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Through the small door

Feature Articles

Cite as: (2007) 81(7) LIJ, p. 46

For small investment schemes, the licensing regime exceptions offered by the Corporations Act may be a cost-effective alternative to obtaining an AFS licence.

By John Munro

For small investment schemes, the licensing regime exceptions offered by the Corporations Act may be a cost-effective alternative to obtaining an AFS licence.
By John Munro

A practitioner may be approached by a client with an idea for an investment venture. For one reason or another loan finance is not an option so capital is to be raised from investors, a course that may require obtaining an Australian Financial Services Licence (AFS licence). The small scale of the venture may make the process of applying to ASIC and obtaining such a licence impractical.

This article is not designed as a guide to evading the licensing provisions of the Corporations Act 2001 (the Act). The Act provides important protections for investors. Instead, the article aims to point out certain exceptions[1] provided for by the Act.

Licensing of investment schemes

The Act regulates the licensing of investment schemes. Parts 7.1 and 7.6 of Ch 7 of the Act prescribe the circumstances in which a promoter of an investment scheme is required to hold an AFS licence. Under Ch 7, an AFS licence is generally required to operate an investment scheme.

The usual structure of an investment scheme is a unit trust structure with a corporate trustee in which units are issued to investors. This structure constitutes what is termed in the Act a “managed investment scheme”.

The essence of managed investment schemes is that investors’ money is pooled (or there is a common enterprise) and investors do not have day-to-day control of the operation of the scheme.[2] In earlier legislation managed investment schemes were known as “prescribed interests”.

A managed investment scheme is required to be registered with the Australian Securities and Investments Commission (ASIC), subject to the exceptions discussed later in the article.

Licensing regime under the Act

For present purposes the licensing regime operates as follows. Section 911A of the Act requires that a person who carries on a financial services business[3] in Australia must hold an AFS licence. Section 766A sets out when a person provides a financial service. This includes operating a registered managed investment scheme: s766A(1)(d). It also includes dealing in a financial product: s766A(1)(b). Dealing in a financial product includes issuing a financial product: s766C(1)(b). Both shares and interests in certain managed investment schemes are financial products: s764A(1).

Thus, in general, the issue of interests in, and the operation of, a managed investment scheme requires the holding of an AFS licence. The same applies to the issue of shares in a company, subject to the exceptions discussed later in this article.

Exceptions for small managed investment schemes: registration and licensing

As mentioned previously, a unit trust will generally constitute a managed investment scheme. Subject to specified exceptions, a managed investment scheme is required to be registered with ASIC.

For small schemes, the Act provides for two exceptions to the obligation to register a management investment scheme with ASIC. They are:

  • under s601ED(1), if the scheme has no more than 20 members; and
  • under s601ED(2), if the scheme is not required to give investors a product disclosure statement (the equivalent of a prospectus) under Div 2 of Part 7.9 of the Act.

Although there is some overlap between these two exceptions, for licensing purposes there is a significant difference between them. Interests in a scheme that is exempt from registration under s601ED(1) is not a financial product, whereas interests in a scheme that is exempt under s601ED(2) is a financial product (provided it has more than 20 members). Thus the first registration exception gives rise to an exemption from holding an AFS licence while the second does not.[4]

However, while the exception under s601ED(1) would exclude the scheme interests from being financial products, the trustee of the scheme may still require an AFS licence if it is intended that the scheme invest in financial products, such as shares, on behalf of the scheme. This is because of the operation of s761A(1)(b), that is, dealing in a financial product by a trustee on behalf of a member of the scheme, may itself be considered to be providing a financial service.

The definition of “dealing” in s766C(1) includes acquiring (and disposing of) financial products. This may limit the scope of the scheme to investing in assets, such as property, that are not financial products if the trustee is considered to be carrying on a business.[5] It is worth noting that there is also specific ASIC class order relief from the registration and licensing provisions of the Act for small property syndicates and participating property syndicates, subject to certain conditions set out in the class orders CO 02/183 and CO 02/239.

There are a couple of anti-avoidance provisions designed to prevent promoters from artificially structuring schemes to fall within the s601ED(1) exception:

  • the promoter must not be in the business of promoting managed investment schemes. It is stressed that the exemption from licensing only applies to “one-off” schemes and any intention to promote other schemes may result in the exemption not being available. If there is an intention to promote more than one scheme, the promoter could be in danger of being regarded as “a person ... who was ... in the business of promoting managed investment schemes”: see s601ED(1)(b). This is likely to be the case if there was any evidence that the scheme in question “was the first in a business of promoting similar undertakings”.[6] Note too that the exception does not operate where the scheme is promoted by an associate of a person who was in the business of promoting such schemes. If the question of association is likely to be an issue, the practitioner should refer to ss10-17 of the Act.
  • the scheme must not be structured to get below the 20 member ceiling by splitting it into two or more schemes: s601ED(1)(c). ASIC has the power to determine that a number of schemes are related and to aggregate the number of members: s601ED(3).

Company shares

If a managed investment scheme is employed as the vehicle for operating an investment scheme, this effectively limits the number of investors to 20 if the requirement to obtain an AFS licence is to be avoided. If the contemplated venture involves more than 20 investors, an alternative structure may be an investment company raising capital by offering shares in the company to investors.

As noted previously, the carrying on of a financial services business, including a business of dealing in financial products, requires an AFS licence. Shares are financial products and issuing shares is dealing. Prima facie, therefore, the issue of shares requires an AFS licence.

Exemption for shares

There is, however, an exemption in certain circumstances for companies issuing their own shares. The relevant provision is s766C(4)(c) which reads:

“Also, a transaction entered into by a person who is, or who encompasses or constitutes in whole or in part, any of the following entities:...

(c) a body corporate or an unincorporated body;

is taken not to be dealing in a financial product by that person if the transaction relates only to:

(d) securities of that entity; ... ”.

For the purposes of Ch 7, “security” includes “a share in a body”.[7]

If s766C(4) applies, therefore, a company is not dealing by issuing its own shares and hence not providing a financial service. Consequently, there would be no requirement to hold an AFS licence for the issue of the shares.

Limitations on the operation of ss766C(4)(c) and (d)

Sections 766C(4)(c) and (d) operate subject to the restrictions in s766C(5). Section 766C(5) provides that the exemption in s766C(4)(c) does not apply if:

(a) the body corporate carries on a business of investment in securities, interests in land or other investments;[8]

and also

(b) in the course of that business, invests funds subscribed ... after an offer or invitation to the public (within the meaning of s82) ... ”.

There are thus two tests to be applied. First, does the company carry on an investment business as set out in s766C(5)(a)? Second, is there an “offer or invitation to the public”? If the answer to both is “Yes”, the exemption under s766C(4)(c) is not available. If the answer to either is “No”, then the s766C(4)(c) exemption applies.

Carry on business

Practitioners will be familiar with the general law relating to “carry on business”. It speaks in terms of a “series of repetition of acts”,[9] “features of continuity and system”[10] and “system, repetition and continuity”.[11]

Whether or not a particular scheme is “carrying on a business” etc. will need to be considered on a case by case basis.[12] Clearly the condition is restrictive in terms of the nature of the scheme, but perhaps not as restrictive as first appears.

In Ballantyne v Raphael[13] the Victorian Supreme Court held that a scheme involving a single transaction of purchasing a block of land, subdividing it and selling the subdivided lots did not amount to carrying on a business. This is reflected in the Explanatory Memorandum to the Financial Services Reform Bill 2001 (inserting the current Ch 7 of the Act) which states at para 11.5:

“The common law meaning of ‘carrying on a business’ encompassing elements of system, repetition and continuity suggests that one-off transactions relating to the provision of financial services and financial products are unlikely to be caught by the new regime”.

The scope of the scheme would, however, be a determinant. According to Dawson J in United Dominions Corp Ltd v Brian Pty Ltd,[14] “a single adventure under our law may or may not, depending on its scope, amount to the carrying on of a business”.

It is arguable on the basis of these authorities that the operation of a single scheme of limited scope may not amount to carrying on a business.

Offer or invitation to the public

Section 82 defines this term widely. Significantly, it includes an offer or invitation to any section of the public. It also provides that it is immaterial that the offer or invitation is made to clients of the person making the offer or is only capable of acceptance by the person to whom it is made.

In Corporate Affairs Commission (SA) and Another v Australian Central Credit Union[15] the majority of the High Court held that where there was a subsisting relationship between the offeror and the members of the offeree group or where there was a common characteristic of the offeree group which connected it to the offer, whether or not the offeree group was to be regarded as a section of the public would be determined by a number of factors, the most important of which would be:

  • the number of persons in the group (the larger the group, the more likely the offer would be caught as an offer to the public);
  • the subsisting relationship between the offeror and the members of the group;
  • the nature and content of the offer; and
  • whether the common characteristic had any connection with the offer.

Again, whether there is an offer or invitation to the public will depend on the specifics of the scheme. Note, however, that even if the scheme involves an offer etc. to the public, s766C(5) will not apply unless the “carry on business” requirement is also satisfied.

The intermediary exemption

Practitioners should also be aware of the exemption contained in s911A(2) of the Act. This provides, in summary, that the issuer of a financial product can enter into an arrangement with an AFS licence holder for the issue of the provider’s product under an “intermediary authorisation” arrangement: s911A(2)(b). The AFS licence held by the AFS licence holder must cover the type of financial product offered by the product provider. The product issuer would then be relieved of the requirement to hold an AFS licence itself.

Conclusion

If it is impractical for a promoter of a small investment scheme to obtain an AFS licence, two issues are relevant. The first is whether there will be 20 or fewer investors. If so, the scheme may be structured generally as a managed investment scheme, and neither registration with ASIC nor an AFS licence will be required.

If more than 20 investors are contemplated, the investment vehicle may be structured as a company but the question will be whether the scheme involves the carrying on of an investment business, with emphasis on the question of whether the “carry on business” test is satisfied. If not, it may be operated by a company issuing shares in itself and an AFS licence will not be required. Further, if there is no “offer or invitation to the public” as per s82 of the Act, no AFS licence is required, even if the business test is satisfied.

Finally, if the scheme enters into an “intermediary authorisation” with the holder of an existing AFS licence for the issue of interests in the promoter’s scheme, the scheme may not be required to obtain a licence itself.


JOHN MUNRO is a Victorian barrister, practising in corporations, criminal and administrative law. He was previously an investigator with ASIC.


[1] The word “exception” is used as shorthand. Technically the provisions of the Act do not apply in the circumstances outlined in this article.

[2] See the definition of “managed investment scheme” in s9. The definition includes time-share schemes but these are not relevant for present purposes.

[3] See notes 4 and 12 below for a discussion of “carrying on business”.

[4] Note that the “carry on business” test referred to in note 12 below will not apply where a scheme that has more than 20 investors and is required to be registered as an AFS licence is required to operate a registered scheme.

[5] As to what are and are not financial products, see ss763A (general definition), s764A (specific inclusions) and s765A (specific exclusions).

[6] See Australian Securities Commission v Woods and Johnson Developments Pty Ltd & Anor (1991) ACLC 1493 at 1496.

[7] See the definition in s761A. Shares are generally securities in the Act, but s761A provides definitions specific to Ch 7.

[8] See the definition of “investment” in s9.

[9] Smith v Anderson [1874-80] All ER Rep 1121.

[10] Hyde v Sullivan (1956) 56 SR(NSW) 113.

[11] Hungier v Grace (1972) 127 CLR 21.

[12] Note that for the licensing provisions of the Act to apply, s911(1) requires a person to be carrying on a financial services business. Note also that s761C provides that the matters set out in Div 3 of Part 1.2 of the Act (with the exception of s21(3)(e)) are to be taken into account in determining whether a business is, or is not, being carried on.

[13] (1889) 15 VLR 538.

[14] (1985) 157 CLR 1 at 15.

[15] (1985) 157 CLR 201. This case concerned s5(4) of the then Securities Industry Code (SA) which was in substantially similar terms to s82 of the Corporations Act 2001.

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