Stallion Syndication

29th November 2007

By Tony Fleiter B.Ec. LLB., Solicitor (October, 2007)

www.macquarielegal.com.au

www.sirecustodians .com.au

Tony Fleiter is the Principal of law firm Macquarie Legal Practice and Managing Director of Sire Custodians Ltd (AFSL 223671). He specializes in the provision of legal services to the Australian thoroughbred industry and has a unique level of practical work experience within the industry.

1 Introduction

Numerous federal and state laws are relevant to the ownership of thoroughbred horses, as well as their sale and purchase whether by “private treaty” or “public auction”, including the Corporations Act, Partnership Act, Sale of Goods Act, Trade Practices Act, Stock & Station Agents Act, etc. Like it or not, these federal and state laws have application to the thoroughbred industry and anyone trading in contravention, whether out of ignorance or in blatant defiance, is running the risk of being liable for the appropriate remedy, which may include either restitution, damages and or penalties in the event the aggrieved party to any transaction takes recourse. Claiming to be either ignorant of the law or a “hobbyist” is not a legitimate defence in the eyes of the law.

One only has to read the auction sale conditions published by the two (2) main auction sales companies William Inglis & Son Ltd and Magic Millions Sales Pty Ltd to see the significant lengths both companies have gone to in order to address issues such as the merchantable quality of the horses being offered for sale arising under the Trade Practices Act, Sale Of Goods Act etc. The conditions of sale of each company now specifically and appropriately deal with various physical conditions specific to horses such as roarer, wobbler, windsucker, and in the case of the major sales, the issue of x-rays of leg joints etc. is also addressed.

The purpose of this paper is to provide the reader with a greater understanding and improved working knowledge of the current regulatory regime relevant to the establishment and ongoing management of Stallion Syndicates.

2 The Law relating to the syndication of thoroughbred Stallions

It is established law that the syndication of thoroughbred Stallions in Australia is regulated by the Corporations Act and regulations (“the Act”). Suffice to say here that a Stallion Syndicate “does” possess the essential features of a Managed Investment Scheme and “does” come within the scope of the definition set out in Section 9 of the Act.

What is a Managed Investment Scheme?

Section 9 defines “Managed Investment Scheme” to mean:

“(a) A Scheme that has the following features:

(ii) Any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interests in property, for the people (the “members”) who hold interests in the Scheme (whether or not they have the right to be consulted or to give directions); or ….”

When must a Managed Investment Scheme be registered?

Section 601ED (1) provides:

“Subject to subsection (2), a managed investment scheme must be registered under Section 601EB if:

(a) It has more than 20 members;

(b) It was promoted by a person, or an associate of a person, who was, when the scheme was promoted, in the business of promoting managed investment schemes; or

(c) A determination under subsection (3) is in force in relation to the scheme and the total number of members of all of the schemes to which the determination relates exceeds 20”.

Stallion Syndicates are generally established and promoted by commercial Studmasters (irrespective of whether or not the Studmaster is the Owner of the Stallion and the Seller of the Shares) and therefore come within the scope of sub-clause (b) of Section 601ED (1), notwithstanding the fact that the Syndicate may have no more than 20 Owners.

Section 601ED (1) specifies a “three-pronged” criteria as to when a Managed Investment Scheme is required to be registered. If a Scheme is caught by any “one” of the criteria, then it is required to be registered, unless it is either:

1. Eligible for the relief afforded by Section 1012E (2);
2. Eligible for the relief granted by ASIC CO 02/178 [issued by ASIC on 14^th February, 2002]; or
3. A “Wholesale Scheme” available only to “Wholesale clients”.

Relief afforded by Section 1012E (2)

“Private” Stallion Syndicates are generally established, promoted and operated by commercial Studmasters (regardless of whether or not the Studmaster is the Owner of the Stallion and the Seller of the Shares). Consequently, they come within the scope of sub-clause (b) of Section 601ED (1), notwithstanding the fact that the Syndicate may have no more than 20 Owners.

Section 601ED (2) provides that a Managed Investment Scheme does not have to be registered if all the issues of “interests” in the scheme that have been made would not have needed “disclosure” to investors.

Section 1012E (2) provides that “small scale offers made personally” to an offeree do not require disclosure provided the offer does not result in the issue of “interests” to more than 20 investors in 12 months; or the offeree raising more than $2 million in a 12 month period.

In recognition of the unique features of Stallion Syndicates and the practical difficulties of complying with the provisions of Section 1012E (2), the Australian Securities & Investments Commission (“ASIC”) (in response to industry submissions) has issued Class Order 02/178 (“CO 02/178”) granting specific relief from the requirement to register for small scale Stallion Syndicates comprised of no more than 40 interests or shares (regardless of the number of individual owners of those shares and the value of the interests or shares), provided all of the other relevant provisions of the CO 02/178 are complied with.

The provisions of the CO 02/178 have recently been further emphasised in Regulatory Guide 91 [issued by ASIC on 2^nd July, 2007] (“RG 91).

Relief afforded by CO 02/178

How does CO 02/178 operate to exempt some Stallion Syndicates, and not others, from the provisions of the Act requiring them to be registered with ASIC as Managed Investment Schemes, promoted and operated in full compliance with the Act?

CO 02/178 also requires that interests or shares in a “private” Stallion Syndicate must only be offered for sale by “personal offer”, as defined by Section 1012E (5) of the Act.

Section 1012E (5) provides:

“A personal offer is one that:

(a) may only be accepted by the person to whom it is made; and

(b) is made to a person who is likely to be interested in the offer, having regard to:

(i) previous contact between the person making the offer and that person; or

(ii) some professional or other connection between the person making the offer and that person; or

(iii) statements or actions by that person that indicates that they are interested in offers of that kind”.

The effect of this Section is that a Promoter or Seller of shares in a “private” Stallion Syndicate cannot either publicly advertise the shares, or engage the services of an Agent to actively promote the sale of the shares to the Agent’s clients. The Section does not extend to or prohibit a Studmaster from inviting the Studmaster’s existing clients [and/or persons who have indicated their interest in acquiring shares] to acquire shares. Furthermore, Owners of shares must also comply with the provisions of this Section when on-selling their shares at any time during the life of the Syndicate, as they are permitted to do so only by “personal offer”.

Wholesale Scheme

A “Wholesale Scheme” is an “unregistered” an “unrestricted” Scheme which is only available to “Wholesale clients”.

“Wholesale clients” include those who:

*  Invest $500,000 or more; or can provide a certificate (given in the last 6 months) from a qualified accountant stating that the person;

• Has net assets of at least $2.5 million; or

• Has a gross income of $250,000 for each of the last 2 financial years; or

*  Is otherwise a wholesale client within the meaning of section 761G of the Act.

Establishment of a Stallion Syndicate

A. Private – Unregistered (restricted) Syndicate

Restricted: “personal offer” – Syndicates of this type must not be comprised of more than 40 shares and shares can only be sold by “personal” offer.

The Syndicate Manager must:

1. Hold either an appropriate Australian Financial Services Licence (“AFSL”) or ownership of at least 10% of the Stallion the object of the Syndicate; and
2. Establish and operate the Syndicate in accordance with the provisions of an appropriate Syndicate Agreement and the requirements of CO 02/178.

B. Managed Investment Scheme (MIS) – Registered (unrestricted) Syndicate

Unrestricted: No restriction on either the number of shares or the offering of shares.

The Promoter [who will usually also be the Management Company and Responsible Entity] must:

1. Hold an appropriate AFSL;
2. Establish and operate the Syndicate in accordance with the provisions of an appropriate Syndicate Deed and the relevant provisions of the Act.
3. Lodge an application (including Syndicate Deed and Compliance Plan) with ASIC to register the Syndicate as a Managed Investment Scheme;
4. Compile a Product Disclosure Statement (PDS) which complies with the requirements of ASIC PS 168;
5. Lodge with ASIC a Form FS53 (PDS in-use notice); and
6. Provide each prospective purchaser of a share with a copy of the PDS, Financial Services Guide (FSG) and Share Application Form.

C. Wholesale Scheme – Unregistered (unrestricted) Syndicate

Unrestricted: No restriction on either the number of shares or the offering of shares.

The Promoter [who will also usually be the Syndicate Manager) must:

1. Hold an appropriate AFSL;
2. Establish and operate the Syndicate in accordance with the provisions of an appropriate Syndicate Deed and the relevant provisions of the Act;
3. Compile an Information Memorandum (“IM”) disclosing the essential features of the Syndicate to potential investors; and
4. Comply with the provisions set out in the Act relating to Wholesale Schemes;

Ongoing management of a Stallion Syndicate

A. Private – Unregistered (restricted) Syndicate

The Syndicate Manager must:

1. Operate the Syndicate in accordance with the terms of its Syndicate Agreement;
2. Hold either an appropriate AFSL or ownership of at least 10% of the Stallion the object of the Syndicate;
3. Act fairly and impartially and manage the Syndicate in the best interests of all of the Owners, treating all Owners equally; and
4. Ensure for the life of the Syndicate that Shares are not either offered for sale or on-sold by the Owners thereof other than by “personal” offer [Section 1012E (5)].

B. Managed Investment Scheme (MIS) – Registered (unrestricted) Syndicate

The Management Company and Responsible Entity must:

1. Operate the Syndicate in accordance with the terms of its Syndicate Deed, Compliance Plan, and the relevant provisions of the Act;
2. Hold an appropriate AFSL;
3. Establish and maintain appropriate Syndicate records, including Share register and transfer journal, secretarial and accounting records;
4. Prepare an Annual Return for the Syndicate and lodge it with ASIC by 30 September each year, including audited financial statement and compliance auditor’s certificate; and
5. Act fairly and impartially and manage the Syndicate in the best interests of all Owners, treating all Owners equally.

C. Wholesale – Unregistered (unrestricted) Syndicate

The Syndicate Manager must:

1. Operate the Syndicate in accordance with the terms of its Syndicate Deed and the relevant provisions of the Act;
2. Hold an appropriate AFSL;
3. Establish and maintain appropriate Syndicate records, including Share register and transfer journal, secretarial and accounting records; and
4. Act fairly and impartially and manage the Syndicate in the best interests of all Owners, treating all Owners equally; and
5. Ensure for the life of the Syndicate that Shares are offered for sale and/or on-sold only to Wholesale clients.

Winding-up of a Stallion Syndicate

A. Private – Unregistered (restricted) Syndicate

Upon termination, the Syndicate must be wound-up by the Syndicate Manager in accordance with the terms of its Syndicate Agreement.

B. Managed Investment Scheme (MIS) – Registered (unrestricted) Syndicate

1. Upon termination, the Syndicate must be wound-up by the Management Company and Responsible Entity in accordance with the terms of its Syndicate Deed, Compliance Plan and the Act; and
2. The Management Company and Responsible Entity must apply either to ASIC or to the court for permission to wind up the Syndicate, which consent will usually be granted, but on the condition that all statutory requirements are met, including the preparation and distribution to Owners of a final audited Financial Statement and Balance Sheet, including profit and loss statement.

C. Wholesale – Unregistered (unrestricted) Syndicate

Upon termination, the Syndicate must be wound-up by the Syndicate Manager in accordance with the terms of its Syndicate Deed.

A high level of consistency and compliance has now been achieved nationally throughout the thoroughbred industry in relation to Stallion Syndication.

Whilst the majority of Stallion Syndicates are established and operated as either “private” Syndicates which comply with the requirements of CO 02/178, or as ASIC-registered Managed Investment Schemes, it is evident that a number of Stallion Syndicates are still being established and operated as non-compliant “private” unregistered Syndicates in clear breach of the law, with the most obvious breaches being either the establishment of supposedly “private” syndicates comprised of more than 40 shares and/or the use of Syndicate Agreements which do not comply with the requirements of CO 02/178.

Consequences of non-compliance

The Act prescribes various penalties for breaches of its provisions relating to failure to register Managed Investment Schemes which are required to be registered.

Also, there is established precedent in the case of a thoroughbred Stallion Syndicate where the Studmaster, who was the Promoter and Manager of an unregistered Syndicate which should have been registered prior to the sale of shares, was required, some years later, when the Stallion had declined in value, to provide full refunds to purchasers of Shares, regardless of the benefits derived by the Owners of the Shares during the period of their participation in the Syndicate.

In other words, if a Stallion is syndicated other than in full compliance with the Act and/or Class Order 02/178, and subsequently declines in value, then the Promoter (in most cases the Studmaster) will potentially be liable to make full restitution to the purchasers of those shares at any time in the future, should they decide to claim.

A claim of lack of knowledge of the law or lack of intention to breach the law by the Promoter of a Stallion Syndicate, in breach of the law, will not be an acceptable defence either to a claim for damages by an aggrieved investor or charges by ASIC for breaches of the Act.