The best interests covenant is simply stated. Yet the conduct examined by the Commission, and submissions made by trustees, suggested that some trustees had difficulty understanding when and how the covenant applied.
For example, one group of trustees said that the duty is not an overarching obligation to act in members’ best interests. They said that the covenant operated to qualify the performance of a particular duty, or the exercise of a particular power. Whether or not that is a complete statement of the law, describing the covenant in this way is apt to mislead. It suggests that the covenant has only limited application. Yet whenever a trustee acts it will be performing a duty or exercising a power, and an obligation to perform duties and exercise powers necessarily covers omissions. A trustee cannot avoid its obligations by doing nothing. It follows that any suggestion that the covenant has only limited application is not right.
The same trustees emphasised the alleged complexity of the covenant and the need to consider all of the circumstances. Another group of trustees listed six matters ‘by way of example of the complex considerations’ that can arise. The tenor of this submission was that accurately identifying a breach of the covenant was fraught with difficulty. Yet the ‘complex considerations’ it pointed to were straightforward matters, such as recognising the importance of the superannuation context and accepting that the application of the covenant will depend upon the circumstances of the case. Again, such observations are more likely to confuse than to assist.
At the other extreme was a trustee who, in response to a letter from APRA, suggested that ‘the so-called pub test’ was a ‘proxy’ for members’ best interests. The reduction of members’ best interests to this yardstick is likely to mislead for other, more obvious, reasons.
It should be concerning to regulators that professional trustees apparently struggle to understand their most fundamental obligation. No doubt a trustee must consider all relevant circumstances when deciding what is in the best interests of beneficiaries. It may also be accepted that the role of a professional trustee is complex, and that a trustee is not responsible for every outcome that turns out to be ‘unbeneficial’ to members. But that does not make the covenant incomprehensible or its content unknowable. Assertions of complexity must not obscure or confuse the obligations imposed on a trustee. The concept of acting in members’ best interests is not hard to understand.
A trustee ‘must do the best they can for the benefit of their beneficiaries, and not merely avoid harming them’. This can be achieved if a trustee keeps the best interests of beneficiaries ‘front of mind’ at all times. The case studies revealed that, all too often, trustees did not. Usually, they did not because a conflict arose between the beneficiaries’ interests and the interests of the trustee or another person or entity.
It is therefore necessary to say something about the covenant in section 52(2)(d) of the SIS Act. Again, the covenant is simply stated: it requires the trustee to prioritise the beneficiaries’ interests where a conflict arises.
By contrast to their approach to section 52(2)(c), most RSE licensees had little difficulty identifying what section 52(2)(d) requires. Their written submissions said that it could be met by ‘management frameworks’ and policies intended to ‘identify’ and ‘manage’ conflicts.
In addition to the obligation imposed by section 52(2)(d), Prudential Standard SPS 521 requires that a trustee’s conflicts management framework provide ‘reasonable assurance that all conflicts are being clearly identified, avoided or prudently managed’. I emphasise avoidance because the surest way to prevent a breach of the covenant is to avoid the potential conflict entirely. Yet the case studies showed that trustees rarely sought to avoid a conflict.
I accept that section 52(2)(d) and SPS 521 contemplate the existence of conflicts of interest. But care needs to be taken not to assume that their identification and purported management satisfies the obligations in the section. Rarely did entities identify how the interests of beneficiaries were prioritised over others that conflicted. None said that the trustee should have avoided the conflict in the first place. Instead, trustees relied on policies that attempted to identify and manage the conflict. As discussed further below, those policies were often ineffective.
Most of the case studies to which I am referring involved conflicts between the duties to members and the interests of, or the duties owed to, the owner of the trustee company. But it is important to recognise that conflicts can and do arise in profit‑for‑member funds as well as retail funds. In the case of profit‑for‑member funds, shareholders or nominating organisations of the trustee may have, and may seek to pursue, interests that differ from the interests of members.
One particular kind of case about conflict of interest merits separate consideration: the case in which the trustee undertakes competing obligations as both trustee of a superannuation fund and as responsible entity of a managed investment scheme, and thus becomes a ‘dual–regulated entity’.
The moment a trustee tries to wear two hats, conflicts will arise. The duties the trustee owes to members of the superannuation fund are not the same as the duties it will owe as responsible entity of a managed investment scheme and the duties will be owed to two different classes of members.
Conflicts of this kind only arise because a trustee undertakes the obligations of responsible entity. Taking on those obligations may be seen as yielding some commercial convenience for the group of companies concerned. But those considerations do not outweigh the practical consequences for the trustee’s performance of its duties to its members.
The solution is simple: the trustee of an RSE should not be permitted to assume any obligations other than those arising from or in the course of its performance of the duties of trustee. A prohibition of that kind would prevent a trustee from acting as a dual–regulated entity. But it would go further. It would prevent a trustee from undertaking any obligation that does not arise out of its holding the office of trustee. The wider prohibition is desirable because it deals directly with the fundamental issue.
To be clear, an RSE licensee may be the trustee of more than one superannuation fund. Acting as the trustee of another superannuation fund is unlikely to give rise to unmanageable conflicts. But a trustee should not be permitted to take on obligations of any other kind.
Recommendation 3.1 – No other role or office
The trustee of an RSE should be prohibited from assuming any obligations other than those arising from or in the course of its performance of the duties of a trustee of a superannuation fund.
It is necessary to say something more about the position of the trustees of retail funds.
2.2.2Conflicts of interest and the trustees of retail funds
The evidence led in the Commission, and my remarks above, might be understood as suggesting that it is not possible for the trustee of a retail fund to perform its covenants to act in the best interests of members and to give priority to their interests over the interests of related parties or any other person. I do not consider that the evidence showed that a trustee of a retail fund cannot fulfil its duties. The evidence showed that there are some recurring issues and difficulties to which trustees and the regulators need to give close and continuing attention.
The essential character of the conflict that confronts the trustee of any fund established for the profit of its parent company or corporate group is the conflict between the commercial interest of the parent company – to maximise profit – and the trustee’s obligation to give priority to the duties to, and interests of, the beneficiaries. The conflict may emerge in any number of different ways.
One way the conflict may emerge is in the choosing of what entities should perform services in connection with the administration or investment of the fund, and fixing the fees or other remuneration that is to be paid to those entities. It is in the interests of the parent company to maximise the profits earned by the administration company. But the trustee’s duty is to minimise the amount it must pay for proper administration services.
As a result, dealings between the trustee and other entities related to the trustee of the fund always require special consideration. There will always be two groups of questions. First: how and why was the related entity chosen to provide the particular service? Were external entities considered? Second: how was the price for the service struck? Has the trustee compared what is offered from within the corporate group with the performance and pricing offered by entities outside the corporate group?
Another way the conflict may emerge is in the day‑to-day administration of the fund. One obvious case is when the trustee depends upon information supplied to it by administrators or others connected with the fund’s parent company. As the case studies show, the information supplied to the trustee may be based upon premises that in some way or another reflect the commercial interests of the parent company, whether that is a direct interest in maximising profit or some less direct interest such as maintaining the goodwill of advisers aligned with the parent company. Unless those premises are exposed, the trustee may take the information that it is given at face value and base the decision it takes upon an incomplete understanding of what courses of action may be available to it.
Trustees can fulfil their duties to members only if they recognise that the interests of the fund’s parent company and the interests of members are not only different but are often opposed. There are three consequences.
First, disclosure of conflicts of interests on its own is not enough. Information supplied in product disclosure statements will often tell those joining a retail fund that the trustee has arrangements with related entities and will plainly reveal to intending members that the fund is organised and run for the profit of its parent company. Disclosure of that kind is, of course, essential. But the statutory duty to comply with the RSE licensee law and to perform properly the duties of the trustee demands action, not just disclosure.
Second, as the best interests covenant makes plain, the trustee’s obligation is to perform its duties and exercise its powers in the best interests of the beneficiaries. Each time a trustee makes an arrangement for others to act in connection with the administration or investment of the fund constitutes an act done in performance of the trustee’s duties and in the exercise of its powers. Hence, both the instigation and maintenance of every arrangement about administration and investment must be judged against the best interests of members.
Having chosen a related entity to provide services to the fund, the trustee must also be conscious of the conflicts of interest that unavoidably arise, particularly where a trustee relies on a related entity to perform core functions such as investment and management of the fund. To varying degrees, trustees who gave evidence to the Commission acknowledged the conflicts generated by such arrangements. But, again, the solutions they proposed involved policies, together with contracts expressed to enable oversight and service delivery, which too often proved to be ineffective.
Outsourcing of the trustee’s day-to-day administration and management of a fund to a related entity, or indeed, any third party, requires ongoing care and diligence on the part of a trustee. Where it is relying on information provided by the related entity, it must test the information it receives and seek further information where necessary. The trustee must satisfy itself that the trust is being run in the best interests of the members. The case studies showed that trustees are not always discharging this responsibility and regulators have not acted on this.
Third, regulators must be astute to observe whether trustees are giving priority to the interests of members. As already noted, proper performance of the best interests duty is essential to trustees meeting the financial promises they make. Performance of that duty is central to achieving the best outcomes for members.
It should be remembered that Prudential Standard SPS 231 provides that an RSE licensee who outsources a material business activity to a related party ‘must be able to demonstrate that the arrangement is conducted on an arm’s length basis and in the best interests of beneficiaries’. The case studies suggest that, to date, this obligation has not led to sufficient rigour in the selection and monitoring of related–party service providers. As later explained in the chapter on insurance, I recommend additional scrutiny for related-party engagements.
2.2.3Frameworks for managing conflicts
As already observed, many retail trustees seek to identify and manage conflicts of interest, rather than avoid them.
For example, AMP submitted that the trustees ‘ensure their responsibilities and obligations to members are met by the terms of their outsourcing arrangements, the work of Trustee Services, the use of the Business Monitoring Model (BMM) framework and other complementary monitoring activities’. Similarly, NULIS said it engaged an administrator to act as its service provider. That administrator was legally liable for breaches of its contractual obligations in its capacity as administrator, which are required to be reported under the Administration Agreement.
The issue, however, is not whether such arrangements exist on paper. Conflicts of interest cannot be managed through box-ticking processes. The issue is how those arrangements are implemented in practice. As explained in Volume 2, all too often these arrangements failed to operate effectively. For example, the AMP trustees endorsed plans prepared by a related party for the transfer of accrued default amounts to MySuper products. The trustees were not told about, and did not enquire about, the related party’s detailed commercial consideration of the effect that the timing of transfers would have on the profits of the AMP Group. Nor did they enquire about the effect of the proposed timing on their members. In another example, AMP’s Trustee Services team considered that member fees were too high. But it also considered that this was a matter for the AMP product team, not the trustee, to address. In such cases, the existence of the BMM framework did not result in adequate management of conflicts.
Although regulators should stand ready to protect members’ interests when trustees cannot, or will not, they do not always do so. In 2017, APRA conducted a review of the BMM and characterised it as ‘robust’. As explained in more detail in Volume 2, this characterisation suggests that APRA may not have grappled with how the trustees’ arrangements worked in practice, and what impact those arrangements had on members. In his evidence to the Commission, Mr Byres acknowledged that the evidence received by the Commission and ‘subsequent discussions’ revealed that ‘the application of the framework was not as one would expect it to be’.
More broadly, Mr Byres said that in its supervision, APRA’s focus had been on whether regulated entities had robust frameworks and policies, on the basis that ‘if you have a good set of frameworks and policies and your audit and compliance function are doing their job … things should broadly work as intended’. However, he acknowledged that a ‘general lesson’ for APRA was that it needed to consider how to ‘get deeper’ and identify where frameworks and policies were not effective. He said that the AMP case study examined by the Commission was an example of where APRA’s approach had been inadequate, and that a deeper examination had been required.
The number of retail trustees who have failed to manage conflicts effectively, despite having elaborate written frameworks in place, suggests that this is not an isolated issue. No doubt APRA can and should ‘get deeper’ in its supervision and take appropriate steps to remedy issues with particular trustees. But something more is required. As the Productivity Commission identified, strategic conduct litigation – that is, bringing strategic enforcement action to both address the immediate member harm, and to deter future conduct – appears at times to be ‘missing in action’ in the superannuation industry.
It is important to notice, therefore, that following the Commission’s taking of evidence, in August 2018, about some issues concerning the IOOF Holdings Ltd group of companies, APRA commenced proceedings in the Federal Court of Australia, on 6 December 2018, against IOOF Investment Management Ltd (IIML), Questor Financial Services Pty Ltd, and five individuals holding senior positions at IOOF. By those proceedings, APRA seeks declarations that IIML and Questor breached their duties as trustees and contravened various provisions of the SIS Act by failing to exercise their powers in the best interests of the beneficiaries of the superannuation funds and failing to give priority to the interests of beneficiaries over the interests of all other persons. APRA seeks declarations that two of the individuals (Mr Christopher Kelaher, Managing Director of IOOF Holdings Ltd and Mr George Venardos, Chairperson of the company) contravened some provisions of the SIS Act and further seeks disqualification orders under section 126H of the SIS Act. As against the three other individual defendants (Mr David Coulter, the Chief Financial Officer, Mr Paul Vine, the General Manager – Legal, Risk and Compliance and Company Secretary, and Mr Gary Riordan, the Group General Counsel) APRA seeks disqualification orders under section 126H of the SIS Act.
These proceedings having been instituted, I will say nothing about what emerged in evidence before the Commission about events and circumstances referred to in the papers filed by APRA in the Federal Court.
2.2.4Conflicts of interest and industry funds
As already noted, it is not only the trustees of retail funds that encounter conflicts of interest. So, too, the trustees of industry funds, and ‘profit‑for‑member’ funds more generally, must also recognise and deal with conflicts between the interests of members and the interests of shareholders or nominating organisations.
A deal of attention was given to the ‘Fox in the Henhouse’ advertising program sponsored by industry funds. The principal focus was upon the best interests and sole purpose obligations of the trustees of those funds that contributed to the cost of making and broadcasting of the advertisement. I have dealt with those aspects of the matter in Volume 2 of this Report and do not seek to add to or repeat what is said there about those issues.
Instead, I observe that those who criticised funds who contributed to the costs associated with that advertisement can be seen as making a complaint that has its roots in notions of conflict of interest: what is seen as the conflict between duties to members and the interests of some shareholders or nominating organisations of industry fund trustees. As I record in Volume 2, I do not find that the conduct of the trustees might have amounted to misconduct or that it was conduct falling short of community standards and expectations.
The events were of a kind, however, that some suggested should lead to some rule prohibiting funds from engaging in certain kinds of ‘political’ advertising. I do not favour the adoption of a rule of that kind. Even if a rule of that kind could be made (and I do not stay to examine how the implied freedom of political communication might apply) it is not a rule that I consider should be made. Rather, I consider that the existing rules, especially the best interests covenant and the sole purpose test, set the necessary standards. Those standards should be applied according to their terms and without more specific elaboration.
2.2.5Extend best interests duty?
I do not consider that the difficulties the trustee of a retail fund will encounter in complying with the best interests covenant and the covenant that it give priority to members’ interests over all others would be lessened by extending the class of persons who owe members those obligations. As has been noted, directors of the trustee owe parallel obligations. And both the trustee’s and the directors’ obligations focus upon the performance of duties and exercise of powers, in effect, in execution of the trust.
Formulating the duties that would be imposed on other entities is not without difficulty. What would be the content of the duty that might be imposed on (say) the shareholders of the trustee company? Would it be to exercise some or all of their powers only in the interests of the members of the fund of which the company is trustee? What would be the content of the duty that would be imposed on (say) a company retained by the trustee to perform some administrative function or functions for the trustee? Would it be to perform its duties under the administration agreement in the best interests of members? Unless the duties were to be framed in a way that imposed on these other entities duties of the same kind as a trustee owes members, how would imposing those duties make a difference? And, even if the duties imposed were to be to the same effect as the duties that a trustee now has, the same question must be asked. How would imposing those duties make a difference?
No matter what duties other persons may owe to members of the superannuation fund, the trustee would still be bound by its duties. The bare fact that others have correlative duties would not relieve the trustee of its duties. It would still have to take the necessary steps to ensure that what its shareholders and administrators were doing did not cause it, the trustee, to be in breach of its obligations. And, at least in the case of administration arrangements, the agreements made between trustees and administrators now commonly provide that the administrator must act in a way that will not adversely affect the trustee’s performance of its duties.
Rather than introduce a new layer of regulation, necessarily accompanied by an increased regulatory enforcement task, I think it better to focus upon the existing and central requirements: that trustees of superannuation funds (and their directors) perform their obligations. I do not consider that meeting those central requirements would be assisted by making persons other than the trustees (and the directors of corporate trustees) subject to parallel obligations. To do so would, I think, serve only to allow blame‑shifting and to distract from the close attention that must be given to the performance of trustees and their directors.
2.2.6Prohibit ‘for–profit’ funds?
The most radical response to address difficulties encountered by the trustees of for-profit superannuation funds would be to prohibit, or at least inhibit, the carrying on of a superannuation fund for profit. For the reasons that follow, I do not favour proposals of that kind.
It would be a very large step to say that the only persons or groups of persons who can conduct a superannuation fund are those who will not seek any return on their investment in the venture. To take a step of that kind now would have several effects.
First, it would eliminate one set of existing participants in the market and thereby reduce the competitive forces at play in the overall industry. Second, it would insulate existing not‑for‑profit participants from whatever competitive pressures are exerted by the threat of large for‑profit entities entering this part of the financial services market and providing some new and better offering to consumers. Eliminating either or both of those competitive forces is undesirable and is probably reason enough to reject the idea.
But whether or not that is right, I am not persuaded that the trustees of funds established for the profit of the parent company cannot perform their duties to act in the best interests of members and give members’ interests priority over those of the parent company. As is apparent from what I have said in Volume 2 of this Report, I accept that trustees of for–profit funds have not always performed their duties. Further, I accept that the trustees of for‑profit funds encounter particular difficulties in the performance of their duties. And I accept that trustees and regulators must give close and continuing attention to these issues. But neither separately nor together do these observations cause me to conclude that outright prohibition of for‑profit funds is the only, or even preferable, solution to be adopted.
It may be said that some form of ‘structural separation’ between product manufacture and product sales is a necessary response to the issues about conflicts that have been identified in connection with for‑profit superannuation funds. The separation suggested would require the party dealing with consumers (the trustee of the fund) to be controlled and managed separately, in the least, from the party or parties that manufacture the financial products that the trustee will acquire, and also perhaps, from the party or parties that carry out administrative, investment or insurance functions for the trustee.
Separation of the general kind described would preclude a trustee from investing the whole of the fund, as some retail funds now do, in insurance products issued by a life company associated with the parent company of the fund. It would also preclude the trustee from dealing with entities associated with the parent company of the fund to provide investment, administrative, insurance, or other services for the fund.
The premise for enforcing structural separation in any of the ways described must again be that it will reduce the nature and scale of the conflicts between the trustee’s duties and the profit interest of the parent company. But, so long as the parent company seeks to make a profit there must come a point at which the interests of members and the interests of the parent company collide. It is in the interests of the members to maximise their returns; it is in the interests of the parent company for it to maximise its return.
The only way in which that conflict can be resolved is by the trustee fulfilling its duties. And to do that the trustee will have to compare what its related entities offer in investment, administrative and insurance services with what others in the market would provide and at what cost they would provide it.
Structural separation would also be a large step to take, as it would affect every person who is currently a member of any one of a significant number of funds. Apart from the members holding MySuper accounts with the relevant entities, all of those members would have chosen the fund in question. If, for any reason, those members consider it would be in their interests to move funds, they can do so. I am not persuaded that a case has been made for imposing some form of structural separation on RSEs.
NAB and NULIS, Module 5 Case Study Submission, 5 .
NAB and NULIS, Module 5 Case Study Submission, 5 .
NAB and NULIS, Module 5 Case Study Submission, 18 , 19–20 –.
CFSIL and Avanteos, Module 5 Case Study Submission, 17 [50(c)].
CFSIL and Avanteos, Module 5 Case Study Submission, 17 [50(c)].
Exhibit 5.302, Witness statement of Stephen Glenfield, 14 August 2018, Exhibit SG-1-40 [APRA.0007.0002.1765 at .1769].
Cowan v Scargill  Ch 270, 287–8. See Finch v Telstra Super Pty Ltd (2010) 242 CLR 254, 270–1 –.
Manglicmot v Commonwealth Bank Officers Superannuation Corporation (2010) 239 FLR 159, 179; Invensys Australia Superannuation Fund Pty Ltd v Austrac Investments Ltd (2006) 15 VR 87, 110–11 .
Cowan v Scargill  Ch 270, 295; Invensys Australia Superannuation Fund Pty Ltd v Austrac Investments Ltd  15 VR 87, 108 .
Bray v Ford  AC 44, 51–2; Breen v Williams (1996) 186 CLR 71, 93, 108, 135.
AMP, Module 5 Case Study Submission, 6 ; NAB and NULIS, Module 5 Case Study Submission, 7 ; IOOF, Module 5 Case Study Submission, 19–20 .
APRA, Prudential Standard SPS 521, 15 November 2012,  (emphasis added); see also .
Westpac, Module 5 Policy Submission, 19–20 –; CFSIL and Avanteos, Module 5 Policy Submission, 23 .
APRA, Module 5 Policy Submission, 25 ; ASIC, Module 5 Policy Submission, 28 .
SIS Act s 29E(1)(a) and (b).
AMP, Module 5 Case Study Submission, 2 ; NAB and NULIS, Module 5 Case Study Submission, 4 .
APRA, Prudential Standard SPS 231, 15 November 2012, .
See Recommendation 4.14.
AMP, Module 5 Case Study Submission, 2 .
NAB and NULIS, Module 5 Case Study Submission, 4 .
Exhibit 5.291, 7 April 2017, Letter from APRA to Sansom, 3.
Transcript, Wayne Byres, 30 November 2018, 7471.
Transcript, Wayne Byres, 30 November 2018, 7470.
Transcript, Wayne Byres, 30 November 2018, 7470.
Productivity Commission, Report 91, Superannuation: Assessing Efficiency and Competitiveness, 21 December 2018, 459.
APRA v Christopher Francis Kelaher & Ors (FCA, NSD 2274/2018).
See, eg, ANZ, Module 5 Policy Submission, 1 .
SIS Act s 52A. See also the additional obligations imposed on trustees and directors of trustees in respect of MySuper products by ss 29VN and 29VO of the SIS Act.
See, eg, AustralianSuper, Module 5 Policy Submission, 9 –; TWUSuper, Module 5 Policy Submission, 20 .