not aspire to investigate the nature or extent of the problem, and simply concluded that ‘The current situation in Australia is that clients discover the limitations of a site’s capacity by not being able to log on to the site during busy periods.’61 Not a single site surveyed by ASIC contained information about the capacity of the site to process transactions, or its contingency plans should there be a ‘market storm’. ASIC recommended disclosure to investors about site capacity, contingency arrangements and security features.62
There are no specific standards or recommendations of systems capacity for online trading firms in Australia. To the extent that this question is dealt with by the law at all, adequate technological systems are one element of ‘organisational capacity’ that is required to obtain and hold an Australian Financial Services License.63 There are also statutory warranties of due care and skill and fitness for purpose implied into the offering of financial services in Australia and trade practices legislation which should influence in a more general way what capacity in trading services is provided.64
(e) Misleading and Deceptive Conduct and Market Manipulation. Except to the extent that they recognize that investor education is an important protection against securities fraud, none of the US or Australian regulatory reports dealt with securities fraud or ‘misleading and deceptive conduct’, as it is called in Australia. While this is a similarity between the US and Australia in being a matter of common concern, there has been variation in the scale of the problem and the
60 Office of the NY Attorney General Eliot Spitzer, From Wall Street to Web Street: A Report on the Problems and Promise of the Online Brokerage Industry, 22 November 1999, pp76-109; Unger, On-Line Brokerage: Keeping Apace of Cyberspace (SEC, 1999), 47-54. 61 ASIC Survey of Online Trading Websites (August 2000): 20 www.asic.gov.au 62 Id at Appendix A. 63 ASIC Policy Statement 164 Licensing: Organisational Capacities (2002). 64 For example, s 12ED Australian Securities and Investments Commission Act 1989, which implies warranties of due care and skill and fitness for purpose into the sale of all financial services, will limit the choice of operational capacity technical standards, at least to some degree. See similar provisions in s 74 Trade Practices Act 1974.
12 regulatory approach taken to handle it. Nonetheless, fraud has been a preoccupation of both ASIC and the Securities and Exchange Commission (SEC) as a number of speeches, enforcement actions and investor education programs of both regulators indicate.
The US authors Walker and Levine identify a number of categories of online securities fraud about which action has been taken by the SEC.65 The leading contenders they identify are market manipulation, offering frauds and illegal touting. They point to ‘momentum trading’ and ‘day-trading recommendation’ websites as important locations of Internet fraud and showing a growing degree of sophistication and specialization in fraudulent schemes, as the Internet evolves. The SEC has been very active in criminal and civil enforcement of Internet securities fraud,66 and has succeeded in obtaining quite lengthy jail terms in some cases of particular premeditation and where substantial losses have been caused.67 More recently, these types of frauds have evolved, often using literally millions of spam messages to promote the contravening schemes. The sophistication is evident in the multiple levels of activity that might be involved in a single scheme, the involvement of company insiders, the compensation arrangements for those involved and coordination of several modes of promoting the illegal schemes to investors. The SEC has used a variety of administrative, civil and criminal actions (the latter in coordination with prosecuting authorities), to enforce a wide variety of provisions against offenders.68
By contrast in Australia there has been only one complete criminal prosecution for misleading and deceptive conduct in a ‘pump and dump’ market manipulation – and
65 R H Walker and D M Levine ‘”You’ve Got Jail”: Current Trends in Civil and Criminal Enforcement of Internet Securities Fraud’, 38 Am.Crim.L.Rev 405 (2001); also J Cella & J Stark ‘SEC Enforcement and the Internet: Meeting the Challenge of the Next Millennium - A Program for the Eagle and the Internet’ (1997) 52 The Business Lawyer 815-849. 66 Walker and Levine id at 3-4, over 200 actions by 2000, and accelerating each year. John Reed Stark, Chief, the Office of Internet Enforcement at the SEC reports that as of early 2005 the agency has now bought over 500 actions: speech for Cyber-Securities Law Institute, Law Faculty, University of Toledo, Ohio, 8 April 2005. 67 Though the exact juridical basis of some of these actions is unclear as Don Langevoort makes clear: D Langevoort, ‘Taming the Animal Spirits of the Stock Market: A Behavioural Approach to Securities Regulation’ (15 April 2002) Berkley Olin Program in Law & Economics, Working Paper Series, Paper 64. http://repositories.cdlib.org/blewp/art64 68 J Reed Stark and Carolyn E. Kurr ‘Using the SEC’s Statutory Weaponry to Combat Spam’ in this symposium at (plse insert page nos of Stark/Kurr piece in this collection).
13 that was of the shares of a US company called Rentech Inc.69 Rentech was listed on NASDAQ and the two defendants conspired to send 4 million spam and place misleading and deceptive messages on Internet bulletin boards operated by Raging Bull Inc and Yahoo Inc. One of the defendants purchased Rentech shares 3 days prior to sending and posting the misleading messages, and sold them the first trading day after. They made $17,000 profit. One defendant received a two year sentence partly suspended (spending three months in jail), the other also received a two year jail sentence, wholly suspended. Both were required to disgorge their profits.
ASIC has used judicial enforcement in relation to other categories of misleading and deceptive conduct, in protecting Australians from off-shore cold-calling and share hawking schemes, which use email and the Internet. This has some coincidence with Walker and Levine’s offering frauds category, though much of the cold-calling involves ‘pyramid’ schemes, not stock offers. These commonly use fake websites designed to give the appearance of legitimacy to the invitations to invest.70 In most of these enforcement actions ASIC obtained an Australian Federal Court order that the site be shut down. If there are sufficient connections with the Australian jurisdiction71 then such an order could be made on the basis of either or both of a failure to be licensed to offer financial services in Australia or the making of misleading or deceptive statements targeted to Australians. It also involves cooperation with regulators in other jurisdictions under mutual assistance treaties and investor education campaigns.72 These scams have generally been identified by investor complaints to ASIC, through International Organisation of Securities Commissions
69 ASIC Media Release 01/66 ‘Two Years Jail – Suspended – for Internet Spammer’ 22 May 2001. R v Hourmouzis (Unreported, Victorian County Court, Stott, J. October 2000). The SEC also sought a disgorgement of profits and a temporary and permanent injunction to prevent the defendants from violating Securities Exchange Act 1934 § 10(b):
14 (IOSCO) surf days,73 and also through the surveillance activities of ASIC’s Electronic Enforcement office. There are of course local unlawful promotions of investment offers as well.74 So along with the US, Australia too has had problems with unlawful investment offerings, though illegal touting (Walker and Levine’s third category) is not a pattern of illegal behavior that has been prominent.
Instead, the most common sort of enforcement action related to online trading has been action against sponsors of sites which offer unlicensed investment advice or dealing services. Recently ASIC has shut down three unlicensed electronic currency trading websites,75 unlicensed sites offering share trading software,76 and has obtained injunctions to stop unlicensed advising using an internet site promoted using relay chat channels.77 In many of these cases the operators agreed to take down the offending website voluntarily, in others Federal Court injunctions were obtained. In this area ASIC has also made frequent use of a relatively new power it has, to accept enforceable undertakings.78 This is an undertaking given by a party that has contravened the law, and is given to ASIC where otherwise ASIC would exercise its powers in respect of a contravention of the Corporations Act 2001. If these undertakings are breached ASIC may apply to the court to have the undertakings enforced as an order of the court. This seems similar to the power of the SEC to take administrative enforcement actions which results in a ‘cease and desist’ order in
73 ASIC Media Release 01/448 ‘ASIC Surfs the Web for Scammers and Swindlers’ 17 December 2001. 74 ASIC Media Releases 01/043 ‘$97,000 returned to investors after ASIC forces withdrawal of fundraising offer’, 14 February 2001 and 01/311 ‘Stephen Matthews found guilty of contempt’ 30 August 2001 in relation to unlicensed advising and unlawful offers using The Chimes investing website. ASIC Media Release 99/249, enforceable undertaking to prevent Martin Leigh Davies- Roundhill promoting an unlawful investment offer which he had posted to 25,000 newsgroup sites through his home computer. 75 ASIC Media Release 04-366 ‘ASIC Acts to Shut Down Electronic Currency Trading Websites’ 9november 2004. 76 ASIC Media Release 04/221 ‘ASIC Obtains Enforceable Undertaking from Promoter of Share- trading Program’, 9 July 2004. ASIC Media Releases 03/207 ‘ASIC Obtains Orders Winding –up Share Trend’ 1 July 2003 and 01/332 ‘Injunctions Against Share Trend Software Remain’ 19 September 2001. Also ASIC Media Release 99/268 where an enforceable undertaking was obtained from Paritech Pty Ltd not to advertise, distribute or sell the computer software package Omnitrader, without an advisor’s license. 77 ASIC Media Release 02.27 ‘ASIC Protects Consumers in Chat Room’ 29 January 2002. 78 Sections 93, 93AA and 93A Australian Securities and Investments Commission Act 2001; the power has been available to ASIC since 1998.
15 public administrative proceedings.79 An enforceable undertaking to ASIC may be given and received without formal proceedings more in the nature of a private settlement. However, all the matters relating to the contravention will be considered by a court if the party giving the undertaking wishes to vary it, or ASIC applies to have it enforced as an order of the court.80 The kinds of provisions which are commonly included in enforceable undertakings are similar to those made as ‘cease and desist orders’ by the SEC, including that the infringer take affirmative steps in the future to comply with the regulation.81
In short, ASIC enforcement has not had to contend with the sophistication of securities fraud facing the SEC. While individuals have lost significant amounts of money, there have not been attacks on the market in particular stocks to anything like the degree evident in Internet manipulations in the US. The enforcement approach to misleading and deceptive conduct in online trading in Australia is one which makes heavy use of civil and administrative techniques, and not very great use of criminal law. It also relies greatly on international cooperation, media publicity and investor education.
(f) Lack of Investor Knowledge and Education. A further concern expressed by both US and Australian regulators, is the lack of investor knowledge about financial matters in general, and online investing in particular.82 They have all made investor education a policy priority, as can be seen by
79 Section 21C Securities Exchange Act 1934; Jennings et al, Securities Regulation (1998 Foundation) at 1565-6. 80 The Australian Competition and Consumer Commission has had a very similar enforceable undertakings power even longer than ASIC, and insights about ASIC’s power can be gained from C. Parker, ‘Restorative Justice in Business Regulation? The Australian Competition and Consumer Commission’s Use of Enforceable Undertakings’ (2004) 67(2) Modern Law Review, 209-246. 81 ASIC has also occasionally used the technique of adding additional conditions to an intermediary’s licence to deter unlawful activity; for example, ASIC Media Release 02/20, 21 January 2002 reported ASIC requiring additional conditions on its dealer’s licence when orders placed by Susquehanna Pacific Pty Ltd on the ASX near the close of trading on 29 June 2001 may have increased volatility and contributed to an unexpected increase in the price of a number of stocks that comprise the ASX S&P 200 Index. This resulted in an increase in the settlement price of the Index and, consequently, the SFE SPI 200 contract, the settlement price of which was determined by reference to the closing price of the Index. The price filters of Susquehanna’s ASX participating broker, were turned off at the time.
82 ASIC Survey of Online Trading Websites (August 2000): www.asic.gov.au passim; L Unger, On-Line Brokerage: Keeping Apace of Cyberspace (SEC, 1999), pp 21–30; Office of the NY Attorney General Eliot Spitzer, From Wall Street to Web Street: A Report on the Problems and
16 the relative sophistication of the SEC and ASIC investor websites and their other investor education activities. 83 III. Australian Differences – US Transplants in Australian Soil. (a) Electronic Prospectuses. As this symposium is to mark the tenth anniversary of the issue of the first electronic prospectus in the US, it seems appropriate to include a consideration of how this departure in securities practice has developed in Australia. As already indicated online trading firms in Australia owe much too American influence, and to some extent the same is true of electronic offering documents. However, transplants often grow differently in foreign soil, and local Australian conditions have had their own shaping effects resulting in national innovations in this and a number of other areas which will be the focus of discussion for the remainder of this paper.
Australia has allowed electronic prospectuses for nine years. The first was the Hartley Poynton Limited prospectus in July 1996.84 Now they are common place, and it would be a matter for questions if a new issue or initial public offering (IPO) did not make a prospectus or other offer document available electronically. Another feature of the single market regulator system in Australia is that all offers of financial products, other than company shares and debentures and listed managed investment funds, must be offered by an offer document called a Product Disclosure Statement (PDS). Offers of securities by companies and listed managed funds still use a prospectus. So all insurance (both life and general), superannuation, unlisted managed funds, derivatives, some types of bank accounts and deposit taking facilities must be offered using a PDS. Although it is both desirable and permissible that these documents vary in the degree to which they have to address the complexity of the products and the risks inherent in them, they are otherwise required to be in similar format and to address a common list of product and issuer characteristics. This is to promote ready comparability between products of the same type and their offerors, and to make easier the comparison between different types of products. The general principles that Promise of the Online Brokerage Industry, 22 November 1999, p 1. 83 ASIC, Educating Financial Consumers, Discussion Paper, July 2000; ASIC, ASIC: Internet and e-commerce initiatives, June 2001, pp 9–10; also FIDO (financial information delivered online) at www.fido.asic.gov.au with a program of Gull Awards, Consumer Alerts, Internet Safety Checks, an e-bulletin (FIDO News) and ASIC’s Financial Information Directory. 84 E. Boros, Multimedia Prospectuses and Other Offer Documents, Issues Paper published by Australian Securities and Investments Commission and Centre for Corporate Law and Securities Regulation (December 1999).
17 have been developed in relation to electronic prospectuses for company securities have been applied to product disclosure statements for other product types as well. This singularity of approach has been an important reason for the take-up of electronic means in Australian financial markets – a single market regulator with policy that applies to pretty much all offer documents. This is a first comparison with the multi- agency approach to regulation in the US.
A second comparison is that unlike in the US where electronic prospectuses may differ from the paper version and have multimedia features, the changes that an issuer may make in the electronic version of a prospectus in Australia are minimal and prescribed. This is done by way of administrative relief from the prospectus requirements of the Corporations Act.85 So as a result Australian electronic prospectuses and product disclosure statements (PDS) are generally in Portable Document format (PDF), and although they are encouraged to use graphics such as tables, charts, graphs etc which may aid clarity of information presentation, they are not permitted to have graphics of the promotional or decorative type. In short, in Australia there are no multimedia prospectuses or offer documents incorporating material through video-clips and other graphic material or audio material. This is by contrast with the US approach where multimedia prospectuses are permitted,86 though as yet they seem to be used to a limited degree. This may change if recent proposals to liberalise the law regulating securities offerings in the US go ahead.87 These proposals would allow, at a variety of stages in the offering process, issuers of standing to issue ‘free writing prospectuses’.88 That is, prospectuses that do not have prescribed
85 ASIC Policy Statement 107 Electronic Prospectuses, 10/02/2000 passim and ASIC Policy Statement 150 Electronic Applications and Dealer Personalised Applications 5/7/2000 passim, both as developed by ASIC Class Order CO 00/43 up-dated by ASIC Class Order, CO 02/261, O2/2002 Electronic Disclosure Documents, Electronic Application Forms and Dealer Personalised Applications - Amendment. 86 Use of Electronic Media for Delivery Purposes, SEC Release No 33-7233(Oct 6 1995); Use of Electronic Media by Broker Dealers, Transfer Agents, and Investment Advisers for Delivery of Information, SEC Release No 33-7288 (May 9 1996) ; H M Friedman Securities Regulation in Cyberspace (2004 Aspen) at 3-33-4; J F Olsen & H L Pitt Securities in the Electronic Age: A Practical Guide to the Law and Regulation (Glasser Legal Works, 2000) 2-56ff; RR Donnelley, Multimedia Disclosure, REALCORPORATELAWYER.com http://www.realcorporatelawyer.com/faqs/multimedia.html (visited 28.03.05). 87 Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004). Insert cross-ref to Broc Romanek’s piece ‘A New Day Dawning for E-communications During the Offering Process’ here, also, with correct page no in final symposium version. 88 Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004); rule 405 (para 230.405) defines the
18 content, and amount to ‘written communications’ including ‘written, printed, broadcast or a graphic communication’. This allows much greater freedom in the form and content of material made available to investors by issuers and issuer participants such as underwriters. Thus we may see more use of multi-media features in these ‘free writing’ communications, which though called prospectuses, will no doubt range from straightforward promotional text with or without graphics to web-casts of electronic road-shows and even entire web-sites devoted to promoting an issue.
There are of course differences between the paper and electronic versions of Australian offer documents, and these are permitted so long as ‘the electronic prospectus contains the same information in the same sequence as the paper prospectus lodged with ASIC’.89 ASIC specifically allows a number of enhancements or differences from the paper version. These are of a type which will facilitate a reader navigating around the document and therefore promote it being read and understood, such as a facility for searching defined expressions, prompts and hyperlinks between parts of the document.90 Australian law allows some documents which have been in the public domain for a time to be incorporated by reference rather than repeated in the prospectus,91 and hyperlinks to such documents may be included. But hyper-links to promotional material are not permitted (though hyper- links from promotional material to the prospectus are encouraged).
Why does Australia have these limitations and what are some of their implications? In fact there has been little official consideration of the question of multimedia offering documents in Australia.92 It is likely that the reasons for not permitting such
‘free writing prospectus’, provides the expanded definition of ‘written communications’ and develops a hierarchy of issuers and the times at which and freedom with which, they may use a ‘free writing prospectus’. So a ‘well-known seasoned issuer’ (defined in rule 405, para 230.405), may issue a ‘free writing prospectus’ at any time before or after the filing of the registration statement for an issue, whereas all other issuers must wait until they have filed their registration statements for the issue (rules 164, 433(b), paras 230.164 and 230.433), and non-reporting and non-seasoned issuers must only use a ‘free writing prospectus’ if it is preceded or accompanied by the issuer’s most recent statutory prospectus (rule 433(1), para 230.433(1)) which is presumably that filed with the registration statement for the issue. 89 ASIC, Policy Statement 107 Electronic Prospectuses, 10/02/2000 at PS 107.29 90 ASIC, Policy Statement 107 Electronic Prospectuses, 10/02/2000 at PS 107.67. 91 Section 712 Corporations Act 2001. 92 With the exception of E. Boros, Multimedia Prospectuses and Other Offer Documents, Issues Paper published by Australian Securities and Investments Commission and Centre for Corporate Law and Securities Regulation (December 1999).
19 prospectuses are several. Firstly, questions of equality of access and the digital divide are never far from the surface in any discussion of electronic modes in Australia. Certainly ASIC has made it clear that it will not give relief to allow modifications or enhancements to electronic documents ‘so that different information is available to different investors depending on the characteristics of different investors’.93 Further the combination of compulsory superannuation and investor choice means that many ordinary individuals are being asked to make important decisions about investing for their retirement income, and ASIC is likely concerned that some would be disadvantaged if they could not access a multimedia product disclosure statement, while others could.94 This may mean that, as was the case in Canada, ASIC might decide to revisit the question of allowing multimedia offer documents when more users have broad band connections to the Internet, and when more people commonly have software that allows the realization of video and audio material. It is partly for these equality of access reasons, that an issuer is still required to make a paper version of the prospectus and application form available free on request to any potential investor.95
The recent SEC proposals for liberalising securities offerings maintain the requirement that the issuer make available a paper copy of a prospectus, if requested by an investor, but they do not provide that a paper copy of ‘free writing prospectuses’ be made available. It is true that the proposals require that most ‘free writing prospectuses’ must be filed with the SEC,96 but to assure equality of access to ‘free writing prospectuses’, this assumes that all investors have the technology available to access the SEC’s ‘EDGAR’ database, where filed documents are made available. On the other hand, as most ‘free writing prospectuses’ will likely contain more selling and promotional material than information about the company, there is a large financial incentive on issuers and their agents to use technology which will make them accessible to the greatest number of investors. Also, there is evidence, that even in relation to statutorily prescribed documents, only about 1% of investors
93 ASIC, Policy Statement 107 Electronic Prospectuses, 10/02/2000 at PS 107.70. 94 For other instances of ASIC’s concern about equality of access to information by investors, see ASIC Issues Paper, Heard it on the Grapevine (2000). 95 ASIC Policy Statement 150 Electronic Applications and Dealer Personalised Applications 5/7/2000, para 150.25. 96 For example, rule 164 (para 230.164), Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004).
20 request a paper copy, and so in the US at least the question of equity in access to information may no longer be an issue related to technology.97 It is very doubtful given the different take-up rates of technology, that this conclusion could safely be drawn in relation to Australian investors at the moment.
Whatever the position on equality of access, it is clear that ASIC is concerned about the possibilities that ‘soft’ information in the multimedia features of electronic offer documents will distract investors from, or even over-ride the hard information in the text. There is great concern that investors should not confuse promotional material with the legislatively required disclosures in the prospectus. That ‘the electronic prospectus and any promotional material are issued in such a way as to encourage investors to make decisions based on the prospectus rather than on the promotional material or pressure selling’.98 Again, the new SEC proposals on securities offerings make it plain that this is no longer a concern of US regulators. “Free writing prospectuses’ may be made available in many cases even in the absence of a filed registration statement or the prior or contemporaneous delivery of a statutory prospectus.99 This assumes a relatively high level of ability in investors to sift and interpret information, to distinguish that which is credible and discard that which is not.
Finally, there is a view in Australia that technology is there to reduce transactions costs, and to enable choices that would otherwise not be available because of distance or other type of inaccessibility. There is less emphasis on technology as a tool in market competition through promotion. So in justifying the grant of relief to allow electronic offer documents and applications, ASIC has laid emphasis on cost and time efficiencies in informing investors and disseminating information to them. ASIC has 97 Broc Romanek and David Lee, E-Communication to Shareholders Outside the Offering Process, insert reference to this in the symposium issue, with correct page no as it will be published, at pages 11-12, who state that the third party document delivery service ADP Investor Communications Services reports this experience, though the report is in relation to different types of documents ie annual reports, interim and proxy statements, not prospectuses: www.icsdelivery.com/live/ 98 ASIC, Policy Statement 107 Electronic Prospectuses, 10/02/2000 at PS 107.77-87. See also ASIC, Policy Statement 101, Prospectus Advertising Depending on how it is presented, promotional material could also run foul of the advertising provisions in section 734 of the Corporations Act 2001. 99 Eg for issues by ‘well known seasoned issuers’ no registration statement need be filed before a ‘free writing prospectus’ is filed, and for ‘seasoned’ and ‘reporting issuers’ the statutory prospectus need not be delivered before or at the time of the ‘free writing prospectus’.
21 also emphasized the greater ability to use and analyse information in this medium (eg word search capacity), and the greater spread of investors that may be reached with a greater range of investment products.100 There is a theme in these reasons of wishing to consolidate the national Australian market and to increase the penetration of investment products, but not to allow a change in the balance between the information providing and promotional aspects of offer documents.101 Again, the recent proposal to allow ‘free writing prospectuses’ in the US seems likely to change the existing balance between the information provision and promotion aspects of offering documents, and suggests that this too is an area of divergence between Australia and the US.
Until the recent US securities reform proposals it was the case that other aspects of Australian regulation of the offering process actually provided greater scope for the easy use of electronic documents and ‘free writing’ material. In Australia no offers or invitations for securities may be made until a prospectus has been lodged with ASIC.102 This equates with the US ‘pre-filing’ period.103 The ‘exposure period’104 follows, during which the issuer may make offers and invitations but may not accept them.105 The ‘exposure period’ lasts 14 days. ASIC does not vet prospectuses during the ‘exposure period’. Instead it relies on selective compliance reviews106 and the receipt of complaints or ‘tip-offs’ from analysts, commentators, journalists and
100 ASIC, Policy Statement 107 Electronic Prospectuses, 10/02/2000 at PS 107.11. 101 Another factor, is that all prospectuses in Australia have to be lodged with ASIC, and ASIC does not presently have the capacity to receive and store prospectuses and product disclosure statements containing multimedia features. ASIC does not require an electronic prospectus to be lodged as well, but requires a copy of any electronic prospectus to be given to ASIC so that the agency can remain informed of the incidence and characteristics of electronic prospectuses being used in the market. ASIC has shown no taste for the SECs dispensation of allowing issuers to provide a transcript or other representation of multimedia material in filed electronic prospectuses. 102 Offer is construed widely by the Australian courts and is not limited to a technical or contractual meaning. It also includes the distribution of material that would encourage a member of the public to enter into a course of negotiations calculated to result in the issue or sale of securities: Australian Softwood Forests Pty Ltd v A-G for New South Wales (1981) CLC 40-734; A-G for New South Wales v Australian Fixed Trusts Limited [1974] 1 NSWLR 110. 103 J F Olsen & H L Pitt Securities in the Electronic Age: A Practical Guide to the Law and Regulation (Glasser Legal Works, 2000) 2-36. 104 ASIC, Policy Statement 152, Lodgement of Disclosure Documents, 07/06/2000, para 152.1. 105 Section 727(1) & (2) Corporations Act 2001, though the ‘exposure period’ may not apply if the securities to be issued are already quoted. 106 ASIC, Policy Statement 152, Lodgment of Disclosure Documents, 07/06/2000, para 152.46-49.
22 members of the public.107 During the ‘exposure period’ ASIC places great importance on the issuer taking steps to make the prospectus ‘generally available’ such as placing the prospectus on an Internet site and using publicity and communication that is likely to be seen by those interested in the securities to be issued.108 While in the US there have been strict controls on publicity, advertising and making of offers or invitations for securities prior to lodgment of a registration statement, 109 during the ‘exposure period’ and thereafter the only real restriction is that advertising must include a statement that the offers of securities are made in the prospectus and that anyone wishing to acquire the securities will need to fill in the application form which is ‘in or will accompany the disclosure document’.110
There is a legislative requirement that for all offers for securities an application form is ‘included in the prospectus or accompanied by a copy of the prospectus.’111 This and the relative freedom in relation to advertising from the time of lodgment of the prospectus are leading reasons why considerable importance has been placed on means to ensure that the investor receives the prospectus before or at the same time as the application form, in an electronic prospectus.112 Also that electronic promotional material is published in such a way that a reasonable person would not confuse it with the prospectus. While an application form will usually be part of a paper prospectus, such a physical connection cannot be relied on in the electronic domain. ASIC suggests that the application form is made part of the same electronic document file as the prospectus, or that other electronic means are used to ensure that investors can
107 ASIC, Policy Statement 152, Lodgment of Disclosure Documents, 07/06/2000, para 152.21 and The Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998, para 8.68. 108 ASIC, Policy Statement 152, Lodgment of Disclosure Documents, 07/06/2000, para 152.03 & 04. 109 Section 734 (2) Corporations Act 2001.Also ASIC, Policy Statement 152, Advertising and Publicity for Offers of Securities, 17/02/2000, passim. 110 Section 734 (4) & (6) Corporations Act 2001. Also no applications can be accepted or given precedence during the ‘exposure period’ (ASIC, Policy Statement 152, Lodgment of Disclosure Documents, 07/06/2000, para 152.60-73) and statutory provision is made for the holding of application monies on trust, section 722 Corporations Act 2001. 111 Section 727(2) Corporations Act 2001. 112 Section 727(2) Corporations Act 2001, ASIC Policy Statement 107 Electronic Prospectuses, 10/02/2000 passim and ASIC Policy Statement 150 Electronic Applications and Dealer Personalised Applications 5/7/2000 passim, both as developed by ASIC Class Order CO 00/44 Electronic Disclosure Documents, Electronic Application Forms and Dealer Personalised Applications 14/2/2000; up-dated by ASIC Class Order, CO 02/261, O2/2002 Electronic Disclosure Documents, Electronic Application Forms and Dealer Personalised Applications - Amendment.
23 access the prospectus only if they have the application form or that the issuer can verify that the investor received the application form first.113 Similarly ASIC encourages issuers to use a separate electronic file for each of the prospectus and promotional material. Also, while there may be hyperlinks from advertising and promotional material to the prospectus, there may be no such links from the prospectus to advertising.114
From this discussion the reader will see that Australia has resolved the regulatory question about whether the issuer should deliver the prospectus115 or make the prospectus available, in favor of availability. Assurance that the investor has made the investment decision on the basis of the prospectus is given by requiring issuers only accept applications for securities made on an application form that the issuer can assure ASIC was available with or in the prospectus. Indeed this is a technique that has been considered by the SEC.116 ASIC suggests a number of ways this assurance can be given: the use of warnings that the application form can only be used if the prospectus has also been provided; if the application form can only be accessed by hyper-link from the prospectus; if the investor must sign an acknowledgement of receipt of the prospectus on a print out of the application form, or on an electronic form enter a personal identification number next to such an acknowledgement.117
The gap between regulation in the two countries is now likely to reduce, given the likelihood of the SEC’s securities offering reforms being adopted. We have already observed that the proposed ability to use ‘free writing prospectuses’ will do much in both legal and practical terms to free up the use of non-proscribed material in the US offering process. In fact it goes further, because as we have also noticed only unseasoned and non-reporting issuers may have to ensure that investors have a
113 ASIC Policy Statement 107 Electronic Prospectuses, 10/02/2000, para 107.51. 114 ASIC Policy Statement 107 Electronic Prospectuses, 10/02/2000, para 107.86. 115 Under current US law, even in the electronic environment, the prospectus must be delivered and the issuer must be able to verify this - H M Friedman Securities Regulation in Cyberspace (2004 Aspen) at 2-1 -18; J F Olsen & H L Pitt Securities in the Electronic Age: A Practical Guide to the Law and Regulation (Glasser Legal Works, 2000) 2-21-26. 116 Use of Electronic Media for Delivery Purposes, SEC Release No 33-7233 (Oct 6 1995) at Section II.B. 117 ASIC Policy Statement 150 Electronic Applications and Dealer Personalised Applications 5/7/2000, para 150.27-33.
24 statutory prospectus in their hands, prior to or contemporaneously with the free writing material, whereas all issuers must do this in Australia.
In a related way, the new US proposals will also go further on the question of whether there should be delivery of electronic prospectuses or whether access is sufficient. If adopted, they will provide that investors are presumed to have access to the Internet and that the obligation to have a final prospectus precede or accompany a security for sale, could be satisfied by filing the final prospectus with the SEC, and its subsequent availability to investors through the SEC’s EDGAR database.118 It could also be made available by posting on another site on the Internet. The difference between the US and Australia in this regard, is quite crucial. The operative provisions of the Securities Act 1933 have resulted in a practice of making the final prospectus available to investors when the securities are delivered or their sale confirmed.119 In other words, the final prospectus is not a guide to the investment decision (though other permitted documents such as the preliminary or ‘red herring’ prospectus or term sheets might be) but ‘tells the investor whether he has acquired a security or a law suit.’120 For these reasons the SEC considers the greatest utility of the final prospectus is as one ‘which informs and memorializes the information for the market’121 and that for this reason there is no need to insist on actual delivery of the prospectus to the purchasers and that access will be sufficient. In Australia by comparison the statutory prospectus is required to precede or accompany an invitation or offer for sale of securities. As a result, while Australia has for some time had an access not delivery approach to getting prospectuses into the hands of investors, ASIC has taken great care to ensure that as far as possible, the issuer makes the document available in a way that the application form which must be used, is accompanied by the prospectus.
118 For example, rule 172 (para 230.172), Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004). 119 Sections 10(a) and 5(b)(2) Securities Act 1934, as explained at pp 67437-8 Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004). 120 L. Loss & J. Seligman, Securities Regulation, section 2-b-3 (3d ed. 2001). 121 Securities and Exchange Commission, SECURITIES OFFERING REFORM; PROPOSED RULE, 17 CFR Parts 228, 229 et el (17 November, 2004) at 67438.
25 (b) First Amendment Issues – Licensing of Provision of Financial Product Advice. Although the Australian constitution was consciously fashioned with the US constitution as a model,122 Australia does not have a Bill of Rights or constitutional charter.123 Australia does not therefore have, a constitutionally entrenched protection of free speech.124 To the extent that a freedom of communication has been implied under the Australian constitution, it has been limited to a freedom of political communication. In ACTV v Commonwealth and Nationwide News Pty Ltd v Wills in 1992 there were glimmerings of potential for something wider. There the freedom was expressed to extend to ‘all matters of public affairs’, and described as ‘a freedom of public discussion of political and economic matters’.125 However in recent decisions it has been resolutely limited to a ‘freedom of communication about government or political matters’ or even more narrowly has effect ‘only to the extent that it is necessary to effectively maintain the system of representative and responsible government provided for by the Constitution’.126 In short, in Australia there is no obvious freedom of speech or communication relevant to the provision of financial information, and the field for regulation is therefore open to support licensing and other methods of regulation.
Because of the greater scope for regulation of financial information provision in Australia, arguments are beginning to surface to deregulate the provision of advice. To rationalise (mostly by deregulation), the structure and amount of regulation. Heavily influenced by US online investing practices as they have always been, Australian online investing operators have cast their eyes enviously across the Pacific at what they see as a much more liberal regime of regulation for the provision of financial information and advice. The US regulation of this area is of course
122 T. Blackshield and G. Williams Australian Constitutional Law and Theory (2nd ed.) (Federation Press, Sydney, 2002) p2. 123 Although the Australian Capital Territory (where the Australian capital city, Canberra, is located) now has a statutory bill of rights which applies to it alone; Human Rights Act 2004 (ACT). 124 Although it does have a substantial common law jurisprudence in this area, which is often thought of as part of a common law bill of rights: Australian Capital Television v Commonwealth (1992) 177 CLR 106; Nationwide News Pty Ltd v Wills (1992) 177 CLR 1; Stephens v Western Australian Newspapers (1994) 182 CLR 211. 125 ACTV v Commonwealth (1992) 177 CLR 106 and Nationwide News Pty Ltd v Wills (1992) 177 CLR 1. 126 Lange v Australian Broadcasting Corporation (1997) 189 CLR 520, Coleman v Power (2004) 78 ALJR 1166.
26 influenced heavily by the guarantees of freedom of speech in the First Amendment to the US constitution. There have been a number of US cases over the last two decades which have made it very difficult to regulate the provision of financial information and advice, unless it is directed to a specific individual.
So for example, in Commodity Trend Service, Inc v. Commodity Futures Trading Commission,127 the court examined whether the publisher of general investment advice concerning the commodity futures market could properly attack, on First Amendment grounds, a requirement that it be subjected to a registration regime. The court found the publications not to be commercial speech because they "do not appear to propose commercial transactions between CTS and any customers," and instead "appear to provide information on commodity trading in general and leave any actual trading to other parties."128 The court concluded that the publications in question were "not commercial speech because they do not propose a commercial transaction between CTS and a specific customer." 129
Likewise, in Taucher v. Born,130 which, like Commodity Trend Service, involves registration requirements under the Commodity Exchange Act,131 the Court found that the provision of information providing generalized advice did not constitute commercial speech.132 The fact that the publications at issue in Taucher included advertising materials did not render them commercial speech, and the Court emphasized that the substance of the publications was not commercial since they proposed no commercial transaction directly between the publishers and any prospective customers.133 Taucher states that "where a personal nexus between professional and client does not exist, and a speaker does not purport to be exercising judgment on behalf of any particular individual with whose circumstances he is directly acquainted, government regulation ceases to function as legitimate regulation of professional practice". Rather, Taucher found that publications it examined
127 149 F.3d 679 (3d Cir. 1998), [**17] 128 Id at 685-86. 129 Id at 686, citing Board of Trustees of State Univ. of New York v. Fox, 492 U.S. 469, 473, 106 L. Ed. 2d 388, 109 S. Ct. 3028 (1989). 130 53 F. Supp.2d 464 (D.D.C. 1999). 131 7 U.S.C. ß 1, et seq. 132 Note 130 at 481. 133 Note 130 at 480-81.
27 qualified as protected speech "because the plaintiffs do not profit from their customers' gains or losses in the market and because the plaintiffs do not exercise judgment on behalf of their customers . . ." 134. These decisions follow the Supreme Court's decision in Lowe v. Securities and Exchange Commission,135 and were reaffirmed last year in a Californian decision Forsalebyowner.com Corp. v. Zinnemann .136
This jurisprudence makes it more difficult in the US to regulate the provision of financial information, opinion or general advice. Advice has to be very specifically targeted to a specific individual, and it may even be the case that there is no room for regulation until that customer has actually supplied the intermediary with particulars of their own financial circumstances. In the absence of a well considered protection in Australia it is considerably easier to regulate the kind of commercial speech,137 found on broker websites, financial information portals, in investing newsletters and the services of data providers, in share trading software, in circular emails and on Internet discussion sites. In fact there is a wide requirement for the licensing of those who provide financial services (this is the single license I mentioned above), one relevant financial service being the provision of ‘financial product advice’.138 A person provides ‘financial product advice’ when they make ‘a recommendation or a statement of opinion, or a report of either of those things, that is intended to influence a person …in making a decision in relation to a particular financial product…or could reasonably be regarded as being intended to have such an influence’.139 This includes both general and personal advice. ‘Personal advice’ is given where the provider has ‘considered one or more of the person’s [investor’s] objectives, financial situation or needs’ or a reasonable person might have expected them to have done so. This is a 134 Note 130 at 477-479. 135 472 U.S. 181, 232, 86 L. Ed. 2d 130, 105 S. Ct. 2557 (1985). 136 347 F. Supp. 2d 868 (D. Cal., 2004). 137 Commercial speech represents an accommodation between the right to speak and hear expression about goods and services and the right of government to regulate the sales of such goods and services. 44 Liquormart, Inc. v. Rhode Island, 517 U.S. 484, 499, 134 L. Ed. 2d 711, 116 S. Ct. 1495 (1996) 138 Section 766B Corporations Act 2001. Although described as licensing in Australia, there are similarities with the obligations imposed by the registration requirement under section 203 (a) Investment Advisors Act 1940 and the obligations on broker-dealers for advising incidental to their broking activities under section 15(a) of the Securities Exchange Act 1934. 139 Section 766B(2)-(4) Corporations Act 2001.
28 very wide definition of advice, by comparison with that which emanates from the US jurisprudence discussed above, where to constitute advice, may require that a specific recommendation to be made to the customer.
In order to cater for traditional publications such as newspapers and magazines, even in their online versions, there are exemptions from the licensing requirement. These reflect a similar public interest in the freedom to publish, that seems to lie behind the wider US protections on speech. Therefore a license is not required by a newspaper or periodical,140 an information service141 or for sound, video or data recordings.142 A license is not required if, in all these instances dissemination involves the provision of general advice, that is available to the public otherwise than on subscription and the sole purpose is not the provision of financial advice. Here ‘information service’ is defined to include a service provided by the Internet, 143 so most general Internet portals will not require a license even if they contain some material that is general financial advice.
The difficulties of whether financial product advisors should be regulated as a financial firm therefore really begin in Australia, when the provider wants to provide solely financial advice, wishes to charge a subscription and where it might be considered that the material is more than simply general advice. In these circumstances, three questions are asked to explicate the definition of ‘financial product advice’144 in the Corporations Act 2001 which is set out above. Those questions are: (i) what is the character of the communications? (ii) what is the context of the advice? and (iii) is the person actually providing the advice, or merely a conduit to its provision?145
140 S911A(2)(ea) Corporations Act 2001 141 S911A(2)(eb) and s911A(6) Corporations Act 2001 142 S911A(ec) Corporations Act 2001 143 Corporations Regulations para 7.6.01B(6)(c) 144 Corporations Act 2001 (Cth) ss 766A(1), 766B. 145 Australian Securities and Investment Commission, FSRB Policy Proposal Paper No 1, Licensing: The scope of the licensing regime: Financial product advice and dealing, 2001, passim and in particular 39.
29 Let us crystallise the discussion by considering the circumstances of an online financial newsletter.
Generally the ‘character of the communications’ in a financial newsletter will range from pure financial facts or information, through impersonal recommendations or opinions, and may even (say through the consideration of a hypothetical) consider particulars of a person’s financial situation or needs, though these will usually be directed to all recipients of the newsletter. So the ‘character of the communications’ may include both impersonal and personal advice. If this is the case, the newsletter will have satisfied the first requirement for investment advisory licensing in Australia, being the publication of ‘a recommendation or a statement of opinion or a report of those things’.146 By contrast, a data provider which supplies only financial information such as a feed of market statistics, is not considered to be providing a ‘recommendation or a statement of opinion’. This will be so if the information supplied is able to be derived from underlying data that is generally available, and the data is objectively ascertainable. Similarly, a vendor of computer software used for financial analysis, will not need a license if the program does no more than manipulate and store financial information. If however, it is programmed to supply an investing system – where in effect the use of the software involves the acceptance of advice about how to make investing decision, then it will have to be licensed.147
The next element to consider is the ‘context of the advice’. The definition of ‘financial product advice’ in Australia, requires that it be ‘intended to influence a person or persons in making a decision in relation to a particular financial product or class of financial products…or could reasonably be regarded as intended to have such an influence’.148 As the raison d’etre of most financial newsletters is to influence investor’s investment decision-making by presenting up-to-the-minute information and expert analysis, the context in which the financial newsletter communicates will also suggest that what is being given is financial advice.
146 Corporations Act 2001 (Cth) ss 766B(1). 147 Id. 148 Corporations Act 2001 (Cth) ss 766B(1)(a) &(b).
30 But it is the third element that is of most help to online financial information providers. If they are only a ‘conduit’ to the recommendations and opinions of others, then they will be able to avoid being licensed as a financial firm. In the case of financial portals that simply host recommendations or opinions provided by others, there will be no need for a licence. This also follows for the operations of an Internet discussion site, where the sponsor technologically facilitates the communications of those making postings on the site. So long as the operator does not authorise, edit or endorse the posts, the mere dissemination of communications is thought to be insufficient to warrant a license. Merely removing defamatory, copyright infringing or other illegal communications, does not involve sufficient control or intervention to warrant licensing either.149
However, an online financial newsletter will not want to merely replicate the views of others, and if it publishes opinion or recommendations, even where those are identical to all recipients, in Australia it will likely need a licence. Indeed, a quick check of some local online financial newsletters showed that they were either published by major brokers (hence already licensed to advise), and otherwise were published by private companies all licensed by ASIC under the Corporations Act 2001.150 Generally, these newsletters were available only on subscription, or as a client of a licensed brokerage.
What are the implications of this for regulation? One is that there is not as much generic or general financial information available in Australia as there is in the US. Another is that you more often have to pay for this information. To what degree this is a difference of degree, reflecting the different size and development of the Australian and US markets is very difficult to tell. But in some ways, it is a position that might be at odds with ASIC’s regulatory policy promoting investor education. Some general financial advice is a potent source of investor education, and provides facts, data and
149 Australian Securities and Investment Commission, FSRB Policy Proposal Paper No 1, Licensing: The scope of the licensing regime: Financial product advice and dealing, 2001at B6. 150 The Rivkin Report, published by Avcol Stockbroking Pty Ltd, Australian Financial Services License Number, 245586; The StockWatch Report, published by Warranted Financial Solutions Pty Ltd, Australian Financial Services License Number 253906; The Intelligent Investor and the Floattank both published by Intelligent Investor Pty Ltd, Australian Financial Services License Number 282288; www.incomeinvst.com.au published by Macquarie Bank; Investorweb published by IWL Limited, AFSL241398.
31 opinion to help investors identify alternatives and priorities. Often, general advice will be most useful when it uses some information about an individual’s circumstances, even if this is still in the form of a hypothetical – eg looking at the typical retiree, or parent looking to educate two children or twenty-somethings just starting in the workforce. General advice of this nature may be a stepping stone to regulated advice, where the investor’s actual rather than hypothetical circumstances are examined.
In short, it may be that to relax the circumstances in which a financial publisher needs an advisor’s license might increase the amount of general financial information and advice available, and have more of it available free. This is certainly a view that is beginning to be considered in the United Kingdom under the ‘Building Financial Capability’ initiative.151 However, it is unlikely that such relaxation would occur in Australia without considerable work on the general development of financial literacy in the population in schools, in the workplace and especially in a country with compulsory privatised superannuation, in relation to specific life events such as retirement.
(c) Internet Discussion Sites – Greater Use of ‘Soft’ Regulation.
As we have just seen, Australia has more of an appetite for regulating investment advice than the US. Although at present it does not require Internet discussion sites to be licensed as advisors, it has used ‘soft’ regulation in the form of guidelines in an ASIC Interim Policy Statement, to constrain the conduct of Australian Internet discussion sites (IDSs). As in the US these are mainly “bulletin boards” that allow still postings (where someone posts a notice that later visitors can read), or a “chat room” which allows real time interactive communication between those with access. ASIC Interim Policy Statement 162152 applies to both bulletin boards and chat rooms that allow the exchange or dissemination of information, opinions and advice about securities and other financial products. ASIC Interim Policy Statement 162 represents a policy balancing act. On the one hand, from the Australian perspective, IDSs do not
151 Financial Services Authority, Building Financial Capability in the UK: the Role of Advice, July 2004, www.fsa.gov.uk/financial_capability/priorities/advice/index.html (visited 22 March 2005). 152 ASIC Interim Policy Statement – Exposure Draft, Internet Discussion Sites, IPS 162, 15 August 2000. See also ASIC Survey of Online Trading Websites (August 2000): www.asic.gov.au, p 9.
32 command the same public interest arguments for remaining free to publish that apply to newspapers, periodicals and other general information services. There is also a real public interest in addressing the fact that they can be the source of harm in the circulation of financial product advice. On the other hand IDSs can be of real benefit as a source of generic financial advice and investor education, and it is clear that there are great impracticalities and difficulties of ‘fit’ in subjecting them to the licensing regime.153
Under the Interim Policy Statement, the first warnings must be positioned so that they are seen by the investor before he or she gains access to the postings.154 These warnings alert the visitor that the postings are not verified in any way by the site operator, and that the material in the postings is at best general securities information and not professional investment advice. The warnings must also advise the online investor to obtain professional investment advice which requires consideration of the investor’s own individual circumstances and needs. Other warnings at this position in the IDS must state the difficulty of taking action against parties making postings from other jurisdictions, that no securities may legally be offered for sale in site postings, and that there is no ASIC-approved dispute resolution scheme to cover any losses incurred in relying on the information in postings. The IDS must also post warnings to people who are making postings on it, and these should be accessible to people who view the postings. These warnings make it clear that those posting notices are personally responsible for their contents as well as for material on sites to which postings contain a link.155 Warnings also alert those making postings to the fact that they must disclose their interests in any securities referred to in postings.156
In addition to voluntary disclosure and warnings by IDSs, in Interim Policy Statement 162 ASIC has set out a series of voluntary standards of conduct for the IDS operator.
153 It is, for example, not easy to see how the provision of mandatory disclosure documents such statements of advice might be accomplished on an IDS. Similarly, the licensing requirements for the supervision and training of representatives has little to grip on since most advice is given by investors. Also testing, is how the application suitability requirement that must be discharged by all licensees supplying investment advice might operate, when advice is given by transient posters.
154 Note 152 at 12. 155 Note 152 at 13. 156 Note 152 at 13.
33 So, for example, the operator must ensure that advertising and promotional material is on a part of the site distinct and separate from the postings.157 It must ensure that the postings do not offer professional securities advice or offer securities for sale158 and that postings do not include material that is misleading or illegal.159 Operators are expected to keep information about the identity of people who make postings on the site, and about the postings.160 They should make the information available to ASIC if it is requested.161 The IDS operator is expected to regulate itself in these areas, and by supervision and exclusion, the conduct and speech of those making postings.
Interim Policy Statement 162 provides a regime of voluntary disclosures and warnings which allows IDSs to operate without a licence, provided that “the postings do not involve the offer of any securities product or advice, and otherwise comply with the guidelines”.162 Those who wish to offer professional securities advice or securities for sale must obtain a licence.163 The regime implemented by Interim Policy Statement 162 has not been followed up by further policy proposals, and it occupies a rather uncertain status in terms of Australian financial regulation. It provides an interesting example of a regulator attempting to change behaviour by influence and exhortation and the latent threat of licensing. It is ‘soft’ regulation rather than legislative or administrative ruemaking.
Clearly these expectations are given motivating force by the latent threat of having to acquire an advisor’s license. Nevertheless, they involve little regulatory activity by the state, in contrast to more traditional forms of regulation, placing much of the burden of accomplishing regulatory outcomes on the IDS operator itself.164 This approach treads a middle path between the relative freedom to do both harm and good enjoyed
157 Note 152 at 17. 158 Note 152 at 17. 159 Note 152 at 18. 160 Note 152 at 18. 161 Note 152 at 18. 162 ASIC, loc cit. 163 Pt 7.3, Div 1 Corporations Act. The regime proposed by IPS 162 is for discussion of securities matters between non-professional investors. 164 ASIC even goes as far as to acknowledge that IDSs may be taking on the role of “de facto regulators”, n 152 at 18.
34 by IDSs in the US, and the full panoply of licensing as an investment advisor which would likely provide greater investor protection, but chill all IDS activity.165
(d) Electronic Selling of Other Financial Products - Compulsory Superannuation Choice and Online Calculators. As already discussed Australia has a single market integrity regulator, and as well as a single license regime for providers of financial services, this structure also makes a single regime of offer and disclosure documents possible. So, with the exception of corporate securities and listed managed funds for which a prospectus is still used, when any other financial product is recommended the customer must receive a Financial Services Guide, a Statement of Advice and a Product Disclosure Statement.166 It has been an important part of online investing regulation in Australia to develop policy for electronic disclosure documents and application forms for these other types of financial products as well. The overarching approach has been to bring the regulation into line with that developed for electronic prospectuses as much as possible.167 In Australia this has been given particular prominence, because of the introduction of investor choice in compulsory superannuation which will come into effect in July 2005.168
Much superannuation sold in Australia is really a life insurance linked investment – there is a relatively small component of life insurance but this has an important impact on price, on the disclosures that must be made by the investor and hence on the
165 The regulation of IDSs is not the only area in which ASIC relies on voluntary or near voluntary codes of conduct. This is much more general, ASIC Policy Statement 183, Approval of Financial Services Sector codes of Conduct, 25 February 2005. But ASIC and other Australian bodies have made particular use of this technique in relation to digital economy matters: Australian Treasury, Internet Code of Conduct (May 2000, www.ecommerce.treasury.gov.au); Building Consumer Sovereignty in Electronic Commerce: A Best Practice Model for Business (May 2000; www.ecommerce.treasury.gov.au ); ASIC, Revised Electronic Funds Transfer Code of Conduct (April 2001), www.asic.gov.au
166 D. Kingsford Smith, ‘Is Due Diligence Dead? Financial Services Disclosure Under the Financial Services Reform Act 2001’ (2004) 22 Company & Securities Law Journal 128-150.
167 ASIC, ASIC Policy Proposal, Electronic Applications for Life Insurance and Superannuation Products, October 2000, 23. 168 Superannuation Legislation Amendment (Choice of Superannuation Funds) Act 2004 (Cth).
35 electronic format of the disclosure and application documents. It is more important in the sale of superannuation to ensure that the identity of the investor filling in the application form is authentic, and also that they understand the obligations of life insurance disclosure and the significance of misrepresentation and omission, than it is for securities. ASIC has been concerned that in an electronic application the common understanding of the gravity and legal significance attached to a written signature may be absent, and that a customer using this method may not comprehend that they are legally responsible for the information they supply.169 This could lead to carelessness in the provision of the information, and later disagreement as to the substance of what was provided.
The questions of authenticity of the investor’s identity and accuracy and completeness of their disclosure have become entangled in the wider difficulties of customer identity verification in the financial services sector in relation to financial terrorism and money laundering. It was initially contemplated that a wholly electronic application could be made for superannuation interests by supplying personal details and payment instructions and requiring the customer to press an electronic button to acknowledge a ‘duty of disclosure’ warning and accept responsibility for the information included in the application form. Though other methods of customer identification, such as digital signature, password or personal identification number offer greater certainty, they also require a pre-existing customer relationship, and undermine the aim of facilitating a wholly electronic application.
Bringing in wholly electronic applications has recently become more difficult with the extension from bank to broker accounts, of the account signatory verification of identity procedure. The Financial Transaction Reports Act 1988 which requires these procedures in relation to bank accounts,170 has since October 2001 been supplemented by Australian regulations to implement the counter-terrorism measure United Nations
169 ASIC, ASIC Policy Proposal, Electronic Applications for Life Insurance and Superannuation Products, October 2000, 25. 170 This legislation is administered by the Australian Transactions Reports and Analysis Centre (AUSTRAC), and the identification records procedure approval power is section 20A, in particular 20A(b)(ii). See also AUSTRAC Guideline No 3, January 2002. While the director of the agency appears to have the power to approve non-paper based identification verification procedures, this has not been used.
36 Resolution 1373.171 Consequently in Australia all initial non-advisory financial product sales are what might be called ‘mixed media’ – they involve the availability of the product disclosure statement and application electronically, but an application can only be made by printing out the application form, signing it and posting or faxing it to the product provider. This seems to be in contrast to the means that have been found in the US to satisfy the verification of identification under the USA PATRIOT ACT 2001,172 by the use of Taxpayer Identification Numbers, Social Security Numbers or Employer Identification Numbers. As far as it is possible to tell from a user’s perspective, when these details are furnished in the electronic application forms for mutual fund shares say, an application may proceed entirely online.173
This brings us to the last comparative observation. It concerns the use of online calculators and risk profilers in the sale of managed financial products such as mutual fund shares (called managed funds in Australia), superannuation interests and other retirement income funds. To the extent that someone just visiting a provider’s website can tell, not only is it possible to purchase interests in managed financial products completely online in the US, but it is possible to do so in one series which moves straight from an online risk profiler through to the product application form.174 It is also possible to make use of other tools that are more in the nature of a product suitability questionnaire and again move seamlessly through to the product application form.175 This is not possible in Australia. Such calculators or questionnaires as are provided are purely for planning or the preliminary assembly of information.176 They do not allow the customer to move straight from the 171 Charter of UN Anti-terrorism Regulations 2001, 15 October 2001. These regulations are seen as something of a temporary measure. The Australian Treasury has announced that it is working to update the Financial Transaction Reports Act 1988 and brokers are expecting changes to be announced this year that will extend the act to the opening of brokerage (not just bank) accounts. 172 Section 326 Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT ACT) Act 2001; Section 5318 of title 31 USC. Also 31 CFR 103 paras 120-175, especially para 103.22 Customer Identification Programs for Broker-Dealers. 173 Eg Vanguard Group Inc mutual funds at https://flagship2.vanguard.com/VGApp/hnw/NAWizardController?WFEvent=evNext (visited 30 March 2005). 174 Eg: Vanguard Group: http://flagship3.vanguard.com/VGApp/hnw/FundFinder? FW_Event=Input&NavStep=5&at=TAXD&ia=1 (visited 30 March 2005) 175 Eg: Vanguard Group: https://flagship3.vanguard.com/VGApp/hnw/FundsInvQuestionnaire 176 Eg: AMP Limited superannuation calculators: http://www.amp.com.au/au/3column/0,2338,CH6357%255FNI10706%255FSI56,00.html http://www.amp.com.au/au/3column/0,2338,CH5157%255FNI9665%255FSI56,00.html
37 questionnaire or calculator, to the product application form. In any case, the application form must be printed out and sent.
The most important legal reason for this difference has to do with the Australian suitability rules,177 by comparison with those in the US.178 It seems that in the US initially it was thought that if a customer could input investment goals and personal information, with the tool displaying a list of investments that the customer might buy, then that was likely a ‘recommendation’ which triggered the broker’s suitability obligation.179 However very recently this situation has changed, with the approval by the SEC of a new interpretation of rules governing communications with the public. This change which came into effect in February 2005 for NASD brokers, does allow brokers to offer customers online investment analysis tools, under certain conditions which mostly relate to disclosure.180 While this change in permitted communications with the public has been approved, it seems to leave for future consideration just how the suitability rule will apply to what seems still to be a ‘recommendation’. Indeed the rule change specifically states that a broker that offers an investment analysis tool under the new interpretation, will have to ensure that they comply with the suitability rule and other relevant securities regulation.181
In Australia there is beginning to be pressure for permission to offer more sophisticated online investment analysis tools. This is coming not only from brokers, but from superannuation trustees, trying to respond to the competitive pressures arising from the arrival of superannuation choice.182 However there are some significant questions to answer before such tools can be offered. The Australian 177 Sections 766B(3), 944A and 761G Corporations Act 2001. 178 Found in interpretations of SEC Rule 10b-5 and in the rules of various Self Regulatory Organisations: NASD Rule 2310; NYSE Rules 405 and 476(a). 179 Taking the NASD rules as an example: N Liblin & J Wrona ‘The Securities Industry and the Internet: A Suitable Match?’ 2001 Colum.Bus. L.Rev 601-681 at 654-5; NASD notice to Members 01-23 Suitability Rule and Online Communications, 03/19/2001, text surrounding endnote 15; NASD Conduct Rule 2210 ‘Communications With the Public’ especially rule 2210.(d)(1) and 2210.(d)(2)(N). Also discussion in H M Friedman Securities Regulation in Cyberspace (2004 Aspen) at 16-28 to 29. For further comment see report from the staff of the Commission, SEC Office of Compliance Inspections and Examinations, ‘Examination of Broker-Dealers Offering Online Trading: summary of Findings and Recommendations’ 25 January 2001: http://www.sec.gov/news/studies/online.htm 180 On 28 September 2004 the SEC approved an NASD Interpretive Material (IM) to rule 2210, designated IM-2210-6. It came into effect on 14 February 2005. Announced in NASD Notice to Members 04-86, November 2004. 181 NASD, IM-2210-6-(a).
38 position on the suitability rule is still rather undeveloped in relation to online securities transactions. The suitability rule is often thought not to apply at all because the medium is supposedly non-advisory.183 However the Corporations Act 2001 does require there to be a reasonable basis for personal advice where the provider of the advice ‘has considered one or more of the person’s objectives , financial situation and needs…or a reasonable person might expect the provider to have considered one or more of these matters.’184 The provision of personal information by a customer in an online questionnaire or calculator would seem at least to raise a reasonable expectation that the information has been considered by the broker.
If it is accepted that there are communications between online brokers and their customers, and that these may amount to personal advice,185 then there are further questions to deal with. The Corporations Act 2001 requires a statement of advice to be given to all retail customers to whom personal advice is given.186 It is difficult to see how this would be accomplished in the online mode, unless the reports that are produced by the investment analysis tool could be considered sufficient. Another difficulty is it is likely that disclaimers will be less effective in Australia in removing the implication that the report of an online calculator is a recommendation or amounts to personal advice. A condition in a contract for the acquisition of a financial product will be void if it requires that a party waive compliance with any section of the Corporations Act 2001 which deals with the provision of personal advice, including the suitability requirement.187 Any disclaimer will have to be drafted with great care, so that it is not considered to be such a waiver. In conclusion then, it seems most
182 ASIC Information Release 04-17 ASIC Provides Guidance on Superannuation Calculators, 4 May 2004. 183 This seems to be the view of Australia’s leading securities law text: R Baxt, A Black and P Hanrahan, Securities and Financial Services Law, (Lexis Nexis Butterworths, 6th ed, 2003) at 427. It is also a view that was held by some in the US as well in the late 1990s: L Unger, On-Line Brokerage: Keeping Apace of Cyberspace (SEC, 1999), pp 27-30, where brokers consulted in the preparation of the report argued that the suitability rules did not apply. 184 Sections 766B(3)(a) & (b) and 944A and 945A Corporations Act 2001. 185 N Liblin & J Wrona ‘The Securities Industry and the Internet: A Suitable Match?’ 2001 Colum.Bus. L.Rev 601-681 at 640-41. 186 Sections 766B(3), 944A, 946A&C, 947B Corporations Act 2001. See also D. Kingsford Smith, ‘Is Due Diligence Dead? Financial Services Disclosure Under the Financial Services Reform Act 2001’ (2004) 22 Company & Securities Law Journal 128-150. 187 Section 951A Corporations Act 2001.
39 unlikely that online questionnaires and calculators will be made more generally available in Australia, until these questions have been considered further.
IV. The Future: the Same but Different? This paper has considered online investing, where US technology and business practices have been very influential in Australia. There is close identity in the services on broker sites as well as in the providers of financial information. The online services offered, the structure of transactions, the terms of customer contracts and the intensity of advertising are all very similar.
Many of the problems which have been identified and which are diminishing as the market matures, are also shared. There have been improvements in site disclosure, operating capacity difficulties, investor knowledge and education as the online market has developed. There is still work to be done in all these areas and in the area of securities fraud and market manipulation, but the general shape of the problems is understood, even if not all agree on the regulatory responses to them.
Another area where there are considerable similarities in online means must just be mentioned. Like the US, the role of investor relations websites in Australian online investing is growing in importance.188 As in the US, the Internet has become a commonplace in the compulsory and voluntary disclosure by companies of corporate information of importance to investors and advisors.189 Indeed the ASX Corporate Governance Guidelines annexed to the ASX Listing Rules, several times recommends the use by Australian companies of their websites for corporate disclosure. The same is of course true of the use by US companies of their investor relations websites, especially since Sarbanes-Oxley.
188 E. Boros, The Online Corporation – Electronic Corporate Communications, Discussion Paper (Centre for Corporate Law and Securities Regulation, 1999). 189 Eg all of the top 20 Australian listed companies (indeed many more than the top 20) have investor relations websites including key financial information on the company, company reports and presentations, extensive FAQ about the company’s products, services and other operations. Some companies include webcasts, image libraries, links to online services. The ASX AUSTRALIAN STOCK EXCHANGE CORPORATE GOVERNANCE COUNCIL, PRINCIPLES OF GOOD GOVERNANCE AND BEST PRACTICE RECOMMENDATIONS (March 2003) assumes that all listed companies will have a website in order to properly discharge some of the disclosure obligations that the Principles impose.
40 While the similarities are many, the differences though fewer are telling. They evidence parallel, but different responses of national legal systems, to very similar underlying technological and financial structures and processes. It is not so much a case of legal transplants, as one of similar legal systems responding differently to substantially identical online investing systems. The differences are not dramatically different, as one might expect from legal systems that share many background assumptions. As one might also expect from securities regulation regimes that have much in common, as well as being encouraged towards convergent standards and practices by transnational bodies such as IOSCO.
What sense can we make of these differences? The most obvious is the greater room for regulation of information providers and investment advice, enjoyed by Australian financial services regulators. This is obviously a result, of historical and constitutional differences, and not chiefly to do with financial regulation. The US financial regulators have demonstrated an equal willingness to regulate the provision of financial advice as have Australian regulators, but have been constrained by constitutional jurisprudence. So the more restrictive approach in Australian financial regulation is not so much a product of conscious financial regulatory policy, but constitutional accident.
A very similar analysis explains the Australian ‘soft’ regulation of ISDs. Whereas constitutional difficulties make the prospect of such regulation more difficult in the US, it is not from this direction that the constraints on licensing ISDs emerge in Australia. Rather, the use of a ‘soft’ regulatory regime is a clever accommodation of the regulatory imperative to protect investors while recognizing the benefits of general advice which can be gained from such sites. In using the ‘mere conduit’ exception to route around the licensing requirement, ASIC has also recognized the need for a light hand in regulating emerging technology where the balance of benefits and burdens remains unclear. This approach also avoids the tremendous difficulties of ‘fit’ in conforming an ISD to the current licensing regime, which has been developed with full service brokers and advisors in mind. The ‘soft’ regulation approach probably also comes more easily to Australian regulators as the ‘Of Manners Gentle’ characterization of Australian regulation generally would suggest. There are plenty of
41 examples of such ‘soft’ regulation in Australia in all of the aspects of standard setting, supervision and enforcement aspects of regulation.
But how does one explain the caution in relation to new developments in areas such as electronic prospectuses and online applications for securities and other financial products such as superannuation, in Australia? It is likely there are several reasons. Firstly, the emphasis on private personal financial provision has grown steadily in Australia in the last two decades, and is most obvious in its policy of compulsory private superannuation. This is a change from the post-world war II period when there were higher levels of government provision, and many people owned only their own home. This means that there is a particular public interest in regulating for investor protection, while at the same time working towards ‘self-responsibilisation’ of the investor. The latter is a very long-term regulatory project. Steps such as reducing the scope of regulated general advice and allowing greater access to investment analysis tools by ordinary investors will only occur with the growing financial capability of the population.
Secondly, although Australia was early in the adoption of the electronic prospectus, it has developed the electronic capacities of the document in a fashion that reflects a less experienced investor population. It is probably true that Australian regulators are less sanguine about the capacity of investors to sift credible information from superficially attractive or even simply distracting features in prospectuses, and this has led to little consideration being afforded to the use of multimedia prospectuses. By contrast with the US where the recent securities offering proposals suggest the prospectus is no longer the primary document but first amongst equals, in Australia investor protective requirements continue the premier position of the prospectus. So for example, the only electronic linking permitted is from advertising to the prospectus. Likewise, the mandatory application form can only be accessed by first accessing the prospectus. Australian regulators have been keen to promote those aspects of the electronic prospectus which makes it more easily available and more searchable, and hence more useful than the paper document. From the same perspective the importance of the prospectus is also maintained in the policy reticence about using multi-media offering documents because they require software or Internet connections that many people do not have.
42 The emphasis on availability of disclosure documents, rather than their delivery, and the use of the Internet and other technology to ensure wide dissemination of a prospectus during the ‘exposure period’ of the issuing process, is all part of this approach. It is crafted to ensure that as much as possible, electronic access is provided in such a way that the investor receives the prospectus before or at the same time as the application form for the securities. Many of the same points might also be made in relation to the sale of superannuation and other financial products using electronic PDSs.
Finally, the differences of approach also have to do with variations in regulatory style and resources. For example, the greater use of non-adversarial techniques of regulation in dealing with online securities fraud is partly an historical matter, and partly a reflection of fewer regulatory resources available for prosecutions and for regulation more generally. ASIC is not a generously funded regulator given the very wide range of its supervisory responsibilities. It has placed emphasis on investor education and making available on its website good free generic financial advice. As a result although there is remarkable similarity between the US and Australia in their underlying online investing practices, and overall the regulatory response is similar, there are important variations. These reflect local Australian historical and constitutional, cultural and regulatory circumstances. The US example will undoubtedly remain an influential one. Over time, as general financial capability grows and there is greater access to the Internet and other technology, the reasons for regulatory caution may be fewer. Because Australians like computers, the Internet and investing online, ways will be found to accommodate regulation to changes in online investing practices. However, as they run so deep, differences of regulatory style and approach are likely to remain.
43