The Your Future Your Super reforms put “financial” into best interests and reverse the evidential burden for the new best financial interests duty. NATHAN HODGE, Partner, King & Wood Mallesons and OLIVER HARVEY, Head of Governance, Risk & Compliance Solutions, Nuix, unpack some of the key impacts of these two changes and provide guidance to help super trustees meet the heightened requirements.
The Your Future Your Super reforms change the formulation of the duty from requiring a trustee to act in the “best interests” of super fund members to the “best financial interests” of members. The purpose of this change requires trustees to prioritise members’ financial interests over their non-financial interests. This means that a trustee would breach the duty if members’ non-financial interests were improved at the expense of their financial interests.
The reforms also introduced an evidentiary change whereby the evidentiary burden in civil liability actions commenced by the regulators against super trustees for a breach of the best financial interests duty was reversed. In practice, trustees are now assumed to have breached the new best financial interests duty in these types of actions unless they have evidence to demonstrate otherwise.
Like the duty of best interests, the duty of best financial interests applies to all types of trustee decisions. But whether this change has any real impact for trustees depends on the type of decision the trustee is making. This was exemplified in the English trust law case of Cowan v Scargill [1985] Ch 270 concerning the scope of trustees’ discretion regarding investments for the benefit of their members.
In Cowan v Scargill, the Court stated that:
When the purpose of the trust is to provide financial benefits to beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests. In the case of the power of investment, as in the present case, the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investment in question; and the prospects of the yield of income and capital appreciation both have to be considered in judging the return from the investment.
This case shows that “best interests” normally means “best financial interests”. But the story doesn’t stop there. Cowan v Scargill was about investing, and the Court specifically said that it was only in the context of exercising the investment power that financial interests means investment performance. So, under the Cowan v Scargill formulation of “best financial interests”, what the “financial interests” meant arguably differed depending on what the trustee was doing.
This means that the Your Future Your Super reforms arguably brought no change to investment decision-making by super trustees. This is on the basis that, even prior to the reforms, trustees were under a duty to exercise their investment powers so as to yield the best return for the beneficiaries, judged in relation to the risks of the investment in question.
Interestingly, while the Your Future Your Super reforms adopt the same terminology as used by the Court in Cowan v Scargill, there is no reference to Cowan v Scargill in the legislative guidance. Instead, the legislative guidance focuses on trustee decisions yielding financial benefits to members. The examples of financial benefits outlined in the guidance include a fee reduction and investment returns, although this is not an exhaustive list of relevant financial benefits.
This means that there are arguably differences between the Cowan v Scargill formulation of best financial interests and the new statutory formulation of best financial interests (at least outside investments).
There is no materiality threshold. But what super trustees need to do to comply with the best financial interests duty will depend on the type of decision being made, as well as complexity and significance of the decision.
Further, the best financial interests duty analysis can arguably be undertaken for a “head” decision so that it does not need to be undertaken for each individual sub-decision under that “head” decision. Of course, there needs to be sufficient specificity with the “head” decision in order for proper best financial interests analysis. For example, the best financial interests analysis could be undertaken for a business case and, if the business case is approved as being in members’ best financial interests there should be no need to consider best financial interests for decisions on each individual payment made pursuant to that business case. On the other hand, it is unlikely that a proper best financial interests analysis could be undertaken on a high level budget, for example, a determination of the overall marketing budget for a year.
The change to the evidentiary burden requires super trustees to focus on record keeping. But trustees should note that this change relates to civil court actions commenced by a regulator, and we would hope that the likelihood of a regulator commencing litigation over minor decisions is low.
This could allow super funds to adopt a risk-based approach to record keeping (at least at the beginning). What is meant by this is that trustees initially focus on having proper records for more significant or risky decisions (and not a risk-based approach in relation to the quality of those records).
After the initial period, a focus on record keeping beyond the more significant or risky decisions will likely be important. Focusing on good record-keeping is an established regulatory practice for some regulators here and overseas, where poor record keeping has been traditionally viewed as a potential lead indicator of more systemic compliance and risk concerns in an organisation.
It obviously remains to be seen how regulators will approach this specific issue here, but the law makers clearly consider robust record keeping important and arguably increasingly so. This is also reflected in specific amendments relating to record-keeping which introduce a strict liability offence for the contravention of an operating standard relating to a record-keeping obligation.
Generally speaking, the duty of best interests is normally well covered in board papers and associated legal advices. To help satisfy the evidentiary burden, it is recommended that trustee boards ensure that all board papers contain a section on the best financial interests duty, with appropriate financial analysis.
Currently some trustees already record in their board meeting minutes that they have determined that a decision is in the best interests of members. Moving forward, it is recommended that all minutes record that a decision being made is in the best financial interests of members and the reasons for decisions. This puts boards in the best position to satisfy reversed evidential onus of proof.
It is recommended that board committees ensure all relevant committee papers contain a best financial interests duty section and that committee minutes adopt a similar position to board minutes.
As the best financial interests duty and the reversed evidentiary burden applies to management decisions as well, super trustees should consider what is needed for management decisions to comply. One possibility is a trustee policy on best financial interests and a short best financial interests duty form for management to complete.
More broadly, boards and committee/management will need to be vigilant about wider information or evidence that suggests a failure to meet the best financial interests duty. This may come in a range of forms including complaints made by a member of the superannuation fund. Given the profile of these changes, it is reasonable to assume that regulators will take a dim view of trustees who do not effectively identify, evaluate and where necessary, address a complaint of this type.
In addition to a level of senior oversight and resourcing that reflects the importance of the duty to act in members’ best financial interests, information technology systems and effective data analytics and reporting arrangements can also support the timely and effective management and monitoring of these kinds of concerns. See for example: ASIC Regulatory Guide 271: Internal Dispute Resolution, which came into effect on 5 October.
There are two sides to every coin, and this is true in relation to the reversed evidentiary burden. While records will help a trustee in its defence to any civil actions by a regulator, they do create a paper trail for the regulator and members to discover – which can in turn create a further risk, if records do not show valid reasons. Training and best financial interest audits will be key to managing this side of the risk.
Stay tuned for an upcoming webinar featuring King & Wood Mallesons and Nuix on the practical side of using information governance and data analytics to help you stay compliant with the new requirements.