On 11 March 2016, the Senate Economics References Committee finally released its report into the structure and development of forestry (or agribusiness) managed investment schemes (MIS). It was originally due for release by 27 October 2014.
The Preamble the Committee notes:
“In 2009, two of Australia’s largest agribusiness managed investment schemes (MIS) failed—Timbercorp and Great Southern. In quick succession, a number of other major schemes collapsed, including Willmott Forests Ltd and Gunns Plantation Ltd.
“For the purposes of this inquiry, the committee is concerned primarily with retail investors caught up in these schemes, many of whom were first time investors and not highly literate in financial matters. When the agribusiness schemes collapsed, many investors lost not only their investment and prospects of future income but were saddled with the burden of repaying the loans they took out to fund their venture and the interest accruing on a now valueless asset. Indeed, evidence before the committee is riddled with stories of the shattered lives of people who invested, and borrowed to invest, in agribusiness MIS—separation, broken relationships, lost life savings, bankruptcy, ruined health, depression, self-harm and families placed under enormous stress.
“The causes for this financial failure on such a large scale were many and varied, and all participants in the industry must bear some responsibility for it. They include: the product manufacturers and promoters; the experts who rated the schemes; the financial advisers who recommended the investments; the finance companies, credit assistance advisers and lenders that facilitated and provided the loans; the regulators and governments for their lack of decisive action in monitoring the marketing and performance of these schemes; and retail investors enticed to enter into highly speculative ventures on borrowed money.”
The Terms of Reference were to investigate:
The structure and development of forestry managed investment schemes (MIS), including:
- the motivation and drivers that established the framework for the schemes initially;
- the role of governments in administering and regulating forestry MIS;
- the current policy and regulatory framework of forestry MIS;
- the role of some in the financial services industry in promoting and selling forestry MIS;
- compensation arrangements for small investors in forestry MTS who have lost life savings and their homes in the face of the collapse of forestry MIS;
- the burden on farmers and other agricultural producers who have been left with the uncertainty of timber plantations linked to forestry MIS on their land;
- the options for reforming forestry MIS to protect investors and rural communities; and
- any other related matters.
The committee resolved that under term of reference (8) it would accept submissions that deal with agricultural MIS.
The Executive Summary of the report noted the following.
Over the 20-year life cycle of a typical MIS, investors would pay fees in the first few years as orchards were planted, which would become significant tax deductions. Fees would drop after a few years, and the scheme would return profits as the products were harvested in the latter years. MIS quickly became an attractive new tax deduction for wealthy investors, but in a few short years, demand for the deductions grew, and the nature of the industry changed rapidly, to the point where it is best described as an abhorrent ‘Ponzi scheme’. …
For tax reasons, many agribusiness schemes were structured so that investors were described as operating this investment in their own right. Thus, an agribusiness MIS is a tax effective investment vehicle. …
It was not unusual for growers to borrow up to 90 per cent of the value of their investment or gear their entire investment in MIS. Even those who clearly indicated that they were not in a strong financial position were encouraged to borrow. …
Financial advisers and trust
This report abounds with accounts of investors following the recommendations of their adviser whom they genuinely believed was a professional …. But the committee has established that there were horrifying deficiencies in the way some advisers adhered to the basic requirements to know their client, the product they were recommending and to have a reasonable basis for their advice. …
Financial advisers, however, were only one component in the promotion and selling of MIS. They relied on marketing material provided by the product manufacturers and were often part of a larger public relations campaign to entice investors into the schemes. In some instances, advisers may have misled their clients, sometimes inadvertently, sometimes deliberately, as they themselves may not have understood or appreciated the pitfalls of the products they were promoting.
The producers of agribusiness MIS must then bear some responsibility for the marketing of these speculative ventures to retail consumers. Without doubt, the evidence supports the contention that retail investors need robust consumer protection and, in the case of agribusiness MIS, the current reliance on disclosure—product disclosure documents (PDSs) and statements of advice (SOAs)—is woefully inadequate. …
The liquidators winding up agribusiness MIS have encountered many practical difficulties that were not contemplated by current legislation and exposed the complexities in untangling the rights and obligations of the various parties. It is clear that legislative change is required: that this area of the law is in need of reform. …
Future of agribusiness MIS
The failure of a number of high profile agribusiness MIS has caused significant damage to investors, farmers, neighbouring communities and the reputation of agribusiness MIS. There was no single cause for their failure but a combination of factors including high upfront costs (sizeable commissions to financial advisers, funds diverted into the general working capital of the parent company, excessive overspending on administration and marketing); poor management decisions regarding the planting and location of the schemes; a business structure that depended too heavily on new sales for cash flow; and the lag time between initial investment and dividends.
The Committee’s recommendations included the following notes:
Removing misconception about government endorsement of schemes
It would appear that some product issuers and financial advisers allowed, or even encouraged, investors to assume that an Australian Taxation Office (ATO) product ruling meant that the government was vouching for the commercial viability of the scheme. There was a similar misunderstanding that ASIC was giving its support to the schemes. Thus, growers mistakenly formed the view that the products had ATO and ASIC approval and considered the various schemes safe and suitable for retail investors.
Accountants/tax agents providing financial advice
In light of the evidence and the concerns expressed about possible conflicts of interest and blurring of responsibilities in situations where a tax agent provides financial advice, the committee is convinced that this area of financial advice should be reviewed, particularly advice on borrowing. Clearly, there are important lessons to be learnt from the experiences of retail investors who acted on advice from their accountants or tax agent and invested in MIS.
ASIC provided the committee with examples of its efforts to lift the standard of financial literacy in Australia. The committee has made recommendations that would place obligations on product issuers and research houses to act responsibly in the promotion and marketing of MIS.
Culture in the financial services industry
The committee notes that a code of ethics was one of the government’s proposed legislative amendments to raise financial advisers’ standards. In light of the evidence demonstrating that integrity issues were at the heart of some of the poor financial advice given to MIS investors, the committee highlights the importance of establishing such a code of ethics and suggests that this measure warrants close and determined attention.
Banned or unscrupulous advisers
In its response to the FSI report, the government indicated its intention to develop legislation allowing ASIC to ban individuals in management roles within financial firms from operating in the industry. The committee welcomes this move but, to underline the importance of removing opportunities for a banned financial adviser to resurface in other roles in the industry, the committee considers that the term ‘management’ may be too narrow.
Regulation around investment lending
Investment lending has been instrumental in causing significant financial loss to retail investors who borrowed to invest in agribusiness MIS. In the committee’s view, the responsible lending obligations imposed on brokers and lenders through the new credit laws should apply equally to the promoters, advisers and lenders involved in providing funds for investment purposes.
Legal advice causing harm
Some investors took legal advice to cease repayments on their MIS loans and are now faced with a loan substantially greater than at the time their schemes collapsed. The committee is concerned that vulnerable people who joined class actions expecting, in effect, to have their loans nullified are now in a financial position far worse than when the class actions started.
There can be no doubt that much stronger measures are needed to protect retail investors from the promotion and marketing of high risk products. A number of inquiries, including the committee’s 2014 inquiry into the performance of ASIC and the FSI, have mounted a compelling argument for such action. Agribusiness MIS are a clear example where, based on the evidence before the committee, disclosure was inadequate; information was confusing rather than instructive for retail investors; and oral advice either misinterpreted the disclosure documents, downplayed risks, or selectively presented positive messages. Clearly, improved regulation could have prevented many unwary investors from entering into unsafe financial arrangements.
The Committee made 24 recommendations giving effect to many of the above concerns.
The Greens issued a dissenting report including a recommendation that the Government establish a Royal Commission to examine misconduct within the financial services sector.
FJM Suggestions: I have two of my own suggestions that would protect consumers and effectively select which collective schemes should go ahead.
The first is that the invested amounts should be paid into a trust account for the benefit of the investor, until the manager needs those funds to establish and maintain the project – with independent scrutiny of the disbursement of the funds to the manager. Such a trust account would be an elementary consumer protection but it would be at odds with the tax objective of making the vast bulk of the initial investment deductible in the year it is subscribed. This tax problem follows from the fact that a transfer of money into a trust account, for your own benefit, is not yet a relevant ‘loss or outgoing’ capable of being claimed as an allowable deduction. Waiting for the amount to be disbursed to the manager (to claim the deduction) is then a problem because the subscribed moneys don’t all need to be spent in the first year, leaving significantly less as a deduction in that first year.
The second suggestion is that only ‘limited recourse’ finance from banks be allowed for geared investments. Then the banks would make their own professional assessment of the viability and reliability of the project and not lend for investments in the suspect schemes. They may even make requirements for the design of the scheme, before they would lend. And they would set the percentage they would finance for each of the investment – leaving the investor to fund the balance. This latter aspect would be a clear expression of the level of risk in the scheme and leave only investors capable of funding that risk, to take the risk. Limited recourse borrowing from banks is now common place for SMSF superannuation funds borrowing to invest in property. If a properly structured and supervised MIS could give ‘bankable’ security, then they would be in the market (competing with each other). The Commissioner of Taxation associated ‘non-recourse’ lending with the ‘bad old days’ when it was provided by the promotors and really meant the deductions were being inflated (and thus he would not give the supporting class rulings). This would be different and he should not stand in the way of limited recourse finance of this type.
F. John Morgan – a member of the Victorian Bar (www.FJMtax.com)