The Establishment and Operation of Managed Investment Schemes – Page 5

1102     Part 2M.3. See also International Organization of Securities Commissions, Principles for the Valuation of
Collective Investment Schemes (Final Report May 2013) at 4, FSC Standard No. 9, cl 6.1.4.
1103     Joint  ASIC  and  APRA  guide  Unit  pricing:  Guide  to  good  practice  (2008)  (ASIC  RG 94),  International
Organization of Securities Commissions, Principles for the Valuation of Collective Investment Schemes (Final
Report May 2013) at 1, FSC Standard No. 9 Valuation of Scheme Assets and Liabilities (2006) cll 5.2, 6.1.1,
6.1.2, FSC Standard No. 8 Scheme Pricing (2006), cl 6.1.2. The ALRC/CASAC report (at para 6.11) observed that:
The value of the assets of a collective investment scheme is of vital importance to an investor. It determines the value of his or her investment in the scheme. Changes in the value of a scheme’s assets change the value of each investor’s investment. They also change the value at which investors in the scheme can redeem their investments. The methods used to ascertain these values are, therefore, particularly important.
FSC Standard No. 9 cl 6.1.4 considers that the primary purpose of determining scheme prices is to maintain equity between existing, ongoing scheme investors and potential and exiting investors.
1104     s 601FC.
1105     International Organization of Securities Commissions, Principles for the Valuation of Collective Investment
Schemes (Final Report May 2013) at 4, FSC Standard No. 9 at cl 6.1.1.
1106   International Organization of Securities Commissions, Principles for the Valuation of Collective Investment Schemes (Final Report May 2013) at 4, FSC Standard No. 9, cl 6.1.3, ASIC/APRA, Unit pricing: Guide to good practice (2008) (ASIC Regulatory Guide 94) (RG 94) at 58.
1107     ibid.

Other matters

There are different valuation requirements for each of these purposes. Financial reports must comply with the accounting standards.1108 By contrast, the scheme constitution and Product Disclosure Statement may set out the valuation principles to be applied in meeting compliance obligations: these principles may differ from those in the accounting standards (though in practice the valuation principles adopted in the accounting standards are also used in most instances for compliance purposes).

Valuations also provide relevant information when scheme takeovers and mergers are being contemplated.

The issue is whether the current regulatory framework for the valuation of scheme assets is appropriate and, if not, whether there should be a consistent approach for all purposes.

Current position Corporations Act Financial reporting
The annual report of a registered scheme must include details of the value of the scheme’s
assets at the end of the financial year and the basis for the valuation.1109  Asset values contained in the financial report must be determined in accordance with the accounting
standards.1110

Compliance
One of the duties of the RE is to ensure that scheme property is valued at regular intervals appropriate  to  the  nature  of  the  property.1111   This  duty  is  complemented  by  the requirement for the scheme’s compliance plan to set out the arrangements for ensuring that the scheme property is valued at regular intervals appropriate to the nature of the property.1112

A scheme constitution would normally contain a provision that specifies how units are to be valued on withdrawal, though such a provision is not required by the Corporations Act. Valuation of scheme property for unit pricing purposes would, however, have to be conducted in accordance with the Corporations Act requirement for the RE to treat scheme members who hold interests of the same class equally and members who hold interests of different classes fairly.1113

Accounting standards

The accounting standards govern financial reporting.1114

Various accounting standards may also be relevant to the valuation of scheme property for compliance purposes (in particular for unit pricing), depending on the particular type of property being valued. For instance, there are specific standards applicable to:

•    financial instruments1115

1108     s 296.
1109     s 300(13)(e). This requirement is based on a recommendation in the ALRC/CASAC report, para 6.15.
1110     s 296. See also International Organization of Securities Commissions, Principles for the Valuation of Collective
Investment Schemes (Final Report May 2013) at 4, FSC Standard No. 9, cl 6.1.4.
1111     s 601FC(1)(j).
1112     s 601HA(1)(c).
1113     s 601FC(1)(d).
1114     s 296.

Other matters

•    property, plant and equipment1116

•    investment property.1117

Other standards might be applicable, depending on the nature of the assets held (for instance, non-current assets,1118 intangible assets1119 or agricultural assets.1120 There is also a  standard  on  fair  value  measurement, which  applies  where  an  accounting  standard requires, or permits, an asset to be measured at fair value or at a measure based on fair value.1121

Liabilities are also measured in accordance with the accounting standards.

ASIC guidance

RG 132
ASIC Regulatory Guide 132 Managed investments: Compliance plans (RG 132) gives guidance on what a compliance plan might contain to deal with the valuation requirement in the Corporations Act. It suggests that a compliance plan should set out:

•     how the RE ensures that scheme property is valued at regular intervals appropriate to the nature of the property

•     how the RE ensures that scheme property is valued in a manner appropriate to the nature of the property

•    the system used for calculating unit price, including:

1115     AASB 132   Financial   Instruments:   Presentation,   AASB 139   Financial   Instruments:   Recognition   and Measurement (which provides the requirements for each measurement category of financial instruments: see paras 43-49 and AG64-AG82), AASB 9 Financial Instruments (see paras 5.1-5.2.3; AASB 9 will supersede the requirements in AASB 139 from 1 January 2015 though entities may elect to adopt it earlier).
1116     AASB 116 Property, Plant and Equipment. Property, plant and equipment (PP&E) is to be measured at cost at initial recognition (para 15). The cost of an item of PP&E includes its purchase price plus any additional costs that are directly attributable to the asset and are incurred in bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. Paragraphs 16-22 describe the elements of cost. After initial recognition of PP&E, an entity may elect to use either the cost model or the revaluation model. The cost model is the cost of the asset less any accumulated depreciation and impairment losses. The revaluation model (described in paras 31-42) requires an asset to be remeasured periodically at fair
value. The carrying amount is the fair value at the date of revaluation less accumulated depreciation and
impairment losses.
1117     AASB 140 Investment Property. An investment property is defined for accounting purposes as property (land, buildings or both) held to earn rentals or for capital appreciation or both (para 5). Investment property is to be measured at cost at initial recognition (para 20). After initial recognition, an entity may elect to apply either the cost model or the fair value model. However, where an investment property is held by a lessee under an operating lease, the lessor must apply the fair value model to value the property in the financial statements (para 34). The cost model (as per AASB 116) is generally to be applied if an entity chooses that model to account for investment property (para 56). Under the fair value model, the investment property’s carrying amount is its fair value. Paragraphs 20-56 provide more detailed requirements.
1118     AASB 5 Non-current Assets Held for Sale and Discontinued Operations.
1119     AASB 138 Intangible Assets.
1120     AASB 141 Agriculture.
1121     AASB 13   Fair   Value   Measurement,   applicable   to   annual   reporting   periods   that   begin   on   or   after
1 January 2013, defines fair value (at para 9) as: ‘The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.’ AASB 13 discusses valuation techniques at paras 61-66, Appendix B paras B5-B30. The valuation techniques discussed are the market approach, the cost approach and the income approach. The income approach includes present value techniques, option pricing models and the multi-period excess earnings method, which is used to measure the fair value of some intangible assets.

Other matters

–    the  controls  to  ensure  that  this  system  is  functioning  consistently  with  the scheme’s offering document, that the offering document is consistent with the scheme’s constitution and that supporting systems (such as the system for processing unit buying and selling activities) are adequately operated

–    the procedures to correct pricing errors

•     the controls to ensure that the RE becomes aware of changes in security values and positions  on  a  timely  basis  so  that  changes  in  valuations,  income  accruals  and positions can be evaluated.1122

RG 132  also  suggests  that  the  compliance  plan  for  a  property  trust  should  contain procedures to ensure that the valuation methodologies and frequencies are appropriate.1123

RG 94
ASIC has published, jointly with APRA, Regulatory Guide 94 Unit pricing: Guide to good practice (2008) (RG 94), which contains a guide to good practice in determining asset values for the purpose of pricing units in a scheme.1124

RG 94 emphasises that the RE is responsible for its valuation policies, even if it outsources some aspects of the unit pricing function.1125

RG 94 requires those responsible for providing financial products (including interests in managed investment schemes), when preparing valuations:

•     to document and explain their valuation methodologies and assumptions and why they are reasonable and appropriate for the assets

•     to ensure that valuations are unbiased, with the issuer of the managed investment interests1126 exercising no undue influence on the determination of asset values

•    to monitor and report internally on their valuation procedures

•     to review and update their asset valuation policies and procedures (including those relating to estimation) periodically and as market conditions change (with expert professional valuation advice where necessary)

•    not to use estimates where actual values are available

•     to develop any estimates on a sound and reasonable basis and to be able to justify why an estimate is appropriate in the circumstances.1127

RG 134
Regulatory Guide 134 Managed investments: Constitutions contains various guidelines and requirements relating to the manner in which a scheme constitution should deal with questions of valuation, including:

1122     at 10, 16. See also at 15 for the calculation of unit price.
1123     at 12 (item 7(i)).
1124     Section 5.1.
1125     at 57.
1126     Referred to in RG 94 as the ‘product provider’. Those responsible for providing interests in managed investment schemes may include the RE of the scheme (see at 27).
1127     at 57-59. Estimates are also discussed at 61.

Other matters

•     the valuation of scheme assets for the purpose of setting the consideration to acquire an interest in an unlisted unitised scheme should take into account transaction costs involved in the acquisition and/or disposal of scheme assets1128

•     the market price can be used to determine the value of interests in listed schemes provided the market value that is used is reasonably current1129

•     if a listed scheme has a class of interests on issue that is not quoted, the consideration to acquire an interest in that class should be priced using a formula or method based on the value of scheme property less any liabilities that may be met from scheme property referable to that class divided by the number of interests in that class on issue1130

•     an RE’s method for calculating the value of scheme property in the exercise of a discretion must be consistent with the range of ordinary commercial practice for valuing that type of scheme property and produce a value that is reasonably current at the time of issue or withdrawal.1131 What is ‘reasonably current’ depends on the nature of the asset, but would generally require a figure:

–    calculated on a daily basis where the financial products held are traded on a market with regular daily transactions

–    as determined within the last year, or such longer period as the RE determines if a current valuation would not be materially different where the assets held are illiquid or thinly traded1132

•     an RE’s method for calculating the value of the market price of interests quoted on a financial market in the exercise of a discretion must be consistent with the ordinary commercial practice for determining the market price of interests of the same kind and produce a market price that is reasonably current at the time of issue or withdrawal.1133
What is a ‘reasonably current’ market price depends on the nature of the asset, but would generally be the price or an average price close to the time an issue or an impending issue is announced1134

•     a withdrawal price must be determined on the basis of valuations of scheme property that are consistent with the range of ordinary commercial practice for valuing the particular type of scheme property and are reasonably current1135

•     if  consideration for  a  withdrawal may  be  paid in  specie, the  constitution should provide that the valuations of relevant assets should be consistent with the range of ordinary commercial practice for valuing assets of that type and be reasonably current, as the valuations affect the amount to which a member is entitled on withdrawal and the value of the remaining assets.1136

1128     RG 134.44-RG 134.51.
1129     RG 134.59-RG 134.60.
1130     RG 134.62.
1131     RG 134.108.
1132     RG 134.110(b).
1133     RG 134.109.
1134     RG 134.110(a).
1135     RG 134.176.
1136     RG 134.178.

Other matters

Report 291
ASIC Report 291 Custodial and depository services in Australia (July 2012) observed that valuation is the responsibility of the RE: custodians do not generally question reasonable looking valuations before using them in the calculation of unit prices.1137

In that report, ASIC identified challenges in relation to valuations and unit pricing generally, including where the assets:

•    are illiquid or otherwise infrequently valued, or

•     in the case of shares in companies or units in other schemes that form part of scheme property – are not quoted on a financial market or are suspended from trading.1138

Financial reporting
In addition to the formal guidance concerning valuation in the context of compliance, ASIC has announced findings from a recent review of financial reports of listed and other public interest entities (including managed investment schemes). These findings indicate areas to which the preparers of financial reports might have regard, including:

•     the  recoverability  of  the  carrying  values  of  assets,  including  goodwill,  other intangibles, investment properties and property, plant and equipment

•     the need for reasonable and supportable cash flows and assumptions in determining recoverable amounts, having regard to  such matters as  historical cash  flows, the manner in which an entity is funded and market conditions

•     the need to give adequate weight to matters that might impair the value of assets, such as obsolescence.1139

ASIC also drew attention to the need to provide disclosure of certain matters that are important to investors and other users of financial reports, given their subjectivity, including:

•    key assumptions including discount rates and growth rates

•    periods covered by forecasts.1140

Financial Services Council Standard

The Financial Services Council has issued FSC Standard No. 9 Valuation of Scheme Assets and Liabilities (2006) (the Standard), to be applied by its members, including those who are the RE of a scheme.

The Standard requires that scheme assets and liabilities be valued at least as frequently as interests in the scheme may be traded, except where the RE considers it to be in the best interests of investors to initiate less frequent valuations.1141

1137     ASIC Report 291 Custodial and depository services in Australia (July 2012), paras 122-123. See also PJC Trio report paras 5.61, 7.38-7.39, 9.22.
1138     ASIC Report 291, para 124.
1139     Media Release 13-341MR, ‘Findings from 30 June 2013 financial reports’ (16 December 2013). The ASIC
review covered 280 listed and other public interest entities.
1140     ibid. ASIC observed that ‘[d]isclosure of these matters enables users to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations’.

Other matters

Where the formal valuation of certain assets and liabilities is at extended, infrequent intervals:

•     valuation policies (including the staggering of formal valuations) must be developed to limit the occurrence of sudden significant increases or decreases in net asset value that do not reflect a true sudden increase or decrease in the underlying value of assets and liabilities1142

•     consideration should be given to reflecting estimated movements or general market movements between formal valuations1143

•     the value of assets and liabilities that by their nature are subject to formal valuation at infrequent intervals (for instance, real property, infrastructure, private equity) must be determined at least annually as a minimum.1144

The Standard specifies that the RE must ‘unless it is inappropriate’1145 obtain a valuation from ‘a reputable, independent third party (such as a professional valuer or tax agent)’ where there is no properly regulated market for the assets to be valued.1146 The RE must provide the professional valuer with all the information the valuer may require to complete the valuation (including the purpose of the valuation, the basis on which the valuation is to be determined, any legislative requirements and requirements of the scheme’s constitution and/or Product Disclosure Statement).1147

The Standard requires that the processes of valuing scheme assets and liabilities be documented and transparent, unbiased and equitable,1148 applied consistently and reviewed regularly.1149 The Standard, while not prescribing a valuation methodology, requires that:

•     the methodologies and assumptions used in valuing scheme assets and liabilities be documented and explained1150

•     the valuation of a scheme’s assets and liabilities be based on the market value of all assets  and  liabilities1151   unless  the  market  price  is  deemed  to  be  unreliable  (for instance, where trading is infrequent or the market is thin) or no market price is available, in which case the RE must adopt a valuation in good faith, taking into account all relevant factors and clearly documenting any exceptions to documented policies and methodologies1152

1141     cl 12.5.
1142     cll 12.6, 12.6.1, 12.6.3.
1143     cll 12.6.1, 12.6.3.
1144     cl 12.6.2.
1145     Items that the standard identifies as inappropriate for a third party valuation, notwithstanding the absence of a properly regulated market, are interests in other schemes managed by the RE or by another RE, outstanding settlements, provision for tax, performance fees, and the RE’s fees (cl 11.4.3). For these items, the RE’s valuations must be based on sound and justifiable policies that seek to achieve equity between investors, are
clearly documented and are regularly reviewed.
1146     cl 11.4.
1147     cll 11.4.1, 11.4.2.
1148   A valuation must be objective, not subject to undue influence by the RE or an associate of the RE and independently verifiable (cl 11.5)
1149     cl 9.1.
1150     cl 10.2.
1151     cl 11.1. The market price to be used in any valuation must be the most recent that can reasonably be obtained
(cl 11.3.2).
1152     cll 11.3, 11.3.3, 11.5.3.

Other matters

•     valuations of assets and liabilities traded on a properly regulated market (such as a recognised stock exchange) generally be based on the market price1153

•     assets and liabilities be valued on a ‘going concern’ basis, unless this assumption is clearly inappropriate (for instance, if the scheme is in the process of being wound up).1154

Valuation  processes  must  be  carried  out  in  accordance  with  applicable  Australian
Accounting Standards and generally accepted accounting principles.1155

The  Standard  recommends  that  the  valuation  provisions  of  scheme  constitutions  be brought into line with its requirements,1156 which apply where their application is of material consequence.1157

IOSCO

The International Organization of Securities Commissions, in its Final Report Principles for the Valuation of Collective Investment Schemes (May 2013), put forward the following principles:

•     Principle 1:  The  Responsible Entity  should  establish  comprehensive, documented policies and procedures to govern the valuation of assets held or employed by a [scheme]

•     Principle 2: The policies and procedures should identify the methodologies that will be used for valuing each type of asset held or employed by the [scheme].

The commentary on this principle indicates that:

–     valuations should be determined in good faith

–    where  possible,  assets  should  be  valued  according  to  current  market  prices, provided that those prices are available, reliable and frequently updated

•     Principle 3: The valuation policies and procedures should seek to address conflicts of interest.

The commentary on this principle points out that conflicts may particularly arise with complex or illiquid assets that are hard to value, for which the scheme operator may be the most reliable or only source of information. The commentary suggests various ways to deal with these conflicts, including internal reviews that are independent of the portfolio management function, a conflict of interest policy and an independent pricing service

•     Principle 4: The assets held or employed by [a scheme] should be consistently valued according to the policies and procedures

1153     cl 11.3. Where an asset is traded on more than one properly regulated market, the RE must value the asset on the basis of the primary market for the asset (cl 11.3.1).
1154     cll 12.3, 12.3.2.
1155     cll 5.4, 11.5.3, 12.1.1. See the discussion under Accounting standards, above.
1156     cl 6.2.1.
1157     Section 7.

Other matters

•     Principle 5: A Responsible Entity should have policies and procedures in place that seek to detect, prevent, and correct pricing errors.1158  Pricing errors that result in a material harm to [scheme] investors should be addressed promptly, and investors fully compensated

•     Principle 6: The Responsible Entity should provide for the periodic review of the valuation policies and procedures to seek to ensure their continued appropriateness and effective implementation. A third party should review the [scheme] valuation process at least annually

•     Principle 7: The Responsible Entity should conduct initial and periodic due diligence on third parties that are appointed to perform valuation services

The commentary on this principle points out that the RE retains responsibility and liability for valuations, notwithstanding the use of a third party

•     Principle 8: The Responsible Entity should seek to ensure that arrangements in place for the valuation of the assets in the [scheme]’s portfolio are disclosed appropriately to investors in the [scheme] offering documents or otherwise made transparent to investors

•     Principle 9: The purchase and redemption of [scheme] interests generally should not be effected at historic NAV [net asset value].

Historical pricing is ‘the pricing method whereby investors purchase or redeem units/shares based on the last calculated NAV’ of the scheme.1159 The commentary on this principle favours forward pricing, which is ‘the practice of effecting purchasing and redemption of [scheme] interests at the next computed NAV after receipt of the order’, as it ‘ensures that incoming, continuing and outgoing investors are treated equitably’

•     Principle 10: A [scheme]’s portfolio should be valued on any day that [scheme] units are purchased or redeemed

•    Principle 11: A [scheme]’s NAV should be available to investors at no fee.

IOSCO has also stipulated that regulatory systems should require disclosure of matters material to the valuation of a scheme, including the methodology of asset valuation.1160

Analysis and discussion

Some purposes of valuation of assets are the same for companies and for schemes, for instance the requirement to comply with accounting standards in the preparation of financial statements.

However, valuations play a more central role for schemes than for companies, particularly in the pricing of interests. Par value for shares was abolished in 1998.1161  By contrast,

1158     The commentary on Principle 5 points out that pricing errors can occur for a number of reasons, including incorrect accrual of fees, late reporting of trades in assets or simple human error in inputting data.
1159     Commentary on Principle 9.
1160     IOSCO   Objectives   and  Principles  of  Securities  Regulation  (June 2010),  Methodology  For  Assessing Implementation  of  the  IOSCO  Objectives  and  Principles  of  Securities  Regulation  (September 2011),  Key Questions 1 and 5(e) on Principle 26.
1161     By the Company Law Review Act 1998, which came into effect on 1 July 1998.

Other matters

valuation of the assets of a scheme is the key element in the pricing of scheme interests. Accurate and soundly based valuations, determined on a basis that is fair and equitable to all investors, help ensure that scheme investors in the same class are treated equally (and investors in different classes are treated fairly) in the determination of entry and exit prices and voting entitlements.

Valuation issues are relevant for listed as well as unlisted schemes. For instance, the integrity of the valuation process is directly relevant for determining unit prices in unlisted schemes, as issue and redemption prices for those schemes are calculated on the basis of the value of scheme assets. Valuation is indirectly relevant for listed schemes, as the quoted market price for interests in those schemes incorporates the information in their financial statements, which in turn depends on asset valuations.

Currently, there are different methods of conducting valuations of scheme property for compliance purposes, in particular unit pricing. These various methods may produce different values for particular property: a valuation based on the accounting standards may differ from a valuation prepared on some other basis (for instance, the present value of deferred tax balances may be reflected in a valuation for the purpose of unit pricing, but not in one prepared in accordance with the accounting standards).

A regulatory framework that would promote consistency and comparability in scheme valuations seems desirable to assist investors to understand their investment.

Type of valuation framework

Possible approaches to the development of a uniform valuation framework for compliance purposes (in particular unit pricing) could include one, or a combination, of the following:

•    statutory provisions imposing the appropriate requirements (a statutory approach).
This option could provide for departure from the statutory requirements, provided that the reasons for the departure were disclosed (an ‘if not why not’ approach). The option would include a statutory requirement to apply the accounting standards

•     a principles–based approach such as that provided by IOSCO. A variation of this option might be a principles-based approach that permitted departure from the principles on an ‘if not why not’ basis

•     a requirement that a scheme’s compliance plan1162 or risk management system contain governance  provisions  setting  out  the  RE’s  approach  to  various  aspects  of  the valuation procedure (a self-regulatory approach:1163 see Section 5.6 for a discussion of whether the governance framework for schemes should continue to be focused on compliance or, alternatively, should be centred more on risk management). Under this approach, the RE might be required to document and explain its valuation methodologies and assumptions, and its policy on internal and external valuation, and why these elements are reasonable and appropriate for the assets1164

1162     Currently, the scheme’s compliance plan must include adequate arrangements relating to ensuring that the scheme property is valued at regular intervals appropriate to the nature of the property (s 601HA(1)(c)).
1163   This approach is described as self-regulatory, despite the fact that the requirement to have these corporate governance provisions is imposed by legislation, as the content of the provisions would be determined by the RE.
1164     Joint ASIC and APRA guide Unit pricing: Guide to good practice (2008) (ASIC RG 94) at 57.

Other matters

•     reliance on  existing or  new  guidelines from ASIC1165   or  industry bodies (a  best practice approach). For instance, ASIC could issue guidance on valuation that could incorporate, but go beyond, the relevant guidance on valuation in its guidance on compliance plans (RG 132) and unit pricing (RG 94). Guidelines under this option may provide for departure from the guidance on an ‘if not why not’ basis.

The valuation framework might:

•     relate to the valuation of specific types of scheme asset so that all assets of the same type would be valued on the same basis, regardless of the type of scheme in which the asset is held. This would ensure a level of consistency and comparability

•     apply to the valuation of scheme property generally within a scheme (for instance, the framework might provide either that the valuation methodology adopted for a scheme must be one that is commonly accepted in the market for that asset or that there should be an indication of what methodology has been adopted, with an explanation of how it departs from commonly accepted valuation methodologies).

The  framework  should  ensure  that  any  valuation  requirements  or  guidelines  are appropriate not just for the particular asset being valued, but for the particular scheme and its investors. For instance, ASIC draft guidance on risk management for REs suggests that a scheme’s valuation policies take into consideration such factors as the type of assets in which the scheme invests and the operating model of the scheme (for instance, whether it allows off-market issue and redemption of interests).1166 Retail investors might require information that differs from that required by wholesale investors, both in content and in presentation.

Responsibility for valuation

Currently, it is the duty of the RE to ensure that scheme property is valued at regular intervals.1167 If a statutory approach is maintained, an issue is whether it is appropriate for a valuation requirement to be cast as a specific duty of the RE.

It is a common practice for REs to outsource valuations of scheme property to third parties. Issues that arise in relation to choosing an external valuer are:

•     what  qualifications  the  valuer  should  possess  (for  instance,  membership  of  an appropriate professional body for valuations)

•     how to ensure that the valuer is independent of the RE and the RE’s associates and has no other conflict of interest (for instance, the valuer might be required to sign a declaration to this effect)

•     whether the valuer should be prohibited from performing more than a certain number of consecutive valuations.1168

1165     For instance, RG 94 (at 56) identifies as one of the asset valuation issues ‘developing, documenting and implementing valuation policies for the range of assets held in the fund’.
1166     ASIC Consultation Paper 204 Risk management systems of responsible entities (March 2013), Appendix to draft
Regulatory Guide 000 at p 57 of the Consultation Paper.
1167     s 601FC(1)(j).
1168     For instance, ASIC Consultation Paper 204 Risk management systems of responsible entities (March 2013) suggests rotation of valuers as a means of treating the investment risk arising from valuation and pricing issues (Appendix to draft Regulatory Guide 000 at p 57 of the Consultation Paper).

Other matters

Another issue is whether a regulatory framework should specify any circumstances in which, or any particular types of property for which, an RE should be required to engage an external valuer and, if so, what governance arrangements should apply to that engagement. These arrangements could include such matters as:

•     documentation  that  the  external  valuer  should  provide  to  the  RE  to  explain  its valuation methodology (for instance, the key inputs and assumptions used in the methodology)

•     whether the RE should disclose any such documentation to scheme members and in what circumstances

•     requiring the RE to check the assumptions being made by the external valuer, to determine if they are appropriate for the scheme and the industry in which it operates

•    other ongoing arrangements for the RE to monitor the external valuer

•     a  valuation  committee  or  another  committee,  such  as  a  compliance  or  an  audit committee, to assist in performing the monitoring role

•    arrangements for communication between such a committee and the RE.

One reason for REs to outsource valuation might be the possibility of conflict of interest where an RE values the portfolio that it is managing.

Methodology for valuing assets for compliance purposes

Valuation methodologies differ, depending on the particular type of asset being valued and the time of valuation.1169 For instance, the value of certain structured financial instruments and OTC derivatives cannot be determined by using quoted prices: their valuation requires the use of internal techniques that rely on management’s judgment.1170 Similarly, there are recognised methodologies for determining the values of some assets that are not traded in deep, liquid and well-maintained markets, such as property and infrastructure.1171  These methodologies are applied with varying frequency, depending on market conditions and the professional judgement of investment managers and valuers.1172  Particular valuation issues also arise for assets that are traded only infrequently (thinly traded assets, for instance rarely traded shares) and illiquid assets such as some hedge funds and some types of private equity.1173  Valuations of more complex assets may require specific skills and systems and particular personnel who have an appropriate level of knowledge, experience

1169     See International Organization of Securities Commissions, in its Final Report Principles for the Valuation of
Collective Investment Schemes (May 2013) Principle 2 and the accompanying commentary.
1170     International Organization of Securities Commissions, Principles for the Valuation of Collective Investment
Schemes (Final Report May 2013) at 1.
1171     See the fourth asset valuation issue on p 56 of RG 94.
1172     ibid.  In  other  instances,  the  methodologies  for  valuing  assets  that  are  not  traded  in  deep,  liquid  and well-maintained markets are less well recognised or are specific to a transaction (for instance, some types of complex structured products and some types of OTC derivative): see the fifth asset valuation issue at 56; see also at 58 under the heading Valuation of non-exchange traded assets. In those cases, values may be determined by applying a model, by periodic third party valuation or by using an estimate between specific valuation dates.
1173     id, sixth and seventh asset valuation issues at 56. See also at 61. The commentary on Principle 2 in the International Organization of Securities Commissions Final Report Principles for the Valuation of Collective Investment Schemes (May 2013) points out that ‘[t]he more illiquid such markets are, the more robust the valuation process may need to be’.

Other matters

and training.1174 Where assets are valued infrequently, it is not uncommon for an interim valuation to be conducted on the basis of the manager’s professional judgement.

Where the professional judgement of the RE is used to determine a valuation, there is an issue whether rules or principles should be established to ensure the consistency and quality of any resulting valuation. There is also a question whether it should be mandatory to disclose that a valuation is the result of management’s professional judgement, rather than the result of a professional external valuation.

Where external valuations are carried out, there is an issue whether the RE should be permitted to give the external valuer instructions on how the valuer should carry out the valuation and, if so, whether the RE should be required to have a written policy that forms the basis of any such instructions.

There is also an issue about the weight that should be given to the standards of any relevant professional body of which the valuer is a member. The valuer might be required to apply these standards and state that this is the case. Alternatively, the valuer could be permitted to depart from those standards, but required to explain any such departure (an ‘if not why not’ approach).

Given  the  diversity  of  valuation methodologies, persons  who  have  responsibility for scheme valuations should be required to document and explain their valuation methodologies and assumptions and why they consider that those methodologies and assumptions are reasonable and appropriate for the assets being valued. As discussed under Responsibility for valuation, the person with this responsibility may be an external valuer.

There is a question about to whom this information should be disclosed, given that it may be commercially sensitive. Possible parties to whom information might be disclosed are:

•    scheme members

•     prospective scheme members (who would be interested in the rate of return they might expect from investing in the scheme)

•    the scheme auditor.

Frequency of valuation

Currently, REs have a duty ‘to ensure that scheme property is valued at regular intervals appropriate to the nature of the property’.1175 There is a question whether this duty is an appropriate  way  to  ensure  that  scheme  property  is  valued  sufficiently  frequently. Regularity of valuations does not necessarily ensure that they are valued at appropriate intervals to provide the required information about scheme assets in a timely fashion or that the valuation provides an appropriate measure of the value of that asset at the date of the valuation.1176

1174     International  Organization  of  Securities  Commissions,  in  its  Final  Report  Principles  for  the  Valuation  of
Collective Investment Schemes (May 2013) Principle 2 and the accompanying commentary.
1175     s 601FC(1)(j).
1176     ASIC Consultation Paper 204 Risk management systems of responsible entities (March 2013) states in the
Appendix to draft Regulatory Guide 000 at p 57 of the Consultation Paper:

Other matters

As with the valuation methodology, the intervals at which an asset should be valued to provide an appropriate value for specific circumstances can differ depending on the type of assets being valued. Some asset values change rapidly and valuation of those assets may need to be carried out daily. For instance, in the case of a scheme involving securities quoted on an exchange, the RE (or its agent) will generally obtain daily price feeds from the exchange for these securities.1177 Some REs may even value scheme assets more than once a day if their systems have the necessary capacity.1178 Other assets, such as real property and infrastructure, by their nature are valued only at longer intervals.1179 Where more than one of these assets is held in a portfolio, periodic valuations should occur at different times, where possible.1180

In addition to the type of assets, frequency of valuations might be affected by the nature of the particular scheme. For instance, withdrawals from a particular scheme might only be permissible every five years. For such a scheme, valuation might only be required around the time of withdrawal, even though individual assets within the scheme might be valued more frequently (for instance, annually) for financial reporting or compliance purposes.

These different time horizons for valuation may influence whether the valuation is conducted internally or externally. Where an asset value is required between formal valuations (for instance, to strike a unit price), an RE may only need an estimate of the value of the asset.1181  Where a valuation is needed frequently, the RE may perform an internal ‘desktop’ valuation of the relevant asset or assets, with external valuations of those assets being performed at longer intervals such as every year or two years.

Given these differences in the appropriate frequency of valuation, general requirements relating to this matter may be preferable to a specific rule, for instance:

•     a requirement that valuation of scheme assets occur reasonably frequently, taking into account the nature of each asset being valued, and in accordance with the ordinary commercial practice for that asset

•     a requirement that scheme assets be valued before certain key events in the conduct of the scheme’s business that depend on the scheme’s asset values, for instance:

–    the  determination  of  the  price  for  the  redemption  or  issue  of  units  in  the scheme1182

–    the determination of the RE’s fees or the preparation of the annual accounts.

•     At the scheme level, there is a risk of scheme assets not having a correct valuation on a timely basis. While this risk may not be relevant to some registered schemes (e.g. timeshare schemes, property syndicates or forestry schemes), robust valuation practices are essential for effective liquidity risk management and correct pricing of interests in most registered schemes.
•     This risk generally is higher for schemes that invest in assets that are not traded on a financial market or assets that do not have a liquid market (e.g. mortgage or property schemes) where transparent price setting for scheme assets is more difficult to facilitate.
1177     ASIC Regulatory Guide 132 Managed investments: Compliance plans at 16.
1178     FSC Standard No. 9, cl 12.5.1.
1179     FSC Standard No. 9, cl 12.6.2 (which points out that infrequent valuation may also partly be the result of the costs of obtaining a valuation). RG 94 (at 60) requires that valuations for infrastructure, which has a recognised valuation methodology, be obtained periodically from reputable, professional, third party valuers.
1180     RG 94 at 60, FSC Standard No. 9 at cl 12.6.1.
1181     These ‘soft prices’ are estimated as a part of normal business operations when actual or hard prices are obtainable, but not at the relevant time. These soft prices may be based, for instance, on index or other market movements. See further RG 94 at 56, 59-60.
1182     Cf the second asset valuation issue on p 56 of RG 94. See also at 59 under the headings Frequency of transacting and frequency of unit pricing and Frequency of unit pricing and frequency of asset valuation.

Other matters

One issue under the latter approach would be how close to the date of the key event the valuation should be done and whether this question should be decided differently for different types of asset (for instance, the valuation of shares would change much more frequently than that of real property).

Question 15.1.1. Should a scheme’s valuation procedures be limited to those required by the accounting standards, regardless of the purpose of the valuation?

Question 15.1.2. If the answer to Question 15.1.1 is no, should additional regulations and guidance be introduced to ensure consistency in the valuation of scheme assets for specific purposes (other than for the preparation of financial statements) such as unit pricing?

Question 15.1.3. If the answer to Question 15.1.2 is yes, for which specific purposes and should the regulatory framework be contained in:
•    legislation (a statutory approach)
•    a principles–based approach
•    a scheme’s compliance or risk management framework (a self-regulatory approach)
•    existing or new ASIC or industry guidelines (a best practice approach)
•    some combination of these approaches?

Question 15.1.4. Should any valuation framework:

•     include valuation requirements for specific types of scheme asset, regardless of the type of scheme that holds such assets

•     be sufficiently flexible to take into account the nature of particular schemes and the particular types of investors in a scheme
•     apply to the valuation of scheme property generally within a scheme, so that different schemes can have different valuation frameworks but each scheme must adopt a consistent approach

•    distinguish between liquid and non-liquid schemes?

Responsibility for valuation

Question 15.1.5. Should valuation of scheme assets be a specific duty of the RE?

Question 15.1.6. Where an RE outsources valuation of scheme assets:

•     how should the regulatory framework provide for the selection and terms of reference of the external valuer

•     how should the regulatory framework ensure that the external valuer is independent of the RE and the RE’s associates and has no other conflict of interest
•     should the RE be permitted to give the external valuer instructions on valuation procedure and, if so, should the RE be required to have a written policy that forms the basis of any such instructions

•     what, if any, restrictions should there be on the number of consecutive valuations performed by the external valuer
•     what governance arrangements should apply to the engagement of the external valuer (for instance, documentation to explain the valuation methodology, arrangements for the RE to check the valuer’s assumptions or otherwise monitor the valuer, including with the assistance of a committee)

Other matters

•     what weight should be given to the standards of any relevant professional body of which the valuer is a member?

Question 15.1.7. Should there be a specific requirement for the external valuation of assets:
•     in particular circumstances and, if so, what
•     for particular types of asset and, if so, what (for instance, real property)?

Methodology of valuation for compliance purposes

Question 15.1.8. Should persons with responsibility for scheme valuations be required to:

•    document and explain their valuation methodologies and assumptions, and

•     explain why they consider that those methodologies and assumptions are reasonable and appropriate for the assets being valued?

Question 15.1.9. If so, to whom should that information be given?

Question 15.1.10. Where the professional judgement of the RE is used to determine a valuation, should rules or principles be established to ensure that any resulting valuation meets certain quality standards and is consistent with similar valuations?

Question 15.1.11. Where a valuation relies on the professional judgement of the RE, rather than a professional external valuer, should this be disclosed and to whom?

Question 15.1.12. Should there be any other form of regulation of the methodology for valuing scheme assets and, if so, what?

Frequency of external valuations

Question 15.1.13.  What  requirements  should  there  be  for  the  frequency  of  external valuation of scheme assets, for instance:
•     should there be a flexible requirement for frequency of valuations, based on the nature of the asset being valued and the ordinary commercial practice for valuing that type of asset

•     should there be a requirement that scheme assets be valued before certain key events in the scheme’s business that depend on current asset values and, if so
•     how close to the date of the key event should the valuation be done and would this depend on the type of asset?

15.2    Definition of ‘financial market’

The issue

Should the definition of financial market be amended to make it clear that it does not include mechanisms for withdrawing from non-liquid schemes?1183

1183     The question of distinguishing between liquid and non-liquid schemes is further discussed in Section 9.3 of this paper.

Other matters

Current position

A ‘financial market’ is defined as a facility through which:

•    offers to acquire or dispose of financial products are regularly made or accepted, or

•     offers or invitations are regularly made to acquire or dispose of financial products that are intended to result or may reasonably be expected to result, directly or indirectly, in:

–    the making of offers to acquire or dispose of financial products, or

–    the acceptance of such offers.1184

A financial market requires either:

•    an Australian market licence, or

•    an exemption from the market licensing provisions.1185

The obligations of the holder of an Australian market licence include:

•     to the extent that it is reasonably practicable to do so, to do all things necessary to ensure that the market is a fair, orderly and transparent market

•    to comply with the licence conditions

•     to have adequate arrangements for operating the market, including arrangements for handling conflicts between the licensee’s commercial interests and the need to ensure that the market is fair, orderly and transparent

•    to have sufficient resources (including financial, technological and human resources)
to operate the market properly

•    to ensure that there are any required compensation arrangements

•     to take all reasonable steps to ensure that no disqualified individual becomes, or remains, involved in the licensee.1186

Analysis and discussion

The definition of ‘financial market’ may have caused the REs of some non-liquid schemes not to proceed with some mechanisms that would have allowed members to exit from the scheme by finding a willing counterparty, for fear that to do so would have caused the creation of a ‘financial market’.

Possible  withdrawal  mechanisms  that  may  come  within  the  definition  of  ‘financial market’1187 include:

1184     s 767A(1).
1185     Part 7.2 Div 2.
1186     s 792A(a)-(e),  (i).  Other  obligations  are  found  in  ss 792B-792I.  There  are  also  specific  requirements  for particular types of licensees (s 792A(f)-(h)). See generally ASIC Regulatory Guide 172 Australian market licences: Australian operators.
1187     The activities do not come within any of the current exceptions in s 767A(2), which relate to:

Other matters

•     a grey market (being a market for interests in the scheme operated by the RE where only existing members can buy and sell)

•    a bulletin board whereby:

–    scheme members can post an indication of their willingness to sell their interests at a certain price

–    potential buyers have access to this information in order to decide whether they want to purchase those interests.

In theory, a bulletin board is a process where active matching of buyers with sellers does not occur.

If these potential mechanisms came within the definition of ‘financial market’, persons proposing them would have to develop the regulatory infrastructure required by the financial market licensing system or obtain an exemption.

It may be desirable in certain circumstances to facilitate withdrawals from illiquid funds, especially for retail investors. Equally, however, it is important to maintain protections for investors1188 when withdrawals are permitted.

It may be difficult to tailor a suitable legislative amendment to the definition of ‘financial market’ to facilitate withdrawals from these non-liquid schemes.

Question 15.2.1.   Does   the   definition   of   ‘financial   market’   have   inappropriate consequences for the issue and disposal of managed investment products? If so, how might these consequences best be dealt with?

15.3   Exception to the insider trading prohibition

The issues

Should the exception to the insider trading provisions for withdrawal from a registered managed investment scheme be continued and, if so, should it be restricted to the RE of a registered scheme?

Does the test for calculating the withdrawal amount require clarification?

Current position

A  person who  knowingly possesses inside information about  interests in  a  managed investment scheme is prohibited from dealings in those interests.1189

•     offers or invitations made on a person’s own behalf or on behalf of one party to the transaction only
(subject to a contrary provision in the regulations)
•     treasury operations between related bodies corporate
•     auctions of forfeited shares.
1188     Currently contained in Part 5C.6.
1189     s 1043A, read with the definitions of ‘Division 3 financial products’, ‘relevant Division 3 financial products’
and ‘inside information’ in s 1042A.

Other matters

This prohibition does not apply to a member’s withdrawal from a registered scheme if:

the amount paid to the member on withdrawal is calculated (so far as is reasonably practicable) by reference to the underlying value of the assets of the financial or business   undertaking  or   scheme,   common   enterprise,   investment   contract   or time-sharing scheme to  which  the  member’s interest relates, less  any  reasonable charge for acquiring the member’s interest.1190

This exception to the insider trading prohibition was part of the original insider trading amendments introduced by the Corporations Legislation Amendment Act 1991.1191  The exception responded to concerns that:

there may be a conflict between the redemption requirements of a trust manager under a trust deed and the insider trading provisions. Trust deeds must provide redemption facilities under the Corporations Law and in doing so the trust deed may specify that the buy—back price is to be adjusted on a periodic basis to reflect the underlying value of the assets of the trust and that units are to be bought back at the price quoted at the time of the application for redemption. In such circumstances, the buy—back price may not at any given time reflect all material information in the possession of the trust manager and to avoid contravening the insider trading provisions by waiting for the price to reflect all such information the manager may be in breach of the trust
deed.1192

The Explanatory Memorandum said that the provision containing the exception (originally s 1002H of the Corporations Law):

provides that the manager of a prescribed interest does not contravene the prohibition in subsection 1002G(2) where it redeems a prescribed interest in accordance with a buy—back covenant, at a price that is required to be calculated, so far as reasonably practicable, by reference to the underlying value of the assets to which the prescribed interest relates less any reasonable charge for purchasing the interest. The provision takes into account lags in adjusting the buy—back price for changes in the underlying value of the assets.1193

Analysis and discussion

Although the Explanatory Memorandum states that the manager would not contravene the insider trading prohibition when redeeming interests, the legislation was not in fact stated this way. Instead of a positive exemption for the manager (RE), the legislation stated that the insider trading prohibition does not apply ‘in respect of the redemption’ of a prescribed interest.1194 The same legislative approach was taken when the insider trading provisions were amended to recognise the replacement of prescribed interests with managed investments: the exception is now stated as applying ‘in respect of a member’s withdrawal from a registered scheme’.

This legislative wording makes the exception available for any withdrawal from a scheme, regardless of whether it is the RE or the member who has the inside information. This result departs from the original rationale for the exception, which was to ensure that an RE

1190     s 1043B.
1191   Those amendments were introduced in response to the recommendations in the report of the House of Representatives Standing Committee on Legal and Constitutional Affairs Fair shares for all: insider trading in Australia  (1989),  which  recommended  that  it  be  made  clear  that  the  insider  trading  provisions  apply  to prescribed interests (the predecessors to managed investment schemes).
1192     Explanatory Memorandum to the Bill for the Corporations Legislation Amendment Act 1991, para 347.
1193     para 348.
1194     Former s 1002H.

Other matters

does not have a conflict between its legislative buy-back obligations1195  and the insider trading prohibition.

There does not appear to be any policy reason why a member should be entitled to exercise withdrawal rights while in the possession of inside information. It would appear reasonable for a member in that position to disclose the information to the RE, to obtain the defence that both parties knew the information before entering into the transaction.1196
A member who is not able to disclose the information for confidentiality reasons should not be able to trade.

There may also be difficulties in calculating the withdrawal amount under the exception, for instance:

•     it is not clear whether the exception can apply where schemes have different classes of interests1197

•     the meaning of the term ‘underlying value of the assets’ may not be sufficiently clear or certain.

Question 15.3.1.  Should  the  exception  from  the  insider  trading  prohibition  where  a member withdraws from a managed investment scheme be amended and, if so, in what manner?

15.4   Alignment of corporate and scheme law

A key principle underlying CAMAC’s views on many of the issues considered in this paper is that the regulatory regime for managed investment schemes should be aligned with that for companies, unless there are compelling reasons for treating schemes differently.1198 This principle has been raised (both where there seemed to be a prima facie case for aligning the two regimes and where there appeared to be compelling reasons not to do so) in sections of this paper discussing who is a scheme member,1199 scheme registration,1200 the governance framework for schemes,1201 the scheme constitution,1202 matters relating to  directors and officers of  the  RE,1203   related party  transactions,1204

1195     Part 5C.6.
1196     s 1043M(2)(b).
1197     The terms of the exception make no special provision for schemes with different classes. This may suggest that the test implies a withdrawal amount that will be the same for all interests in the scheme, whether or not they are in the same class. A possible contrary view of the current law is that the exception does not require that the withdrawal amount be calculated only ‘by reference to’ the stipulated asset value, to the exclusion of other relevant factors. On this view, the withdrawal amount could vary for different classes of interests, provided that the calculation of the withdrawal amount for each class is calculated by reference to the stipulated asset value. The exception should ensure that the withdrawal amount is appropriate for the particular interests being bought
back. This would be consistent with FSC Standard No. 9 Valuation of Scheme Assets and Liabilities (2006)
cl 9.1.2, which provides:
Where a Scheme allows for Investors with different classes of interest, the valuation of Scheme Assets and Liabilities must be fair to each class and in accordance with the Scheme’s Constituent Documents and the Corporations Act.
1198     See Section 1.1.2 of this paper.
1199     Sections 3.2 and 9.5.
1200     Sections 4.1 and 4.2.
1201     Section 5.6.1.
1202     Sections 6.2 and 6.3.
1203     Sections 7.4 and 12.4.
1204     Section 7.5.

Other matters

scheme meetings,1205 buy–backs,1206 disclosure,1207 reorganization of schemes,1208 winding up1209 and the application of the civil penalty regime to schemes.1210

CAMAC invites submissions on whether there are any other areas where alignment of company law and scheme law would be appropriate.

Question 15.4.1. Are there any areas not identified in the other sections of this paper where the law applicable to schemes should be, but is currently not, aligned with that applicable to companies?

1205     Sections 8.1-8.3, 8.5-8.7.
1206     Section 9.4.
1207     Section 10.4.4.
1208     Section 11.2.
1209     Section 12.1.
1210     Section 13.2.

Minor matters

16    Minor matters

This chapter discusses various definitions relevant to managed investment schemes. It also examines various administrative, procedural and enforcement issues.

16.1    Definition of ‘class of interests’ in a managed investment scheme

The issue

The Corporations Act definition of ‘class’ in relation to interests in a managed investment scheme does not specify what constitutes a ‘class’. This matter is determined by general law  principles.  Litigation  may  be  necessary  to  determine  the  application  of  those principles in particular instances.

Current position

The Corporations Act provides that:

If the interests in a managed investment scheme to which an undertaking relates are not divided into 2 or more classes, they constitute a class.1211

The Act provides no further detail on what might constitute a class of interests in a scheme. However, in the case of companies, the courts have applied the following principles:

•     a class ‘must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest’.1212  Another formulation is that a class of shares is ‘a category of shares which differs sufficiently in respect of rights, benefits, disabilities, or other incidents, as to make it distinguishable from any other category of shares’1213

•     members may be in the same class notwithstanding that they may have divergent commercial interests, which are strictly separate from their share membership.1214

In addition, the Administrative Appeals Tribunal has said:

The basis of classification might be as simple as a declaration in the constitution that shares can be issued in two classes, even though there is no practical difference between the two types of share.

1211     s 57(2). The equivalent provision for companies is s 57(1). The definition of ‘class’ in relation to shares or interests in a managed investment scheme in s 9 refers to this provision.
1212     Sovereign Life Assurance Company v Dodd [1892] 2 QB 573 at 583.
1213     Clements Marshall Consolidated Ltd v ENT Ltd (1988) 13 ACLR 90 at 93. See also Felix Resources Pty Ltd; in the matter of Felix Resources Pty Ltd (No 2) [2009] FCA 1337 at [12].
The Turnbull Report (Section 5.3.1) raised for further consideration and consultation a proposal that would, in effect, define a ‘class’ of members by amending s 601FC(1)(d) to require that members must be treated equally in relation to interests they have that confer substantially the same right to benefits produced by the scheme and the same obligations, and all members must be treated fairly: class differentiation would be based on the rights attached to an interest, rather than purely on a member’s characteristics.
1214     Felix Resources Pty Ltd; in the matter of Felix Resources Pty Ltd (No 2) [2009] FCA 1337 at [12].

Minor matters

companies should be permitted the widest possible freedom to structure their affairs to achieve an efficient and attractive capital structure. Managed investment schemes are in the same position.1215

Analysis and discussion

It can be important for various purposes to determine whether the interests in a managed investment scheme are divided into different classes. For instance, the RE of a registered scheme, in exercising its powers and carrying out its duties, must treat the members who hold interests of the same class equally and members who hold interests of different classes fairly.1216 Also, an offer by an RE to withdraw, wholly or partly, from a non-liquid scheme can be made to members of a particular class, rather than to all members of a scheme.1217

The potential for litigation to invalidate actions that have been taken on the basis of an incorrect determination of the existence of, or the constitution of, classes poses a risk to commercial activity.

A possible approach would be for the Corporations Act to stipulate circumstances in which classes exist or do not exist. For instance, it might provide that interests would not constitute a different class merely because of a different rate of return or a different investment amount. This approach would leave the courts to develop and apply the general law principles for the determination of classes, but provide some certainty in the specified circumstances.

Another approach would be to give the court an express curative power to validate actions taken on the basis of a view of the class structure of a scheme that subsequently proves to be incorrect.1218

Question 16.1.1. Should the Corporations Act specify circumstances in which there are separate classes of interests in a managed investment scheme and, if so, what should those circumstances be?

Question 16.1.2. Should the Corporations Act specify circumstances that should not be taken to give rise to separate classes of interests in a managed investment scheme and, if so, what should those circumstances be?

Question 16.1.3. Should there be an express curative power for the court to review a decision that relied on an incorrect categorization of the classes of interests in the scheme and to validate any actions taken pursuant to that decision?

1215     Equitiloan Pty Ltd v Australian Securities and Investments Commission [2003] AATA 367 at [29].
1216     s 601FC(1)(d).
1217     s 601KB(2)(b).
1218     A similar curative power was recommended in the CAMAC report Members’ schemes of arrangement (2009) (Section 5.4.1).

Minor matters

16.2    Exception from the definition of ‘managed investment scheme’ for intra‐group schemes

The issue

There is an exception from the definition of ‘managed investment scheme’ for intra-group schemes involving only bodies corporate that are related to the promoter and to each other. The question is whether that exception should apply where other persons have an indirect interest in the scheme.

Current position

The definition of ‘managed investment scheme’ contains an exception for:

(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.

If the exception applies, the scheme need not be registered.

This exception for intra-group schemes adopted a recommendation in the ALRC/CASAC
report, which said:

Some schemes are designed simply to facilitate the operation of a group of companies as between themselves. Given the essentially private nature of such an arrangement and the fact that the ‘investors’ will all be within the same corporate group, the Review recommends that schemes where the only ‘investors’ are bodies corporate related to each other should not be regulated by the collective investment provisions of the Corporations Law.1219

Analysis and discussion

The Turnbull Report noted an argument by ASIC that ‘the intention of [the intra-group] exclusion is undermined if some person unrelated to the scheme promoter indirectly acquires an interest in the scheme’.1220

There are various situations in which parties may gain an indirect interest in an intra-group scheme. For instance, beneficiaries of a trust may gain this type of indirect interest where the trustee is a body corporate that is a member of the scheme and invests trust funds in the scheme. Those beneficiaries may be retail investors who would ordinarily have the protection of the managed investment provisions and the licensing regime in the Corporations Act.

The question is whether the rationale for the exception, namely that an intra-group scheme is essentially of a ‘private nature’, is invalidated if persons who are not related to the promoter or other scheme members have indirect interests in the scheme. The answer may depend on the type of indirect interest involved.

For instance, the potential for some level of indirect involvement in an intra-group scheme is inherent in the concept of a ‘related body corporate’,1221 which is the key element of the intra-group   exception,   and   the   related   concepts   of   ‘holding   company’1222     and

1219     para 3.20.
1220     Section 5.3.2.
1221     Definition of ‘body corporate’ in s 9, s 50.
1222     Definition of ‘holding company’ in s 9, s 46.

Minor matters

‘subsidiary’.1223    For   instance,   Company A   is   the   ‘subsidiary’   of   Company B   if
Company B:

•     ‘is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting’ of Company A,1224 or

•    ‘holds more than one-half of the issued share capital’ of Company A,1225 or

•     ‘controls the composition’ of Company A’s board1226  (such control can be achieved without 100% control of a company’s shares).

The possible presence of minority shareholders of related bodies corporate who have chosen  to  be  active  investors  in  a  risk-taking  enterprise  is  an  inherent  part  of  the intra-group exception.

However, if the related body corporate is a trustee, it may be undesirable to expose beneficiaries of the trust or retail clients who acquire an interest under a custodial arrangement to any risks involved in the activities of an unregistered (and hence largely unregulated) scheme.

If some amendment to the exception were thought necessary, one possibility, raised for further consideration by the Turnbull Report,1227 might be to add words to the following effect at the end of the exception:

and no members:

–    hold an interest on trust except where the only beneficiaries are such bodies corporate: or

–    have acquired their interest as an acquirer under a custodial arrangement as defined in section 1012IA.1228

Question 16.2.1.  Should  the  exception  from  the  definition  of  ‘managed  investment scheme’ for intra-group schemes be amended and, if so, in what way? Please provide reasons for favouring or not favouring an amendment to this exception and for any amendment proposed.

16.3        Application of the definition of ‘securities’ to interests in schemes

The issue

The Corporations Act contains different definitions of ‘securities’ for different purposes. The extent to which these definitions cover interests in managed investment schemes varies  from  definition to  definition. The  definition that  applies to  reporting the  link between remuneration and performance may not be the most appropriate one.

1223     Definition of ‘subsidiary’ in s 9, s 46.
1224     s 46(a)(ii).
1225     s 46(a)(iii).
1226     s 46(a)(i).
1227     Section 5.3.2.
1228     Section 10.4.4 of this paper discusses what is involved in a custodial arrangement as defined in s 1012IA.

Minor matters

Current position

The annual directors’ reports of listed companies must give an explanation if a grant of securities that constitutes an element of the remuneration of a member of the company’s key management personnel does not depend on the satisfaction of a performance condition.1229 The definition of ‘securities’ that applies to this requirement1230 covers interests in a managed investment scheme (primary interests), but does not the following types of secondary interests in schemes:

•    legal or equitable rights or interests in those interests

•    options to acquire those interests

•     options to acquire legal or equitable rights or interests in those interests. These secondary interests are covered by other definitions of ‘securities’.
The various definitions of securities, and the extent to which they apply to primary and secondary interests in managed investment schemes, are set out in Appendix 2 to this paper.

Analysis and discussion

It is not clear why the requirement for the annual report of a listed company to explain the link  between  remuneration  and  performance  does  not  cover  the  grant  of  secondary interests as well as primary interests in managed investment schemes.

Question 16.3.1. Should the requirement for the annual report of a listed company to explain a grant of primary interests in managed investment schemes that does not depend on performance also apply to secondary interests in a scheme?

Question 16.3.2.  Are  there  any  other  regulatory  provisions  in  the  Corporations  Act relating to ‘securities’ that should, but currently do not, apply to primary and/or secondary interests in managed investment schemes?

16.4   Definition of ‘client’

The issue

The financial services provisions in Chapter 7 of the Corporations Act provide various protections for ‘clients’. However, it is not clear who is a ‘client’ in the context of a managed investment scheme.

Current position

There are numerous references to  ‘clients’, particularly retail clients, in the financial services provisions in Parts 7.6 to 7.8 of the Corporations Act, for instance in relation to

1229     s 300A(1)(d). See also s 300A(1)(ba)(iv)(B).
1230     s 92(2).

Minor matters

dispute resolution procedures for retail clients,1231  compensation arrangements for retail clients1232 and Product Disclosure Statements1233 for those clients.

The legislation contains provisions that set out the criteria for determining whether a person is a ‘retail client’ or a ‘wholesale client’.1234 However, it does not define the term
‘client’.1235

Analysis and discussion

The absence of a definition of ‘client’ in the Corporations Act gives rise to uncertainty about who is a ‘client’ and therefore entitled to the investor protections in Chapter 7 of the Corporations Act, including access to compensation arrangements or Product Disclosure Statements. Scheme members can only take advantage of those provisions if they are
‘clients’.

While this lack of certainty about who is a ‘client’ arises in relation to financial products generally, for some products, the legislation contains contextual information that makes it clear who is a ‘client’.1236 However, there is no contextual information that would assist in determining who is a ‘client’ in relation to a managed investment scheme.

It would be beneficial for the legislation to make clear that the term ‘client’ includes members of a managed investment scheme, to ensure that they have access to the investor remedies in Chapter 7 of the Corporations Act. This might be achieved by a provision directed solely at clarifying the position in relation to scheme members or, alternatively, by a broader definition of the term ‘client’ in relation to financial products generally (for instance, that a client is a person to whom a financial product has been issued or sold or to whom advice has been given about a financial product).

Question 16.4.1. Should the Corporations Act make it clear that a member of a managed investment scheme is a ‘client’ for the purposes of the financial services provisions in Chapter 7 of the Act and, if so, how? In particular, should any clarification relate only to scheme members or be a broader definition of ‘client’ in relation to financial products generally?

16.5   Definition of ‘rights issue’

The issues

The Corporations Act definition of ‘rights issue’ may unduly disadvantage holders of interests in managed investment schemes who are resident outside Australia and New Zealand.

1231     s 912A(1)(g), (2).
1232     s 912B.
1233     Part 7.9.
1234     ss 761G, 761GA.
1235     The definition of ‘client’ that appeared in the Corporations Act before the enactment of the Financial Services Reform Act 2001 related to futures brokers. The FSRA replaced the futures industry provisions of the Corporations Act with the current Chapter 7, which regulates financial services and markets.
1236     For instance, the references to ‘client’ in the provision describing when financial products are issued (s 761E) make it clear that the term covers a contributor, or the employee of a contributor, to a superannuation fund, a depositor into a retirement savings account, a contributor to a First Home Saver Account, a purchaser of life insurance and a depositor with an authorised deposit–taking institution.

Minor matters

It also does not apply in the case of unregistered schemes, given that it depends on the existence of an RE.

Current position

The definition of ‘rights issue’ is used in determining whether there is an obligation to give a Product Disclosure Statement.

A ‘regulated person’ (for instance, an issuer of a financial product, a financial services licensee or an authorised representative of that licensee1237) may be relieved of the obligation to give a Product Disclosure Statement where quoted securities are being issued under a rights issue and certain other conditions are met.1238

Three criteria must be satisfied for an issue to come within the definition of a ‘rights issue’.

Two of the criteria are that:

•    the interests being offered for issue are in a particular class, and

•    the terms of each offer are the same.1239

The other criterion relates to the need to provide all holders of interests in the scheme with an equal opportunity to participate in the benefits of the rights issue to the greatest extent possible. It requires that a pro rata offer be made to each person. However, the RE of the scheme, in effect, has the power to modify this condition if the scheme has members whose registered addresses are not in Australia or New Zealand (‘non-residents’).1240 The criterion will be taken to be satisfied in relation to non-residents if the RE follows an alternative procedure. Under that procedure, the RE can:

•     decide that it is unreasonable to offer the interests for issue to non-residents, after taking into account:

–    the number of non-residents in the relevant place to whom offers would otherwise be made

–    the number and value of the interests that would otherwise be offered for issue

–    the cost of regulatory compliance in the relevant place

•     send details of the offer to each non-resident in that place and advise each non-resident in that place that the non-resident will not be offered the securities or interests

•    if the offer can be assigned:

–    appoint a nominee in Australia to sell the invitation or right that would otherwise have been offered to the non-resident and send the non-resident any net proceeds of sale

1237     Definition of ‘regulated person’ in s 1011B. Authorised representatives are covered by Part 7.6 Div 5.
1238     s 1012DAA. There is an equivalent exception relating to rights issues in the securities disclosure provisions
(s 708AA).
1239     s 9A(2)(a), (c).
1240     s 9A(2)(b).

Minor matters

–    advise each non-resident of the nominee’s appointment and obligations.1241

Analysis and discussion

The ‘rights issue’ exception from the obligation to give a PDS is generally intended to be available only where all interest holders have an equal opportunity to participate in the rights issue. However, the alternative procedure in the exception recognises that the laws in some jurisdictions outside Australia and New Zealand (overseas jurisdictions) may make  it  unreasonable to  require  compliance with  the  equal  opportunity condition in relation to non–resident investors, given the number of non-residents, and the number and value of interests, involved.

This allowance for the circumstances of non–resident investors may not operate properly where there are non-resident investors in more than one overseas jurisdiction.

For instance, a scheme may have non-resident investors in two overseas jurisdictions, for only one of which the specified conditions1242 are satisfied. It seems that the rights issue exception is available if the RE follows the alternative procedure for investors in both of those jurisdictions (even if would not be unreasonable to require that interest holders in one of those jurisdictions be given the same opportunity to participate in the rights issue as Australian and New Zealand residents), given that:

•    the alternative procedure is available whenever the stipulated conditions are satisfied

•    those conditions are expressed as relating to one particular place.

This problem is exacerbated if there are non–resident investors in numerous jurisdictions, only one of which satisfies the statutory prerequisites for the exception.

There is no apparent policy reason why non–resident investors in a particular overseas jurisdiction should not have the same opportunity as Australian and New Zealand residents to participate in a rights issue if the statutory prerequisites for the exception are not satisfied in relation to that jurisdiction.

The alternative procedure is also not satisfactory for unregistered schemes, as it requires the taking of certain steps by the RE and unregistered schemes do not have an RE. This difficulty would be avoided if all schemes were required to be registered, as discussed in Section 4.1 of this paper. Even if there is an exception from the registration requirement for small private schemes (as discussed under the heading Numerical test in Section 4.1), those small schemes may be unlikely to make rights issues and may therefore not need to use the rights issue exception from the disclosure requirements.

However, if significant categories of unregistered schemes remain, an amendment to the definition of ‘rights issue’ may be necessary, for instance by adding a reference, in the case of unregistered schemes, to ‘the holder of the office (by whatever name it is known), in relation to the managed investment scheme, that corresponds most closely to the office of responsible entity of a registered scheme’.1243

1241     s 9A(2)(b)(ii), (3).
1242     s 9A(3).
1243     cf s 1012D(8)(b).

Minor matters

Question 16.5.1. Should the definition of ‘rights issue’ be amended to protect the right of residents of a particular jurisdiction to participate in a rights issue unless it would be unreasonable to require that those residents have that right?

Question 16.5.2. Should the definition of ‘rights issue’ be amended to apply to rights issues in relation to unregistered schemes and, if so, how?

16.6    Application of the disclosing entity provisions to managed investment schemes

The issue

Is the 100 person test an appropriate criterion for determining whether a scheme should be a disclosing entity?

Current position

The Corporations Act contains the following definition of ‘disclosing entity’ in relation to a managed investment scheme:

If any interests in a managed investment scheme are ED securities, the undertaking to which the interests relate is a disclosing entity for the purposes of this Act.1244

Securities are only ED securities if they are categorized as such by a specific provision.1245
The following interests in registered managed investment schemes are ED securities:

•    those in a scheme that is listed on a financial market1246

•     those in a scheme where the managed investments are held by 100 or more people who hold them as a result of offers that required a Product Disclosure Statement (the
100 person test).1247

Analysis and discussion

The fact that a scheme has 100 persons as members is not necessarily a satisfactory test for determining whether the scheme should be a disclosing entity, given that the combined economic value of all the interests held by any particular number of persons may or may not be significant.

A monetary test would be a more reliable indicator of the economic significance of a scheme and whether it should be treated as a disclosing entity.

Question 16.6.1. Should the  100  person test  be  replaced with  a  test  that  contains a monetary criterion (for instance, that the scheme has members who acquired their interests as retail clients and involves more than $10 million in assets or satisfies a similar monetary criterion)?

1244     s 111AC(2).
1245     s 111AD.
1246     s 111AE(1A), definitions of ‘managed investment product’ in ss 9 and 761A, s 764A(1)(b).
1247     s 111AFA.

Minor matters

16.7   Failure to fulfil minimum subscription conditions

The issue

There are two separate requirements for the return of subscription money on failure to fulfil minimum subscription conditions. This may be unnecessary and confusing.

Current position

A Product Disclosure Statement (PDS) may state that a financial product to which the
Statement relates will not be issued or sold unless:

•    applications for a minimum number of financial products of that kind are received, or

•    a minimum amount is raised.

If the PDS makes such a statement, the stipulated condition must be fulfilled before the issue or a sale may take place (s 1016C).

If the condition is not fulfilled within four months after the date of the relevant PDS, s 1016E requires that the person who received the money either:

•    repay the applicant, or

•     give the applicant additional disclosures and one month to withdraw the application and be repaid.1248

The provision does not indicate when repayment must occur.

There is also a more general provision that could apply in this situation. Section 1017E regulates how money received for a financial product should be dealt with before the product is issued. One aspect of that provision is a requirement for an issuer or seller of financial products to return money paid to acquire the product if the issuer or seller does not, for whatever reason, issue or transfer the products immediately after receiving the money. In contrast with s 1016E, s 1017E provides a time within which money must be returned, being either ‘before the end of one month starting on the day on which the money was received’ or ‘if it is not reasonably practicable to do so before the end of that month—by the end of such longer period as is reasonable in the circumstances’.1249

Analysis and discussion

It would be in the interests of regulatory simplicity for the return of subscription money on failure to satisfy a condition to be dealt with solely under the provision designed for that purpose (s 1016E). However, it may contribute to greater certainty for that provision to stipulate a definite time within which subscription money must be returned.

Question 16.7.1. Should the return of application money on non-fulfilment of a condition be covered solely by s 1016E, which provides alternative approaches to the reimbursement of investors?

1248     s 1016E(1)(a)(ii), (2).
1249     s 1017E(4)(d), (e). For a discussion of s 1017E and the background to that provision, see Basis Capital Funds
Management Ltd v BT Portfolio Services Ltd [2008] NSWSC 766 at [106]-[133].

Minor matters

Question 16.7.2. If so, should s 1016E be amended to provide a time within which the money must be repaid?

16.8   Right of investors to avoid subscription contracts

The issue

The right of investors to void a contract to subscribe for interests in a scheme by written notice to the offeror can pose an ongoing risk to the operation of the scheme.

Current position

An investor who has obtained an interest in a managed investment scheme in response to an offer for subscription or an invitation to subscribe can void the contract of subscription by written notice to the offeror if:

•    the scheme should have been, but was not, registered, or

•     the person offering the interest did not comply with the Product Disclosure Statement requirements in Part 7.9 Div 2.1250

The initial effect of the notice is to suspend the contract.1251  Unless the offeror makes a successful application to the court to declare that the notice had no effect,1252 ‘the notice takes effect to void the contract’ after a stipulated period.1253 The court in one case took the quoted words to mean:

that the contract is void ab initio, with the consequence that the investor can recover what he paid for his investment. In other words, the parties to the contract are to be restored as far as may be possible to the position they were in before the contract was made.1254

The legislation does not stipulate a time period within which an investor must take any action to exercise this right.1255

Investors do not have an equivalent independent right in relation to interests acquired on a secondary market.1256

Analysis and discussion

The right of investors to void a contract of subscription raises several potential problems.

The right poses an ongoing risk to the operation of the scheme. An affected scheme remains at risk of having to return subscription money to investors for an indeterminate period, given that there is no legislative time limit for the exercise of the right. One

1250     s 601MB. A notice must identify the failure to comply with Part 7.9 Div 2 at the very least in general terms:
Almond Investors Ltd v Emanouel [2012] VSC 413 at [101].
1251     s 601MB(2).
1252     s 601MB(4)-(6).
1253     The period is 21 days unless the offeror challenges the notice in court, in which case the period is extended to allow for the challenge to be determined: s 601MB(3).
1254     In The Matter of York Street Mezzanine Pty Ltd (in liq) [2007] FCA 922 at [47].
1255     It is not clear whether the ability to void the contract is lost once the scheme interest has been issued.
1256     CCH Managed Investments Law and Practice (looseleaf) at ¶13-200.

Minor matters

possibility is for the legislation to stipulate a time limit. By way of comparison, a client must exercise his or her right to rescind an agreement for the provision of financial services that is entered into with a person who does not hold an Australian financial services licence ‘within a reasonable period after becoming aware of the facts entitling the client to give the notice’.1257

In addition, the right survives a change in the RE of a scheme. This may hamper attempts to restructure the affairs of the scheme. Any new RE, and its directors, should be able to operate the scheme without the risk of investors in the scheme voiding their contracts of subscription.

Also, where the right relates to a defective Product Disclosure Statement:

•     it remains regardless of any attempt to rectify the defect in the PDS that gave rise to the right, and

•    it may relate to only a minor defect in the PDS.

On one view, the right of investors to avoid subscription contracts where the PDS was defective is unnecessary, given that investors have specific remedies where they have acquired a financial product relying on a defective PDS.1258

A possible alternative to the right to void a contract for subscription may be a right to claim compensation for loss from parties that were involved when the original breach was committed, for instance:

•    the promoter of the scheme

•    the RE that was in office at the relevant time

•    the directors of that RE at the relevant time.

However, this approach may leave an investor without an effective remedy if those parties do not have assets to meet any claim.

The SLE Proposal may exacerbate, rather than resolve, the problems arising from the right of investors to void their contracts of subscription, as the MIS that was the legal entity that was involved at the time of the contravention would remain, regardless of any change in the RE.1259

Question 16.8.1. Should the right for investors to void a contract to subscribe for interests in a scheme be amended and, if so, how? For instance, should the right:
•     be excluded for non-compliance with a PDS

•     be replaced with a right for the investor to seek damages from specified parties who were involved in the original contravention
•     incorporate a clear time limit for its exercise and, if so, what should that time limit be?

1257     s 925A(2).
1258     s 1016F.
1259     The SLE Proposal is summarised in Section 1.1.1 of this paper.

Minor matters

16.9   Certificates of interests

The issue

The requirement for the RE of a registered scheme to issue certificates of interest may be obsolete.

Current position

The RE of a registered scheme must issue certificates of interests to persons who acquire interests in the scheme (whether by way of issue or transfer).1260

Analysis and discussion

It has become less common for physical certificates of interests to be issued. Scheme constitutions often contain a provision to the effect that certificates will not be issued. This raises the question whether the legislation should continue to require certificates of interests.

The key concern should be to be able to identify who has an interest in the scheme. This goal may be more appropriately achieved through a definitive register of scheme members (see Section 3.2 of this paper).

Question 16.9.1. Should the RE of a registered scheme be required to issue certificates of interests in the scheme to persons who acquire interests in the scheme?

16.10 Obligations to assist those having supervisory responsibilities

The issue

There are inconsistencies in the parties who are required to give assistance to ASIC, the auditor of the compliance plan and the compliance committee in relation to compliance.

Current position

Various parties have a statutory responsibility for checking on compliance with the managed investments supervisory framework, with various other parties having a responsibility for assisting those who have the responsibility for checking.

Minor matters

The table below sets out the respective parties and indicates where there are gaps.

Party to be assisted and

Party responsible for assisting

Officers of

Person other than agent

Member of

nature of that party’s
responsibility    RE
ASIC: check compliance with:
•     constitution

Officers of
the RE

Agent of
the RE

(Corp Reg
5C.2.01, but

agent of
the RE

engaged by the RE

compliance
committee

•     compliance plan
•     Corporations Act
(s 601FF(1))

Auditor of RE’s compliance


(s 601FF(2))


(s 601FF(2))

only in
relation to the    X    X
constitution and the
compliance plan)

√    √


(s 601JD(2))

with the scheme’s
compliance plan
(s 601HG(3))
Compliance committee:
•     monitor compliance with compliance plan and report to RE
•     report to RE on breach of Act or scheme


X
(s 601HG(6))

(Corp Reg
5C.4.02)

(Corp Reg    X    X
5C.4.02)

constitution
•     report to ASIC in the absence of RE action
•     regularly assess adequacy of compliance plan and recommend remedial action
(s 601JC)
Auditor of scheme’s


(Corp Reg
5C.5.01)


(Corp Reg
5C.5.01)


(Corp Reg
5C.5.01)

1261


(Corp Reg    X    X
5C.5.01)

financial statements    X

X (s 312)

X    X    X

Also, the stipulated provisions do not require persons who formerly occupied any of these positions to assist.

A comparison might be drawn with the voluntary administration provisions, under which each director has a duty to assist the administrator in relation to books of the company1262 and to attend on the administrator and give the administrator such information about the company’s business, property, affairs and financial circumstances as the administrator reasonably requires.1263 In addition, the directors collectively have an obligation to give to the administrator a statement about the company’s business, property, affairs and financial circumstances.1264

1261     While there are no relevant statutory requirements, ASIC requires that an agreement between an RE and any asset holder (such as a custodian) require the asset holder to provide all reasonable assistance to any auditor engaged to audit the financial statements of the scheme (Regulatory Guide 133 Managed investments and custodial or depository services: Holding assets at RG 133.91).
1262     s 438B(1).
1263     s 438B(3).
1264     s 438B(2).

Minor matters

Analysis and discussion

There have been various recommendations to remedy some of the inconsistencies in the current law.1265

There is no reason why any person involved in a scheme should not have an obligation to assist those who have been given supervisory responsibility in relation to compliance for a scheme.

Each of the persons identified in the above table should have an obligation to assist each of the parties identified as having supervisory responsibilities.

Question 16.10.1. What amendments, if any, should be made to the provisions imposing obligations to give assistance to ASIC, the auditor of the compliance plan and the compliance committee in relation to compliance?

16.11 Reporting breaches to ASIC

The issue

The periods within which the RE must comply with the various requirements for reporting breaches of the law to ASIC are not consistent.

Current position

The RE of a registered scheme has an obligation under the managed investment provisions to report to ASIC any breach of the Corporations Act that relates to the scheme and has had, or is likely to have, a materially adverse effect on the interests of members.1266 This is to be done ‘as soon as practicable after [the RE] becomes aware of the breach’.1267

The RE, as the holder of an Australian financial services licence, also has a separate obligation under the financial services licensing provisions to report breaches or likely breaches of specific financial services licensing obligations ‘as soon as practicable and in any case within 10 business days after becoming aware of the breach or likely breach’.1268

By way of comparison, the time periods for reporting offences and misconduct in the context of external administration are that:

•    a receiver or managing controller must report ‘as soon as practicable’1269

•    a liquidator must report ‘as soon as practicable, and in any event within 6 months’.1270

Also, the reporting obligations of external administrators apply not just to the Corporations
Act, but to any law of the Commonwealth, a State or a Territory.1271

1265     The Turnbull Report (Section 5.2.8) recommended that the requirement to assist the auditor of the compliance plan and the compliance committee should be extended to include persons other than agents of the RE. The ASIC submission at Stage 1 of the CAMAC review proposed that the obligation to assist ASIC in conducting a check be extended to agents and other persons engaged to perform an RE’s functions.
1266     s 601FC(1)(l).
1267     ibid.
1268     s 912D(1), (1B).
1269     s 422.

Minor matters

Analysis and discussion

It would be desirable to have a uniform test for the period within which reports of breaches of the law (including licence conditions) should be made to ASIC, and the extent of the reporting obligation, unless there is good reason for a different time to be specified in a particular instance.

Question 16.11.1. What is the appropriate period within which the RE should report breaches of the law (including breaches of licence conditions) to ASIC?

Question 16.11.2.  Should  the  RE’s  reporting  obligation  extend  to  any  law  of  the
Commonwealth, a State or a Territory?

1271     For  receivers,  see  s 422,  definition  in  s 9  of  ‘offence’  (‘offence  means  an  offence  against  a  law  of  the Commonwealth or a State or Territory’); for administrators, see s 438D, definition in s 9 of ‘offence’; for liquidators, see s 533.

Appendix 1

Appendix 1    Criteria for determining whether a scheme
should be registered

Overview

A managed investment scheme must be registered if:

•    it (by itself or together with other closely related schemes as determined by ASIC)
involves more than 20 investors (the numerical test),1272 and/or

•     it was promoted by a person, or an associate of a person, who was in the business of promoting managed investment schemes at the time the scheme was promoted (the professional promoter test).1273

A scheme that satisfies either or both of these tests is nevertheless exempt from the requirement to be registered if none of the issues of interests in the scheme would have activated the Product Disclosure Statement (PDS) requirements in Division 2 of Part 7.9 of the Corporations Act1274 (the disclosure test).

The professional promoter test and the disclosure test are discussed in more detail below.

The professional promoter test

A scheme that does not satisfy the numerical test for registration may nevertheless have to be registered if it satisfies the professional promoter test.

The application of the professional promoter test requires two steps:

•    the determination of who is promoting the scheme

•     the determination of whether that person, or an associate of that person, was in the business of promoting managed investment schemes at the time the scheme was promoted.

The legislation provides no guidance on either of these matters. However, there has been some judicial guidance.

When does a person ‘promote’ a scheme

Judicial comments relating to the meaning of promotion of a scheme include:

1272     s 601ED(1)(a), (c), (3).
1273     s 601ED(1)(b).
1274     s 601ED(2), Corp Reg 5C.11.05A.

Appendix 1

•     the term ‘promoter’ has no very definite meaning1275  and sums up ‘a number of business  operations  familiar  to  the  commercial  world  by  which  a  company  [or scheme] is generally brought into existence’1276

•     ‘promoted’ ‘plainly extends to activities in which a person formulates a scheme …, advertises    it,   solicits   others   to   participate   in   it   and   embarks   upon   its implementation’1277

•     ‘promoter’ means a person who ‘engaged in exertion for the purpose of getting up and starting’ a scheme and a person who assists.1278

What constitutes the ‘business of promoting managed investment schemes’

Judicial  comments  on  the  meaning  of  ‘business  of  promoting  managed  investment schemes’ include:

•     the  business  must  involve  the  promotion  of  more  than  one  scheme,  though  the
‘promotion of a single project’ may satisfy the test ‘if that undertaking is the first in a business of promoting similar undertakings’1279

•     there is a business of promoting managed investment schemes where the aim of the business is to seek out investment opportunities, offer them to members, elicit subscriptions and manage the investments on behalf of the participating members, with these activities being done for profit1280 (it follows that the person who carries out these activities is a promoter)

•     there is a ‘business of promoting managed investment schemes’ where the relevant persons undertake the schemes ‘in the course of business activities with a view to profit and … having in mind the undertaking of other such schemes’1281

•     a person may be ‘in the business of promoting’ schemes even if the relevant schemes constitute only a small part of the person’s business activities, as a person may carry on or be involved in more than one business at any given time.1282

1275     ASIC v Young [2003] QSC 29 at [50], which refers to a line of authority that includes Tracy v Mandalay Pty Ltd (1953) 88 CLR 215 at 241-242, Emma Silver Mining Co Ltd v Lewis & Son (1879) 4 CPD 396, Twycross v Grant (1877) 2 CPD 469.
1276     ASIC v Young [2003] QSC 29 at [51], citing Whaley Bridge Calico Printing Co v Green (1880) 5 QBD 109 at
111.
1277     ASIC v Young [2003] QSC 29 at [53]. See also ASIC v Primelife Corporation Ltd [2005] FCA 1229.
1278     ASC v Woods and Johnson Developments Pty Ltd (1991) 9 ACLC 1,492 at 1,495, following Tracy v Mandalay
Pty Ltd (1953) 88 CLR 215. See also ASIC v Young [2003] QSC 29 at [50].
1279     ASC  v  Woods  and  Johnson  Developments  Pty  Ltd  (1991)  9  ACLC  1,492  at  1,494,  1,496.  The  rule  of interpretation that the plural includes the singular (Acts Interpretation Act 1901 s 23(b)) is excluded by the context in which the word ‘schemes’ is used (at 1,494).
1280     ASIC v Chase Capital Management Pty Ltd [2001] WASC 27 at [61].
1281     ASIC v Young [2003] QSC 29 at [54]-[55].
1282     ASIC v Young [2003] QSC 29 at [55].

Appendix 1

The disclosure test

The elements of the test

The disclosure test applies where none of the issues of interests in the scheme would have activated the Product Disclosure Statement (PDS) requirements in Division 2 of Part 7.9 of the Corporations Act.1283

When a decision is being made about whether the PDS requirements would have applied to issues of interests, two assumptions must be made:

•    that the scheme had been registered when the issues were made1284

•     that the Product Disclosure Statement provisions applied to interests in the scheme when the need for registration was being assessed.1285

There are two aspects of the disclosure test that warrant further analysis:

•    the test is activated, and hence the scheme is exempt from registration, where no PDS
is required for issues of interests, even if a PDS is required for sales of interests

•     there are various situations in which a PDS is not required and which therefore satisfy the disclosure test.

Application to issues of interests only

Obligations to give a PDS arise in certain circumstances relating to giving advice about financial products1286 or the issue1287 or sale1288 of financial products, as well as in relation to certain acquisitions under a custodial arrangement.1289

However, the disclosure test refers only to issues of interests in a scheme. In particular, it does not refer to sales of interests,1290 even though there are PDS requirements for certain sales, or sale offers, that amount to an indirect issue,1291 namely where:

•     the sale is made off-market by a seller who controls1292 the issuer (an off-market sale by a controller),1293 or

1283     s 601ED(2), Corp Reg 5C.11.05A.
1284     This is part of s 601ED(2) itself.
1285     This is pursuant to Corp Reg 5C.11.05A, which modifies s 601ED(2).
1286     s 1012A.
1287     s 1012B.
1288     s 1012C.
1289     s 1012IA. There is also a PDS requirement in relation to the provision of superannuation products. An issuer who is to provide superannuation products to the employees of an employer-sponsor of a superannuation entity
must  give  the  employer-sponsor  a  Product  Disclosure  Statement  for  each  of  the  superannuation  products
(s 1012I).
1290     Sales of interests may be covered by the disclosure test if the broader meaning of ‘issue’ in the definition in s 9 is taken to apply to Part 7.9 and is taken to cover sales made under an arrangement with the promoter. However, such an interpretation of ‘issue’ is speculative at best.
1291     s 1012C. This PDS requirement applies to offers to sell a financial product to a retail client (s 1012C(3)) and offers by a retail client to acquire a financial product (s 1012C(4)). Paragraph (b) of the definition of ‘regulated person’ in s 1011B covers a seller of a financial product in certain circumstances.
1292     As defined in s 50AA.

Appendix 1

•     the sale amounts to an indirect issue of the financial product (a sale amounting to an indirect issue),1294 or

•    the sale amounts to an indirect off-market sale by a person who controls1295 the issuer
(a sale amounting to an indirect off-market sale by a controller).1296

These PDS sale requirements were included to prevent avoidance of the requirement for a PDS for the issue of scheme interests.1297  Given that the disclosure test fails to mention sales, a scheme is exempt from the requirement to be registered if no issues of interests in the scheme would require a PDS, even if sales of interests in the scheme would require a PDS. This would be the case where wholesale investors in a scheme on-sell their interests to retail investors in circumstances amounting to an indirect issue (that is, through an off-market sale by a controller, a sale amounting to an indirect issue or a sale amounting to an indirect off-market sale by a controller).

Circumstances in which a PDS is not required

A PDS is not required where all the issues of interests in the scheme are to wholesale clients1298  (unless a wholesale client acquires an interest pursuant to an instruction given by a retail client under a custodial arrangement1299). The disclosure test therefore has the effect that wholesale-only schemes are exempt from the requirement to be registered.1300

There are, however, other reasons why a PDS may not be required for issues of interests in a scheme (with the secondary consequence, under the disclosure test, that a scheme does not have to be registered).

1293     s 1012C(5). The sale may be made off-market either because the product cannot be traded on a licensed market or because the offer is not made in the ordinary course of trading on a licensed market (s 1012C(5)(b)). According to the Explanatory Memorandum to the Bill for the Corporate Law Economic Reform Program Act
1999 (at para 8.106): ‘A controller of a body will either have direct access to, or be in a position to obtain, the necessary information to prepare a disclosure document.’
1294     s 1012C(6). This occurs when the seller, to whom the financial product was originally issued, offers to sell the product to the retail client within 12 months after issue and the product was issued without a PDS and with the purpose (on the part of the issuer or the seller) of on-selling the product.
The  requisite  purpose  is  taken  to  exist  if  there  are  reasonable  grounds  for  reaching  this  conclusion (s 1012C(7)(a)). There is a rebuttable presumption that this is the case if the financial product or a financial product of the same kind issued at the same time is subsequently sold, or offered for sale, within 12 months after issue (s 1012C(7)(b)).
1295     As defined in s 50AA.
1296     s 1012C(8). This occurs when the seller, who acquired the financial product off-market from a person who controls the issuer (the controller), offers to sell the product to the retail client within 12 months after the
acquisition from the controller and the product was sold without a PDS and with the purpose (on the part of the controller or the seller) of on-selling the product.
The sale may be made off-market either because the product cannot be traded on a licensed market or because the offer is not made in the ordinary course of trading on a licensed market (s 1012C(8)(b)).
The  requisite  purpose  is  taken  to  exist  if  there  are  reasonable  grounds  for  reaching  this  conclusion (s 1012C(9)(a)). There is a rebuttable presumption that this is the case if the financial product or a financial product of the same kind sold by the controller at the same time is subsequently sold, or offered for sale, within
12 months after issue (s 1012C(9)(b)).
1297     Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 paras 14.33-14.35.
1298     The PDS requirements for issues only apply in relation to issues, or issue offers, that involve retail clients: s 1012B.  See Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 paras 14.15, 14.69. In addition to issues of a financial product (s 1012B(3)(a)(iii)), the PDS requirement applies to   offers   to   issue   a   financial   product   (s 1012B(3)(a)(i))   and   offers   to   arrange   for   such   an   issue (s 1012B(3)(a)(ii)), as well as offers by a retail client to acquire a financial product by way of issue (rather than transfer) (s 1012B(4)(a)). Paragraph (a) of the definition of ‘regulated person’ in s 1011B covers an issuer of a financial product.
1299     s 1012IA.
1300   CCH Managed Investments Law and Practice (looseleaf) at ¶1-500 nominates the exemption of wholesale schemes as the purpose of s 601ED(2) (see also at ¶10-340).

Appendix 1

The PDS requirements do not apply if the issues constitute a small–scale offering (in essence, an offering that involves personal offers that result in no more than 20 persons purchasing interests and raise no more than $2 million in any 12 month period).1301 There is also a disclosure exemption for an issue or sale made to a person associated with the RE.1302  The small–scale offering exemption and the associated person exemption would cover small private schemes.

In addition, the PDS requirements do not apply to an issue where:1303

•    the client is not in Australia1304

•     the client has already received an up-to-date PDS.1305  For instance, clients who have received a PDS on receiving advice about interests in a proposed managed investment scheme need not be given another PDS when those interests are issued to them

•    the client is providing no consideration for the issue or sale of the interests1306

•     the issue or sale is made as part of a takeover bid and the offer of interests in the scheme is accompanied by a bidder’s statement.1307

1301     s 1012E. The complete criteria for a small–scale offering are:
•      the offers are personal offers (s 1012E(2): personal offer is defined in s 1012E(5))
•      all the financial products are issued by the same person (s 1012E(2)(a))
•     the total number of persons purchasing as a result of the offers does not exceed 20 in any 12 month period (s 1012E(2)(b); the criteria for determining whether there has been a breach of this condition are contained in s 1012E(6)(a), (7)(a), (8), (9))
•     the amount raised by the issuer as a result of the offers does not exceed $2 million in any 12 month period (s 1012E(2)(c); the criteria for determining whether there has been a breach of this condition are contained in s 1012E(6)(b), (7)(b), (8), (9), (10)).
The test was formerly based on 20 offers in 12 months. That test was replaced by the Corporate Law Economic Reform Program Act 1999, as it was regarded as ‘unduly restrictive and difficult to apply in practice’ (the Explanatory Memorandum to the Bill for that Act at para 8.46). That change was supported by the Financial System Inquiry Final Report (1997) (the Wallis report) at 278.
HAJ Ford,  RP Austin,  IM Ramsay,  Ford’s  Principles  of  Corporations  Law  (LexisNexis  Butterworths, looseleaf) at [22.130] states that ‘the justification for the exclusion seems to be the concept that a disclosure
document should not be required for a private offer, because the offeree can make inquiries of the offeror on a face-to-face basis and the cost of requiring a disclosure document is likely to be disproportionately high’.
1302     s 1012D(9A). The categories of associated person are a senior manager of the RE or of a related body corporate,
a spouse, parent, child, brother or sister of a person in that category or a body corporate controlled by a person in one of the first two categories (s 1012D(9B)). These provisions were included to ensure that this exemption, available for securities disclosure under Chapter 6D (s 708(12)), continued to apply to disclosure for managed investment products under Part 7.9 (Supplementary Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 paras 3.125-3.126).
1303     Other PDS exemptions would not flow through to the PDS-related exemption from registration, namely:
•     the client has, or has access to, up-to-date information through a PDS or ongoing information provided under s 1017B or s 1017D, as the client is already an investor in the scheme (s 1012D(2), (10)(b))
•     the  client  already  holds  interests  of  the  same  kind  and  the  circumstances  relate  to  a  distribution reinvestment plan or a switching facility (s 1012D(3))
•     the client is issued the interests under a rights issue (s 1012DAA) and will therefore already have received a PDS for the original interests.
1304     s 1012D(8A), as inserted by Corp Reg 7.9.07FB, enacted pursuant to s 1012G(1)(c). The regulation refers to the client not being in ‘this jurisdiction’. Section 9 defines ‘this jurisdiction’ as referring to the geographical area consisting of each of the States, the Australian Capital Territory, the Northern Territory and, in some circumstances, an external Territory.
1305     s 1012D(1).
1306     s 1012D(5).
1307     s 1012D(7).   HAJ Ford,   RP Austin,   IM Ramsay,   Ford’s   Principles   of   Corporations   Law   (LexisNexis
Butterworths, looseleaf) at [22.130.21] states, in relation to the equivalent securities disclosure exemption, that:

Appendix 1

History of the disclosure test

An exception along the lines of what is now the disclosure test has been in the managed investment provisions since they were first introduced in 1998. At all times, the key element of the test has been whether all the issues of interests in the scheme, when they were made, would have been exempt from the relevant disclosure obligations. However, the range of issues exempted from those disclosure obligations has grown over time.

In 1998, scheme interests were regulated as securities and the relevant categories of issues that did not require disclosure in a prospectus (excluded issues)1308 were:

•     issues to wholesale or professional investors (issues with a minimum subscription amount for each person of at least $500,0001309 or issues to an underwriter under an underwriting agreement1310)

•    small-scale  offerings  (issues  to   no   more  than   20   persons  in   the   preceding
12 months)1311 in relation to a registered scheme

•    issues to associated persons.1312

These exemptions were clearly focused on exempting from disclosure schemes that did not involve large numbers of retail investors. They provided a coherent basis for determining the content of the scheme registration exemption (though, as discussed in Section 4.1 of this paper, CAMAC questions whether there should be a registration exemption for wholesale-only schemes).

These original three disclosure exemption categories remained under the amendments made by the Corporate Law Economic Reform Program Act 1999,1313  in an expanded form in the case of the small-scale offerings exemption and the wholesale/professional investors exemption.1314 The CLERP amendments also introduced two additional exemptions from the prospectus disclosure requirements in relation to:

The policy underlying this exemption is that the disclosure requirements for a bidder’s statement are regulated by Ch 6, which grants special powers to ASIC and the Panel, and therefore there should not be an additional disclosure regime supervised by ASIC and the court under Ch 6D. Nevertheless, the disclosure requirements for a bidder’s statement import the basic requirements of Ch 6D in the case of a scrip bid: s 636(1)(g).
1308     Under the law as it stood when the managed investment provisions were introduced in 1998, the test in s 601ED(2) was whether the issues of interests in the scheme were ‘excluded issues’ of securities. ‘Excluded issues’ were not subject to the prospectus provisions (Corporations Law s 1017(a)).
1309     Corporations Law s 66(2)(a).
1310     Corporations Law s 66(2)(b).
1311     Corporations Law s 66(2)(d).
1312     Corporations Law s 66(2)(e). Certain issues of interests in a managed investment scheme made pursuant to a prospectus were also covered by the definition of ‘excluded issue’ (Corporations Law s 66(2)(m)).
1313     Corporations   Law   s 708(1)-(7)   (small-scale  offerings  exemption),  s 708(8)-(11)  (wholesale/professional investors exemption), s 708(12) (associated persons exemption).
1314     The small-scale offerings category gained a new criterion relating to the amount raised (no more than $2 million in the preceding 12 months), to operate in conjunction with the criterion relating to the number of investors
(issues to no more than 20 persons in the preceding 12 months) (Corporations Law s 708(1)-(7)).
A greater range of wholesale/professional investors was specified as not requiring disclosure, namely:
•     investors who have paid at least $500,000 for the issue and any previous issues (Corporations Law s 708(8)(a), (b), (9))
•     investors with net assets of at least $2.5 million or a gross annual income for each of the previous
2 financial years of at least $250,000, as certified by a qualified accountant (Corporations Law s 708(8)(c))
•     investors to whom an offer is made through a licensed dealer, who is satisfied that they have relevant experience in investing in securities (Corporations Law s 708(10))
•     brokers  and  advisers  who  are  either  licensed  or  exempt  from  licensing  and  are  acting  as  principal
(Corporations Law s 708(11)(a)-(b))

Appendix 1

•    issues and sales requiring no consideration,1315 and

•    offers made as part of a takeover bid and accompanied by a bidder’s statement.1316

These changes to the disclosure obligations had the effect of changing the scope of the disclosure test in the scheme registration requirement, though there is no evidence that the consequences for the scheme registration criteria were taken into account when the disclosure requirements were being amended.1317

With  the  enactment  of  the  Financial  Services  Reform  Act  2001,  the  prospectus requirements for the issue of interests in managed investment schemes were replaced with Product Disclosure Statement requirements (as discussed in Section 10.4.3 of this paper). The exemptions from the PDS requirements (as described above under Circumstances in which a PDS is not required) were substantially the same as the exemptions from the disclosure requirements under the CLERP amendments, with the following exceptions:

•     the wholesale exemption was achieved by making the PDS requirements applicable only where retail clients were involved1318

•     no PDS was required if the client had already received a PDS1319 (for instance, where the issue of interests in a scheme followed the giving of advice on those interests)

•     no PDS was required if the client already held interests of the same kind and the circumstances related to a distribution reinvestment plan or a switching facility.1320

As with the changes to the disclosure exemptions made by the CLERP amendments, there is no evidence that the consequences for the scheme registration criteria were taken into account when the disclosure requirements were being amended.

•     various registered or regulated bodies (Corporations Law s 708(11)(c)-(g))
•     persons who control at least $10 million for the purpose of investment in securities (Corporations Law s 708(11)(h)).
The exemption for issues to associated persons appeared in s 708(12) under the CLERP amendments.
1315     Corporations Law s 708(15). This exemption has been maintained for prospectuses in the Corporations Act s 708(15).  It  also  applies  to  the  Product  Disclosure  Statement  requirements  for  managed  investments: s 1012D(5). See Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 para 14.47.
1316     Corporations Law s 708(18). This exemption has been maintained for prospectuses in the Corporations Act s 708(18).  It  also  applies  to  the  Product  Disclosure  Statement  requirements  for  managed  investments:
s 1012D(7). See Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001
para 14.49.
1317     The Explanatory Memorandum to the Bill for the Corporate Law Economic Reform Program Act 1999 did not comment on the effect that the change in the disclosure exemptions might have on the exemption from registration.
1318     ss 1012B, 1012C.
1319     s 1012D(1). See Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001
paras 14.39-14.40.
1320     s 1012D(3).

Appendix 2

Appendix 2    Definitions of ‘securities’ and their
application to interests in schemes

The principal provision that defines ‘securities’ contains five definitions:1321

•     a definition that is used unless one of the other definitions applies1322  (the general definition)

•     a definition that applies when the term ‘securities’ is used in relation to a body (this definition includes ‘interests in a managed investment scheme made available by the body’)1323 (the definition in relation to a body)

•     a definition (the control and continuous disclosure definition) to be used in relation to:

–    takeovers (Chapters 6 and 6B of the Corporations Act)

–    compulsory acquisitions and buyouts (Chapters 6A and 6B)

–    ownership of companies and schemes (Chapter 6C), and
–    continuous disclosure (Chapter 6CA) and disclosing entities (Part 1.2A)1324

•     a definition to be used in relation to financial services and markets1325  (the financial markets definition)

•     a definition to be used in relation to fundraising1326 (the fundraising definition, which for the most part is the same as the financial markets definition1327).

These definitions vary in the extent to which they cover:

•     interests in schemes (‘primary interests’), and

•     ‘secondary interests’ in those schemes, being:

–    legal or equitable rights or interests in the primary interests

–    options to acquire the primary interests

–    options to acquire legal or equitable rights or interests in the primary interests.

1321     Section 9 of the Corporations Act states that ‘securities’ has the meaning given by Section 92. There is a further definition of ‘securities’ in s 1200A(1) for the purpose of Chapter 8, which covers mutual recognition of securities offers. Chapter 8 of the Corporations Act is discussed in Section 14.1 of this paper.
1322     s 92(1).
1323     s 92(2).
1324     s 92(3).
1325     ss 92(4), 761A. The Revised Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 stated (at para 6.75): ‘Although the defined term ‘security’ is in the singular, it is intended that references to the plural ‘securities’ in Chapter 7 are also to be taken to refer to this definition, rather than the definition of
‘securities’ in section 92.’
1326     ss 92(4), 700.
1327     The elements of the financial markets definition that are excluded from the fundraising definition are:
•     certain acquisition rights under a rights issue
•     a depository interest that can be transferred through a licensed clearing and settlement facility (a CGS
depositary interest): s 700(1), paragraphs (e) and (f) of the definition of ‘security’ in s 761A.

Appendix 2

Of the five definitions, only the control and continuous disclosure definition applies to all primary and secondary interests in schemes.1328

The financial markets definition applies to neither primary nor secondary interests in schemes. However, both types of scheme interests come within the legislative frameworks for financial markets and services, as they fall within the definition of ‘financial product’.1329

The  fundraising definition  also  does  not  apply  to  primary  or  secondary  interests  in schemes. Financial product disclosure for these interests is governed by Part 7.9 of the Corporations Act (financial product disclosure) (introduced by the Financial Services Reform Act 2001), rather than by Chapter 6D (fundraising).1330 The change in disclosure requirements for schemes from the prospectus requirements in Chapter 6D to the Product Disclosure Statement requirements in Part 7.9 is discussed in Section 10.4.1 of this paper.

Neither the general definition nor the definition in relation to a body covers secondary interests in schemes.1331

The table below summarises whether the various types of interest in a managed investment scheme come within each of the definitions of ‘securities’.

1328     It was considered ‘appropriate that the takeovers provisions continue to apply to managed investments’: Revised
Explanatory Memorandum to the Bill for the Financial Services Reform Act 2001 para 6.73.
1329     s 764A(1)(b).
1330     See paras 14.8-14.10, 20.43 of the Revised Explanatory Memorandum to the Bill for the Financial Services
Reform Act 2001.
1331     The general definition and the definition in relation to a body cover secondary interests through the concept of
‘unit’, rather than by including them directly, as in the other definitions. ‘Unit’ is defined in s 9 as follows: unit, in relation to a share, debenture or other interest, means a right or interest, whether legal or equitable, in the share, debenture or other interest, by whatever term called, and includes an option to acquire such a right or interest in the share, debenture or other interest.
However, notwithstanding the reference in this definition to ‘a share, debenture or other interest’, the relevant parts of the general definition (s 92(1)(d)) and the definition in relation to a body (s 92(2)(d)) refer only to
‘units’ of ‘shares’, not ‘units’ of ‘interests in managed investment schemes’ (or ‘units’ of ‘debentures’).

Appendix 2

Interest in a managed

Type of interest

Legal or equitable

Option to acquire legal or equitable

Definition

investment scheme (‘a managed investment interest’))

rights or interests in a managed investment interest

Option to acquire a managed investment interest

rights or interests in a managed investment interest

General definition    Yes [s 92(1)(c)]    No (as only ‘units’
of ‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

General: No (as only ‘units’ of
‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

No (as only ‘units’
of ‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

Definition in relation to a body

Yes [s 92(2)(c)]    No (as only ‘units’
of ‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

No (as only ‘units’
of ‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

No (as only ‘units’
of ‘shares’ are
‘securities’ under s 92(2)(d), not
‘units’ of any other types of securities)

Control and continuous disclosure definition

Financial markets definition

Fundraising definition [managed investment products, and interests in and options over them, are governed by the product disclosure requirements of
Pt 7.91332]

Yes [s 92(3)(c): registered schemes only]

No [an interest in a registered scheme is a separate category of
‘financial product’
in Chapter 7
(s 764A(1)(b)(i)), distinct from a
‘security’
(s 764A(1)(a)]

No [see above note in relation to the financial markets definition]

Yes [s 92(3)(d)(iii): registered schemes only]

No [a legal or equitable right or interest in an interest in a registered scheme is a separate category of
‘financial product’
in Chapter 7
(s 764A(1)(b)(ii) in combination with
s 764A(1)(b)(i)), distinct from a
‘security’
(s 764A(1)(a)]

No [see above note in relation to the financial markets definition]

Yes [s 92(3)(e) in combination with s 92(3)(c):
registered schemes only]
No [an option to acquire, by way of issue, an interest in a registered scheme is a separate category of
‘financial product’
in Chapter 7
(s 764A(1)(b)(iii) in combination with
s 764A(1)(b)(i)), distinct from a
‘security’
(s 764A(1)(a)]

No [see above note in relation to the financial markets definition]

Yes [s 92(3)(e) in combination with s 92(3)(d)(iii):
registered schemes only]
No [an option to acquire, by way of issue, a legal or equitable right or interest in an interest in a registered scheme is a separate category of
‘financial product’
in Chapter 7
(s 764A(1)(b)(iii) in combination with
s 764A(1)(b)(i), (ii)), distinct from a
‘security’
(s 764A(1)(a)]
No [see above note in relation to the financial markets definition]

1332     HAJ Ford,  RP Austin,  IM Ramsay,  Ford’s  Principles  of  Corporations  Law  (LexisNexis  Butterworths, looseleaf) at [22.090].

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