- Trustees of investment funds should be proactive in their assessment and considered in their response and remember that knee-jerk reactions may cause more harm than good.
These are uncertain times for trustees of investment funds, including super funds, registered schemes and wholesale investment trusts. Now more than ever, it is important that these trustees are guided in their response to the crisis by the best interests of their members, that they take reasonable steps to safeguard those interests and, if conflicts arise, they give priority to their members' interests. While it is not always possible to know all the consequences of a particular decision, it is critical to be able to demonstrate that you followed a proper process in making the decision.
This article provides a guide for trustees on how they can best protect themselves against personal liability as well as safeguard their members' interests in turbulent times.
Four Pillars of trustee decision-making
The impact of the global financial crisis is having a very sobering effect on the Australian financial services industry and the Australian mums and dads invested in that industry. Now more than ever, the investment community is looking to trustees as the guardians of their benefits to safeguard their interests.
There are thousands of laws that have been enacted over the last 15 years that are designed to ensure that trustees do the right thing by their members. This regulatory regime can be a minefield both for new entrants and experienced players in the financial services industry.
It is important that these trustees comply with the prescriptive legal obligations and the terms of their governing rules in their response to the financial crisis. However, many of those laws leave it to the trustees to decide how best to protect the interests of the members of their funds. Where trustees are given a discretion under their trust deeds, there are "Four Pillars" that they may wish to use to guide and support their response to managing the financial crisis:
- Best Interests: always act in the best interests of your fund members;
- Reasonable Steps: take reasonable steps to safeguard their interests;
- Manage conflicts: manage conflicts by giving priority to members' interests; and
- Good Governance: be able to demonstrate that you acted in the above manner and in proper discharge of your prescriptive legal obligations.
Adopting this approach may better protect trustees (and their directors and management) against personal liability and better safeguard their members' benefits in these turbulent times.
Best Interests Pillar
In the exercise of their powers under the fund's governing rules, trustees have a fiduciary obligation to act in the best interests of their members as a whole. This is also a statutory duty that applies to trustees of regulated super funds and registered schemes.
Importantly, the courts leave it to the trustee to decide how best to serve the interests of those members. The courts acknowledge that different trustees may come to different conclusions, as may the courts. The court's role is not to step into the shoes of the trustee and substitute its own decision. Rather, the court's inquiry is a negative one, using a number of tests to determine whether a particular decision of the trustee was not in the interests of the members of the fund.
So, how does a trustee ensure that it serves the members' interests? As a guide, trustees need to identify the purpose of the fund from their governing rules and disclosures to members. The purpose may also be influenced by the commercial and regulatory environment in which the fund operates, as well as the fund's membership profile.
Trustees need to understand how the fund and its members may be affected by the crisis and then consider how best to protect those interests. This is a cost/benefit exercise as different options may vary in cost and affect members in different ways. While the duty is to act in the interests of members as a whole, it also requires the trustee to act fairly between different groups of members who are affected in different ways.
Finally, where an issue affects the industry or other players, stress-testing of the options with peers and industry bodies, and even the regulators, may provide a helpful measure of the reasonableness of the decision. The courts accept that there is a range of reasonable decisions and as long as the trustee's decision is within this range, the courts are unlikely to interfere with the trustee's decision.
Reasonable Steps Pillar
Trustees of regulated super funds and registered schemes are subject to a statutory duty to exercise reasonable care and diligence in relation to all matters affecting their funds. Trustees of unregulated funds are subject to a general law duty of care and diligence, however, this duty is limited to investment matters. Important, professional trustees are subject to a higher standard of care which is imposed under both the general law and the various Trustee Acts around Australia, being that of the prudent man of business.
The duty of care is an ongoing obligation that requires trustees to proactively manage the risks that affect their funds, put in place reasonable controls that are designed to identify, respond to and properly manage those risks and continuously test the effectiveness of those controls.
The directors of a corporate trustee of a regulated super fund or registered scheme are also subject to statutory duties to take reasonable steps to ensure that the trustee complies with its statutory best interests and reasonable care duties. A person who suffers loss as a result of a breach of these statutory duties can sue the trustee and the directors (and any one involved in the breach) to recover that loss. Therefore, taking reasonable steps (aka ensuring reasonable controls are in place) to safeguard members' interests is essential protection against personal liability. More on this later...
When the judgment in ASIC v Citigroup was handed down in 2007, there was a general sigh of relief from the financial services industry because the Court recognised that Citigroup could contract out of being a fiduciary and that the AFSL conflicts obligation did not require the avoidance of conflicts but only their management.
However, there are a couple of points that need to be clarified about the relevance of that case for trustees. First, they cannot contract out of being fiduciaries. Secondly, as fiduciaries they are subject to a fiduciary obligation to avoid placing themselves in a position where their duty to the fund members conflicts with their personal interest or duty to some one else. Importantly, trustees may be able to take advantage of one of three exceptions to the conflicts rule, namely that the conflict was expressly authorised by the governing rules or by obtaining the express or implied consent of the fund members. Many funds take advantage of these exceptions to earn their remuneration and engage in related party arrangements as part of their integrated corporate structures.
If a conflict arises and an exception applies, the trustee is permitted to act despite the conflict. However, if the conflict involves the exercise of a fiduciary discretion, the trustee still has an overarching statutory obligation to act in the interests of the fund members. That is, the trustee must still give priority to the interests of those members.
As the holders of an AFSL or RSE licence, trustees should already have in place conflicts policies, processes and procedures that are designed to identify, monitor and manage the conflicts that affect their fund. The effectiveness of those arrangements may also have been reviewed after the Citigroup decision.
However, they may need to be revisited as the current circumstances may give rise to different conflicts and the existing arrangements may not identify, properly monitor or manage those conflicts in a manner that gives priority to the interests of fund members.
Good Governance Pillar
Hindsight is a powerful tool against decision-makers who are faced with difficult decisions in a time of crisis. It is not always possible to know all the consequences of a particular decision. However, if members suffer loss as a result of the consequences of your decision, it is important that you are able to demonstrate that you acted in what you genuinely believed was their best interests, that you took reasonable steps to safeguard their interests, and gave priority to their interests where any conflict arose.
The benefits of doing so are many, including:
- protection against personal liability
- reducing the risk of breaching the law
- minimising penalties and regulatory action
- reducing the risk of class actions
- strengthening the brand
- retaining and growing the membership base and reaping the benefits that come with greater scale; and
- taking advantage of the opportunities that arise out of the crisis.
So, what should trustees do?
Having regard to the best interest and reasonable care duties, trustees should undertake a proactive impact assessment on their fund and its service providers and develop a considered response to the financial crisis.
If a crisis team is formed, it must be given the authority to act, with appropriate monitoring and supervision by senior management and the Board. It is important that you ensure that you have the resources to both manage the crisis and continue to perform business as usual functions. Remember, this is an ongoing condition of your AFSL and RSE licence.
The financial crisis is resulting in the re-rating of many risks affecting investment funds and, accordingly, trustees should revisit their risk management arrangements. We suggest preparing an impact assessment report that describes the risks that may adversely affect the fund assets, the trustee's operations and its service providers. It should also assess the effectiveness of the existing controls to manage those risks and any action required to ensure those risks are managed within the risk appetite acceptable to the trustee.
The response to a crisis involves the weighing up of different options, which have different impacts and varying costs. Perfection and complete equity is an ideal that many may aspire to, but it does not reflect practical and commercial reality. Any response to the crisis is one of compromise and there will be winners and losers in any proposed action. The important thing is for the trustee to have a reasonable basis for its decision and be able to demonstrate that it acted appropriately and in proper discharge of its prescriptive legal obligations.
Demonstrating good governance
Bearing this in mind, trustees should document their delegations to management, map out the reporting lines between the crisis team, and the other parts of the trustee's management, including the Board. Likewise, initial planning, budgets, resourcing, impact assessments, action plans in response, reports to management and the Board, and all relevant outcomes should be documented and be accessible to all relevant stakeholders. However, it is also important to consider whether, and how, to maintain legal professional privilege and confidentiality as part of that process.
Member engagement is central to any effective response to the crisis. Regulated trustees need to comply with the specific disclosure regime under Chapter 7 of the Corporations Act and the ASIC Act. The crisis is increasing the risk of defective disclosure and increasing the number of significant event notices and supplementary PDSs as circumstances rapidly change and unforseen consequences occur.
Disclosure documents should be reviewed to understand member expectations and operational processes and procedures should be reviewed to confirm what actually happens in practice. The impact assessment should identify potential controls that need to be changed or new controls that need to be implemented. It is important that these changes are communicated to members as early as possible to minimise the adverse impact of the crisis on their benefits and manage their expectations. There are various modes of communication that can be used with varying impact and these need to be carefully assessed in terms of their effectiveness.
Trustees should also think about how members may respond to the changes resulting from the impact assessment and the communications sent to them. Trustees should think about what questions members may ask them, and provide scripted answers to call centres. Likewise, they should consider whether their existing complaints handling procedures need to be changed in order to deal with the type and volume of queries and complaints that may arise.
Engagement with the regulators
Finally, the regulators have been actively collecting information and building up their databases with probing questionnaires, industry surveys and through their annual review process. Be prepared for action. The Government and the regulators have foreshadowed a strong regulatory response to the crisis and it will only be a matter of time.
If you were the regulator and knowing your trustee operations, what questions would you ask? What would be your response right now and what should it be from a good governance perspective? Think about those questions and what action and changes you may need to make in order to get your house in order. Finally, make sure that you can demonstrate that you acted appropriately.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.