Submissions - Freehills
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Review of Managed Investments Legislation
Review by Freehills
The following submission is in response to Press Release No. FSR/059
issued by the Minister for Financial Services and Regulation in relation
to the review of the managed investments legislation contained in Chapter
5C of the Corporations Act.
This is a "high level" review.
We have not conducted a detailed review of every aspect of the managed
investments regime. Rather, we have focused on what we consider to be problem
2 Terms of reference
Clearly, as a law firm we are not qualified to comment on a number of matters
contemplated by the terms of reference of the review. For example, we have
not considered whether the managed investments regime has reduced costs
of investing. However set out below are a number of issues that we believe
require refinement in the light of the commercial and legal difficulties
that have arisen under the managed investments regime. We simply focus on
those aspects of the regime where we believe refinements could be made so
as to increase legal efficiency.
The structure of the regulation of managed investments can be summarised
Chapter 5C of the Corporations Act;
regulations made under Chapter 5C;
Class Orders and other exemptions made by the Australian Securities
and Investments Commission (ASIC) in respect of Chapter 5C; and
ASIC Policy Statements, Practice Notes and media and information
Our submission does not address each of the above separately. Rather, it
focuses on particular issues, dealing with all regulatory aspects of each
issue where relevant.
4 General nature of MIA regulation
As a general conceptual issue, the managed investments regime has been
drafted on a "lowest common denominator" approach. It quite properly
seeks to impose protections and safeguards that are appropriate for smaller
and more novel schemes. However as the regime applies uniformly to all schemes,
it often contains restrictions which are inappropriate for listed managed
investment schemes and wholesale schemes that are not required to be registered
but are nevertheless registered. Although there are some exceptions to the
uniformity of application (such as those contained in Class Order 98/52,
discussed below), these exceptions are more "one offs" and have
not been implemented on a consistent conceptual basis.
We recommend that listed schemes be treated by the managed investments
regime in a manner that is consistent with listed companies. From a commercial
perspective, listed schemes are traded on the Australian Stock Exchange
in the same manner as listed companies. Such schemes operate, except where
otherwise restricted by the managed investments regime, in the same manner
as listed companies. Those schemes are subject to the ASX Listing Rules,
including the continuous disclosure requirements, in the same way as listed
In addition, the directors of a responsible entity have specific duties
to investors that exceed the duties placed on the directors of listed companies.
As such, a responsible entity is statutorily obliged to act in the best
interests of the members of a scheme. In these circumstances, the additional
restrictions placed on listed schemes in comparison to listed companies
are unnecessary and uncommercial. We recommend those restrictions be removed.
5 Custodial issues
The responsible entity of a registered scheme must be a public company
that holds a dealers licence authorising it to operate a managed investment
scheme (section 601FA).
ASIC has set out its views on the licensing of responsible entities in
Policy Statements 130 and 131.
Among other things, in order to obtain a licence a responsible entity must
meet the mandatory NTA requirement set out in section 784(2A). However anyone
operating a managed investment scheme with less than $5 million NTA must
use a third party custodian to hold assets unless those assets fall within
certain exceptions (Policy Statement 131).
Accordingly, responsible entities are in many cases required to appoint
an independent custodian to hold scheme property. This provides difficulties
for the following reasons:
the independent custodian is only a "bare trustee" or
nominee and must act on instructions of the responsible entity;
where the independent custodian is on notice of the terms of the
relevant scheme, the custodian must consider whether it should act on the
responsible entity's instructions; and
the separation of legal and beneficial ownership causes profound
operational problems, for instance in the leasing and mortgaging of property.
As a further issue, some features of ASIC policy on holding scheme property
is impracticable in light of commercial realities.
5.1 The custodian as a bare trustee
Property held by a custodian is typically held in the name of the custodian
on "bare trust" for the responsible entity.
Custodians have never been intended as "watch dogs" or fiduciaries
in respect of property. Their commercial existence derives from:
the desire of asset managers and individuals to outsource the many
"back office" functions associated with holding property; and
in the case of off-shore property, the need to appoint someone in
the relevant jurisdiction with experience of local markets.
As a bare trustee, an independent custodian must only act when it is instructed
to act, and must act only as instructed. It does not have fiduciary duties
to discharge, nor does it have any discretion as to the manner of administration
of the trust. It has no duty to perform, except to convey property on demand
and comply with certain other obligations in the relevant custody agreement.
It is no more than a "nominee or cypher, in a commonsense commercial
view" (Corumo Holdings Pty Ltd v C Itoh Ltd (1991) 24 NSWLR
399, Meagher JA.)
If the responsible entity proposes to act fraudulently in disposing of
or transferring scheme property, a custodian must act in accordance with
its instructions. In any event, a custodian will not always be on notice
of the fraudulent circumstances. The requirement for a custodian does not
provide additional investor protection.
5.2 Aiding and abetting a breach
In many cases, custodians will be on full notice of the terms of the trust
as set out in the constitution and the Corporations Act. This leads to two
Firstly, a custodian acting in accordance with the directions of the responsible
entity, although contrary to the terms of the trust, may aid and abet a
breach of trust by being knowingly concerned and be liable, under both general
law and section 79 of the Corporations Act, for that breach.
Secondly, a custodian may because of its familiarity have a responsibility
when it is on notice of a breach of duty notwithstanding that its appointment
is as a bare trustee. Of course, it is unlikely that this duty will manifest
itself until a trust collapses and the survivors look for someone to sue.
If such an action were to proceed to final judgement, we will then have
some certainty as to the extent of the custodian's duty. It is clear that
a custodian will have duties which arise because of the functions it performs.
The difficulty is in expressing the scope of these duties and that it is
generally not understood, or if it is, it is ignored. Accordingly there
is a risk that once custodians become aware of the potential risks, they
might act in a manner which is reminiscent of the prescribed interest regime
rather than that contemplated by the current law.
Avoiding such confusion was one of the key policies underpinning replacement
of the prescribed interest regime by the managed investments regime.
5.3 Title to scheme property
The requirement for a custodian also presents difficulties for schemes
mortgage or otherwise secure their assets; and
appoint agents to collect the income derived from a particular scheme
For example, property trusts typically use debt financing to acquire assets
which involve the granting of a first ranking registered mortgage to the
financier. Additionally, property trusts frequently appoint property managers
to collect the income from real property assets such as shopping centres,
with all net income forwarded on a monthly basis to the responsible entity.
These practices are inconsistent ASIC policy on holding scheme property.
Policy Statement 133 - Managed Investments: Scheme Property Arrangements
set out the minimum standards for scheme property custodians. The mortgagees
and property managers discussed above rarely meet these requirements.
We consider that ASIC policy and licensing conditions should be appropriately
amended to exclude or specifically contemplate these types of arrangements.
Other problems that arise in the course of mortgaging or leasing scheme
property flow from the split in legal and beneficial ownership between the
responsible entity and the custodian. These problems include that:
the Land Titles Office only recognises the legal owner of property,
creating difficulties with the registration and transfer of title;
the negotiation and implementation of leasing arrangements is considerably
more complex as it is only the custodian as legal owner that can give a
registrable lease over property, however the custodian as a directed bare
trustee is not in a position to provide any of the usual warranties and
undertakings that lessees of property require. In addition, during the term
of a lease the split in legal and beneficial ownership causes additional
administrative complexity and cost to scheme members without providing any
the mortgaging of property suffers from similar problems to those
outlined above in relation to leasing. The split in legal and beneficial
ownership and the nature of the custodians' role increase cost and complexity
in negotiating and amending a mortgage and dealing with mortgaged property.
We recommend dispensing with the policy requirement for a separate custodian.
A separate custodian does not provide additional protection because it is
only a bare trustee. When it is more than a bare trustee, uncertainty arises
over roles and potential for aiding and abetting breaches of the Corporations
Act and the constitution.
Managed investment schemes should not be distinguished in this sense from
public companies. In the latter case a board of directors is entrusted with
the operation of the company, without additional NTA or custodial
6 Calculation of issue price
Section 601GA(1)(a) of the Corporations Act requires the constitution of
a registered scheme to make adequate provision for the consideration that
is to be paid to acquire an interest in the scheme.
ASIC sets out its views on this provision in Policy Statement 134. It provides
that a constitution must cater for an independently verifiable price.
Some of the issues arising from the application of this section and supporting
ASIC policy and class orders include:
(a) ASIC policy on the requirement for objective verification of the issue
price is not supported by the drafting of section 601GA(1)(a); and
(b) exemptions from this provision as set out in Class Order 98/52, including
exemptions for placements and forfeited units, are not consistent with commercial
practice for investment vehicles other than managed investment schemes.
6.1 Objective verification of issue price
ASIC's policy on the ability to objectively verify the issue price from
the constitution is not supported by the underlying section itself. All
it provides is that the constitution must make "adequate provision
for the consideration that is to be paid to acquire an interest in the scheme".
If the government supports ASIC's Policy Statements, it should refine section
601GA(1)(a) to reflect those policy requirements. In our view, ASIC's Policy
Statements on this matter exceed the ambit of the section and do not provide
meaningful guidance for the industry.
6.2 Limitations on capital raising activities by listed trusts
Class Order 98/52 provides exemption from the issue price provision in
recognition of common capital raising techniques utilised by listed vehicles.
These techniques typically involve issuing securities at a discount to market
price. Examples are placements, rights issues and rights issues of options.
Under the Class Order, placements may occur provided certain conditions
are met. These are generally consistent with the corresponding listing rule
requirements (see chapters 7 and 10) relating to placements.
However ASIC policy and the listing rules diverge on a number of issues,
including placements to associates and the 10% limitation on placements
at a discount in a 12 month period. As mentioned above, from a conceptual
point of view there should be absolutely no difference between capital raisings
undertaken by a listed scheme and those that can be undertaken by a listed
company. To impose additional restrictions on listed schemes is adverse
to the interests of investors in those schemes. Such restrictions are unnecessary
as they do not increase investor protection and are uncommercial as they
restrict the ability of a responsible entity to fund transactions that would
be beneficial to investors.
It should be remembered that under general law and section 601FC(1), a
responsible entity is bound by a number of duties. As a matter of law, powers
of a responsible entity may only be exercised subject to those duties.
Section 601FC(1)(c) provides that a responsible entity must act in the
best interests of the members and, if there is a conflict between the members'
interests and its own interests, give priority to the members' interests.
Why then is a responsible entity prohibited from raising funds when it is
in the interests of members to do so and the ASX Listing Rules have been
complied with in all material respects?
We recommend treating listed schemes in the same manner as listed companies.
6.3 Forfeiture of partly paid units
Partly paid units are a common means of capital raising, especially for
As noted above, section 601GA(1)(a) requires the constitution of a registered
scheme to make adequate provision for the consideration that is to be paid
to acquire an interest in the scheme.
Class Order 98/52 at paragraph (vi) addresses forfeited units in listed
schemes. This paragraph incorrectly characterises the forfeiture of a partly
paid interest for non-payment of an instalment.
Sub paragraph (vi)(A) contemplates that the relevant interest is forfeited
to the responsible entity on trust for the members. Rather, the correct
view is that the unitholder retains title to the unit but loses all of its
rights relating to the unit. The responsible entity merely obtains a power
of sale in respect of the unit. This is no different from the exercise of
a power of sale under a mortgage or other form of security.
Sale of a forfeited units is therefore a secondary sale intended to recover
an amount contractually owned to the scheme by the defaulting unitholder.
If the ambit of section 601GA(1)(a) is to extend to the sale of forfeited
units, then it should also extend to the transfer of units by one member
to another person. Clearly this is not intended to be the case because a
member is entitled to transfer his or her unit at any price it deems appropriate.
The sale of a forfeited unit is also a secondary sale and the sale price
will be determined by the market at the relevant time. It should not be
considered to fall within the ambit of section 601GA(1)(a).
ASIC policy and Class Order 98/52 should be amended to remove the forfeited
7 Differential fees
Section 601FC(1)(d) provides that in exercising its powers and carrying
out its duties, the responsible entity of a registered scheme must treat
the members who hold interests of the same class equally and members who
hold interests of different classes fairly.
This provision, although based on a general law duty, has for many years
caused debate in the managed investments industry in relation to the ability
to charge differential fees. Differential fee arrangements have been implemented
by responsible entities, and the former managers of prescribed interest
schemes, for many years although ASIC has indicated it considers such activity
to be a breach of section 601FC(1)(d) and the corresponding provision under
the prescribed interest regime.
Freehills supports the submission by the Investment and Financial Services
Association with respect to differential fees.
8 Investments in unregistered schemes
Section 601FC(4) provides that a responsible entity may only invest scheme
property, or keep scheme property invested, in another managed investment
scheme if that other scheme is also a registered scheme.
Exemptions from this section are set out in Class Order 98/55 and are discussed
in Policy Statement 136. ASIC's underlying principles for requiring the
investment in registered schemes is to ensure that proper standards are
in place for the safe-keeping of scheme property. ASIC believes that having
scheme property held by entities that comply with minimum requirements ensures
that scheme property is not exposed to unnecessary risk and that competent
operational arrangements are in place for managing scheme property. We
consider this provision should be deleted.
Under the former prescribed interest regime and under the current regime,
responsible entities have always been able to legally devise methods to
avoid the application of this section.
We submit that Chapter 5C should not concern itself with the regulation
of investment decision making by a responsible entity. This is rather a
question for Chapter 6D of the Corporations Act and the regulation of disclosure.
In any event and as discussed above, a responsible entity is charged with
various fiduciary duties. In addition to a duty to act in the best interests
of members, a responsible entity must exercise the degree of care and diligence
that a reasonable person would exercise in the same position (section 601FC(1)(b)).
Chapter 6D requires an issuer of securities to disclose all risks associated
with the relevant investment. Clearly this would require disclosure of an
intention to invest in unregistered schemes and the attendant risks.
Responsible entities frequently identify important investment opportunities
that accord with their stated intentions in their prospectuses. Sometimes
these potential investments involve unregistered schemes. Investors should
not be unfairly prejudiced by a fund not being permitted to invest in such
schemes where appropriate investment opportunities arise. It should be remembered
that many of these funds may be operated offshore and outside the ambit
of the Corporations Act.
Another example of the difficulties that arise in this area is that many
aspects of the managed investments regime are inappropriate in their application
to wholesale schemes that are not required to be registered but are nevertheless
registered. The nature of a wholesale scheme is that investors are highly
sophisticated and often exercise a large degree of influence over the operation
of the scheme. This has been reflected both in sections 601ED(2) (in relation
to scheme registration) and 708 (in relation to disclosure). However in
order to attract the investment of registered schemes or for other reasons,
it is not unusual that a wholesale scheme be registered. We believe that
in these circumstances many of the restrictions contained in the managed
investments regime are inappropriate, including:
the requirement for the responsible entity to hold a dealers licence;
the requirements for holding scheme property set out in ASIC Policy
the exception from the licensing provisions contained in Regulation
7.3.11(1) does not extend to schemes that do not require registration but
are nevertheless registered.
Accordingly, we believe that 601FC(4) is superfluous.
The history of this section, it seems to us, is that it was included as
a result of the submissions by ASIC or its predecessor. However, there appears
to have been little discussion as whether it should be included or not.
In our view it does not enhance investor protection.
9 Responsible entity to hold scheme property on
Section 601FC(2) provides that the responsible entity holds scheme property
on trust for scheme members.
Where a scheme is constituted as a trust under a trust deed (as is the
case with most schemes), the responsible entity is a trustee and
must hold property accordingly.
Confusion arises in circumstances where the scheme is not intended to be
constituted as a trust. For example many real property schemes are organised
as syndicates where each member is a tenant in common in respect of the
scheme property. Typically the responsible entity is appointed under the
syndicate agreement to hold the property for each member as nominee.
This arrangement should be distinguished from an ordinary fixed trust arrangement
where the trustee has duties and discretions not recorded in the trust instrument.
A nominee for property under a syndicate agreement must act only in accordance
with the strict terms of the agreement. Additionally it holds each tenancy
in common interest under a separate and distinct bare trust. There is no
pooling as with a fixed trust.
The purpose of the section is to make it clear that if the responsible
entity holds any scheme property and subsequently becomes insolvent the
scheme property is not available for the claims of the creditors of the
responsible entity in its personal capacity.
The confusion arises because section 601FC(2) appears to impose a trust
(together with all the discretions and duties that run with a trust) where
one is not commercially necessary or intended.
We recommend this provision should be redrafted.
10 The compliance plan
Each scheme must have a compliance plan. Section 601HA(1) requires the
compliance plan to set out adequate measures that the responsible entity
is to apply in operating the scheme to ensure compliance with the Corporations
Act and the scheme's constitution.
Section 601HG requires that compliance with the compliance plan must be
We do not consider that the requirement for audit of a compliance plan
materially adds to consumer protection.
As discussed in section 11 below, a responsible entity must either have
an independent board or a compliance committee for each scheme. Directors
and compliance committee members are under specific statutory (and in some
cases general law) duties requiring them to continually assess the adequacy
of compliance measures. An audit process can only ever be a (spot check)
after the event process. Accordingly an audit methodology will never be
as complete as ongoing checking and monitoring.
We query the regulatory benefit of the compliance plan audit requirements.
is expensive as it typically involves large accounting firms;
will only uncover breaches after they have occurred;
is not suitable for audit given that a compliance plan must focus
on legal requirements, which an auditor is not generally qualified to assess;
is complicated by the fact that a responsible entity is vested with
a large number of powers and duties, which of their nature involve the exercise
of discretions. We query how it is possible for an auditor to properly assess
the exercise of a discretion by a responsible entity, which in any event
a court is loath to do; and
will not prevent a breach from occurring.
We acknowledge that the requirement may engender a greater compliance culture
within an organisation but given the existing safeguards of the independent
board or compliance committee weighed against the cost of the audit, we
suggest that any regulatory benefit would be marginal.
11 The compliance committee/independent board
A compliance committee is necessary when less than half of the directors
of the responsible entity are "independent".
The role of the compliance committee is to monitor the extent of compliance
by the responsible entity with the compliance plan and to report its findings.
It must also:
report to the responsible entity breaches of the Corporations Act
and the constitution and report to ASIC if those breaches are not adequately
regularly assess the adequacy of the compliance plan.
A number of practical issues arise in relation to compliance committee/independent
board requirement, including:
the test of independence;
the commercial relationship between a responsible entity and a compliance
committee member; and
the qualifications and experience requirements for a compliance
11.1 The independence requirement
There are various tests for independence of a committee or board member
as set out in sections 601JA(2) and 601JB(2). However we wish to focus only
on the application of sections 601JA(2)(d) and 601JB(2)(c).
These provisions prohibit a person from acting as an "independent"
board/committee member if they are a member of a partnership that is or
has in the last 2 years been substantially involved in business dealings
or in a professional capacity with the responsible entity or a related body
corporate of the responsible entity. Paradoxically, a director of a company
that has relevant dealings with the responsible entity may sit on the committee/board,
but a partner of a firm that has such dealings may not.
This essentially prohibits a partner of a legal or accounting firm from
acting as an independent board/committee member where the relevant firm
has an existing relationship or would like to have one.
This is unfairly prejudicial for a number of reasons, including:
lawyers and accountants are bound by ethical rules requiring them
to act with probity at all times, thus enhancing their ability to act independently;
lawyers and accountants are generally well qualified to sit on a
board/committee as their professional services to responsible entities often
focus on compliance;
removing lawyers and accountants dramatically reduces the number
of persons who are suitably qualified to sit on a board/committee; and
committee and board members are subject to a number of duties including
to act honestly, with care and diligence and not to make improper use of
We believe these provisions unfairly prejudice legal and accounting firms
and should be deleted.
11.2 Commercial relationship between the responsible entity and committee
Committee members are appointed and paid by the responsible entity. Committee
membership has developed as a business in its own right with the potential
for conflicts between the member's statutory duties and their livelihood.
There are no rules governing the appointment and dismissal of a committee
member. Introducing such provisions would increase the likelihood that members
will act upon breaches of the constitution and Corporations Act as they
are required to do under section 601JC.
11.3 Qualifications and experience of committee members
There are no statutory or ASIC policy requirements in relation to the experience
or qualifications of a committee member. In contrast, the requirements for
a responsible officer of a responsible entity are highly prescriptive.
We do not recommend a highly prescriptive approach although certain minimum
experience and qualification requirements should be implemented to ensure
the integrity of the compliance committee concept.
12 Withdrawals of interests
The Managed Investment Act removed the mandatory buy back obligation imposed
on trust managers. The new regime governing redemptions and withdrawals
sensibly leaves the issue of a right to redemption to product design and
disclosure. Freehills supports this approach.
However the current withdrawal regime distinguishes between "liquid"
and "non-liquid" schemes (Part 5C.6). This distinction is easy
to manipulate and a responsible entity can quite legally and properly draft
a constitution that will permit the most illiquid of schemes to be liquid
under the terms of the current regime.
Section 601KA(4) provides a registered scheme is liquid if liquid assets
account for at least 80% of the value of scheme property.
Section 601KA(5) sets out examples of certain liquid assets including cash,
bank bills and marketable securities.
Section 601KA(6) provides that any other property is a liquid asset if
the responsible entity reasonably expects that the property can be realised
for its market value within the period specified in the constitution for
satisfying withdrawal requests while the scheme is liquid.
For example, in the case of a property or infrastructure trust, assets
are usually illiquid, but if the constitution specifies that the redemption
period is say twelve months, then section 601KA(6) will operate to provide
that the scheme will be liquid.
The difficulty that arises is that the alternative route specified in the
Corporations Act is impractical and may be disadvantageous to investors.
We would be happy to elaborate on this point if you wish.