Du Val fails in High Court appeal

  • Legal update

    04 July 2022

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On Friday, the High Court declined to find an error of law in the direction by the Financial Markets Authority (FMA) to Du Val to pull advertisements published on social media and other online channels of wholesale investment offers on the basis that they had inappropriately targeted “inexperienced investors”.

A link to the FMA’s media release is available here.

Who needs to read it? Why?

This judgment is relevant to those who offer and advertise financial products or services (particularly, but not exclusively, to wholesale investors).  It also shows the approach the Courts will take to reviewing the FMA’s powers to make directions.  Further, it highlights how the Courts will determine whether promotional material is misleading or deceptive.

Background – Direction issued by the FMA

In September last year, the FMA directed Du Val to remove advertising materials that the FMA believed were likely to mislead or deceive investors, and therefore breached section 19 of the Financial Market Conducts Act 2013 (FMCA).  The FMA believed that Du Val’s promotion of its Mortgage Fund Limited Partnership (the Fund) led investors to think that investing in property development-related financial products was low risk.

Wholesale investor exclusion

Du Val had used the wholesale investor exclusion in the FMCA when making its offer to invest in the Fund, which relieves an entity from having to provide a product disclosure statement. This exclusion, according to the FMCA, is “designed for investors considered highly experienced and/or well-resourced”, for example investment institutions.

The FMA was concerned by Du Val using social media and other online channels for promotional purposes, as this meant the offer was potentially attracting non-wholesale investors. The FMA has been monitoring the use of the wholesale investor exclusion since early 2021 as more inexperienced investors have been developing interest in a variety of offers (that they are perhaps not as well equipped for), given increasingly modest returns on low-risk investments such as fixed-term deposits. The FMA stated that it is becoming concerned about wholesale offers spreading to mainstream advertising, and that it expects entities relying on the wholesale exclusion to take note of the direction to Du Val, and consider their marketing practices carefully.

Red flags in promotion

The FMA took issue with statements such as “providing investors with a level of certainty hard to come by in this market,” “high security and high return,” and “the best of both worlds in terms of security and return”.  The FMA’s view is that property development is an inherently risky area of investment, and on this basis the advertisements were misleading.

The direction further required that promotions of the mortgage fund should not use statements that there were “no fees” attached to investment, as Du Val receiving 100% of all profits above the 10% fixed return to investors was in effect a performance-based fee.  The FMA also directed that advertisements for the Fund must not contain inappropriate comparisons to term deposits, bank deposits or other low risk financial products.

Du Val complied with the direction but decided to test its legitimacy in court.

The High Court decision

Du Val failed to convince the High Court that its online promotions did not breach the “fair dealing” provisions of the FMCA and therefore the FMA’s direction was borne out of an error of law.  The questions of law the Court addressed were as follows.

Test for whether material is likely to mislead and deceive, and whether the FMA applied this correctly

The Court found that the correct approach to determining whether an advertisement is likely to mislead or deceive firstly requires identification of the target of the representation.  This can be the public at large or a particular class of persons. In both cases outliers are to be excluded. Next, the standard of care that can reasonably be expected from the target group (and therefore their vulnerability to being misled and deceived) is to be assessed with regard to all the circumstances, taking into account the characteristics of the group.

The Court concluded that the FMA did in fact identify the relevant class of potential investors by stating in its direction that the representations were targeted to inexperienced investors, and by rejecting the idea that wholesale and experienced investors could be equated.  The Court added that identifying the target for representations is a factual question for the FMA, which can only be challenged as an error of law if “clearly insupportable”.

When determining the characteristics of the target group of consumers, and thus the standard of care that can be expected of them, the Court found that the FMA was entitled to reject Du Val’s submission that wholesale investors are “inherently more sophisticated than others,” and that large investors who do not fall within the same category are not.  The Court said that it may be correct that unsophisticated or inexperienced wholesale investors should not be disregarded as outliers (therefore irrelevant to the test), so it was open to the FMA to conclude that at least some unsophisticated wholesale investors should be included in an assessment of the target group.  The inclusion of these unsophisticated wholesale investors in the target group gives a basis for the FMA’s conclusion that the promotions could be misleading and deceptive, so again the Court concluded there was no error in law in the direction.

Can retained profit properly be characterised as a ‘fee’?

The Fund allowed Du Val to retain 100% of profits over the 10% pa return promised to investors.  Du Val submitted that the claim that there were “no fees” would not mislead the reasonable wholesale investor into Du Val would not retain profits. The FMA argued the right to retain profits amounts to a fee, and that its interpretation of ‘fee’ is a broad one.

The Court did not find that the Financial Markets Conduct Regulations 2014 assisted on this issue, but that whether it was misleading to potential investors was a question of fact.  The Court concluded that since this is not a case where there is no evidence to support the FMA’s determination, or the only reasonable conclusion contradicted their decision, it was not for the Court to impose its own view.

Our view

Although the FMCA does not prohibit advertising an offer limited to wholesale investors widely, the FMA is clearly signalling that it will apply close scrutiny under the fair dealing rules where this is the case.

The FMA is also clearly focussed on how financial services businesses talk about the risks of their products and services, particularly where comparisons are made to other products (such as bank deposits).  Comparisons must be apples to apples.

This fits within the wider concepts discussed in the October 2021 guidance published by the FMA on the advertising of financial products. That guidance, although primarily directed at retail offers, states that if an offer is only available to wholesale investors the advertisement should make it immediately and prominently clear that it is not suitable for retail investors.

In March of this year, direction orders were also issued to Simplicity on the basis that the advertising of its KiwiSaver Fund was likely to mislead and deceive.

Together, these items make clear that the FMA is focussed on both retail and wholesale markets.

What next?

If you have any questions in relation to the FMA’s supervision of entities offering financial services and products please contact one of our experts.


This article co-authored by Elise Plunket, a Law Clerk in our Financial Services team.