The syndication of thoroughbred Stallions for commercial breeding purposes is subject to regulation under the Corporations Act
This paper is about the syndication of thoroughbred stallions for and the regulatory regime designed to promote and protect market integrity.
There are many industry partisans who advocate that the sale and purchase of interests/shares in thoroughbred stallions should not be subject to regulation, because it is highly speculative and nothing more than a game of chance. When doing so, they ignore, either through ignorance or for convenience, the fact that such transactions and ownership arrangements are subject to numerous laws (both federal and state) which can potentially impact the rights and obligations of the parties, including (without limitation) the following Federal and State laws:
- Competition and Consumer Act;
- Corporations Act 2001;
- Personal Property Securities Act 2009;
- Insurance Contracts Act 1984; and
- Taxation legislation (GST, income tax and capital gains tax); and
State and territory legislation:
- Sale of Goods Act;
- Conveyancing Act 1919 (NSW), Property Law Act 1958 (NSW), and similar legislation in other jurisdictions);
- Civil Liability Act 2002 (NSW), Wrongs Act 1958 (Vic), and similar legislation in other jurisdictions;
some of which have consumer protection provisions embedded within them.
This paper is intended to provide an in-depth analysis of the statutory provisions, regulations and rules that form the basis of the regulatory regime governing the sale of interests in thoroughbred stallions for commercia breeding purposes and the subsequent operation of those schemes.
Persons who engage in this activity (known as “syndication”) as promoter or seller typically acquire a stallion with the intention of selling interests /shares and having the stallion provide stud duties at the stud farm of the promoter or seller, or a stud farm nominated by the promoter or seller, to enable the owners (members) to obtain the benefit of the stallion from the provision of stud services during each stud season [1 September to 31 December each year]. Investors in interests/shares will typically be experienced breeders who own mares and wish to utilize services rights to the stallion in relation to their own mares.
WHY THE NEED FOR REGULATION?
Market integrity is important for promoting the depth of market necessary to attract investors.
The regulatory regime governing this activity is founded upon the provisions of the Corporations Act 2001 (“the Act”) relating to managed investment schemes.
WHAT IS A MANAGED INVESTMENT SCHEME?
Non-lawyers tend to associate the phrase “managed investment scheme” and its prefix “MIS” with investment schemesthat are designed to invest in securities and other traditional investments. However, it is established law that the meaning given to that term by the Act is deliberately wide and designed to catch virtually all arrangements targeting collective investment and would, by itself, catch virtually all business models and structures.
The statutory provisions which govern the requirements of ASIC to carry out activities concerning such schemes, and the restrictions on promoting them, have broad application and have been held to cover such diverse activities as film, agriculture, mortgage funds, property development, sports betting, thoroughbred horse breeding and racing, etc. These types of managed investment schemes can be distinguished from the limited asset classes that have been exempted from the regime because they are considered “non-speculative” and for “personal use”, such as time share resorts, luxury car and boating clubs.
Under the Act, any person (promoter) who is “carrying on a financial services business” [“dealing is a financial product” (which includes the “issuing”, “underwriting” and “disposing” of interests in any managed investment product), or “operating a registered scheme”], must be licensed, and the scheme must be registered, subject to specific statutory exemption or ASIC Instrument relief granted administratively by ASIC.
A distinction is made between “retail clients” and “wholesale clients”. Generally, the consumer protection provisions will only apply to “retail clients”, as it is recognized that “wholesale clients” (including professional and sophisticated investors) do not require the same level of protection, as they are better informed and better able to assess the risks involved in financial transactions. A financial product is provided to a person as a “retail client” if it is not provided to the person as a “wholesale client”. To be treated as a “wholesale client”, the investor must satisfy a wealth, occupation or other threshold test.
The advertising or public promotion of “financial products” (that are managed investment products) is permitted only in relation to those offers of interests that require a Product Disclosure Statement (“PDS”) and a PDS is available, or where participation is available only to “wholesale clients”.
WHO DOES THE REGULATORY REGIME APPLY TO?
The regulatory regime applies to any person (promoter) who is carrying on a business dealing in interests/shares in thoroughbred stallions for commercial breeding purposes, as virtually all arrangements [typically partnership, co-ownership or unit trust arrangements] between 2 or more persons (members) will, prima facie, satisfy the definition of a managed investment scheme.
WHAT IS ASIC’S APPROACH TO REGULATION?
While ASIC has responsibility for administering the Act, it has consistently exercised its discretionary powers and granted limited relief [to operators other than professional commercial operators] for small-scale “private stallion schemes” from the statutory provisions relating to registration and licensing.
ASIC’s approach to the regulation of Horse breeding and Stallion schemes is set out in Regulatory Guide 91 (“RG91 ”). If you have not already read RG91  and the ASIC Explanatory Statement, it would be advantageous for you to do so before proceeding to read this paper.
The current ASIC Corporations (Horse Schemes) Instrument 2016/790 commenced on 30/08/2016 [as amended on 16/12/2016] (ASIC Instrument). It replaced:
The purpose of the ASIC Instrument (as was also the case with the earlier Class Orders) is to relieve those small-scale schemes which comply with the terms of the ASIC Instrument from otherwise having to comply with the statutory provisions requiring registration.
The scope of the relief is limited to the terms of the ASIC Instrument.
WHAT ARE THE BASIC REQUIREMENTS OF THE CURRENT REGULATORY REGIME?
While the statutory provisions and regulations are complex, the basic requirements of the regulatory regime, and how it operates, is simply explained as follows:
1. THE RULES (SPECIFYING EXPECTED BEHAVIORS AND OUTCOMES)
Requirement for Schemes to be registered and the exceptions
Under the Act, any stallion scheme established by a promoter carrying on a business dealing in shares must be registered as a managed investment scheme, unless it is either:
(a) a personal offer scheme;
(b) a wholesale scheme; or
(c) a private stallion scheme (that complies with the terms of the ASIC Instrument.
Investors who are “retail clients” are not permitted to participate in a wholesale scheme.
Requirement for promoters and managers to be licensed AND the exception
Any person who IS a professional promoter or operator of commercial stallion schemes must hold an appropriate AFS licence authorizing the licensee to provide the services or be an authorized representative of a licensee.
Any person who IS NOT a professional promoter or operator of commercial stallion schemes may establish and operate a “private stallion scheme” [provided it complies with the terms of the ASIC Instrument].
The ASIC Instrument provides conditional relief to the operators of certain stallion schemes from the requirements under the Act to register a managed investment scheme, hold an AFS licence and give point-of-sale disclosure in a PDS.
2. THE STANDARDS (USED AS BENCHMARKS FOR COMPLIANCE)
Disclosure of key information
The promoter of an “offer of interests” in a stallion scheme that is a registered managed investment scheme must disclose to prospective investors who are “retail clients” all key information required to enable them to make an informed decision whether or not to invest. The information is generally required to be set out in a PDS, which must be provided to prospective investors prior to sale.
The promoter must include with the key information an agreement which will govern the future ownership of the horse(s) the object of the scheme, including provisions dealing with the appointment of a manager and a studmaster, and arrangements for the payment of operating expenses and distributions of income earned, if any.
Handling of Application Moneys and transfer of ownership
The promoter must deposit all application moneys for interests paid by investors into a designated application moneys trust account until the legal and beneficial ownership of the horse/interests/shares is transferred to them, unencumbered. If an “offer of interests” is not fully subscribed, the promoter must refund to investors all application moneys received, together with any interest earned.
3. THE SANCTIONS (APPLIED FOR NON-COMPLIANCE WITH THE RULES)
There are serious consequences for promoters who engage in this activity in contravention of the Act. Enforcement action may include prosecution and the imposition of punitive penalties, or orders requiring the payment of compensation.
4. THE ADMINISTRATIVE PROCESS (TO ENFORCE THE RULES AND ADMINISTER SANCTIONS)
ASIC is responsible for administering the Act, including surveillance activities to promote compliance, investigating suspected non-compliance, and prosecuting breaches.
While the current regulatory regime has been in place since 2002 (with very little change under the current ASIC Instrument) and is similar in effect to the old “prescribed interests” regime which operated from the early 1990’s, there continues to be a significant level of conflicting opinion amongst industry participants (including various Principal Racing Authorities) in relation to its application. The writer hopes that the conclusions set out in this paper will provide clarification.
Various statutory provisions and regulations are quoted in full for the convenience of readers.