The risks of operating unregistered financial products: ASIC v Web3 Ventures Pty Ltd [2024]

The recent Federal Court case of Australian Securities and Investments Commission v Web3 Ventures Pty Ltd [2024] serves as a valuable reminder to businesses of the risk of operating unregistered or unlicensed financial products, managed investment schemes or investment facilities. In this case, the Court was asked to consider whether two services, offered by a business without an Australian Financial Services License (AFSL), constituted a financial product, managed investment scheme or investment facility. There are substantial penalties for operating financial products, managed investment schemes or investment facilities without the appropriate registration or an AFSL.

Background

Web3 Venture, trading under the name Block Earner, introduced two online products to their existing range in March of 2022:

• The “Earner” product, which allowed customers to receive a fixed rate yield on their AUD deposits by converting that AUD into cryptocurrency to be loaned to third parties through the Block Earner platform; and
• The “Access” product, which operated through an ‘omnibus’ wallet that allowed users to invest cryptocurrency and view the performance of their individual holdings.

At the time of the Earner and Access products’ operation, Block Earner did not hold an AFSL. Their Terms of Use disclaimed that, by participating in the Earner and Access products, a customer would “acknowledge and agree that…[they] do not intend for Block Earner to use the Eligible Cryptocurrency to generate a financial benefit or act as an investment” for them. Additionally, a statement published on the Block Earner website partly claimed, in response to the question “How is fixed yield generated?”, that the rate paid out to Earner customers was derived by “pooling customer funds and lending it to [Block Earner’s] trusted partners…thereby receiving a favourable yield rate”.

In October of 2022, ASIC wrote to Block Earner expressing concerns that Earner constituted a financial product by way of being a managed investment, investment facility, or derivative. The matter of whether Block Earner had contravened the law by offering the Earner and Access products without an AFSL thus came before the Court.

Decision

The Court found that, while the Access product did not constitute a financial product, the Earner product constituted both a managed investment scheme and investment facility, and that Block Earner had operated an unregistered financial product in contravention of the Corporations Act.

Managed Investment Scheme

The decision that Earner was a managed investment scheme was based on the Corporation Act’s definition of such a scheme:

• Parties contribute money (or money’s worth) in order to acquire rights to benefits produced by the scheme;
• Any contributions to the scheme are to be pooled to produce benefits in finance, rights or property to the members holding interest in the scheme; and
• Members do not have day-to-day control over the operation of the scheme.

Block Earner contended that no contribution had occurred in the operation of the Earner product because the term ‘contribution’ suggested an investor pooling funds with those of other users, and no such representation had been made to users in its Terms of Use. While the Court agreed with this characterization of contributions, it found that Block Earner’s loans consisted of both Block Earner and other users’ cryptocurrencies, satisfying the contribution requirement.

Block Earner also claimed that its loans to third parties were carried out with the intention of generating profit for the company rather than producing a benefit for scheme users. No mention of pooling for common benefit existed in the Earner product’s Terms of Use. However, the Court referred to a statement published on the Block Earner website which represented the purpose of pooling funds in a loan to be the generation of returns from which users would be paid a fixed yield; such payments were held to be a financial benefit derived from pooled contributions to the scheme. Regardless of whether or not the Terms of Use made such a representation to users, the existence of this representation in another form was sufficient to fulfil the legislative requirement of benefit production.

Block Earner also claimed that its loans to third parties were carried out with the intention of generating profit for the company, and did not constitute a benefit for scheme members because such loans were not necessary to the payment of fixed yields. This position was adopted by a disclaimer in its Terms of Use. However, the Court referred to a statement published on the Block Earner website, which asserted that the purpose of pooling funds was to allow Block Earner to pay users a fixed yield. Regardless of the contractual effect of this statement, its representation to users was sufficient to fulfil the requirement regarding benefit production.

The Court also concluded that the ability of users to enter and withdraw from the scheme did not constitute day-to-day control of the scheme. The Earner product was therefore held to be a managed investment scheme, having possessed the characteristics of such an operation as defined by the Corporations Act.

Investment Facility

The Court found that the Earner product held all the legal characteristics of an investment facility. This classification was based on the definition of such facilities as ones where an investor has no day-to-day control over the use of their contribution of money or money’s worth, and any of the following apply:

• The other party uses the contribution to generate a financial return or other benefit for the investor;
• The investor intends that the other party uses the contribution to generate a financial return or other benefit for the investor; or
• The other party intends that the contribution will be used to generate a financial return or other benefit for the investor.

A particular focus was placed on the effect of the disclaimer regarding user intention in the Terms of Use compared to a statement published to the Block Earner website claiming fixed yields were generated by pooling customer funds. It was held that the intention of investors should be determined holistically, and that the relative lack of prominence of the Earner product’s Terms of Use compared to the website’s representation indicated users likely intended that Block Earner generate a financial return or benefit for them.

Takeaways

In summary, Block Earner was found to have engaged in several contraventions of the law by failing to hold an AFSL and operating an unregistered managed investment scheme. The Court will hold a future hearing to determine the potential pecuniary penalties to be imposed upon Block Earner.
This decision demonstrates:

• That, when classifying a product, the Court will prioritise its substance over its represented definition;
• Employing a disclaimer alone will be ineffective in defining consumer behaviour or intentions; and
• Operators of a financial product or service should ensure marketing is consistent with the definition of that product or service.