SMSF disputes: Lessons from AFCA complaints

Robert Barnes

What are the most common complaints lodged by SMSFs?

Alexandra Sidoti

The highest volume that we have is where there’s conflicted advice models, basically where self-managed super funds are being recommended as an avenue to shoehorn clients into specific investments that they wouldn’t be able to recommend through other funds. So certainly in the Shield/First Guardian batch of complaints, you know, a lot of that investment was actually through superannuation wrap platforms because Shield and First Guardian had been added to those wrap platforms. But the initial complaints we saw in that batch were actually from to advice firms who were exclusively recommending investment through SMSFs. And I suspect that’s because they’d previously been targeting recommending investments that were conflicted, that weren’t available on wrap platforms. So the main one there was the Global Capital Property Fund, which was an unlisted company, which was focused entirely on property development. And the recommendations were largely to get the majority of people’s superannuation into that single investment, which happened to be a related party of the financial firm.

Robert Barnes

Where are trustees most commonly getting their compliance obligations wrong?

Alexandra Sidoti

So it really depends on the types of complaints. I mean, we had the Dixon Advisory batch of complaints, which largely involves self-managed super funds. In those circumstances, the vehicle of the self-managed super fund is just not a relevant factor in the complaint. So those issues of trustee obligations and things like that don’t really come up. It’s a bit of an anomaly though. Most often the SMSF complaints we see are people who are pretty unsophisticated and have very low balances. So this is where things tend to go a bit wrong. And in those circumstances, we find most commonly they have no understanding at all of what their legal obligations are as trustees. And that’s often a big part of the problem is they haven’t really been adequately assessed in terms of their suitability to act in that role and take on those obligations. And these people are largely not well placed to do it.

Robert Barnes

What warning signs suggest an SMSF may have been unsuitable from the outset?

Alexandra Sidoti

Yeah, so there are a few factors. Sometimes it’s the speed at which it’s all done. In a lot of these complaints we’re seeing, a very truncated timeframe between initial contact, the suggestion of an SMSF is brought up in that initial contact call before any fact finding or anything is done. So it’s obviously the idea or the strategy has been conceived of before even really understanding anything about this client. So that’d be the biggest warning sign, I think, when everything’s happening very close together. In some circumstances, we see fact find and SOA and SMSF establishment all happening on the same day, you know, or at least the kickoff paperwork all happening on the same day. The other big factors I think we see are low balances and again, people who just aren’t particularly sophisticated. A real warning sign would be when people haven’t been actively seeking advice, but they’ve maybe clicked on a Facebook ad or, you know, had a cold call or something like that. It’s sort of a big tip to go from, I wasn’t, I was just vaguely thinking about comparing my super to, let’s get you into an SMSF.

Robert Barnes

What does poor diversification in an SMSF typically look like?

Alexandra Sidoti

So if you think about what you would see in, you know, your standard super funds, whether it’s an APRA-regulated fund or well-managed super, self-managed super funds, you’ll see investment in a range of different asset classes, right? So you might have, depending on the risk profile, a certain amount of Australian equities, international equities, maybe a smaller amount of property, a small segment that’s dedicated to more speculative assets depending on the risk profile. What we’re really seeing here is a complete concentration of assets, either just in one class or often even in a single asset. So one of the main issues we see come up are these conflicted advice models where you’ve kind of got a one-stop shop. So you’ve got your advice arm, your realty arm, your accounting arm, all in the one place and people with quite low balances are encouraged to set up a self-managed super fund, buy an off-the-plan property from the Realty arm, and before you know it, their entire super is concentrated not just in property, but a single property, and there’s not much left over to diversify. Yeah.

Robert Barnes

What happens if you have a mortgage?

Alexandra Sidoti

It’s really tricky, and I think partly because there’s a huge degree of variation in how advisers as approach risk discussions with clients. The biggest problem we would see is when that discussion doesn’t occur at all. So sometimes all we’ll see is a really brief description of, in the statement of advice of, oh, you’re high growth and what that means is this, but we can’t see any evidence of how that risk profile’s been arrived at, what sort of questions have been asked, or really testing that in any way. You know, likewise, when someone— we might see a risk profile that spits out a certain answer, but if you look at the specific questions within that, there are certain questions that would raise flags and you would think should prompt more of a conversation. So I think sometimes there’s a real concern when advisers are just relying on the number that’s spat out at the end and what category that puts them in without really thinking about what sits underneath. All of that because most of the time the consumers we see don’t have any real concept of what different risk profiles mean in practice.

Robert Barnes

What are some concerning trends you’ve seen around SMSFs?

Alexandra Sidoti

The most concerning factor is the use of SMSFs for sub-pure motives, let’s call it. So we are really seeing a key theme of SMSFs being used as the vehicle of choice for conflicted advice models. You know, if you want to get a client into a particular product and you’re not really concerned about their circumstances, you’re just looking for clients for a product, an SMSF is the easiest vehicle to do that. And while we’ve seen in the Shield and First Guardian batch of complaints a number of superannuation wrap platforms being involved as well, I think we can see from the response to that from the likes of Macquarie and Netwealth who are starting to really cut investments from their platforms. If they’re tightening up things at their end, self-managed super funds are going to again be the preferred vehicle.

Robert Barnes

Are there proportionally more complaints related to APRA funds or SMSFs?

Alexandra Sidoti

We definitely are seeing proportionately higher SMSF complaints than we are APRA regulated fund complaints. I think particularly in recent years, over the last year, I think it’s over a third of the complaints in the investments and advice space relate to SMSFs, and they’re predominantly around the suitability of an SMSF structure and the conflicted advice models.

Robert Barnes

Are there any recent AFCA determinations that have been contentious?

Alexandra Sidoti

Yeah, so I think the most contentious issue is probably AFCA’s two recent determinations regarding the appropriate wholesale retail test for self-managed super funds. So I think there’s previously been an understanding amongst some parts of industry, certainly not all parts of industry, that the appropriate test to apply is under 761G subsection 7, which is where we find the assets and income test. So if the trustee has $2.5 million assets or has earned over $250,000 in 2 consecutive years, they’re classifying them as wholesale rather than retail. But AFCA’s view is the appropriate section is actually subsection 6 because the financial advice relates to a superannuation product, which is the SMSF. So as soon as we’re satisfied the service relates to a superannuation product, it’s subsection 6 that applies. And it is very clear in saying that an SMSF needs to have $10 million in assets before it can be treated as wholesale. So it’s a very different threshold level.

Robert Barnes

Is wholesale investor the same as sophisticated investor?

Alexandra Sidoti

Sophisticated investor is a subset of wholesale investment. So it’s usually based, and just to keep things really confusing, the Corporations Act has a different definition of sophisticated investor for Chapter 6 purposes than it does for Chapter 7 purposes. So if we’re under Chapter 7, which is the advice space, then sophisticated investor relates to their skills and experience and understanding of financial investment rather than an income or assets test.

Robert Barnes

What problems arise with wholesale investor classifications and how does AFCA evaluate them?

Alexandra Sidoti

Great question. So I think there are two key issues that we see. The first is whether the advisor or the financial firm is applying the correct test. So certainly we see instances where the compliance that an adviser does to correctly classify someone is all right, except they’re using the wrong test. So it doesn’t work out. And that’s where, you know, the $10 million versus $2.5 million issue is, is really pronounced. We see advisers have done a really good job of checking off the $2.5 million or the $250,000, but it’s just the wrong test, so it doesn’t work. The other issue we see more of is around the sophisticated investor classification. Oftentimes you might have a client who’s got a fair degree of investment experience, but there are steps that a financial firm has to really carefully go through before they classify them as sophisticated and can treat them as sophisticated. And that’s under Section 761 GA of the Act. And it steps out very clear steps. So advisers just need to be sure that they’re actually following all that step, those steps. And it includes providing written reasons as to why they think this person meets the sophisticated investor classification and making sure the client is aware of that assessment and understands the implications of that.

Robert Barnes

Is there a case for reviewing the thresholds for sophisticated investor?

Alexandra Sidoti

Yeah, so when you say that, I assume you’re talking about the Chapter 6 thresholds for sophisticated, which is the Chapter 7 wholesale. So the $2.5 million in net assets or $250,000. I mean, I think generally speaking, yes, we do need to have a conversation about that. You know, I think you can own a letterbox in Sydney and you’ll be over that threshold test these days. So yeah, the housing market in particular is moving far faster than that is. And it’s that real question too, I think, around what’s the purpose of these tests and what are we trying to achieve in having these tests? And I think traditionally we’re thinking of those sorts of threshold levels as reflecting a certain degree of financial understanding, because you would think if you have those sorts of assets, you’re dealing with finance in some way. And that just doesn’t really hold true anymore if that’s concentrated in the family home, for example, and not much else. And it’s not unusual that you’ll see, for example, you know, a couple where one of them is very financially savvy and engaged, but then they might pass away. And the one that’s left certainly has these assets and income, but has not in their lives ever really engaged with the financial side of their lives.

Robert Barnes

What is the final lesson you would like advisers and trustees to take away?

Alexandra Sidoti

I think from an adviser’s perspective, the most important thing is to really think about client suitability. So is this client actually properly equipped, not just with the skills and experience, but certainly the time as well to properly act as an SMSF trustee. And then for trustees, I think the big thing is to be across your obligations. You know, it is more complex than a lot of people think. There’s obligations in terms of accounting, investment strategies, residency factors. You know, there’s a whole lot of things that I think people aren’t that aware of. But once you’re in that role as a trustee, you don’t, you have different protections. You know, you don’t have the Part 23 of the SIS Act protections that’s available to APRA-regulated funds. So you really need to be across what’s happening in your fund.