Responsible entities and protecting the rights of investors

As corporate and scheme failures continue to emerge as a result of the financial crisis, the merits of engaging an independent responsible entity are being revisited, so as to avoid both actual and perceived conflicts. Vicki Allen discusses.

As corporate and scheme failures continue to emerge as a result of the financial crisis, the merits of engaging an independent responsible entity are being revisited, so as to avoid both actual and perceived conflicts. Vicki Allen discusses.

The economic downturn triggered by the global financial crisis of 2008 has played havoc with equity and debt markets in Australia.

As the number of corporate failures increase, the calls are getting louder for independent responsible entities to be appointed, particularly in the managed investment scheme arena.

The Managed Investments Act 1998 requires that a responsible entity (RE) be appointed to a managed investment scheme (MIS), taking on the dual role of trustee and manager, monitoring and protecting the interests of the underlying scheme or fund investors.

The Act imposes important responsibilities on the RE, including the duty to act honestly, to exercise a reasonable degree of care and diligence, to act in the best interest of the members of a scheme, and to treat scheme members equally.

Traditionally, in distressed situations the role of RE has been performed by the administrator or liquidator of an MIS. On face value, this might make sense. However, in distressed situations, uncertainty reigns and conflicts of interest can and do regularly occur.

The duty of an administrator or liquidator is to achieve the best possible outcome for the creditors of an MIS or fund — not the underlying investors themselves.

Therefore, taking into account that investors are not usually creditors, an administrator can find itself in a conflicted situation.

As corporate and scheme failures continue to emerge as a result of the global financial crisis, the merits of engaging an independent RE are being revisited by experienced insolvency practitioners and industry bodies, so as to avoid both actual and perceived conflicts.

For example, if investors in a distressed MIS needed to pursue the manager of the MIS for a particular claim, or vice versa, the administrator or liquidator pursues the interests of the creditors and the independent RE pursues the interests of the underlying investors, thereby ensuring appropriate representation of all parties.

Recent corporate failures are instructive on this issue. When Timbercorp went into administration, 18,400 investors had invested $2 billion in the 33 managed investment schemes run by the group.

Until April 2009, Timbercorp Securities, a subsidiary of Timbercorp, had played the role of responsible entity of the schemes.

However, with the collapse of the Timbercorp Group, Timbercorp Securities was found to be hopelessly insolvent and in liquidation.

In subsequent developments, some of the individual Timbercorp schemes have appointed independent REs.

In these cases, the underlying investors have argued that their respective schemes remain viable and solvent and should be immune from any group-wide wind-up.

The actions of these ‘grower investors’ in appointing an independent RE sends a signal to the financial services industry from underlying investors; their interests remain paramount in distressed situations.

Professional trustee companies providing RE services bring specialist skills and technical expertise to an MIS at its most critical time.

They help investors and unit holders work through issues and assist in avoiding a fire sale of assets.

This is particularly the case where borrowings are involved and debt covenants and arrangements are triggered by banks.

These specialist skills also provide flexibility and speed, as practical areas of concern can be identified and prepared for before they arise.

Appointing an independent RE can also bring significant cost savings for investors in an MIS, in some cases costing a scheme up to 80 per cent less than insolvency practitioners, and at a time when the preservation of any remaining capital is of paramount importance.

When urgent circumstances arise and time will not permit the removal of an existing RE and the appointment of a permanent replacement, independent REs can fill the gap.

There is an argument that it should be the Australian Securities and Investments Commission (ASIC) that appoints a workout RE, and not the insolvency practitioners or bankers, when a scheme is in difficulty.

This argument has considerable merit, as this practice would give greater opportunities for the scheme to revive its fortunes.

Indeed, the current Ripoll inquiry into Financial Products and Services in Australia has released a report recommending the corporate watchdog be given new powers to appoint a temporary RE to manage schemes that have collapsed.

Currently, it is possible for investors to call a meeting, subject to obtaining enough member agreements, to remove an RE, as was seen in the Timbercorp example.

Considering the havoc that many investment schemes have encountered recently, and are likely to encounter in the months ahead, the time is right to ensure that underlying investors don’t fall prey to the wind-up stampede.

Vicki Allen is chief operating officer at Trust Company Limited.