APRA's failed proceedings against superannuation entities in Federal Court has implications for the sector and trustees, says Professor Pamela Hanrahan.
In August 2018, media and public interest in the proceedings of the banking Royal Commission was at its height. The fifth round of public hearings, dealing with management of Australia’s $2.87 trillion superannuation sector, was underway. The case studies selected for examination by the Commission in this round included the retail superannuation business owned by the listed company IOOF Holdings Ltd and operated by its two registrable superannuation entity (RSE) licensee subsidiaries, IIML and Questor.
The evidence adduced raised significant red flags for regulators. In December 2018, the Australian Prudential Regulation Authority (APRA) commenced proceedings against IIML, Questor and two directors in connection with five incidents affecting the IOOF funds from 2007 to 2018. APRA alleged significant contraventions of important statutory duties imposed by sections 52 and 52A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) on RSE licensees and their directors. These duties are, in effect, to exercise the requisite degree of care, skill and diligence, to act in the best interests of the beneficiaries of the superannuation funds, and to give priority to the interests of the beneficiaries in the event of a conflict of interest.
By September 2019, APRA’s case had failed. In APRA v Kelaher  FCA 1521, Justice Jayne Jagot concluded that APRA had not produced the evidence needed to establish that the conduct of the RSE licensees and their directors had breached the statutory standards. This was the result of “systemic weaknesses” in the way APRA framed and ran the litigation. Justice Jagot found that “APRA has not realistically confronted the need for reliable evidence of the particular factual circumstances said to give rise to the breaches of the statutory covenants”. This resulted in “an evidentiary vacuum when it comes to [the RSE licensees’] existing systems and procedures, making it impossible to perform the kind of analysis that would be required for APRA to make good its claims”.
Kelaher is of direct significance to the 114 RSE licensees, and about 900 individuals who are directors of RSE licensees, who operate the retail, industry, corporate and non-exempt public sector superannuation funds. These comprise more than $1.9 trillion in assets and 26 million member accounts. The duties of RSE licensees are a complex amalgam of the general law of trusts, the SIS Act and the financial services laws. For directors of RSE licensees, their statutory and general law directors’ duties to the RSE licensee are supplemented by specific SIS Act duties concerning the management of the fund, including duties to act honestly, to exercise care, skill and diligence, to perform their duties and exercise their powers in the best interests of the beneficiaries, and to manage conflicts.
While the statutory duties of RSE licensees and their directors are specific to the superannuation context, the case provides guidance for all trustee companies and their directors.
The case engaged the duties of care, the duty to act in the best interests of beneficiaries, and the rules for managing conflicts. Justice Jagot stressed that “a trustee’s duty [of care] does not amount to a duty to avoid all loss and that an ordinary prudent person [and for that matter prudent superannuation trustee] can commit errors of judgement without being liable”. Even the heightened standard in the SIS Act “does not convert a superannuation trustee into a surety of no loss and does not involve strict liability”.
In relation to the duties to act in the best interests of beneficiaries, APRA focused on the process used by the defendants to arrive at decisions affecting the funds. In making decisions about beneficiaries’ entitlements, trustees must give properly informed consideration to applications for entitlements and, if that necessitates further inquiries, they must make them. APRA sought to extend this principle “to any and all matters potentially affecting the capital of the trust”. But Justice Jagot found that, “There must be myriad decisions taken every day by trustees of large superannuation funds which potentially affect the fund both materially and immaterially. The extension of the principle which APRA proposes appears onerous in the extreme and highly impractical.” Flaws in a trustee’s decision-making process are only relevant to the extent that they produced a flawed decision, although it will be a breach of the best interests covenant if it is proved that “the trustee’s subjective purpose or object in acting was contrary to the best interests of the beneficiaries”.
The fact that APRA failed to establish a breach of the best interests duty meant that it also failed on important aspects of the conflicts case. The specific statutory requirements in the SIS Act provide that, in the event of a conflict between the interests of the beneficiaries and those of others, including the RSE licensee or its directors, they must give priority to the duties to and interests of the beneficiaries over the duties to and interests of other persons; ensure the duties to beneficiaries are met despite the conflict; ensure ; the interests of beneficiaries are not adversely affected by the conflict; and comply with prudential standards in relation to conflicts.
The first three requirements overlap with the best interests duty. The requirement to give priority to the duties to and interests of the beneficiaries “involves both a subjective and objective element. These provisions are concerned with and require that in the decision-making process actual [not merely theoretical or potential] conflicts are recognised… and that priority is given to the interests of beneficiaries over the interests of other persons”.
The statutory no-conflicts covenant “is not about avoiding conflicts of interest. Conflicts of interest are inevitable. It is about managing conflicts of interest. And the conflicts which need to be managed are actual conflicts which have the capacity to significantly impact on the duty to act in the best interests of beneficiaries”.
One final aspect of the case is worth noting. APRA argued that the respondents breached the law because they acted in a manner inconsistent with APRA’s published views — including in its policy documents — about what the law required. This was not enough to prove its case.
As the respondents submitted: “If APRA correctly described the law, or the required course of action… then it must prove that in these proceedings by means other than its own prior statements. Unless there is an obligation backed by legislation to comply with a command or recommendation of APRA, or to consider its opinions, then the fact that APRA has spoken does not shed any light at all on the issues to be determined.”
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