WRIGHT PATTON SHAKESPEARE CAPITAL LIMITED And AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION
[2008] AATA 1068
•28 November 2008
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2008] aata 1068
ADMINISTRATIVE APPEALS TRIBUNAL )
) No 2007/0697
GENERAL ADMINISTRATIVE DIVISION ) Re WRIGHT PATTON SHAKESPEARE CAPITAL LIMITED Applicant
And
AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION
Respondent
DECISION
Tribunal Senior Member Bernard J McCabe Date28 November 2008
PlaceBrisbane
Decision The Tribunal sets aside the decision under review and remits the matter to the respondent for reconsideration in accordance with these reasons pursuant to s 43(1)(c)(ii) of the Administrative Appeals Tribunal Act 1975. ......................[Sgd]........................
Senior Member
CATCHWORDS
CORPORATIONS – Supervision, Regulation and Correction – Product disclosure statement – Corrective product disclosure statements – Stop order – Product disclosure statements defective or not worded in a clear, concise and effective manner – Whether applicant’s product disclosure statements contain information which retain client would require for the purpose of making decision to acquire the financial product – meaning of “retail client” – Respondent claims applicant’s product disclosure statements defective or not worded in a clear, concise and effective manner – Failure to disclose establishment fees – Failure to disclose withdrawal information – Failure to include information about loans to related parties – Failure to include sufficient information about authorised investments – Failure to include information about valuation policy and limits of loans – Failure to include sufficient information about cash-flow management – Failure to disclose reasonable basis for prospective financial information – Decision set aside and remitted
Administrative Appeals Tribunal Act 1975 (Cth), s 43
Australian Securities and Investments Commission Act 2001 (Cth), s 1
Corporations Act 2001 (Cth), ss 760A, 769C, 1013C, 1013D, 1013E, 1020D, 1020E, 1022A
Trade Practices Act 1974 (Cth), s 51A
Re Drake and Minister for Immigration and Ethnic Affairs (No 2) [1979] AATA 179; (1979) 2 ALD 634
Re Wright Patton Shakespeare Capital Limited v Australian Securities and Investments Commission [2007] AATA 2101
Morning Star Co-operative Society Ltd v Express Newspapers Ltd (1979) FSR 113
Re Pacific Hotels Pty Ltd v Asian Facific International Limited [1986] FCA 297
REASONS FOR DECISION
28 November 2008 Senior Member Bernard J McCabe 1. Wright Patton Shakespeare Capital Limited is the applicant in these proceedings. It is locked in a dispute with the regulator, the Australian Securities and Investments Commission (“ASIC”), over the content and presentation of the product disclosure statements issued in connection with the Wright Patton Shakespeare No 2 Mortgage Fund. ASIC has issued what is known as a “stop” order under s 1020E of the Corporations Act 2001 (“the Act”) which prevents the documents being used to promote the Fund.
2. ASIC decided the applicant’s original product disclosure statement (“the PDS”) was defective in a number of respects. The applicant disagreed with this view but drafted a supplementary product disclosure statement (“the SPDS”) to address ASIC’s concerns. ASIC now says the proliferation of documentation has created a fresh problem: the documents no longer present the appropriate information in “a clear, concise and effective manner” as required under s 1013C of the Act.
3. The applicant has since issued a fresh PDS in connection with its Fund but it is determined to press its application for review in respect of the earlier documents. It disagrees with ASIC’s criticism of the original PDS. It adds that in any event the original PDS and the SPDS read together meet the obligations in s 1013C. The applicant appears to think ASIC is treating it unfairly. ASIC says it would be futile for the Tribunal to conduct a review because a fresh PDS has now been issued.
4. I am not convinced ASIC is right on the question of futility. It will therefore be necessary for me to consider ASIC’s nine objections to the original PDS, as well as its objection to the issue of a SPDS.
The factual background to the dispute
5. The applicant holds an Australian Financial Services Licence. It has established several investment funds which it promotes to retail investors. It had difficulties with ASIC in relation to an older product, the No 1 Mortgage Fund. ASIC issued a stop order in respect of the documents issued in connection with that Fund. There were lengthy negotiations over a supplementary product disclosure statement. The documents in relation to the No 2 Mortgage Fund were apparently prepared with an eye to the earlier difficulties. The applicant’s counsel suggested in written submissions that the applicant thought it had addressed all of ASIC’s concerns in the new documents.
6. The No 2 Mortgage Fund is a pooled mortgage fund. It makes money by advancing loans to commercial borrowers who pay interest. The loans are secured by mortgages over real property. Investors in the Fund expect returns on their investments in the form of monthly distributions. The applicant is the manager and responsible entity of the Fund, although Perpetual Trustee Company Limited acts as the custodian that holds all of the assets and securities.
7. A PDS in relation to the No 2 Mortgage Fund was issued on 3 October 2006: Exhibit 1 at folios 109-147. ASIC wrote to the applicant on 18 December 2006 enclosing a Statement of Concerns about the PDS and advertisements promoting the product. A copy of the letter is found at Exhibit 1 at folios 192-214. An interim stop order was issued to prevent the applicant from proceeding with its promotional activities. The applicant produced a draft SPDS during the course of the negotiations that followed.
8. A delegate conducted a hearing on 8 January 2007 to formally discuss ASIC’s Statement of Concerns. In the meantime, the applicant produced a further draft SPDS for ASIC’s consideration. A copy of that document is found at Exhibit 1 at folios 306-307.
9. ASIC was unmoved. A final stop order in respect of the PDS and SPDS was made on 11 January 2007: Exhibit 1 at folio 41. In the Statement of Reasons dated 9 February 2007 (Exhibit 1 at folios 7-16), the delegate briefly explained why she upheld ASIC’s concerns that were set out in the Statement of Concerns. She also found (at folio 15 [34]) the applicant’s proposed form of corrective disclosure addressed all but one of those concerns. However, the delegate went on to add that the form of corrective disclosure was inadequate because there were so many problems with the PDS that it would be practically difficult to read the PDS and the SPDS together. She concluded (at folio 16 [35.5]) the applicant must effectively start again by issuing a fresh PDS if it wished to market the Fund to investors.
The statutory scheme
10. I will turn shortly to address ASIC’s concerns. Before I do that, I will describe the statutory scheme.
11. The starting point of the discussion is s 1(2) of the Australian Securities and Investments Commission Act 2001 (“the ASIC Act”) which sets out ASIC’s objectives. I will not reproduce those objectives here, but I am conscious that they are binding on the Tribunal: s 1(3) of the ASIC Act. I must take them into account in the course of my deliberations. I must also be conscious of the objectives of Chapter 7 of the Act. Those objectives are set out in s 760A.
12. The Act imposes a series of obligations on entities offering financial products to retail clients. Less stringent regulations apply to entities dealing with wholesale clients who are better able to protect their own interests. There is no question the applicant in this case attracts the operation of the more comprehensive rules that regulate retail arrangements.
13. The rules include a requirement that the entity prepare a PDS in connection with each financial product. The PDS must be provided to a retail client who is considering whether to acquire the product.
14. There are rules set out in Part 7.9 of the Act, Div 2 Sub-div C regulating the content and presentation of a PDS. If a PDS does not conform to those rules, ASIC is able to step in. Section 1020E(1) permits ASIC to determine that a PDS (or SPDS) (a) is “defective” or (b) is not “worded and presented in a clear, concise and effective manner”. The definition of “defective” is found in s 1022A. A disclosure document might be defective in the relevant sense because it:
·contains a misleading or deceptive statement (which includes statements as to future matters that are deemed to be misleading or deceptive in certain circumstances: s 769C(1)); or
·omits material that the Act says must be disclosed. A number of provisions refer to matters that must be disclosed. Of particular interest for present purposes, s 1013D identifies a number of matters that must be addressed in the PDS, including information about significant benefits and risks of the product, information about costs, fees and commissions, and information about other significant characteristics or features of the product. Section 1013E imposes a general obligation to disclose other matters that might reasonably be expected to have a material influence on a retail client’s decision to acquire the product.
15. I should say a word about the hypothetical retail client who acquires products of this kind (as opposed to products of a different kind, or products that are marketed to investors with particular identifiable qualities). The “retail client” concept is central to the operation of s 1013D in particular. That person will typically be reasonably intelligent; at a minimum, the decision-maker should not assume the retail investor is obtuse, unusually stupid, or prone to behave like a “moron in a hurry”: Morning Star Co-operative Society Ltd v Express Newspapers Ltd (1979) FSR 113 at 117 per Foster J; see also Re Pacific Hotels Pty Ltd v Asian Facific International Limited [1986] FCA 297 at [28] per Spender J. While not expert in matters of finance, the retail client will exercise ordinary common sense and be reasonably diligent and reflective when deciding whether to make an investment. He or she may be less interested in technical details than regulators sometimes assume. The retail client can read what is plainly explained without drawing unlikely or off-beat conclusions. He or she has a reasonable tolerance for risk, especially where the investment opportunity in question involves financing property development. I do not suggest the individual will be incautious, but he or she is unlikely to approach a document with the lawyer’s forensic eye for nuance and heightened sensitivity to risks, both real and imagined.
16. The Act does not define the expression “worded and presented in a clear, concise and effective manner”. I was provided with a copy of ASIC’s Regulatory Guide 168, entitled Disclosure: Product Disclosure Statements (and other disclosure obligations), which is designed to provide “policy guidance” on preparing a PDS. Regulatory Guide 168 also sets out ASIC’s “Good Disclosure Principles” that are helpful in forming a view about whether the document is presented in an appropriate way. The policy document is not binding on the Tribunal, but the decision of Brennan J in Re Drake and Minister for Immigration and Ethnic Affairs (No 2) [1979] AATA 179; (1979) 2 ALD 634 makes it clear (at 643) that the policy should at least be considered in the course of the Tribunal’s deliberations to avoid the evil of inconsistency.
Asic’s nine areas of concern in relation to the pds
17. I turn now to the matters identified by ASIC in its Statement of Concerns. The first issue was referred to as a failure to disclose establishment fees. The establishment fees in question are those paid by borrowers who take advances from the Fund. The investors are not liable to pay the fees; indeed, they are the ultimate beneficiaries of the fees in the sense that fee income is paid into the Fund along with interest payments and the repayment of principal.
18. The amount of establishment fees is not disclosed in the PDS, although the applicant argues information about the fees and their impact on distribution rates can be ascertained easily enough by visiting the applicant’s website or making a telephone call to its office. The applicant says the establishment fees are not a significant characteristic of the product that must be disclosed in the PDS pursuant to s 1013D(1)(f). ASIC disagrees. ASIC notes fees paid by a borrower feed into the income of the Fund which affects the rate of return. ASIC says investors would expect to be told about anything that affects the rate of return on the investment.
19. Why would the applicant resist including information about establishment fees? The income generated through these fees can only have a positive impact on the return to investors. Even if the fees make a minor contribution to the Fund’s income and rates of return, as the applicant contends, is there any harm (or even some marketing benefit) associated with the disclosure?
20. The applicant has an answer. In its submissions, it says (at [77]) that none of its competitors disclose this information. The applicant argues that including the information in its PDS creates a risk that consumers who are comparing investment opportunities will become confused if establishment fees are treated differently in comparable PDSs. In this regard, the applicant notes Regulatory Guide 168 at RG 168.62 refers to the desirability of drafting a PDS to make it “easier for consumers to make comparisons … between two or more competing financial products”. The Regulatory Guide goes on to say (at RG 168.64) that a product issuer should comply with any relevant industry standards (there are none in issue here) and refers to the danger that a product issuer might mislead a consumer if it “fails to follow industry practices that consumers would expect it to follow …”.
21. I will accept for the purposes of the argument that the PDSs referred to by the applicant are issued by entities that are properly characterised as the applicant’s competitors so that a comparison might validly be made. I indicated in Re Wright Patton Shakespeare Capital Limited and Australian Investments and Securities Commission [2007] AATA 2101 (at [18]) that a bare comparison of the PDSs issued by rivals was likely to be of limited use because the comparison could do no more than establish that a practice of non-disclosure existed. I have not been provided with any evidence to suggest the perceptions of investors had been shaped or conditioned by such a practice to the extent that a departure from it could mislead. In the absence of such evidence, I am left to form my own view as to whether a retail client would reasonably require the information for the purpose of making a decision to invest. Is the imposition of establishment fees a significant characteristic or feature of the product?
22. If the establishment fees were a cost to the Fund that had the potential to reduce returns, I would not hesitate to find the imposition of fees was something that should be disclosed. But that is not the situation here. The decision not to disclose the practice of charging borrowers an establishment fee that increased the income of the Fund might yield a pleasant surprise for investors who did not make further inquiries. There is a theoretical risk that a loan becomes more risky if establishment fees are charged because the borrower must go further into debt. Whether that makes any practical difference to the riskiness of the loan is unclear.
23. I am ultimately persuaded that the imposition of establishment fees should be disclosed in the PDS. The test in s 1013D of the Act refers to matters that would be relevant to the decision whether or not to invest. While the detail of charges or risks are obviously important to that decision, retail investors would also reasonably expect to be told of things that might make the investment more attractive. The statute does not anticipate a product issuer hiding its light under a bushel. If the feature is significant, it does not matter whether it is a negative or a positive.
24. The applicant argues the contribution of the establishment fee income to the rate of return is minor. The parties did not draw my attention to any figures that would enable me to be persuaded that the contribution was so small that a retail investor would reasonably ignore it.
25. It follows I am satisfied ASIC’s first concern is made out. I am not persuaded that requiring the applicant to make the disclosure would make it more difficult for the retail investor to compare the applicant’s product with other similar products. The additional detail is unlikely to faze or confuse a retail investor acting reasonably.
26. ASIC’s second concern was the applicant’s alleged failure to summarise fee information. The PDS includes a table in section one at p 3 of the document with the heading “Key Features”. The table includes a number of subheadings, including “Entry Fees”, “Exit Fees” and “Other Fees”. Under the first heading, the table informs the reader: “No entry fees are payable.” Under the second hearing, it says: “No exit fees are payable when investments are held until maturity.” Under the third heading, it reads: “For the other fees payable from the Fund refer to Section 8”.
27. Section eight is found at pp 19-21 of the PDS. It refers to establishment, contribution, withdrawal and termination fees, all of which are classified as “Fees when your money moves in or out of the Fund.” I take it those fees are the “Entry Fees” and “Exit Fees” referred to in the table of key features. Section eight also includes information about management fees and expenses. It includes a “dollar fee example” at p 21. ASIC says the example is inconsistent with the information provided elsewhere. I acknowledge that the example singles out contribution fees without referring to the other species of Entry and Exit Fees. The example is less helpful than it could be, but I do not think it misleads the retail investor acting reasonably.
28. ASIC also criticised the failure to include information about management and other fees and expenses in the table of “Key Features”. ASIC says the information would be relevant to the investor. It says the decision to leave this information out of the table of “Key Features” rendered that table effectively unintelligible. I disagree. I am satisfied a retail investor acting reasonably would consult the Key Features table and note the reference to other fees in section eight. The information is clearly flagged, readily accessible and tolerably clear to anyone who wants to read it. Attempting to summarise important information about management fees and costs in a “Key Features” table would in any event be difficult, and perhaps undesirable. It is appropriate that the reader be clearly directed to the finer print.
29. I am not satisfied the applicant has failed to comply with its obligation under s 1013D(1)(d) to include information about costs, fees, expenses or charges. I am satisfied the information is presented in a clear, concise and effective manner. It follows I do not accept ASIC’s second concern is made out.
30. The third concern identified by ASIC was a failure to summarise withdrawal information. Recent events in the financial markets have drawn attention to the need for promoters to spell out the rules regulating withdrawals. That information is referred to in the “Key Features” table in section one of the applicant’s PDS and in section 10, which is titled “Additional information”. ASIC says the disclosure is inadequate because the information is not presented in a clear, concise and effective manner. It also says there is not enough information to satisfy the requirement in s 1013D(1)(f) that the applicant provide information a retail investor would reasonably require in relation to a significant characteristic of the product or one of the “rights, terms, conditions or obligations attaching to the product”.
31. The “Key Features” table includes a subheading “*Withdrawals”. The point of the asterisk is unclear. It does not appear to be connected with a footnote. The text accompanying the subheading reads as follows:
The Manager expects to pay withdrawals within two business days of receipt of a valid withdrawal request for Access Account investors or at the end of a fixed investment term. The Constitution allows the Manager to delay payment of withdrawals by up to 180 days or in particular circumstances for a further 180 days. (Refer to Section 10)
32. Section 10 includes information about a range of topics, including complaints resolution and the imposition of differential fees. Information about withdrawals is found at p 25. The entry with respect to withdrawals does not repeat the remark in the “Key Features” table about the Manager expecting to pay withdrawals within two days of receiving a valid notice from an Access Account holder, or within two days of the expiration of a term investment. The entry at p 25 refers to the Constitution permitting the Manager to take up to 180 days to pay valid withdrawal requests. The entry goes on to talk about the circumstances in which the Fund may extend the period allowed for repayment by a further 180 days.
33. ASIC says the note in the “Key Features” table makes the product sound like an “at call” arrangement, while a close reading of the note in section 10 makes it clear that a lengthy delay in repayments might occur in some cases. ASIC says there is ambiguity in the “Key Features” table that should be clarified.
34. I disagree. The note in the “Key Features” table expressed what is clearly a hope or expectation that the Fund would make repayments within two days of a valid demand being made. While a reasonable retail investor would undoubtedly anticipate payments being made within that time frame in the ordinary course, he or she would also appreciate from the note that repayments might not occur so quickly, and that substantial delays might occur if there were issues of the kind referred to in section 10. The applicant points out that the provision of information involves a balancing process: too little information is an obvious problem, but too much detail is equally problematic because it can obscure the message. I think the applicant has struck the right balance in this case. I do not accept the discussion of circumstances in which a delay might occur is inadequate, or that the information is not presented appropriately. The retail client has access to the information about withdrawal rights that he or she reasonably requires in order to make an investment decision.
35. I turn now to ASIC’s concern about the failure to include information about loans to related parties. A note about related-party loans is found in section four of the PDS at p 6 which is headed “Further Information on the Investment”. The note says:
The Fund may provide loan advances to parties involved in property development and property investment including parties who are related to the Manager. All loans to related parties will be assessed in the same manner as loans to unrelated parties and will be subject to compliance with the lending policies of the Manager, including loan security. In the early stages of the Fund related party loans may comprise a significant proportion of the assets of the Fund. The Corporations Act requires that loans to related parties will be made on arms-length commercial terms.
36. The PDS also refers to the issue of related-party loans at p 17 under the heading “Related party loans”. It says:
The Fund may provide loan advances to parties who are related to the Manager. In the early stages of the Fund related party loans may comprise a significant proportion of the assets of the Fund.
The Fund has lending policies and procedures for providing loan advances to related parties. All such loans will be assessed in the same way as loans to unrelated parties, will be made on arms-length commercial terms, and will be subject to compliance with the lending policies of the Manager, including loan security. The Board must approve all loans to related parties.
37. There is a further entry on p 25 under the heading “Disclosure of Interests”. The entry refers to a number of matters but adds:
Directors or their associates may borrow from the Fund. Any such loans will be made on an arms length basis and must comply with the lending policies of the Manager. Board approval is required for all loans to associated parties. Details of any related party loans will be disclosed in the quarterly Fund updates issued by the Manager.
38.
There are also references to related-party loans at p 14 and (obliquely) at
p 18.
39. ASIC says this disclosure is inadequate. It notes there is no information about:
·the identity of the related parties to whom loans have been or might be made;
·how many loans have already been made; and
·what percentage of the loan portfolio is or will be involved.
40. ASIC says the PDS does not satisfy the requirements in ss 1013D(1)(c) of the Act, which requires disclosure of information about significant risks that the retail investor would require in order to make a decision. ASIC also says the PDS fails to satisfy s 1013D(1)(f), which requires information about significant features or characteristics of the product or any rights, terms conditions or obligations attaching to the product.
41. The applicant points out the Fund had not made any loans to anyone at the time the stop order was made. There was nothing specific to disclose at that point. It says the PDS clearly signalled to investors that significant loans were likely to be made to related parties. The PDS described the lending approval process in general terms and offered assurances about disclosure of related-party loans on a quarterly basis. The applicant pointed out it issued supplementary PDSs in March and April 2007 which included information about related-party loans shortly after they were made.
42. I do not agree that the PDS fails to comply with the obligations referred to in ss 1013D(1)(c). Making loans to related parties involves obvious risks. The intention to make the loans has been clearly disclosed in the PDS. I accept the PDS does not identify a precise percentage of the Fund’s assets that will consist of related-party loans. It nonetheless makes clear these loans are likely to account for a “significant proportion of the assets of the Fund” during the early stages in particular. The retail investor has probably been told all that he or she reasonably needs to know pursuant to s 1013D(1)(c) about the risks associated with the investment. I do not accept that such an investor needs the PDS to “spell out” an obvious risk of this nature.
43. On the same basis, I do not think it could be said that a retail investor acting reasonably would expect more elaborate disclosure pursuant to s 1013D(1)(f). Once he or she becomes aware that related-party loans will be a feature or characteristic of the applicant product, that investor surely knows what he or she is getting into. I do not think the investor is likely to derive much assistance from the detailed disclosure of the lending policies in the PDS. That sort of disclosure might tend to obscure the risk with turgid detail, rather than illuminate it.
44. It follows I do not accept ASIC’s concern about related-party loans has been made out.
45. I turn next to ASIC’s concern that the PDS failed to include sufficient information on authorised investments.
46. The principal remarks about authorised investments are found at p 6 of the PDS. It says:
The Constitution of the Fund allows the Manager to invest in a range of Authorised Investments which include but are not limited to deposit products with authorised deposit taking institutions, cash management trusts and other related or unregistered managed investment schemes where the Manager is satisfied with the credentials of that manager. These investments may form part of the Fund’s investments whilst sourcing suitable loan advances and when suitable loan advances are not readily available.
47. The purpose behind the disclosure is clear enough: the Manager wants the Fund to have alternative investments available when it is unable to identify appropriate borrowers in the course of its primary business of lending money to property developers and others on the security of registered mortgages. That seems fair enough. But has the PDS done enough to identify what those alternative investments might be?
48. The applicant notes the PDS contains a further reference to authorised investments at p18. The entry at p 18 repeats some of what is said at p 6 and adds:
There is a risk that the party with whom the funds are invested may itself suffer liquidity problems and/or losses that inhibit its ability to meet interest or distribution payments or return part or the entire principal sum invested.
49. I would have thought this statement was unnecessary in the sense that the retail client I have described in these reasons would realise the Manager cannot and does not guarantee the performance of any investment in these circumstances. But the central question remains: has the retail client been provided with enough information about the nature of the alternative investments to make an informed decision as to whether he or she should invest money in the Fund?
50. I agree with ASIC’s claim that the discussion of the type of investments that will be included in the definition of “Authorised Investments” is vague and open-ended. A potential investor cannot make a sensible decision about investing in the product unless he or she knows more about the risks attached to different kinds of investments. The alternative investments may be more or less risky than the Fund’s principal business of making advances to property developers and others against the security of registered mortgages. It follows I am not satisfied the PDS complies with the obligation in s1013D(1)(c) to disclose significant risks associated with holding the product. I also agree that a properly articulated investment policy is a significant feature of the Fund that one would ordinarily expect to see disclosed as required in s 1013D(1)(f).
51. ASIC’s next concern relates to the alleged failure to include sufficient information on valuation policy and limits to loans. Valuations and valuation policy are dealt with at p 9 under the heading “A Secured Investment Fund”. The relevant extract reads:
The current lending policies adopted by the Manager provides for a maximum loan-to-valuation ratio of 80%.
Loans for construction and development are limited to 80% of the On-completion Valuation of the development as set out in a Valuation by an approved, suitably qualified and independent, registered valuer. Progressive loan draw downs during the development phase are monitored by the Manager and confirmed by a suitably qualified and independent quantity surveyor. The Manager retains sufficient loan funds as recommended by the quantity surveyor to complete the project in line with the On-completion Valuation.
In all cases, Valuations of security properties must be dated not more than 3 months before the date of the first advance.
52. There is also information about valuations in section six, which discusses lending policies, and in section seven, which discusses risk and risk management.
53. A retail client would reasonably expect to be provided with sufficient information about valuation policies to enable him or her to make a decision about whether to invest in the product. The information is necessary in order for the retail client to assess the risk: s 1013D(1)(c). It might also speak to the features or characteristics of the investment: s 1013D(1)(f). Does the information disclosed in the PDS satisfy those obligations?
54. ASIC says no. The delegate criticised the absence of detailed information about the valuation policy. The delegate said the PDS did not identify limits to the number and amounts of loans or the types of development. The delegate was also concerned that there was no indication of any geographical limit to the loan portfolio. There was no information about the then current loan portfolio.
55. The applicant says there was no reference to limits on the number of loans made to construction and development borrowers because there were no limits. But it appeared to concede that there was inadequate disclosure in the original PDS with respect to some of the delegate’s other issues. The applicant’s submissions pointed out that the Manager’s lawyer had explained the details of the valuation policy to the apparent satisfaction of the delegate at the hearing. But as ASIC rightly observes in its submissions, the lawyer’s oral explanation to the delegate is beside the point because the information should be disclosed in the PDS.
56. It is difficult to know whether the ordinary retail client would derive much assistance from detailed information about valuation policies and practices. The details might interest a sophisticated investor who was familiar with the niceties of valuations. The ordinary retail client might not know what to make of the information in the PDS, and providing still more information will not necessarily enlighten him or her.
57. I do not share ASIC’s concern about the extent of the detail per se. Requiring that the applicant disclose additional information is pointless unless the information is explained in a way that makes sense to the retail client. He or she requires an explanation of valuation policies that incorporates sufficient details about the policy together with clear explanations of (a) the significance of that information and (b) how it impacts on the investor’s risk.
58. The original PDS runs into difficulty because the information provided about valuations is not clearly explained. The answer does not lie in providing still more information. Indeed, it may be possible to leave out some of the details which have already been provided if the explanations of the valuation policy and its import were clearer.
59. I am not satisfied the disclosure in relation to valuation policies provides the retail client with the information he or she reasonably requires to make an informed assessment about the risk of the product. He or she might also be unclear about important features or characteristics of the product. It follows the applicant has not satisfied the obligations in ss 1013D(1)(c) and 1013D(1)(f).
60. ASIC’s seventh issue relates to the alleged failure to include sufficient information on the types of borrowers. The risk of borrowers being unable to service or repay their loans is discussed at p 15 of the PDS. ASIC says it is particularly worried by the applicant’s failure to disclose it might make advances to borrowers who are denied finance by traditional lenders. According to ASIC, that is a specific risk which ought to be disclosed in order to meet the applicant’s obligations under ss 1013D(1)(c) and 1013D(1)(f).
61. The applicant says ASIC proceeds from the questionable assumption that construction and development borrowers are “high risk” borrowers. It also says the fact some of the borrowers are refused finance by a traditional bank does not necessarily indicate a higher level of risk. Some borrowers prefer to deal with entities like the applicant precisely because they have more flexible lending policies and can make decisions quickly. The applicant points out that many funds operating in the same business have enjoyed relatively low-default rates in the past.
62. The applicant’s submissions also refer to the discussion of debt serviceability in section six of the PDS at p 14. That entry reads:
In assessing loan applications, the Manager does not intend to rely on the potential borrower’s ability to show proof of serviceability. However, the Manager will obtain and review a credit reference report from a credit reference agency on all borrowers and guarantors (if any) as well as take into consideration the borrower’s previous credit history. The Manager will predominantly rely on the loan-to-valuation when determining whether to proceed with a loan.
In the case of construction and development loans, the Manager’s assessment of the borrower’s capacity to repay the loan is generally determined by its view of the borrower’s ability to complete and sell the project.
63. The text set out above would alert the attentive reader to the possibility that borrowers are being assessed on different criteria to those which might be applied by a bank. An astute retail client would probably appreciate some of the loans (and therefore an investment in the Fund) might be more risky. Less experienced retail clients, however, might miss the significance of the disclosure in its current form.
64. The applicant suggested a form of words to be used in the SPDS which addressed ASIC’s concerns. The form of words is set out in Exhibit 1 at folio 307 under the heading “Borrowers”. The relevant extract reads:
Generally, the borrowers seeking loans (including loans for construction purposes) from the Fund do not typically deal with traditional lenders such as banks for a number of reasons including; the ability for the Fund to review and approve loans in a shorter time frame, the Fund’s ability to provide loan advances (for construction purposes) up to a maximum of 80% of the Valuation as compared to lower traditional lending ceilings by traditional lenders and borrowers that may not meet the lending criteria of traditional lenders. Therefore, the risk of providing loans to such borrowers, including the risks described in section 7 of the PDS, may be higher than those accepted by traditional lenders such as banks.
65. I think an explanation along the lines set out in the SPDS is necessary in this case if the applicant is to discharge its obligations under s 1013D(1)(c) in particular. While I accept more sophisticated investors would understand the implications of the disclosure in the original PDS, the message about risk might not be as clear to less sophisticated retail clients who are nonetheless acting reasonably. The failure to make an adequate disclosure in relation to these matters might also leave the retail client unsure about a significant characteristic of the product.
66. It follows I accept ASIC’s concern in relation to the information supplied about borrowers is made out. The applicant’s PDS does not meet the standard imposed by ss 1013D(1)(c) and 1013D(1)(f).
67. ASIC’s eighth concern relates to the applicant’s alleged failure to include sufficient information on cash-flow management. ASIC says the applicant should have disclosed how the Fund’s management proposes monitoring the cash-flow position of the Fund on an ongoing basis with a view to ensuring that the Fund is able to meet its commitments to investors.
68. The applicant’s submissions referred to information about cash-flow management at pp 9 and 16 of the PDS. Those pages do not include a detailed discussion of the process by which the Manager monitors cash flow. There is a more extensive discussion of cash-flow shortfalls at p 17.
69. The applicant says the information is superfluous. The applicant points out the terms of its Australian Financial Services Licence (“AFSL”) require that it manage the Fund with due care and skill. It argues there is no point in including a statement in the PDS to the effect that the applicant will comply with its obligations under the AFSL.
70. While some obligations imposed by statute or by a licence may be notorious, I am satisfied retail clients are unlikely to possess a detailed knowledge of the obligations imposed under an AFSL. I do not accept a product issuer is able to avoid disclosing information required by the retail client merely because that information describes an obligation imposed under a licence or a statute. If the information in question is not already well-known and disclosure would otherwise be required to discharge the obligations set out in the Act that information should be included in the PDS.
71. I accept information about cash-flow management processes would enable a sophisticated investor to form a view about the risk associated with an investment. But while the information might be useful for assessing risk, the question required under s 1013D(1)(c) in particular focuses on the needs of the retail client. Would he or she be assisted by that information?
72. I think the retail client described earlier in these reasons would derive assistance from a simple explanation of the applicant’s approach to cash-flow management. An appropriately worded statement is not included in the original PDS. I note the applicant’s draft SPDS includes a note to the effect that the applicant “actively manages the cash flow of the Fund including forecasting the flow of interest payments from borrowers, forward loan commitments, and Fund expenses.” A statement in that form in addition to the existing material would satisfy the retail client’s needs. In the absence of such a statement, the original PDS does not satisfy the obligation imposed pursuant to s 1013D(1)(c). I think it also falls short of satisfying the obligation imposed by s 1013D(1)(f).
73. I turn now to the last of ASIC’s concerns about the original PDS. ASIC says the PDS failed to have a reasonable basis for including prospective financial information. The delegate criticised several statements in the PDS to the effect that the applicant expected the Fund would generate returns that “compare favourably” with similar funds. The statements are found in the chairman’s letter at p 1 and on p 4 under the heading “Attractive and Favourable Returns”. ASIC says the applicant should have identified the assumptions upon which the expectation was based. The applicant should also have included a warning that the claim was a prediction which should not necessarily be relied on, and an explanation of how the prospective financial information was calculated.
74. Statements and predictions as to future matters are problematic. Section 769C of the Act says a representation with respect to any future matter is taken to be misleading (for the purposes of s 1020E, for example) if the person does not have reasonable grounds for making that representation. Its equivalent is found in s 51A of the Trade Practices Act 1974.
75. The applicant says the statements in question cannot be viewed as statements about a future matter or prospective financial information. The statements merely explained the objectives of the Fund and its expectations with respect to the returns it will generate for its investors. The applicant goes on to say in its submissions that it has earned superior rates of return. The submissions assume the Manager is entitled to express the opinion that the returns will continue to be superior. The applicant also pointed out it did not attempt to specify what the return is likely to be. The opinion is a general one.
76. The parties’ submissions did not discuss ASIC’s Regulatory Guide 170, entitled Prospective Financial Information. That document is referred to in Regulatory Guide 168. Regulatory Guide 170 offers guidance to product issuers about what sort of disclosure is required in connection with statements about future matters. The document offers examples of what sort of information ASIC would regard as being a reasonable basis for a prediction. I have not relied on that document in reaching my decision given that the parties did not make any submissions, but I take it to set out a common sense approach.
77. I do not accept the applicant’s argument that the representations were merely a statement of objectives and therefore outside the Act. Even a simple statement of objectives may include within it a representation as to a future matter. In particular, it may communicate a belief that the objective is realistic and achievable in the future. That belief must have a reasonable basis, failing which it may be deemed to mislead. The challenge is even greater in relation to stronger words like “expected” and “expect”. Those words clearly suggest a positive belief that something will occur. That belief is implicitly based on a factual premise. Section 769C of the Act effectively says the decision-maker is entitled to analyse the factual premise and assume the representation is misleading if the factual premise is unsound, or if it does not tend logically to lead to the conclusion for which the applicant contends.
78. The Act does not require that the representation in question relates to “prospective financial information”, although that expression is used in Regulatory Guide 168 and Regulatory Guide 170. Section 769C refers to representations with respect to any future matter. Nor does the Act require that the factual basis for the representation be set out in the PDS itself. While it is undoubtedly good practice to do that, s 769C does no more than require that the maker of the statement be in a position to refer to an appropriate factual basis when called upon to do so. Regulatory Guide 170 at RG 170.18 offers examples of the sort of data or material that one would expect to be relied upon. While the parties did not refer me to that list, and it is not in any event exhaustive, I accept it is a useful guide.
79. The applicant’s submissions referred me to [38]-[40] of the statement of Mr Sabados. I assume I was being asked to rely on that statement as evidence of a reasonable basis for the representations as to the Manager’s expectations about returns. But that extract does not assist me. It merely re-states the argument in the submissions. In particular, it insists that it is unobjectionable to talk about “objectives” as if that term were interchangeable with “expectations”. As I have explained, the terms communicate quite different messages.
80. In the absence of references to other evidence, I think ASIC was right to conclude the representation was misleading by operation of s 769C of the Act.
A note about the evidence and the arguments
81. I have not addressed the applicant’s argument that it was denied procedural fairness when the delegate declined to have regard to material issued by rivals. As I explained in the course of my decision in ReWright Patton Shakespeare Capital Limited and Australian Investments and Securities Commission [2007] AATA 2101 at [25], questions about the decision-making process of the original decision-maker are usually irrelevant upon a merits review that is conducted de novo. In any event, for reasons I set out in my discussion of ASIC’s first concern in these reasons and at [18] of my earlier decision in 2007, I am satisfied the comparisons were unhelpful. Evidence of a practice in the industry is probably only useful if the practice has effectively shaped the expectations of the retail investors. If the evidence established that the retail investor did have certain expectations, I would need to take them into account when considering whether the obligations under s 1020D(1) have been met. The evidence did not establish the existence of such an expectation.
Corrective disclosure
82. I noted at the outset of these reasons that the applicant disagreed with ASIC’s findings. Even so, the applicant decided it was convenient to address the concerns by drafting a SPDS. After reviewing the final draft of the SPDS, ASIC decided the applicant had successfully addressed the concerns of the delegate. The SPDS made changes to 16 pages in the PDS in the process, although I note the applicant’s argument that some of these alterations are minor. ASIC decided the extent of the changes meant the reader would have difficulty reading the two documents together. In ASIC’s view, when read together, the PDS and SPDS were not worded and presented in a clear and concise and effective manner.
83. ASIC pointed out in its submissions that there was unlikely to be an effective remedy available to the applicant given the passage of time and the fact that it had already issued a fresh PDS. My difficulty is that I am unable to reach a view as to whether the SPDS and the PDS read together will pass muster in light of the findings I have made in relation to ASIC’s original concerns. Given I decided some of ASIC’s concerns were not made out, the SPDS as drafted includes more disclosure than may be required. There is no longer any point reaching a view on the merits of that document. If the applicant wishes to persist with the process, it would be necessary to draft and submit a revised SPDS that takes into account my findings.
Conclusion
84. Some of ASIC’s concerns have been made out. It follows I am satisfied the original PDS was “defective” within the meaning of s 1022A of the Corporations Act 2001. The stop order issued under s 1020E(1) of the Act was properly made in relation to the original PDS. But the reviewable decision did not just deal with the original PDS. The stop order was made in relation to the PDS and SPDS. I have indicated I am not in a position to reach a concluded view in relation to that issue unless and until the SPDS is re-drafted to take into consideration my findings in relation to the original PDS. I have therefore decided to set the decision aside pursuant to s 43 of the Administrative Appeals Tribunal Act 1975 and remit the matter to the respondent for reconsideration in accordance with these reasons. In the course of that reconsideration, the respondent should provide the applicant with a reasonable opportunity to submit a revised draft SPDS that takes into account these reasons.
I certify that the 84 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member Bernard J McCabe:
Signed:................................[Sgd]..............................................
Michael Buckingham, AssociateDate of Hearing 23 June 2008
Date of Decision 28 November 2008
Counsel for the applicant Ms C Muir
Solicitor for the applicant McCullough Robertson Lawyers
Counsel for the respondent Mr M PlunkettSolicitor for the respondent Australian Securities and Investments Commission
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