When a group of people pool money for the purpose of joint investment, for example in shares or property, it is often referred to as an ‘investment club’. When starting an investment club, it is very important to have a clear legal structure and purpose.
If a club satisfies certain legislative conditions regarding membership and decision-making, it can be classified as a managed investment scheme and subject to strict legal regulations under the Corporations Act 2001 (Cth). It is important that you are clear from the outset as to whether your investment club is actually a managed investment scheme, as failing to comply with the legislative requirements can have significant consequences.
When looking to set up an investment club, you must first consider the following:
- Who will be in the club?
- How much money will each member contribute?
- Will the investment be in the form of an initial lump sum or will there also be periodic member subscription fees?
- What is the purpose of the club?
- Does everyone understand the club’s objectives?
- Do members have similar goals? For example, do members prefer a short term or long term investment approach?
- Who will perform the administrative functions?
- How will decisions be made?
Structuring the Club
There is no predetermined structure that an investment club has to follow. However, most commonly they are structured as either a partnership or through a unit trust.
In a partnership, partners share control. It is not a separate legal entity, therefore, each partner is jointly liable for the club’s debts and obligations. A partnership has its own ABN and TFN, however each partner (rather than the partnership itself) pays tax on the share of the profit they receive.
A unit trust is where assets are held and administered by the trustee for the benefit of the unit holders in the trust. Each investor will have a number of units proportionate to their investment or subscription and this unit holding determines their share of the profits. The trustee controls the unit trust assets. So, for investment club purposes, it is common to have a corporate trustee where each unitholder is also a shareholder and director of the corporate trustee. The reason each unit holder would also be a director of the corporate trustee will become apparent when we explore the regulations regarding managed investment schemes.
No matter which structure you choose, it is important to have an agreement between the club members. For a partnership, you will have a partnership agreement, and if using a unit trust, you will have a unitholder and shareholder agreement. A clear and appropriately drafted governing agreement is vital to the success of your investment club. This agreement will cover matters such as:
- The purpose and goals of the club;
- Decision making;
- Meeting arrangements;
- Profit and loss distribution;
- Bringing on new members;
- Individual exit;
- Dispute resolution; and
What are the Legal Obligations?
After determining your membership and structure, you may decide to task one person with managing the scheme, ensuring that it runs effectively, and making the final decision on particular matters. While this might seem like an appropriate way to run your club, you may find that you fall under the ambit of the Corporations Act, and therefore subject to certain obligations.
A managed investment scheme, also referred to as a ‘collective investment’, involves the pooling of money by investors into the scheme in return for an interest in the profits (or losses) of the scheme. Investors make these contributions for the purpose of producing financial benefit. What sets a managed investment scheme apart from a typical investment club, however, is that investors do not have day to day control over the operation of the scheme.
When determining whether your members will have day to day control, consider the following:
- Have the investors delegated the management of their investment to you or another party?
- Do your members have a right to be consulted or must they be consulted?
- Do the members as a whole participate in the making of routine or ordinary, everyday business decisions? If so, is the group bound by the decisions which are made?
Your members will unlikely have day to day control unless they are required to participate in all decision making and have not delegated their decision making or representation to another person or entity.
It’s important then to properly structure your investment club and clearly define decision making rights. Remember, if your investment club is actually a managed investment scheme, the Corporations Act will regulate its operation.
If you think your investment club is likely a managed investment scheme, you should identify whether you are required to register. A managed investment scheme must be registered when:
- It has more than 20 members (if a trust is a subscriber to the investment scheme, the members are taken to be the beneficiaries of the trust, rather than the trustee);
- It was promoted by a person in the business of promoting managed investment schemes; or
- ASIC determines that it must be registered (for example if there are a number of schemes which are closely related and the total number of members exceed 20).
A scheme will only be exempt from these registration requirements if the interests of members would not give rise to requiring a product disclosure statement. This would be the case if it is either a small offer exemption (under 20 members, under $2 million per year) or it is to non-retail clients (large businesses, professional investors, etc).
Essentially, the registration requirements are drafted to ensure that certain activities cannot be caught, for example:
- An entrepreneur pooling start-up funds to start his or her own business; or
- A small group of friends coming together to invest $500,000 in the stock market.
There are significant consequences for failing to register your investment scheme, including:
- The contracts of members being made void;
- The scheme being wound up;
- A compensation order made; or
- Even criminal implications.
However, if your scheme does not fulfil the registration requirements, it is not precluded from being a managed investment scheme. As the operator of such a scheme, you should still know and understand your obligations.
Obligations for Registered Schemes
Two of the most important obligations the Corporations Act imposes on registered schemes are:
- The responsible entity must be a public company; and
- The responsible entity must hold an Australian Financial Services Licence authorising it to operate the scheme and any other associated financial services.
Beyond this, there are financial product disclosure requirements and the responsible entity must conform with their duties under the act, such as acting in the best interest of members, ensuring that all payments are made to members under the constitution. The investment property must also be held on trust for the benefit of members, and therefore the responsible entity is also subject to duties as trustee.
Obligations for Unregistered Schemes
For unregistered schemes, the obligations are less clear. The legislation does not expressly provide that unregistered schemes must be operated by an entity with an Australian Financial Services Licence or comply with the Financial Product Disclosure requirements. However, if the scheme is carrying on a ‘financial services business’ the licence requirements may still apply. For example, a scheme could be considered a financial services business if it is dealing with or advising on financial products in a systematic way.
If you are unsure whether your investment club may be providing financial services, but it is not large enough to require registration, it is important to get specialist legal advice on your obligations. Get in touch with our commercial lawyers on 1300 544 755.