Australia: Banking Royal Commission – managed investment funds under the spotlight

Last Updated: 18 February 2019
Article by Bill Glover

Most Read Contributor in Australia, February 2019

The Banking Royal Commission focused on misconduct by banks, insurance companies, mortgage brokers and superannuation trustees.

However, anyone who is in the business of managing other people's money needs to pay attention to what the Royal Commission said. 

If you are an investment manager or you run an equity or credit fund, hedge fund or private equity fund then there are lessons you need to take from the Royal Commission.

The expectations that investors and regulators have for trustees of investment funds, including trustees who manage wholesale or institutional funds, will change as a result of the Royal Commission. Here are some of the key messages for trustees:

Don't ignore explosive devices - conflicts of duty and interest

The Royal Commission saw many instances where a trustee thought it could balance the competing interests of investors with those of a related party or the trustee's owner or parent company. The Commission had no tolerance for these trade-offs. The investors' best interests must be the paramount, and only, concern of the trustee.

"A trustee must act in the best interests of members and prefer their interests over the interests of anyone else. It will breach its duties if it disadvantages its members or disregards their interests for its own, or others', profit or convenience"

"Conflicts must not just be 'managed' – trustees have an overriding obligation to prefer the interests of beneficiaries"

"Conflicts of interest and conflicts between duty and interest should be eliminated rather than managed"
- Commissioner Kenneth M. Hayne

The Royal Commission's report gives the impression that Commissioner Hayne would like to have blasted every chief executive with the question: "Have you even heard of a trustee's duty to avoid conflicts?"

Here is that duty - actually two duties - in a nutshell: a trustee must avoid a situation where it has conflicting duties (such as to different investors or clients) or where its personal interest may conflict with its fiduciary duty to investors. Obtaining an investor's informed consent to either conflict of interest is the only sure way to deal with the issue.

Don't just watch bad behaviour, deal with it

The Royal Commission was very critical of how a major bank conducted an internal investigation of blatant wrongdoing. The investigation was more concerned with minimising the bank's exposure and preserving its reputation than with remedying the problem. What might be called 'damage control.'

"The conduct that has been described reflected a culture, demonstrated by senior executives within the NAB Group, of unwillingness to put right, wholly and promptly, what was evidently wrong conduct. And the conduct had been allowed to continue for years."

- Commissioner Kenneth M. Hayne

As U.S. Presidential candidate, Ross Perot, once said: "If you see a snake, just kill it. Don't appoint a committee on snakes."

Most importantly, management needed to act with investors in mind, rather than itself.

Bad investments require good management

One of the many case studies analysed by the Royal Commission concerned a large infrastructure investment by one of Australia's industry super funds. The investment performed poorly. What interested the Royal Commission was how the industry fund responded to a deteriorating situation.

The industry fund became actively engaged with its investment manager and participated in the manager's strategic review of the investment. The industry fund told its manager what that the strategic review needed to cover. The industry fund also undertook its own internal review of the investment. 

The Royal Commission was satisfied that the industry fund had acted in the best interest of its members and had exercised the degree of care, skill and diligence of a prudent trustee.

What people do when no-one is watching

The Royal Commission emphasised the importance of culture and governance in shaping how an organisation deals with regulatory compliance and risk. 

The Commission described culture as 'what people do when no-one is watching' and governance as the structures and processes by which an organisation is run. Remuneration both affects and reflects culture because it tells staff what the organisation values.

The Commission found that accountability is at the heart of good corporate governance. Who is to be held accountable and for what is done or not done? How are those who are accountable to be held to account? In a financial services company:

" .. it is the role of the board to be aware of significant matters arising within the business, and to set the strategic direction of the business in relation to those matters"

" .. boards must have the right information in order to discharge their functions. In particular, boards must have the right information in order to challenge management on important issues including breaches of law and standards of conduct"

- Commissioner Kenneth M. Hayne

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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