Superannuation Review 2008 – 'The business of being a trustee' articles

February 2008

February 2008 – The business of being a trustee: enforcement of the law by APRA – what do you need to know?

Current situation

The Superannuation Industry (Supervision) Act (SIS) section 120A currently confers on APRA the power to disqualify individuals where:

• an individual contravenes SIS
• the individual is a responsible officer of a corporate entity at a time when the entity contravenes SIS, or
• the individual is not otherwise a fit and proper person.

In the first two circumstances, APRA has to be satisfied that the nature, seriousness and number of contraventions justify disqualification. A disqualified individual can appeal APRA’s decision to the Administrative Appeals Tribunal (AAT) or the Federal Court.

While it appears on the face of SIS section 120A that each of the grounds for disqualification is separate (and the AAT has not expressly indicated otherwise), we believe that the better view is that disqualification should not occur unless there is an absence of fitness and propriety. This is of particular concern for innocent directors. We note in this regard the AAT decision of VBN v APRA on 25 July 2006 which reversed APRA’s decision to disqualify seven directors of a staff superannuation fund trustee by finding that there was no breach of the prudent person or best interest covenants. APRA had disqualified these directors for allegedly breaching these covenants but had not alleged that these directors had acted dishonesty or for an improper purpose.

There remains a lack of clarity regarding the application of section 120A where there is no absence of fitness and propriety and while this remains so there is scope for inappropriate outcomes in the disqualification of trustees and trustee directors.

APRA has shown increasing willingness to exercise its powers of disqualification under section 120A since the introduction of this section on 18 January 2001. In more recent years, this has been matched by an increasing number of appeals against APRA’s disqualifications.

Proposed changes

By the introduction of the Financial Sector Legislation Amendment (Review of Prudential Decisions) Bill 2007, the Howard Government sought to improve the 'efficiency, transparency and consistency of the process for disqualifying  individuals from operating financial sector entities and enhance the accountability of the regulator for administrative decision-making'. This Bill lapsed when Parliament was prorogued before the federal election.

On 13 February 2008, the Rudd Government re-introduced the Financial Sector Amendment (Review of Prudential Decisions) Bill 2008 to the Senate. This Bill sets out the same amendments to SIS section 120A which were proposed in relation to disqualification of trustees under the Financial Sector Legislation Amendment (Review of Prudential Decisions) Bill 2007.

The 2008 Bill proposes:

• repeal of the current SIS section 120A
• introduction of a court-based process for disqualification of an individual from an APRA-regulated entity, and
• disqualification must be ‘justified’—in deciding whether disqualification is justified, the court may have regard to the individual’s conduct in relation to the management, business or property of any corporation and any other matters the court considers relevant.

However, the 2008 Bill uses the same criteria for disqualification as current SIS section 120A. Consequently, the interpretation issues mentioned earlier could still arise under the proposed new court-based disqualification. Once again, this is of particular concern for innocent directors who are a responsible officer of a trustee at the time of a contravention.

It is hoped that, if the 2008 Bill is passed in its current form, the courts would develop some guidance as to whether a trustee or trustee director could be disqualified where there is no absence of fitness and propriety. It also remains open to the government to fix this uncertainty, either by amendment of the Bill or by regulation. The 2008 Bill allows regulations to specify further matters for the court to take into consideration in determining whether a person may be disqualified.

April 2008 – Class actions: the implications for superannuation fund trustees

These days it is common to hear about class actions so we thought it would be helpful to provide a basic explanation of what’s involved. 

What is a ‘class action’?

A class action involves: 

• a claim of seven or more persons against the same person  
• which arises out of related circumstances, and   
• which gives rise to a substantial common issue of law or fact.  

Class actions have been used for a wide variety of situations as there is no limit to the subject matter of class actions.   

There is likely to be continued growth in the number and size of class actions in Australia given:  

• class actions may be commenced with ease and run with a great degree of flexibility 
• the growth in the number of commercial funders of litigation and a more liberal approach by the courts to litigation funding, and
• the ability of a large number of persons to bring an action following an admission of guilt by an entity or a successful prosecution of an entity by a regulator, such as APRA or ASIC.

The rise of class actions is significant for trustees in two ways—firstly, if a class action is brought against the trustee by members of the superannuation fund, and secondly, if the trustee has the option to join a shareholder class action.

Class actions against the trustee

If a trustee is faced with a class action by fund members, the trustee will require an expert understanding of how the matter will proceed under the relevant court rules. These proceedings are not necessarily run in the same way as other proceedings.

Particular care needs to be taken, given the potential for growth in the number and value of the claims involved in a class action. Based on our experience, class actions against super fund trustees would be most likely to occur in the areas of disclosure and investment performance.

Class actions by the trustee

On the other hand, trustees of superannuation funds can join as a plaintiff in shareholder class actions.

Recent shareholder class actions in Australia have involved the following elements:

• a class of shareholders who have all purchased shares during a particular period of time
• allegations of corporate misconduct arising out of statements made by, or failed to have been made by, the company to the market
• loss or damage incurred by the shareholders, and
• a causal connection between the alleged misconduct and the loss or damage to the shareholder. This aspect has usually required the shareholder to prove specific reliance on the alleged misconduct in entering the share purchase transaction. However the requirement of reliance has been the subject of recent judicial review and consideration.

A trustee may have the opportunity (or need) to participate in a class action against a company in which it holds shares.

Whether, and how, the trustee participates in a class action will involve careful consideration of the facts of the particular claim, the trustee’s duty to the members of the fund and the mechanics of the particular class action.

June 2008 – The business of being a trustee: ASIC Regulatory Guide 126 – compensation and insurance arrangements for AFS licensees

Corporations Regulation 7.6.02AAA sets out the new requirements for compensation arrangements for AFS licensees providing financial services to retail clients pursuant to section 912B of the Corporations Act 2001 (Cth) (Corporations Act).

As discussed in our Superannuation Update December 2007, existing licensees must hold professional indemnity insurance cover from 1 July 2008 that:

• is adequate having regard to:
  
  • the licensee’s membership of an external dispute resolution scheme, taking account of the maximum liability that has a realistic potential of arising in connection with any particular claim against the licensee and all claims in respect of which the licensee could be found to have liability, and
  • other relevant considerations in relation to the licensee, including the volume of its business, the number and kind of its clients, the kind of business and the number of authorised representatives, or
  • is approved by ASIC as an alternative arrangement.

ASIC will be administering the new requirements in a staged approach as detailed under Regulatory Guide 126 ‘Compensation and insurance arrangements for AFS licensees’:

• minimum standards as set out in Section D of the Regulatory Guide will apply to existing trustees during the initial implementation period from 1 July 2008 to 31 December 2009, and
• from 1 January 2010, all licensees will be expected to comply with the higher standards as detailed in Section C of the Regulatory Guide.

The Regulatory Guide was amended March 2008.

The superannuation industry is currently grappling with implementation of the details of the Regulatory Guide and negotiating with insurers regarding the necessary changes to insurance policies.

Freehills has been in close liaison with ASIC regarding ASIC’s interpretation of some of the more difficult practical issues arising from implementation of the Regulatory Guide. Overall, it is important to note that section 912B of the Corporations Act places the onus to establish the level of adequate professional indemnity insurance with licensees. The terms of the applicable insurance policy must be carefully reviewed in order to ensure that the cover provided is not detrimentally affected by limitations under the policy. Further, licensees must retain records of how they determined what level of cover was adequate for them.

Section D of the Regulatory Guide requires the following for professional indemnity insurance policies from 1 July 2008 (or at the latest 31 December 2008 if the policy is not up for renewal by 1 July 2008):

• the insurance must be provided by an ‘authorised insurer’ (that is, an insurer which is regulated by APRA or which operates under an exemption under the Insurance Act 1973 (Cth)). This may be a particular issue for multinational companies
• based on the ‘revenue’ of the trustee, the amount of cover under the policy must be at least $2 million for any one claim and in the aggregate. For a licensee with total revenue from financial services provided to retail clients which is greater than $2 million, minimum cover should be generally equal to actual or expected revenue (as defined in AASB 118), up to a maximum of $20 million, plus defence costs. Records should be kept as to how the licensee determined the appropriate level of cover. This concept of revenue is particularly difficult for not-for-profit trustees
• the scope of cover must include liability for loss or damage suffered by retail clients because of breaches of Chapter 7 of the Corporations Act by the licensee or its representatives, including liability for fraud and dishonesty and liability under external dispute resolution (EDR) scheme awards. Licensees should have particular regard to the scope of their existing cover for crime in reviewing the adequacy of their existing cover
• the terms and exclusions of cover must not exclude cover for EDR scheme awards, loss caused by representatives generally, fraud and dishonesty by directors, employees and other representatives or liability arising from claims notified to ASIC, and
• the deductible must be appropriate to the business and licensees must retain records of their assessment of the appropriateness of the deductible amount.

Freehills is in the process of assisting many licensees with a review of their current professional indemnity insurance policies in the light of the initial implementation requirements and liaising with ASIC regarding their interpretation of these requirements in practice.

August 2008 – The business of being a trustee: conflicts of interest

Conflicts of interest are increasingly on the agenda as regulators focus on conflicts as an issue in the converging superannuation industry. Care needs to be taken at all times to manage the risk of a conflict arising, identifying it in a timely fashion and dealing with the conflict appropriately.

What is a conflict of interest?

A fiduciary has certain obligations to its beneficiaries. This is so for a trustee in relation to a beneficiary of a superannuation fund and a company director in relation to the company.

This includes a duty of loyalty which has two main components:

• a duty to avoid a position where the fiduciary is tempted to prefer his or her own interests or the interests of a third party over the beneficiaries’ interests, and
• a duty not to receive any advantage from the position.

If a fiduciary breaches this duty of loyalty, they will be liable unless they are excepted by the terms of the trust or have obtained the informed consent of the person to whom the fiduciary owes the duties. In order to obtain full informed consent, the fiduciary must disclose all relevant information.

These duties exist at general law, under the Superannuation Industry (Supervision) Act 1993 (Cth) and the Corporations Act 2001 (Cth) (Corporations Act). ASIC has issued Policy Statement 181 Licensing: Managing conflicts of interest detailing its views of the conflicts laws. We understand that APRA is currently working on its own guidelines on conflicts of interest.

ASIC Regulatory Guide 181 paragraph 15 states:

‘Conflicts of interest are circumstances where some or all of the interests of people (clients) to whom a licensee (or its representatives) provides financial services are inconsistent with, or diverge from, some or all of the interests of the licensee or its representatives. This includes actual, apparent and potential conflicts of interest.’

The legislative requirements build upon the general law requirements by requiring a policy to be in place regarding how an AFS licensee and a RSE licensee manage conflicts of interest.

How is a conflict of interest different to a conflict of duty?

A conflict of duty occurs where a fiduciary has two competing duties which conflict.

The classic scenario in which this may occur in the superannuation context is where a particular person is on the board of two related companies, one a trustee of a superannuation fund, the other a service company of the superannuation fund. The director’s duty to both companies may at times conflict and particular caution needs to be exercised in this scenario.

Can a director’s fiduciary duty to a company co-exist with a director’s fiduciary duty to members?

The trustee company owes fiduciary duties to the members of the superannuation fund.

Directors of a corporate trustee owe fiduciary duties to the trustee company itself.

It is unclear whether at general law directors of a trustee company owe fiduciary duties directly to the members of the fund. It is arguable that under section 52(8) of the SIS Act they do, either directly or indirectly.

When do conflicts commonly arise?

In practice, the most common examples of conflicts of interest include contracting with a company and when a personal profit is made or benefit derived.

Contracting with the company

For example, this occurs where a fund outsources a function of the superannuation fund to a related company, such as an administrator, life insurer or investment manager. This can create conflicts at the time of outsourcing or in supervising the related company during the life of the contract.

It is important for the agreements between these related parties to be appropriate and on a true commercial basis, that is, on terms no less favourable than an arms length arrangement.

The trustee of a superannuation fund cannot outsource to a related party without adequately considering the outsourcing, acting in the best interests of members at all times and providing proper disclosure to members.

When a personal profit is made or benefit derived

Remuneration of a trustee or a trustee company can occur where the trust deed allows the trustee to be remunerated or if fully informed consent is obtained.

If fully informed consent is being obtained, it is necessary to ensure that the consent is obtained from the appropriate persons. This would be the members of the fund where a corporate trustee is involved. However, identification of the appropriate party for providing consent is a more difficult issue in relation to remuneration of a director of a corporate trustee.

Part 7.7 of the Corporations Act requires full disclosure of remuneration. However, there remains a question as to whether the product disclosure statement or the financial services guide provides enough information to allow fully informed consent. And consent would actually need to be obtained in order for this exception to be relied upon. This would require careful consideration of the application forms for the fund.

How are conflicts best handled in practice?

There are a number of approaches that can be taken to address conflicts of interest. The most appropriate measure will depend on the nature of the conflict and the relevant regulatory requirements which apply to the conflict.

ASIC expects AFS licensees to establish a written conflicts management arrangement which:

• identifies the conflicts of interest relating to the business
• assesses and evaluates those conflicts, and
• provides for implementation of an appropriate response to the conflict.

Disclosure is an integral part of managing conflicts but disclosure will not be effective management of all conflicts.

ASIC Regulatory Guide 181 paragraph 42 recognises that in some cases the ‘only way to adequately manage those conflicts will be to avoid them’.

ASIC expressly discourages some conflicts, such as:

• advice about a particular financial product issue or product in return for benefits or business, and
• remuneration arrangements where advisers are paid exclusively by commission.

When can a conflict of interest or duty mean that a director is no longer ‘fit and proper’ for the role?

This will depend upon the circumstances. It is conceivable that a director of a corporate trustee may not be a ‘fit and proper’ person for the position by virtue of other positions held by the director which give rise to unacceptable conflicts of interest.

It should be noted that APRA and ASIC both have the power to require additional licence conditions to deal with any conflicts of interest concerns if necessary.

October 2008 – The business of being a trustee: Update on waiver of legal professional privilege

On Thursday 7 August 2008, the High Court handed down a judgment on when legal professional privilege may be lost. Given the potentially harmful consequences of a loss of privilege, we thought it useful to provide you with a summary of the decision.

In Osland v Secretary to the Department of Justice [2008] HCA 37 the High Court has:

• rejected the notion that in all cases a reference to the substance of legal advice will lead to a loss of privilege, and
• highlighted the importance of assessing the facts and circumstances of each case to determine whether the disclosure of the existence and effect of legal advice is inconsistent with maintaining confidentiality in that advice (which is the accepted common law test for determining whether there has been a waiver of privilege).

The case involved a petition for mercy to the Attorney-General of Victoria. The Attorney-General refused the petition and said in a press release that:

I appointed a panel of three senior counsel ... to consider Mrs Osland's petition. This week I received a memorandum of joint advice from the panel [which] recommends on every ground that the petition should be denied.

The question was whether, in making this public statement, the Attorney-General had waived privilege.

The High Court held that privilege had not been waived, and that:

The evident purpose of what was said in the press release was to satisfy the public that due process had been followed in the consideration of the petition, and that the decision was not based on political considerations. The three eminent lawyers who gave the advice were appointed following consultation with the State Opposition. They were external to the Department. Their advice covered all the grounds upon which the petition was based. They recommended denial of the petition. Their advice was carefully considered, and the petition was denied. The Attorney-General was seeking to give the fullest information as to the process that had been followed, no doubt in order to deflect any criticism, while at the same time following the long-standing practice of not giving the reasons for the decision. This did not involve inconsistency; and it involved no unfairness to the appellant.

It was important that there was a proper purpose for the disclosure of the legal advice, unrelated to any attempt to secure a tactical advantage in litigation:

This was not a case of a party to litigation 'deploying' a partial disclosure for forensic advantage, while seeking unfairly to deny the other party an opportunity to see the full text of the privileged communication.

It may be that similar reasoning can permit some disclosure of the conclusions but not the reasoning of legal advice without loss of privilege in other contexts, for example, where the disclosure is essential in discharging statutory obligations.

The key point to note from the Osland decision is that it cannot be assumed that disclosure of the existence, effect or conclusion of legal advice to someone outside the corporate entity does not risk the waiver of privilege. Each case will depend on its own facts (including how and why the existence, effect or conclusion of legal advice is used, and the exact nature of the relevant comment). For example, the court made it clear that the partial disclosure of legal advice ‘for a forensic advantage’ would be more likely to result in a waiver of privilege.

In the circumstances, extreme care should be taken before disclosing even the conclusion or gist of legal advice to outsiders given the possibility of an unintended waiver of privilege.

December 2008 – The business of being a trustee: Same-sex legislation – are you ready?

On 4 December 2008, the much publicised Same-Sex Relationships (Equal Treatment in Commonwealth Laws—Superannuation) Bill 2008 received Royal Assent.

The Same-Sex Relationships (Equal Treatment in Commonwealth Laws—Superannuation) Act 2008—No. 134 of 2008 (Act) amends the Superannuation Industry (Supervision) Act 1993 (SIS) to broaden the definitions of ‘child’, ‘spouse’ and ‘dependant’ in order to provide equal treatment in superannuation entitlements for same sex couples and their children.

The changes most notably expand the following definitions under SIS:

• ‘spouse’, to include a person of the same or different sex with whom the person is in a ‘registered’ relationship and a person ‘who, although not legally married to the person, lives with the person on a genuine domestic basis in a relationship as a couple’, and
• ‘child’, to include a ‘child of the person’s spouse’ and ‘someone who is a child of the person within the meaning of the Family Law Act 1975 (Cth). This is a surprisingly complex definition. Trustees will need to be cautious where complex family relationships exist.

The meaning of ‘dependant’ under SIS will reflect these amended definitions.

The amendments to SIS apply retrospectively from 1 July 2008.

Trustees of superannuation funds should as a matter of priority consider how the legislative changes will affect them. This will include the following:

1. Review of each fund’s trust deed to determine the impact of the Act.
   
   The amended definitions may affect the payment and taxation of death benefits, who qualifies as an eligible spouse member, contributions splitting and family law splitting.
   
   If the trust deed adopts the SIS definition of ‘spouse’ and ‘child’, the revised definitions in the Act will apply from 1 July 2008. This may open up the possibility of challenges to death benefits which have been paid in the last six months where the expanded definitions include a person who was previously not eligible to receive a death benefit under SIS.
   
   If the trust deed has a more restrictive definition, the trustee will need to give careful consideration as to whether and, if so, how the trust deed should be amended to broaden the definition of spouse, child and dependant.
   
   Under SIS, there is no requirement for trust deeds to be amended. Indeed, in the defined benefit context there may be funding implications if the class of potential beneficiaries is widened. However, given the duty of a trustee to act in the best interests of the members and the application of anti-discrimination laws, each trustee must consider whether it is appropriate and possible to amend the relevant trust deed.
2. Consideration of the extent to which the trustee should communicate these changes to members and the timing of disclosure to members. These changes may be a significant event, particularly where a binding death benefit nomination is held by the trustee. Particular care should be taken in dealing with death benefits which arise on or after 1 July 2008 to ensure that all possible dependants are notified of the existence of the death benefit and are considered by the trustee in determining the distribution of the death benefit.
3. Amendment of disclosure materials, websites, standard forms and other information provided to members.
4. Training of call centre staff so that members receive correct information.
5. Development of polices and practices with regard to determination of the meaning of the phrase ‘in a relationship as a couple’. There is currently no regulatory direction on how the term ‘in a relationship as a couple’ should be interpreted. A starting point may be to consider similar factors to those judicially considered in determining whether an opposite-sex de facto relationships exists. We note that section 4AA of the Family Law Act 1975 (Cth) and section 22C of the Acts Interpretation Act provide a definition of a defacto relationship. These definitions do not directly apply to SIS however they are useful reference tools. We further note section 22C of the Acts Interpretation Act which defines a ‘registered relationship’ which, upon registration, will provide conclusive evidence of a relationship for certain laws.

More information

For information regarding possible implications for your business, contact the Superannuation Partners.