05 August 2009
Do we need a change?
With the recent collapses of Timbercorp and Great Southern, which were specialist fund managers operating agricultural managed investment schemes, questions are now being raised about how effective the current "responsible entity" structure is in protecting investors, and whether the current legal structure for managed investment schemes needs changing.
A history lesson
Prior to 1988, a managed investment scheme required a manager to manage the investment and a trustee to hold the legal title to the investments and to monitor the actions of the manager. Following the 1987 stock market and property crash, the Managed Investment Act 1988 was introduced to change the legal structure of managed investment schemes, in response to what was perceived to be a weakness in the dual structure, which required both a manager and a trustee.
Following the 1987 crash, it became apparent that there were 3 major weaknesses in the structure:
- In some cases, both the trustee and the manager denied responsibility for what had happened, and they blamed each other for what had gone wrong. Even legal action taken by investors after the event often failed to identify clearly which party was responsible;
- Investors had a mistaken impression of what the trustee was supposed to be doing - in some cases, investors thought that the trustee played a larger role in protecting their investments by in fact guaranteeing their investments, which was clearly not the case.
- Some trustees were subsidiaries of larger companies. It was thought, mistakenly, that the larger company would support the subsidiary trustee company if and when investors were successful in their actions against the trustee company. Unfortunately, the trustee companies were not supported by their parent companies and there were insufficient funds to satisfy investors' losses. The trustee companies then went into liquidation.
Following a review of the collapses of a number of managed investment schemes at this time, the Managed Investment Act 1988, which is now Chapter 5C of the Corporations Act 2001, was passed.
The fundamental conceptual change introduced by the Managed Investment Act 1988 was the creation of the "Responsible Entity" whose role was to replace both the trustee and the manager under the previous regime.
The single Responsible Entity
The Act introduced the single Responsible Entity. The idea of having a single Responsible Entity was to overcome the major weakness identified above, namely the "finger pointing" between the trustee and the manager that went on after the collapse of a managed investment scheme. Under the new arrangement, there was only one entity to look to if things went wrong. Having only a single entity also went some way to overcoming the second weakness noted above.
There were some other safeguards introduced in the Managed Investments Act 1988:
- The Responsible Entity was defined in the Act as acting as the trustee of the funds on behalf of the investors, an arrangement which preserved the trustee responsibilities existing under the old structure;
- If the Responsible Entity did not have $5 million in net tangible assets, the assets of the managed investment scheme had to be held by an independent custodian, namely an entity independent of the Responsible Entity that held the legal title to the investments,
- If the Board of the Responsible Entity did not have a majority of external directors, a "Compliance Committee" comprised of a majority of people external to the Responsible Entity had to be established to undertake the compliance role previously under taken by the trustee. This provided an extra "independent" overview of the actions of the Responsible Entity.
- All Responsible Entities had to have in place compensation arrangements for the benefit of investors.
It was widely agreed at the time that the single Responsible Entity was a vast improvement on the old system that it replaced.
Interestingly, the essential elements of the old structure that applied to managed investment schemes prior to 1988 remains today with debenture companies, where an entity that wants to issue debentures must enter into a trust deed and appoint a trustee, both of which must comply with the Corporations Act 2001. Following the appointment of the trustee, the debenture company acts essentially in the same role as the manager would have under the old structure.
Which is better - the old or the new?
Whenever there is a financial crisis, many questions will always be asked - how did it happen and what can be done to prevent it from happening again?
As part of this discussion, another question is often asked - would more regulation or a change of regulation be better?
A review of the last 20 years in Australia's financial history shows that no system is perfect. There were catastrophic failures under the old structure prior to 1988, there have been significant losses incurred under the debenture structure in recent times with companies like Fincorp and Bridgecorp, and there are likely to be more collapses like Timbercorp and Great Southern under the single Responsible Entity structure. And these have all occurred under the regulatory supervision of ASIC, and its predecessor, the Australian Securities Commission. So having a supervising regulator cannot guarantee success.
A cynic may say that there will always be failures, no matter what systems and structures are in place and that only through the diligence and vigilance applied by investors themselves can there be some protection against loss.
Regular readers of La Trobe's Investment News will be aware of some of our basic investment philosophies - diversification, know what you're investing in, take responsibility for your own investments, higher returns mean higher risks, and getting rich slowly will never go out of fashion - which apply equally well under all investment structures.
As for which legal structure is better - we hold the view that a properly governed Responsible Entity under the current structure works well for the majority of investors and there is no convincing reason to change.
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Head of Funds Management
t +61 3 8610 2811
Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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