Review of the Managed Investments Act 1998

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 Submissions - David Eales Routley

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                  David Eales Routley
                  5 September 2001

Managed Investments Act Review
c/o Financial Markets Division
The Treasury
Langton Crescent



I am a 67-year old retiree with a small investment in a retail managed fund which invests in listed company shares. Under the Corporations Law, this fund is called a "managed investment scheme" and it is registered with the Australian Securities and Investments Commission (ASIC). The manager of the fund is called the "responsible entity" and this body is responsible for making the investment decisions and administering the fund.

The fund is governed by its own constitution, the Corporations Law and general law. The constitution deals with the responsible entity's responsibilities and the rights of the unit holder. There is also a Compliance Plan, which sets out the rules which are to be followed to ensure there is compliance with Corporations Law and the constitution.

There are hundreds of managed funds in existence, which operate within a similar legal framework to the one outlined above.

The point I wish to raise, concerns the liability of unit holders in these managed investment schemes. It appears that the current position is that a fund is not a legal entity and that the responsible entity is liable for the fund's debts. The responsible entity would normally look to the fund's assets for reimbursement and if the funds are insufficient then, depending on how the constitution is worded, the liability may pass to the unit holders. What this means is that the liability of unit holders could, in certain circumstances be unlimited.

A glance at the prospectuses issued by some of the large fund managers, indicates that the constitutions provide that unit holders are not obliged to indemnify the responsible entity or its creditors for liabilities in excess of the assets of the fund. However, ASIC does not seem to think the liability can be excluded and it requires that prospectuses state that the exclusion of liability by the constitution may not be effective in every situation.

If we accept that limited liability is necessary, then it seems, based on the foregoing, that there is a clear case for enacting legislation which would limit the liability of unit holders in a managed fund and eliminate any doubt.

On the other hand, there is still the question of whether or not the benefits of limited liability are needed. There is a notable lack of any discussion on this matter in investment journals and books and attempts by me to discuss the subject with fund employees is met with a luke-warm response.

Most fund employees seem to be of the opinion that the internal controls of the fund are such that a deficiency is unlikely. This is probably true in most cases, given the quality of management which is high and the existence of the compliance plan and audit. However, large sums of money can be lost as a result of management making the wrong investment decisions and this, in combination with a large fraud may well cause a deficiency in funds.

There could be other reasons for deficiency of funds. Certain types of funds offering high returns carry more risk; for example, some derivative funds and some geared funds.

Turning to the needs of the holder of units in a managed fund, it seems that there are compelling reasons for introducing limited liability. The past twenty years have seen a dramatic increase in the number and type of managed funds available and investors influenced by advisors, past fund performance, glossy brochures for funds etc. have invested in droves. Ask a unit holder for the name of the Chief Executive of his fund and in most cases he could not answer. A unit holder can elect not to receive the financial statements in some funds. In many cases, most fund holders have a fairly limited knowledge of the investments the fund holds and cannot find out. Only in one case have I met a unit holder who knew his liability was unlimited. Such is the position of the unit holder, who is often a retiree, has limited knowledge about investing and who is facing at the present time, what could be a sustained bear market

In summary, there appears to be a good reason for limiting the liability of unit holders in a fund. They are indirect investors and rely completely on the integrity and ability of the fund manager (the authorised entity). Although fund managers fervently believe their funds will always be solvent, nothing is certain in this world and unit holders need to get as much protection as possible.

It is therefore recommended that the law provide that the liability of investors in managed investment schemes be limited to the amount of their investment in the scheme. In relation to the "Terms of Reference", if legislation was introduced to limit liability, there would be greater certainty with respect to the obligations and liability of scheme operators and better protection would be given to investors.




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