Review of the Managed Investments Act 1998

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 Submissions - Australian Securities and Investments Commission


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Submission 1 (Part 2):

SUBMISSION
BY
AUSTRALIAN SECURITIES & INVESTMENTS COMMISSION

REVIEW OF THE
MANAGED INVESTMENTS ACT 1998

PART 2 OF SUBMISSION

26 SEPTEMBER 2001

10. Part 2 of ASIC's Submission to the MIA Review

10.1 Introduction

On 13 September 2001 ASIC provided Part 1 of its Submission to the MIA Review, comprising two documents - the text of the submission itself, and appendices to the Submission.

Part 1 of the ASIC Submission (sections 1 to 9 of the entire submission) addressed all aspects of the Terms of Reference except the last:

"... to review the effectiveness of the arrangements for the regulation of managed investments introduced by the Managed Investments Act 1998 (the Act), contained in Chapter 5C of the Corporations Act 2001, to determine whether...

    refinements could be made (whether requiring legislative amendment or not) to enable the arrangements to operate more efficiently and effectively, while not unnecessarily detracting from the protection afforded to investors."

This part of the Terms of Reference is addressed in this supplementary submission, Part 2 of the ASIC Submission (section 10 of the entire submission).

10.2 Content of Part 2 of ASIC's Submission

This Part contains a number of proposals for law reform, based on issues which have emerged during ASIC's administration of the Managed Investments Act 1998 (the MIA) from July 1998 to the present. The issues have arisen from a range of ASIC activities and functions including:

• licensing and scheme registration,

• surveillance and enforcement action, and

• assessing applications for relief from the law.

In addition, a number of issues have arisen from discussion with industry participants.

10.3 Whether... refinements could be made (whether requiring legislative amendment or not) to enable the arrangements to operate more efficiently and effectively, while not unnecessarily detracting from the protection afforded to investors

The following table outlines matters for law reform and suggested amendments to address these matters. The first column identifies or summarises the provision(s) of the Corporations Act 2001 to which the proposal refers. References are also made to provisions, as amended, of the Financial Services Reform Bill (FSRB). The second column provides an explanation of the background to the issue and the need for amendment. The third column sets out, where relevant, ASIC's proposal for modification.

The table is presented in two divisions - the first division discusses matters of broad policy implication and the second division discusses matters of a more technical nature.

Division 1 - matters of broad policy

    No.

    Provision

    Concern

    Proposal for Law Reform

    1

    Part 5C.2 Division 1 - responsibilities and powers

    s601FB(2) - responsible entity operates scheme

    The responsible entity concept is based on the responsible entity alone being responsible to members for operating the scheme in all its aspects. This includes the promotion, ongoing operation and winding up of the scheme. Others that take part in the operation of the scheme should do so only as agents of the responsible entity or persons engaged under s601FB. Allowing other parties to contract directly with members to perform services in relation to the operation of the scheme is inconsistent with the responsible entity concept.

    Given the importance of this matter, s601FB(2) should clearly provide that the responsible entity must operate the scheme (including the promotion, the offer or issue of interests in, or inviting contributions to a scheme, as well as all ongoing activities and winding up) and no other person may take any part in the operation of the scheme except as an agent of, or a person engaged by, the responsible entity.

    No.

    Provision

    Concern

    Proposal for Law Reform

    2

    Part 5C.2 Division 1 - responsibilities and powers

    601FC(1)(d) - responsible entity must treat members of same class equally and members of different classes fairly

    Section 601FC(1)(d) requires members of a class to be treated equally but no definition is given as to what constitutes a class. Further it would be more appropriate to recognise that class is a characteristic of an interest rather than a member. To provide certainty and to avoid arbitrary distinctions, the requirement should be to treat members equally in relation to interests they hold that are of the same class. "Class" in relation to an interest should be defined by reference to having the same rights to benefits produced by the scheme and the same obligations attached to the interests. This would mean that mere differentiation in fees, for example, did not create different classes and make it clear that differentiation based on a member's characteristics rather than the rights attached to an interest was not permitted.

    Section 601FC(1)(d) should be amended to require that members must be treated equally in relation to interests they have that confer substantially the same right to benefits produced by the scheme and the same obligations, and all members must be treated fairly. A corresponding amendment reflecting this concept of class should be made to s601KB(2)(b) and any other sections that refer to class.

    3

    Part 5C.2 Division 1 - responsibilities and powers

    601FC(1)(d) - responsible entity must treat members of same class equally and members of different classes fairly

    ASIC currently provides relief from the equal treatment provision for some differential fee arrangements in Class Order 01/50. The terms of that Class Order have generated submissions from industry seeking to expand the categories of differential fee arrangements that should be permitted. ASIC is currently reviewing the scope of the exemption and as part of that review will consider whether the section needs to be modified.

    ASIC will provide further submissions, by the end of October, about whether it considers that s601FC(1)(d) should be modified to permit differential fee arrangements.

    No.

    Provision

    Concern

    Proposal for Law Reform

    4

    Part 5C.2 Division 2 - Changing the responsible entity

    s601FL - if a responsible entity wishes to retire and a new responsible entity cannot be found, the current responsible entity can apply to the court for appointment of a temporary responsible entity.

    s601FN - scheme members or ASIC may apply to the court for appointment of a temporary responsible entity if the current responsible entity is not a public company and is not licensed to operate MI schemes.

    CONTINUED BELOW

    ASIC has identified practical difficulties in three respects in relation to the appointment of temporary responsible entities;

    • timing problems in obtaining a court appointment for a temporary RE,

    • identifying a suitable entity to approve as a temporary responsible entity, and

    • the willingness of entities to take on the role of temporary responsible entity.

    1. ASIC has the power to revoke the licence of a responsible entity unable to perform its duties. Once a licence is revoked, the former responsible entity is not able to operate the scheme. ASIC depends on a timely decision from the court for appointment of a temporary responsible entity to operate the scheme.

    To date, this issue has only manifested itself in the inconvenience of having to closely co-ordinate administrative action (such as licence revocation) with court action to appoint a temporary responsible entity. ASIC is concerned however, that any delay in getting a court appointment might prejudice the safety of scheme property. Various options could be adopted to deal with this, including giving ASIC an administrative power to appoint a temporary responsible entity (similar to the power APRA is given under s134(1) of the Superannuation Industry (Supervision) Act) or giving ASIC administrative powers to make binding orders for the protection of assets.

    1. Part 5C.2 Division 2 is modified to give ASIC administrative powers to make binding orders for the protection of scheme property pending the appointment of a temporary or replacement responsible entity.

    No.

    Provision

    Concern

    Proposal for Law Reform

    4

    CONTINUED FROM ABOVE

    Part 5C.2 Division 2 - Changing the responsible entity

    s601FL - if a responsible entity wishes to retire and a new responsible entity cannot be found, the current responsible entity can apply to the court for appointment of a temporary responsible entity.

    s601FN - scheme members or ASIC may apply to the court for appointment of a temporary responsible entity if the current responsible entity is not a public company and is not licensed to operate MI schemes.

    2. It is not always possible to find an entity able to be a temporary responsible entity. Effectively, the entity must be an existing responsible entity authorised to operate a scheme. It would assist if the categories of entities which could take over the operation of a scheme in the short term could be expanded.

    3. Entities suitable to be temporary responsible entities often refuse to take on the role because of the potential liabilities which transfer to them under s601FS and s601FT. This issue is considered separately [Item 6] below.

    2. Part 5C.2 Division 2 is modified to include a provision extending the definition of the type of entity which may be appointed by the court to operate a scheme, for the same period as a temporary responsible entity and with the same functions, including protecting assets and reporting to members.

    This broader definition could include a court appointed "official liquidator" who would act as an administrator of the scheme and who would be entitled to payment of fees from scheme property, pursuant to court order.

    Such an administrator would not need to be a public company holding a dealer's licence authorising operation of managed investment schemes.

    No.

    Provision

    Concern

    Proposal for Law Reform

    5

    Part 5C.2 Division 2 - Changing the responsible entity

    s601FM - removal of responsible entity by members voting on a resolution.

    Part 2G.4 - meetings of members of registered managed investment schemes

    s252B - RE calls meeting

    s252D - members call meeting

    s252E - court calls meeting

    s252J - content of notice of meeting

    1. For listed schemes, ASIC understands that the Parliamentary intention was that only an ordinary resolution was required to remove a responsible entity. However, s601FM does not expressly provide this. This has created uncertainty since provisions of Part 2G.4 do not appear to permit an ordinary resolution. In s252B, s252D, s252E, s252J references are to extraordinary and special resolutions only.

    2. Case law indicates that members are entitled to rely on the contractual provisions of the constitution to change the responsible entity, for example where the constitution enables members to remove a responsible entity by ordinary resolution.1 This opens the way for constitution provisions that automatically remove a replacement responsible entity and so entrench the original responsible entity.

    1. s601FM is modified to clarify that an ordinary resolution is required for listed schemes. Part 2G.4 is modified to clarify that the procedural rules also apply to an ordinary resolution under s601FM.

    2. Part 5C.2 Division 2 should be amended to make it clear that the change of a scheme's responsible entity can only be achieved under the processes set out in that Division, and not otherwise.

    No.

    Provision

    Concern

    Proposal for Law Reform

    6

    Part 5C.2 Division 3 - Consequences of change of responsible entity

    s601FS - a temporary or new responsible entity takes on the rights, obligations and liabilities of the former responsible entity

    s601FT - a temporary or new responsible entity takes the place of the former responsible entity in all contracts relating to operation of the scheme

    A responsible entity may appoint agents or engage persons to do anything the responsible entity is authorised to do in relation to the scheme, but the responsible entity remains responsible for the actions of its agents (s601FB). Contracts with persons appointed under s601FB should be seen as personal to a particular responsible entity, as they are the means by which a responsible entity performs its duties.

    It may be inappropriate for a new responsible entity to take office subject to the contracts (including the rights and liabilities under those contracts) that the former responsible entity entered with its agents. For example, it may not be appropriate for the new responsible entity to take on a contract with a related body corporate of the former responsible entity. As the responsible entity is responsible for the acts of its agents, it should have choice about who acts as its agents.

    These provisions could frustrate the legislative intention that the responsible entity can be removed by a vote of members, or by the court in some circumstances.

    CONTINUED BELOW

    Sections 601FS and 601FT should be modified to eliminate inappropriate forced inheritance of contracts. This could be achieved by modification to the effect that these provisions do not apply to contracts between the temporary or new responsible entity and agents or persons appointed under s601FB by the former responsible entity, unless the temporary or new responsible entity elects to be bound by them, either prior to appointment or within a fixed timeframe. Appropriate modifications may need to consider the rights of parties to some contracts that should not be avoided and transitional arrangements for contracts which are currently on foot.

    6

     

    CONTINUED FROM ABOVE

    Forced inheritance of contracts of agents or persons appointed under s601FB with the former responsible entity may:

    • entrench the position of the former responsible entity in the ongoing operation of the scheme

    • reduce the number of entities willing to take on the role of new or temporary responsible entity

    • limit the ability of members to eliminate underperformance.

     

    No.

    Provision

    Concern

    Proposal for Law Reform

    7

    Part 5C.3 - the constitution

    s601GA(2) - RE's rights to fees must be specified in the constitution and must relate to proper performance of duties

    Some constitutions make provision for a fee payable on the removal of the RE. The cost to the scheme posed by the potential fee may act to entrench the responsible entity, thereby frustrating Parliament's intent that the members should have practical capacity to change the responsible entity.

    A specific prohibition should be included in relation to all provisions that provide for a fee or right of indemnity where the timing of payment, or the entitlement to the right of indemnity, relate to a change in the responsible entity.

    8

    Part 5C.3 - the constitution

    s601GA(2) - contents of the constitution

    It is not clear whether s601GA(2) prohibits payment of fees and indemnities to a responsible entity for performance of duties subsequent to the payment.

    If a responsible entity receives payment in advance it increases the risk of non-performance by the responsible entity. This is particularly problematic for primary production schemes promoted on the basis of tax benefits for investors. In such schemes there is commercial pressure, in order to maximise tax benefits, to pay remuneration to the responsible entity and its agents at the earliest time. ASIC has seen examples where the responsible entity has then gone into liquidation before the primary production activity commenced. This has meant, for example, in the context of a tree plantation scheme, that investor money has been totally expended before any trees were planted.

    s601GA(2) should be modified to make clear that a responsible entity may not receive fees or indemnities in relation to duties until they are properly performed.

    s601GA(2) should be modified to make clear that the words "in relation to the performance of its duties" (where they first occur) relate both to "rights to be paid fees out of scheme property" and to "be indemnified out of scheme property for liabilities or expenses incurred".

    No.

    Provision

    Concern

    Proposal for Law Reform

    9

    Part 5C.3 - the constitution

    s601GA(2) - contents of the constitution

    s601LD - application of the related party transaction provisions

    1. The law should make it clear that no person other than the responsible entity may, for services provided in connection with the operation of the scheme, derive a fee or be entitled to indemnities out of scheme property or from the members. The responsible entity may however be indemnified for liabilities to its agents but only subject to s601GA(2). The responsible entity's agents should not be able to have greater rights to fees than the RE does as against members or the scheme property. Further the absence of this restriction facilitates avoidance of s601GA(2) by allowing payments in advance to agents of the responsible entity.

    2. In addition it is difficult to see when it would be reasonable to provide a benefit out of scheme property by way of remuneration to an officer of the responsible entity. This should be paid by the responsible entity and the responsible entity should seek indemnity if it can under s601GA(2). Accordingly s211 should not apply.

    1. Part 5C.3 should be modified to exclude any person other than the responsible entity from having any right in respect of scheme property or against the members in relation to the scheme for services provided in connection with the operation of the scheme.

    2. Section 601LD should be amended to also exclude s211.

      The following matters relating to the audit of the compliance plan should be addressed as a package.

    No.

    Provision

    Concern

    Proposal for Law Reform

    10

    Part 5C.4 - the compliance plan

    s601HG(3) - auditor of compliance plan must give report to responsible entity

    s601HG(7) - responsible entity must lodge compliance plan audit report at the same time as the financial statements

    Section 601HG requires that the auditor give the report to the scheme's current responsible entity. The Corporations Act 2001 does not specify the people who can rely on the report.

    For 30 June 2000, 99% of audit reports were addressed to the responsible entity.

    This contrasts with the situation under section 308, which requires auditors of financial statements to report to members (not to the company).

    Some have suggested that the audit report should be addressed to and provided to scheme members on the basis that the audit report contains potentially useful information to members, who should be entitled to rely on it.

    s601HG should be modified to clarify who the compliance plan audit report should be addressed to.

    In the event that it is concluded that the report should be addressed to scheme members, consideration should be given to a requirement that the compliance plan audit report be sent to members with the annual financial statements.

    No.

    Provision

    Concern

    Proposal for Law Reform

    11

    Part 5C.4 - the compliance plan

    s601HG(3) - the compliance plan auditor must give to the responsible entity a report which states whether, in the auditor's opinion, the plan continues to meet the requirements of Part 5C.4

    Section 601HG requires that the auditor give an opinion as to whether "the plan continues to meet the requirements of this Part", but no period or date is specified in the Act.

    For 30 June 2000, 93% of audit reports used statements to the effect that the compliance plan was adequate as at the end of the financial year.

    In ASIC's view it is important that the auditor consider whether the compliance plan complied with the Law in all material respects during the financial year until the audit report is signed.

    ASIC is concerned that deficiencies in the plan during the year should be reported, even if they are remedied before year end, as such deficiencies may reflect on the staff and systems of the responsible entity.

    Section 601HG should be modified to require the opinion to relate to all times during the financial year.

    No.

    Provision

    Concern

    Proposal for Law Reform

    12

    Part 5C.4 - the compliance plan

    s601HG(7) - the compliance plan audit report must be lodged at the same time as the scheme financial statements

    Part 2M.3 Division 4 - annual financial reporting to members

    s323D - the first financial year for a scheme commences on the date of registration and may last for a period of not more than 18 months.

    s315(3) and s314 - the scheme financial statements must be lodged within 3 months of the end of the financial year

    The combined effect of these provisions is that the first compliance plan audit report for a new scheme may not be lodged until 21 months after registration. However, ASIC's experience is that the risk of system inadequacy is higher in the early months of scheme operation.

    Such risk may be reduced if the Corporations Act 2001 requires an audit opinion on the compliance plan to be lodged with the registration application and an audit report on the compliance plan and compliance with the plan to be prepared and lodged within a set earlier time, for example within 9 months of registration.

    Amend s601HG(7) so that the first compliance plan audit report for a new scheme must be completed and lodged within 9 months of registration of the scheme.

    Amend s601EA(4) so that an opinion of a registered company auditor that the compliance plan is adequate must be lodged for a new scheme with the other documents to be lodged when an application is made for registration of a scheme.

    No.

    Provision

    Concern

    Proposal for Law Reform

    13

    Part 5C.4 - the compliance plan

    s601HA(1) - Content of compliance plans

    The requirements for compliance plan content include requirements about compliance committee membership, meetings and reports. Where compliance committees are not used plans often fail to deal with the need for these matters as part of board responsibility. ASIC has seen examples where compliance responsibility is not given sufficient prominence as part of general board meetings.

    601HA(1) is modified to include requirements for separate meetings, for reporting arrangements and membership of those meetings where no compliance committee is appointed.

    14

    Part 5C.4 - the compliance plan

    s601HG(3) - the compliance plan audit report must state whether the responsible entity has complied with the compliance plan

    Arguably, the law does not limit the audit opinion to comment on material breaches.

    It would assist certainty if the law is modified to confirm that the audit report needs to be qualified for "material" issues.

    ASIC has provided guidance in IR 00/12 that, "it is appropriate to focus on material issues. 'Material' in this context is what a reasonable person reading the report would reasonably need to know to assess compliance with the compliance plan and its adequacy."

    s601HG(3) is modified so that an auditor does not need to mention in the compliance plan audit report any contravention or deficiency that is not material to any users of the report.

      The following matters relating to the composition of the compliance committee should be addressed as a package.

    No.

    Provision

    Concern

    Proposal for Law Reform

    15

    Part 5C.5 - the compliance committee

    s601JA - "external directors"

    s601JB - "external members of compliance committee"

    The current definition of "external" may permit persons who are not independent (for example, those who have a possible conflict of interest) to act as an external director or external compliance committee member.

    For example, s601JA(2)(f) and s601JB(2)(e) exclude relatives of people who are not external because those people have a material interest in the responsible entity or a related body corporate. However, relatives of other excluded persons are not themselves excluded.

    Widen the definitions in s601JA and s601JB so that relatives of any person ineligible to be "external" are also ineligible.

    16

    Part 5C.5 - the compliance committee

    s601JA(2)(e) and s601JB(2)(d) - "material interest in the responsible entity or a related body corporate"

    "Material" is not defined. There is lack of clarity about how materiality should be assessed. To ensure independence, a strict and clear test should apply.

    Modify Part 5C.5 to set clear standards for "material". For example, if a person has any interest in the responsible entity with an independently verifiable value exceeding a modest fixed amount that person does not fit within the definition of "external".

    17

    Part 5C.5 - the compliance committee

    s601JB - external members of compliance committees

    ASIC has given relief so that a person is not taken to have been substantially involved in business dealings, or in a professional capacity, with a responsible entity because they are an external director of a related body corporate or a member of a compliance committee of a registered scheme operated by a related body corporate.

    Modify s601JB(3) so that "and paragraph 4(a)" is inserted after "2(a)"; and modify subsection 601JB(4) by the insertion of "or a related body corporate" after "responsible entity" wherever appearing.

    No.

    Provision

    Concern

    Proposal for Law Reform

    18

    Part 5C.5 - the compliance committee

    s601JC - functions of members

    s601JD - duties of members

    These sections expressly set out the functions and duties of compliance committee members. The law does not currently set out similar duties for the members of the board where there is no compliance committee. ASIC has seen instances where board members did not consider that they had any obligation to monitor compliance with, or adequacy of, the compliance plan.

    Amend s601JC and s601JD so that they apply, where relevant, to the members of the board where there is no compliance committee.

    19

    Part 5C.5 - the compliance committee

    s601JE- compliance committee members have qualified privilege in certain cases.

    This section gives qualified privilege to compliance committee members in respect of statements made to the responsible entity or to ASIC. The provision does not apply once a compliance committee member resigns or is replaced. It would be undesirable if former compliance committee members were reluctant to provide information to the responsible entity or to ASIC because they feared liability for doing so.

    Amend s601JE to apply to former compliance committee members.

    20

    Part 5C.5 - the compliance committee

    This part provides for the appointment of external compliance committee members.

    If a compliance committee member is ineffective, ASIC has no direct administrative power to remove that member. At the moment, such action would be taken indirectly, by drawing to the attention of the responsible entity that its compliance arrangements appeared to be inadequate.

    Provide ASIC with an administrative power to remove compliance committee members who have not complied with their duties, and to ban such members from being a member of a compliance committee.

    No.

    Provision

    Concern

    Proposal for Law Reform

    21

    Part 7.3 - participants in the securities industry

    s784(2A) - net tangible assets

    ASIC Policy Statement 131 - financial requirements

    The setting of requirements about appropriate levels of capital which must be maintained by responsible entities is an important area which raises many difficult questions about the purpose of such requirements and the appropriate level of those requirements. Section 784(2A) currently prescribes the net tangible assets which a responsible entity must maintain, being a minimum of $50,000 to a maximum of $5,000,000. The definition of net tangible assets is set out in s784(2C) and expanded in PS131. Under FSRB no capital requirements will be set out in the legislation. Capital requirements will be set as a part of ASIC licensing policy.

    The amount of the current net tangible asset requirement was based, in part, on the requirements for Approved Trustees under the Superannuation Industry (Supervision) Act. If that legislation is reviewed it will be important to also review the capital requirements for responsible entities to ensure that the basis for the imposition of capital requirements remains consistent.

    If the capital requirements for Approved Trustees under the Superannuation Industry (Supervision) Act are reviewed, then the capital requirements for responsible entities should be reviewed and if necessary adjusted, at the same time. Any such review might also consider whether the basic requirements should be included in the legislation or regulations.

    No.

    Provision

    Concern

    Proposal for Law Reform

    22

    Part 7.11 Division 2 - prohibited conduct

    s1001B - continuous disclosure - unlisted disclosing entities

    s1001D - material effect on price or value

    (s675 and s677 in Chapter 6CA in FSRB)

    Part 1.2A Division 2

    s111AF - securities relate to disclosing entity if there is a lodged or deemed prospectus with more than 100 members at all times since issue.

    (s111AFA in FSRB)

    Part 7.9 (FSRB) - financial product disclosure and other provisions relating to issue and sale of financial products

    s1017B - ongoing disclosure of material changes and significant events.

    The way that the continuous disclosure obligations apply to unlisted registered managed investment schemes is problematic.

    1. The difficulties in application are particularly acute in relation to unlisted schemes where the member has no right of withdrawal. The current provisions are difficult to apply because they are enlivened by expectations about price or value - concepts which are of limited application where there is no redemption facility. ASIC does not believe that the continuous disclosure obligations need apply to these schemes, particularly in light of the ongoing disclosure obligation in s1017B(FSRB).

    Accordingly, for unlisted schemes which do not offer redemption, it may be appropriate to amend the way that the continuous disclosure obligations in Chapter 6CA (FSRB) operate, or alternatively, to simply rely on the ongoing disclosure requirement of s1017B(FSRB). Both options have some advantages. For reasons of clarity and simplicity, ASIC would prefer merely to rely on s1017B.

    2. The continuous disclosure provisions have application for all listed schemes and unlisted schemes where there is a right of withdrawal. ASIC believes, however, that the application of these provisions is more appropriately determined by reference to the value of scheme property rather than the number of investors (as is currently the case).

    s1001B (s675 FSRB) is amended:

    1. to exclude unlisted managed investment schemes which do not offer a redemption/withdrawal facility.

    2. to apply to other registered managed investment schemes which have scheme property over a certain value ($10 million, for example).

    No.

    Provision

    Concern

    Proposal for Law Reform

    23

    Part 1.2 Division 1

    s9 - managed investment scheme definition

    In part, the definition provides that people contribute money's worth to acquire rights to benefits produced by the scheme.

    It is not clear whether redundancy funds come within the definition of managed investment scheme.

    Redundancy schemes are dissimilar to managed investment schemes in that contributions are made by employers, while the people with the rights to the benefits are the employees.

    Where redundancy funds are established as a part of the process of setting industrial agreements involving unions, the interests of members of the fund are protected by the involvement of the unions.

    There is a question as to whether it is desirable for ASIC to have a regulatory role. ASIC has previously made submissions to Treasury on this issue.

    ASIC has given relief to these schemes until 30 December 2002.

    The definition of managed investment scheme should be amended to specifically exclude or, if considered appropriate, to include a scheme to which employers make, or are required to make by an award or agreement, contributions where the primary objective of the scheme is to fund redundancy entitlements and other incidental benefits for employees.

    No.

    Provision

    Concern

    Proposal for Law Reform

    24

    Part 1.2 Division 1

    s9 - managed investment scheme definition

    While investment companies have to be licensed (Reg 7.3.12) (s766C(4) and (5) FSRB), companies offering securities in investment businesses, other than as interests in managed investment schemes, avoid being required to provide investors with the protections of Chapter 5C. This also provides a regulatory distortion as to which business structure to use.

    Companies that carry on investment businesses except merely incidentally to their other activities should not be excluded from being managed investment schemes.

    Amend the definition of s9 so that, after "time-sharing scheme", the following words are inserted, "or carries on an investment business other than merely incidentally to another business."

    25

    Part 1.2 Division 1

    s9 - scheme property definition

    Investors in schemes such as primary production schemes do not usually have a proprietary interest in the land on which the scheme is operated. Members are vulnerable to the land being taken by others with a legal right to do so, such as liquidators, mortgagees and transferees of the land owner. To protect their rights a sufficient interest in the land should be held on trust for investors.

    ASIC is currently considering whether this matter can be addressed by way of licence condition.

    It appears that it may be appropriate to amend the definition of scheme property in s9 to specifically include an interest in the land necessary for the operation of a primary production scheme, for the duration of the scheme.

    No.

    Provision

    Concern

    Proposal for Law Reform

    26

    Part 2D.3 Division 1 - appointment of directors

    s201L - company to notify ASIC of appointment

    Part 2D.5 - public information about directors and secretaries

    s205B - company to lodge with ASIC the personal details; company to lodge with ASIC if a person stops being a director or secretary

    Public companies, including responsible entities are required to notify ASIC of appointment and change in directors. As compliance committee members have a role in the supervision of the scheme assets, it would assist scheme members if the details of compliance committee members were also lodged with ASIC, particularly given the compliance committee is an extension of, and is appointed in substitution for, an external board.

    Amend the law to include a requirement to notify ASIC of appointment, removal and retirement of compliance committee members, and to notify ASIC of the same details of compliance committee members as are required for directors.

    No.

    Provision

    Concern

    Proposal for Law Reform

    27

    Part 2D.5 - public information about directors and secretaries

    s205G - director to notify market of shareholdings etc

    A responsible entity may be listed and/or a scheme may be listed.

    Section 205G requires the director of a listed company to notify the relevant securities exchange of the interests of the director in the securities of the listed company or related bodies corporate, and of contracts that confer rights including the right to interests in collective investment schemes made available by the company or related bodies corporate.

    However if the scheme is listed, but not the responsible entity, there is no requirement for the director of the responsible entity to disclose such interests.

    The predecessor of s205G (s235) had a subsection (1A) which required such disclosure.

    In ASIC's view the directors of responsible entities operating listed schemes should be required to make such disclosures to the licensed market (after commencement of FSR) on which the schemes are listed.

    Amend s205G to require that disclosure by directors of a responsible entity of a listed scheme in the same way that disclosure is required from directors of a listed company.

    ASIC notes that the ASX Listing Rules are being amended to rectify this problem. The change is expected to take effect from 1 January 2002. However, in ASIC's view a matter of fundamental obligation is appropriately addressed in the Act.

      Division 2 - matters more technical in nature

    No.

    Provision

    Concern

    Proposal for Law Reform

    28

    Part 5C.1 - registration of managed investment schemes

    s601EB(1) - registration of managed investment scheme within 14 days

    During the transitional period for the introduction of MIA, the period for registration of schemes was 28 days. This was reduced to 14 days from 1 July 2000. ASIC is concerned that the 14 day registration requirement may not provide adequate time for necessary ASIC review of scheme documentation during the FSRB transitional period. ASIC expects that resource demands over the FSRB transitional period will mean that resources need to be applied in a very flexible way.

    Modify s601EB(1) so that ASIC must register a scheme within 21 days during the transitional period for the FSRB. Thereafter that period revert to 14 days.

    No.

    Provision

    Concern

    Proposal for Law Reform

    29

    Part 5C.1 - registration of managed investment schemes

    s601ED(1) - when a scheme must be registered

    s601ED(2) - scheme does not need to be registered if issue of interests does not need disclosure, for example, for small scale offerings (s708(1)).

    Part 7.9 (FSRB) - financial product disclosure and other provisions relating to issue and sale of financial products

    s1012E - when small scale offerings need disclosure

    s1012IA - arrangements where a person can instruct another person to acquire a financial product

    There are a number of matters relating to the operation of s601ED(2), for example:

    • the effect of the provision, taking into account the effect of provisions of FSRB

    • whether s601ED(2) relates to sales as well as issues.

    In determining when scheme registration is not required, because all issues and sales would not require disclosure, it is inappropriate for s1012E to be taken into account. Having both 601ED(1) and 1012E providing exemptions from registration creates complexity and may lead to anomalous outcomes. The test in s1012E is based on numbers of issues during a year rather than total number of members. The latter is a more appropriate basis to assess cost-benefit in relation to registration.

    s1012IA ensures that persons who acquire interests in registered schemes through a custodial arrangement are not inappropriately denied the benefit of disclosure. There should be similar provision to prevent such clients being inappropriately denied the protections of registration.

    Modify s601ED(2) to:

    (a) exclude reliance on s1012E

    (b) exclude the exemption if there are sales to retail clients, except sales made by sellers not associated with the responsible entity

    (c) include acquisitions through a custodial arrangement , such as a wrap account, on behalf of a retail client.

    Within this framework, s601ED(2) should provide that a scheme is not required to be registered if none of the members acquired interests other than by sale by a person not associated with the responsible entity as:

    (a) retail clients

    (b) an acquirer in relation to a custodial arrangement, who acquired the interest pursuant to an instruction from a retail client.

    The terms in (b) are defined as in s1012IA.

    No.

    Provision

    Concern

    Proposal for Law Reform

    30

    Part 5C.1 - registration of managed investment schemes

    s601ED(2) - scheme does not need to be registered if issue of interests does not need disclosure - including sales in 12 months (s708(1)).

    Part 7.9 (FSRB) - financial product disclosure and other provisions relating to issue and sale of financial products

    s1012C - obligation to give product disclosure statement - sale amounting to indirect issue - offer made within 12 months after the issue of the financial product

    An RE may issue interests to another person for the purposes of resale to a third person. In this case, disclosure should be required, regardless of when the sale takes place.

    It is common in time-sharing schemes for all the interests to be issued to a developer who sells them over several years.

    s1012C should be amended or modified so that s1012C(6)(a) and s1012C(8)(a) do not apply to managed investment schemes. A presumption as to the relevant intention would only apply where a sale takes place within 12 months of issue.

    No.

    Provision

    Concern

    Proposal for Law Reform

    31

    Part 5C.2 Division 1 - responsibilities and powers

    601FC(2) - responsible entity holds scheme property on trust for scheme members

    1. There is confusion about the operation of s601FC(2), as the section makes a statement rather than creating an obligation.

    2. Some confusion has been expressed about the persons for whom property is held when someone other than the responsible entity holds the property (such as a custodian). ASIC believes that the intention of the law is that custodians only hold property as agent for the responsible entity, which is liable for all aspects of scheme operation.

    3. The effect of the (implied) obligation to hold scheme property on trust has also caused some confusion, for example, as to whether a scheme is required to be structured as a trust. ASIC has applied the law in a way that allows non-trust structures to be registered as schemes. This issue could be dealt with other than by law reform. It could be dealt with in the Explanatory Memorandum to any reform Bill, for example.

    1. Amend s601FC(2) to create an obligation for the responsible entity to hold scheme property on trust for members.

    2. The law should provide that whoever (other than the responsible entity) holds scheme property or the beneficial interest in scheme property holds it on trust for:

    (a) the responsible entity; or

    (b) if directed in writing by the responsible

      entity, an agent or a person engaged

      under s601FB by the responsible entity

      holding directly or indirectly on trust for

      the responsible entity;

    and the responsible entity holds scheme property and any beneficial interest in scheme property on trust for the members or if provided in the constitution, one or more of the members in the proportions specified in the constitution.

    In addition to creating these trusts, the law should require that the responsible entity ensure that the scheme property and any beneficial interest in scheme property is held in accordance with a trust in relation to that property as the Act provides.

     

    No.

    Provision

    Concern

    Proposal for Law Reform

    32

    Part 5C.3 - the constitution

    s601GA(2) - contents of the constitution

    Currently s601GA(2) only applies to payment of fees or indemnities out of scheme property. For clarity, the same provisions should apply in relation to payment to the responsible entity from other sources, for example, payment directly from investors where, for some reason, those payments do not become scheme property. Normally any such payments would become scheme property on receipt, but it should not be necessary for this to be the case for the restrictions on taking fees or indemnities to apply.

    s601GA(2) should be modified so that it applies to payments of fees or indemnities out of scheme property or from any other source.

    No.

    Provision

    Concern

    Proposal for Law Reform

    33

    Part 5C.3 - the constitution

    s601GB - constitution must be legally enforceable

    Section 601GB seeks to enable enforcement of rights under the constitution. However it would be more effective if it provided that by force of the Act the constitution is enforceable rather than merely requiring the responsible entity to make it enforceable.

    Further the constitution should in any event not include any provisions which are contrary to law. This is a common problem identified when ASIC reviews constitutions (eg the responsible entity may purport inappropriately to exclude its liability) and an express prohibition would be helpful in maximising compliance.

    Section 601GB should provide that so much of the constitution as is not contrary to any law is enforceable between the members and responsible entity. It should also provide that the constitution must not contain a provision that is contrary to or inconsistent with any applicable law.

    34

    Part 5C.3 - the constitution

    s601GC - changing the constitution

    Section 601GC allows a special resolution to amend the constitution. This does not provide any protection for members holding interests of different classes from the majority. It also does not provide any protection for the responsible entity (for example, if the resolution is to reduce its fees).

    Amend section 601GC to require that a change to the constitution based on a special resolution must be agreed to by the responsible entity and comply with any requirements of the constitution to protect members holding classes of interest.

    Alternatively, a class rights regime similar to Part 2F.2 could be adopted.

    No.

    Provision

    Concern

    Proposal for Law Reform

     

    35

    Part 5C.3 - the constitution

    s601GC - changing the constitution

    ASIC registers a scheme as required by s601EB. In part, this provision requires that a scheme be registered unless it appears to ASIC that the constitution does not comply with s601GA and s601GB. However constitutions generally contain many other provisions than those relating specifically to s601GA and s601GB. It is not efficient for ASIC to carefully examine every provision in every constitution at the registration stage.

    From time to time ASIC becomes aware of constitutions which do not appear to comply with some aspects of the law. ASIC currently has no power to direct or effect changes to constitutions. The available remedies, such as scheme deregistration, may have severe and adverse consequences for members.

    Amend s601GC to enable ASIC to:

    • amend or remove a provision of the constitution, to comply with the Act to the extent that the provision is inconsistent with the Act.

    • include a provision in the constitution to the extent that such inclusion is necessary for the constitution to comply with the Act.

    No.

    Provision

    Concern

    Proposal for Law Reform

    36

    Part 5C.4 - the compliance plan

    s601HB - incorporation by reference in compliance plans

    Section 601HB permits a compliance plan to incorporate specified provisions, as in force at a specified time, of a compliance plan of another registered scheme. The words "as in force at a specified time" mean that it is only possible to incorporate parts of the other plan as at a specified date. This means if the first plan is amended this will not result in the part that had been incorporated in a later plan being amended as well.

    ASIC Class Order 98/50 modifies the Law so that a plan can incorporate parts of another plan "as that plan was amended from time to time" but only where the compliance plan for the later scheme contained a statement "to the effect that the responsible entity will review the appropriateness of the compliance plan when any amendment is made to a part of the compliance plan that is incorporated by reference in it."

    Modify s601HB to incorporate the modifications effected by Class Order 98/50.

    No.

    Provision

    Concern

    Proposal for Law Reform

    37

    Part 5C.8 - effect of contraventions

    s601MB - voidable contracts

    Section 601MB makes contracts to subscribe for interests pursuant to illegal offers or in relation to illegally unregistered schemes voidable. However it does not include protection in relation to sales contracts covered by s1012C (FSRB).

    The provision should apply to protect consumers in this case

    A provision to the effect of s601MB(1) should be included applying in relation to a sale to which s1012C (FSRB) applies. A sale of an interest in an unregistered scheme being operated in contravention of s601ED(5) should be voidable if the sale is made in any of the cases described in s1012C (FSRB).

    No.

    Provision

    Concern

    Proposal for Law Reform

    38

    Chapter 5C Regulations

    • 5C.01.02

    • 5C.02.02

    • reflecting 5C.04.01, s601HC and s601HE(3) should expressly permit signing by agents

    • 5C.04.02 should be extended to persons engaged under s601FB and not merely agents

    • 5C.05.01 should be extended to persons engaged under s601FB

    • 5C.11.03

    • 5C.11.04 - context of regulation 5C.1.01(3) should be included

    • 5C.11.06 - clear provision against double recovery by members should be included

    Many of the provisions of the Regulations would be better inserted directly in the text of Chapter 5C of the Corporations Act 2001.

    Some provisions of the Act should be modified to be more consistent with the regulations.

    The regulations indicated should be incorporated in Chapter 5C, with amendments as indicated.

    39

    Chapter 5C Regulations

    5C.11.05A

    The content of the modification is now included in s601ED(2) of the Corporations Act 2001.

    Delete 5C.11.05A

    No.

    Provision

    Concern

    Proposal for Law Reform

    40

    Part 1.2 Division 1

    s9 - managed investment scheme definition

    Promoters have approached ASIC asking whether several related arrangements are in fact parts of one scheme.

    It is administratively impractical to regulate arrangements based on whether a promoter subjectively envisages them as parts of one scheme, rather than as separate individual schemes. ASIC believes that there may be significant loss of investor protection if a constitution provides the ability to create additional unit trusts ad infinitum.

    In a matter where ASIC refused to register a series of unit trusts as one scheme, the applicant commenced proceedings in the AAT. Those proceedings were subsequently discontinued, but ASIC considers that the issue warrants clarification.

    Either:

      1. add a provision to the definition of managed investment scheme to the effect that, if a scheme comprises more than one managed investment scheme, the scheme is not a managed investment scheme unless there is a substantial degree of interdependence in the benefits to members.

      or:

      2. amend s601ED by inserting a new paragraph, "where an applicant applies to register more than one scheme as a single registered scheme, ASIC may determine in writing that each scheme must be separately registered, rather than registering the scheme comprising more than one scheme."

    If the second option is taken, reference to ASIC exercising the discretion based on the degree of interdependency and economic relationship may be appropriately included in the Explanatory Memorandum.

    No.

    Provision

    Concern

    Proposal for Law Reform

    41

    Part 1.2 Division 1

    s9 - definition of managed investment scheme - does not include (e) a scheme in which all the members are bodies corporate that are related to each other and to the body corporate that promotes the scheme.

    This operates inappropriately where the membership of the scheme is held on trust for some other person, and in particular where it is held on trust for a responsible entity of another scheme. This can apply, for example, to a sub-trust.

    The intention of the exclusion is undermined if some unrelated person chooses to acquire an economic interest in the excluded scheme, even if only through acquiring an interest in a trust of a membership.

    In these circumstances retail investors may be exposed indirectly or directly to an unregistered scheme, with a loss of investor protection.

    Paragraph (e) of the definition is amended by adding at the end, "and no members:

    (i) hold an interest on trust except where the only beneficiaries are such bodies corporate; or

    (ii) have acquired their interest as an acquirer under a custodial arrangement as defined in section 1012IA"

    No.

    Provision

    Concern

    Proposal for Law Reform

    42

    Part 1.2 Division 1

    s9 - managed investment scheme definition

    Under the rules of the Federal and other Courts, participants in a class action may make payments to solicitors acting in the matter, so they can be party to any judgement in their favour. ASIC has had requests for relief from Chapter 5C for such arrangements.

    It is arguable whether class action arrangements constitute managed investment schemes. The benefits flowing from any successful judgement arise from the pre-existing cause of action rather than being produced by the scheme (the class action itself). The amount paid by the participant is usually relatively small. Relevant state legislation regulates the conduct of solicitors.

    ASIC considers that these arrangements are more appropriately regulated under the rules of the Court than under the Corporations Act.

    Amend definition to exclude class actions and costs paid for legal proceedings.

    43

    Part 1.2 Division 1

    s9 - scheme property definition

    The definition of scheme property is based on part (a) of the definition of managed investment scheme and is not adapted to the definition of time-sharing scheme.

    At this stage we recommend that Treasury review these provisions early in 2002 in the light of further advice from ASIC based on our discussions with industry.

    The definition of scheme property should expressly include property to which a time-sharing scheme relates.

    No.

    Provision

    Concern

    Proposal for Law Reform

    44

    Part 1.2 Division 1

    s9 - scheme property definition

    The definition of "scheme property" in s9 does not make clear when property ceases to be scheme property. Once the property is paid to members or to a person as a fee or indemnity under s601GA(2), or is no longer held by the responsible entity or its agents or persons it engages under s601FB (unless a constructive trust arises) the property should cease to be scheme property.

    Amend the definition of "scheme property" to clarify when property ceases to be scheme property.

    45

    Part 2A.1 - what companies can be registered?

    s115 - restrictions on size of partnerships and associations

    A partnership or association cannot be formed with more than 20 members under s115 subject to certain exceptions. This is intended to require larger partnership and associations to incorporate. However if the partnership or association were a registered scheme, there would be no reason to preclude it, as regulation as a registered scheme would substitute for the requirement for a company.

    Amend s115 to provide that it does not apply to a registered scheme.

    No.

    Provision

    Concern

    Proposal for Law Reform

    46

    Part 2M.4 Division 2 - registered schemes

    s331AD - effect of winding up on auditor

    Section 331AD inappropriately terminates the office of auditor of a registered scheme when the scheme ceases or is wound up. This is analogous to the provision with companies. However generally registered schemes are wound up by the responsible entity in contrast for the provision for liquidators in the case of companies. It is necessary for there to be an audit of the winding up process of a registered scheme.

    Section 331AD should be repealed.

    47

    Part 2N.1 - annual returns

    s349 - contents of annual return - registered schemes

    The information required by s349 is not always appropriate.

    Specifically, the value of scheme property is not currently included. Additionally, for some types of schemes (such as IDPS-like schemes) the identification of the top 20 interest holders (Item 7) and the amount held by them is to inappropriately intrude on their privacy by, in effect, revealing their general financial position.

    Amend s349 so that either:

    • ASIC has the power to determine the content of the annual return for registered schemes, that is, to determine an approved form,

    or

    • the value of scheme property is included, and Item 7 need not apply to IDPS-like schemes.

1 MTM Funds Management Ltd v Cavalane Holdings Pty Ltd (2000) 18 ACLC 819


Submission 2

31 October 2001

Mr Malcolm Turnbull
Managed Investments Act Review
c/- Financial Markets Division
The Treasury
Langton Crescent
PARKES ACT 2600

Dear Malcolm

Review of Managed Investments Act 1998

On 26 September 2001 ASIC provided you with Part 2 of its submission for the Review. That Part of the submission specifically addressed the Term of Reference dealing with "refinements that could be made to enable the arrangements to operate more efficiently and effectively whilst not unnecessarily detracting from the protection afforded to investors".

Differential Fees

At Item 3 of that submission, ASIC indicated that it would provide further submissions by the end of October about whether it considers that section 601FC(1)(d) should be modified to permit differential fee arrangements. As indicated in that submission, ASIC currently provides relief from the equal treatment provisions for some differential fee arrangements set out in Class Order 01/50. The terms of that class order have generated a number of submissions seeking to expand the categories of differential fee arrangements that should be permitted. ASIC will continue to deal with those individual applications and will continue to work with applicants to resolve those particular issues.

ASIC has, however, as part of processing those applications, considered the broader issue of whether the current legislation provides an adequately flexible framework for differential fee arrangements. In ASIC's view, the requirement to treat members "equally" in section 601FC(1)(d) is not a legislative criterion which allows differential fee arrangements to be appropriately considered. ASIC considers that a slightly more flexible criterion, such as an obligation to treat members "fairly", may provide a better basis on which to consider the regulation of such fees.

ASIC would not propose, however, that the issue be resolved merely by substituting a test of "fairness" for a test of equality in relation to fees.

Firstly, ASIC considers that any such amendment would need to provide a framework within which investors are provided with adequate disclosure such that they are able to compare, in a meaningful way, the effect of differential fee arrangements. We would be concerned if allowing greater use of differential fees were to result in making consumer comparisons of fees more difficult. We believe that this disclosure should deal both with the ability to compare different fee structures available from the one offeror and also the effect of differential fee structures as between different offerors. We note, for example, that in the United States, mutual funds are required to provide examples of costs, in dollar terms, over sample periods of time.

Secondly, ASIC believes that it would be necessary for any such amendment to provide additional constraints beyond those which the words "fair" or "fairly" might otherwise suggest. We believe that it may be necessary that fairness be interpreted by reference to some economic justification; for example that a differential fee arrangement must be reasonable having regard to the difference between the cost incurred by the responsible entity in providing services to any member who is a party to a differential fee arrangement and the cost incurred in providing services to any member who is not a party to the arrangement. Imposing a disclosure requirement in relation to this requirement might also be an effective regulatory tool.1

We would suggest that further discussion be held on whether this interpretational support should be included in legislation or in ASIC policy.

Forfeiture of Members' Interests

Another issue which has arisen for consideration since our previous submission relates to the mechanism by which members' interests in managed investment schemes may be forfeited. This can occur because of failure to pay levies associated with the member's interest (for example, in a timeshare scheme) or a failure to pay calls on partly paid interests. Following consultation with the timeshare industry, ASIC has formed the view that forfeiture of members' interests may be necessary to facilitate the effective management of the schemes for the benefit of all members and may therefore be appropriate in some circumstances.

The issue has arisen specifically in the context of time-share schemes and the way which members' interests in those schemes are forfeited following non-payment of levies. ASIC is developing proposals to deal with those particular issues by use of its modification and exemption powers, however, we believe that the question of forfeiture is not merely limited to time-share schemes. It raises a number of issues which warrant further consideration, including :

• the obligation on the responsible entity to make disclosure about the arrangements for possible forfeiture at the time of issue;

• ownership of the forfeited interest;

• the process by which forfeited interests are sold, including the nature of the obligations which should be placed on the responsible entity when effecting the sale; and

• rules for distribution of the proceeds of sale.

Whilst ASIC is able to deal with current matters by the use of its modification and exemption powers, we do believe that broader issue of establishing an appropriate framework within which members' interests may be forfeited is a matter of legislative reform. In particular this may involve refinements to sections 601FG(1)(a) and 601GA(1)(a). Any amendment to facilitate the responsible entity acquiring units for non payment should ensure the manager assumes the same type of duties as a mortgagee to provide some additional protection for investors who default in payments. Whilst we may not have an opportunity to fully consider this issue in time for your report, we would be happy to provide comments in relation to any proposals in relation to those sections.

Yours sincerely

Jillian Segal
Deputy Chair

1 ASIC's recommendation that the "equal treatment" requirement in s.601FC(1)(d) should be reconsidered relates solely to the effect which that requirement has on differential fee arrangements. In all other respects, so far as ASIC is aware, the requirement has a beneficial regulatory effect and should be retained in its current form.

 

 

 

 

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