The Federal Treasurer has announced that litigation funders are to be subject to greater regulatory oversight by requiring them to hold an Australian financial services licence ("AFSL") and to comply with the statutory regime governing managed investment schemes. This will be done by removing the tailored exemptions excusing litigation funders from compliance with those regulatory regimes, which had been implemented to soften the impact of a landmark Full Federal Court decision in 2009 which held that arrangements between a litigation funder and group members in a class action constitute a managed investment scheme under the Corporations Act 2001 (Cth) ("Act"). This is a welcome reform, which recognises the significant role of litigation funders in the Australian class action landscape – as well as the abundant profits that funders make from class action recoveries.
What is changing?
On 22 May 2020, the Federal Treasurer announced that the Morrison Government is ensuring that litigation funders are subject to greater regulatory oversight by requiring them to hold an AFSL and to comply with the managed investment scheme regime in the Act. While the precise terms of this reform do not appear to have been released, it is understood that it will be achieved by amending the Corporations Regulations 2001 (Cth) ("Regulations") to remove the post-Multiplex exemptions that were inserted over a decade ago.
That occurred in light of the decision of the Full Federal Court in Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd  FCAFC 147. In that case, the Court held that arrangements existing between a litigation funder and the group members in the securities class action against Brookfield Multiplex regarding the building of the Wembley National Stadium constituted a managed investment scheme. This was in circumstances where neither of the potential operators of that scheme was said to be qualified to be a responsible entity as required by section 601FA of the Act, and the scheme was not registered but should have been – absent a basis for exemption which did not then exist.
Following that ruling, the Regulations were amended to provide that litigation funding schemes were excluded from the definition of managed investment scheme, and the provision of litigation funding schemes and arrangements that met certain requirements was covered by an exemption from the requirement to hold an AFSL. A condition of this regulatory relief was a requirement that litigation funders maintain adequate conflict of interest management practices, and ASIC has published a regulatory guide explaining the processes that a litigation funder must implement in order to manage conflicts of interest.
What is the effect of this reform?
By removing from the law the present exemption available to profit-seeking litigation funders, the Federal Government will require litigation funders to subject themselves to the Chapter 5C and 7 regulatory regimes which apply generally to the operators of managedt investment schemes and providers of financial services.
Managed investment schemes must, unless exempt, be registered under Chapter 5C and operated by a "responsible entity" that is an Australian public company holding an AFSL authorising the operation of the scheme.
Chief among the licence obligations that will be imposed on litigation funders will be the (plainly reasonable) obligations:
- to do all things necessary to ensure that the financial services covered by their licences are provided efficiently, honestly and fairly;
- to maintain an appropriate level of competence to provide financial services and to ensure that their representatives are adequately trained and are competent to provide those financial services;
- to have adequate organisational resources to provide the financial services covered by their licence; and
- to have in place adequate arrangements for the management of conflicts of interest.
The reform may also have broader consequences for litigation funders. The Design and Distribution Obligations ("DDO") regime is due to commence in 2021. It requires an issuer of a financial product to make a "target market determination" before offering it to investors. The determination must describe the class of clients who comprise the target market for the product, set out any distribution conditions for the product, set out circumstances that would reasonably suggest the determination is no longer appropriate and set out arrangements for periodic review. The issuer must also take reasonable steps that will, or are reasonably likely to, result in the distribution of the product that is consistent with the determination, and must not engage in retail product distribution conduct if they know (or ought reasonably to know) that a review trigger has occurred. In short, the DDO regime is as appropriate to a litigation funding arrangement as to any other type of financial product to which it applies. Litigation funders provide their services to litigants who are in substance no different to retail "investors". If there is doubt as to the applicability of the DDO regime to litigation funders, there are cogent reasons for confirmation that the regime will apply.
Further ASIC will have power make product intervention orders in relation to litigation funding schemes that might result in significant consumer detriment. A broad range of orders could be made including in relation to the content of advertisements and even banning some schemes.
A step in the right direction
The changes announced today are said to complement the inquiry being undertaken by the Parliamentary Joint Committee on Corporations and Financial Services into litigation funding and the regulation of the class action industry. The changes are positive in that they impose on litigation funders the same compliance burden and the same level of regulatory oversight to which other financial services providers have long been subject. This is particularly appropriate given the interface between litigation funders and often-unsophisticated class action claimants (who are essentially retail investors) and the tendency towards opacity which at times seems to characterise parts of the funding industry (particularly its offshore and unlisted participants who are not bound by Australian market disclosure obligations).
It is hoped that this reform is a sign of further rebalancing in the future.
Note: King & Wood Mallesons (including a number of the authors) acted for Brookfield-Multiplex in the proceedings mentioned in this article.