eToro and the picador - ASIC sues online investment platform for sale of CFDs

eToro is a popular investment platform in Australia, which ASIC is taking to Court over the relatively new "design and distribution" obligations (DDO) for distributing financial products in Australia*.

The case relates to contracts for difference (CFD) products, which ASIC considers a "volatile" investment product, inappropriate for most investors.

ASIC alleges that eToro's CFD target market was far too broad, its screening test was very difficult to fail and that the platform failed to do all things necessary to ensure that the financial services covered by its licence were provided efficiently, honestly and fairly.

ASIC's initiation of this case serves as a timely reminder to holders of financial service licenses that ASIC takes a keen interest in ensuring firms observe their DDO in providing financial products to consumers.

*These are prescribed under the Corporations Act 2001 (Cth).

Who is eToro?

eToro is a financial services company which provides a platform for users to trade in a number of assets including shares, commodities, exchange traded funds and CFDs. Founded in 2007, eToro has more than 32 million users in over 100 countries. The investment platform hit Australians shores in 2019 and from 5 October 2021 to 14 June 2023, it had approximately 30 thousand CFD clients.

What is a CFD?

For those unfamiliar, a CFD is a derivative financial product, which means its value is "derived" from another asset, for example a share, currency or commodity. This allows traders in CFDs to speculate on price movements of the assets from which the CFD derives its value. However, unlike shares, a CFD investor never actually owns the underlying asset.

Typically, CFD trading involves a consumer entering into a contract with a broker, whereby the parties agree to exchange the price difference between the opening and closing dates of the contract. Essentially, a consumer makes a leveraged bet on the future changes in the market price of certain assets. As such, this type of trading is complex, increases a consumer's market exposure and is not suitable for long term investment plans.

Obligations under the Corporations Act

Given the high risk and volatile nature of CFDs, in October 2021, DDO were introduced into the Act for CFD issuers to ensure its products are suitable for the relevant target market. The DDO regime, means CFD issuers must make a target market determination (TMD), which:

• describes who the product is appropriate for based on needs, objectives and financial situations;
• specifies any conditions/restrictions around how the product can be distributed to consumers; and 
• outlines how and when the target market determination will be reviewed. 

TMDs aim to protect inappropriate or unsophisticated consumers from trading in volatile products such as CFDs where they do not align with their investment objectives, sophistication and financial means. 

Let's dig a little deeper - ASIC allegation

eToro has now found itself in hot water after ASIC commenced legal proceedings in the Federal Court, alleging (amongst other things) that eToro breached its DDO under the Corporations Act. In particular ASIC allege that:
 

1.    eToro’s target market was far too broad

During the relevant period, eToro made three purported TMDs. Each TMD identified factors which determined whether a consumer fell within the target market. The factors included the consumer's risk appetite, trading experience, investment portfolio, and understanding of CFD risks and benefits.  The extent to which those factors were relevant to a consumer determined whether the person fell within eToro's target market for a CFD product.

ASIC alleges that if a consumer had a medium risk tolerance (tick) but had no understanding of the risks of trading CFDs (cross), was not an experienced investor (cross) and did not have a suitable level of income (cross), that consumer still fell within eToro's target market for a CFD product because the person met one of the determinants.   
 

2.    eToro’s screening test was wholly inadequate and difficult to fail >

Before consumers could acquire a CFD product, eToro required them to undertake a screening test to assess their suitability, using answers to 41 questions to assess each consumer against the factors above.
From 5 October 2021 to 25 January 2022, a consumer would pass the screening test if they scored 5 or more out of a total of 41. From 26 January 2022 onwards, the only way to fail the screening test was if a consumer:

• had never traded in crypto assets; and 
• had no financial knowledge; and 
• had never traded in equities; and 
• had no leveraged investing experience; and 
• failed to identify a “correct statement” about trading in CFDs.

This meant that the screening test was very difficult to fail. In fact, ASIC claim that only 8% of consumers failed the test during the initial period, and only 6% failed from 26 January 2022 onwards. 
 

3. eToro failed to ensure that the financial services were provided efficiently, honestly and fairly 

In light of the above, ASIC claim that eToro failed to do all things necessary to ensure that it provided financial services efficiently, honestly and fairly, particularly given eToro’s broad marketing strategy. As a lead sponsor of the Wallabies, eToro adopted a mass marketing strategy, reaching a wide audience. Accordingly, eToro was under an obligation to implement strong mechanisms to determine whether the products were suitable for certain consumers. ASIC allege that eToro failed to uphold this obligation and, as a result, consumers were inappropriately exposed to the CFD product. 
 

What does this mean for financial service providers?

This case provides a timely reminder to all financial service providers to ensure they are meeting their DDO, including developing appropriate TMDs. While this may be the corporate watchdog’s first DDO court action, it most certainly won’t be the last. The date for the first court hearing is yet to be scheduled – so watch this space. 

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

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