Review of the Managed Investments Act 1998

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 Submissions - MAI Services Pty Limited

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Management and Investment Services

ACN: 000-937-575; ABN: 50 000 937 575

P.O. BOX 266 WOOLLAHRA, Sydney, NSW, 1350

Ph: 02 9328-7466; Mobile: 0418-222-378

Fax:02 9327-1497

3 Sutherland Ave. Paddington, N.S.W., 2021

The Secretary
Managed Investments Act Review
C/- Financial Markets Division
The Treasury
Langton Crescent

September 7th, 2001

Dear Sir/Madam

This submission can be made public

This submission recommends that the Act be repealed and that the original arrangements be improved by introducing elements of self-regulation by giving investors power to participate in their own protection to reduce costs and the involvement of the government through prescriptive detailed legislation and the excessive involvement of the Regulator.

However, the terms of reference are deficient, as they do not entertain this option. As explained below they divert attention from the fundamentally flawed concepts on which the Act is based. The terms of references are framed on the tacit assumption that the Act improves the objectives of providing better protection to investors while reducing costs and providing greater flexibility to operators in the industry.

One must conclude that the terms of reference represents naivety and/or a thoughtless assumption, or perhaps a cunning face saving bureaucratic "yes minister" device to avoid facing reality that the Act represents a fundamental blunder.

Further to the first item of the terms of reference the Act fails in regards to all four points to:

(i) Better protection of investors' investments

(ii) Greater certainty as to the responsibilities, obligations and liability of the scheme operators

(iii) The rights of investors in managed investment schemes

(iv) Reducing the costs of investing in managed investment schemes.

Failure arises from each point respectively because:

(i) The Act has introduced a statutory conflict of interest between the duties of directors to the company as a whole and to the investors in the scheme to fatally flaw the concept of having a single responsible entity.

(ii) The conflict of interest between the responsible entity and the investors introduces greater uncertainty as to who obtains the benefit of the doubt in such matters as specified in Sections 601FG(b) and 601GC(1)(b). If investors were not given the benefit of doubt as required in Sections 601FC(c) and 601FD(c) who would know if this was in fact complied with? The conflicts increase the potential exposure of directors and the scheme manager to the cost of litigation.

(iii) Investors have no commercial non-legal cost effective method to determine and/or exercise their rights.

(iv) The uncertainties created by the conflicts introduced by the Act introduce additional actual and contingent legal costs of compliance.

The Act is highly prescriptive with details that are assumed to enhance the concerns raised by the four points in the first item of the terms of reference. For example the idea that "external" directors can provide investor protection is misplaced, misleading and misguided and could be judged in a court of law to be deceptive and misleading or likely to deceive and mislead investors. This assumption is supported by detailed prescriptions qualifying external directors in Section 601JA(2) that ignore that these details can be quite irrelevant in empowering external directors to protect investors. The extent of the details introduces so much black letter substance to the concept of external directors that people may be mislead to mistakenly believe that these qualification provide real substance in assuring investor protection.

Likewise, the existence and operation of a "Compliance committee" as conceived by the Act in Part 5C.5. The reliance on external directors and a compliance committee is more dangerous and misguided than relying on regulators, auditors, external directors and accounting standards to protect the interest of investors as evidence of recent major failures where neither regulators, auditors or external directors protected investors and other stakeholders. The result is that the Federal and State government are paying hundreds of millions of dollars in compensation to stakeholders.

Recent very major corporate failures have occurred without out any warning from the auditors or regulators to provide abundant evidence that it is naive and dangerous for the government, its regulator and investors to rely on the protection an auditor and/or a Compliance Committee as constituted under the Act. Research in the US has presented compelling arguments why auditors cannot be independent as reported by Bazerman, M.H., Morgan, K.P. & Loewenstein, G.F. 1997, `The impossibility of auditor independence', Sloan Management Review, Summer Issue, 38:4.

Likewise, a compliance committee has its members appointed and remunerated at the grace and favour of the single responsible entity. They can not be expected to bite the hand that feeds them. It illustrates the fundamental flaw of having a "single responsible entity". A division of power and checks and balances are required with much more power provided to the investors so as to introduce more self-regulation and much less reliance on prescriptive details and the need and cost to have recourse to the regulator. These arguments are developed in greater details in my articles such as: 'Corporate Governance Reform: Improving competitiveness and self-regulation', Corporate Law Economic Reform Program Conference, Australian National University, Canberra, November 21, 1997.; `Corporate Charters with Competitive Advantages', St. Johns Law Review, St. Johns University, New York City, 74:44, pp. 101-159, Winter, 2000. `The competitive advantages of compound boards', Corporate Governance International, 4:2, pp. 22-38, June, Hong Kong, 2001.

The second item of the terms of reference reflects the dangerous and naïve assumption that with "strengthen compliance practices, procedures and awareness amongst responsible entities" the Act will safeguard investors. The terms of reference explicitly avoids to ask if the Act provides superior investor protection and operating efficiency over the situation before the Act was introduced. The second item of the terms of reference implicitly assumes that the Act makes improvements and so diverts attention from the fact that the concept of a single responsible entity is fundamentally flawed. The reasons why unitary control is a fundamentally a flawed concept is analysed in my articles published in refereed international academic journals. Refer to `Failure in law reform: The case of AMP Limited', Corporate Governance: An international review, 9:2 pp. 127-33, April 2001 and the two articles cited in the above paragraph being: `The competitive advantages of compound boards' and `Corporate Charters with Competitive Advantages'.

The third and fourth terms of reference likewise represent diversionary issues from the fundamental need to provide investor protection with operational and regulatory efficiency.

My recommendations are as follows:

1. The Act be repealed and/or amended to include the features set out below.

2. All managed investment schemes to hold annual meetings of investors to allow all parties involved to become publicly accountable to their particular investors.

3. Each scheme to appoint an investor "watchdog" committee of three people self-nominated and elected by investors on a one vote per investor basis. The committee members would not be paid and be indemnified from any liability. No investment adviser accepting commissions or fees from any investment manager or their agents could be a member. The committee would have the power to veto any action of the managers that involved a conflict of interest and to avoid the managers being exposed to any conflict of interest in holding meetings of investors these would be chaired by a member of the watchdog committee. Any action subject to veto could be overturned by a general meeting of investors voting on a one vote per investment unit basis. Activities subject to a veto would be all related party transactions, appointment or retirement of the auditor and approval of the accounting policies, replacement of the manager and/or trustee, custodian, compliance agent or other parties involved in protecting the interest of investors.

The watchdog board would replace the need for a compliance committee and make a significant change in the balance of power between managers and investors and the accountability of managers and their agents including the auditors. If the act is not repealed then a major re-write is required. It would allow many of the current detailed prescriptive provisions to be removed. This would illustrate how much of the prescriptive details in the Act are only required because of it's flawed conception.

Because the watchdog board is not paid and there is a need for detailed expert knowledge of the processes involved in complying with such activities as transferring assets and issuing and redeeming units the watchdog board would need to appoint a remunerated compliance agent. This could be a custodian, trustee or other properly qualified company.

4. The acceptance of these proposals would require a major re-write of the Act to eliminate much of its prescriptive details and the degree to which ASIC would need to be involved.

By placing the onus of detailed monitoring and oversight on investors and their representatives, the protection available to investors could be substantially improved. This could also reduce the costs of operating collective investment schemes and provide flexibility and the costs of ASIC involvement. It should also reduce the moral obligation of government to compensate investors when external directors, auditors, compliance committees and regulators fail as they have so convincingly over the years.

A fundamental problem in designing and drafting laws on regulation is that lawyers and social scientists are not educated in the science of governance. The science of governance has a mathematically grounded law that states that the regulation of many variables requires a matching number of controllers. This means centralised control cannot work. Another law states that regulation can never be amplified, it can only be supplemented. Watchdog boards provide supplementation to regulate complexity that is impossible for a centralised regulator to achieve. It introduces an additional controller to manage complexity.

Another problem with a legal approach to regulation is a belief that its is physically impossible for ordinary humans to undertake the responsibilities imposed upon them under the law. The practical matter of humans suffering information overload seems to be blithely assumed away by law-makers. Practical business people recognise that the span of command and control of individuals is typically limited to around half a dozen people. As a result complex tasks require decomposing into simpler activities to allow ordinary people to achieve extra-ordinary results. In other words, operational complexity requires structural complexity to decompose monitoring and decision making labour into simpler components to allow humans to manage complexity. A single responsible entity does not provide sufficient decomposition of intellectual labour to allow their directors to carry out the legal obligations imposed upon them.

In addition, the politics of the conflicts of interests introduced by a single responsible entity denies their external directors access to independent information, the will to act and capability to act independently of management who appoint them.

I would be please to provide such further information as may be desired in the development of my analysis and recommendation.

Yours faithfully

Shann Turnbull



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