Some of the issues that can arise when there is substantial market volatility have been considered in Basis Capital Funds Management v BT Portfolio Services Limited (2008) NSWSC 766 (28 July 2008).
This case also involved consideration of a number of the financial services provisions in Chapter 7 of the Corporations Act 2001 (Cth). Although the case concerned a managed investment scheme, the issues considered have relevance for a superannuation fund.
The case considered:
- The nature of the interest acquired when application moneys are received and when the relevant interest was issued on an application for new units in a managed investment scheme.
- The dealing with money obligations in section 1017E.
- Redemptions - whether the trustee had the ability to defer and apply a different price after the date for redemption in the trust deed had arrived.
- Whether the Chapter 5C liquidity provisions of the Corporations Act applied.
Nature of interest acquired on application for an interest
The Court went through the steps that were involved in the issuing of units by the trustee of a unit trust. At the time of receipt of money there is a contractual right to the issue but no issue of the interest. The application had to be processed - the contractual right to the interest was itself a financial product in terms of section 761E.
Both the contract to issue the interest and the issue of interest were financial products in terms of the definition 'financial product' in Chapter 7 of the Corporations Act.
Apart from statutory provisions as to return, once the interest in the trust was issued, the application moneys became part of the trust fund and any rights are that of a unit holder rather than a contractual right to issue of units.
The equivalent provision in section 761E(3), in the case of superannuation funds, is the issue of an interest to a member. Member is not defined and, accordingly, the meaning of member in the trust deed would be relevant. So, in the case of a superannuation fund, it is the time when the person becomes a member. This requires an analysis of the deed. If silent, it is presumably when entered as a member in the records of the fund.
There may also be a contractual right to issue the interest. This will depend on the circumstances of the application - an individual application in response to a PDS may well constitute a contract. However, it will often be the case that the employer enrols under an employer sponsor arrangement that has no contractual force - no deed - and therefore no consideration moves to the employee from the trustee.
Section 763B could apply - the payer intends the recipient to use the money for investment. So, the process prior to the issue of the superannuation interest raises the possibility of an intermediate financial product.
Statutory right of return
Section 1017E imposes on the issuer a statutory return obligation. It applies to the interest for which the money is paid, not the contractual (or other) right to acquire the interest.
Section 1017E was held to require return within 30 days unless it is not reasonably practicable to do so. Justice Austin looked at the dictionary meaning of 'practicable' - 'capable of being put into practice, done or effected, especially with the available means or with reasonable prudence: feasible'. It was not the case that it was at the discretion of the user. It was a question of whether it was physically possible.
This is relevant in the context of contributions to meet superannuation guarantee (SG). That is, whether time can be extended where the employer fails to provide sufficient information to enable the interest to be issued, but at the same time would not be expecting a return in circumstances giving rise to an SG liability. It will be physically possible to return the contribution, but the payer would not regard it as being reasonable to thereby impose such an unexpected liability on the payer by so doing.
While it is physically possible to return the contribution, to do so would not be to exercise reasonable prudence as far as the payer is concerned. The payer has not been given an opportunity to avoid the tax liability that will arise from return.
It is arguable that circumstances in which the payer made the payment can be examined. Convenience of the issuer clearly cannot.
Trustees need to review their procedures as to when issue occurs to identify when section 1017E applies.
Switching procedures - redemption
Freezing of redemptions cannot be applied once the date for redemption has arrived.
In terms of the trust deed, the right of redemption had crystallised - the rights transmuted from that of a unit holder to that of a creditor.
Justice Austin also held it would not be fair in terms of any obligations under section 601GA(4) of the Corporations Act to permit suspension after the obligation to redeem had arrived.
SIS equivalent to section 601GA(4) is section 52(2)(c)
Trust deeds, to allow a deferral or suspension after the date for payment has arrived, need terms that allow deferral of the payment date.
Redemption also needs to be in terms set out in the deed. Once the time for redemption arrives, the member becomes a creditor with a right to be paid the redemption amount. It is not clear how this applies to a superannuation fund. Arguably a person does not cease to be a member until payment of benefit has been made.
It is also relevant for switching from one investment to another within the fund - the right to switch arises at a point in time as determined by the terms of the fund.
One unit holder had requested withdrawal and the trustee agreed to withdraw their request. It was held the unit holder could by agreement with the trustee withdraw that request.
The trustee in Basis Capital claimed the fund was not liquid and so it could freeze. Section 601KA(2) of the Corporations Act only meant it was not liquid where assets could not be realised within the redemption period at market value (section 601KA(6)). This had no application where there had been a dramatic fall in market value. Assets could be realised at market value, it was just this reduced market value was considered too low.
The equivalent SIS provisions should give the opposite result. Regulation 6.34(7) of SIS provides for the freezing of redemption and transfer where investment is illiquid in terms of Regulation 6.31(1). The test is that it cannot be converted to cash in the redemption time, or conversion would have a significant adverse impact on the realisable value of the investment.
This should result in the opposite outcome, as the readily realisable market value can have a significant adverse impact on value.
Trust deed terms need to provide sufficient flexibility to deal with market volatility and pricing errors.
Each stage in each transaction needs to be analysed, and the terms of the trust deed must permit rights sufficient to allow the trustee to react as it considers appropriate. In addition, appropriate policies and disclosure are required.
Disclosure needs to be appropriate.
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