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Lessons about how not to meet SMSF professional standards

strategy
By Shelley Banton
October 26 2018
5 minute read
6 View Comments
Lessons about how not to meet SMSF professional standards
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One of the most critical aspects of the Ryan Wealth Holdings Pty Ltd vs Baumgartner [2018] NSWSC 1502 case was the auditor failing to confirm that the fund’s investment strategy had given appropriate consideration to risk, return, liquidity and diversification and that the fund’s investments were made in line with that investment strategy.

The consequences of this omission not only saw the SMSF auditor liable for $1.62 million of the total $7.2 million losses incurred by the trustee but also has critical implications for those SMSF auditors who give the investment strategy a cursory glance during the audit.

The impact of the Ryan case provides a lesson for all SMSF auditors and advisers to meet their professional standards or face potential litigation from trustees when their investments go to custard.

 
 

SIS Regulation 4.09

Regulation 4.09 of the Superannuation Industry (Supervision) Regulations 1994 (“SIS”) covers the requirement to have an investment strategy.

SMSF trustees must consider all of the fund’s circumstances before any investments are made that include:

  1. The risk involved in making, holding and disposing of fund investments taking into account the fund’s objectives and its cash flow requirements
  2. The likely return form fund investments taking into account the fund’s objectives and its cash flow needs
  3. The composition of the fund’s investments taking account of the fund’s exposure to risks from inadequate investment diversification
  4. The liquidity of the fund’s investments to make sure that the fund’s cash flow needs can be met
  5. The fund’s ability to discharge its existing and future liabilities (for example, paying pensions)
  6. Whether the trustees of the fund should hold a contract of insurance for one or more members of the fund

The trustees must ensure that the fund’s investment strategy is used as a blueprint for all investment decisions and regularly reviewed; usually on an annual basis and noted in the year-end minutes. 

What Should Happen At Audit

An investment strategy is not just a superficial compliance document. It is, in fact, an integral part of the audit process as evidenced by the following statement signed by the auditor in Part B of the audit report:

‘My procedures included testing that the fund has an investment strategy that complies with the SISA and that the trustees make investments in line with that strategy, however, no opinion is made on its appropriateness to the fund members’.

An SMSF auditor must review the investment strategy from a compliance perspective only. There is no scope for a qualitative review or to judge its’ effectiveness and, indeed, that is not the point of the auditor’s obligations to the fund’s trustees.

Whether the investment strategy is good, bad or indifferent, the SMSF auditor looks no further than whether the trustees have formulated an investment strategy that has regard to the whole of the circumstances of the fund.

The main components as outlined in SIS r4.09 must be present for the fund to comply with its trustee requirements. 

What Happens in Practice

Some SMSF auditors lump the investment strategy in the same bucket as annual minutes: they are given a quick once-over to ensure the document contain keywords such as ‘risk’, ‘diversification’, ‘liquidity’, ‘cash flow’, ‘insurance’ and the audit marches on.

(Note that Ryan covered the 2007 – 2009 audit years and the amendments to the SIS Regulations in respect to life insurance commenced from August 2012).

One of the main reasons for this “quickie” approach by SMSF auditors is that the majority of trustees appear to put very little thought into formulating and revising their investment strategies.

Standard templates are used to create many investment strategies that get tweaked in line with the investments held by the fund at balance date. The preparation of the financial statements is usually the catalyst to get these changes made.

In reality, some SMSF trustees never review their investment strategy even though their annual minutes state otherwise.

Back to Basics

An SMSF auditor must read the investment strategy and “report accurately as to whether each investment by the Super Fund as recorded in the financial statements was made in accordance with an investment strategy that had regard to all of the circumstances of the fund”.

The 2007 investment strategy presented in the Ryan case contained more complex conditions than usual, for example: 

            Liquidity and Cash Flow

Access to substantial amounts of cash or cash type investments is not required. However, investments shall normally be of the type convertible to cash within 90 days. The trustees will also maintain a minimum cash reserve sufficient to pay the expenses of the firm as they fall due.

Where some assets are not readily converted to cash then at least 50% of the fund assets shall be invested in assets which are convertible to cash within 90 days, unless certain assets represent particular direction from the members.

The fund had invested in high-risk unsecured loans, and unit trusts worth $7.2 million that were effectively worthless. The auditor failed to advise the trustee that the fund’s investments did not meet the requirements of the investment strategy.

As a result, SMSF auditors are at significant risk when they don’t scrutinise the investment strategy more closely and query the trustee when the fund’s asset allocation and investments differ materially.

The auditor must document the trustee’s response, which means the trustee should provide either a revised investment strategy or advise the auditor when the asset allocation, or the investments of the fund, will be returned to meet the conditions of the original investment strategy.

Asset allocation % ranges aren’t a legislative requirement in an SMSF investment strategy, but most trustees have them included in their signed investment strategies.

Unfortunately, investment strategy ranges are often too restrictive and cause unnecessary review points, which can be frustrating for everyone as it delays audit completion. SMSF advisers should, therefore, consider whether it’s appropriate to include these ranges in the fund’s investment strategy.

The requirement for the auditor to undertake a thorough review of the investment strategy in line with r4.09 SIS has always been part of the audit process.

The fine art of performing this audit task, however, has been largely lost in the cloud of technological development and low-cost audit fees.

Conclusion

The Ryan case demonstrates that the court can put any aspect of the audit under the microscope and make SMSF auditors accountable, especially when they are the last person standing with PI insurance in a long line of SMSF professionals.

SMSF trustees will continue to lose money from poor investment choices and fraud, while SMSF auditors now have 1.6 million reasons to stop cutting corners in a race to the bottom.

The real lesson from the Ryan case, however, is that any SMSF advisor not meeting their professional standards should expect future litigation from trustees looking to recoup losses when their investments go south.

There’s no doubt that most SMSF trustees would prefer to be made aware of potential compliance issues rather than spending the time, money and emotional energy going to court. They may just have to accept that this peace of mind comes with a slightly higher price tag.

Shelley Banton, executive general manager, technical services, ASF Audits 

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Comments (6)

  • avatar
    SMSF advisors professional , I don't think so . The message is that the trustee is the client, not the advisor accountant
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  • avatar
    Katrina @ Elite Super Monday, 29 October 2018
    Well said Shelley. I suspect we will have push back when asking for amended investment strategies in this new audit landscape. Our audit fees will have to increase to cover this extra time spent analysing strategies in depth & then going back to advisors for changes. I find it difficult to accept however that auditors have a high duty of care to prevent the investment losses of the fund through fraud & comment on the risky investments in the fund to trustees. This is the job of the financial planner. Oh wait ... he could be dodgy so we have a duty of care to raise concerns about conflict of interest now too? Apparently so. We also must assume all trustees are unsophisticated investors with limited awareness of where their money is placed. Oh wait ... I thought we were auditing a SELF managed fund. Hmm. Not to mention that “recoverability “ is now a major audit focus. For unlisted investments not controlled by trustees we must not take the financial statements provided at face value but keep digging into the underlying assets of these unlisteds to see if the entities stack up. This adds more time & angst to each audit with unlisteds. But clear from this case & Mc Goldricks case we have a major duty of care to raise concerns to trustees when unlisteds don’t have assets behind them to say they are recoverable. I suspect I will have firms leave us because we are now asking for “too much” as part of our audits in this area. It’s certainly a new landscape.
    0
    • avatar
      Katrina, your comment "he could be dodgy" could be equally applied to any link in the chain of professional services provided to an SMSF client. The lawyers writing the deed, the accountants doing the admin & accounting work, the auditors looking to deliver down to a price instead of up to a service. Yet you only select one link in the chain for your disdain. In my experience unlisted investment structures are the wet dreams of accountants doing their best to circumvent SIS rules in relation to investments. Those 'dodgy' financial planners are more likely to stick with more vanilla solutions such as cash, equities and property.
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      • avatar
        Except in the Baumgartner case, where the FP was in it up to his eyeballs. And I think that's the point of Katrina's post...........Pretty hard for an auditor to uncover dodgy dealings when the same guy arranges the investments, signs the paperwork, handles all the money, prepares the financial statements for the Fund and the unlisted entities and, no doubt, provides continuing assurances that all is well in Kansas.
        Whether that guy is a FP or an Accountant is irrelevant. The simple facts in this case are: the trustee was a fool; the FP was crooked; yet the auditor was left holding the bag.
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  • avatar
    This appears to be more a case of the Trustees looking for a scapegoat for their bad investment decisions and the court agreeing that almost 25% of this problem was the auditors fault. A rough call.
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  • avatar
    99.99999% of smsfs run stock std investment strategys (cash/shares/real estate) .. the Ryan case is an absolute exception to this observation/rule. As an smsf auditor this fund rings so many alarm bells. I wouldn't have touched it with a 50foot barge pole. I regularly refuse smsf audits (pig farms/related party transactions etc etc) and this would have been one of them. The auditor lead with his professional jaw and he got smashed ... end of story.
    0
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