Background

In July 2022 ASIC commenced civil penalty proceedings alleging that Lanterne had failed to meet its risk and compliance obligations.

Lanterne runs a "licensee for hire" business where it authorises companies and individuals to operate as corporate authorised representatives (CARs) and authorised representatives (ARs) under its AFS License. During the relevant period, Lanterne had approximately 62 to 69 CARs operating under its license, and approximately 134 to 205 ARs with a total of AUD 1.658 billion funds under management. Specifically, ASIC alleged that Lanterne breached its general obligations as an AFS license holder pursuant to s 912A of the Corporations Act 2001 (Cth) ("Corporations Act"). This included failure to:

• Maintain adequate risk and compliance and management systems
• Document its processes for identifiying and assessing risks
• Have sufficient human resources with the appropriate knowledge, skills and qualifications
• Take reasonable steps to ensure its representatives were adequately trained and complied with financial services laws
• Provide financial services efficiently, honestly and fairly.

While Lanterne acknowledged these breaches, there remained a dispute over the appropriate quantum of the penalty to be imposed on the company.

The impugned conduct

Insufficient risk management systems

Section 912A(1)(h) of the Corporations Act requires Lanterne to have adequate risk management systems. This includes developing a framework within the business and implementing tools that can regularly identify and respond to regulatory risks. In breach of this obligation, Lanterne did not have sufficient employees with risk management experience and failed to identify and document risks relating to its ARs and CRAs. The evidence showed that it conducted no real due diligence on prospective representatives nor did it independently verify any of the information provided to it, it relied solely on self-reporting from CARs and ARs.

Insufficient organizational competence

Section 912A(1)(e) and (f) of the Corporations Act requires AFS Licensees to have sufficient competence and to ensure its representatives are adequately trained and competent to provide financial services. Lanterne relied on one responsible manager (their sole director) who had no formal qualifications in risk management. Lanterne also failed to provide any training to its representatives or properly verify their competence.

Failure to ensure representatives' compliance

Section 912A(1)(ca) of the Corporations Act provides that AFS licensees must take reasonable steps to ensure representatives comply with financial services laws. This may be contravened without proving that any financial services law has, in fact, been breached. In this case, Lanterne failed to design and maintain an effective system to monitor its representatives. It failed to document and conduct due diligence or internal audits on its representatives, relying solely on their self-assessments.

The case for pecuniary penalities

The main dispute at hand was the quantum of the pecuniary penalty to be imposed on Lanterne. This comes from the courts power pursuant to s 131G(1) of the Corporations Act to issue such penalties.

While ASIC argued that a AUD 1.5 million penalty should be imposed, the Federal Court concluded that a penalty of AUD 1.25 million was appropriate. In doing so, Justice concluded that Lanterne's conduct was "comprehensive", "serious" and "systematic". In making this conclusion the court considered:

• Lanterne's continued failure to address and remedy any of its admitted contraventions
• The inadequacy of Lanterne's risk and compliance management systems (using undocumented processes to monitor its representatives, minimal human resources, lack of due diligence etc.)
• The potential to significantly harm consumers based on the fact that the CARs and ARs operating under Lanterne's AFS license had up to AUD 1.685 billion funds under management across a variety of industries; however
• The court did recognise Lanterne's co-operation with the proceedings and its agreement to implement a compliance regime imposed by the court.

Key takeaways

This case warns AFS License holders about the continuous nature of its risk and compliance obligations. ASIC's Commissioner, Alan Kirkland, commented on the significant penalty imposed, stating that it is "vital for the protection of consumers and investors that licensees take their compliance obligations seriously". Importantly taking those compliance obligations seriously means have the necessary systems, processes, procedures and expertise to monitor and supervise those representatives.

In answer to our question, whilst we would like the answer to be 42, the calculus for the number of Authorised Representatives depends on the circumstances and must take into account the overall control framework and the diversity of the conduct of the representatives. Where representatives are providing a range of financial services across a range of financial products the expertise, control framework and supervision must match that diversity of conduct.

Other takeaways to note:

• ASIC has clarified its expectation of AFS licensees to monitor its CARs and ARs, this includes ensuring adequate training is provided, conducting independent due diligence and maintaining oversight over its representatives.
• Courts are more likely to impose higher pecuniary penalties when there is a greater risk of harm to consumers based on the amount of funds under management by its representatives.
• The court found it unnecessary to determine whether Lanterne or its responsible manager's conduct amounted to recklessness and instead focused on whether the evidence showed that AFS license obligations were "effectively ignored".
• The court considered that it is of "highest importance" to impose a pecuniary penalty sufficient to deter other "license for hire" businesses from engaging in similar conduct.