The law of best interests duty

Many financial services providers (referred to below as "providers") are subject to a statutory obligation to act in the best interests of their clients. Such a requirement applies to:

• The responsible entity of a registered managed investment scheme (MIS) — the obligation is owed to the investors in the MIS¹;
• The trustee of a superannuation fund — the obligation is owed to the beneficiaries of the fund²;
• A financial adviser providing personal financial product advice to retail clients — the obligation is owed to the client³.

These statutory obligations also apply expressly to the directors of providers that are issuers of an MIS or a superannuation fund. While the directors of a provider that provides financial advice are not expressly subject to a corresponding statutory best interests oblig-ation they can incur derivative liability in relation to breaches of the obligation by the provider. It should also be borne in mind that all company directors are subject to a best interests obligation owed to the company⁴.

Providers that provide financial advice have the benefit of a statutory "safe harbour" pro-
tection in relation to their best interests obligation which is not available to other providers⁵. However, this protection is not available when they provide taxation advice and is also subject to a "catch all" provision which largely undermines the value of the protection.

Failure to meet these statutory require-ments can have considerable adverse conse-quences for the provider. So, what exactly does it mean to act in a person's best interests?

The meaning of "best interests"

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Taken literally, the best interests obligation imposes a very high obligation on any person subject to it. Not only must the provider know what the interests of the client are, they must also determine which of them are the best and then act in those best interests. Meeting such requirements would appear to require both omniscience and prescience.

However, in a legal context the best interests obligation is a statutory expression of a duty that has existed under the general law (particularly the law of trusts) for a considerable period of time and has, accordingly, acquired a distinct legal meaning. The courts have looked at the expression in the context of the activities that it relates to rather than its literal meaning. This has resulted in a legal meaning for the express-ion that is considerably less exacting and far more practical than the literal meaning.

It is first useful to consider each word of
the expression in isolation before considering them as a whole and within the financial services context.

What are the interests of the client?

A client will potentially have a wide range of interests. The legislation acknowledges this by expressly referring to interests in the plural.

Do all of a client's interests then need to be identified? Most clients would have an interest in improving their financial position or having a financially secure retirement but they may also have any number of other interests such as:

• Access to particular product features;
• Providing for their relatives and dependants;
• Increasing their financial education and confidence levels;
• Managing risks and returns;
• Improving or maintaining their health;
• Involvement in sport, cultural activities and hobbies; and
• The advancement of particular causes.

The potential range of interests is, therefore, huge and largely personal to the particular client.

The courts have recognised this difficulty and have, in relation to a financial services context, narrowed down the range of interests that need to be considered. For example, in the case of Cowan v Scargill⁶ Sir Robert Megarry V-C stated (in relation to a superannuation fund):

"When the purpose of the trust is to provide financial benefits for the beneficiaries…the best interests of the beneficiaries are normally their best financial interests."

Such a conclusion would appear to be equally applicable to a financial adviser so that the courts will normally confine their analysis to whether the provider has acted in the best financial interests of a client.

Doing your "best"

Not only must a provider act in the client's financial interests but it must also act in their "best" financial interest. The use of this word raises even more difficulties.

In the first instance it is difficult to see what, if anything, the word actually adds to the expression. That is, there does not appear to be much difference between a decision that was in a client's interests and one that was in the client's best interests. However, its inclusion in the expression does imply that a provider must do more than avoid harm to the client or merely improve the client's position.

Secondly, the word "best" is a superlative — there can (theoretically at least) only be one "best" result. Taken literally, the provider would need to find an objectively verifiable "perfect solution" for each client. It is not clear how a provider is to ascertain which of the client's interests are the best ones and the provider would, obviously, be subject to considerable risk of having this decision challenged on the basis of alternative opinions and with the benefit of hindsight.

In view of these problems the courts have also narrowed down this aspect of the obligation in order to give it some form of reasonable and practical operation. For example, in the Prime Trust case⁷ Justice Murphy stated (in relation to the responsible entity of a MIS):

"…the expression may be argued to indicate a requirement that the RE meet the ‘highest' standard rather than just a high standard. It may also be argued to set a requirement for the RE to obtain an objectively determined "best" outcome rather than requiring the best efforts of the RE. I am disinclined to such a view because such meanings may cause real difficulties for a trustee in performing his or her role. It is not clear to me how in many common circumstances the "highest" standard is to be determined let alone met, or how any requirement to achieve an objectively determined ‘best' outcome sits with the general law obligation on a trustee to act with care, competence and caution."

His Honour further stated that:

"I do not though wish to be seen as accepting the proposition that to act in the members' best interests a trustee must actually achieve the best outcome…"

The expression as a whole

Beyond what has been discussed above, the courts are reluctant to provide specific guidance - preferring to decide only those issues that arise in the particular case before them. For example, in the Prime Trust case Justice Murphy held that the provider had not acted in the client's interests at all so it was not necessary to identify the "best" interests.

It can be seen that the courts will give a meaning to the best interests obligation in a financial services context that is considerably less exacting than the literal meaning of the expression and the following propositions are relatively clear:

• The obligation is foundational rather than overarching and operates in conjunction with other legal duties. A provider needs to consider a client's best interests as one part of the set of obligations which are owed to the client.
• The obligation is clearly applicable to conflict of interest situations and requires the client's interests to be preferred over those of the provider⁸.
• The obligation applies to the making of a decision by the provider and not on the outcomes of a decision.
• It is an objective test. Acting honestly and to the best of the provider's ability is not sufficient if that conduct does not meet the standards of a reasonable person in the provider's situation.

Beyond that, the legal requirements for satisfying the best interests obligation can be considered to be an amalgam of two distinct obligations:

• The first (which is sometimes referred to as a duty of loyalty to the client) is to act in the financial interests of the client and ensure that the client's financial interests are paramount and placed ahead of the provider's own interests.
• The second is to pursue to the utmost (but with appropriate diligence and prudence) the financial interests of the client.

While this legal restatement of the oblig-ation is not without its own problems it provides a more practical and reasonable obligation on the Provider than the seemingly unachievable demands which result from a literal inter-pretation of the expression.

It should also be noted that Australian Securities and Investments Commission (ASIC) considers the best interests obligation for a financial adviser in its Regulatory Guide RG 175. ASIC's view is, essentially, that the adviser must reasonably believe that the client is likely to be in a better position if the client follows the advice⁹. While this view is consis-tent with the manner in which the courts have read down the best interest obligation it seems to go too far. Putting the client in a better position does not appear to be a particularly demanding requirement and, in my opinion, understates the obligation. Although the courts may have read down the expression they still insist on a high standard of conduct to the utmost of the adviser's ability.

David Court is a Partner of Holley Nethercote Commercial & Financial Services Lawyers.

¹ Section 601FC(1)(c) of the Corporations
Act 2001.

² Section 52(2)(c) of the Superannuation Industry (Supervision) Act 1993.

³ Section 961B(1) of the Corporations Act 2001.

⁴ Section 181(1)(a) of the Corporations Act 2001.

⁵ Section 961B(2) of the Corporations Act 2001.

⁶ [1985] Ch. 270 at page 295.

⁷ [2013] FCA 1342 at paragraphs 463 and 488.

⁸ All providers are now subject to statutory client priority rules to the same effect —
see, for example, section 961J of the Corporations Act 2001.

⁹ See paragraphs RG 175.224 to RG 175.231.

"It is not clear how a provider is to ascertain which of the client's interests are the best ones and the provider would, obviously, be subject to considerable risk of having this decision challenged on the basis of alternative opinions and with the benefit of hindsight."