Compliance: Theory and Practice in the Financial Services Industry

10. Managed Investments

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IMPORTANT NOTE: These slides have been provided primarily for the use and benefit of students taking the "Compliance: Theory and Practice in the Financial Services Industry" course at Sydney University Law School. They are a summary only of the subject matter covered and are not intended to be, nor should they be relied upon as, a substitute for legal or other professional advice. In particular, it should be noted that the slides are not always verbatim quotes from the underlying source material and that material may have been abridged or paraphrased for presentational purposes. There also may have been legislative, regulatory or other developments since these slides were last updated that are not incorporated.

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Outline

   Definitions
   Registration of Schemes
   Licensing and Disclosure Requirements
   Responsible Entities
   Scheme Constitutions
   Compliance Plans
   Compliance Committees
   Statutory Duties
   Related Party Transactions
   Civil Liability for Breach of Chapter 5C
   Common Law Duties
   Soft Dollar Arrangements
   Allocation Policy
   Inter-funding
   Cross Trading
   Authorised Investments
   Custodians
   Investor Directed Portfolio Services
   Managed Discretionary Accounts
   FSC Standards and Guidance Notes

 


Definitions

CA s9 – Definition of Managed Investment Scheme
Managed investment scheme means:
(a)   a scheme that has the following features:
  (i)   people contribute money or money's worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, prospective or contingent and whether they are enforceable or not);
  (ii)   any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interests in property, for the people (the members) who hold interests in the scheme (whether as contributors to the scheme or as people who have acquired interests from holders);
  (iii)   the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or to give directions); or
(b)   a time-sharing scheme.
See Australian Softwood Forests Pty Ltd v A-G (NSW) (1981) 148 CLR 121, 133 (meaning of "common enterprise"); ASC v United Tree Farmers Pty Ltd (1997) 15 ACLC 957 (meaning of "scheme"); ASIC v Enterprise Solutions 2000 Pty Limited (2000) 35 ACSR 620, ASIC v Drury Management Pty Ltd [2004] QSC 68 and Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (No 3) [2009] FCA 450 (meaning of "pooled"); Re Risqy Limited [2008] QSC 107 (meaning of "benefit").

"Time-sharing scheme" is defined in s9. They are not relevant for the purposes of this course.

Australian Softwood Forests Pty Ltd v A-G (NSW) dealt with the meaning of "common enterprise". There a company offered interests in a pine plantation divided into lots holding around 300 trees. Investors paid $50 for the trees and a further $340 by monthly instalments for planting, tending and maintenance. Upon maturity, the manager would notify the investors that the trees were now marketable and they would have 6 months to arrange for their felling and clearing. Otherwise, the manager would do so and keep 20% of the net proceeds of the sale of the trees. A trust was established to hold title to the plantation as security for investors that the company would perform its obligations with growers. This was held to constitute a "common enterprise" and therefore the offering of interests in that enterprise to the public required a prospectus. Mason J said (at p 133):

    

"The argument is that in order to constitute a "common enterprise" there must be a joint participation in all the elements and activities that constitute the enterprise. I do not agree. An enterprise may be described as common if it consists of two or more closely connected operations on the footing that one part is to be carried out by A and the other by B, each deriving a separate profit from what he does, even though there is no pooling or sharing of receipts of profits. It will be enough that the two operations constituting the enterprise contribute to the overall purpose that unites them. There is then an enterprise common to both participants and, accordingly, a common enterprise."

In ASC v United Tree Farmers Pty Ltd, the court made a declaration that four respondent companies together participated in offering investors "prescribed interests" contrary to the Corporations Law. One company owned or subleased land; one managed a tea tree plantation on the land; one provided finance to would-be investors; and one was a company that investors were introduced to as having the expertise to harvest the trees. The arrangements were structured as individual contracts between each investor and the relevant company in respect of individual strips of land. Notwithstanding this, the court held that there was a clear case of a scheme involving the utilisation by investors of the land, management services and lending capacity of the first three companies in the generation of profits and other advantages for those investors from the development and exploitation of tea tree plantations. The fourth company was also privy to the scheme because even though there were no formal contractual arrangements in place between it and the investors, investors had a reasonable expectation that it would provide services to harvest, distil and market their oil.

In ASIC v Enterprise Solutions 2000 Pty Limited, the promoter of a betting scheme who collected funds from Australian punters and bet them on horse races in Australia and Hong Kong using a proprietary software program, was held to be operating an unlawful managed investment scheme. An argument that punters did not acquire any "interest" in a scheme and were only provided with betting services was rejected. The court said that the scheme involved rights to the benefits produced even though there was no assurance that the money invested would result in winning bets. The court also rejected an argument that there was no pooling of funds because each punter had his own account with the promoter for book-keeping purposes. The court noted that the funds were ultimately pooled into the one account of the promoter before being gambled and any winnings were collected into one account of the promoter before being paid out to investors and that was sufficient to constitute a pooling for these purposes.

In ASIC v Drury Management Pty Ltd, it was held that two accountants who had obtained loans from private investors, guaranteeing returns in the range of 12% to 15% per annum, were conducting an unlawful managed investment scheme without the requisite licence. The pair raised nearly $8 million from 118 investors, mainly by way of promissory notes. The money was paid in each instance to Drury Management Pty Ltd, which received the money into one or other of two trust accounts, and then applied by it for a variety of purposes, including the purchase of stocks and bonds, the purchase of real estate and the financing of loans to proprietary companies controlled by various associates of the respondents. The fact that contributions from investors were in fact pooled in the two trust accounts and that 3 of the contributors had been told by one or other of the respondents that their money was to be pooled with the funds of other people, was held to be sufficient to satisfy the requirement for pooling of funds in the definition of managed investment scheme.

In Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (No 3) [2009] FCAFC 450, a majority of the Full Court of the Federal Court held that litigation funding agreements entered into in connection with two representative shareholder proceedings against Multiplex in the Federal Court constituted an unregistered managed investment scheme. The contractual promise by participating shareholders to allow the litigation funder a financial benefit in the event of a successful resolution of their claims was held to constitute a contribution of money's worth. Those contributions were pooled by the participating shareholders for the benefit of the participants, the litigation funder and the law firm running the action so as to allow the class action to proceed. In this regard, the majority held that the requirement for pooling of contributions did not require a physical pooling of money in a common fund and it was sufficient if the promises by individual shareholders were contributed for a common purpose of prosecuting the scheme.

Following the Brookfield case, the Corporations Regulations were amended (see the Corporations Amendment Regulation 2012 (No. 6)) to introduce rr5C.11.01 and 7.6.01(1)(x). The former regulation excludes litigation funding schemes and "proof of debt" schemes from being managed investment schemes under CA s9.  The latter regulation exempts such schemes from the AFSL licensing regime in Chapter 7 on condition that they maintain adequate conflict handling arrangements in place (on this, see ASIC Regulatory Guide 248 Litigation schemes and proof of debt schemes: Managing conflicts of interest).

In Re Risqy Limited [2008] QSC 107, some 266 investors deposited amounts of money totalling approximately $14.5 million into Risqy's bank accounts. Some of those funds were transferred to other accounts including an open E'cry account held in the US. This was used by Risqy in its discretion to trade in foreign exchange and futures markets. Investors were promised a fixed rate of interest on their money of 4.23% per month. It was held that the prospective benefit of earning interest at the rate of 4.23% per month compounding was a benefit of the scheme and that this requirement of the definition of "managed investment scheme" was therefore satisfied. In other words, "benefit" isn't confined to an equity-type return. It also includes returns in the nature of interest.

The definition of "managed investment scheme" is very wide and captures things like solicitor mortgage schemes, strata unit management schemes, school enrolment deposits, investment clubs, horse racing syndicates, private horse breeding schemes and the like. There is a power in s601QA for ASIC to exempt a managed investment scheme from chapter 5C and it has exercised that power on numerous occasions (see ASIC Regulatory Guide 136 Managed Investments: Discretionary powers and closely related schemes).

 

CA s9 – Exclusions From Definition
Excludes:
(c)   a partnership that has more than 20 members but does not need to be incorporated or formed under an Australian law because of regulations made for the purposes of s115(2);
(d)   a body corporate (other than a body corporate that operates as a time-sharing scheme);
(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;
(f)   a franchise;
(g)   a statutory fund maintained under the Life Insurance Act 1995;
(h)   a regulated superannuation fund, an approved deposit fund, a pooled superannuation trust or a public sector superannuation scheme, within the meaning of the Superannuation Industry (Supervision) Act 1993;
(ha) a FHSA trust;
(i)   a scheme operated by an Australian ADI in the ordinary course of its banking business;
(j)   the issue of debentures or convertible notes by a body corporate;
(k)   a barter scheme;
(l)   a retirement village scheme that is not a time-sharing scheme;
(m)   a scheme operated by a WA co-operative company;
(ma)   a “contribution plan”; or
(n)   a scheme of a kind declared by the regulations not to be a managed investment scheme.

In relation to (ma) above, CA s9 defines "contribution plan" to mean a plan in respect of which: (a) regular deductions are made from the wages or salary of an employee or director (the contributor) to acquire financial products that are offered for issue or sale to the contributor under an eligible employee share scheme; (b) the deductions are authorised by the contributor in a form which is included in, or accompanies, the disclosure document or the Product Disclosure Statement for the scheme; (c) before acquiring the financial products under the scheme, the deductions are held on trust in an account with an Australian ADI that is kept solely for that purpose; (d) the contributor may elect to discontinue the deductions at any time; (e) if the contributor so elects, the amount of the deductions standing, at that time, to the credit of the account for the contributor, and any interest on that amount, is repaid to the contributor; and (f) the scheme does not involve the offer to the contributor of a loan or similar financial assistance for the purpose of, or in connection with, the acquisition of the financial products that are offered under the scheme.

In relation to (n) above, CR r5C.11.01 excludes approved benefit funds under s16B(1) of the Life Insurance Act and certain "proof of debt" and litigation funding schemes from being managed investment schemes.

Note that under (h) above, superannuation funds, approved deposit funds and pooled superannuation trusts are not managed investment schemes. Their establishment and the regulation of their day to day activities is governed by the Superannuation Industry (Supervision) Act and not by the Corporations Act, although superannuation products are financial products and so their marketing is governed by CA Part 7.9 and the people who market them are subject to Parts 7.6 - 7.8.

Note also the similarity of the definition of "managed investment scheme" to the general definition of "making a financial investment" in s763B. The only substantive difference between the two is the requirement in paragraph (a)(ii) of the definition of "managed investment scheme" for there to be a pooling of contributions or a common enterprise. In fact, the similarities are such that any financial product that meets the general definition of "making a financial investment", that involves any pooling of investments or common enterprise and that does not fall within the specific list of exclusions to the definition of managed investment scheme mentioned in CA s9, will constitute an interest in a managed investment scheme and be regulated as such.

This feature of the definition of "managed investment scheme" used to have particular application to schemes involving promissory notes with a face value of $50,000 or more, which prior to 1 July 2009 were excluded from the definition of "debenture" and therefore fell outside the definition of "security" and also outside the carve-out for debentures in para (j) of the definition of managed investment scheme. Because it was unable to regulate these products  as securities, to avoid a lacuna in the law, ASIC sought to regulate them as interests in managed investment schemes (see eg ASIC v Emu Brewery Mezzanine Limited [2004] WASC 241 - we looked at this case when we examined the meaning of "debenture" in lecture 1 - and ASIC v Drury Management Pty Ltd [2004] QSC 68). However, these products do not fit comfortably within the definition of "managed investment scheme" and really ought to regulated as debt instruments. ASIC also wasn't always successful in running this argument (see eg ASIC v Great Northern Developments Pty Ltd [2010] NSWSC 1087). The legislature has now fixed this problem by amending the definition of "debenture" so that promissory notes of any denomination issued by companies are debentures, and therefore are regulated as "securities" under Part 7.

This feature of the definition of "managed investment scheme" also has particular application to derivative products. By definition, if something is an interest in a managed investment scheme that is registered or required to be registered under Chapter 5C and therefore a financial product under s764A(1)(b) or (ba), it cannot be a derivative, since the definition of "derivative" in s761D specifically excludes any of the other financial products specifically listed in s764A(1) (see s761D(3)(c)). Hence, if a derivative product is sold to more than 20 investors and the funds raised are pooled or otherwise involve a common enterprise (as they may well be under trust accounting requirements or for the purposes of hedging the issuer's exposure under the derivative product), there is a significant risk that the investment will technically be considered to be an interest in a managed investment scheme rather than a derivative product and therefore subject to Chapter 5C.

CA s9 - Definition of Interest
Interest in a managed investment scheme means a right to benefits produced by the scheme (whether the right is actual, prospective or contingent and whether it is enforceable or not).

 

CA s764A(1) - Things that are Financial Products
Subject to subdivision D (s765A), the following are financial products for the purposes of Chapter 7: ...
(b)   any of the following in relation to a registered scheme:
  (i)   an interest in the scheme;
  (ii)   a legal or equitable right or interest in an interest covered by (i);
  (iii)   an option to acquire, by way of issue, an interest or right covered by (i) or (ii);
(ba)   any of the following in relation to a managed investment scheme that is not a registered scheme, other than a scheme (whether or not operated in this jurisdiction) in relation to which none of ss601ED(1)(a), (b) and (c) are satisfied:
  (i)   an interest in the scheme;
  (ii)   a legal or equitable right or interest in an interest covered by (i);
  (iii)   an option to acquire, by way of issue, an interest or right covered by (i) or (ii).

CA s9 defines "registered scheme" to mean a managed investment scheme that is registered under s601EB.

To understand these provisions, you need to know that CA s601EB permits managed investment schemes that meet various conditions to register under the Corporations Act and CA s601ED(1) in fact requires schemes that meet any of the criteria mentioned in paras (a), (b) or (c) of that section to register under the Corporations Act before they can be marketed to investors (see below).

An interest of the type referred to in paras (i), (ii) or (iii) above in any scheme that is so registered is a financial product under s764A(1)(b).

There are also certain types of schemes that fall within the requirements for registration under s601ED(1) but that are exempt from registration under CA s601ED(2). I will call these "s601ED(2) schemes". They are also often called "wholesale schemes" in the industry because the exemption in s601ED(2) essentially only applies if the scheme has wholesale investors (or other investors who don’t require a PDS). An interest of the type referred to in paras (i), (ii) or (iii) above in a s601ED(2) scheme that is not registered under s601EB is a financial product under s764A(1)(ba).

Note the words in s764A(1)(ba) – “other than a scheme ... to which none of ss601ED(1)(a), (b) or (c) are satisfied”. I will call these schemes “wholly exempt schemes”. These words are there to prevent any interest in an unregistered scheme that is a wholly exempt scheme from being a financial product under s764A(1)(ba). That exclusion is reinforced by s765A(1)(s) below.

CA s765A(1) - Things that are not Financial Products
Despite subdivision B (s763A) or C (s764A), the following are not financial products for the purposes of Chapter 7: ...
(r)   any of the following:
  (i)   an interest in something that is not a managed investment scheme because of para (c), (e), (f), (k), (l) or (m) of the definition of 'managed investment scheme' in s9;
  (ii)   a legal or equitable right or interest in an interest covered by (i);
  (iii)   an option to acquire, by way of issue, an interest or right covered by (i) or (ii);
(s)   any of the following in relation to an managed investment scheme (whether or not operated in this jurisdiction), in relation to which none of ss601ED(1)(a), (b) and (c) are satisfied and that is not a registered scheme:
  (i)   an interest in the scheme;
  (ii)   a legal or equitable right or interest in an interest covered by (i);
  (iii)   an option to acquire, by way of issue, an interest or right covered by (i) or (ii).

Taking these in reverse order, s765A(1)(s) provides that an interest in a wholly exempt scheme that is not registered under the Corporations Act is not a financial product.

CA s765A(1)(r) provides that interests in things that are not managed investment schemes because one of the exclusions to the definition of "managed investment scheme" referenced in that section applies are also not financial products. The paragraphs referred to in s765A(1)(r) cover partnerships with more than 20 partners, schemes that only involve related bodies corporate, franchises, barter schemes, retirement villages and WA co-operative schemes.

CA s761A – Definition of Managed Investment Product
Managed investment product means a financial product described in s764A(1)(b) (ie an interest in, or other right or option over an interest in, a registered managed investment scheme).

Therefore, while an interest in, or other right or option over an interest in, a s601ED(2) scheme that is not registered under s601EB is a financial product under s764A(1)(ba), it is not a "managed investment product" for the purposes of Chapter 7.

Return to Outline


Registration of Schemes

CA s601ED(1) – Criteria for Registration
Subject to s601ED(2), a managed investment scheme must be registered under s601EB if:
(a)   it has more than 20 members;
(b)   it was promoted by a person, or an associate of a person, who was, when the scheme was promoted, in the business of promoting managed investment schemes; or
(c)   a determination under s601ED(3) is in force in relation to the scheme and the total number of members of all of the schemes to which the determination relates exceeds 20.
See ASC v Su (1995) 13 ACLC 770 and ASIC v Young & Others [2003] QSC 029.

A scheme that does not meet any of (a), (b) or (c) above – a “wholly exempt scheme” – does not have to be registered. This explains those references in the slides above relating to ss764A(1)(ba) and 765A(1)(s) to schemes to which none of ss601ED(1)(a), (b) or (c) are satisfied.

In relation to (a), s601ED4) provides that for the purpose of s601ED, when working out how many members a scheme has: (a) joint holders of an interest in the scheme count as a single member; and (b) an interest in the scheme held on trust for a beneficiary is taken to be held by the beneficiary (rather than the trustee) if: (i) the beneficiary is presently entitled to a share of the trust estate or of the income of the trust estate; or (ii) the beneficiary is, individually or together with other beneficiaries, in a position to control the trustee.

In relation to (b), in ASC v Su, Su was involved in the promotion of an undertaking for the production of cups made from potato flour. The undertaking involved the purchase of 3 machines to make the cups and 3 separate units trusts were set up, one to own each machine. Investors were sought to finance the undertaking. The undertaking failed and the investors who held units in the trusts lost their investments. ASC brought an action against Su for breaching s1064 of the old law - offering prescribed interests for sale without a prospectus. There was an exemption in the regulations that would have applied unless Su and colleagues could be said to be in the business of promoting similar schemes. ASC argued because they had set up 3 trusts, they were in the business of promoting similar schemes. The court rejected this argument, saying that even though 3 trusts were involved, there was really only one scheme.

In ASIC v Young & Others, it was held that the activities of real estate agents in raising finance from and selling property to participants in a so-called "Investors Club" constituted the unlawful operation of a managed investment scheme. The court found that the promotion of 7 property developments through the club was sufficient to mean that the schemes were promoted by a person in the business of promoting managed investment schemes and therefore the schemes required registration even though they each had less than 20 members.

In relation to (c), CA s601ED(3) gives ASIC the power to determine that a number of managed investment schemes are closely related and that each of them has to be registered at any time when the total number of members of all of the schemes exceeds 20. This is to stop people avoiding the registration requirements by splitting up schemes into a number of related schemes with less than 20 members. Given the approach of the court in ASC v Su, it is arguable that this power is not necessary. Someone attempting to split what is in reality a single enterprise into a number of separate schemes - eg by creating separate trusts for each purported scheme - will likely face a finding by the court that there is only one "scheme" involved even though separate trusts have been created. Australian Softwood Forests Pty Ltd v A-G (NSW), above, would also clearly support such a finding.

CA s601ED(2) – Registration Not Required if No PDS Required
A managed investment scheme does not have to be registered if all the issues of interests in the scheme that have been made would not have required the giving of a Product Disclosure Statement under Division 2 of Part 7.9 if the scheme had been registered when the issues were made.

CA s601ED(2) most typically applies to so-called "wholesale funds". Recall from lecture 8 that a Product Disclosure Statement is only required for an offer of financial products to retail investors and not needed for an offer of financial products to professional or sophisticated investors. So if membership of a managed investment scheme is limited to professional or sophisticated investors, the scheme will be exempt from registration under s601ED(2).

In the past, many wholesale funds that need not have been registered under s601ED(2) in fact use to apply to be registered in order to permit other managed investment schemes to invest in them under the former s601FC(4), thereby broadening their potential investor base. S601FC(4) used to provide that an RE of a registered managed investment scheme could only invest scheme property in another managed investment scheme if that other scheme was also registered under Chapter 5C, but it was repealed by the Corporations Legislation Amendment (Simpler Regulatory System) Act 2007.

Note that CR r5C.11.05 amends s601ED(2) by adding at the end "and Division 2 of Part 7.9 applied to the interests at that time". These words were added to avoid any issue with the transition to the FSR reforms (preventing someone from arguing, where interests in a scheme were issued prior to Division 2 of Part 7.9 coming into effect, that no PDS was required at that time and therefore the scheme did not have to be registered).

Consequences of Failure to Register
•     Criminal offence - 200 penalty units and/or imprisonment for 5 years for individuals and 1,000 penalty units for bodies corporate (s601ED(5), s1311 and schedule 3, s1312).
•     Any contract to subscribe for the interest is voidable at the option of the subscriber (s601MB).
•     Scheme may be wound up (s601EE).
•     Injunctions (s1324).
•     Compensation orders (s1325).
•     If person infringing is a licensed RE or its representative – cancellation or suspension of licence (ss915C(1)(a) and 912A(1)(c)) or banning order (s920A(1)(e)) for breach of a financial services law.

Note s601MB(1) – the voidability of contracts to subscribe for interests - also applies if a person fails to comply with Division 2 of Part 7.9 when offering an interest in a registered scheme for subscription or issuing an invitation to subscribe for an interest in a registered scheme.

In an interesting application of these provisions, ASIC used them to bring ANZ and Merrill Lynch to the negotiating table to reach a settlement of Opes Prime debacle by asserting a potential claim for compensation against them for being involved in a contravention of the managed investment provisions of the Corporations Act by Opes Prime: see ASIC Media Release MR09-37.

CA s601EB(1) - Requirements for Registration
•     Application must comply with s601EA.
•     Scheme must have a distinctive name (r5C.1.01).
•     Proposed RE must meet the requirements of s601FA.
•     The scheme's constitution must meet the requirements of ss601GA and 601GB.
•     The scheme's compliance plan must meet the requirements of s601HA.
•     The copy of the compliance plan lodged with the application must be signed by the directors of the RE, as required by s601HC.
•     Audit arrangements must be in place in relation to the compliance plan that will satisfy the requirements of s601HG.

If you satisfy these requirements then ASIC must register the scheme within 14 days of receiving the application and give you an Australian Registered Scheme Number (s601EB(2)). The ARSN or an Australian Business Number (which is a derivation of the ARSN) must be used on all documents lodged with ASIC (s601EC and r5C.1.03).

CA s1020A - Offers of Interests in Unregistered Schemes
A person must not:
(a)   make a recommendation, as described in s1012A(3), that is received in this jurisdiction;
(b)   make an offer, as described in s1012B(3) or 1012C(3), that is received in this jurisdiction;
(c)   accept an offer, made as described in s1012B(3) or (4), that was received in this jurisdiction,
in relation to an interest in an unregistered managed investment scheme if the scheme concerned needs to be, or will need to be, registered and has not been registered (even if it is proposed to register the scheme).

CA ss1012A, 1012B and 1012C set out the 'recommendation situations', 'issue situations' and 'sale situations' where an investor must be given a PDS. Those sections only apply to retail investors and so, if you limit your recommendations or offers to non-retail investors, you fall outside those sections and therefore outside s10210A. This marries in with the position under s601ED(2), mentioned above.

CA s1020A does not apply to a recommendation or offer made in a situation to which a subsection of s1012D, other than s1012D(1), applies (s1020A(3)). CA s1012D sets out the circumstances when a PDS is not required for the marketing of a financial product. CA s1012D(1) is the exemption where the client has already been given a PDS.

Return to Outline


Licensing and Disclosure Requirements

Licensing and Disclosure Requirements
•     Persons who carry on a business of advising on, or dealing in, s764A(1)(b) or (ba) products need a financial services licence authorising them to provide that service or to be an authorised representative of such a licensee.
•     If they deal with retail clients, they need:
  •     Financial Services Guide
  •     Statement of Advice for any advice given
  •     Product Disclosure Statement for any products provided or recommended
  •     To act in the best interests of the client
  •     To avoid conflicted remuneration and comply with ongoing fee requirements
  •     To warn if giving personal advice based on incomplete or inaccurate information or if giving general advice
  •     Dispute resolution systems
  •     Compensation arrangements

Note that CR r7.7.08A, which permits a combined FSG and PDS to be issued as a single document for certain simpler financial products, does not apply if the PDS is for a simple managed investment scheme to which Subdivision 4.2C of Division 4 of Part 7.9 applies (r7.7.08A(1D)). The reason is that the Government wants to ensure that the consumer is provided with a short and simple PDS for a simple managed investment scheme (see below), and combining the PDS with other documents is not consistent with this objective.

AFSL Required to Operate Registered Schemes
•     The responsible entity (RE) of a registered scheme must be a public company that holds an AFSL authorising it to operate a managed investment scheme (s601FA).
•     A person provides a financial service if they operate a registered scheme (s766A(1)(d)).
•     None of the exemptions from licensing requirements in s911A(2) apply to the operation of a registered scheme (s911A(4)).
•     These provisions do not apply to unregistered s601ED(2) schemes or wholly exempt schemes, but that is not the end of the matter (see below).

 

Other Licensing/Disclosure Issues - Registered Schemes
•     RE's AFSL will need to authorise advising on or dealing in interests in the scheme if done with sufficient system, repetition and continuity to constitute a "financial services business" (ss766B and 766C and see ASIC v McNamara (2002) 42 ACSR 488).
•     If operation of scheme involves dealing in other financial products with sufficient system, repetition and continuity to constitute a "financial services business", RE's AFSL will need to authorise dealing in those products (s766C).
•     RE does not need an AFSL authorising it to make a market in scheme products (s766D(2)).
•     RE does not need an AFSL authorising it to provide a custodial or depository service just because it operates or holds the assets of a registered scheme (s766E(3)(b)).
•     To the extent such schemes involve retail clients, RE will need to comply with the disclosure obligations in Parts 7.7 and 7.9 and the cooling off regime in Part 7.9 Div 5.

But for CA s766D(2), an RE of a registered managed investment scheme might require an AFSL authorising it to make a market in interests in the scheme if it offers a redemption or repurchase facility for those interests.

In relation to the last bullet point, CA s1010B(2)(a) deems the issue of a managed investment product to occur in the course of a business of issuing financial products.

In ASIC v McNamara (2002) 42 ACSR 488, a limited partnership was formed to provide finance to a joint venture entity. Two individuals, acting on behalf of the general partner, sought and received subscriptions from 55 mostly retail investors for units in the limited partnership. The conduct in question spanned the transition date for the FSR reforms. The limited partnership was not registered as a managed investment scheme and neither the general partner nor the individuals acting on its behalf held a dealers licence under the old law or an AFSL under the new law. The Federal Court held that the offering of units to 55 investors was sufficiently "systematic, repetitious and continuous" that the general partner and the individuals concerned were all carrying on a securities business under the old law and a financial services business under the new law and had contravened the Corporations Act by not having the requisite licence.

Other Licensing/Disclosure Issues - Section 601ED(2) Schemes
•     Interests in an unregistered scheme that is exempt from registration under s601ED(2) are not "managed investment products" but are still "financial products" (s764A(1)(ba)) and therefore RE's AFSL will need to authorise advising on or dealing in interests in the scheme if done with sufficient system, repetition and continuity to constitute a "financial services business" (ss766B and 766C).
•     If operation of scheme involves dealing in other financial products with sufficient system, repetition and continuity to constitute a "financial services business", RE's AFSL will need to authorise dealing in those products (s766C).
•     RE does not need an AFSL authorising it to make a market in scheme products (s766D(2)).
•     If RE of scheme holds financial products for the scheme, RE may require an AFSL authorising it to provide a custodial or depository service (s766E).
•     As s601ED(2) schemes normally only involve wholesale clients, Parts 7.7 and 7.9 (other than s1017E and 1018B) generally will not apply.

Again, but for CA s766D(2), an RE of a s601ED(2) scheme might require an AFSL authorising it to make a market in interests in the scheme if it offers a redemption or repurchase facility for those interests.

In relation to the fourth bullet point, ASIC has granted class order relief from the requirement for the trustees of certain wholesale schemes to hold an AFSL authorising them to provide a custodial or depository service (see ASIC Regulatory Guide 192 Licensing: wholesale equity venture capital schemes - trustee licensing).

In relation to the last bullet point above, s1017E regulates an issuer dealing with money received for a financial product before the product is issued and applies both to retail and non-retail clients. CA s1018B prohibits a person from advertising an offer, or intended offer, of financial products that does not need a PDS because of s1012E (see next note).

CA s1012E provides that a PDS is not required in relation to small scale offerings of managed investment products or other prescribed financial products - ie offerings that involve 20 or less purchasers investing $2 million or less over a 12 month period. Interests in unregistered schemes are prescribed products for these purposes (CR r7.9.16A).

There are some other provisions in Part 7.9 that might apply to a s601ED(2) scheme in certain limited circumstances. For example, CA s1017F imposes an obligation to issue confirmations in respect of certain transactions involving retail clients. It is possible that a retail client could invest in an unregistered scheme under s1012E (see previous note) without triggering an obligation to register the scheme or provide the client with a PDS. In such a case, s1017F would require the responsible entity of the scheme to issue the client a confirmation in respect of their investment even though the investment is largely unregulated by the balance of Part 7.9.

Other Licensing/Disclosure Issues - Wholly Exempt Schemes
•     Interests in an unregistered scheme that is exempt from registration under s601ED(1) are not "financial products" (s765A(1)(s)) or "managed investment products". Therefore:
  •     do not need AFSL to advise on or deal or make a market in those interests; and
  •     Parts 7.7 and 7.9 do not apply to scheme.
•     If operation of scheme involves dealing in other financial products with sufficient system, repetition and continuity to constitute a "financial services business", RE will need AFSL authorising it to deal in those products.
•     If scheme holds financial products, RE (or its trustee or custodian) may require an AFSL authorising it to provide a custodial or depository service (s766E).

 

CR r7.9.11W – Modified PDS Requirements for Simple Managed Investment Schemes
A PDS for a simple managed investment scheme to which Subdivision 4.2C of Division 4 of Part 7.9 applies must:
(a)   include the information and statements mentioned in CR schedule 10E; and
(b)   be in the form mentioned in CR schedule 10E.

CR r1.0.02 (1) defines "simple managed investment scheme" to mean a registered management investment scheme which is or was offered because it meets one of the following requirements: (a) the scheme invests at least 80% of its assets in money in an account with a bank on the basis that the money is available for withdrawal immediately during the bank's normal business hours or at the end of a fixed-term period that does not exceed 3 months; (b) the scheme invests at least 80% of its assets in money on deposit with a bank on the basis that the money is available for withdrawal immediately during the bank's normal business hours or at the end of a fixed-term period that does not exceed 3 months; or (c) the scheme invests at least 80% of its assets under one or more arrangements by which the responsible entity of the scheme can reasonably expect to realise the investment, at the market value of the assets, within 10 days.

The modified PDS requirements for simple managed investment schemes in CR schedule 10E are quite prescriptive. For example, the length of a PDS (including any title page, contents or matter in writing that is applied, adopted or incorporated by the PDS) for must not exceed: (a) 8 pages if it is printed on A4; (b) 16 pages if it is printed on A5; or (c) 24 pages if it is printed on DL. The minimum font size for text in the PDS is 8 points for the name, address, ARSN, ABN, ACN and AFSL of the person giving the PDS and 9 points for all other text.

The PDS must include sections which must be numbered and titled as follows:

1. About [name of responsible entity]

2. How [name of simple managed investment scheme] works

3. Benefits of investing in [name of simple managed investment scheme]

4. Risks of managed investment schemes

5. How we invest your money

6. Fees and costs

7. How managed investment schemes are taxed

8. How to apply.

The PDS may include additional sections after sections 1 to 8 and may include other information, provided it does not contravene the limitations on length mentioned above. The regulations contain further requirements as to what can and can't be included in each section mentioned above.

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Responsible Entities

The Role and Qualifications of a Responsible Entity
•     The role of the RE of a registered scheme is to operate the scheme and perform the functions conferred on it by the scheme's constitution and the Corporations Act (s601FB(1)).
•     The RE of a registered scheme must be a public company that holds an Australian financial services licence authorising it to operate a managed investment scheme (s601FA).
•     If the RE holds the assets of the scheme, generally it will need to hold a minimum NTA equal to the greater of: (a) $10 million; or (b) 10% of its average responsible entity and IDPS revenue. Otherwise, it must appoint a third party custodian with that level of NTA (see ASIC Regulatory Guide 166 Licensing: Financial requirements (appendix 2 table 9) and Class Order CO 13/760 Financial requirements for responsible entities and operators of investor directed portfolio services).
•     If the RE holds the assets of the scheme, it must meet the asset holding standards set out in ASIC Regulatory Guide 133 Managed investments and custodial or depository services: Holding assets and Class Order CO 13/1409 Holding assets: Standards for responsible entities or otherwise appoint a third party custodian which meets those standards and have a written agreement with that custodian with certain prescribed terms.

The requirements to change an RE are set out in ss601FJ to 601FQ. We don’t need to worry about those for the purposes of this course.

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Scheme Constitutions

CA - General Requirements
•     The constitution of a registered scheme must be contained in a document that is legally enforceable as between the members and the RE (s601GB).
•     Constitution can be modified, or repealed and replaced with a new constitution, by:
  •     a special resolution of the members of the scheme; or
  •     by the RE if the RE reasonably considers the change will not adversely affect members' rights (s601GC(1)).
•     Original constitution must be lodged with ASIC (s601EA(4)(a)), as must any amendments (s601GC(2)). ASIC can require a consolidated constitution to be lodged (s601GC(3)).
•     The RE must send a copy of the scheme's constitution to a member of the scheme within 7 days if the member asks the RE, in writing, for the copy and pays any fee (up to the prescribed amount of $10.00) required by the RE (s601GC(4)).

In ING Funds Management Ltd v ANZ Nominees Ltd [2009] NSWSC 243, the NSW Supreme Court (Barrett J) held that a deed poll executed by the responsible entity of a registered managed scheme to modify its constitution to freeze redemptions was beyond the responsible entity's powers of amendment in section 601GC(1)(b) of the Corporations Act and ought to have been made by a special resolution of members under section 601GC(1)(a). The court also held that preliminary attempts to amend the constitution by an incorrectly executed deed poll were legally ineffective and did not comply with section 601GB, on the basis that the constitution itself was a deed and as such could only legally be amended by another properly executed deed.

There is some controversy about the scope of the RE's power to make unilateral amendments to a scheme constitution under s601GC(1), particularly as it relates to the price at which interests in a scheme are issued under the constitution. In the matter of Centro Retail Limited and Centro MCS Manager Limited in its capacity as Responsible Entity of Centro Retail Trust [2011] NSWSC 1175, the NSW Supreme Court (Barrett J) held that an RE was justified in unilaterally amending the CRT's constitution to allow the RE, as part of the broader Centro restructure, to issue units based on the CRT's net equity value, rather than the prevailing market price, as was required under the existing terms of the constitution. In so doing, it expressly disagreed with the finding in Premium Income Fund Action Group Inc v Wellington Capital Ltd [2011] FCA 698 that unitholders in a registered managed investment scheme had a right to have units issued at the price determined in accordance with the scheme's constitution and any amendment to that provision of the constitution to confer flexibility on the RE to issue units at a different price potentially adversely affected their rights. However, in 360 Capital Re Ltd v Watts [2012] VSCA 234, the Full Court of the Victorian Supreme Court preferred the reasoning in the latter case to that in the former and held that the RE of a registered scheme could not unilaterally amend its constitution to remove certain constraints on an issue of interests in the scheme.

CA s601GA(1) - Contents of the Constitution
The constitution of a registered scheme must make adequate provision for:
(a)   the consideration that is to be paid to acquire an interest in the scheme;
(b)   the powers of the RE in relation to making investments of, or otherwise dealing with, scheme property;
(c)   the method by which complaints made by members in relation to the scheme are to be dealt with; and
(d)   winding up the scheme.
See generally ASIC Regulatory Guide 134 Managed investments: constitutions.

Note also CA s601NA, which provides that a provision of a constitution that purports to provide that the scheme is to be wound up if a particular company ceases to be its responsible entity is of no effect.

CA s601GA(2) - Indemnities
If the RE is to have any rights to be paid fees out of scheme property, or to be indemnified out of scheme property for liabilities or expenses incurred in relation to the performance of its duties, those rights:
(a)   must be specified in the scheme's constitution; and
(b)   must be available only in relation to the proper performance of those duties;
and any other agreement or arrangement has no effect to the extent that it purports to confer such a right.
See Reader v Fried [2001] VSC 495.

This affirms the common law rule that a trustee is only entitled to a fee for acting as trustee if the trust deed so provides and otherwise must act gratuitously. However, it modifies the common law position that a trustee is entitled to be indemnified out of the trust estate for any expenses properly and reasonably incurred in the administration of the trust without the need for any express authorisation in the trust deed. It is therefore critical from the RE's standpoint that the fee clause is drafted correctly and the constitution sets out the widest possible power for the RE to claim an indemnity for expenses incurred on behalf of the scheme. Otherwise, it will have to meet these expenses out of its own resources.

What is "proper performance"? Given the RE's statutory duties in this regard, it likely means that the RE must have acted honestly; exercised a reasonable degree of care and diligence; acted in the best interests of the members and, if there was a conflict between the members' interests and its own interests, given priority to the members’ interests; and complied with the scheme’s constitution.

Note as a matter of general law, exculpation and indemnity clauses for trustees are usually construed strictly. In Reader v Fried, the Victorian Supreme Court held that the trustees of a superannuation fund who sold property to the fund were liable for breach of trust and could not rely on an exclusion clause limiting their liability to acts involving their own "dishonesty". The court found that by putting their personal interests above those of the beneficiaries, the trustees had acted dishonestly within the meaning of that clause. If the courts interpret “dishonesty” in a fiduciary context this widely, they are likely to take a similar approach to the reference in s601GGA(2) to “proper performance”.

CA s601GA(3) – Borrowing Powers
If the RE is to have any powers to borrow or raise money for the purposes of the scheme:
(a)   those powers must be specified in the scheme's constitution; and
(b)   any other agreement or arrangement has no effect to the extent that it purports to confer such a power.

 

CA s601GA(4) – Withdrawal From Scheme
If members are to have a right to withdraw from the scheme, the scheme's constitution must:
(a)   specify the right;
(b)   if the right may be exercised while the scheme is "liquid" (see s601KA) - set out adequate procedures for making and dealing with withdrawal requests; and
(c)   if the right may be exercised while the scheme is not "liquid" - provide for the right to be exercised in accordance with Part 5C.6 and set out any other adequate procedures (consistent with that Part) that are to apply to making and dealing with withdrawal requests.
The right to withdraw, and any provisions in the constitution setting out procedures for making and dealing with withdrawal requests, must be fair to all members.

Rights to withdraw from a registered scheme are addressed further in Part 5C.6 (ss601KA to 601KE). We don’t need to worry about these provisions for the purposes of this course.

Note that the High Court held in MacarthurCook Fund Management Ltd v TFML Ltd [2014] HCA 17 that the compulsory redemption of a member's interest in a registered managed investment scheme is not a withdrawal for the purposes of CA Pt 5C.6. In the High Court’s view, a withdrawal by a member that is regulated by Pt 5C.6 involves "some act of volition on the part of the member". Accordingly, a member does not withdraw from a scheme for the purposes of Pt 5C.6 merely by reason of the responsible entity: (a) exercising a power compulsorily to redeem the interest of a member; or (b) performing an obligation to redeem which arises under the terms of issue of a class of interests if that obligation is required by those terms to be performed independently of any act on the part of the member.

Aside from the mandatory requirements in s601GA, the scheme constitution can contain essentially whatever the RE/promoter wants to include.

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Compliance Plans

CA - General Requirements
•     A compliance plan must be signed by the directors of the RE (s601HC).
•     A compliance plan may incorporate provisions from another scheme's plan (s601HB).
•     ASIC may direct the RE of a registered scheme to give it information about the arrangements contained in the compliance plan (s601HD).
•     An RE may amend a scheme's compliance plan or repeal it and replace it with a new compliance plan and ASIC may direct it to do so in order to ensure that the plan is consistent with s601HA (s601HE).
•     Original compliance plan must be lodged with ASIC (s601EA(4)(b)), as must any amendments (s601HE). ASIC can require a consolidated compliance plan to be lodged (s601HF).
•     Compliance plan must be audited within 3 months after the end of the scheme’s financial year (s601HG).

In relation to the second bullet point - typically compliance plans do incorporate provisions of other plans. The RE prepares a master compliance plan for all schemes it administers and lodges that with a cover sheet or wrap-around as the compliance plan for each scheme.

In relation to the last bullet point, CA s601HG(4) requires the auditor of a compliance plan to notify ASIC in writing as soon as possible if the auditor: (a) has reasonable grounds to suspect that a contravention of the Corporations Act has occurred; and (b) the contravention is: (i) a significant one; or (ii) not a significant one but the auditor believes that the contravention has not been or will not be adequately dealt with by commenting on it in the auditor's report or bringing it to the attention of the directors of the RE. The auditor must also notify ASIC if anyone attempts to unduly influence, coerce, manipulate or mislead a person involved in the conduct of the audit or otherwise interferes with the proper conduct of the audit.

CA s601HA - Contents of Compliance Plans
The compliance plan of a registered scheme must set out adequate measures that the RE is to apply in operating the scheme to ensure compliance with the Corporations Act and the scheme's constitution, including the arrangements for:
(a)   ensuring that all scheme property is clearly identified as scheme property and held separately from property of the RE and property of any other scheme;
(b)   if the scheme is required to have a compliance committee - ensuring that the compliance committee functions properly, including adequate arrangements relating to:
  (i)   the membership of the committee;
  (ii)   how often committee meetings are to be held;
  (iii)   the committee's reports and recommendations to the RE;
  (iv)   the committee's access to the scheme's accounting records and to the auditor of the scheme's financial statements; and
  (v)   the committee's access to information that is relevant to the RE's compliance with the Corporations Act;
(c)   ensuring that the scheme property is valued at regular intervals appropriate to the nature of the property;
(d)   ensuring that compliance with the plan is audited as required by s601HG;
(e)   ensuring adequate records of the scheme's operations are kept; and
(f)   any other matter prescribed by the regulations.
See generally ASIC Regulatory Guide 132 Managed investments: Compliance plans.

See also RG 116 Commentary on compliance plans: Agricultural industry schemes, RG 117 Commentary on compliance plans: Financial asset schemes, RG 118 Commentary on compliance plans: Contributory mortgage schemes, RG 119 Commentary on compliance plans: Pooled mortgage schemes and RG 120 Commentary on compliance plans: Property schemes.

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Compliance Committees

CA - General Requirements
•     The RE of a registered scheme must establish a compliance committee if less than half of the directors of the RE are external directors (s601JA).
•     A scheme’s compliance committee must have at least 3 members and a majority of them must be external members (s601JB).
•     Members can’t be indemnified in respect of any liability as member or have their liability excluded except in respect of a liability: (a) to a third party incurred in good faith; or (b) for costs and expenses incurred in defending proceedings, civil or criminal, in which judgment is given in favour of them or in which they are acquitted or in connection with an application in relation to such proceedings in which the Court grants relief to them under the CA (s601JF).
•     Members can’t be insured by the RE for wilful breach of duty (s601JG).
•     The committee must keep minutes of its meetings and records of its reports and recommendations (s601JH(2)).
•     Members must disclose any direct or indirect pecuniary interest that they have in a matter being considered by the committee if their interest could conflict with the proper performance of their duties (s601JJ).

CA s601JA(2) defines when a director of the RE is an external director. CA s601JB(2) defines when a member of a compliance committee is an external member.

CA s601JC - Functions of Compliance Committee
The functions of a scheme's compliance committee are:
(a)   to monitor to what extent the RE complies with the scheme's compliance plan and to report on its findings to the RE;
(b)   to report to the RE:
  (i)   any breach of the Corporations Act involving the scheme; or
  (ii)   any breach of the provisions included in the scheme's constitution in accordance with s601GA;
  of which the committee becomes aware or that it suspects;
(c)   to report to ASIC if the committee is of the view that the RE has not taken, or does not propose to take, appropriate action to deal with a matter reported under (b); and
(d)   to assess at regular intervals whether the compliance plan is adequate, to report to the RE on the assessment and to make recommendations to the RE about any changes that it considers should be made to the plan.

CA s601JC(2) empowers the compliance committee to commission independent legal, accounting or other professional advice or assistance, at the reasonable expense of the RE.

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Statutory Duties

CA s601FC - Duties of Responsible Entity
In exercising its powers and carrying out its duties, the RE of a registered scheme must:
(a)   act honestly;
(b)   exercise the degree of care and diligence that a reasonable person would exercise if they were in the RE's position;
(c)   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;
(d)   treat the members who hold interests of the same class equally and members who hold interests of different classes fairly;
(e)   not make use of information acquired through being the RE in order to:
  (i)   gain an improper advantage for itself or another person; or
  (ii)   cause detriment to the members of the scheme;
(f)   ensure that the scheme's constitution meets the requirements of ss601GA and 601GB;
(g)   ensure that the scheme's compliance plan meets the requirements of s601HA;
(h)   comply with the scheme's compliance plan;
(i)   ensure that scheme property is:
  (i)   clearly identified as scheme property; and
  (ii)   held separately from property of the RE and property of any other scheme;
(j)   ensure that the scheme property is valued at regular intervals appropriate to the nature of the property;
(k)   ensure that all payments out of the scheme property are made in accordance with the scheme's constitution and the Corporations Act;
(l)   report to ASIC any breach of the Corporations Act that:
  (i)   relates to the scheme; and
  (ii)   has had, or is likely to have, a materially adverse effect on the interests of members;
  as soon as practicable after it becomes aware of the breach; and
(m)   carry out or comply with any other duty, not inconsistent with the Corporations Act, that is conferred on the RE by the scheme's constitution (s601FC(1)).
The RE holds scheme property on trust for scheme members (s601FC(2)).

Note this last point – the RE holds the scheme property on trust for scheme members – we will come back to this shortly when we look at the duties of trustees.

CA s601FC(1) effectively codifies a number of the fiduciary duties that the law of equity would impose upon the RE as a trustee - eg (a), (c), (d), (e), (i), (k) and (m).

CA s601FC(3) provides that these duties of the RE override any conflicting duty an officer or employee of the RE has under Part 2D.1 (ie to the company that is the RE).

A RE who contravenes these duties and any person who is involved in a RE’s contravention, contravenes s601FC(5), which is a corporation/scheme civil penalty provision (see section 1317E). That means they can be subjected to a $200,000 civil penalty and can be liable to the scheme for any loss or damage suffered as a result of the contravention.

In In the matter of Macquarie Investment Management Limited [2016] NSWSC 1184, Macquarie Investment Management was subjected to a $400,000 civil penalty for breaching CA ss601FC(1)(b) and 601FC(5). It was found to have accepted a recommendation from its investment manager Van Eyk to invest $30 million investment in a Cayman Islands-based account without conducting appropriate checks and to have ignored warning signs when a redemption request on the account was not honoured. The investment eventually failed and led to the collapse of Van Eyk.

For an important decision on the duties of a responsible entity of a managed investment scheme when dealing with applications for the issue and redemption of interests in the scheme, see Basis Capital Funds Management Ltd v BT Portfolio Services Ltd [2008] NSWSC 766.

CA s601FD -Duties of Officers of Responsible Entity
An officer of the RE of a registered scheme must:
(a)   act honestly;
(b)   exercise the degree of care and diligence that a reasonable person would exercise if they were in the officer's position;
(c)   act in the best interests of the members and, if there is a conflict between the members' interests and the interests of the RE, give priority to the members' interests;
(d)   not make use of information acquired through being an officer of the RE in order to:
  (i)   gain an improper advantage for the officer or another person; or
  (ii)   cause detriment to the members of the scheme;
(e)   not make improper use of their position as an officer to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to the members of the scheme; and
(f)   take all steps that a reasonable person would take, if they were in the officer's position, to ensure that the RE complies with:
  (i)   the Corporations Act;
  (ii)   any conditions imposed on the RE's AFSL;
  (iii)   the scheme's constitution; and
  (iv)   the scheme's compliance plan.
See ASC v AS Nominees Ltd (1995) 13 ACLC 1822, esp at p1831 and pp1835-6.

For these purposes, "officer" effectively means a director or secretary of the RE and anyone else who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the RE or who has the capacity to affect significantly the RE's financial standing (see s9). In other words, directors, secretaries and senior managers.

Apart from (c) and (f), these duties are broadly the same as the duties of an officer of a company vis-à-vis the company – see ss 180-184 in Part 2D.1. However, CA s601FD(2) provides that a duty of an officer of the RE under s601FD(1) overrides any conflicting duty the officer has to the RE under Part 2D.1.

An officer of a RE who contravenes these duties contravenes s601FD(3), which is a corporation/scheme civil penalty provision (see section 1317E). Again, this means they can be subjected to a $200,000 penalty and can be liable to the scheme for any loss or damage suffered as a result of the contravention. If the contravention is intentional or reckless, then that is a criminal offence (s601FD(4)) carrying a fine of 2,000 penalty units and/or 5 years jail.

Note that this is probably not that much of an extension to the common law position. In ASC v AS Nominees Ltd, the ASC brought an action against 3 trustees and managers of various superannuation and unit trusts to have them wound up and to have a receiver manager appointed to their property. This was a novel case as none of the companies was insolvent or likely to become insolvent. The ASC's winding up action was founded on the ground that it was just and equitable for the companies to be wound up to protect the interests of the investing public and the beneficiaries of the trusts they managed. There was clear evidence of a persistent breach of trustee obligations - the pooling of separate trust funds contrary to statutory and equitable obligations, a failure to keep proper accounts and minutes, transactions involving multiple breaches of fiduciary duty, gross negligence and possible fraud. The court granted the orders sought by the ASC.

In the course of argument, the ASC tried to get the court to rule that the directors of trustee companies owed a direct fiduciary duty to the beneficiaries of the trusts. The court did not take up the invitation and instead said (at p1,835):

    

"It is questionable, in my view, whether this heralded development in our law is a desirable or necessary one in the trust company context. To the extent that it is advanced as a means of protecting trust beneficiaries from misuse by directors either of their company's trustee powers or of their own position vis-à-vis the trust property, it can be said that that protection can be afforded by other quite orthodox means and in a more extensive way."

First the court pointed out that the fact that the company was a trustee coloured the duties that the directors owed to the company. It said (at p1,831):

    

"Where the trustee is itself a company the requirements of care and caution are in no way diminished. And here, unlike with companies in general, these requirements have a flow-on effect into the duties and liabilities of the directors of such a company. It was early established - largely it would seem from case law on charitable and municipal corporations - that at least when, and to the extent that, directors of a trustee company are themselves "concerned in" the breaches of trust of their company, they are liable to the company according to the same standard of care and caution as is expected of the company itself …

    

To affirm such a limited coalescence in the standard of care of directors and trustees in the case of directors of trust companies is not to reignite the arid debate on whether directors are trustees … It is merely to say that in this context the duties of trusteeship of the company can give form and direction to the common law and statutory duties of care and diligence imposed on directors, where the directors themselves have caused their company’s breach of trust.

And then later (at p1,836):

    

"Legal decision and scholarly opinion in common law jurisdictions are converging in the view that at least what is known as the second ("the knowing assistance") limb of the rule in Barnes v Addy is a fault based form of accessorial liability. For present purposes that liability rule can be formulated (conservatively) as one which exposes a third party to the full range of equitable remedy available against a trustee if that person knowingly or recklessly assists in or procures a breach of trust or of fiduciary duty by a trustee …

    

As has long been recognised in case law in the United States … this form of liability is one of no little significance to the directors of a trust company for the very reason that, often enough, it will be their own conduct in exercising the powers of the board which causes their company to commit a breach of trust. They are, in other words, peculiarly vulnerable to this rule …"

Illustrating the point, in Re S & D International Pty Ltd (No 4) [2010] VSC 388, the Supreme Court of Victoria held that the director of a corporate trustee of a unit trust was liable for a breach of duty by the trustee under the second limb in Barnes v Addy because he knowingly assisted in the breach.

 

CA s601FE - Duties of Employees of Responsible Entity
An employee of the RE of a registered scheme must not:
(a)   make use of information acquired through being an employee of the RE in order to:
  (i)   gain an improper advantage for the employee or another person; or
  (ii)   cause detriment to members of the scheme; or
(b)   make improper use of their position as an employee to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to the members of the scheme.

These duties are broadly the same as the duties of an employee of a company vis-à-vis the company – see ss182 and 183 in Part 2D.1. CA s601FE(2) provides that a duty of an employee of the RE under s601FE(1) overrides any conflicting duty the employee has to the RE under Part 2D.1.

An employee of a RE who contravenes these duties contravenes s601FE(3), which is a corporation/scheme civil penalty provision (see section 1317E). Again, this means they can be subjected to a $200,000 penalty and can be liable to the scheme for any loss or damage suffered as a result of the contravention. If the contravention is intentional or reckless, then that is a criminal offence (s601FE(4)) carrying a fine of 2,000 penalty units and/or 5 years jail.

CA s601JD – Duties of Members of Compliance Committee
A member of a scheme's compliance committee must:
(a)   act honestly;
(b)   exercise the degree of care and diligence that a reasonable person would exercise if they were in the member's position;
(c)   not make use of information acquired through being a member of the committee in order to:
  (i)   gain an improper advantage for the member or another person; or
  (ii)   cause detriment to the members of the scheme; and
(d)   not make improper use of their position as a member of the committee to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to the members of the scheme.

Breach again is a corporation/scheme civil penalty provision (ss601JD(3) and 1317E). If the breach is intentional or reckless, that is a criminal offence (s601JD(4)) punishable by a fine of 2,000 penalty units and/or imprisonment for 5 years.

A member of the compliance committee must also take all reasonable steps to assist ASIC in carrying out a check under s601FF(1) - s601JD(2).

CA s601FB(2) – Liability for Agents
The RE has power to appoint an agent, or otherwise engage a person, to do anything that it is authorised to do in connection with the scheme. For the purpose of determining whether:
(a)   there is a liability to the members; or
(b)   the RE has properly performed its duties for the purposes of s601GA(2);
the RE is taken to have done (or failed to do) anything that the agent or person has done (or failed to do) because of the appointment or engagement, even if they were acting fraudulently or outside the scope of their authority or engagement.

While this gives the RE the power to delegate, it also makes the RE liable for the misconduct of any delegate it appoints. This overrides 2 common law trust law principles – (1) unless the terms of trust confer on the trustee a power to delegate or there is a compelling case of "moral necessity", a trustee must administer the trust personally (McMillan v McMillan (1891) 17 VLR 33); and (2) where a trustee has the power to appoint an agent, they are not liable for losses incurred by the agent provided they used the requisite care in selecting and supervising the agent (Re Speight (1883) 22 Ch D 727). We will come back to this latter case shortly when we look at fiduciary responsibilities.

The scope of this section is unclear. There seems little doubt that it applies to custodians, investment managers and registrars appointed by the RE as they are all doing things the RE is required to do under the CA (which includes operating the scheme and complying with the scheme constitution). However, does it apply to other agents which the RE instructs to do things on behalf of the scheme? For instance, what if the RE instructed a broker to buy shares for the trust and an employee of the broker stole the purchase money or invested it in something that s/he was not supposed to? Would the RE be responsible for that? What if the RE instructed a lawyer to act on a sale of trust property and the lawyer absconded with the proceeds of sale? Would the RE be responsible for that? It is submitted that a court ought to read down the words "authorised to do in connection with the scheme" as only applying to the core responsibilities that the RE itself is required to perform in relation to the scheme but until the matter gets tested in court we will not know.

Note that ASIC has confirmed its view that s601FB(2) applies to appointment of custodians and that a responsible entity that engages an asset holder to hold scheme property is liable to members for the acts and omissions of the asset holder under s601FB(2) of the Corporations Act (see para 55 of ASIC Regulatory Guide 133 Managed investments: Scheme property arrangements).

Whatever the outcome on that issue, s601FB(2) means that REs have to be very careful in negotiating agreements with custodians, investment managers and registrars. As we saw when we looked at s601GA(2)(b) above, REs have only limited rights to be indemnified out of scheme assets and lose those rights if they have not "properly performed" their duties. To the extent that those agents are doing functions that the RE should be doing under the Act or the scheme constitution, the RE will be strictly liable for any misconduct on their part and will not have any right of indemnity out of the scheme assets. As a consequence, REs need to be very careful about any disclaimers or limitations on liability for misconduct they give away to agents in agency contracts. Otherwise, the RE could find itself liable to the scheme because it is deemed to have committed the misconduct the agent committed, but have no right of indemnity out of the scheme assets and no right of recourse against the agent.

CA s601FB(3) – Liability for Sub-agents
An agent appointed, or a person otherwise engaged, by:
(a)   the agent or person referred to in s601FB(2); or
(b)   a person who is taken under this subsection to be an agent of the RE;
to do anything that the RE is authorised to do in connection with the scheme is taken to be an agent appointed by the RE to do that thing for the purposes of s601FB(2).

What this does is treat any sub-agents appointed by the agent as if they were agents appointed by the RE, thereby making the RE liable for their misconduct. This continues on down the chain of any agency appointments – sub-sub agents, sub-sub-sub agents and so on. So if you are an RE appointing an agent, you want to have tight controls on their power to delegate or appoint sub-agents.

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Related Party Transactions

CA s601LA - Chapter 2E Applies With Modifications
Chapter 2E applies to a registered scheme with the modifications set out in ss601LB to 601LE and as if:
(a)   references to a public company were instead references to the RE of the scheme;
(b)   references to a benefit being given to or received by a related party of a public company were instead references to a benefit being given to or received by the RE or a related party;
(c)   references to a resolution of a public company were instead references to a resolution of the members of the scheme;
(d)   references to a general meeting were instead references to a members' meeting of the scheme;
(e)   references to members of a public company were instead references to members of the scheme; and
(f)   references to the company's best interests were instead references to the best interests of the scheme's members.

It is worth noting at the outset that these provisions are not well drafted. The shorthand and economical manner in which the company related party provisions have been applied to registered managed investment schemes creates a number of problems. Some of these are highlighted in the notes below.

See generally ASIC Regulatory Guide 76: Related party transactions.

CA s208, 601LC(1) - Need for Member Approval
If:
(a)   a financial benefit is given by:
  (i)   the RE of a registered scheme;
  (ii)   an entity that the RE controls; or
  (iii)   an agent of, or person engaged by, the RE;
(b)   the benefit either:
  (i)   is given out of the scheme property; or
  (ii)   could endanger the scheme property; and
(c)   the benefit is given to:
  (i)   the person or a related party; or
  (ii)   another person referred to in (a) or a related party of that person;
then, for the person referred to in (a) to give the benefit, either:
(d)   the person referred to in (a) must:
  (i)   obtain the approval of the scheme's members in the way set out in ss217 to 227; and
  (ii)   give the benefit within 15 months after the approval; or
(e)   the giving of the benefit must fall within an exception set out in ss210 to 216.

In relation to (c)(i) above, while it is not well drafted, the reference to "the person" must mean the person referred to in (a) who is giving the benefit.

In relation to (d)(i) above, CA s253E which has the effect of precluding the RE and any associates who hold interests in the scheme from voting those interests on a member resolution under s208.

In relation to (d)(ii) above, CA s208(2), as modified by s601LC, provides that if a benefit is given under a contract that was conditional on member approval and that was approved by members within 15 months of having been entered into, then the benefit need not be given within 15 months.

In relation to (e) above, the exceptions in ss213 and 214 are taken to have been omitted for these purposes (see s601LD).

The omission of s214 would seem to be problematical. In a corporate context, s214 provides that member approval is not needed to give a financial benefit if the benefit is given by a body corporate to a closely-held subsidiary of the body or by a closely-held subsidiary of a body corporate to the body or an entity it controls. For these purposes, a body corporate is a closely-held subsidiary of another body corporate if, and only if, no member of the first-mentioned body is a person other than: (a) the other body; (b) a nominee of the other body; (c) a body corporate that is a closely-held subsidiary of the other body because of any other application or applications of these provisions; or (d) a nominee of a body referred to in (c). Shares that are non-voting shares are disregarded for these purposes. There should be an equivalent provision for managed investment schemes for closely held entities that an RE controls in its capacity as RE (as distinct from entities that it controls in its own right or as RE of a different scheme). Otherwise, the prohibition on giving financial benefits by an RE to an entity controlled by the RE will capture the capitalisation by the RE of, and other transactions between the RE and, wholly owned intermediate holding vehicles and sub-trusts for scheme assets and technically the RE will be required to show that these transactions have taken place on arm's length terms or otherwise obtain member approval to the transactions.

CA s208(3), as modified by s601LC, provides that s208(1) does not prevent the responsible entity from paying itself fees, and exercising rights to an indemnity, as provided for in the scheme's constitution under s601GA(2).

CA s229 - What is a Financial Benefit?
(1)   In determining whether a financial benefit is given for the purposes of this Chapter:
  (a)   give a broad interpretation to financial benefits being given, even if criminal or civil penalties may be involved;
  (b)   the economic and commercial substance of conduct is to prevail over its legal form; and
  (c)   disregard any consideration that is or may be given for the benefit, even if the consideration is adequate.
(2)   Giving a financial benefit includes the following:
  (a)   giving a financial benefit indirectly, for example, through one or more interposed entities;
  (b)   giving a financial benefit by making an informal agreement, oral agreement or an agreement that has no binding force;
  (c)   giving a financial benefit that does not involve paying money (for example by conferring a financial advantage).
(3)   The following are examples of giving a financial benefit to a related party:
  (a)   giving or providing the related party finance or property;
  (b)   buying an asset from or selling an asset to the related party;
  (c)   leasing an asset from or to the related party;
  (d)   supplying services to or receiving services from the related party;
  (e)   issuing securities or granting an option to the related party;
  (f)   taking up or releasing an obligation of the related party.

 

Who is a Related Party of the RE?
(a)   An entity that controls the RE (s228(1)).
(b)   If the RE is controlled by an entity that is not a body corporate, the persons making up that entity (s228(2)(c)).
(c)   Directors of the RE or of an entity that controls the RE (s228(2)(a) and (b)).
(d)   Spouses and de facto spouses of (b) and (c) (s228(2)(d)).
(e)   Parents and children of (b), (c) and (d) (s228(3)).
(f)   Entities controlled by (a) – (e) unless they are also controlled by the RE (s228(4)).
(g)   Anyone who has fallen within (a) – (f) within the past 6 months (s228(5)).
(h)   Anyone who believes or has reasonable grounds to believe that they are likely to fall within (a) – (f) at any time in the future (s228(6)).
(i)   Anyone acting in concert with someone described above (s228(7)).

 

Exceptions to Requirement for Member Approval
•     Benefits provided on arm’s length terms (s210).
•     The payment of reasonable remuneration or reimbursement of expenses to an officer or employee of the RE (s211) ??
•     The reasonable provision of an indemnity, exemption, payment of insurance premium or payment of legal costs for an officer of the RE (s212) ??
•     The payment of fees to the RE or the RE exercising rights of indemnity as provided for in the scheme’s constitution (s208(3), as modified by s601LC).
•     Benefits given to a related party as a member that do not unfairly discriminate against other members (s215).
•     Benefits given under a court order (s216).

As mentioned above, the exceptions in ss213 and 214 are omitted for these purposes (see s601LD).

The question marks next to the 2nd and 3rd bullet points are there because these amounts would normally be paid by the RE out of its own resources (they are part of the RE's overheads that it would defray from the fee it receives for acting as RE), rather than being directly reimbursed out of scheme assets. This appears to the writer to be a drafting error attributable to the rather indiscriminate way in which the public company related party provisions have been applied to managed investment schemes.

CA s209 - Consequences of Breach
•     Contravention does not affect the validity of any contract or transaction connected with the giving of the benefit (s209(1)(a)).
•     The RE is not guilty of an offence (s209(1)(b)) ??
•     Anyone involved in the contravention by the RE contravenes s209(2), a corporation/scheme civil penalty provision. This may attract a civil penalty of $200,000 and potential liability to anyone who suffers loss or damage as a result of the contravention.
•     If the contravention is dishonest, that is a criminal offence, punishable by a fine of 2,000 penalty units and/or jail for 5 years.
•     An injunction may be granted under s1324 to stop the RE giving the benefit to the related party.

The question marks next to the 2nd bullet point highlight another issue that arises from the rather indiscriminate way in which the public company related party provisions have been applied to managed investment schemes. In the public company related party provisions, where there is a contravention, the public company is not guilty of an offence and liability instead is sheeted home to those involved in the contravention (usually the related party receiving the illegal benefit or the officers of the public company who caused it to provide the illegal benefit). That makes sense because it is the shareholders of the public company who suffer the detriment of the related party benefit. If you fined the public company you would just be further punishing the innocent shareholders. CA s601LA treats the RE as if it were the public company for the purposes of the related party provisions. That has the consequence that if there is a contravention, the RE is not guilty of an offence. That does not make sense. In this case, the persons who suffer the detriment are the scheme members, not the RE or its shareholders. More likely than not it will be the RE, or someone related to the RE, receiving the benefit. Why shouldn't an RE who contravenes these provisions have the same criminal and civil liability as an officer of the RE who is involved in the contravention?

FSC Guidance Note 8 – Related Party Transactions
•     A related party transaction (either as principal or as agent) between a scheme and a party related to the scheme should be demonstrably conducted in the best interests of investors as a whole [para 9.10.1].
•     An operator should, prior to initiating, and during the term of an agreement governing, a related party transaction, ensure that such a transaction meets and continues to meet the following criteria:
  •     it should be in the best interests of potential and existing investors as a whole;
  •     it should be fair value and be reasonable;
  •     it should be properly documented; and
  •     it should be appropriately disclosed [para 9.9.1].
•     In originating a related party transaction, the operator should maintain appropriate records to justify such transaction, the price, and any other terms and conditions upon which the related party transaction was entered into. This should, for example, include the rationale for the related party transaction as well as details of the terms upon which the related party transaction was made. The records must be similar to those maintained for transactions with non-related parties. A report by an independent party as to the reasonableness of the price and any other terms and conditions upon which a related party transaction has occurred may be appropriate in certain circumstances [para 9.10.4].
•     Where reimbursable expenses are incurred by an operator of a scheme, the amount reimbursed should be no more than that which would be payable by a scheme for a similar transaction conducted on an arm's length, commercial basis by a non-related party to the scheme [para 9.11.1].
•     Any allocation of overheads incorporated in a reimbursable expense must be fair and reasonable and properly documented. It may be appropriate for an operator to obtain an independent third party review of the basis and terms upon which an amount of reimbursable expenditure is calculated [para 9.11.2].

Click here for a copy of FSC Guidance Note 8 - Related Party Transactions.

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Civil Liability for Breach of Chapter 5C

CA s601MA - Civil Liability of Responsible Entity to Members
(1)   A member of a registered scheme who suffers loss or damage because of conduct of the scheme's RE that contravenes a provision of Chapter 5C may recover the amount of the loss or damage by action against the RE whether or not the RE has been convicted of an offence, or has had a civil penalty order made against it, in respect of the contravention.
(2)   An action under s601MA(1) must be begun within 6 years after the cause of action arises.
(3)   This section does not affect any liability that a person has under other provisions of the Corporations Act or under other laws.

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Common Law Duties

General Duties as Trustee
As a trustee, the RE has the following fiduciary duties under the general law (to the extent that they are not modified in the constitution of the scheme):
•     to acquaint itself with the terms of the trust;
•     not to impeach the terms of the trust or the title of the cestui que trust;
•     to adhere to and carry out the terms of the trust;
•     to get in the trust property;
•     to properly invest any trust funds in accordance with the trust instrument or as authorised by statute or court order;
•     to pay and transfer the trust property and the income therefrom to the correct beneficiaries;
•     to act impartially between the beneficiaries;
•     to keep and render proper accounts;
•     to exercise reasonable care;
•     to execute the trust personally (ie not to delegate its duties or powers); and
•     to act gratuitously (ie for no fee).

Historically, managed investment schemes have generally been established either as unit trusts or limited partnerships. The use of limited partnerships all but disappeared with changes to Australian tax laws to tax them as companies rather than as partnerships. For those schemes established as unit trusts, the RE clearly has duties as a trustee. Even for schemes established in some other way, the fact that the RE is taken under CA s601FC(2) to hold the scheme property on trust for scheme members would seem to subject the RE to common law fiduciary duties as trustee.

This was affirmed by Barrett J in In the matter of Centro Retail Limited and Centro MCS Manager Limited in its capacity as Responsible Entity of Centro Retail Trust [2011] NSWSC 1175, at para 38-39, where he said:

     

"The s 601GC(1)(b) power is a power conferred by statute on an entity declared by statute to be a trustee. Section 601FC(2) expressly states that the responsible entity of a registered managed investment scheme "holds scheme property on trust for scheme members". Since the scheme's constitution is the instrument by which rights of members in respect of scheme property (being trust property) are defined and secured and the responsible entity is required by s 601FB(1) to operate the scheme and to perform the functions conferred on it by the constitution and the Act itself, the s 601GC(1)(b) power, like all other powers of the responsible entity, must be taken to be subject to the constraints that apply to the powers of trustees generally.

      It must follow, in my opinion, that the responsible entity's power under s 601GC(1)(b) co-exists with the irreducible duty of a trustee to perform the trust honestly and in good faith, for the benefit of the beneficiaries ..."

 
Conflicts and Abuse of Position
A trustee also has a duty not to deal with the trust property for its own benefit or otherwise to profit from the trust and must account for any benefit or gain which has been obtained or received:
•     in circumstances where a conflict or significant possibility of conflict existed between the trustee’s fiduciary duty and its personal interest in obtaining that benefit or gain; or
•     by use or by reason of its fiduciary position or of opportunity or knowledge resulting from it.
Unless expressly authorised by the terms of trust or sanctioned by the beneficiaries or a court order, the purchase of trust property by the trustee in its personal capacity is liable to be set aside even if the terms are fair.

Typically the scheme's constitution will empower the RE to sell property in which it has an interest to the scheme and to buy property from the scheme, although that will be subject to the CA provisions regarding related party transactions. It is important that the constitution does this because the transaction is voidable if not so authorised.

There have been some interesting examples in recent years of fund managers falling foul of the principle that a fiduciary should not profit from their position as fiduciary.

In August 2003, the US Securities and Exchange Commission charged Deutsche Asset Management, Inc. (DeAM), the investment advisory unit of Deutsche Bank AG, for failing to disclose a material conflict of interest in its voting of client proxies for the 2002 merger between Hewlett-Packard Company (HP) and Compaq Computer Corporation. The SEC found that, unbeknownst to DeAM's advisory clients, Deutsche Bank's investment banking division was working for HP on the merger and had intervened in DeAM's proxy voting process on behalf of HP. This created a material conflict of interest for DeAM, which had a fiduciary duty to act solely in the best interests of its advisory clients. It further found that DeAM violated this duty by voting the proxies on the HP stock owned by its advisory clients, without first disclosing the conflict. The SEC made an order censuring DeAM, directing it to cease and desist from further violations, and imposing a civil penalty of US$750,000. DeAM consented to the issuance of the order without admitting or denying its findings. For details, see: http://www.sec.gov/news/press/2003-100.htm.

In September 2004, NY Attorney General Eliot Spitzer announced a $450 million settlement with two prominent US mutual fund management companies, Invesco Funds Group and AIM Advisors, to resolve charges that the companies permitted illegal market timing trades (short-term investing in mutual fund shares and/or the exploitation of pricing inefficiencies in mutual fund share pricing) and late trades (obtaining a given day's mutual fund share price for orders to buy, sell or exchange shares that were placed after the close of the market on that day) in shares in their funds. For details, see: http://www.ag.ny.gov/press-release/invesco-and-aim-settle-mutual-fund-timing-cases.

A Trustee’s Duty of Care
•     "A trustee ought to conduct the business of a trust in the same manner that an ordinary prudent man of business would conduct his own" (Re Speight (1883) 22 Ch D 727, at 739 per Jessel MR).
•     "The duty of a trustee is not to take such care only as a prudent man would take if he had only himself to consider, the duty is rather to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide" (Re Whiteley (1886) 33 Ch D 347, at 355, per Lindley LJ).
•     "A professional corporate trustee is liable for breach of trust if loss is caused to the trust fund because it neglects to exercise the special care and skill which it professes to have" (Bartlett v Barclays Trust Co Ltd [1980] 1 Ch 515, at 534, per Brightman J).
•     See generally ASC v AS Nominees Ltd (1995) 13 ACLC 1822, at p1,831-2.

In Re Speight, a trustee employed a broker for the investment of £15,000 in stocks. The broker never acquired the securities and appropriated the money to his own purposes. The trustee kept chasing the broker for the securities and was given excuses for a month, at which point the broker went into bankruptcy. It was held that the trustee was not liable to make good the loss. He was entitled to appoint a broker to acquire the stocks, he had acted with the prudence of an ordinary businessman and therefore was not liable for the misappropriation by the broker.

In Re Whiteley, trustees invested £3,000 in a mortgage over a brickworks and £2,000 in a mortgage over 4  freehold properties at 5% per annum. Both mortgagors failed and the security proved inadequate to cover the principal amounts of the mortgages. A valuation of £7,000 for the brickworks showed only £2,000 attributable to the land and the balance to buildings, plant and machinery. The court held that this was not a prudent investment for the trustees to make and they were liable to make good the loss of principal plus interest foregone. However, they were not liable in relation to the other mortgage because the court was not able to say that an ordinary prudent man would not have lent £2,000 on the security of those properties.

In Bartlett v Barclays Trust Co Ltd, Barclays Trust had since 1920 held 99.8% of the shares in a property company on trust for the family members of the settlor of the trust. By 1960, there were no representatives of the trustee or the family on the board of directors of the company. The board decided to embark upon speculative property developments. It set up an investment subsidiary to purchase parcels of land for a development it was proposing to undertake with another joint venturer near the Old Bailey shortly before the end of the property boom in the early 1970s. It also purchased a parcel of land for a second development in its own right. The inevitable happened and with the downturn in the property market, the investment subsidiary became insolvent. It was sold off at a loss of £4.49m. The land purchased by the company for the second development, however, was sold at a profit of £271k. The beneficiaries sued the trustee for the £4.49m loss alleging that it had not exercised the appropriate degree of care and skill in allowing the company to embark upon speculative property development. The court agreed and ordered restitution. It found that the trustee had not sufficiently supervised the activities of the company and its board. The court said (at p 534):

    

"I am of the opinion that a higher duty of care is plainly due from someone like a trust corporation which carries on a specialised business of trust management. A trust corporation holds itself out in its advertising literature as being above ordinary mortals. With a specialist staff of trained trust officers and managers, with ready access to financial information and professional advice, dealing with and solving trust problems day after day, the trust corporation holds itself out, and rightly, as capable of providing an expertise which it would be unrealistic to expect and unjust to demand from the ordinary prudent man or woman who accepts, probably unpaid and sometimes reluctantly from a sense of family duty, the burdens of trusteeship. Just as, under the law of contract, a professional person possessed of a particular skill is liable for breach of contract if he neglects to use the skill and experience which he professes, so I think that a professional corporate trustee is liable for breach of trust if loss is caused to the trust fund because it neglects to exercise the special care and skill which it professes to have."

However, in an apparent departure from previous law, it allowed the trustee to set off the £271k profit that had been made on the successful investment against the loss on the sale of the shares in the investment company, saying that they "stemmed from exactly the same policy and … exemplified the same folly".

In ASC v AS Nominees Ltd, this is what the court had to say about the duty of trustees (at p1831):

    

"It is old and accepted law that in managing a trust business the trustee should exercise the same care as an ordinary, prudent business person would exercise in conducting that business as if it were his or her own …There is an equally well accepted gloss on (or adjunct to) this in relation to trustee investments which is aptly described in Scott on Trusts as the "requirement of caution" … That requirement is well expressed in King v Talbot … to which Scott refers:

    

    

It ... does not follow, that, because prudent men may, and often do, conduct their own affairs with the hope of growing rich, and therein take the hazard of adventures which they deem hopeful, trustees may do the same; the preservation of the fund, and the procurement of a just income therefrom, are primary objects of the creation of the trust itself, and are to be primarily regarded.

    

In these proceedings I emphasise particularly the requirement of caution. It is this which, often enough, is used to differentiate the expectations properly to be had of trustees and of directors respectively. So in Daniels v Anderson … for example, Clarke and Sheller JJA observed that:

    

    

While the duty of a trustee is to exercise a degree of restraint and conservatism in investment judgments, the duty of a director may be to display entrepreneurial flair and accept commercial risks to produce a sufficient return on the capital invested."

In ASC v AS Nominees Ltd, the Court also endorsed the view (at p1,832) that professional trustees are subject to a higher standard of care than non-professional trustees:

    

"The standard of trustee care and caution of which I have been speaking so far does not differentiate between types of trustee. It is of general application. That standard, moreover, was settled a century ago and during a period when trust corporations were not used for the trading and investment purposes that are the commonplace in this country today. There is, in my view, a substantial question now to be answered as to whether a higher standard is not to be exacted from at least corporate or professional trustees (i) which hold themselves out as having a special or particular knowledge, skill and experience and (ii) which, directly or indirectly, invite reliance upon themselves by members of the public in virtue of the knowledge etc they appear so to have.

    

In Bartlett v Barclays Trust Co Ltd … Brightman J was prepared to impose such a higher duty of care on a trust corporation …This decision has been cited with apparent approval, though it was not in terms relied upon, by Gleeson CJ in Gill v Eagle Star Nominees Ltd … It is, in its own way, consistent with observations of the Privy Council in the Australian appeal, National Trustees Company of Australasia Ltd v General Finance Company of Australasia Ltd … when refusing to excuse a trust company from a breach of trust. There is an extensive United States case law affirming such a higher standard. …

    

If it were in fact necessary for me so to do (which it is not), I would be prepared to apply to the trustee companies in these proceedings a standard of care higher than that of the ordinary prudent business person."

Hence, while unit trusts may (largely for tax reasons) be the preferred legal vehicle in Australia for managed investment schemes, the fact that they import the common law duties of trustees around prudence and caution means that they are not particularly well suited to entrepreneurial activities.

In In the matter of Macquarie Investment Management Limited [2016] NSWSC 1184, the NSW Supreme Court addressed this issue in the following terms:

    

"… the exercise of prudence and caution must be considered through the prism of the particular registered scheme in question, having regard to its constitution and particular investment mandate, and the profile of the accepted risks and potential returns the subject of the investments that may be undertaken pursuant to the registered scheme. In Hanrahan, Funds Management in Australia … the author states:

    

    

So how does the requirement of caution apply in the context of commercial investment trusts? The general law standard of care in relation to trustee investments does not work in such a way as to prohibit a funds management company from making high-risk investments. The rule does not require the company to eschew a high-risk investment strategy where that is the nature of the scheme that has been marketed to investors. Rather, it requires the company to implement the advertised strategy prudently. Although its application in a commercial context is yet to be fully explored fully by an Australian court, Dr Paul Ali has concluded that ‘it is likely that Australian courts will interpret this rule as requiring fiduciaries to assess proposed investments in the context of their impact on the risk profile and return objectives of the entire trust fund, having regard to modern investment models and techniques’.

  In other words, the fund management company is not required to alter the advertised investment strategy to accord with the requirement of caution; instead, it must implement that investment strategy (whatever it is) in a manner consistent with the requirement."

 

Liability for Breach of Trust
•     If a trust profits from the trustee’s breach of duty (eg the trustee buys an unauthorised investment and sells it at a gain), the trust is entitled to retain that profit.
•     If a trust suffers a loss from the trustee’s breach of duty (eg the trustee buys an unauthorised investment and sells it at a loss), the trustee is liable to make good that loss.
•     Generally the law does not allow a trustee to set off a profit made on one breach of trust against a loss from another breach of trust (quaere except where they are part of the one transaction or course of conduct: per Brightman J in Barlett v Barclays Trust Co, above).
•     A trustee is liable to account for any profit the trustee makes in breach of the duty not to deal with trust property for its own benefit or otherwise to profit from the trust.
•     The obligation is to make restitution: Re Dawson (dec’d) [1966] 2 NSWR 211.

In Re Dawson, in 1939 the trustees (who were also sons of the settlor and beneficiaries of the trust) improperly paid away NZ£4,700 of trust money (they gave it to someone in cash to evade NZ exchange controls so they could get the money out of NZ and into NSW in the hope that they could use it to make a loan to companies in which they had an interest – itself a breach of trust - but the fellow absconded with the cash). At the time, there was parity between the NZ and Australian pounds. The breach was discovered many years later in the course of winding up the trust and the surviving trustee proposed a reduction in the amount due to the estate of one of the defaulting trustee/beneficiaries to compensate the trust for the loss. The question arose as to what exchange rate should be used to calculate the compensation, as the Australian pound equivalent of the amount in question had risen over the years from £4,700 to £5,800. Held it should be the higher amount as the duty of the trustee was to make restitution and to put the trust in the position it would have been had the breach of trust not been committed.

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Soft Dollar Arrangements

•     Soft dollar income = the receipt by an investment manager of free goods and services from, or of goods and services paid for by, a broker because the investment manager has used their broking services.
•     Without the informed consent of relevant clients, these arrangements may amount to a breach of fiduciary duty by the investment manager if they involve, or can be seen to involve, the exploitation of the investment manager’s fiduciary position for personal gain.
•     Soft dollar expenses = the provision by an investment manager of free goods and services to, or the payment for goods and services on behalf of, a financial planner or other adviser because the financial planner or adviser has put their client into the investment manager's products.
•     These arrangements potentially breach CA Part 7.7A (conflicted remuneration). For the planner/adviser, they may also amount to a breach of fiduciary duty if they involve, or can be seen to involve, the exploitation of the planner/adviser’s fiduciary position for personal gain, and raise concerns about conflict of interest, bias and compliance with statutory disclosure obligations. For the investment manager, they may give rise to liability for knowingly involved in a breach of fiduciary duty or for giving an equitable bribe.

We looked at the issue of equitable bribes in lecture 7.

Re soft dollar income, in November 2004, the NASD issued the Report of the Mutual Fund Task Force on Soft Dollars and Portfolio Transaction Costs. It defined the term "soft dollars" to mean products and services, other than execution of securities transactions, that an investment manager receives from or through a broker-dealer in exchange for the adviser's direction of client brokerage transactions to the broker-dealer. The report recommending the narrowing of the types of research services that might be obtained with soft dollars, expanding the disclosure in fund prospectuses about soft dollar practices and portfolio transaction costs, and providing more explicit guidance about the types of information that fund boards should receive about soft dollar practices and portfolio transaction costs.

Consequently, in 2006, IFSA (the predecessor to the FSC) put out FSC Guidance Note 10 - Brokerage Arrangements. It recommended that:

•    

Investment managers should always seek to obtain best execution, irrespective of any other brokerage arrangements they enter into.

•    

Soft dollar arrangements are acceptable only where they can reasonably be expected to assist in the provision of investment services, trading activity or making decisions to trade for those clients of the investment manager on behalf of whom brokerage is paid.

•    

Examples of appropriate benefits include: inhouse research, third party research, prime brokerage services and software that assists with pre-trade analysis.

•    

Examples of inappropriate benefits include: provision of market data available from data service providers; subscriptions for publications; office administrative computer software; computer hardware; the purchase or rental of any other items of office equipment; office rental; staff remuneration; travel, accommodation and entertainment costs; costs associated with attending conferences and seminars; membership fees to professional associations; services relating to the valuation or performance measurement of portfolios; and custody services.

•    

An investment manager should have written policies outlining their strategy for obtaining best execution and ensuring that any brokerage arrangements do not interfere with that imperative and for managing the potential conflicts involved in any alternative brokerage arrangements.

•    

Those policies should be disclosed on its website and to investors annually upon request. The disclosure should extend to the costs and expected benefits of alternative brokerage arrangements.

Re soft dollar expenses, in June 2004, ASIC released a research report (REP 30) on Disclosure of Soft Dollar Benefits in the financial planning industry. It defined soft dollar benefits as benefits other than standard commission payments. The report revealed that a wide range of soft dollar benefits were being offered. Benefits to individual advisers included overseas trips, share options and cash bonuses for selling particular financial products. Benefits to financial planning firms included 'fee rebates', potentially worth millions of dollars each year to the larger firms. The report contained examples of both good and poor practice and provided guidance about effective disclosure.

Consequently, IFSA and the FPA put out FSC Standard 14 - FSC/FPA Industry Code of Practice on Alternative Forms of Remuneration in the Wealth Management Industry and FSC Standard 15 - FSC/FPA Industry Guide on Rebates & Related Payments in the Wealth Management Industry. These have now been superseded by the FOFA reforms and have been repealed.

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Allocation Policy

•     Allocations of investments or opportunities between various funds or clients can raise fiduciary issues if one fund or client is given favourable treatment to the detriment of another fund or client.
•     It is preferable to identify up-front which funds or clients are participating in a transaction and to have an objectively reasonable basis for allocation between them (eg pro rata to the size of the fund or client assets being managed). Any departure from that objective standard should be able to be justified on reasonable grounds.

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Inter-funding

•     Inter-funding = the investment of money from one fund into another fund managed by the same or a related RE. Often done to secure scale advantages and for administrative convenience.
•     Inter-funding arrangements can raise issues about:
  •     whether the investment into the related fund is an authorised investment;
  •     whether it requires member approval as a related party transaction;
  •     whether it is an appropriate exercise of fiduciary discretion (ie are there better investment opportunities available for the investing fund?); and
  •     double dipping on fees.
•     Inter-funding arrangements must be specifically authorised by the fund’s constitution and ought to be clearly disclosed in the relevant marketing document (ie in the PDS for retail investors or information circular for professional investors).

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Cross Trading

•     Cross trading = the sale of investments from one fund to another fund managed by the same or a related RE. Often done in the context of re-balancing portfolios.
•     There is an inherent conflict between the interests of the buying fund (securing the asset at the lowest price) and the interests of the selling fund (realising the asset at the highest price). Cross trading may also raise related party transaction issues.
•     Cross trading needs to be specifically authorised by the fund’s constitution and the price at which a cross trade is effected must be objectively reasonable to both parties.
•     Note that under some foreign laws, cross trading is strictly prohibited (eg ERISA in the US) or highly regulated (eg the US Investment Advisers Act of 1940).

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Authorised Investments

Liability for Unauthorised Investments
•     The combination of the RE’s:
  •     fiduciary duty as trustee to adhere to and carry out the terms of the trust and to properly invest the trust funds; and
  •     statutory duty to ensure that all payments out of the scheme property are made in accordance with, and to comply with any other duty conferred on the RE by, the scheme's constitution,
  means that the RE will be strictly liable for any loss suffered by the scheme if it invests in something that is not an authorised investment under the scheme’s constitution.
•     The fact that something is an authorised investment under the scheme’s constitution does not necessarily mean that the RE can invest in it with impunity – eg if it is contrary to representations in a PDS or the RE’s duty of care and prudence.

The first bullet point applies no matter whether the trustee was acting honestly and in good faith or just simply made a mistake. Note the court does have a statutory power to excuse a trustee who has acted in breach of trust but in doing so has acted honestly and reasonably and ought fairly to be excused (eg s85 Trustee Act 1925 (NSW)). However, it is submitted that it would be most unlikely to exercise that power in favour of a professional RE who had made an unauthorised investment to the detriment of a managed investment scheme, except in the most unusual of circumstances.

A key role of the Compliance Department in any managed funds operation is to map out the authorised investments for its various funds, including any volume or exposure limits that might apply to particular products, taking into account not only the fund constitutions but also product disclosure statements and any other relevant documents, and to install systems to monitor compliance with those requirements.

Trustee Powers of Investment – Trustee Act 1925 (NSW) s14
A trustee may, unless expressly forbidden by the instrument (if any) creating the trust:
(a)  invest trust funds in any form of investment, and
(b)  at any time vary any investment.

Click here for a copy of the Trustee Act 1925 (NSW).

All States have an equivalent provision. From a constitutional standpoint, this State law cannot override the obligation of an RE under the Corporations Act, a federal law, to comply with the scheme’s constitution. Having said that, it has been usual to include in most scheme constitutions a clause empowering the RE to invest in anything that under the law a trustee is authorised to invest in – harking back to the days when the various State Trustee Acts used to include a list of authorised trustee investments. Query how these clauses will be interpreted, or indeed whether a court will allow them to have any operation at all, now that State trustee legislation has been amended to do away with specified lists of authorised trustee investments.

Trustee Act 1925 (NSW) s14A
(1)   This section has effect subject to the instrument (if any) creating the trust.
(2)   A trustee must, in exercising a power of investment:
  (a)   if the trustee's profession, business or employment is or includes acting as a trustee or investing money on behalf of other persons, exercise the care, diligence and skill that a prudent person engaged in that profession, business or employment would exercise in managing the affairs of other persons, or
  (b)   if the trustee is not engaged in such a profession, business or employment, exercise the care, diligence and skill that a prudent person would exercise in managing the affairs of other persons.
(3)   A trustee must exercise a power of investment in accordance with any provision of the instrument (if any) creating the trust that is binding on the trustee and requires the obtaining of any consent or approval with respect to trust investments.
(4)   A trustee must, at least once in each year, review the performance (individually and as a whole) of trust investments.

Note: some Acts deem investments under those Acts to be investments that satisfy the prudent person test. See, for example, s39 of the Public Authorities (Financial Arrangements) Act 1987 (NSW).

Trustee Act 1925 (NSW) s14DB
(1)   The regulations may make provision for or with respect to guidelines for the investment by trustees of trust funds.
(2)   A trustee does not comply with section 14A merely by complying with any regulations made for the purposes of this section.

 

Trustee Regulation 2015 (NSW) r4
(1)   This clause sets guidelines with respect to the investment of trust funds by trustees where the value of the funds subject to the trust does not exceed $50,000.
(2)   The following investments are investments that a trustee might reasonably consider appropriate for the investment of trust funds:
  (a)   any public funds or Government stock or Government securities of the Commonwealth or any State,
  (b)   any debentures or securities guaranteed by the Government of New South Wales,
  (c)   any debentures or securities:
    (i)   issued by a public or local authority, or a statutory body representing the Crown, constituted by or under any law of the Commonwealth, or of any State or Territory, and
    (ii)   guaranteed by the Commonwealth, any State or the Northern Territory,
  (d)   any debentures or securities issued by the Northern Territory and guaranteed by the Commonwealth,
  (e)   interest-bearing deposits in a bank,
  (f)   any deposit with, withdrawable shares in, or loan of money to, an authorised deposit-taking institution.

Click here for a copy of the Trustee Regulation 2015 (NSW).

No guidance is given in the Regulations for trust funds that exceed $50,000.

Investments in Schemes by REs
The RE of a registered scheme may acquire and hold an interest in the scheme, but it must only do so:
(a)   for not less than the consideration that would be payable if the interest were acquired by another person; and
(b)   subject to terms and conditions that would not disadvantage other members (s601FG).

Breach of s601FG is a corporation/scheme civil penalty provision (s601FG(2) and s1317E). An intentional breach is a criminal offence (s601FG(3)) carrying a fine of 2,000 penalty units and/or 5 years jail for individuals and 10,000 penalty units for bodies corporate.

If the RE or an associate does hold an interest in the scheme, it needs to have regard to s253E, which provides that the responsible entity of a registered scheme and its associates are not entitled to vote their interest on a resolution at a meeting of the scheme’s members if they have an interest in the resolution or matter other than as a member (although, if the scheme is listed, they can vote on a resolution to remove the RE and choose a new RE).

In In the matter of AMP Capital Funds Management Limited (in its capacity as responsible entity of the AMP Capital China Growth Fund  [2016] NSWSC 986, the NSW Supreme Court held that s253E precludes an associate of an RE from voting on a resolution when the RE, but not the associate, has an extraneous interest in the resolution. In that matter, AMP Capital Funds Management Limited was the RE of AMP Capital China Growth Fund, a registered management investment in which AMP Life Limited (a related body corporate and therefore associate of AMP Capital) held units. It was held that AMP Life was not entitled to vote on resolutions proposing a buy-back of units and a winding up of the fund as it was an associate of the RE and the RE had an interest in the resolutions because, if passed, they would have an adverse effect on its fees as RE.

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Custodians

ASIC Regulatory Guides 166 and 167 – Licensing Requirements for Custodial and Depository Services
•     ASIC applies the standards it uses for Investor Directed Portfolio Services (see below) to those seeking a licence to operate a custodial or depository service [RG 167.20].
•     Accordingly, the licensee must comply with:
  •     Paras 8-10 and 32-63 of RG 130 Managed investments: Licensing, other than 9(e) and 60(a);
  •     RG 132 Managed investments: Compliance plans, other than 12(f); and
  •     RG 133 Managed investments: Scheme property arrangements, other than 26(a) and custody related financial requirements [RG 167.21].
•     Most custodians will have to maintain a minimum NTA equal to the greater of: (a) $10 million; or (b) 10% of average revenue [RG 166 appendix 4 table 13].
•     Custodians must meet the minimum asset holding standards set out in ASIC Regulatory Guide 133 Managed investments and custodial or depository services: Holding assets and Class Order CO 13/1410 Holding assets: Standards for providers of custodial or depository services.

Click here for a copy of ASIC Regulatory Guide 167 Licensing: Discretionary powers. On the capital requirements that apply to the providers of custodial and depository services, see ASIC Regulatory Guide 166 Licensing: Financial requirements (appendix 4) and Class Order CO 13/761 Financial requirements for custodial or depository service providers.

Note that RG 130 has been superseded by RG 104 and 105.

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Investor Directed Portfolio Services

ASIC Regulatory Guide 148 - Platforms that are managed investment schemes
•     IDPS generally fall within the definition of "managed investment scheme" because their custody assets are usually pooled to achieve netting advantages and administrative savings. Investors get benefits from participating in the scheme through access to investments (especially wholesale funds) that they could not otherwise access.
•     IDPS operators may choose to structure their service as a registered managed investment scheme, in which case they will get the benefit of certain relief from the fundraising disclosure requirements under Class Order CO 13/762 Investor directed portfolio services provided through a registered managed investment scheme.
•    

Alternatively, they can operate them as unregistered schemes via Class Order CO 13/763 Investor directed portfolio services, which exempts IDPSs from the MIS regime and instead regulates them via licence conditions. It also grants equivalent relief from the fundraising disclosure requirements that Class Order CO 13/762 (above) provides for IDPS-like schemes.

•     To operate an IDPS or IDPS-like scheme, you must be a public company that holds an AFSL specifically authorising you to operate the IDPS or scheme [RG 148.17].
  Operators of IDPS or IDPS-like schemes will generally have to maintain a minimum NTA equal to the greater of: (a) $10 million; or (b) 10% of their average responsible entity and IDPS revenue (ASIC Regulatory Guide 166 Licensing: Financial requirements (appendix 2 table 9 and appendix 3 table 11) and Class Order CO 13/760 Financial requirements for responsible entities and operators of investor directed portfolio services).

An IDPS is a service enabling customers to acquire and hold investments through a custodian, who provides consolidated reporting. It generally will involve a menu of investment opportunities that investors can access, with the investor making all the investment decisions. Arrangements typically marketed as master funds and wrap accounts are likely to be IDPSs. Via ASIC relief, IDPS can be operated as a registered or unregistered managed investment scheme.

Click here for a copy of ASIC Regulatory Guide 148 Platforms that are managed investment schemes (ASIC uses the term "platform" to refer to IDPS and IDPS-like registered managed investment schemes).

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Managed Discretionary Accounts

ASIC Regulatory Guide 179 - Managed Discretionary Account Services
[RG 179.5] Generally, MDA services are arrangements that involve a person (an MDA operator) managing a portfolio of assets for a retail client on an individual basis.
[RG 179.6] MDA services involve a range of financial products and financial services, such as offering and trading in financial products, operating a custodial and depository service, and giving personal advice. Because of the individualised nature of the range of financial services involved, we will regulate persons contracting with retail clients to provide MDA services as providers of financial services rather than issuers of a financial product.
[RG 179.7] We will apply a tailored regulatory approach, exempting MDA operators from the managed investments provisions in Chapter 5C and the product disclosure provisions in Chapter 6D and in Part 7.9 of the Corporations Act. However, to have the benefit of that relief, MDA operators must comply with the licensing and conduct provisions in Parts 7.6 and 7.7 of the Corporations Act and some additional conduct requirements designed to promote consumer protection.
[RG 179.8] As the person contracting with the client to provide MDA services, the MDA operator will be responsible to the client for all the financial services and functions involved in the operation of these services, including those carried out by an agent of the MDA operator (such as an external contractor). These services include:
(a)   dealing in financial products in clients’ portfolios (ie execution of trades);
(b)   custodial and depository services (custody services) relating to clients’ portfolio assets; and
(c)   the preparation and/or review of the investment program included in the MDA service under our relief.

Click here for a copy of ASIC Regulatory Guide 179 Managed discretionary account services. [RG 179.30] – [RG 179.31] set out the AFS licence authorisations that are needed, and [RG 179.32] – [RG 179.59] set out the other conditions that must be met, for an MDA operator to qualify for the relief mentioned in [RG 179.7].

ASIC Pro Forma 209 - Meaning of Managed Discretionary Account
Terms and Definitions: "MDA service" means a service with the following features:
(a)   a person ("the client") makes client contributions;
(b)   the client agrees with another person that the client's portfolio assets will:
  (i)   be managed by that other person at their discretion, subject to any limitation that may be agreed, for purposes that include investment;
  (ii)   not be pooled with property that is not the client's portfolio assets to enable an investment to be made or made on more favourable terms; and
  (iii)   be held by the client unless a beneficial interest but not a legal interest in them will be held by the client; and
(c)   the client and the person intend that the person will use client contributions of the client to generate a financial return or other benefit from the person's investment expertise.

Click here for a copy of ASIC Pro Forma 209.

ASIC Pro Forma 209 - Standard Licence Conditions for Operation of Managed Discretionary Accounts
40. The licensee may operate an MDA service that is not under a registered scheme and must do so only in reliance on:
(a)   Class Order 04/194 as at the date of this licence and as amended by any disallowable legislative instrument;
(b)   any disallowable legislative instrument that replaces Class Order 04/194;
(c)   an individual instrument of relief granted by ASIC to the licensee which expressly provides relief to operate an MDA service.
41. The licensee must not provide an MDA service to a retail client except when operating a registered scheme.
42. Despite condition 41, the licensee may provide custodial or depository services relating to an MDA service in reliance on the relief for an external MDA custodian under:
(a)   paragraphs 2.1, 2.2 or 2.3 of Class Order 04/194 as at the date of this licence and as amended by any disallowable legislative instrument;
(b)   any corresponding provisions in any disallowable legislative instrument that replaces Class Order 04/194;
(c)   an individual instrument of relief granted by ASIC to the licensee which expressly provides relief to an MDA service.

Condition 40 is imposed on licensees authorized to operate an MDA service under Class Order 04/194. Conditions 41 and 42 are imposed on all licensees who indicate in their licence application that they will be acting as an external MDA custodian that will directly contract with retail clients. Otherwise, if a licensee indicates in their licence application that they will not be operating an MDA service or acting as an external MDA custodian, Condition 43 is imposed, which provides that the licensee must not provide an MDA service to a retail client except when operating a registered scheme.

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FSC Standards and Guidance Notes

FSC Guidance Note 7 – Personal Trading
•     Each investment manager should adopt rules with respect to personal trading by directors and employees based on the following principles and guidelines requiring them:
  •     to place the interests of clients and investment manager first at all times;
  •     to avoid and be seen to avoid, actual or potential conflict between personal interest and duty to clients and/or to the investment manager;
  •     not to derive any personal advantage from information which is not generally available and which has been obtained by reason of, or in the course of, their employment;
  •     not to trade, where the investment manager is precluded from trading by law or FSC guidelines or where the investment manager has outstanding client orders for the same security or class of security;
  •     to seek prior approval to trade from a designated officer to ensure client interests are not compromised;
  •     to ensure that personal trading is on a scale that reflects the individual’s financial ability to fund and maintain an appropriately sized portfolio;
  •     to ensure that personal trading does not adversely impact on the individual’s ability to perform normal duties;
  •     not to utilise broker credit. Relevant exchange settlement terms must apply on all occasions and all transactions must be settled as detailed in industry standards. This prohibition does not extend to normal documented margin lending or loan facilities offered to the general public by brokers; and
  •     to refer offers to participate in a float or placement to the head of the investment management firm for guidance and approval to participate [para 11.1].
•     Directors and employees should be required to sign a written acknowledgment upon appointment that they have read and understand the investment manager’s trading rules, and will comply with them [para 12.1].
•     Where an individual undertakes a transaction on behalf of any person or corporation other than clients, all dealings should be executed by one of a panel of brokers approved by the investment manager [para 12.2].
•     Investment managers should require directors and employees, whether proper authority holders or not, to maintain the register of interests in securities required to be maintained by proper authority holders under the Corporations Law. The employer has the right to inspect these records at any time and should have procedures to ensure at least an annual inspection [para 12.3].
•     Any offer of securities made personally to directors or employees by a sharebroking firm or equivalent body, to participate in a float or placement should ensure that the fiduciary obligations of the investment manager to its clients are not compromised. In particular:
  •     all offers should be addressed to the Chief Investment Officer or designate to ensure the investment manager is aware of the offer;
  •     the offer must be a firm offer with a designated number of shares and price per share and the letter of offer clearly stating that the offer is made to the staff of the investment manager;
  •     the offer must state that it is in addition to any other offer made to the investment manager on a professional basis for its clients and the rights of those clients have not been prejudiced in any way;
  •     any offer (including offers to individuals) should be disclosed to the Chief Executive Officer or designate for approval in accordance with these guidelines; and
  •     it is recommended that offers to directors and employees be rigidly policed to ensure that strict guidelines are met. Offers to participate in such floats and placements could be construed as a privilege of employment and as such investment managers should be on notice to ensure that the investment and financial services industry is not brought into disrepute through non compliance with guidelines [para 12.4].
•     Employees should be aware that breaches of an investment manager’s requirements in the matter of personal trading would have serious consequences, which may include immediate dismissal [para 12.5].
•     A client of an investment manager should be entitled, on request, to a copy of the investment manager’s personal trading policy [para 12.6].

The Financial Services Council (formerly called the Investment and Financial Services Association or IFSA) is a national not-for-profit organisation which represents the retail and wholesale funds management, superannuation and life insurance industry in Australia. Its website is located at http://www.fsc.org.au.

Click here for a copy of FSC Guidance Note 7 – Personal Trading.

Other FSC Standards and Guidance Notes Relevant to Compliance
•     FSC Standard 1 - Code of Ethics & Code of Conduct – note that this requires the Board of the FSC member to adopt a resolution each year stating they are satisfied that the member has complied with mandatory FSC standards and to submit that to the FSC within 3 months of financial year end.
•     FSC Standard 17 - Incorrect Pricing of Scheme Units - Correction and Compensation.
•     FSC Guidance Note 8 - Related Party Transactions (see above).
•     FSC Guidance Note 10 - Brokerage Arrangements (see above).
•     FSC Guidance Note 24 - FSC/FPA Guidance on Managing Mutual Obligations Under Chapter 7 of the AML/CTF Rules

Compliance with standards is compulsory for FSC members. Compliance with guidance notes is voluntary but strongly encouraged. There are a number of standards dealing with operational performance, calculation and presentation of returns, management expense ratios, scheme pricing, valuation of assets etc. The above are the core standards and guidance notes relevant to Compliance.

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