Financial services and banking

Best interests duty is not that complicated

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has thrown some light onto the superannuation sector’s conduct while left alone in the dark with the retirement savings of Australians.

Although the interim report Commissioner Kenneth Hayne handed down doesn’t focus heavily on conduct or policy issues directly related to the superannuation industry, the central importance of trustee responsibilities to manage retirement savings in the best interests of beneficiaries has been illuminated.

We heard counsel assisting and witnesses make more than 200 references to best interests during round five of the hearings. It is as important as ever for those of us involved in the management of other people’s retirement savings to understand what this means, even if it might be challenging in practice.

There have been sensible voices from within the legal and finance sectors pointing out that there is often scant judicial interpretation of many of the statutory duties under superannuation law, including the best-interests duties. However, this does not necessarily mean that in practical terms, best interests responsibilities are uncertain or unclear.

Trustee responsibility to exercise their powers for proper purpose, in good faith, and in the best interests of beneficiaries has clear and established meaning – a meaning found in loyalty and prudence.

Loyalty is not a complex concept. It simply means that where there are diverging interests, or conflicts of interest, the interests of the member or client must –always must – be prioritised.

This means more than paying lip service that customers come first; it’s having conduct, practice and structure that actively prioritises members’ interests.

Hayne demonstrated the point in the early hearings of the royal commission, illustrating the binary choice financial institutions faced between prioritising consumer outcomes or commercial outcomes and profits.

The correct answer to the question, in a fiduciary context, isn’t that there is a balancing act between the interests of the members and those of the trustee or anybody else, but a responsibility to prioritise members – always.

Loyalty must be complemented with prudence. This requires that trustees responsible for managing other people’s retirement savings are capable and competent to the standard of care that the community has a right to expect – that of a prudent superannuation trustee.

This means having appropriate systems and structures in place to ensure that risks are quickly identified, readily assessed and diligently managed. At the very least, it also means that other people’s retirement savings must be managed in accordance with the product terms and conditions. It’s not too much to expect.

The fundamental duty of a trustee is to administer the trust in accordance with the terms of the trust. This shouldn’t be merely an aspiration but the foundation upon which prudence and trust are built.

The prudent management of other people’s retirement savings also requires that superannuation trustees strike the balance between long-term performance and costs, along with ensuring the commercial arrangements in supply chains are the best available, that opportunities to promote scale efficiency through consolidation are seriously considered, and that claims and complaints are dealt with fairly and efficiently.

So if the law is less opaque than some suggest, how have we ended up in a position where nearly every issue counsel assisting raised in closing submissions contemplates a failure to adhere to these fundamental aspects of managing other people’s money? Why have some organisations failed to act consistently with what the law requires? While the interim report focuses on greed, there are more specific themes that warrant attention.

Because of the inevitable low level of engagement in a mandatory, opaque, complex and very long-term investment, we can’t necessarily rely on members or a competitive market to weed out the bad apples and poor performers.

While regulatory enforcement and action have an important role to play in guiding practices, trust can be rebuilt only from within the industry. There are some sensible places to start the process.

Corporate group structures involving relationships between related parties can hard wire practices that can grate against the best interests of beneficiaries. Serious attention is required to ensure that outsourcing with related parties is genuinely at arm’s-length and that the trustee is able to make decisions without direction or undue influence of related companies.

Short-term performance incentives and rigid profit targets also need to be managed much better. They can create conflicts that might relegate the interests of members beneath those of the trustee or another related party.

Lack of operational controls to ensure that product fees are applied accurately is a glaring weakness of many organisations. Investing in emerging regtech technologies can institutionalise accuracy and transparency, and maximise the probability of the best outcomes for clients and members.

These questions go to the heart of what the superannuation industry will need to do to maintain social licence and public trust.

In his 2015 book looking back at the GFC titled Other People’s Money, Financial Times journalist John Kay quoted American writer Upton Sinclair: “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

Key decision-makers may need to revisit what acting in the best interests of a member or client really means: even if their salary – or bonuses – have been dependent on not understanding it in the past.