Submissions - Kelly & Co Lawyers
MANAGED INVESTMENTS ACT
Kelly & Co Lawyers
This paper makes submissions concerning the review of the Managed Investments Act, being undertaken by Mr Malcolm Turnbull, appointed by the Minister for Financial Services and Regulation, Mr Joe Hockey, on 6 August 2001.
We consider that there are three areas where the Managed Investments Laws can be improved. These are:
1. Changed disclosure responsibility - move responsibility for disclosure documents to the promoters and operators of schemes to encourage more professionally operated responsible entities.
2. Improved provisions for changes of responsible entity - changes to clarify how the security position of lenders is not affected on the change of a responsible entity.
3. Continued existence for prescribed interest schemes with reduced compliance - allow dormant prescribed interest schemes to continue with reduced audit and compliance costs.
Under the present regulatory scheme, the responsible entity issues any disclosure document required for the scheme, and thus its directors bear the ultimate liability for the disclosure document.
The risk that is assumed by the directors of the responsible entity in issuing a disclosure document means that a professional responsible entity is likely to charge a premium to promoters for its services, thereby discouraging the use of professional responsible entities by promoters of schemes.
Due to the higher cost of engaging a professional responsible entity, promoters of schemes are tempted to establish their own responsible entity in order to save costs, and then use a custodian (which may be a body that could have offered professional responsible entity services) to hold scheme property.
It is our submission that this is not in the best interests of investors, and that the interests of investors and the managed investments industry could be better served by reducing the cost of accessing professional responsible entities by allowing disclosure documents to be issued by promoters and operators of the scheme not just the responsible entity.
We consider that the merits of this submission are as follows:
1. An independent responsible entity will offer greater protection to investors.
Our submission is that other than not being responsible for the issue of disclosure documents, the role of the responsible entity should not change.
This would see the responsible entity continue to be the contractual nexus of a managed investment scheme. The responsible entity would contract with managers for the operation of the scheme, and with dealers for the promotion of interests in the scheme. The responsible entity would be responsible to investors (s601FC), and its officers subject to the strict requirements of s601FD.
The fact that the officers of the responsible entity will retain the potential personal liability for a breach of their duties would mean that the officers and employees of a professional responsible entity, without a personal interest in the scheme, would be solely motivated to act in the interests of investors.
Further, professional responsible entities will necessarily have greater expertise in the provision of the compliance and investor protection services involved in acting as a responsible entity.
2. Liability correctly placed.
It is the promoters of a scheme who will generally be responsible for the establishment and operation of a scheme. Disclosure documents issued in relation to a scheme will be based primarily on information provided by the promoters of a scheme. If a professional responsible entity is involved in the scheme, its directors will have no direct personal knowledge of the scheme.
Therefore, it follows that making promoters liable under a disclosure document for the scheme places liability for the disclosure document with the correct party.
3. Encourage the creation of new schemes
Currently, potential promoters of managed investment schemes must either pay the risk premium to a professional responsible entity, or meet the initial and ongoing costs of the licensing requirements that are visited on a responsible entity under the Corporations Act.
If the need for the risk premium charged for the issue of disclosure documents by managed investment schemes was removed, independent responsible entity services would become more affordable to promoters. This would encourage growth within the industry by removing a barrier to new entrants. It would also encourage promoters to use professional responsible entities rather than establish their own responsible entity. It would enable managers to get on with the business of finding and operating managed investments, and leave issues of compliance and investor protection to a professional responsible entity.
4. Reduced supervision
If independent responsible entity services were more affordable, then it is likely that responsible entity services would become concentrated among professional responsible entities.
This would have the potential to reduce ASIC supervision costs, as there would be fewer participants to supervise, and fewer inexperienced, new responsible entities.
Sections 601FS and 601FT deem that on the change of responsible entity, the rights, liabilities and obligations of the old responsible entity become the rights, liabilities and obligations of the new responsible entity. Further, the documents executed by the old responsible entity will have effect as if the new responsible entity were party to the document.
This provision is acceptable in theory, however, it creates a practical problem. The provisions do not go nearly far enough to prescribe a procedure whereby the property and obligations are passed from the old responsible entity to a new responsible entity without affecting any relevant third party.
This problem is particularly relevant for financiers and could raise difficult priority questions. For example, say that a particular scheme is financed by a bank, and the bank has taken a first ranking charge over the property of the scheme to protect its interests. That charge would be registered with ASIC as a charge over the responsible entity. The responsible entity then changes. At the time of the change, the new responsible entity is subject to a fixed and floating charge over the whole of its assets. The current legislation does not provide a mechanism for the bank, who had financed the old responsible entity, to transfer the charge to the new responsible entity but preserving the priority it had with the previous responsible entity.
These problems could be fixed by regulatory change, either to the statute itself or to the regulations. Such changes would aim to clarify the procedure for the transfer of security interests when a responsible entity is changed including the preservation of priority.
WINDING DOWN SCHEMES
There remain a number of schemes in existence that are regulated under the old prescribed interests legislation. These will generally be closed schemes, where investors will have realised the majority of any benefit that they could receive under the scheme.
These schemes must either convert to managed investment schemes at the expiry of any extension of their regulation under the old law by ASIC, or hold a meeting of members to convert to a managed investment scheme or wind up.
In the many cases that schemes remain regulated by prescribed interest laws, it would not be economical to convert to a managed investment scheme. However, it may be worth continuing the scheme if it is still providing small returns for investors. Common examples are film schemes set up in the 1980s which are still returning a royalty stream to investors. In these situations, returns to investors may be enhanced if compliance and audit requirements and therefore costs are reduced.
In these rare situations, where the scheme is essentially dormant, but continuing to provide small returns to investors, we submit that the scheme should be permitted to continue to be regulated under the prescribed interest legislation, but with legislative change to reduce the audit and compliance requirements placed on the scheme.
18 September 2001
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