Businesses need to consider whether their sales incentive and reward structures are driving the right behaviours with regard to compliance, writes Professor Pamela Hanrahan.

    Some businesses seem destined, by design, to break the law. Collapsed financial services firm Forex Capital Trading (ForexCT) — which sold risky contracts for difference and margin foreign exchange contracts to unsophisticated clients — arguably falls into that category. In June, civil proceedings brought by the Australian Securities and Investments Commission (ASIC) against ForexCT and its sole Australian director were finalised by consent, with the imposition of a $20m penalty on the company for breaching financial services laws. ForexCT director and CEO, Shlomo Yoshai, was also ordered to pay a $400,000 civil penalty and disqualified from managing corporations for eight years. The penalty was for aiding ForexCT’s unconscionable conduct and breaching his statutory duty of care under section 180 of the Corporations Act 2001 (Cth).

    The settlement in Australian Securities and Investments Commission v Forex Capital Trading Pty Limited [2021] FCA 570 is significant in the developing jurisprudence around directors’ duty of care. It signals a willingness by ASIC and the courts to hold a CEO to account where inappropriate remuneration structures and inadequate staff training and compliance monitoring arrangements created an unacceptable compliance and conduct risk for the business.

    ASIC’s negligence case — admitted by Yoshai and accepted by Justice John Middleton in the Federal Court — proceeded on the basis that Yoshai’s responsibilities included management and oversight of the day-to-day operations of ForexCT and management of its obligations as a financial services licensee. It was agreed that a reasonable person in Yoshai’s circumstances would have known that ForexCT was subject to laws that would likely be contravened by the company’s conduct towards its clients and that there was a real possibility that ASIC would take regulatory action in relation to any contraventions.

    On this basis, Yoshai admitted that he “failed to exercise a reasonable degree of care and diligence and thereby contravened s 180(1)” of the Corporations Act in three respects. First, he authorised and implemented “remuneration structures and financial incentives for [staff] which focused on and encouraged the achievement of individual key performance indicators and targets, in particular in relation to the quantum of [sales], and did not promote compliance with legal obligations and requirements”. Second, he allowed and oversaw “the implementation of inadequate or inappropriate training materials” for staff. Third, he authorised “a compliance monitoring program that was inadequate to ensure that ForexCT provided financial services in accordance with its legal obligations”.

    Yoshai further admitted that “his conduct gave rise to a risk that ForexCT representatives would engage in conduct in contravention” of financial services laws and that “by reason of a failure to exercise adequate care and skill, [he] failed to appreciate that such conduct would jeopardise ForexCT’s interests by creating a real risk” of enforcement action by ASIC. In the circumstances, Yoshai “exercised his powers of management in a way that jeopardised ForexCT’s interests”. This behaviour was inconsistent with the standard, expressed by Justice Thomas Thawley in the full Federal Court in Cassimatis v Australian Securities and Investments Commission [2020] FCAFC 52, that executive directors have “a duty to exercise the powers of management of the company and its business in a manner which did not jeopardise the company’s interests”.

    Risky remuneration

    In the ForexCT case, sales drove everything. It was conceded that “The trading floor culture... [was] directed towards maximising client deposits and trading volume: for instance, a bell or gong was rung when clients deposited funds of certain amounts into their trading accounts, and account managers could participate in incentive games such as ‘wheel of fortune’ roulette tables and dice games to win cash if certain client deposit targets were met”.

    Such skewed incentives for frontline staff can give rise to unacceptable compliance and conduct risks. This includes risks that the business will behave illegally or unethically in its dealings with customers. The 2019 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry belled that cat, with recommendations 5.1–5.5 all dealing with remuneration design in financial institutions. These included a recommendation that, “All financial services entities should review at least once each year the design and implementation of their remuneration systems for front line staff to ensure that the design and implementation of those systems focus on not only what staff do, but also how they do it.”

    In the ForexCT case, the defendants and the court accepted that it was negligent of the CEO to adopt a remuneration structure that incentivised sales without due regard to compliance. Poor staff training and an inadequate compliance monitoring program compounded the risk.

    Stepping stones

    The ForexCT case develops the thinking we saw in the majority judgment in the 2020 Cassimatis case against the executive directors of Storm Financial. In both cases, the court found that poor management decisions exposed the company itself to an unacceptable risk of harm — that the company would contravene the law and be punished by the regulator for doing so.

    It is not enough to show that something could have been done to avert the harm; the question for the court is what a reasonable director would have done at that time.

    Unlike Cassimatis, the ForexCT case was settled by the parties by agreement, with Yoshai accepting for the purpose of ASIC’s action that he aided the company’s unconscionable conduct and was negligent in designing and implementing the remuneration structures, the staff training program and the compliance monitoring systems at ForexCT. The legal issues were not explored in depth by Justice Middleton. Nevertheless, in imposing the penalty on Yoshai, his Honour needed to satisfy himself that the breach of s 180 of the Corporations Act was made out.

    To establish negligence in such a case, ASIC must show that a director acted (or failed to act) in a way that exposed their company to a foreseeable risk of harm and that a reasonable person in the director’s position — in those circumstances and having the office and responsibilities they held — would have acted differently. It is not enough to show that something could have been done to avert the harm; the question for the court is what a reasonable director would have done at that time, answered without the benefit of hindsight.

    How to incentivise and reward frontline staff is an issue for every customer-facing business, not just financial services firms. The ForexCT case suggests that all businesses need to think carefully about whether the structures they put in place are driving the right behaviours. Where poorly designed remuneration, training and compliance systems create a foreseeable risk of compliance or conduct failures in the business, the individuals responsible for creating them may be held to account.

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