There has been discussion lately about the compensation arrangements for SMSF investors who suffer loss due to theft or fraud. This is not surprising in the wake of the Trio Capital collapse, which saw many investors, including those with SMSFs, lose substantial sums of money.
For example, ASIC Consultation Paper 216, which was released for public comment in September last year, contained proposals to impose specific disclosure obligations on advisers, including a requirement to warn clients that SMSFs do not have the same access to compensation as APRA-regulated funds.
Some submissions in response to this consultation paper argued that the debate around compensation arrangements for SMSFs is complex and requires a measured regulatory response rather than a broad brush disclosure approach. But why is this argument so complex and why is the broad brush disclosure approach not necessarily the answer?
There are a number of compensation schemes in place which, when looking at the typical asset allocation of an SMSF, is likely to provide compensation to SMSF investors in the event they suffer a loss due to theft or fraud.
All institutions that subscribe to ASIC’s ePayment code (which is virtually all banks, credit unions and building societies along with a number of non-banking subscribers) will compensate their customers in the event of electronic payment fraud that the customer has not contributed to.
This is in addition to the financial backing, governance practices and codes of conduct of Approved Deposit Taking Institutions, which provide a guarantee of compensation in the event of theft or fraud which the customer has not contributed to.
There are other default compensation arrangements, such as the National Guarantee Fund which provides compensation where a client suffers loss by reason of misappropriation of, or unauthorised dealing by stockbrokers and other market participants who transact through their market.
A difficulty in comparing the compensation available to SMSFs with that available to APRA-regulated funds is that there are situations where compensation is unlikely to be available to members of APRA-regulated funds who suffer a loss due to theft of fraud. For example, many APRA-regulated funds now offer members direct listed investment options. If a member invests in a listed company and that company suffers a loss due to theft or fraud, due to normal market fluctuations it would be problematic to see how compensation, which is potentially available to APRA-regulated funds under Pt. 23 of the Superannuation Industry (Supervision) Act 1993, would apply in these situations.
SMSFs are by their definition self-directed investors and are not prudentially supervised. This means that trustees have more flexibility to invest in smaller – but also potentially riskier – listed companies. However, the statistics show that SMSFs, when compared to APRA-regulated funds have, if anything, a more conservative approach to investing, including an overweight exposure to the top 10 listed companies.
According to the latest Australian Taxation Office figures, listed investments account for around 35 per cent of total SMSF investments, and cash and term deposits make up around 30 per cent. This together means that on average 65 per cent of SMSF investments are arguably no more at risk to inadequate compensation than investments held by an APRA-regulated fund.
When you also consider the 17 per cent of SMSF assets that are invested in direct property, for which theft or fraud is not generally an issue, it means less than 20 per cent of SMSF investments on average are potentially exposed to higher levels of inadequate compensation compared to the investments held by an APRA-regulated fund.
Even within this 20 per cent, a significant proportion would be invested in investment schemes operated by institutions where compensation payments in the event of theft or fraud would be highly probable.
There is no denying continued education is needed to ensure that trustees are aware of the risks associated with certain types of investments but this disclosure should be aimed at investment products where the risk of inadequate compensation is real.
We should never trivialise the impact that fraud has had on the victims of Trio Capital and other collapses which have resulted in SMSF investors losing money due to theft or fraud. But we also need to ensure the debate and any regulatory response does not unfairly paint SMSFs as an unsafe or risky vehicle.