A recent federal court decision in Australian Securities and Investment Commission v PE Capital Funds Management Limited (administrators appointed) [2022] FCA 76 reminded scheme operators (responsible entities, trustees, and investment managers) of some key points to consider when determining whether a managed investment scheme can operate without being registered with ASIC.
Managed investment schemes with only wholesale investors (wholesale funds) are less regulated than those involving retail investors (retail funds). Retail funds must be registered with ASIC and comply with the requirements outlined in the Corporations Act 2001 (Cth) (the Act)1, which are designed to protect retail investors from systemic and large-scale financial disasters. Retail fund operators must adhere to the requirements outlined below, among others.
| Requirements for registered schemes | References |
|---|---|
| Scheme operator (or responsible entity) must be a public company that holds an Australian financial services licence | Section 601FA of the Act |
| Responsible entity must meet the minimum net tangible asset requirements | ASIC Regulatory Guide 166 |
| Scheme’s constitution (or trust deed) and compliance plan must be lodged with ASIC, and meet the content requirements | Sections 601EA(4), 601FC(1)(f)-(g) of the Act |
| Responsible entity may be required to establish a compliance committee to ensure that the compliance plan is being followed | Sections 601HA to 601JJ of the Act |
| Scheme’s compliance plan must be audited within 3 months of the financial year end | Section 601HG of the Act |
| Responsible entity must comply with their disclosure obligations, including the obligation to provide a Product Disclosure Statement | Sections 1010A to 1016F of the Act |
| Responsible entity must prepare annual audited financial statements | Section 989B of the Act |
If units in a scheme are only offered to or purchased by wholesale clients, such scheme may not need to be registered with ASIC2, and less regulatory obligations apply. Wholesale funds are hence the preferred investment vehicle for promotors seeking institutional, sophisticated, or high-net-worth investors.
Recent federal court decision
Recently, a scheme operator and trustee of several managed investment schemes, namely, PE Capital Funds Management Limited (“Defendant”), were found to be in breach of section 601ED(5) of the Act, where “a person must not operate … a managed investment scheme that … requires to be registered under section 601EB unless the scheme is so registered”3.
- Business of promoting managed investment schemes
The Court first established that the Defendant’s managed investment schemes required to be registered under section 601EB of the Act. Section 601EB(1)(b) of the Act provides that a managed investment scheme must be registered “if it was promoted by a person …. in the business of promoting managed investment schemes”.
The Defendant set up the relevant schemes in question, formulated and issued information memorandums stating that they “provide information for prospective investors to decide whether they wish to invest in the Fund“, transferred moneys invested by investors, and issued units to investors. Based on this, the Court determined that the Defendant was in the business of promoting managed investment schemes. Offering documents and investment registers, as well as the years of promotional activities repeated for other registered schemes, weighed in on the decision. The Court went on to clarify that the “business of promoting managed investment schemes” includes developing a scheme, advertising it, soliciting it, and implementing it.
- Evidentiary burden of the wholesale client exemption
Section 601EB of the Act required the Defendant’s schemes to be registered unless “all issues of interests in the scheme[s] that have been made would not have required the giving of a Product Disclosure Statement“4. A PDS is not required when scheme interests are solely issued to wholesale clients and not to any retail clients. This rule is often referred to as the wholesale client exemption.
The information memorandums for the relevant schemes included statements to the effect that:
- the “Fund” is a “wholesale managed investment scheme” or a “wholesale unit trust”;
- the “Fund” is only open to wholesale clients;
- the information memorandum is not (and not required to be) a disclosure document or a PDS for the retail client purposes of the Act.
Despite the above, the Defendant provided no evidence that the wholesale client exemption applied to the schemes throughout the court proceedings. The Court reminded that the evidentiary burden rests with the Defendant. The following section of this article, titled “The wholesale client exemption“, summarises what comprises interests in a scheme made available to wholesale clients.
- Small scale offering
A PDS is also not required for personal offers that are small in scale5. A personal offer is one that:
- may only be accepted by the person to whom it is made; and
- is made to a person who is likely to be in the offer, having regard to:
- previous contact between the person making the offer and that person; or
- someone professional or other connection between the person making the offer and that person; or
- statements or actions by that person that indicate that they are interested in offers of that kind6.
In a previous proceeding, the Defendant claimed that all offers made to their schemes’ investors were personal small-scale offers. However, the information memorandums are expressed to be in general terms and are accompanied by a blank application form that, on its face, is not restricted to being completed by the person to whom it was given. Furthermore, the Defendant was unable to show their pre-existing relationship with some of their investors of the schemes. The Court reminded again that the evidentiary burden rests with the Defendant, and the Defendant failed to discharge its burden. The following section of this article, titled “Small scale offering“, summarises what interests in a scheme created on a personal small-scale include.
The Court emphasised that the scheme operator carried the evidentiary burden in this case. There was no ascertainable evidence that the Defendant was not required to be registered under section 601ED(2) of the Act. As a result, the Court determined that the schemes should have been registered and ordered that they be wound up7.
This recent federal court decision serves as a reminder to scheme operators that they must provide substantiation when relying on the wholesale client or small-scale offering exemptions from a PDS. Further, it encourages the appropriate use and forms of information memorandums for the schemes.
A recap of the registration requirements for managed investment schemes
A “managed investment scheme8” must be registered if it:
- has more than 20 members; or
- is promoted by a person in the business of promoting managed investment schemes; or
- is part of a group of a related scheme with more than 20 members, and
a Product Disclosure Statement (PDS) is required under Part 7.9 of the Act for any issues of interests in the scheme9.
The small scale offering exemption
A scheme does not require a PDS for small scale offerings that are personal in nature10. Offerings are considered small scale if those are:
- made to not more than 20 persons; and
- raised for not more than $2 million,
in any 12-month period11. If the issues of interest in the scheme can be shown to be on a small scale, registration for this scheme is not necessary.
The wholesale client exemption
A PDS is generally required if interests in the scheme are issued to retail clients12. In other words, where issues of interests are provided to non-retail clients, i.e., wholesale clients13, a PDS is not required, and registration is unlikely.
The six (6) instances when interests in the scheme are deemed offered to wholesale clients are listed below.
| # | Tests | Descriptions | References |
|---|---|---|---|
| 1 | Price/Value Test | The product or service is provided to a wholesale client if “the price for the provision of the financial product, or the value of the financial product equals or exceeds” A$500,000 | Section 761GA(7)(a) of the Act and regulation 7.1.18(2) of the Corporations Regulations 2001 (Cth) |
| 2 | Non-Small Business Test | The product or service is provided to a wholesale client if it is “provided for use in connection with a business that is not a small business”. Small business means “a business employing less than: if a business is or includes the manufacture of goods – 100 people; orotherwise – 20 people.” | Sections 761GA(7)(b), 761G(12) of the Act |
| 3 | Asset Test | The product or service is provided to a wholesale client if: it is “not provided for use in connection with a business”; and the client can provide a certificate by a qualified accountant stating that he or she has a net asset of at least A$2.5 million | Section 761G(7)(c)(i) of the Act |
| 4 | Income Test | The product or service is provided to a wholesale client if: it is “not provided for use in connection with a business”; and the client can provide a certificate by a qualified accountant stating that he or she has a gross income of at least A$250,000 for each of the last two (2) financial years | Section 761G(7)(c)(ii) of the Act |
| 5 | Professional Investor Test | The product or service is provided to a wholesale client if the client is a “professional investor”, defined as, amongst others, a person that: holds an Australian financial services licence (AFSL); is a body regulated by Australian Prudential Regulation Authority (APRA); is the trustee of a superannuation fund and the scheme has net asset of at least A$10 million; orcontrols at least A$10 million (including any amount held by an associate or under a trust that the person manages) | Sections 9 and 761G(7)(d) of the Act |
| 6 | Sophisticated Investor Test | The product or service is provided to a wholesale client if the client is a “sophisticated investor”, meaning that the licensee (or trustee) is “satisfied on reasonable grounds that the client has previous experience in using financial services and investing in financial products that allows the client to assess: the merits of the product or services; andthe value of the product or service; and the risks associated with holding the product; and the client’s own information needs; andthe adequacy of the information given by the licensee and the product issuer” | Section 761GA(d) of the Act |
[1] See obligations outlined under Chapters 2, 5C and 7 of the Act.
[2] Sections 601ED, 761G, and 761GA of the Act
[3] Australian Securities and Investment Commission v PE Capital Funds Management Limited (administrators appointed) [2022] FCA 76
[4] Section 601ED(2) of the Act.
[5] Section 1012E(2) of the Act.
[6] Section 1012E(5) of the Act.
[7] Section 472 of the Act.
[8] Section 9 of the Act
[9] Section 601ED of the Act.
[10] Section 1012E(5) of the Act.
[11] Section 1012E(2), (6) and (7) of the Act.
[12] Sections 1012A to 1012C of the Act.
[13] See sections 761G(1) and (4) of the Act.