Was the Earner product a managed investment scheme?
35 Section 9 of the Act defines "managed investment scheme" relevantly as follows:
(a) A scheme that has the following features;
(i) people contribute money or money's worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, perspective or contingent and whether they are enforceable or not);
(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 interest in property, for the people (the members) who hold interests in the scheme (whether as contributors to the scheme or as people who have acquired interests from holders);
(iii) the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or give directions) …
36 The first issue which arises in applying that definition is whether the Earner product constituted a "scheme". A "scheme" must be capable of being identified within certain boundaries, the essence of a "scheme" being a coherent and defined purpose, in the form of a "program" or "plan of action", coupled with a series of steps or course of conduct to effectuate the purpose and pursue the program or plan: Australian Securities & Investments Commission v Takaran Pty Ltd [2002] NSWSC 834; (2002) 43 ACSR 46 at [12] and [15] (Barrett J); Australian Securities and Investments Commission v Marco (No 6) [2020] FCA 1781 at [65] (McKerracher J). In oral submissions, ASIC identified the relevant "scheme" by reference to its Amended Concise Statement at [2]-[12] and [14], which relevantly referred to:
(a) the effect of the Terms of Use from 17 March 2022 until around 16 November 2022 being that the consumer, in acquiring, investing in or using the Earner product, deposited money with or "lent" money to Block Earner, and Block Earner undertook to repay that money;
(b) the Earner product was marketed as making use of the cryptoassets known as USDC, PAXG and BTC;
(c) the representation on the Block Earner website that "Block Earner is able to generate returns by pooling customer funds and lending it to our trusted partners, who are all vetted in accordance with our risk policy, thereby receiving a favourable yield rate" and subsequent changes on the website to the answer to the relevant question as well as other material on the website;
(d) for a consumer to acquire, invest in or use the Earner product offered by Block Earner, they must have had an account with Block Earner into which they deposited AUD, which process included agreeing to the Terms of Use, and by using the Earner product, the consumer then provided that AUD to Block Earner;
(e) from the consumer's perspective, the following process took place when they participated in the Earner product via the Block Earner platform:
(i) any AUD deposited by the user appeared in their "Block Earner Cash Account", at which point the user could select the relevant Earner Product and nominate the amount of AUD in their account to be deposited into the product;
(ii) at the same time the user was shown the equivalent amount of relevant cryptoassets (corresponding to the Earner product selected) and the exchange rate and any fees applied by Block Earner for the conversion, and the user was also shown the fixed yield they would receive for the deposit;
(iii) users were required to tick a box agreeing to the Terms of Use and click "Transfer In";
(iv) Block Earner's platform then displayed the user's cash balance, holdings in the Earner product, any yield earned to date (in AUD) and the APY, and users' Block Earner accounts were credited with their yield on a daily basis;
(v) to withdraw from the Earner product, the user followed the prompts on Block Earner's platform to transfer an amount from the Earner product to their "Block Earner Cash Account", and as part of that process, the user was shown the equivalent amount of AUD and the exchange rate and any fees applied by Block Earner for the conversion of the relevant cryptoasset into AUD; and
(vi) the consumer could then withdraw the AUD from the Block Earner platform by requesting a bank transfer to a third party bank account, or nominate for the funds to be placed into the same or a different Block Earner product;
(f) the following processes occurred concurrently with the processes set out in the previous subparagraph, but were not necessarily apparent to consumers using the platform:
(i) once the user clicked "Transfer In", Block Earner converted the nominated amount of AUD to the relevant cryptoasset through an overseas crypto exchange platform, being referred to in the Terms of Use as the Exchange Service;
(ii) the newly converted cryptoassets were automatically "loaned" to Block Earner on an unsecured basis, being referred to in the Terms of Use as the "Lend" service;
(iii) Block Earner then lent those cryptoassets on an unsecured basis to a third party under a pre-existing commercial arrangement, for which it received a fixed yield; and
(iv) a similar conversion or exchange process to the one described above occurred when Block Earner received a request to withdraw funds from the Earner product, albeit in reverse, whereby Block Earner converted the cryptoassets back into AUD at the prevailing exchange rate and charged the customer a fee for the conversion;
(g) the Terms of Use provided that by using the Earner product, consumers "lend" the cryptoassets (into which the AUD had been converted) to Block Earner, in return for daily interest which was paid in the same cryptoasset "loaned" to Block Earner, and users also agreed to grant Block Earner all rights and title to those cryptoassets for Block Earner to use at its sole discretion during the term of the "loan"; and
(h) the amount of AUD received back by the consumer varied by reference to the exchange rate between AUD and the relevant cryptoasset.
37 I accept that there existed at the relevant time a "scheme" to the effect alleged in those paragraphs of the Amended Concise Statement, which satisfied the requirements of a "scheme" as expressed by Barrett J in ASIC v Takaran.
38 The next question is whether the element set out in subpara (a)(i) of the definition is satisfied. That element comprises three requirements, namely: (a) a "contribution" of money or money's worth; (b) that the "contribution" is "consideration" to acquire rights (whether actual, prospective or contingent and whether they are enforceable or not); and (c) that those rights are to "benefits produced by the scheme". Block Earner submits that none of these three requirements is satisfied in the case of the Earner product.
39 First, Block Earner submits, and I accept, that the word "contribution" connotes pooling, in that as a matter of ordinary English, the requirement that an investor "contribute" suggests that the investor is not acting alone or intending to act alone and independently in the payment of money so as simply to recover a return on their own investment: Australian Securities & Investments Commission v MyWealth Manager Financial Services Pty Ltd (No 3) [2020] FCA 1035; (2020) 146 ACSR 270 at [64] (Derrington J). That construction is reinforced by the third element referred to above, that the contribution be consideration to acquire benefits produced by the scheme. ASIC then places emphasis on the Terms of Use, which convey that the Earner product involved a bilateral arrangement between Block Earner and the user, and that the loan of cryptocurrency was "in return for" a fixed interest rate: cl 4.3(a). The user, it was submitted, was entitled to payment of principal and interest irrespective of the success of Block Earner's business, and irrespective of how the cryptocurrency of other users of Earner was applied. The return did not fluctuate according to the fortunes of the business, nor did users have any right to require income earned by Block Earner from its lending of cryptocurrency to third parties to be applied in payment of principal or interest: cl 4.3(l)(i).
40 While I accept that the word "contribution" connotes that investors pay money or money's worth jointly with others or to furnish a common fund, I regard that element, and the other requirements of (i) of the definition of managed investment scheme, as satisfied by the Earner product. I have referred above to the statement on the Block Earner website from March to May 2022 to the effect that Block Earner was able to generate returns by pooling customer funds and lending it to third parties, thereby receiving a favourable yield rate. As I have stated above, I do not regard that statement as inconsistent with Mr Karaboga's evidence at [90] of his affidavit, in that Mr Karaboga's evidence was in effect that the result of pooling loans of cryptocurrency assets from users, together with Block Earner's own assets, enabled Block Earner to lend cryptocurrency to third parties and derive revenue for its own benefit from those loans in an amount which was designed to exceed the amount of fixed interest which Block Earner was obliged to pay to users, thus identifying the source of revenue from which the benefit of the promised fixed interest to users would be paid. The representation on the website did not refer to Block Earner contributing its own cryptocurrency, but the fact that it did so does not mean that users were not themselves making contributions jointly or to furnish a common fund. Users thus contributed money or money's worth jointly with all other users, as consideration to acquire the right to the promised fixed interest yield under the Earner product which Block Earner represented it would be able to pay because of the benefit produced by the scheme of enabling Block Earner to earn revenue in a greater amount by deploying the pooled contributions from users (as well as its own cryptocurrency) in lending the aggregated cryptocurrency to third parties at a higher rate. Block Earner submitted that it was conceivable that Block Earner may have been able to put itself in funds to pay the fixed interest in some other way, but that was not what was represented to users.
41 In my view, the above conclusion is consistent with the reasoning of White J in Australian Securities & Investments Commission v Great Northern Developments Pty Ltd [2010] NSWSC 1087; (2010) 79 ACSR 684. In that case, White J reviewed a number of cases in which it was held that loans with fixed interest returns can fall within the definition of "managed investment scheme" and that the right to interest and repayment of principal can be a right to "benefits produced by the scheme". As his Honour said at [69], in each of those cases, some representation was made to investors that by lending money to the promoter of the scheme the investor would derive a return, sometimes a very high return, out of the anticipated successful operation of the scheme, which was to be operated using the vaunted skills of the promoter. White J distinguished those cases, on the basis that there was no evidence before his Honour that representations were made to any of the persons to whom promissory notes were issued that the payment of principal or interest due under the notes would be derived from any particular source: at [70]. Accordingly, White J held that it was neither a term of a promissory note, nor was there any evidence of a representation being made to a holder of a promissory note, that the holder had a right, even an unenforceable right, to acquire benefits produced by the defendant's business of raising money from lenders and developing and selling properties: at [77]. In the present case, there is such a representation which was clearly made on Block Earner's website, which satisfies the element that was missing in Great Northern Developments.
42 Turning to subpara (a)(ii) of the definition of "managed investment scheme", it is clear from the statement which appeared on the Block Earner website from March to May 2022 that the contributions made by users were to be "pooled", "pooling customer funds" being the very term used on the website. The purpose of that pooling was represented to enable Block Earner to generate returns by lending the funds to third parties in return for a favourable yield rate. Given that that was stated in answer to the question "How is fixed yield generated?", the purpose of that pooling was clearly represented to provide Block Earner with the wherewithal from which it would pay users the fixed yield promised to them under the Earner product. The payment of the fixed yield to users was obviously a financial benefit to them, as too was the capacity of Block Earner to earn revenue from which that fixed yield would be paid. Subpara (a)(ii) was therefore satisfied. As I have said above, I do not regard the evidence of Mr Karaboga at [90] of his first affidavit as contrary to those propositions. The representation on the website also satisfies the requirement, which has been held to be implicit in subpara (a)(ii), that contributors must objectively intend that pooling to produce financial benefits: see National Australia Bank Ltd v Norman [2009] FCAFC 152; (2009) 180 FCR 243 at [88] (Graham J); [148]-[150] (Gilmour J, with whom Spender J agreed).
43 I accept that the Terms of Use do not mention pooling for any common benefit. However, it is sufficient that Block Earner represented that contributions would be pooled in order to generate a financial benefit for users. Block Earner relies on the acknowledgment in cl 4.3(l)(iii) that "by participating in Lend [ie Earner], you do not intend for Block Earner to use the loaned Eligible Cryptocurrency to generate a financial benefit or act as an investment for you". Read literally, that is inconsistent with the representation on the website to which I have referred. However, in my view, those apparently contradictory statements can be reconciled. In my view, cl 4.3(l)(iii) should be read consistently with the effect of Mr Karaboga's evidence at [90] of his first affidavit, namely that Block Earner would not pass on to users the amount of the return which it earned by dealing in the cryptocurrency which users had lent to it, but would receive only the fixed yield promised to them, irrespective of the amount of revenue which Block Earner was able to earn from its dealings with third parties. In effect, the acknowledgment was that there would be no equivalence or no direct correlation between the revenue earned by Block Earner by using the loaned cryptocurrency, on the one hand, and the fixed yield payable to users, on the other hand.
44 As to subpara (a)(iii), the users of the Earner product did not have day-to-day control over the operation of the scheme, which was operated and controlled by Block Earner. Block Earner submits, and I accept, that users did have the ability to control when they entered into the scheme and when they withdrew from the scheme, but I do not regard that as a matter of day-to-day control of the scheme itself.
45 Block Earner also submitted that it is legitimate and appropriate to consider the potential difficulties in the application of the regulatory regime concerning managed investment schemes in deciding whether the definition of "managed investment scheme" is satisfied. It is now well established that it is relevant and appropriate to consider such issues in deciding whether a scheme is a "managed investment scheme" as defined: LCM Funding Pty Ltd v Stanwell Corporation Ltd [2022] FCAFC 103; (2022) 292 FCR 169 at [163]-[165] (Anderson J, with whom Middleton and Lee JJ agreed); Spicer Thoroughbreds Pty Ltd v Stewart [2023] NSWCA 82 at [66] (Leeming JA, with whom Mitchelmore JA and Griffiths AJA agreed). In the present case, there is a potential difficulty in the application of that regulatory regime to the Earner product, but only if it were to be found that cryptocurrency is a kind of property. The definition of "scheme property" in s 9 of the Act includes not only contributions of money or money's worth to the scheme, but also "property acquired, directly or indirectly, with, or with the proceeds of, contributions or money …", and s 601FC(2) requires that the responsible entity of the scheme holds scheme property on trust for scheme members. In the case of Earner, the contributions of money were almost immediately converted to cryptocurrency which was then dealt with by Block Earner "in its sole discretion" on the basis that Block Earner has been granted "all rights and title" to that cryptocurrency: cl 4.3(f). That would appear to be antithetical to the notion that Block Earner held the cryptocurrency on trust for scheme members. However, this issue does not arise if cryptocurrency is not property at all. Neither party advanced an argument to the effect that cryptocurrency is property, and both parties accepted that it was not necessary for me to decide that question in order to resolve these proceedings. Given the way in which the case has thus been conducted, it would not be appropriate to pursue further the question whether there are insuperable difficulties in the application of Pt 5C of the Act which would compel a conclusion that the Earner product does not satisfy the definition of "managed investment scheme".
46 Block Earner submitted that, even without deciding that cryptocurrency is property, there remains a difficulty in applying Pt 5C of the Act to the Earner product, in that if the product was a managed investment scheme users would be "reaping the benefit or the loss that arises from those third party lending arrangements" (T88.06-7). The submission appears to be based on the definition of "scheme property", which includes "income … derived, directly or indirectly from contributions", and it may be thought that if all that income were held on trust for members under s 601FC(2) this would change the nature of their investment because members were entitled to the fixed yield and only the fixed yield. However, the terms of any such trust would have to conform to the contractual entitlement of members to be paid the fixed yield irrespective of the income that Block Earner derived from contributions, and as to any income in excess of the fixed yield, the duty of the responsible entity of a registered scheme under s 601FC(1)(k) is to ensure that all payments out of the scheme property are made in accordance with the scheme's constitution.
47 I note that the section of Block Earner's website headed "Risk Disclosure" stated that Block Earner does not hold AUD on trust. As that disclosure does not have contractual force, it represents a conclusion of law which, in my view, would have been wrong if the Earner product had been a registered scheme, in light of s 601FC(2). In any event, counsel for Block Earner submitted that Block Earner was a trustee of the AUD which users of Earner and Access had paid to it (T55.40-56.09), despite what was stated in the "Risk Disclosure".