Corporate Governance and Risk Management – The Importance of Disclosure For Regulated Financial Institutions

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Writing an article about how to write high-quality disclosure is risky business. What if the article is wrote no good?…… [Editor’s note.  We know this grammar is incorrect.  We get a kick out of the humorous juxtaposition of a grammar error at the beginning of an article on good writing.  If you keep reading, we promise the article gets more substantive.  In a perfect world, either we would not (1) have to explain our “jokes” or (2) tell jokes people don’t understand.  Sadly, we do not live in a perfect world.] 

In this article, we will share our thoughts on why good disclosure is so important and offer best practice suggestions.

BACKGROUND

We believe that all businesses are obliged to engage in “fair dealing”. While fair dealing is not a defined term, the Monetary Authority of Singapore (the “MAS”) uses the term when describing its expectations for how financial institutions should conduct business with their customers in the Guidelines on Fair Dealing – Board and Senior Management Responsibilities for Delivering Fair Dealing Outcomes to Customers (the “Fair Dealing Guidelines”). Though the Fair Dealing Guidelines only explicitly apply to financial advisers today, the MAS launched a consultation proposing to extend the Fair Dealing Guidelines to all financial institutions in December 2022. In addition, we think the Fair Dealing Guidelines are relevant to all financial institutions given the MAS’ expectation for a financial institution to be honest and have integrity pursuant to the Guidelines on Fit and Proper Criteria.

MAS GUIDANCE ON DISCLOSURE

The Fair Dealing Guidelines set out five fair dealing outcomes and explain why each outcome is important. Outcome 4 is that “customers receive clear, relevant and timely information to make informed financial decisions”. Among other comments, the MAS observed:

  • A financial institution should
    • ensure that disclosures to customers are:
      • in plain language and avoid the use of technical terms; and
      • presented in a format that is simple to read and easy to understand;
    • train its representatives to avoid the use of terms or phrases which some customers may not understand or convey a false sense of security.
    • present information in a fair and balanced manner, including highlighting all key risks of an investment product, the potential upside and downside of the investment, fees and
    • charges, important terms and conditions, rights and obligations of customers and early withdrawal penalties.
    • ensure that all marketing and advertising materials give a fair and balanced representation of the features and risk-reward characteristics of the products.
    • explain to customers the range of possible outcomes for the investment product, including the worst case scenario.
    • inform customers how they can provide feedback or lodge complaints about the financial institution or its representatives should provide information and updates about their investments after the sale has been concluded.
  • Important features and risks of an investment product should not be in fine print;
  • Advertising and marketing materials should not:
    • misrepresent or omit key product features and risks;
    • contains words or graphics that could convey an impression that is inaccurate or inconsistent with the nature or risks of the products

HM’S OBSERVATIONS

Especially in the fintech and digital asset industries, we think considerable improvement is needed with respect to disclosures given to customers.

Plain English

We think the United States Securities and Exchange Commission offers a good explanation of plain English in its “Plain English Handbook” (the “Handbook”):

Plain English means analyzing and deciding what information investors need to make informed decisions before words, sentences, or paragraphs are considered. A plain English document uses words economically and at a level the audience can understand. Its sentence structure is tight. Its tone is welcoming and direct. Its design is visually appealing. A plain English document is easy to read and looks like it’s meant to be read.(1)

We recommend the Handbook for practical tips on how to write in plain English. While plain English may not be suitable for legal agreements or a company’s terms of business, we think it is relevant for any materials that describe or advertise regulated activities, especially company websites.

Placement and Style

We have seen many examples of companies putting risk disclosures in fine print, in a font colour that is difficult to read against the website’s background and/or on a page of the company’s website that is rarely accessed by customers. We think those are poor practices for many reasons, including that it may suggest to regulators that fintech and digital asset businesses do not take fair dealing seriously and invite stricter regulation with unintended consequences that adversely affect good actors.

Example

A digital payment token (“DPT”) trading firm conducts regulated activities and shares a website with an affiliated company that conducts unregulated activities such as trading digital payment token derivatives. If the shared website contains multiple references to (1) being regulated and (2) the derivative trading offering, but only discloses the fact that the derivatives trading is conducted by an unregulated affiliate when you sign up, we think this can leave customers with a false impression about whether it trades in derivatives via a MAS-regulated entity.

To address this, we would add an asterisk next to references to DPT derivatives trading on every page of the website, with a footnote at the bottom highlighting that the activity is conducted by an unregulated affiliate.

Misleading Statements and False Impressions

We think it is critical for all companies, but especially regulated financial institutions given the higher stakes, to ensure that their websites contain no misleading statements (by omission or otherwise).

Example

A MAS-regulated business conducts the unregulated activity of lending money to corporations secured by the customer’s DPT holdings. As part of its selling proposition, the company highlights that it is a crypto liquidity provider that is a regulated entity in Singapore, despite the fiat lending business being an unregulated activity for which customers would not necessarily benefit from MAS oversight.

Our solution would be to reconsider all such disclosure and add a disclaimer clarifying that the lending business is unregulated.

Example

A DPT lending firm compares its interest rates to that of MAS-regulated banks. We think this is misleading disclosure given that the products have material differences.

Example

A crypto platform company says it is founded or headquartered in Singapore but does not highlight that the contractual entity facing the majority of, or all, customers is in another jurisdiction.

Example

We have seen multiple examples of firms suggesting a regulatory endorsement, such as that the firm is “officially approved” by a regulator or that a regulator is “highly supportive” of the firm in some respect. Although we cannot be certain that any of this disclosure is untrue, we are skeptical that a regulator would offer such endorsements. To quote Anson Zeall, a license “is like I have a driver’s license from the Land Transport Authority, but it doesn’t mean the [MAS] endorses me as a good driver”.(2) Moreover, the MAS recently emphasized “The most important lesson from the FTX debacle is that dealing in any cryptocurrency, on any platform, is hazardous”.(3)

We would caution businesses, especially licensed financial institutions, to be meticulous that anything they say about a regulator is true and complete in all respects and not misleading in any respect. The statements not only reflect on the regulator, it also is likely to have significant weight with customers.

CONCLUSION

Regardless of the above observations, good disclosure is an art rather than a science. Poor disclosure is usually not due to any malicious intent by the author. However, regulated financial institutions are judged by a high standard and must scrutinise their disclosures in order to meet their obligations to treat customers fairly.

HM helps financial institutions vet their websites and marketing materials to comply with the Fair Dealing Guidelines. That said, we know that legal and compliance advisors have a reputation for ruining marketing materials by being over-cautious or requiring too much legalese. You may feel reluctant to pay for an advisor who is going to pour cold water on all the marketing language on your website. That is a legitimate concern.

Our response is that you don’t have to follow our advice if you think the advice is unreasonable. Like any service provider, HM is not the final arbiter of what constitutes fair disclosure.(4)

We invite you to contact HM if you would like to explore how we can assist with reviewing your customer disclosures. While we would be happy to take you out for a coffee, please let us know in advance if you are contacting us to criticize HM or the article and the many ways it could have been written better. That reason entitles you to a dinner.

 

For further information, contact:

Chris Holland: Partner | chris.holland@hmstrategy.com

Disclaimer: The material in this post represents general information only and should not be relied upon as legal advice. Holland & Marie Pte. Ltd. is not a law firm and may not act as an advocate or solicitor for purposes of the Singapore Legal Profession Act.

 


(1) See Page 5 of the Handbook

(2) Taufiq Zalizan, Explainer: What is the MAS’ Investor Alert List and are crypto sites not on it considered safe? , Today, 23 November 2022

(3) See Paragraph 12 of MAS Statement to Address Misconceptions in the Wake of Collapse of FTX

(4) In our view, the final arbiter would be the courts of a relevant jurisdiction.

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