The Regulatory Regime governing the syndication of thoroughbred Stallions for commercial breeding purposes
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 and the regulatory regime designed to promote and protect market integrity.
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 syndication of thoroughbred stallions for commercial breeding purposes and the subsequent operation of those syndicates.
Persons who engage in this activity as promoter or seller typically acquire a stallion with the intention of selling fractional ownership interests (shares) and having the stallion provide stud services either at the stud of the promoter or seller, or another nominated stud, to enable the owners to obtain the benefit of the stallion from the provision of stud services during each stud season (1St September to 31st December each year). Participants in the syndicate will typically be experienced horse breeders who own broodmares and wish to use the service rights [entitlement to stud services by the stallion attaching to their share(s)] in relation to their own broodmares.
The regulatory regime governing this activity is founded upon the provisions of the Corporations Act 2001 (the Act) relating to managed investment schemes.
The general public tends to associate the phrase “managed investment scheme” and its prefix “MIS” with investment schemes that are designed to invest in securities and other traditional investments, however, the definition set out in 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 provisions of the Act that 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 MISs’ can be distinguished from the limited asset classes that have been exempted from the regime because they are considered to be “non-speculative” and for “personal use”, such as time share resorts, luxury car and boating clubs.
Under the Act, any person who is “carrying on a financial services business” [“dealing in 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(s) must be registered, subject to specific statutory exemption or Class Order relief.
A distinction is made between “retail clients” and “wholesale clients”. Generally, the consumer protection provisions will apply only 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 and 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”.
A Stallion syndicate satisfies the definition of MIS ascribed by the Act and is subject to regulation.
ASIC has set out its approach to regulating horse breeding and horse racing schemes in Regulatory Guide 91 [issued in 2012, replacing RG91 issued in 2007] [“RG91 ”). If you have not already read RG91 , it would be advantageous for you to do so before proceeding to read this paper.
While ASIC has responsibility for administering the Act, it has elected to exercise its discretionary powers and granted conditional relief for small scale schemes from specific provisions of the Act relating to “licensing” and “registration”, in the form of Class Order 02/178 – Horse breeding schemes – private stallion syndication [issued by ASIC on 14/02/2002] (“the Class Order”).
The effect of the Class Order is to relieve those “promoters” who, and those “schemes” that, comply with the terms of the Class Order, from otherwise having to comply with provisions of the Act, which require that the promoter be appropriately “licensed” and that the “syndicates” be “registered”.
The scope of the relief is limited by the terms of the Class Order.
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 promoters and managers to be licensed
Any person (promoter) who is [carrying on a financial services business] dealing in shares in stallion syndicates, must hold an appropriate AFSL authorizing the licensee to provide the services, subject to specific statutory exemption or Class Order relief.
The manager of a stallion syndicate that is either a “registered” MIS, or an “unregistered scheme where shares are available only by “personal offer’, or to “wholesale clients”, must be an AFS Licensee.
Under the Class Order the promoter or seller (offeror) of the shares is relieved from the requirement to be “licensed”, and the syndicate is relieved from the requirement to be “registered” provided that:
(a) the offeror holds either an appropriate AFSL, or at least 10% fully paid of all shares in the syndicate;
(b) the syndicate is the subject of a stallion scheme agreement that complies with the requirements for such agreements specified in the Class Order;
(c) shares in the syndicate are only issued as a result of acceptance by the person of an “Offer made personally” to them; and
(d) the issuing of shares in the syndicate does not result in the offeror “issuing” or “selling” more than 40 shares in any Stallion syndicate(s) within the previous 12 months
Requirement for Schemes to be registered and the exceptions
All stallion syndicates that are established as the result of a promoter dealing in shares are subject to regulation as MISs’.
Under the Act and the Class Order, a stallion syndicate that is established as a result of a promoter dealing in shares must be registered as a MIS, unless it is either:
(a) an unregistered [personal offer] scheme;
(b) an unregistered [wholesale] scheme;
(c) an unregistered [private - Class Order compliant] syndicate.
2. The standards (used as benchmarks for compliance)
The promoter of an “offer of shares” 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 product disclosure document (PDS) that must be provided to prospective investors prior to the point-of-sale.
The promoter must ensure that the key information includes an appropriate stallion scheme agreement that will govern the future ownership of the stallion, including provisions dealing with the appointment of a manager and a studmaster, and arrangements for the payment of costs and distribution of income, if any.
The promoter must deposit all application moneys for shares paid by/received from investors into a designated application moneys trust account until the legal and beneficial ownership of the stallion is transferred to them, unencumbered. If an offer of shares (the syndicate) is not fully subscribed prior to the expiration of the relevant PDS (within 6 months after the date of issue), 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 and/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 and to detect non-compliant activity, as well as investigating suspected non-compliant activity and prosecuting breaches.
While the current regulatory regime has been in place since 2002, and is similar in effect to the previous regime, there continues to be a significant level of conflicting opinion amongst industry participants in relation to its application. The writer hopes that the conclusions set out in this paper will provide clarification.
Various sections of the Act and the Class Order are quoted in full for the convenience of readers.