Source: https://www.oneinvestment.com.au/the-establishment-and-operation-of-managed-investment-schemes-page-2/
Timestamp: 2018-07-19 19:36:17
Document Index: 606383193

Matched Legal Cases: ['art 2', 'art 5', 'art 2', 'art 2', 'art 2', 'art 2', 'art 2', 'art 2', 'art 5', 'art 5', 'art 5', 'art 2', 'art 2', 'art 5']

The Operation of Managed Investment Schemes - Page 2 -
The Establishment and Operation of Managed Investment Schemes – Page 2
251 In addition to the obligations in the Corporations Act, a licensee must comply with any other obligations that are prescribed by regulations: s 912A(1)(j). One regulation has been enacted pursuant to this provision. It only applies to foreign entities that are not foreign companies: Corp Reg 7.6.03B.
252 s 912A(1)(a).
253 s 912A(1)(aa).
254 s 912A(1)(b). ASIC’s power to impose licence conditions is in s 914A.
255 s 912A(1)(c), (ca). ‘Financial services law’ is defined in s 761A and covers various provisions in the Corporations Act, including Chapter 5C, as well as Part 2 Div 2 of the ASIC Act and Commonwealth, State and Territory legislation relating to the provision of financial services.
256 s 912A(1)(d). From July 2015, APRA-regulated registrable superannuation entity licensees (RSEs) that manage non-superannuation registered managed investment schemes (dual-regulated entities) will be subject to the Corporations Act licensing requirement to have adequate resources: amended s 912A(1)(d) and new s 912A(4), introduced by the Superannuation Legislation Amendment (Service Providers and Other Governance Measures) Act 2013 Schedule 1 Items 4 and 6.
257 s 912A(1)(e).
258 s 912A(1)(f).
259 s 912A(1)(g), (2).
260 s 912B. These arrangements were the subject of the report Compensation arrangements for consumers of financial services: Report by Richard St. John (April 2012).
261 s 912D. In relation to the obligation to comply with the financial services laws in s 912A(1)(c), the reporting obligation only applies to the stipulated financial services laws in the Corporations Act and the ASIC Act: s 912D(1)(a)(ii). This limitation does not apply to the corresponding obligation to take reasonable steps to ensure that its representatives comply with the financial services laws (s 912A(1)(ca)). This appears to be an oversight.
262 s 912E.
Governance framework for schemes
licence of a registered scheme’s RE if the scheme’s members have suffered, or are likely to suffer, loss or damage because the RE has breached the Corporations Act.263
5.2.2 The constitution
Each scheme must have a constitution, which must make adequate provision for:
• the consideration that is to be paid to acquire an interest in the scheme
• the powers of the RE in relation to making investments of, or otherwise dealing with, scheme property
• the method for dealing with complaints made by members
• winding up the scheme.264
There are also certain rights or powers that must be included in a scheme’s constitution if they are to exist:
• the rights (if any) that the RE is to have to be paid fees out of scheme property, or to be indemnified out of scheme property for liabilities or expenses incurred in relation to the performance of its duties
• the powers (if any) that the RE is to have to borrow or raise money for the purposes of the scheme
• the right (if any) that members are to have to withdraw from the scheme and the procedures for dealing with withdrawal requests.265
Section 6.1 of this paper discusses whether there should be any additional rights or powers that must be included in a scheme’s constitution if they are to exist.
The constitution must be legally enforceable between the RE and the scheme members.266
The enforceability of the constitution is discussed in Section 6.2 of this paper.
The RE has a duty to ensure that the scheme’s constitution meets these requirements,267 as well as a duty to carry out or comply with any other duty lawfully conferred by the scheme’s constitution.268 Similarly, the RE’s officers have a duty to take reasonable steps to ensure that the RE complies with the scheme’s constitution.269
263 s 915B(3)(c). Other paragraphs of s 915B(3) enable ASIC to suspend or cancel an RE’s licence if the RE ceases to carry on business, becomes externally administered or applies for ASIC to suspend or cancel the licence. Other ASIC powers include a power to direct a licensee to provide a written statement about its financial services (s 912C).
264 s 601GA.
265 s 601GA(2)-(4). ASIC has stated that ‘it is not sufficient to merely state in the constitution that the key elements of the withdrawal procedures are set out in a separate document, such as a PDS’ (ASIC Regulatory Guide 134
Managed investments: Constitutions at RG 134.156). Similarly, an RE’s discretion to suspend the right to withdraw from a scheme should be set out in the scheme’s constitution, not in another document (RG 134.165).
266 s 601GB.
267 s 601FC(1)(f).
268 s 601FC(1)(m).
269 s 601FD(1)(f).
The RE can unilaterally amend the scheme constitution if the RE ‘reasonably considers the change will not adversely affect members’ rights’.270 Scheme members can also amend the constitution by special resolution.271 The procedure for amending the constitution is discussed in Section 6.3 of this paper.
A company, unlike a scheme, need not have a constitution.272 CAMAC’s general approach 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. There appears to be a rationale for schemes to have a constitution. A scheme constitution is necessary to establish the respective rights and powers of the various parties involved in the scheme. By contrast, a company has the legal capacity and powers of an individual273 (though if the company has a constitution, that constitution ‘may contain an express restriction on, or a prohibition of, the company’s exercise of any of its powers’274).
5.2.3 The compliance plan
Each registered scheme must have a compliance plan.275 The requirements for compliance plans are discussed in more detail in Section 5.3 of this paper. The RE has duties to ensure that scheme’s compliance plan meets those requirements276 and to comply with the compliance plan.277 Similarly, the RE’s officers have a duty to take reasonable steps to ensure that the RE complies with the Corporations Act, the licence conditions, the scheme’s constitution and the compliance plan.278
5.2.4 Meetings of scheme members
Another key aspect of the governance framework for schemes is the role of meetings of scheme members, particularly in replacing the RE of a scheme. The provisions governing the calling and conduct of meetings of scheme members are closely modelled on those applicable to companies.279 Issues relating to meetings of members are discussed in Chapter 8 of this paper.
5.2.5 Corporations Act requirements common to schemes and companies
Some governance requirements of the Corporations Act apply to registered schemes as well as to companies, for instance:
• the requirement to keep written financial records that correctly record and explain their transactions and financial position and performance and would enable true and fair financial statements to be prepared and audited280
• the requirement to prepare an annual financial report and directors’ report281
270 s 601GC(1)(b). The principles concerning the exercise of this power by the RE are set out in 360 Capital Re Ltd
(ACN 090 939 192) v Watts (as trustees for the Watts Family Superannuation Fund).
271 s 601GC(1)(a). See Re Elders Forestry Management Ltd [2012] VSC 287 at [72]-[74].
272 s 125.
273 s 124.
274 s 125.
275 Part 5C.4.
276 s 601FC(1)(g).
277 s 601FC(1)(h).
278 s 601FD(1)(f).
279 Part 2G.4. See Explanatory Memorandum to the Bill for the Company Law Review Act 1998 paras 10.4, 10.84.
280 s 286.
• the requirement to have the financial report for a financial year audited282
• the requirement to provide to members a financial report, a directors’ report and an auditor’s report or a concise version of those reports283
• the obligation to keep registers284
• the provisions relating to the inspection of books of the scheme.285
Also, companies and schemes that are disclosing entities have the same continuous disclosure obligations.286
As mentioned in Section 5.2.4, the provisions governing the calling and conduct of meetings of scheme members are closely modelled on those applicable to companies.287
Also, as discussed in Section 5.2.1, the duties applicable to an RE, its officers and its employees are analogous to those applicable to company officers and employees, but have been adapted to ensure that the beneficiaries of the duties are the scheme members.
5.2.6 Compliance requirements common to schemes and companies
Where a company has a statutory obligation, the duty of directors and other officers to exercise their powers and discharge their duties with care and diligence288 requires those officers to facilitate compliance with the statutory obligation.289 This principle would apply to the duty of care and diligence that officers of an RE have under the managed investment provisions (see the discussion in Section 5.2.1)290 as well as the equivalent duty under the directors’ duties provisions.291
The factors that the courts take into account in determining penalties for a contravention of the law also provide an incentive for the adoption of compliance systems. These factors, applicable whether the contravention involves a company or a scheme, include:
281 s 292(1). This requirement applies to registered schemes, as well as disclosing entities, public companies and large proprietary companies. The only unregistered schemes that are subject to this requirement are certain recognised New Zealand schemes that are disclosing entities (see Section 14.1 of this paper). The ALRC/CASAC report recommended that scheme operators be required to give investors in schemes for which they are responsible an annual audited report on scheme activities (para 5.25).
A scheme that is a disclosing entity must also prepare a half-year financial report and director’s report (s 302). The requirements for those reports are found in Part 2M.3 Div 2. The ALRC/CASAC report recommended (at para 5.31) that half-yearly reporting requirements apply to schemes.
ASIC Class Order [CO 13/1050] allows issuers of stapled securities to present consolidated or combined financial statements.
282 s 301 (see also Part 2M.1 Div 3 for audit and the auditor’s report). The auditor has a right of access to the scheme’s books and may make a reasonable request for any officer of the RE to give the auditor information, explanations or other assistance for the purposes of the audit or review (s 310). An officer of the RE has an obligation to allow access and give the information, explanation or other assistance requested (s 312). Those provisions refer to an officer of a registered scheme: however, that expression is taken to refer to an officer of the RE (s 285(3)). Provisions similar to ss 310 and 312 apply to controlled entities (ss 323A, 323B). For the concept of a ‘controlled entity’, see the definition of ‘control’ in s 9, s 50AA.
283 s 314. This requirement applies to registered schemes, as well as disclosing entities and companies. The only
unregistered schemes that are subject to this requirement are certain recognised New Zealand schemes that are disclosing entities (see Section 14.1 of this paper).
284 Part 2C.1.
285 Part 2F.3.
286 Chapter 6CA of the Corporations Act.
287 Part 2G.4.
288 s 180.
289 This principle was applied, for instance, in ASIC v Vines [2005] NSWSC 738 at [1182]-[1183] in relation to a company’s continuous disclosure obligation.
290 s 601FD.
291 s 180.
• the existence of compliance systems, including provisions for and evidence of education and internal enforcement of such systems
• remedial and disciplinary steps taken after a contravention and directed to implementing a compliance system or improving existing systems and disciplining officers responsible for the contravention.292
Furthermore, where a business conducted by a company (whether in its own right or as the RE of a scheme) is regulated by a law of the Commonwealth, the Criminal Code provides for the elements that are to be considered in proving a criminal offence against that law. Those elements encourage a focus on compliance. The Criminal Code provides:
If intention, knowledge or recklessness is a fault element in relation to a physical element of an offence, that fault element must be attributed to a body corporate that expressly, tacitly or impliedly authorised or permitted the commission of the offence.293
The means by which such an authorisation or permission may be established include:
• proving that a corporate culture existed within the body corporate that directed, encouraged, tolerated or led to non-compliance with the relevant provision; or
• proving that the body corporate failed to create and maintain a corporate culture that required compliance with the relevant provision.294
5.2.7 Exchange rules and guidelines
Listed schemes must comply with the listing rules of the relevant exchange. Those schemes listed on the ASX are also expected to implement best practice guidelines promulgated by the ASX Corporate Governance Council or explain why not (the ‘if not why not’ approach).295 These guidelines cover such matters as ethical and responsible decision making, integrity in financial reporting and timely and balanced disclosure, as well as risk management.
In August 2013, the ASX Corporate Governance Council released a consultation paper seeking comments on a proposed third edition of the guidelines. It is anticipated that the third edition will be published in the first half of 2014.296
5.2.8 General law rules
A scheme is also subject to the general law rules applicable to the legal structure of the particular scheme (trust, contractual, limited partnership). In addition, trust law principles apply (regardless of the overall legal structure of the scheme) in relation to the holding of
292 Australian Securities and Investments Commission, in the matter of Chemeq Limited (ACN 009 135 264) v Chemeq Limited [2006] FCA 936 at [99]. See also at [96], [112]. The Chemeq decision was applied in Australian Securities and Investments Commission v Macdonald (No 12) [2009] NSWSC 714 (see particularly at [395], [405]-[406]). See also R Baxt, ‘Company law and securities: The importance of a culture of compliance’ (2013) 41 Australian Business Law Review 106.
293 Section 12.3(1). The Criminal Code is in the Schedule to the Criminal Code Act 1995.
294 Criminal Code s 12.3(2)(c), (d).
295 ASX Corporate Governance Principles and Recommendations with 2010 Amendments (2nd edition) at 2. The Principles and Recommendations use the term ‘company’ to encompass any listed entity, including listed managed investment schemes (trusts) and references to ‘shareholders’ and ‘investors’ include references to unitholders of unit trusts where appropriate (see at p 7).
296 For the application of the third edition to listed managed investment schemes, see the consultation draft of the third edition at 33.
scheme property, given that the RE ‘holds scheme property on trust for scheme members’.297
5.2.9 Remedies
Members of a scheme may have civil remedies against the RE and its directors where the scheme has been mismanaged.298 They also have remedies at general law against the RE for breach of its common law duty of care, as well as remedies for breach of fiduciary duties against the RE and persons involved in the breach,299 which could include officers of the RE.300
An RE may seek remedies on behalf of scheme members in various circumstances, including where there has been a breach of trust by a former RE or its officers.301
ASIC has powers to take action against REs and persons involved for breaches of the statutory duties (discussed in Section 5.2.1 of this paper).302
5.3.1 The compliance plan
Each registered scheme must have a compliance plan, which, together with the scheme’s constitution, must be lodged with an application to register the scheme.303 The lodged copy of the compliance plan must be signed by all the directors of the RE.304
The compliance plan of a registered scheme must set out adequate measures that the RE must apply in operating the scheme to ensure compliance with the Corporations Act and the scheme’s constitution.305 Compliance with the Corporations Act includes compliance
297 s 601FC(2).
298 See, for instance, ss 601MA, 1324, 1325.
299 Under the principles in Barnes v Addy (1874) LR 9 Ch App 244.
300 For a discussion of members’ remedies, see CCH Managed Investments Law and Practice (looseleaf) at
¶75-200.
301 See, for instance, ss 1317J(2) and 1317H. An RE may also act under general law principles to protect the interests of scheme members, and in some circumstances may be under a duty to do so. For instance, in Young v Murphy (1994) 12 ACLC 558 at 562, the Court observed that:
The standing of a trustee to take proceedings to have a breach of trust redressed against a trustee or former trustee or a stranger who has become liable to redress a breach of trust is well recognised. Not only may a trustee take such proceedings, but he runs the risk of himself committing a breach of trust if he fails to do
See also Permanent Trustee Australia Ltd v Perpetual Trustee Co Ltd (1994) 15 ACSR 722. The RE’s power to recover is discussed in more detail in CCH Managed Investments Law and Practice (looseleaf) at
¶76-100-¶76-500.
302 ss 1324, 1325, a compensation order under ss 1317J(1), 1317H, ASIC Act s 50.
303 s 601EA(4)(b), Part 5C.4.
304 s 601HC.
305 s 601HA(1). It is also one of the duties of an RE as the holder of an Australian financial services licence to comply, and take reasonable steps to ensure that its representatives comply, with the financial services laws (s 912A(1)(c), (ca)). Furthermore, a licensee (other than one regulated by APRA) must have available adequate resources to carry out supervisory arrangements (s 912A(1)(d)). From July 2015, APRA-regulated registrable superannuation entity licensees (RSEs) that manage non-superannuation registered managed investment schemes (dual-regulated entities) will be subject to the Corporations Act licensing requirement to have adequate resources: amended s 912A(1)(d) and new s 912A(4), introduced by the Superannuation Legislation Amendment (Service Providers and Other Governance Measures) Act 2013 Schedule 1 Items 4 and 6.
with conditions that ASIC imposes on the RE’s licence306 and compliance with the compliance plan itself.307
The matters that the Corporations Act specifies for inclusion in the compliance plan are the arrangements for ensuring that:
• all scheme property is clearly identified as scheme property and held separately from property of the RE and property of any other scheme308
• the compliance committee (if one is required309) functions properly, including adequate arrangements relating to membership, frequency of meetings, reports to the RE and access to various sources of information310
• the scheme property is valued at appropriate regular intervals311
• compliance with the plan is audited312
• adequate records of the scheme’s operations are kept.313
The RE must ensure that the scheme’s compliance plan contains these arrangements as well as any other measures that are needed to ensure compliance with the Corporations Act.314
There is also provision for compliance plans to include any other matter prescribed by the regulations.315 There are no relevant regulations.
ASIC Regulatory Guide 132 Managed investments: Compliance plans (RG 132) sets out the following guidance on how to prepare a compliance plan for a managed investment scheme:
• REs should undertake a structured and systematic process that:
– considers their obligations under the Corporations Act and the scheme constitution, including the outcomes that those obligations are designed to deliver
– identifies the risks of non-compliance with each obligation posed by the operations of the scheme, given various relevant factors including the scheme’s nature, environment, size, members and asset types
– establishes measures designed to meet each of those risks, taking into account the likelihood and impact of failure to achieve the desired outcome of the relevant obligation316
306 s 912A(1)(b) (a duty of the RE as holder of an Australian financial services licence).
307 s 601FC(1)(h) (a duty of the RE). An officer of the RE of a registered scheme must take all reasonable steps to ensure that the RE complies with the scheme’s compliance plan (s 601FD(1)(f)(iv)).
308 s 601HA(1)(a). See also s 601FC(1)(i).
309 See s 601JA.
310 s 601HA(1)(b).
311 s 601HA(1)(c).
312 s 601HA(1)(d). See also s 601HG.
313 s 601HA(1)(e).
314 s 601FC(1)(g). The requirements are in s 601HA.
315 s 601HA(1)(f).
• the compliance plan should describe the key structures, systems and processes with sufficient detail to enable ASIC and the scheme auditor to assess whether the RE has complied, but without detailing every aspect317
• a compliance plan should be tailored to the individual scheme318
• compliance plans should be focused on protecting the interests of scheme members.319
At a minimum, compliance plans should ensure that:
– scheme property is held in a way that minimises the risk of loss by misappropriation or through insolvency of the RE320
– the interests of the RE or its related parties are not placed above the interests of the member321
– the RE and its officers and employees will not profit from improper use of information322
– there is adherence to the scheme’s investment policy323
– members are told all information necessary for them to make decisions about their holdings
– scheme members of the same class are treated equally and all scheme members are treated fairly324
– members do not suffer loss because the RE does not act, or its officers or employees do not act, with reasonable care and diligence or otherwise fail in their duties.325
These measures should be documented in the compliance plan.326 The compliance plan should also contain arrangements for the RE continuously to monitor, review and audit the outcomes of its compliance activities.327
There are also provisions in the Corporations Act and RG 132 for the compliance plan of one registered scheme to incorporate parts of the compliance plan of another registered scheme of the same RE.328
RG 132 does not provide a checklist of what should be in a compliance plan.329
316 RG 132.2, RG 132.10-RG 132.11.
317 RG 132.4, RG 132.7, RG 132.17-RG 132.19.
318 RG 132.6(a), RG 132.8.
319 RG 132.6(b), RG 132.12.
320 cf s 601FC(1)(i). RG 132 at p 9 gives as examples of what might be included in a compliance plan the controls that ensure that scheme assets are identified appropriately and separated from those of the RE and other
321 cf ss 601FC(1)(c), 601FD(1)(c).
322 cf ss 601FC(1)(e), 601FD(1)(d), 601FE(1)(a).
323 The role of investment guidelines in scheme governance is discussed in Section 5.7.
324 cf the duty of the RE in s 601FC(1)(d). This duty is discussed in Section 7.1 of this paper.
325 cf ss 601FC(1)(b), 601FD(1)(b).
326 RG 132.13, RG 132.15–RG 132.16.
327 RG 132.14.
328 s 601HB, RG 132.20-132.22.
329 RG 132.3.
In addition to RG 132, ASIC has issued regulatory guides containing commentary on compliance plans for particular types of schemes.330 Those regulatory guides include advice that better compliance plans:
• use plain language
• include an overview about the plan, its scope and aim and where it sits in the RE’s compliance and risk management framework
• contain clear information about relevant obligations, the risks of non-compliance with those obligations, procedures to meet the obligations, how those procedures are monitored and who is responsible for monitoring
• focus on the tasks that staff must perform, to enable them to find out easily who is responsible for a certain task, when or how often the task must be performed, how they can meet their obligations and how their work will be monitored
• state when reporting on compliance must take place, using specific dates or references to timeframes (for instance, ‘no less than monthly’)
• outline how breaches are reported, who is responsible for rectifying them and what action needs to be taken.
In addition, ASIC guidance on disclosure for particular types of scheme requires that the compliance plans for those schemes contain adequate procedures to ensure that REs comply with their initial and ongoing disclosure and advertising obligations.331
5.3.2 The compliance committee
Where less than half of the directors of the RE are external directors, the RE must establish a compliance committee to report on the RE’s compliance with the compliance plan.332
The functions of a scheme’s compliance committee are:
• to monitor the extent to which the RE complies with the compliance plan and to report on its findings to the RE
• to report to the RE any breach of the Corporations Act or the scheme’s constitution of which the committee becomes aware or that it suspects
• to report to ASIC if the committee is of the view that the RE has not taken, or does not propose to take, appropriate action to deal with a matter reported to it
330 Regulatory Guide 116 Commentary on compliance plans: Agricultural industry schemes, Regulatory Guide 117
Commentary on compliance plans: Financial asset schemes, Regulatory Guide 118 Commentary on compliance plans: Contributory mortgage schemes, Regulatory Guide 119 Commentary on compliance plans: Pooled mortgage schemes, Regulatory Guide 120 Commentary on compliance plans: Property schemes.
331 Regulatory Guide 45 Mortgage schemes: Improving disclosure for retail investors, particularly at RG 45.179-RG 45.180, Regulatory Guide 46 Unlisted property schemes: Improving disclosure for retail investors, particularly at RG 46.168.
332 Part 5C.5, in particular ss 601JA(1), 601JC.
• to assess at regular intervals whether the compliance plan is adequate, to report to the RE on the assessment and to make recommendations to the RE about any changes that it considers should be made to the plan.333
There are no legislative requirements concerning the experience, competence or qualifications required for a person to be a compliance committee member (though the compliance plan must include adequate arrangements relating to the membership of the compliance committee334).
There are requirements about the minimum number of members of a compliance committee,335 its overall composition,336 its functions,337 the duties of its members,338 the circumstances in which the RE can indemnify, and pay insurance premiums for, the members of the committee339 the keeping of minutes of meetings and records of recommendations and reports340 and disclosure of conflicts of interest.341
The compliance plan must include adequate arrangements relating to how often compliance committee meetings are to be held and the committee’s reports and recommendations to the RE.342 In other respects, compliance committees may regulate themselves and their proceedings as they consider appropriate (as long as they do so consistently with the compliance plan).343
A member of a scheme’s compliance committee has qualified privilege in respect of a statement concerning the operation of the scheme made by or on behalf of the committee, or a member of the committee, to the RE or to ASIC.344 This qualified privilege does not continue once a person ceases to be a member of a compliance committee.
ASIC has observed:
The compliance committee is intended to act as an intermediary between the operational compliance unit and board of directors in relation to compliance monitoring, assessment and reporting. Given ASIC’s finite resources, the compliance committee also plays an important role as ‘gatekeeper’.345
333 s 601JC. In carrying out its functions, the compliance committee may commission independent legal, accounting or other professional advice or assistance, at the reasonable expense of the RE (s 601JC(2)).
334 s 601HA(1)(b)(i).
335 s 601JB(1), (5)-(7).
336 s 601JB(1)-(4).
337 s 601JC.
338 s 601JD.
339 s 601JF-601JG.
340 s 601JH.
341 s 601JJ.
342 s 601HA(1)(b)(ii), (iii).
343 s 601JH(1).
344 s 601JE.
345 PJC Trio report, para 1.43. KPMG, in its submission to the PJC Trio inquiry, noted that the purpose of compliance committees is independently monitoring the area performing the primary compliance function of the RE and reporting on its functioning to the RE’s board. However, KPMG also observed that the independent operation of the committee may be compromised given that the RE has the responsibility for ensuring the proper functioning of the compliance committee and the committee meets only a few times a year (PJC Trio report, paras 5.17-5.18).
5.3.3 Audit of the compliance plan
Compliance with a scheme’s compliance plan must be audited each year.346 ASIC has said:
The purpose of requiring an audit of the compliance plan is to ensure the compliance plan is current at all times.347
Within three months after the end of a financial year of a scheme, the auditor of the scheme’s compliance plan must:
• examine the compliance plan
• carry out an audit of the RE’s compliance with the compliance plan during the financial year
• give the RE a report that states whether, in the auditor’s opinion:
– the RE complied with the scheme’s compliance plan, and
– the plan continues to meet the Corporations Act requirements.348
The compliance plan auditor must be a company auditor registered under the Corporations
Act.349 However, the auditor cannot be:
• an associate of the RE
• an agent holding scheme property on behalf of the RE or an associate of such an agent
• the auditor of the RE’s financial statements350
though the auditor of the compliance plan and the auditor of the RE’s financial statements may work for the same firm of auditors or audit company, as may the lead auditor or review auditor of the compliance plan (on the one hand) and the lead auditor or review auditor of the RE’s financial statements (on the other hand).351
In some instances, there may be an overlap between the financial services licensing requirements for REs (which may, in particular cases, specifically require an audit) and the auditing standards and compliance plans for the schemes that they manage. The proposal in the 2012 CAMAC report that each new scheme be operated only by a sole–function RE352 might reduce the potential for overlap between any audit of the RE and the audit of the scheme.
346 s 601HG(1).
347 PJC Trio report para 1.42.
348 s 601HG. Auditing and Assurance Standards Board GS 013 Special Considerations in the Audit of Compliance Plans of Managed Investment Schemes interprets this requirement as meaning that the plan continues to meet the Corporations Act requirements as at the end of the scheme’s financial year (para 22, footnote 4).
349 s 601HG(1).
350 s 601HG(2).
351 s 601HG(2A).
352 Section 1.6.1.
When a meeting of members is being held, the auditor of the compliance plan must be given written notice of the meeting and any other communications relating to the meeting that a scheme member is entitled to receive.353
The measures in the compliance plan should be set out with enough certainty to allow the auditor of the compliance plan (as well as ASIC) to assess whether the RE has complied with the compliance plan.354
Auditing and Assurance Standards Board guidance
Auditing and Assurance Standards Board GS 013 Special Considerations in the Audit of Compliance Plans of Managed Investment Schemes gives guidance for those planning, conducting and reporting on the audit of a scheme’s compliance plan,355 including the following:
• the terms of the compliance plan audit engagement with the RE may be outlined in an audit engagement letter356
• the audit engagement letter may also:
– outline arrangements for liaison with the RE’s compliance committee (if there is one), other compliance advisers and other auditors, including the auditor of the RE’s financial report and the auditor of the scheme’s financial report357
– clarify the respective roles of the RE’s directors and auditor358
Inherent limitations of auditing compliance with the compliance plan
• an audit opinion is expressed in terms of reasonable assurance, as it cannot constitute a guarantee that the compliance plan is completely free from any deficiency or that all compliance breaches have been detected359
• the auditor performs tests periodically throughout the financial year, as there are practical limitations in requiring an auditor to perform a continuous examination of the compliance plan360
Planning and conduct of the audit
• as compliance plans vary between different REs and their respective schemes, it will be necessary for the auditor to apply professional judgement when applying audit procedures and evaluating compliance plans and the design of compliance measures,
353 ss 252G, 252H.
354 RG 132.4. See also Auditing and Assurance Standards Board GS 013 Special Considerations in the Audit of
Compliance Plans of Managed Investment Schemes at para 12.
ASIC is consulting on various matters relating to the resignation, removal and replacement of auditors: Consultation Paper 209 Resignation, removal and replacement of auditors: Update to RG 26 (May 2013).
355 ASAE 3000 Assurance Engagements Other than Audits or Reviews of Historical Financial Information and
ASAE 3100 Compliance Engagements are also relevant to these audits.
356 para 18.
357 para 19.
358 para 20.
359 para 23.
360 para 24.
having regard to the size and complexity of the particular scheme under examination361
• the auditor considers materiality in the context of the RE’s compliance objectives when determining the nature, timing and extent of audit procedures and evaluating the effect of identified compliance plan breaches or weaknesses in compliance measures362
• the auditor considers the adequacy of the measures in the compliance plan, key responsibilities and risks, processes to implement the measures and processes established by the RE to monitor adherence to the compliance plan,363 as well as the scheme’s constitution, any conditions on the RE’s licence, any recent changes to the compliance plan, any changes to the operation of the scheme, any legislative changes and various auditors’ and other reports364
• the auditor is expected to report significant detected breaches that, either individually or collectively, the auditor judges to be material (based on qualitative as well as quantitative factors)365
• before issuing the auditor’s report on the compliance plan audit, the auditor seeks a written representation from the directors of the RE containing their assertions that the RE has complied with the scheme’s compliance plan during the financial year and that the plan continues to meet the requirements of Part 5C.4366
• the report is addressed to the scheme’s RE.367
The other major element of the internal monitoring framework derives from the fact that the RE of a managed investment scheme must have an Australian financial services licence. One of the licensee obligations is to have adequate risk management systems368 (unless the licensee is regulated by APRA,369 which also imposes risk management requirements370).
361 para 26.
362 paras 27-28. However, there is no express provision that permits an auditor to disregard immaterial non-compliance.
363 paras 31-32.
364 para 33.
365 paras 29-30. However, there is no express provision that permits an auditor to disregard immaterial non-compliance.
366 para 38.
367 para 39. Other matters are set out in paras 34-37. The report is also lodged with ASIC and is available for public inspection.
368 s 912A(1)(h). A person’s application to become a licensee must include information about the person’s arrangements for complying with the general licensee obligations (s 913A(a), Corp Reg 7.6.03(g)).
369 s 912A(1)(h). From July 2015, APRA-regulated registrable superannuation entity licensees (RSEs) that manage non-superannuation registered managed investment schemes (dual-regulated entities) will be subject to the risk management requirements of the Corporations Act licensing provisions for their non-superannuation activities: amended s 912A(1)(h) and new s 912A(5), introduced by the Superannuation Legislation Amendment (Service Providers and Other Governance Measures) Act 2013 Schedule 1 Items 5 and 6.
370 See APRA Prudential Practice Guide SPG 200 Risk Management (August 2010).
ASIC has provided guidance on what this risk management obligation requires, both generally for all AFS licensees and specifically for REs.
Regulatory Guide 104 Licensing: Meeting the general obligations (2007) (RG 104) provides general guidance on what ASIC looks for when assessing the general AFS licensee obligations, including the requirement to have adequate risk management systems.371 RG 104 states that ASIC expects that a licensee’s compliance measures will take into account the specific compliance risks of its business, especially those that may materially affect consumers or market integrity.372 The guide requires that a licensee’s risk management system:
• be based on a structured and systematic process that takes into account the licensee’s obligations under the Corporations Act
• identify and evaluate risks faced by its business, focusing on risks that adversely affect consumers or market integrity (this includes risks of non-compliance with the financial services laws)
• establish and maintain controls designed to manage or mitigate those risks
• fully implement and monitor those controls to ensure they are effective.373
It states that risk management systems will depend on the nature, scale and complexity of the licensee’s business and its risk profile.374
ASIC Report 298 Adequacy of risk management systems of responsible entities (September 2012) presents the results of a review, conducted in 2011-12, of how REs specifically managed financial, investment and liquidity risk. Key findings of that report included:
• some of the most sophisticated risk management systems (adopted by REs that were part of an APRA-related group) were based on a ‘three lines of defence’ risk management model focused on checks and balances for management, compliance and risk management, and independent audit
• the REs covered by the review generally appeared to demonstrate compliance with their obligation as AFS licensees to maintain adequate risk management systems, although improvements could be made, particularly for non–APRA regulated REs
• each of the selected REs had a unique risk management system that reflected the nature, scale and complexity of its financial services business
• a resource adequacy risk specific to small REs was that the skills and experience required by the RE were concentrated in one or two key people and/or that the RE may rely too much on compliance and risk management consultants to establish and monitor risk management systems
371 s 912A(1)(h).
372 RG 104.42.
373 RG 104.62. See also RG 104.47.
374 RG 104.63.
• the REs relied on disclosure of investment and liquidity risks, the responsibility for which they then regarded as being with the investors
• most of the selected REs conducted little or no stress testing and, where it was conducted, there were diverse approaches
• most of the selected REs indicated that their risk management system did not change as a result of the global financial crisis.
Subsequently, ASIC released Consultation Paper 204 Risk management systems of responsible entities (March 2013), which consulted on proposals for more targeted requirements for risk management systems of REs and draft guidance for complying with these requirements.
Most recently, ASIC’s Regulatory Guide 133 Managed investments and custodial or depository services: Holding assets gave some risk management guidance in relation to the holding of assets.375
Richard St. John report
A possible risk management system for schemes was raised in the report Compensation arrangements for consumers of financial services: Report by Richard St. John (April 2012):
One possibility would be to require responsible entities of managed investment schemes to have a risk management system that reflects the nature, scale and complexity of its business. The risk management system might also require independent scrutiny, such as an assessment by an auditor that the controls adequately safeguard investment assets held on a pooled basis and mitigate the risk of fraud. Licensees would be expected to include a process to monitor their risks on an ongoing basis and update their controls as required.376
The ASX Corporate Governance Principles and Recommendations with 2010
Amendments (2nd edition) are relevant for managed investment schemes listed on the ASX (see Section 5.2.7 of this paper).377 Principle 7 Recognise and manage risk states:
375 See RG 133.40 (risks associated with employee functions and measures to deal with fraud risks), RG 133.51 (pre-contract inquiries in relation to the RE’s clients) and RG 133.74 (the risks of the RE engaging another party to hold scheme assets).
376 para 3.55.
377 The Principles and Recommendations use the term ‘company’ to encompass any listed entity, including listed managed investment schemes (trusts) (see at p 7).
• Recommendation 7.4: Companies should provide the information indicated in the
Guide to reporting on Principle 7.
In August 2013, the ASX Corporate Governance Council released for comment a proposed third edition of the Corporate Governance Principles and Recommendations.378
The proposed revision of Principle 7 Recognise and manage risk states:
• Recommendation 7.1: The board of a listed entity should: (a) have a risk committee which:
(2) is chaired by an independent director, and disclose
(3) the charter of the committee;379
(b) include within the responsibilities of the audit committee the responsibilities normally undertaken by a risk committee;380 or
(c) if it does not have a risk committee (whether as a stand-alone committee or as part of the responsibilities of the audit committee), disclose that fact and the processes it employs for identifying, measuring, monitoring and managing the material business risks it faces.
378 For the application of the third edition to listed managed investment schemes, see the consultation draft of the third edition at 33.
379 The draft states (at 29) that the role of the risk committee, which would be set out in its charter, ‘is usually to review and make recommendations to the board in relation to:
• the adequacy of the entity’s processes for identifying, measuring, monitoring and managing the material business risks it faces;
• any incident involving fraud or other break down of the entity’s internal controls; and
• the entity’s insurance program, having regard to the entity’s business and the insurable risks associated with its business’.
The charter would also confer on the committee the powers necessary to perform its role, which would usually include ‘the right to obtain information, interview management and internal and external auditors (with or without management present), and seek advice from external consultants or specialists where the committee considers that necessary or appropriate’.
380 The draft states (at footnote 28): ‘If the responsibilities of the audit committee are expanded to cover the responsibilities that would normally be undertaken by a risk committee, it is generally a good idea to refer to the committee as the “audit and risk committee” so that investors understand the full extent of the role undertaken by the committee.’
• Recommendation 7.2: The board or a committee of the board should:
(a) review the entity’s risk management framework with management at least annually to satisfy itself that it continues to be sound, to determine whether there have been any changes in the material business risks the entity faces and to ensure that they remain within the risk appetite set by the board; and
(b) disclose in relation to each reporting period, whether such a review has taken place.
• Recommendation 7.3: A listed entity should disclose:
• Recommendation 7.4: A listed entity should disclose whether, and if so how, it has regard to economic, environmental and social sustainability risks.
There are international guidelines on risk management for schemes.
The International Organization of Securities Commissions (IOSCO) publication Methodology For Assessing Implementation of the IOSCO Objectives and Principles of Securities Regulation (2011) states that the regulatory standards for schemes should require a comprehensive risk management framework supported by an independent risk management function, appropriate to the size, complexity and profile of the scheme.381
IOSCO has also published principles of liquidity risk management for collective investment schemes.382
In addition, there is an international standard for risk management, which is not specific to the managed funds sector.383
Risk management standards for schemes might also draw on international standards applicable to companies. The OECD Principles for Corporate Governance (2004) require that companies have systems for risk management.384
Other jurisdictions have adopted risk management standards. For instance, the United
Kingdom Corporate Governance Code (2012) requires company boards to:
• determine the nature and extent of the significant risks they are willing to take in achieving their strategic objectives385
• maintain sound risk management and internal control systems386
381 This requirement relates to Principle 28, which relates to ensuring appropriate oversight. Principle 28 is one of a set of principles relating to collective investment schemes and hedge funds.
382 Final report, Principles of liquidity risk management for collective investment schemes (FR 03/13, March 2013).
383 ISO 31000:2009 Risk management: Principles and guidelines. This standard was based on an Australia/New Zealand initiative and was developed from AS/NZS 4360:2004. See also Risk management guidelines – Companion to AS/NZS ISO 31000:2009 (SA/SNZ HB 436:2013).
384 Principle VI.D.7.
385 Section C.2.
• at least annually conduct a review of the effectiveness of the company’s risk management and internal control systems and report to shareholders that they have done so.387
Also, guidance on risk management for investment companies has been introduced by the Monetary Authority of Singapore (MAS)388 and the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).389
5.5 Assessment of the current scheme governance framework
5.5.1 Comparison with the corporate governance framework
As discussed in Section 5.2.1, many of the duties of the RE and its officers and employees under the scheme provisions are analogous to those of officers and employees of a company under the general Corporations Act provisions (though the scheme duties of officers and employees of an RE390 take priority over their general duties). Also, as discussed above, the scheme governance and corporate governance frameworks have in common certain Corporations Act requirements (Section 5.2.5), certain factors favouring a culture of compliance (Section 5.2.6) and, in the case of schemes and companies listed on the ASX, the ASX Listing Rules and ASX Corporate Governance Council guidelines (Section 5.2.7).
However, some key investor protection features of corporate governance do not apply to schemes.
While scheme members can remove the RE of a scheme,391 they have no role in the appointment or replacement of the directors of the RE. By contrast, a company’s shareholders can appoint its directors by resolution in general meeting392 (unless the company’s constitution provides otherwise393). Similarly, company shareholders can remove a director (the constitution of a proprietary company can provide otherwise,394 but this right is always available to members of a public company395).
Scheme members also do not have access to the statutory derivative action procedure396 (under which they might be able to bring proceedings against defaulting officers of the RE on behalf of the RE where the RE itself was unwilling to take action), nor is the oppression remedy397 available to them.
In addition, a wide-ranging body of law (including case law) and practice that provides a well-established set of rules for corporate governance has developed over time. Industry
387 Code Provision C.2.1.
388 ‘MAS Implements Enhanced Regulatory Regime for Fund Management Companies’, MAS media release,
389 BaFin Circular 4/2010 (WA) Minimum requirements for the compliance function and additional requirements governing rules of conduct, organisation and transparency pursuant to sections 31 et seq. of the Securities
Trading Act (Wertpapierhandelsgesetz—WpHG) for Investment Services Enterprises (2011).
390 s 601FD.
391 s 601FM.
392 s 201G.
393 Section 201G is a replaceable rule. A replaceable rule can be displaced or modified by the company’s constitution (s 135(2)).
394 s 203C, which is a replaceable rule (see previous footnote).
395 s 203D.
396 Part 2F.1A.
397 Part 2F.1.
bodies run courses to promote awareness of corporate governance law and practice on the part of those who manage companies. Schemes (many of which are major businesses) are a discrete legislative structure, designed to be a passive investment vehicle, and do not have the same breadth of entrenched governance law and practice as is available for companies. It cannot be automatically assumed that the courts would apply corporate governance jurisprudence to scheme governance.
The absence of these corporate governance elements from the scheme governance framework raises the question whether some additional governance features for schemes, to provide investors in schemes with governance protection comparable to that for investors in companies, are required. Under the current regulatory framework, these additional features are provided by the scheme’s constitution,398 the compliance requirements (consisting of a compliance plan and either a majority of external directors of the RE or a compliance committee) and the risk management obligations of the RE (which encompass the risks faced by the schemes that it operates). In practice, a scheme may also have an investment manager and a custodian, though these roles are not required by the Corporations Act.
Sections 5.5.2 and 5.5.3 of this paper discuss the operation of the compliance and risk management elements of the current framework in practice, while Section 5.6 discusses possible options for reforming the current compliance/risk management structure.
5.5.2 Compliance
There has been a tendency for compliance plans to be cast in general terms, rather than designed to suit the circumstances of the particular schemes to which they relate. The measures stated in those plans are then supplemented by detailed compliance procedures and processes in separate manuals.
There are several possible reasons for this trend:
• the range of matters that the Corporations Act requires to be included in compliance plans399 is limited
• liability for breach of a compliance plan attaches to any contravention of the plan rather than just material contraventions (so that the fewer the number of specific requirements in the plan, the less opportunity there is for breaches that would attract liability)400
• many compliance risks and the measures that an RE will apply to deal with them apply to schemes generally or to all schemes of a particular kind.
This tendency to have general compliance plans is contrary to ASIC guidance, which advises that a compliance plan should be tailored to the individual scheme401 and contain sufficiently certain measures to allow ASIC and the auditor of the compliance plan to
398 A company may, but does not have to, have a constitution: its internal management may be governed by the replaceable rules in the Corporations Act (see s 135), by a constitution or by a combination of both (s 134). If a company has a constitution, the Corporations Act does not prescribe any matters that it must contain. By contrast, certain matters are prescribed for inclusion in a scheme constitution (see s 601GA and the discussion at Sections 5.2.2 and 6.1 of this paper).
399 s 601HA(1).
400 PJC Trio report paras 4.50, 5.19, 5.21.
401 RG 132.6(a).
assess whether the RE has complied with the compliance plan.402 Furthermore, reduced detail in the compliance plan may reduce the likelihood of an auditor identifying non-compliance with the compliance plan.
Given the general nature of many compliance plans, compliance plan audits, which are only required to ‘audit compliance with the scheme’s compliance plan’,403 are often similarly limited in nature. They are backward-looking in that they examine whether the past conduct of the scheme complied with relevant requirements (though the auditor must give an opinion on whether the plan continues to meet the statutory requirements404). They do not deal with the broader operation of a scheme’s business, including how it identifies and manages risk. Such a broader purpose would assist in conducting the scheme’s business and planning for the future and might form part of any risk management framework specifically for schemes (as opposed to risk management systems for the REs that operate them) (see Section 5.6).
An ASIC review of compliance plan audits for the 2011-12 financial year has also revealed other deficiencies in these audits. It found that, where certain functions are outsourced (for instance, custodial or investment administration or back-office accounting), compliance plan auditors often rely on the auditors of the service organizations in relation to:
• the design, implementation and/or effectiveness of operating controls
• specific assertions such as valuation and existence of investments.405
ASIC found that auditors of compliance plans did not always obtain sufficient and appropriate audit evidence on which to base their conclusions in areas such as:
• whether the compliance plan continued to meet the statutory requirements (Part 5C.4)
• the adequacy of procedures for reporting and assessing breaches of the compliance plan
• the assessment of whether the service organization auditor’s report could be relied on in relation to outsourced functions, risk assessments performed by the auditors, and the relationship to work performed on areas of the compliance plan audit
• the testing of specific areas, such as subsequent events up to the date of issuing the compliance plan audit report, calculations of net tangible assets (for the RE) and cash flow projections.406
5.5.3 Risk management
ASIC Report 298 Adequacy of risk management systems of responsible entities (September 2012) found that the REs that ASIC selected for review generally appeared to demonstrate compliance with their licensing obligation to maintain adequate risk
402 RG 132.4.
403 s 601HG(1).
404 s 601HG(3)(c).
405 ASIC Report 317 Audit inspection program report for 2011–12, para 56.
406 id at para 57.
management systems.407 However, the report identified various inadequacies in the risk management systems of the selected REs, including:408
• the risk management systems did not change in response to significant events that affected the risk profile of the relevant scheme, such as the global financial crisis
• small REs had the following specific resource adequacy risks:
– concentration of the skills and experience required by the RE to successfully run a financial services business in one or two people who are crucial to its operation or have dominance in its culture (key person risk)
– overreliance on external compliance and risk management consultants, who are not closely linked to the organization, to establish and monitor risk management systems
• little or no stress testing by most of the selected REs that are not part of an APRA-regulated group. Where stress testing practices are adopted, there appears to be a diversity of approach, which may be explained by the nature, scale and complexity of an RE’s business.
The report also identified the following areas that may require further attention from some of the selected REs:
• the extent to which risk management systems are embedded in strategic and business planning, as well as day-to-day operations
• risk identification, assessment and management (particularly where the approach taken to these involves electronic systems designed and tested by external compliance and risk management consultants without consideration by the board of the RE or an independent risk or compliance committee)
• treatment of residual risk (the remaining risk after the exercise of risk controls)
• the impact of the global financial crisis on risk management systems.409
Any risk management framework specifically for schemes (see Section 5.6) might take into account the matters raised in ASIC Report 298.
5.6 Reform options
Extension of the corporate governance framework to schemes
CAMAC’s general approach 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.
407 Table 2 at p 15.
408 Table 1 at pp 5-6.
409 paras 33-56.
One way of applying that approach in the governance context would be to extend to schemes some of the features of the corporate governance framework that do not currently apply to schemes. For instance, the categories of those having standing to bring an action for oppression410 or to initiate a statutory derivative action411 could be extended to include, where the company is an RE, members of a registered scheme that the RE operates.
However, it would not be desirable to replicate the control that shareholders have over the personnel who manage the company in the context of schemes. It would be inappropriate to give scheme members the power to vote on the appointment or removal of the directors of the RE. An RE is a company with its own shareholders, who should not have their votes diluted by persons who are external to the company. Those external persons could be numerous if the RE operates a large scheme or a large number of schemes.
Also, it is not possible simply to apply to schemes the considerable body of corporate governance law and practice that has developed over a lengthy period of time (see Section 5.5.1). While the regulatory regimes for schemes and companies have certain common features (as discussed in Sections 5.2.1, 5.2.5-5.2.7 and 5.5.1), there are differences between these two commercial structures that would need to be taken into account in any effort to bring the respective governance regimes into closer alignment. The corporate structure was introduced as a vehicle for entrepreneurial risk-taking and the law relating to companies has developed over a long period of time. The scheme structure was developed more recently as an investment vehicle (particularly for retail investors), though it has trust elements that are governed by long-standing principles of trust law (as discussed in Chapter 2 of this paper).
Modification of the compliance and risk management framework
Given the potential complexities and difficulties of extending some aspects of the corporate governance framework to schemes, increased protection for investors in schemes may best be promoted by focusing on the need for changes to the current compliance and risk management framework in response to the matters raised in Section 5.5. Options include:
• Option 1: retain the current framework (compliance plan supplemented by risk management obligations of the RE as a licensee)
• Option 2: introduce a risk management regime specifically for schemes that would operate side by side with the compliance regime and link into the risk management framework for REs that operate them
• Option 3: remove the current compliance regime, with compliance to be dealt with as part of a broader risk management framework for schemes that could link in with the risk management framework for the REs that operate them.
A focus on risk management specifically for schemes, as envisaged in Option 2 or Option 3, may be justifiable, given the widespread failure of risk management during the global financial crisis. The OECD report Corporate Governance and the financial crisis – Conclusions and emerging good practices to enhance implementation of the Principles (2010) noted, in relation to companies:
410 s 234.
411 s 236(1).
In many cases risk was not managed on an enterprise basis and not adjusted to corporate strategy. Risk managers were often separated from management and not regarded as an essential part of implementing the company’s strategy. Most important of all, boards were in a number of cases ignorant of the risk facing the company.412
Section 5.7 discusses the role of investment guidelines in the scheme governance framework. These guidelines could form part of a risk management regime under any of the three identified governance options.
In assessing the reform options, account needs to be taken of the fact that REs of schemes may also be trustees of superannuation funds, which are subject to a separate risk management regime.
5.6.2 The reform options in detail
Option 1 (retain the current framework)
Under this option, there would continue to be a requirement for schemes to have a compliance plan, as well as a compliance committee where less than half of the directors of the RE are external directors, and for compliance with the plan to be audited.
Risk management would remain a general licensee obligation of the RE.
If the current framework is retained, there is an issue about whether steps should be taken to improve the quality of compliance plans.
One approach, supported by ASIC, is to change the law relating to compliance plans to focus on material breaches rather than minor breaches: in ASIC’s view, this would encourage the development of a strong compliance culture within REs.413 ASIC suggested amending the RE duty and liability provisions414 and the officer duty and liability provisions415 to remove the liability for a non-material breach of the compliance plan.416
Other approaches to discouraging high level compliance plans that lack detail would be:
• to define compliance plan in the Corporations Act so that it covers all the company’s documents that deal with compliance with the law
• for the Corporations Act to prescribe additional (or alternative) matters that must be included in the compliance plan, for instance, valuation frequency (not just arrangements for ensuring that scheme property is valued at regular intervals, as at present417), compliance committee processes and a detailed description of the registered managed investment scheme and its investment strategy.418
412 para 35, Box 2.
413 PJC Trio report para 4.52.
414 s 601FC.
415 s 601FD.
416 The ASIC submission to the PJC noted (at para 133) that the Productivity Commission declined to accept these suggestions, which were originally made in February 2010 to the Productivity Commission’s Annual Review of Regulatory Burdens on Business and Consumer Services.
417 s 601HA(1)(c).
418 The PJC Trio report recommended that the government investigate options to improve the oversight and operation of compliance plans, focusing particularly on the need for more detail to be included in compliance plans (rec 7).
An argument in favour of Option 1 is that it may avoid the need for existing schemes to introduce a new governance framework, as under Option 2 or Option 3 (though Option 3 has the potential to streamline requirements by enabling REs to deal with compliance in the broader context of risk management rather than requiring them to implement separate procedures for compliance and risk management).
Given that Option 1 involves retaining the basic overall legislative structure, the compliance committee and auditing of compliance with the compliance plan would remain an important part of the governance framework.419 The introduction of more detailed requirements for the matters to be included in the compliance plan may result in more useful audit reports.
The PJC Trio report supported a review of the effectiveness of compliance plans and, if necessary, requiring more detail to be provided in these plans.420
Option 2 (strengthened risk management alongside compliance)
This option would involve retention of the requirement for a compliance plan (possibly with steps being taken to improve the quality of those plans, as discussed under Option 1), together with the introduction of legislative risk management requirements for schemes that would link in with the current licensing obligation for a scheme’s RE to have adequate risk management systems. In practice, an RE would be able to have a single risk management system that deals with risks separately at the RE level and at the scheme level.
The purpose of the risk management requirements for schemes would be to provide a governance framework that encourages attention being given to the full range of risks that might be involved in the conduct of the scheme’s business, not just compliance risk. Matters that might be provided for in a risk management regime for schemes might include:
• the procedure for identifying and assessing relevant risks
• the procedure for determining how to deal with identified risks
• monitoring compliance with the risk management system
• ensuring that the risk management system can adapt in response to significant changes in the risk profile of the relevant scheme
• the procedure for outsourcing a risk management system
• record-keeping and reporting.421
See ASIC submission to the PJC Inquiry into the collapse of Trio Capital Limited, para 148(a). See also paras 132(a), 135(b), 137. The ASIC submission to the PJC noted that the Productivity Commission declined to accept these suggestions, which were originally made in February 2010 to the Productivity Commission’s Annual Review of Regulatory Burdens on Business and Consumer Services: para 133.
419 CAMAC notes that KPMG, in a submission to the PJC Trio inquiry, raised the possibility of a stronger role for compliance committees, which may include holding management accountable for acting on recommendations of the compliance committee (PJC Trio report para 5.16). That KPMG submission also raised the contrasting possibility of removing the need for a compliance committee by mandating a majority of truly independent directors of the RE. The PJC Trio report did not take a view on these alternatives.
420 p xxiii, paras 4.55, 7.34-7.35 (rec 7), 9.21.
The risk management regime for schemes could either itself set standards in these areas or require that a scheme’s RE set risk management standards for that scheme in relation to each of the specified criteria.
Issues under this option would include:
• whether a scheme’s risk management regime should be in writing
• whether there should be specific requirements for particular types of risk and, if so, for what risks and what requirements should apply to those risks (for instance, in relation to a scheme that involves ongoing investment of members funds, whether a scheme’s risk management system should be required to include appropriate investment guidelines: this issue is discussed in more detail in Section 5.7422).
An argument in favour of Option 2 is that it would enable schemes to preserve their current compliance regimes, while at the same time promoting a greater focus on risk management.
The comments made under Option 1 about the detail to be included in the compliance plan would be equally applicable under Option 2.
Adoption of Option 2 would raise the question whether the move to a stronger risk management regime would obviate the need for a compliance committee to oversee the RE’s compliance with the compliance plan or be a means for independent monitoring. This may especially be the case if the new risk management regime includes a requirement for a risk committee (see the discussion of the appropriate governance structure for monitoring risk management under Option 3, below).
As with Option 1, more detailed compliance plans may increase the usefulness of audits of those plans. However, under Option 2, the question arises whether there should be an audit of the risk management system instead of, or in addition to, an audit of the compliance plan. Audit of risk management arrangements is further discussed under Option 3, below.
Option 3 (subsume compliance into risk management)
Under this option, a scheme’s compliance risk would not be subject to a discrete set of requirements, as under the current law, but would be one of the risks covered by a risk management framework for schemes, which would link in with the RE’s risk management obligation. As with Option 2, an RE would in practice be able to have a single risk management system that deals with risks separately at the RE level and at the scheme level.
Arguments for adopting Option 3 include:
• the current compliance plan requirement only covers compliance risk (the risk that the
RE will fail to comply with applicable laws in its operation of the scheme).
421 These factors were discussed in ASIC Consultation Paper 204 Risk management systems of responsible entities
422 ASIC currently recommends that a compliance plan should ensure that there is adherence to the scheme’s investment policy: RG 132.12(d).
Compliance risk is not the only risk a scheme faces and may not be the most important risk423
• mere adherence to a compliance plan does not adequately deal with risks424
• a greater regulatory emphasis on risk management for schemes may help focus the attention of REs on the key strategic, enterprise and other business risks facing each of the schemes that they operate, as commercial entities, rather than merely compliance risk, which is just one of the risks of a commercial enterprise. This, in turn, may create a climate that is more conducive to good decision making. Risks change regularly
• it would be more sensible to deal with compliance and other types of risk in a single integrated document, rather than requiring that REs develop two separate sets of procedures for what are related concepts
• as discussed in Section 5.5 and in this Section under Option 1, the details in the current compliance plan requirements are meagre in any event, with the result that many compliance plans are couched in general terms, rather than tailored to the particular scheme.
A possible argument against Option 3 is that compliance with the Corporations Act and the scheme’s constitution is an essential element of the operation of a scheme, not merely one factor to be weighed against other factors. However, it is not possible for legislation to prevent deliberate non-compliance. The answer lies in the regulatory response to that non-compliance. The courts have indicated that they will heavily penalise such behaviour. In Australian Securities and Investments Commission, in the matter of Chemeq Limited (ACN 009 135 264) v Chemeq Limited,425 the Court, in applying the concept of a ‘culture of compliance’ (discussed in Section 5.2.6 of this paper) to the continuous disclosure provisions, said:
From the point of view of proper risk management against the possibility of contravention, a conservative approach which favours disclosure is to be preferred. Certainly those who play calculated risk games of non-disclosure in the shadow of the Rules cannot expect indulgence from the courts if their assessments are not accepted.426
When a corporation takes a calculated risk by intentionally or recklessly failing to disclose material information to the market, it may be inferred that there is a corporate culture which encourages or, at least, tolerates or permits decision-making which expressly or implicitly weighs the benefit of non-compliance against the risk if
423 Compliance plans and risk management systems both involve the identification of risks (for compliance plans, see RG 132.2, RG 132.10; for risk management systems, see ASIC CP 204 para 9).
424 It has been noted, for instance, that there are no specific obligations on licensees (which includes REs) to mitigate the risk of fraud, only a general obligation to have ‘adequate risk management systems’: Compensation arrangements for consumers of financial services: Report by Richard St. John (April 2012), para 3.51. The requirement to have adequate risk management systems is at s 912A(1)(h).
425 [2006] FCA 936.
426 at [87].
non-compliance is detected. For such deliberate conduct, the risk associated with re-offending must be set at a high level by high penalties.427
The matters that might be provided for in a risk management regime for schemes under this option, and the issues relating to such a regime, would be the same as discussed above under Option 2.
If Option 3 is adopted, consideration needs to be given to the appropriate governance structure for monitoring the enhanced risk management framework. This might involve establishing a committee that has responsibility for overseeing the scheme’s approach to risk management, which may be achieved by broadening the role of the current compliance committee, replacing that committee with a risk committee or including risk management as a function of another committee such as an audit committee.428
ASIC Consultation Paper 204 Risk management systems of responsible entities (March 2013) considered it good practice for REs to establish a designated risk management function and/or a risk management committee.429 It said that the responsibilities of a risk management committee may generally include:
• assisting the board in developing the risk management system
• implementation of the risk management system throughout the organization
• reviewing the effectiveness of the risk management system
• reporting to the board on breaches of risk tolerance or risk management procedures according to the RE’s escalation policy
• reporting to the board about the risk management system and its effectiveness or otherwise.430
A risk management committee might also regularly review the risk profile of the scheme’s business.
Another issue under Option 3 is whether there should be a requirement for an audit of a scheme’s risk management arrangements, to replace the current requirement for an audit of the compliance plan.431 ASIC CP 204 considered that it was good practice for REs to use internal and/or external audits to review compliance with, and the effectiveness of, their
427 at [93]. In determining the penalty for a contravention, the court will take into account the existence of compliance systems, including provisions for and evidence of education and internal enforcement of such systems, and remedial and disciplinary steps taken after the contravention and directed to implementing a compliance system or improving existing systems and disciplining officers responsible for the contravention: id at [99] (see also at [96], [112]). See also R Baxt, ‘Company law and securities: The importance of a culture of compliance’ (2013) 41 Australian Business Law Review 106, Criminal Code s 12.3(2)(c), (d). The Criminal Code is in the Schedule to the Criminal Code Act 1995.
428 Schemes listed on the ASX must have an audit committee ‘to independently verify and safeguard the integrity of their financial reporting’ or explain why not: ASX Corporate Governance Principles and Recommendations
with 2010 Amendments (2nd edition), Recommendation 4.1 and Principle 4. This requirement is maintained in the draft third edition released for comment in August 2013.
429 Proposal D1, draft RG 000.40. ASIC CP 204 recognised that the responsibilities of a risk management committee and a compliance committee may overlap (draft RG 000.41, RG 000.44). The draft regulatory guide in CP 204 said that the board of an RE should foster an environment in which the risk management committee receives support from staff, including access to all aspects of the RE’s business that may be subject to risks and authority to carry out its duties effectively (draft RG 000.45).
430 Draft RG 000.43.
431 s 601HG.
risk management systems.432 It considered that such audits can be important in identifying whether:
• risk management processes have been followed
• risk identification and assessment processes and procedures are effective and implemented
• treatment measures and controls to address material risks are operational and effective
• risk management systems are reviewed regularly, with any weaknesses identified for ongoing improvement.433
Question 5.6.1. Should the current governance framework consisting of compliance requirements (including a compliance plan, a compliance committee in certain circumstances and audit of the compliance plan) and risk management requirements be retained (Option 1) and why? What problems and/or inadequacies have been experienced with the current framework and what steps might be taken to overcome them?
Question 5.6.2. Alternatively:
• should risk management requirements be introduced specifically for schemes, to operate alongside the compliance requirements for schemes and link in with the risk management licensing obligation of the RE (Option 2) and why, or
• should the current compliance requirements be abolished, with compliance to be covered as part of a risk management regime for schemes that could link in with the risk management framework for the REs that operate them (Option 3) and why?
Question 5.6.3. If Option 1 or Option 2 is adopted, should one or more of the following changes (or some other change and, if so, what) be made to the compliance plan requirements:
• remove the liability of the RE and its officers for non-material breaches of the compliance plan to encourage more detailed plans
• define ‘compliance plan’ in the Corporations Act so that it covers all the company’s documents that deal with compliance with the law
• prescribe additional (or alternative) matters that must be included in the compliance plan?
Question 5.6.4. If additional matters are prescribed, what should those matters be?
Question 5.6.5. If alternative matters are prescribed, which of the matters stipulated in s 601HA should be replaced and with what?
Question 5.6.6. If a risk management regime for schemes, to operate in conjunction with the compliance regime, is introduced (Option 2) or if compliance is merged into a risk management regime for schemes (Option 3):
• what should the elements of the risk management regime be
• should the legislation itself set standards for each of these elements or, alternatively, require that the RE set standards for each element
432 Proposal D1.
433 CP 204 para 45, draft RG 000.81.
• should the risk management regime be in writing
• should the risk management regime include specific requirements for particular types of risk and, if so, what risks should be subject to specific requirements and what should those requirements be?
Question 5.6.7. If Option 2 or Option 3 is adopted, how should the scheme’s risk management arrangements be supervised? For instance, should a risk committee or an audit committee supervise those arrangements and, if so, what governance arrangements should apply to such a committee?
Question 5.6.8. If Option 2 or Option 3 is adopted, should there be a requirement for an audit of the scheme’s risk management arrangements?
Question 5.6.9. Under any of the options, what potential is there for duplicated or inconsistent regulation where the RE:
• is listed in its own right
• is prudentially regulated by the Australian Prudential Regulation Authority and how might any duplication or inconsistency be avoided?
Question 5.6.10. What transitional arrangements might be required if Option 2 or
Option 3 is adopted?
Question 5.6.11. Should the oppression remedy and/or the statutory derivative action procedure be available to members of a scheme in relation to the RE of the scheme and why?
5.7 Investment guidelines
5.7.1 Guidance rather than requirements
Investment guidelines, indicating how scheme property will be invested and based on a scheme’s risk profile, might form an important part of any risk management system for schemes that involve the ongoing investment of funds. For instance, the investment guidelines for an unlisted property scheme might include:
• a liquidity limit, aimed at ensuring that the scheme has sufficient liquid funds to enable it to make suitable acquisitions as the opportunity arises, or
• percentage restrictions on the location of properties or the types of tenant.
The guidelines for most schemes constitute guidance only, so that the schemes have the flexibility to respond to circumstances from time to time, including the prevailing market conditions. Departure from a guideline may be beneficial for the overall investment strategy of a scheme in a particular case to enable the scheme to make an advantageous property acquisition, on the basis that the scheme will subsequently adjust its investment portfolio to restore compliance with the relevant guideline. Investor protection in these situations might be safeguarded by ensuring that the committee with responsibility for overseeing the scheme’s approach to risk management supervises this process. This supervisory role would be important, as it may take some time to reweight the portfolio in some instances and it may not be possible to specify the time required.
Replacement of the current compliance framework with a risk–based framework may facilitate this flexible approach to investment guidelines. Currently, ASIC’s guidance on
compliance plans takes a strict approach, stating that one of the minimum requirements for a compliance plan would be ensuring that there is adherence to the scheme’s investment policy.434
A governance structure that may assist to give investment guidelines force, while maintaining flexibility and avoiding confidentiality concerns, would be to require that a committee such as a risk committee or an audit committee review proposed investments:
• to certify that the investments are in accordance with the guidelines, or
• to approve the investments, notwithstanding their departure from the guidelines, either outright or subject to conditions.
In addition, any auditor who is part of the governance framework could check whether scheme investments are in accordance with the investment guidelines.
5.7.2 Disclosure
Investment guidelines, including gearing ratios, may currently need to be disclosed in a Product Disclosure Statement, as being one of the ‘significant characteristics or features of the product’.435 Presumably, the PDS would need to make clear that the guidelines might be departed from in appropriate circumstances where that is the case.
It may be preferable for the Corporations Act to contain a clear and specific requirement to disclose a scheme’s investment guidelines.436 Disclosure of those guidelines would give investors the opportunity to consider whether the scheme’s investment strategy is compatible with their own investment goals. Any departure from previously disclosed guidelines, and the reasons for the change, should also be disclosed, to ensure that investors continue to have the information necessary to decide whether investment in the scheme remains appropriate for them. This requirement to disclose departures from investment guidelines could cover a complete change of investment strategy, as well as temporary departures from existing guidelines for a specific purpose. Disclosure of a departure from, or change to, the guidelines would complement the supervisory role that a committee might play in these circumstances.
An argument against a disclosure requirement is that it may detract from commercial confidentiality and assist a scheme’s competitors. However, most market participants are aware of the investment guidelines and weightings of their competitors.
A disclosure requirement would be in accordance with the approach recommended by the
International Organization of Securities Commissions.437
434 RG 132.12(d).
435 s 1013D(1)(f).
436 The ALRC/CASAC report recommended that:
• the disclosure document for a scheme require disclosure of all the kinds of investments authorised by the scheme’s constitution (para 5.14)
• the annual report of a scheme include the investment policy of the scheme and the scheme’s performance against that policy, as well as any material change in the investment policy (para 5.27).
That report envisaged the disclosure document for schemes being a prospectus (paras 5.9-5.21). Disclosure is examined in more detail in Chapter 10 of this paper.
437 Methodology For Assessing Implementation of the IOSCO Objectives and Principles of Securities Regulation (September 2011), Principle 26, Methodology Key Questions 5(i) and 12. See further the discussion in Section 14.2 of this paper (Item 7).
Question 5.7.1. Should there be an express requirement for schemes that involve the ongoing investment of members funds to have investment guidelines?
Question 5.7.2. Should departure from any investment guidelines be permitted in some cases and, if so, subject to what safeguards (for instance, approval by a risk committee)?
Question 5.7.3. Should the RE be required to disclose the scheme’s investment guidelines and any changes to, or departure from, those guidelines and, if so, how?
Question 5.7.4. Should a committee (for instance, a risk committee or an audit committee) be given a role in relation to investment guidelines, for instance to certify that a proposed transaction is in accordance with the guidelines or to approve a transaction that departs from the guidelines, either outright or subject to conditions? If so, what governance arrangements should apply to such a committee?
6 Scheme constitution
This chapter discusses what rights and powers should be specified in a scheme constitution if they are to exist, the enforceability of scheme constitutions and the procedure for changing them.
6.1 Rights and powers requiring inclusion in the constitution if they are to exist
Are there any types of right or power in relation to schemes that should only be permitted to exist if specified in a scheme’s constitution, but that currently do not need to be so specified?
The following rights and powers must be included in a scheme’s constitution if they are to exist:
• the right (if any) that members are to have to withdraw from the scheme and the procedures for dealing with withdrawal requests.438
The constitution is one of the key governance documents of a scheme (the other being the compliance plan, which is intended to ensure compliance with the constitution as well as with the Corporations Act). The rights and powers that can only exist if set out in the scheme constitution might be seen as being such fundamental matters of scheme governance that they should have to be contained in the constitution and not in some other document (such as a separate contractual arrangement or a disclosure document). Inclusion in the constitution would also ensure that the specified rights and powers cannot be varied without following the stipulated statutory procedure (generally a members’ special resolution: the procedure for changing a scheme constitution is discussed in Section 6.3 of this paper).
An additional matter that might require inclusion in the constitution is a power of the RE
to grant a security over scheme property. If a power to borrow money has to appear in the
438 s 601GA(2)-(4). ASIC has stated that ‘it is not sufficient to merely state in the constitution that the key elements of the withdrawal procedures are set out in a separate document, such as a PDS’ (ASIC Regulatory Guide 134
constitution if it is to exist (as under the current law), it is logical that a right to grant security for the repayment of money so borrowed should also have to appear in the constitution. In practice, the REs of some schemes have given security over the scheme property of those schemes to support a guarantee for another entity (for instance, a related party) to raise money.
Question 6.1.1. What rights and powers, if any, not currently requiring specification in a scheme constitution should be required to be so specified if they are to exist (for instance, an RE’s power to grant security over scheme property)?
6.2 Enforceability of the scheme constitution
Should scheme constitutions be enforceable in the same way as company constitutions?
A scheme constitution does not receive legal enforceability by force of the Corporations Act. Instead, the Corporations Act requires that the constitution of a registered scheme be contained in a document that is legally enforceable as between the members and the RE.439
It is uncertain whether this requirement extends to requiring that the constitution be enforceable between the members among themselves.440
By contrast, if a company has a constitution, the Corporations Act provides that it has effect as a contract:
• between the company and each member
• between the company and each director and company secretary
• between a member and each other member.441
There is no apparent policy reason why a scheme constitution should not be enforceable in the same way as a company constitution, that is, by virtue of the Corporations Act and between all relevant parties (not just between the RE and scheme members).
439 s 601GB. Regulatory Guide 134 Managed investments: Constitutions (February 2014) at RG 134.205-RG 134.215 gives guidance on the matters that ASIC takes into account in assessing compliance with this provision.
440 CCH Managed Investments Law and Practice (looseleaf) at ¶23-200, ¶65-400. Under the general law, a public unit trust deed would not usually be directly enforceable at the suit of another unitholder: HAJ Ford, RP Austin, IM Ramsay, Ford’s Principles of Corporations Law (LexisNexis Butterworths, looseleaf) at [1.370.3], citing Perpetual Trustees WA Ltd v Corporate West Management Ltd (1988) 13 ACLR 568 at 578, AF & ME Pty Ltd v Aveling (1994) 14 ACSR 499, 12 ACLC 831.
441 s 140.
If the SLE Proposal is not adopted,442 the Corporations Act could provide that a scheme constitution has effect as a contract between all the relevant parties, being each scheme member, the RE and each director and company secretary of the RE. If the SLE Proposal is adopted, the relevant parties to the legislative contract would also include the MIS.
The Turnbull Report recommended that a scheme constitution should be enforceable between the members and the RE by virtue of the Corporations Act.443 That report noted that:
ASIC is aware of some constitutions which do not appear to be legally binding. Some of these were constitutions ‘converted’ from trust documents during the transitional period for the new legislation …
Given this, it is considered that legislative amendments to make scheme constitutions legally binding and enforceable by virtue of the [managed investment provisions of the Corporations Act] … are necessary to guard against an erosion of investors’ rights and the efficacy of schemes generally.444
CAMAC does not anticipate any costs for schemes if the Corporations Act were changed to ensure that scheme constitutions are enforceable by all relevant parties against all other relevant parties. Any inconsistent provisions of scheme constitutions would simply be overridden by the Act.
Question 6.2.1. How common is it for scheme constitutions to fail to provide that they are legally enforceable by all relevant parties against all other relevant parties?
Question 6.2.2. Are there any instances of scheme members experiencing difficulties through being unable to enforce the scheme constitution against other members?
Question 6.2.3. Are there any reasons why the approach to the enforceability of scheme constitutions should not be the same for schemes as for companies?
6.3 Procedure for changing the scheme constitution
Should the procedure for changing the constitution of a scheme be the same as that for changing the constitution of a company?
The constitution of a registered scheme may be modified, or repealed and replaced with a new constitution:
• by special resolution of the members of the scheme445 (this is the same as the procedure for modifying or repealing a company’s constitution446), or
442 The SLE Proposal is summarised in Section 1.1.1 of this paper.
443 rec 5.
444 Section 2.5.
445 s 601GC(1)(a).
• by the RE unilaterally if the RE reasonably considers the change will not adversely affect members’ rights (there is no equivalent means for amending a company’s constitution).447
A modification to the constitution does not take effect until a copy of the modification has been lodged with ASIC.448
There has been considerable judicial consideration of the provision enabling the RE to modify a scheme’s constitution.
The RE’s task when contemplating exercise of this power is set out in ING Funds Management Ltd v ANZ Nominees Ltd; ING Funds Management Ltd v Professional Associations Superannuation Ltd:
• the RE must first ascertain the rights of members created by the constitution, as they exist immediately before the modification
• the RE must then decide whether those rights (as distinct from the enjoyment of them or their value) will be changed or impinged upon by the modification
• if the RE decides that the rights will be so affected, it must undertake a process of comparison and assessment to decide whether the impact ‘adversely affects’ members’ rights.449
The RE can exercise this power if it ‘reasonably considers’ that the modification will not adversely affect members’ rights. The Court in the ING case said that the expression
‘reasonably considers’:
• has the same meaning as ‘considers on reasonable grounds’ or ‘believes on reasonable grounds’
446 s 136(2). A special resolution requires the approval of 75% of the votes cast by those entitled to vote on the resolution: definition of ‘special resolution’ in s 9. The analogy between the procedure for amending a scheme constitution and the procedure for amending a company constitution and debenture trust deeds is discussed in ING Funds Management Ltd v ANZ Nominees Ltd; ING Funds Management Ltd v Professional Associations Superannuation Ltd [2009] NSWSC 243 at [56]-[59].
447 s 601GC(1)(b). The term ‘members’ rights’ in s 601GC(1)(b) includes the members’ contractual and equitable rights provided in the constitution: Smith v Permanent Trustee Australia Ltd (1992) 10 ACLC 906 at 913-914; ING Funds Management Ltd v ANZ Nominees Ltd; ING Funds Management Ltd v Professional Associations Superannuation Ltd at [94]; Premium Income Fund Action Group Incorporated v Wellington Capital Limited [2011] FCA 698 at [34], Australian Securities and Investments Commission v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (No 3) [2013] FCA 1342 at [656].
448 s 601GC(2). The Court in Australian Securities and Investments Commission v Australian Property Custodian
Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (No 3) [2013] FCA 1342 at [27], and again at [673], rejected the contention that, even if not validly made, amendments to a scheme constitution become effective upon lodgement with ASIC and remain so until they are declared invalid. The Court in that case held (at [445]) that the purpose of lodgement with ASIC pursuant to s 601GC(2) was to ensure that:
• there is certainty about the contents of scheme constitutions
• ASIC holds the current constitution of each scheme in its records in order to satisfy itself that the constitution complies with the Corporations Act and/or so that it can deal with enquiries or complaints in
regard to compliance
• the members can have ready access to the scheme’s constitution and be certain that it is current. The Court also said that:
The section promotes transparency and accountability by an RE in relation to the primary legal instrument of the scheme. It is intended to protect the members’ interests and promotes the efficient regulation of managed investment schemes (ibid).
449 [2009] NSWSC 243 at [96]. See also at [100].
• requires that:
– the relevant belief or opinion be actually held by the RE
– facts exist that are sufficient to induce the belief or opinion in a reasonable person.450
While these principles from the ING case have been applied in subsequent cases,451
another aspect of that case has not been followed. The Victorian Court of Appeal in 360
Capital Re Ltd (ACN 090 939 192) v Watts (as trustees for the Watts Family Superannuation Fund) held that members’ rights include a right to have the managed investment scheme operated and administered according to the constitution as it stands and that an RE must therefore consider this right when contemplating a change in a scheme constitution.452 The Court of Appeal rejected453 the contrary view in the ING case.454
The Explanatory Memorandum to the Bill for the Managed Investments Act 1998 gave no reason for giving the RE of a scheme the power to alter the scheme constitution in the stipulated circumstances.455 The Court in one case said that the power ‘is designed to protect the rights of members of registered schemes while permitting responsible entities to amend the constitutions of schemes in ways that they reasonably consider do not adversely affect members’ rights, without the inconvenience and expense of convening meetings of members’.456 However, it is not readily apparent that this rationale provides a relevant point of distinction between schemes and companies.
A company constitution has effect as a contract between various parties457 and can only be changed by special resolution of members.458 There is no apparent policy reason why the nature of a scheme constitution and the procedure for changing it should be any different.
450 at [102]. See also Re Great Southern Managers Australia Limited (recs & mgers app’t) (in liq) [2009] VSC 627 at [19].
451 Re Great Southern Managers Australia Limited (recs & mgers app’t) (in liq) [2009] VSC 627 at [18], Re
Timbercorp Securities Limited (in liq) [2010] VSC 50 at [7], Premium Income Fund Action Group Incorporated v Wellington Capital Limited [2011] FCA 698, Re Centro Retail Ltd [2011] NSWSC 1175 at [17], Re Elders Forestry Management Ltd [2012] VSC 287 at [53]-[58], Watts & Watts v 360 Capital Re Limited [2012] VSC
320 at [26], [41].
452 [2012] VSCA 234, approved in Australian Securities and Investments Commission v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (No 3) [2013] FCA 1342 at [449], [658]-[659], [668]. The Court of Appeal endorsed the decision of the Court at first instance (Watts & Watts v 360 Capital Re Limited [2012] VSC 320) and approved the decision on this point in Premium Income Fund Action Group Incorporated v Wellington Capital Limited [2011] FCA 698. The constitutional amendment in the 360 Capital case would have permitted the issue of redeemable unsecured convertible notes. The constitutional amendment in the Premium Income case would have changed the method
for determining the issue price of a unit in the scheme.
453 at [25]-[45].
454 [2009] NSWSC 243 at [98]. See also Re Centro Retail Ltd [2011] NSWSC 1175, particularly at [35].
455 The discussion of the provision for changing a scheme constitution in the Explanatory Memorandum to the Bill for the Managed Investments Act 1998 (paras 9.6-9.9) mentions this power, but does not explain the rationale for it.
456 Watts & Watts v 360 Capital Re Limited [2012] VSC 320 at [40].
457 s 140.
458 s 136(2). A special resolution requires the approval of 75% of the votes cast by those entitled to vote on the resolution: definition of ‘special resolution’ in s 9.
If the scheme constitution is treated as a contract between the involved parties, it would be unusual to permit one party to the contract (the RE) to change it unilaterally.
Question 6.3.1. What difficulties, if any, have been experienced as a result of the current procedure for amending scheme constitutions?
Question 6.3.2. Is there any reason why the procedure for changing a scheme constitution should differ from that for amending a company’s constitution?
Question 6.3.3. If the procedure for amending a scheme constitution should differ from that for amending a company’s constitution, does the current procedure for schemes (in particular the ability of the RE to amend the constitution where the RE reasonably considers that the amendment would not adversely affect members’ interests) need to be modified and, if so, how?
The responsible entity and others involved in the operation of a scheme
7 The responsible entity and others involved in the
operation of a scheme
This chapter considers the duty of REs to treat scheme members equally and the entitlement of REs to fees and indemnities, as well as their liability for the acts and omissions of their agents. It discusses the disclosure of interests of directors of the RE and the scope of the related party transaction provisions applicable to schemes. It also raises for consideration the possibility of simplifying the procedure for replacing the RE in some circumstances. Finally, it examines the place of scheme custodians in the regulatory framework.
7.1 Duty to treat members equally
Should the obligation for an RE to treat members of the same class equally and members who hold interests of different classes fairly be replaced with an obligation for an RE to treat all members fairly?
In exercising its powers and carrying out its duties, the RE of a registered scheme must treat the members who hold interests of the same class equally and members who hold interests of different classes fairly.459 The legislation does not define what is meant by a
‘class’.460
The duty to treat members of the same class equally prevents an RE from charging differential fees to members of the same class. However, ASIC provides class order relief from this equal treatment provision to permit some differential fee arrangements by reference to such matters as:
• the total value, or the number, of interests in the scheme held by a member
• the total period of time during which the member held interests in the scheme
• the member’s use of electronic trading and communications.461
An obligation for the RE to treat members of the same class ‘fairly’ may provide REs with more flexibility than the current obligation to treat those members ‘equally’.
459 s 601FC(1)(d). The ALRC/CASAC report at para 2.8 refers to the ‘need to ensure that, if investors are divided into classes, investors in one class are treated fairly compared with those in another class’.
460 This paper discusses in Section 16.1 whether the Corporations Act should be amended to provide further detail about what constitutes a class of interests in a managed investment scheme.
461 ASIC Class Order [CO 03/217]. Other situations where the Class Order permits differential fees are the member being an employee of the RE or a related body corporate, the member having acquired the interests in the scheme under a switching facility that involved the member withdrawing from another scheme operated by the RE and savings to the scheme arising from particular characteristics of the member.
A particular example of the administrative flexibility that would be afforded to REs by such a change is the ability to charge differential fees, which have been the focus of the reform proposals that have been made to date in this area.462
Question 7.1.1. Should the RE’s obligation to treat members of the same class ‘equally’
be replaced with an obligation to treat those members ‘fairly’?
Question 7.1.2. Are there any reasons why such a change should not be made?
Question 7.1.3. Should such a change be accompanied by any consequential amendments (for instance, disclosure to investors of relevant details about differential fee arrangements)?
7.2 RE’s entitlement to fees and indemnities
It is not always clear what is entailed in the concept of ‘proper performance’ of an RE’s duties in relation to an RE’s entitlement to fees and indemnities.
An RE only has the right to be paid fees out of scheme property, or to be indemnified out of scheme property for liabilities or expenses incurred in relation to the performance of its duties, if two conditions are satisfied:
• the right must be specified in the scheme’s constitution, and
• the right must be available only in relation to the proper performance of the RE’s duties.463
The Corporations Act does not elaborate on the meaning of ‘proper performance’.
Circumstances in which it is unclear whether the ‘proper performance’ requirement is satisfied (and the RE is therefore entitled to fees and indemnities) include:
462 Turnbull Report rec 15; the Parliamentary Joint Committee on Corporations and Financial Services report on the Turnbull Report, Report on the Review of the Managed Investments Act 1998 (2002) rec 15. The Turnbull Report recommended that the right to charge differential fees should be subject to a requirement that investors be provided with adequate disclosure to allow them to compare the effect of differential fee arrangements. ASIC’s second submission to the Turnbull Review said that this disclosure should cover:
• different fee structures available from the one offeror
• the effect of differential fee structures as between different offerors.
The Turnbull Report recommendation favoured further consideration being given to whether there is also a need
for the fairness ‘test’ to be interpreted by reference to some other criterion such as economic justification, and whether any interpretational material supporting the fairness test should be located in legislation or in ASIC policy. ASIC’s second submission to the Turnbull Review gave as an example of an economic justification criterion that a differential fee arrangement must be reasonable having regard to the difference between:
• the cost incurred by the RE in providing services to any member who is a party to a differential fee arrangement, and
• the cost incurred in providing services to any member who is not a party to the arrangement.
463 s 601GA(2).
• where the RE has properly performed some duties in relation to the scheme (in the sense that the RE’s actions do not constitute a breach of the relevant duties), but has not properly performed other duties
• where the RE has breached its duties in relation to the scheme, but has subsequently remedied the breaches.
Furthermore, it is unclear whether the concept of ‘proper performance’ is limited to the mere absence of breach or extends to situations where an RE’s performance of its duties is not to an appropriate standard, even though it has not breached any of those duties.
There are several options for clarifying the law in this area.
Option 1: require proper performance of all duties
The law might provide that an RE is only entitled to a fee or a right of indemnity or reimbursement if all the RE’s duties are performed without any breach. This option may encourage a higher standard of behaviour on the part of REs.
Option 2: entitlement in relation to duties properly performed
The law might provide that an RE is entitled to a fee or a right of indemnity or reimbursement for work that is done in the proper performance of its duties and does not involve a breach, even if other work has involved a breach of duty.
This option may be preferable to the ‘all or nothing’ approach represented by Option 1, as it may provide a continuing incentive for an RE to strive to perform its duties properly, even though it has previously committed a breach.
Option 3: require proper performance of all duties but permit atonement
This option would be a variation on Option 1.
The law might provide that an RE is only entitled to a fee or a right of indemnity or reimbursement if there is no outstanding breach in relation to any of the RE’s duties. However, in contrast with Option 1, this result could be achieved by permitting the RE:
• to remedy any breach, including by way of set-off, or
• to indemnify every member and former member for any loss caused by the breach.
This option would provide an incentive for the identification and rectification of breaches and alleviate the strict approach represented by Option 1.
Option 3 would raise the further question whether any reinstated entitlement following on from the remedy of a breach should cover fees and expenses incurred during the period of breach. Excluding amounts relating to that period would provide REs with an additional incentive to perform their duties properly.
Option 4: entitlement in relation to duties properly performed, including by atonement
This option would be a variation on Option 2.
The law might provide that an RE is entitled to a fee or a right of indemnity or reimbursement for work in relation to which there is no outstanding breach, even if breaches remain in relation to other work. However, as with Option 3, but in contrast with Option 2, this result could be achieved by permitting the RE:
This option may provide a greater incentive for the identification and rectification of breaches than Option 3, as it would enable the RE to claim payment for fees or indemnification for liabilities or expenses on a progressive basis, rather than having first to identify and rectify all breaches.
The further question raised under Option 3 concerning the coverage of any reinstated entitlement would apply equally to Option 4.
Option 5: clarify the standard entailed in the concept of ‘proper performance’
The law might be amended to clarify that proper performance of duties means performance to a specified standard, rather than merely the absence of any breach.
A clarification along these lines would not deal with the questions at which Options 1 to 4 are directed (the consequences where some duties have been properly performed but not others or where a breach has been remedied).
However, if the specified standard were applied in determining proper performance, Options 1 to 4 could be restated as follows:
• Option 1: an RE is only entitled to a fee or a right of indemnity or reimbursement if all the RE’s duties have been performed to the specified standard
• Option 2: an RE is entitled to a fee or a right of indemnity or reimbursement for work done in the performance of duties to the specified standard, even if other work does not satisfy that standard
• Option 3: as for Option 1, but with the ability for the RE to satisfy the specified standard by taking remedial action
• Option 4: as for Option 2, but with the ability for the RE to satisfy the specified standard by taking remedial action.
Question 7.2.1. What issues have arisen in practice in relation to the concept of ‘proper performance’ of an RE’s duties?
Question 7.2.2. If clarification of the meaning of ‘proper performance’ is required, which of the options mentioned above should be adopted? Alternatively, should some other option be adopted and, if so, what?
Question 7.2.3. If Option 3 or Option 4 is adopted, should any restored entitlement to fees or rights of indemnity or reimbursement extend to amounts relating to the period of the breach?
Question 7.2.4. If Option 5 is adopted, what standard for determining ‘proper performance’ should be specified?
7.3 Attribution to the responsible entity of acts or omissions of persons engaged to perform the responsible entity’s functions
The Corporations Act only attributes to the RE acts or omissions of an agent, or other person engaged by the RE, for two purposes:
• determining the RE’s liability to members
• determining whether the RE has properly performed its duties for the purpose of establishing its right to be paid fees, or to be indemnified, out of scheme property.
The issues considered in this section are:
• for what purposes or in what circumstances, if any, should the acts or omissions of an agent be attributed to the RE
• what continuing liability should an RE have for losses arising from acts or omissions of its agent once amounts have been recovered from the agent to cover those losses.
The RE of a registered scheme has the responsibility for operating the scheme and performing the functions conferred on it by the scheme’s constitution and the Corporations Act.464
The RE can engage other persons to perform any of its functions in connection with the scheme.465 For this purpose, the RE can:
• appoint an agent, or
• otherwise engage a person.
This power of the RE is wider than that of a trustee at general law, under which trustees:
• are not entitled to cast upon others the duty of performing the trusts and exercising the judgment and discretion that they are bound to perform and exercise themselves, but
• are entitled to employ others when it would be in the ordinary course of business to do so and they use due diligence in selecting their agents.466
One example of a person that the RE may engage is a custodian to hold scheme property.467 Other parties that an RE may want to engage include investment managers, property managers, back-office service providers and providers of registry services.468
464 s 601FB(1).
465 s 601FB(2). Where a person engaged by the RE engages another person, that other person is taken to be an agent appointed by the RE to perform its functions (s 601FB(3)).
466 Re Speight (1883) 22 Ch D 727 at 744, 756, 762–763.
467 Explanatory Memorandum to the Bill for the Managed Investments Act 1998 para 8.5. Custodians are discussed further in Section 7.7 of this paper.
468 CCH Managed Investments Law and Practice (looseleaf) at ¶30-300.
The wide power for an RE to engage other persons to perform its functions is balanced by a provision that attributes to the RE acts or omissions of those persons for certain purposes. The RE is taken to have done (or failed to do) anything that an agent or other person has done (or failed to do) (even if the agent or other person was acting fraudulently or outside the scope of his or her authority or engagement) for the purpose of determining whether:
• there is a liability to the members, or
• the RE has properly performed its duties for the purposes of establishing its right to be paid fees, or to be indemnified, out of scheme property469 (the question of what constitutes ‘proper performance’ of an RE’s duties is considered in Section 7.2 of this paper).
This liability of the RE overrides provisions under State and Territory legislation that would only impose liability on an RE, as a trustee, for its own default.470 It ‘places the onus upon the responsible entity to make good to scheme members any losses suffered by a scheme as a result of the conduct of persons engaged by the responsible entity in relation to the scheme’.471
The legislation makes provision for the respective liabilities of the RE and its agent. Subsection 601FB(4) provides that:
However, Corp Reg 5C.11.06 provides that:
In determining the liability under subsection 601FB(2) of the Act of the responsible entity of a registered scheme to the members of the scheme for an act or omission of an agent appointed by the entity under that subsection, the amount recovered under subsection 601FB(4) of the Act is to be disregarded.
There is an issue concerning the interaction of these two provisions. It has been stated that the intention of this regulation is ‘to prevent the possibility of compensating the managed
469 ss 601FB(2), 601GA(2).
470 Trustee Act 1925 (ACT) s 59, Trustee Act 1925 (NSW) s 59, Trustee Act (NT) s 26, Trusts Act 1973 (Qld) s 71, Trustee Act 1936 (SA) s 35, Trustee Act 1898 (Tas) s 27, Trustee Act 1958 (Vic) s 36, Trustees Act 1962 (WA) s 70. The language giving rise to the trustee’s liability varies from jurisdiction to jurisdiction: ‘own wilful neglect or default’ (ACT, NSW), ‘own wilful default’ (NT, Tas, Vic, WA), ‘own acts, receipts, neglects or defaults’ (Qld), ‘own wrongful or negligent act or omission’ (SA).
471 Explanatory Memorandum to the Bill for the Managed Investments Act 1998 para 8.6.
investment scheme twice for an act or omission by an agent appointed by the responsible entity’.472 However, the regulation appears to have the opposite effect.
Purposes for which acts or omissions are attributed to the responsible entity
In principle, the attribution to the RE of acts and omissions of its agent may enhance investor protection (including by providing REs with an incentive to choose suitable agents and closely monitor their activities).
For the most part, the first purpose for which attribution may occur (the determination of liability to members) appears largely to satisfy this investor protection goal. Attribution for this purpose means that members who have suffered loss through the acts or omissions of the RE’s agent do not have to identify and pursue that agent, but rather can take action against the RE itself as the operator of the scheme. However, a possible limitation from the investor protection point of view is that the current provision would not attribute to the RE acts or omissions of its agent for the purpose of determining liability to:
• prospective investors who for some reason fail to become scheme members,473 or
• persons who have ceased to be members.
Furthermore, in relation to proper performance of an RE’s duties, it appears to be unduly restrictive to limit attribution to the determination of the RE’s entitlement to fees and indemnities. Investor protection, particularly the provision of an incentive to choose appropriate agents, may be enhanced by permitting attribution of an agent’s acts or omissions to the RE in all matters relating to the proper performance of its duties474 or, more widely, in all instances, regardless of the matter in question.
Continuing liability of the responsible entity
Given that the effect of Corp Reg 5C.11.06 appears to be the opposite of that intended, it may be advisable to clarify the law. Any legislative clarification might be facilitated if the relevant law were contained solely in the Corporations Act: it is unnecessarily complex to have the provisions determining the quantum of the RE’s liability split between the Corporations Act and the Corporations Regulations.475
Question 7.3.1. For what purposes, or in what circumstances, should an RE be liable for the acts and omissions of its agents?
Question 7.3.2. Are there any reasons why liability should not be imposed on REs for the acts and omissions of their agents in all instances?
472 Explanatory Statement to Corporations Regulations (Amendment) 1998 No. 186, reg 13.
473 For instance, where an intended issue of interests in the scheme proves to have been invalid, the persons who would have held the interests are not members: see Watts & Watts v 360 Capital Re Limited [2012] VSC 320 at [72].
474 For instance, attribution would be appropriate for determining whether an RE:
• has exercised the requisite degree of care and diligence (s 601FC(1)(b)), or
• has adequate arrangements to manage conflicts of interests (s 912A(1)(aa)).
475 The Turnbull Report (Section 5.2.8) took this view, as did the ASIC submission at Stage 1 of the CAMAC