The future of our financial system

8 Updating a PDS—guidance for responsible entities

10Relief for employee incentive schemes

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THINKING OF STARTING YOUR OWN VENTURE CAPITAL FUND?

DECEMBER 2015 ISSUE 13

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From the editorIn this edition of Fundamental we wrap up the year with a review of recent and significant developments for stakeholders in the funds management industry, including:

• the key features fund managers need to be aware of before establishing a venture capital fund

• ASIC’s focus on advertising and promotional material

• what the key recommendations of the Financial System Inquiry mean for the funds management industry

• the three key messages for a responsible entity updating a PDS

• options for employers now that ASIC has broadened its relief for employee incentive schemes

• the circumstances when a disclosure document is misleading or deceptive.

Also, we have boosted our Real Estate team with the addition of partner Marcus Cutchey and senior associate Monica Hii in Melbourne to meet strong client demand for real estate services. These appointments follow closely on the recent addition of special counsel Natalie Humzy-Hancock in Brisbane.

Our Real Estate team has a unique understanding of the issues involved in the acquisition, development, management and disposal of properties by fund managers and are very happy to assist with any queries you might have.

Our sincere thanks for your ongoing support and best wishes to you and your family for a safe and happy Christmas.

Best regards

Brendan Ivers

Partner, Funds Management

From the editor

ASIC’s focus on advertising and promotional material

Relief for employee incentive schemes

Thinking of starting your own venture capital fund?

When is a disclosure document misleading or deceptive?

The future of our financial system

Updating a PDS—guidance for responsible entities

Snapshot

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Contents

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ASIC’S FOCUS ON ADVERTISING AND PROMOTIONAL MATERIALWhat level of due diligence do you apply to your advertising and promotional material? Does it comply with ASIC Regulatory Guide 234—Advertising financial products and advice services including credit: Good practice guidance? Can you properly substantiate all claims made on your website and in social media? Senior Associate Jeunesse Meldrum looks at these questions which ASIC is asking Australian financial services (AFS) licensees.

ADVERTISING REQUIREMENTSThe general rule is promotional material for financial products and services must be clear, accurate and balanced and should be presented in a way that avoids potentially misleading or deceiving consumers. Representations made in advertising are likely to be misleading or deceptive if they cannot be properly substantiated. Importantly, the overall impression given by promotional material must be a balanced message about the returns, benefits and risks of investing in the financial product or of receiving the financial service.

Also, AFS licensees should always follow the rule that if a statement is good enough for an advertisement, it is good enough for a disclosure document. Product issuers will mislead consumers if there is inconsistency between the two.

ASIC’S RECENT ACTIVITIESASIC has taken issue with promotional material across a range of media, including in social media and in headlines appearing on search results pages generated via Google. Where ASIC has had reasonable grounds to believe an AFS licensee has contravened consumer protection laws with respect to advertising, ASIC has issued infringement notices imposing penalties of over $10,000 for each contravention. ASIC appears to be particularly focused on advertisements in foreign languages targeted at consumers from non-English speaking backgrounds.

For responsible entities (REs) and trustees, ASIC has identified defective or misleading disclosure and advertising material and an absence of effective controls over the authorisation and review of promotional materials and disclosure documents as a notable compliance concern.

As a result of the compliance failures identified, ASIC has required REs and trustees to do the following:

• Amend and update compliance measures.• Develop procedures such as those related

to the due diligence and authorisation ofdisclosure documents and promotionalmaterial.

• Make changes to their risk managementarrangements and implement additionalmeasures to monitor the reporting of returns.

• Withdraw disclosure documents and marketingmaterials.

• Issue revised or supplementary disclosure.

WHAT SHOULD LICENSEES DO?Licensees should regularly review and update promotional material across all media to ensure the overall impression given by the material does not mislead or misinform consumers. Indications are that ASIC will continue to monitor advertising material and, where necessary, take enforcement action. Specifically, ASIC has said it will continue to conduct reviews of licensees in the superannuation and managed investments sector to assess compliance with their AFS licence obligations, rectify any deficiencies and to improve overall industry standards. We can help you to take stock and implement any measures necessary to comply with your legal obligations when advertising financial products and services.

Jeunesse Meldrum

Senior Associate Funds Management

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Grace Ball

Lawyer Funds Management

RELIEF FOR EMPLOYEE INCENTIVE SCHEMESOver the years, there have been various Government initiatives to encourage employee incentive schemes (EISs) where an employer offers its employees an ownership interest in the business. An EIS can support mutual interdependence and longevity of the relationship between employer and employee, which in turn is good for a company’s productivity and the Australian economy overall.

Adding to this, ASIC has provided employers various forms of relief from obligations which would generally be imposed on them by the Corporations Act (Act). Grace Ball explores what options might be available to employers now that ASIC has broadened its relief.

OBLIGATIONS UNDER THE CORPORATIONS ACT The offer of financial products generally triggers some or all of the following obligations under the Act:

• The provision of disclosure documents (egprospectus).

• The requirement to hold an Australian financialservices licence.

• Prohibitions on advertising or makingunsolicited offers of financial products.

• The obligation to register a managedinvestment scheme.

• Provisions relating to the on-sale of financialproducts.

ASIC PROVIDED RELIEFAlthough the Act provides some limited exemptions, ASIC has released various class orders providing extensive conditional relief if an employer is a listed or unlisted body offering certain products to eligible participants.

ASIC class order relief was broadened last year to better facilitate EIS offerings. ASIC now has two relevant class orders—one covering the listed sector and the other for unlisted bodies.

WHO CAN MAKE OFFERS?For a listed body, offers can be made by the body and its related bodies corporate, including bodies listed on the ASX and approved foreign markets.

For an unlisted body, offers can now be made by the body as well as its wholly owned subsidiaries. Previously, only the body itself could make offers.

WHAT FINANCIAL PRODUCTS CAN BE OFFERED? A listed body can offer shares, certain depository interests, units in registered schemes, stapled securities and certain options over and incentive rights in relation to any of those products.

An unlisted body can offer ordinary shares, options over those ordinary shares and incentive rights to receive ordinary shares or a cash amount, or some combination of both, for no more than nominal monetary consideration. This is an expansion of the class order. Previously, an unlisted body could only issue options over fully paid shares, and those options could only be exercised if a prospectus was issued or the company was subsequently listed and the shares had been quoted on the ASX for 12 months.

ELIGIBLE PARTICIPANTSPreviously, ASIC only provided relief for offers made to full or part time employees and directors of the body making the offer, or its related companies. With broader relief now available, the following additional individuals are considered eligible participants:

• Contractors and casual employees who workan equivalent of 40 percent or more of acomparable full time position.

• Prospective participants, provided the offeris conditional on the acceptance of a relevantengagement with the employer.

An offer may also be transferred from an eligible participant to:

• an immediate family member• a company whose members are all eligible

participants or their immediate family• a corporate trustee of a self-managed super

fund where the eligible participant is the fund’sdirector.

CONDITIONS ON RELIEFMany conditions apply to EISs if an employer takes advantage of the relief offered through these class orders. The conditions are varied, and depend on whether the body making the offer is a listed or an unlisted body. The conditions should be closely examined prior to applying for the relief.

TAKING ADVANTAGE OF THE RELIEF The class order relief available for an EIS enables employers to strengthen the employment relationship, whilst enjoying minimal compliance costs and obligations. ASIC continues to support these schemes, and is open to giving individual relief to employers where the general conditions described above are inappropriate for a particular EIS.

Our lawyers can assist with any queries you may have about employee incentive schemes.

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THINKING OF STARTING YOUR OWN VENTURE CAPITAL FUND?

INVESTING IN A VC FUNDSIV investors and fund managers looking to establish a VC Fund for SIV purposes should be aware that investors must invest directly into a VC Fund for it to be a complying investment. This means it is not possible to employ the traditional model of investing in a “fund of funds” to then invest in a VC Fund.

This requirement runs contrary to industry expectations and several Government publications which suggested fund managers would be able to set up a ‘one stop shop’ to simplify the investment process for SIV investors.

However, we are aware of at least one fund manager that applied for and obtained Government approval to allow investments into a VC Fund via the manager’s investment fund. We are closely monitoring developments in this area, and expect this requirement to be amended or tempered in the future.

Benson Chin

Lawyer Funds Management

One of the major changes to the Significant Investor Visa (SIV) program is the introduction of investments in venture capital funds (VC Funds) as ‘complying investments’. Since their introduction, we have seen a cautious uptake from fund managers setting up VC Funds as investment vehicles.

Here Benson Chin explores some of the key features fund managers need to be aware of before establishing a VC Fund.

LIMITED PARTNERSHIPSVC Funds are structured differently from traditional managed investment schemes. Whilst schemes employ a trust model, VC Funds are structured as limited partnerships. These are statutory entities which are registered and governed by legislation.

Limited partnerships are well understood and favoured internationally as investment vehicles, particularly in the context of venture capital. Limited partnerships are less common in Australia, in part because of the popularity of the trust structure for investment vehicles.

Like traditional partnerships, limited partnerships must have at least two entities in partnership with each other, carrying out a business in common with a view to profit.

However, unlike traditional partnerships, limited partnerships can be registered as ‘incorporated limited partnerships’. This grants the partnership legal status separate from the partners, in the same way a company is a separate legal entity from its shareholders.

HOW DOES A LIMITED PARTNERSHIP BECOME A VC FUND?To establish a VC Fund, a limited partnership must first be registered under the relevant legislation. Then, the limited partnership must be registered as a VC Fund with Innovation Australia under the Venture Capital Act (VCA).

As part of this process, a partnership deed governing the activities of the partnership must be prepared. The partnership deed must meet the requirements imposed for limited partnerships and VC Funds under the relevant state and territory legislation, as well as the VCA.

Fund managers should also have documents outlining their investment plans for the VC Fund ready to go. This will include the offer document that will eventually be used to promote the fund, as well as an investment plan and capital raising plan which the limited partnership will follow.

Fund managers must also be prepared to enter into a consultative process with AusIndustry as part of the registration process, where they will be required to answer questions about the VC Fund being established.

FEELING LOST?McMahon Clarke has experience assisting fund managers with setting up VC Funds and other types of investment vehicles. Please contact one of our lawyers if you would like more information about how to set up your own investment structure.

WHAT TYPE OF VC FUND?There are several types of VC Funds, each with different limitations and legislative requirements. The two main VC Funds used as investment vehicles are venture capital limited partnerships (VCLPs) and early stage venture capital limited partnerships (ESVCLPs).

Both types of entities:

• normally require investment in a businesslocated in Australia (defined as having 50percent of their assets and staff located inAustralia), at the time of the investment and forat least 12 months after

• only allow investment in businesses wherethe predominant activity is not propertydevelopment or land ownership, finance,insurance, construction, making investmentsdirected at deriving passive income

• must invest by buying shares in companies orunits in trusts.

VCLPs can invest in a business that has total assets of up to $250 million at the time of investment. In contrast, ESVCLPs can only invest in a business with total assets of up to $50 million, and must divest investments in entities where the total value of assets later increases to $250 million. VCLPs can also invest in a company or trust which is listed, provided it is delisted within 12 months of acquisition. ESVCLPs on the other hand, can only invest in a listed company or trust if the investment was made prior to the company or trust listing.

VCLPs and ESVCLPs also provide different tax concessions, depending on whether investors are Australian tax residents or foreign tax residents. Other VC Fund structures, such as Australian fund of funds and venture capital management partnerships, can also be employed to obtain different tax concessions.

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Facilitate innovative disclosure—remove regulatory impediments to innovative product disclosure and communication with consumers, and improve the way risk and fees are communicated to consumers.

Align the interests of financial firms and consumers—better align the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice.

Amongst other things, the Government will ask ASIC to examine remuneration structures in the mortgage broking sector.

Managed investment scheme regulation—support the Government’s review of the Corporations and Markets Advisory Committee’s (CAMAC’s) recommendations on managed investment schemes, giving priority to matters relating to consumer detriment, including illiquid schemes and freezing of funds; and regulatory architecture impeding cross-border transactions and mutual recognition arrangements.

The Government will draw on the CAMAC report and a forthcoming Senate Committee Inquiry report to develop legislative amendments to enhance the regulatory framework for managed investment schemes.

Strengthening ASIC’s funding and powers—introduce an industry funding model for ASIC and provide ASIC with stronger regulatory tools.

The Government released a consultation paper, Proposed Industry Funding Model for the Australian Securities and Investments Commission, on 28 August 2015 which provides an industry funding model for ASIC’s regulatory activities. Under the model, ASIC’s regulatory activities will be recovered from industry via fees for service that reflect ASIC’s actual costs in providing specific on-demand services to individual entities. It also provides for annual supervisory levies that reflect the portion of ASIC’s activities dedicated to each of its regulated sectors.

Our lawyers can assist with any queries you might have about the impact of these recommendations.

THE FUTURE OF OUR FINANCIAL SYSTEMThe Federal Government accepted all but one of the 44 recommendations of the Financial System Inquiry into establishing a direction for the future of Australia’s financial system. Those recommendations addressed five strategic priorities - resilience, superannuation and retirement incomes, innovation, consumer outcomes, and the regulatory system. Here, Kristy McCluskey highlights the key recommendations and what they mean for the funds management industry.

BACKGROUNDThe Inquiry was asked to make recommendations that would position the financial system to best meet Australia’s evolving needs and support economic growth

On 7 December 2014, the Federal Government released the Final Report of the Inquiry. A period of consultation followed and the Government’s Response was subsequently released on 20 October 2015.

KEY RECOMMENDATIONSWe now look at some of the key recommendations.

Direct borrowing by superannuation funds—remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.

The Government did not agree with the Inquiry’s recommendation, on the basis of insufficient data to justify significant policy intervention. However, the Government has agreed to commission the Council of Financial Regulators and the ATO to monitor leverage and risk in the superannuation system and report back after three years.

Governance of superannuation funds—mandate a majority of independent directors on the board of corporate trustees of public offer superannuation funds, including the independent chair; align the direct penalty regime with managed investment schemes; and strengthen the conflict of interest requirements.

The Government agreed with the need to improve the governance of superannuation funds, and has already introduced legislation requiring superannuation fund trustee boards to have a minimum of one-third independent directors, including an independent chair.

Crowdfunding—graduate fundraising regulation to facilitate crowdfunding for both debt and equity, and over time, other forms of financing.

Community consultation followed by draft legislation is expected to be introduced next year.

Impact investment—explore ways to facilitate development of the impact investment market and encourage innovation in funding social service delivery; provide guidance to superannuation trustees on the appropriateness of impact investment; support law reform to classify a private ancillary fund as a ‘sophisticated’ or ‘professional’ investor, where the founder of the fund meets those definitions.

The Government agrees and will prepare a discussion paper to explore ways to facilitate the development of the impact investment market in Australia.

Retail corporate bond market—reduce disclosure requirements for large listed corporates issuing ‘simple’ bonds and encourage industry to develop standard terms for ‘simple’ bonds.

Introduce product intervention power—introduce a proactive product intervention power that would enhance the regulatory toolkit available to ASIC where there is a risk of significant consumer detriment.

Kristy McCluskey

Lawyer Funds Management

Brit Ibanez

Partner, Commercial Disputes and Funds Management

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WHEN IS A DISCLOSURE DOCUMENT MISLEADING OR DECEPTIVE?Recently, I was again asked about whether some omissions and statements in a disclosure document were misleading or deceptive. The question reminded me of the comments of the judge in the landmark Lehman Brothers case involving Wingecarribee, Parkes and Swan Councils which has had far-reaching implications for the interpretation of our financial services laws.

The case involved relatively unsophisticated Council officers investing millions of ratepayers’ funds in highly complex financial instruments. The court said Lehman Brothers (known as Grange Securities at the time) had breached its fiduciary duties and engaged in misleading and deceptive conduct and ordered hundreds of millions of dollars in compensation to the local councils involved.

The Federal Court commented about how difficult it is for the courts, the parties and the lawyers to grapple with the myriad legislation which applies to misleading and deceptive conduct in the context of financial products and services. Compare this to the repealed simple section 52 of the Trade Practices Act that prohibited corporations engaging in misleading or deceptive conduct in trade or commerce. The court encouraged the Federal Parliament to consider returning to that simple legislative prohibition.

HOW DOES IT WORK NOW?Although this decision was delivered in 2012, there has been no reform of the sort suggested. We have little judge-made law to provide guidance on how the provisions might apply to sophisticated investors.

Although the issue is raised with us constantly, not many of the accusations are taken all the way to a judgment. This means we continue to recommend that product issuers over disclose, over explain and issue supplementary disclosure for fear that any statement or omission capable of causing the ordinary investor some confusion, could be found to be misleading or deceptive. We look forward to the courts providing further guidance about the circumstances where misleading or deceptive conduct will be found in relation to sophisticated investors and for the bar to be sensibly higher than might exist in the retail environment.

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RELIEF UNDER ASIC CLASS ORDER 03/237ASIC Class Order 03/237 provides limited relief from the obligation to issue a supplementary PDS following a change in circumstance or the availability of new information. If the new information or change in circumstance is not materially adverse, then, rather than issue a supplementary document, a RE may update a PDS by way of a notice to investors. Generally, the notice is posted on the RE’s website.

To obtain the class order relief it is necessary to comply with all of the following requirements:

• The proposed change was not materiallyadverse.

• The PDS was up-to-date when it was prepared.• The PDS clearly explained that non-materially

adverse information may change and beupdated in the manner contemplated.

• The updated information must be easily foundand provided in hard copy free of charge uponrequest.

• The updated information must be provided toall distributors of the product and the RE mustkeep a copy of the information for seven years.

ROLE OF THE REThe RE must consider whether the availability of new information or a change in circumstances has resulted in the PDS becoming “defective” and requiring the issue of a supplementary PDS.

Ultimately, whether new information or a change in circumstances causes a PDS to become “defective” is an issue of materiality, which inevitably has an element of subjectivity and uncertainty. The RE should consider the issue, and reach and document its conclusions on this issue of materiality, having considered the perspective of a reasonable applicant in the circumstances. The RE must make its own decision and may seek legal advice.

If the RE reasonably determines the availability of new information or the change in circumstances is not materially adverse to investors, then it may

UPDATING A PDS—GUIDANCE FOR RESPONSIBLE ENTITIESIn this article, James Crinion highlights the three key messages for a responsible entity (RE) updating a PDS:

1. The RE (as issuer) should be aware oftheir obligation to ensure a PDS is notdefective and is up-to-date when it isgiven to a potential investor.

2. ASIC Class Order 03/237 provideslimited relief from the obligation toissue a supplementary PDS followinga change in circumstances or theavailability of new information sincethe date the PDS was issued.

3. The RE must keep in mind that civilliability may still attach where aninvestor has suffered loss or damageas a result of a “defective” PDS, evenif the defect is not “materially adverse”to investors.

James Crinion

Funds Management

be able to seek relief under ASIC Class Order 03/237 to update the PDS (provided the stipulated conditions are satisfied).

CIVIL LIABILITY FOR A DEFECTIVE PDS—A LOWER STANDARD OF PROOFIt is important to realise the definition of “defective” under the Act’s civil liability provisions is different from the definition which applies for the purpose of the supplementary PDS provisions. This means civil liability may still attach to a “defective” PDS where there is a misleading or deceptive statement or omission in the PDS, even if this is not “materially adverse” to an investor.

Therefore, REs should be aware that even where something has arisen which is not enough to trigger the need for a supplementary PDS, an investor could still conceivably maintain an action for damages against the RE (as issuer) or another party involved in making or issuing a “defective” PDS, provided the investor can prove they have actually incurred loss or damage as a result of this.

However, REs can take some comfort from the “due diligence defence” in the Act, which may apply if they can demonstrate they took reasonable steps to ensure the PDS would not be defective. Therefore, REs should ensure a good and thorough due diligence process is conducted in the preparation of a PDS, to increase the likelihood of those involved in its preparation successfully using the Act’s due diligence defence if the PDS is discovered to be “defective”.

If you require further information or assistance with a PDS, then please contact a member of our Funds Management team.

PDS REQUIREMENTS AND OPEN-ENDED SCHEMESThe Corporations Act (Act) requires that a PDS contain specific information about a product (including significant risks) and all other information that might have a material influence on a prospective investor’s decision to acquire the product. Importantly, information in a PDS must be up-to-date at the time it is given to a prospective investor.

Circumstances often change, or new information becomes available, after a PDS is issued. For an open-ended scheme (ie one which allows investment on an ongoing basis during the lifetime of the scheme rather than for a defined period at the outset), this is a particular problem. The issue for the RE is whether the PDS must be amended by issuing a supplementary PDS.

A SUPPLEMENTARY PDSThe Act provides for a supplementary PDS to be issued to:

• correct a misleading or deceptive statement inthe PDS

• correct an omission from the PDS• update or add to the information in the PDS• change statements about the minimum

amount of the issue or the proposed listing ofthe financial product.

IS THE PDS DEFECTIVE?A supplementary PDS may be required if the RE becomes aware the PDS was either “defective” at the time it was prepared, or subsequently became or has become “defective”.

A PDS will be “defective” if it contains a misleading or deceptive statement, or an omission, that is or would be materially adverse from the point of view of a reasonable person considering whether to invest. The availability of new information or a change in circumstances may result in the PDS becoming “defective”.

There is little guidance about the meaning of “materially adverse” within the context of the PDS regime. Case law describes the hypothetical retail client as being typically reasonably intelligent, and while not expert in matters of finance, will exercise ordinary common sense and will be reasonably diligent and reflective when deciding to make an investment. So, the test is whether the hypothetical retail client would reasonably require the information for the purposes of making the decision to invest.

Ultimately, whether new information or a change in circumstances causes a PDS to become “defective” is an issue of materiality, which inevitably has an element of subjectivity and uncertainty.

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Boosting our Real Estate teamWe have recently expanded our Real Estate team with the addition of partner Marcus Cutchey and senior associate Monica Hii in Melbourne to meet strong client demand for real estate services. These appointments follow closely on the addition of special counsel Natalie Humzy-Hancock in Brisbane.

These new appointments are an important strategic initiative for the firm. The expansion of our Real Estate team continues our plan for growth, builds our real estate capability, and reflects our aim to attract market leading lawyers.

Real estate, funds management and commercial disputes are the core platforms of our business. The breadth of experience of our new team members adds significantly to the firm’s capability to provide across-the-board real estate services to our clients.

Snapshot

62 Charlotte St Brisbane QLD 4000 GPO Box 1279 Brisbane QLD 4001 T 07 3239 2900 F 07 3239 2990

Level 15 385 Bourke St Melbourne VIC 3000 T 03 9909 1400 F 03 9909 1499 www.mcmahonclarke.com

Marcus Cutchey (Partner)

Marcus has over 15 years’ experience in property acquisitions and disposals, commercial, retail and industrial leasing, and property development in both Australia and the UK. Known for his commercial and pragmatic approach, his clients include funds management groups, developers and investors. Prior to joining McMahon Clarke, Marcus was a partner at a leading Melbourne law firm.

Natalie Humzy-Hancock (Special Counsel)

Natalie advises major property developers and investors on transactions and issues across the commercial, retail and industrial property sectors. She also has a comprehensive understanding of the retirement villages sector having advised developers and operators on acquiring, establishing and operating facilities. Prior to joining McMahon Clarke, Natalie was a partner in the property division of a national firm and also in-house counsel for Buildev Development (Qld) and Opus Capital Limited.

Monica Hii (Senior Associate)

Monica has over 10 years’ experience in property law and focuses on commercial leasing. She advises shopping centre owners on leasing and general property matters and assists tenants with negotiating and finalising leases. She has also advised major banks and government bodies on property matters. Monica speaks Mandarin and Cantonese and is admitted to the High Court of Sabah and Sarawak, Malaysia.