The Corporations and Markets Advisory Committee (CAMAC) published its report in relation to Managed Investment Schemes on 7 August 2012.
The report is in response to a request from the Government for advice on various matters concerning the regulation of managed investment schemes (schemes) under Chapter 5C of the Corporations Act, following the recent failure of a number of high profile schemes, particularly in the agribusiness sector.
CAMAC has considered these matters within the broader context of significant developments that have occurred with the use of schemes in the decade since the current legislation was introduced, in particular the greater use of contract-based ‘common enterprise’ entrepreneurial schemes (such as horticultural or forestry schemes) alongside more traditional trust-based ‘pooled’ investment schemes (such as cash management trusts or property funds). Also, it has become more commonplace for responsible entities (REs) (who manage schemes) to operate a number of schemes or to have other business operations of their own (multi-function REs). This contrasts with responsible entities whose only function is to operate one scheme (sole-function REs).
These developments have raised complex issues concerning the adequacy of the current legal framework, both for the regulation of on-going schemes as well as for schemes or their responsible entities that experience financial stress.
In essence, CAMAC recommends:
- a prohibition on the creation of new common enterprise schemes;
- a new regulatory structure for the operation of schemes, described as the Separate Legal Entity Proposal (SLE Proposal);
- a requirement that new schemes be operated only by sole-function REs (unnecessary if the SLE Proposal is introduced); and
- a series of other reforms, including:
- each scheme be required to have a definitive register of scheme agreements and a definitive register of scheme property
- various ways to overcome the disincentives for an entity to act as a temporary responsible entity (TRE)
- facilitative provisions to permit a financially stressed scheme to be placed in voluntary administration
- a liquidation procedure for insolvent schemes.
The following sets out some of the principal recommendations by CAMAC in the Managed Investment Schemes report. A more complete summary of these matters, together with other CAMAC recommendations, is set out in Section 1.6 of the report.
Common enterprise schemes: the problem of intermingling the affairs and property of the scheme with that of scheme members
CAMAC observes in the report that the problems encountered with schemes or responsible entities in financial stress in recent years have arisen principally in the context of common enterprise schemes, where scheme members (for taxation or other reasons) might play an active entrepreneurial role to some degree. This can result in the intermingling of the affairs and property of the scheme with that of its members, with confusion or disputation arising in attempting to untangle these arrangements where a scheme fails.
CAMAC considers that this intermingling problem could be avoided if only pooled schemes were permitted, where members act in a manner similar to shareholders in a company. While not proposing the redesign or termination of existing common enterprise schemes, CAMAC sees merit in preventing future intermingling problems by a prohibition on the creation of new common enterprise schemes. Entrepreneurial activities in which investors seek a greater personal proprietary or other involvement could be undertaken through a corporate or joint venture structure.
Multi-function REs: the problem of untangling the various affairs of an responsible entity
A further problem that became apparent during the course of the review was the potential for complexity where schemes are run by a multi-function RE and it becomes necessary to determine which of its dealings are referable to which scheme.
This untangling problem would not arise if the only function permitted of an RE was to operate one scheme (a sole-function RE). While recognising that it may not be feasible to require this of all existing schemes, CAMAC sees merit in a legislative initiative to require all new schemes to be operated only by a sole function RE.
Resolving other problems: the Separate Legal Entity Proposal
CAMAC identified a number of other problems that arise under the current legal framework, and which can become particularly apparent where an responsible entity or a scheme suffers financial stress:
- Claims against scheme property – under the current law, a counterparty to an agreement with an responsible entity as operator of a particular scheme (while having rights against the personal assets of the responsible entity, unless agreed otherwise) cannot claim directly against the property of that scheme. The counterparty has a remedy in relation to the indemnity rights of the RE over scheme property. However, those indemnity rights, and therefore the remedy of the counterparty, may be lost by improper conduct of the responsible entity that is unknown to the counterparty;
- Transfer of liability of the responsible entity – where an responsible entity of a particular scheme, for any reason, is unable to continue in that role, the task of finding a suitable replacement responsible entity can be made more difficult by the current statutory requirement that the obligations and liabilities that an responsible entity has personally incurred in operating a scheme automatically transfer to a TRE or new responsible entity. This requirement, while intended to protect counterparties to these agreements, can discourage suitable entities from undertaking the role of a TRE or a new responsible entity as it involves an immediate assumption of the liabilities of the outgoing responsible entity; and
- External administration – where a scheme or its responsible entity suffers financial stress, the process of attempting a rehabilitation or orderly winding up can be complicated by any entangling of the affairs of the scheme and the affairs of the responsible entity.
In response to the problems identified under the current legal framework, CAMAC has developed an alternative framework for the regulation of schemes, described as the Separate Legal Entity (SLE) Proposal. In essence, each scheme would involve the registration of a separate legal entity, to be known as the MIS. The MIS would be distinct from the RE or members of the scheme. The MIS, not the RE (as under the current legal framework), would hold legal title to all scheme property and would be the principal in all agreements entered into by the responsible entity as operator of the scheme. The RE would act as the agent of the MIS in entering into legal arrangements as well as the manager of the scheme.
In consequence, under the SLE Proposal:
- Claim against scheme property – each person dealing with a MIS would have a direct claim against scheme property, thereby overcoming the limitations of the remedy of the counterparty under the current law;
- Transfer of liability of the responsible entity – the responsible entity, as agent, would not incur personal obligations and liabilities in operating the scheme. The issue under the current legal framework of the transfer of obligations and liabilities on a change of RE would not arise, thereby assisting the process of changing the responsible entity of a scheme, including attracting a TRE to operate a scheme as an interim measure; and
- External administration – the process of introducing a voluntary administration, or liquidation, procedure for a financially stressed scheme would be simpler under the SLE Proposal because of the full separation of the affairs of the scheme and the affairs of its responsible entity.
This full separation of the affairs of a scheme and the affairs of its responsible entity under the SLE Proposal would also overcome any need to limit responsible entities to sole-function REs, as it would be irrelevant from the perspective of a scheme whether it was operated by a sole-function or multi-function RE.
The SLE Proposal does not overcome the problem with common enterprise schemes of the intermingling of the property and affairs of the scheme with that of its members. CAMAC maintains its view that there should be a prohibition on the creation of new common enterprise schemes, whether or not the SLE Proposal is adopted.
Other reform proposals
CAMAC has recommended a series of other reforms, including:
- Requiring each scheme to have a definitive register of the affairs of the scheme and a definitive register of the property of the scheme. Clear identification of the affairs and property of each scheme is essential to the effective day to day operation of a scheme, the transfer of the responsible entity of a viable scheme, the restructuring of a financially stressed but potentially viable scheme, or the winding up of a scheme;
- Reducing the disincentives for a party to undertake the role of TRE, including limiting the liabilities of the TRE (necessary if the SLE Proposal is not adopted) and modifying the duties of a TRE to be commensurate with the temporary nature of that office;
- Adopting a statutory concept of insolvency for schemes, similar to corporations;
- Introducing a facilitative voluntary administration procedure for financially stressed schemes, similar to the procedure for corporations, with the approach under the SLE Proposal being the preferred option;
- Creating a winding up procedure for an insolvent scheme, comparable to the procedure for winding up an insolvent company; and
- Giving scheme members statutory limited liability, similar to shareholders, and regardless of any contrary provision in a scheme constitution.
CAMAC made a number of recommendations to simplify and facilitate the changing of a responsible entity of a viable scheme including:
- legislative amendments to simplify the due diligence process undertaken by a TRE or an incoming responsible entity;
- an obligation on the incumbent responsible entity to provide reasonable assistance to a prospective TRE or incoming responsible entity in its due diligence exercise;
- a general power of the court to determine the remuneration of a TRE of any scheme;
- statutory controls on responsible entity remuneration arrangements to cover the situation where an responsible entity is replaced during a financial year;
- where agreements (eg debt covenants) or scheme constitutions include ‘change of responsible entity’ provisions, which are triggered when a person ceases to be the responsible entity of a scheme, those provisions should only be enforceable if they do not unreasonably limit the right of scheme members to replace the responsible entity;
- a reduction in the voting requirement to replace the responsible entity of an unlisted scheme to a simple majority of the votes of scheme members cast at the meeting (in person or otherwise) provided that the total of the votes cast (for and against) of each of the resolutions constitutes at least 25% of the total votes of scheme members;
- an expansion of the criteria for eligibility to be a TRE to include a registered liquidator or anyone appointed by the court;
- if the SLE Proposal is not adopted, amendments to the statutory novation provisions to confirm that the transfer of property rights, obligations or liabilities under those provisions from an RE to a TRE or incoming responsible entity shall not, of itself be taken to be a change of ownership of that property for the purposes of triggering pre-emptive rights or default events; and
- the court should be given a general power to adjust the TRE’s duties and liabilities to particular circumstances.