CPD: SMSFs and the Code of Ethics

SMSFs comprise more than one quarter of Australia’s $3.54 trillion^[1]. superannuation sector, are subject to a number of rules and regulations and – importantly – aren’t appropriate for everyone. This article, proudly sponsored by GSFM, examines the ethical considerations for advisers recommending SMSFs to clients.

A self-managed superannuation fund (SMSF) is a privately run superannuation fund established for the sole purpose of providing retirement benefits to its members. SMSFs can have between one and six members, and, as any adviser who has worked with SMSFs knows, come with innumerable rules and regulations that are subject to regular change.

Australians’ interest in managing their own super has not waned in recent times (figure one), despite the recent challenges of inflation, interest rates and market volatility. Generation X and Millennials are leading the charge to establish new SMSFs; more than 52 percent were set up by Gen X investors and 23.7 percent by Millennials in financial year 2023^[2].

In December 2022, ASIC released Information Sheet 274 (INFO 274), to provide guidance to Australian financial services (AFS) licensees and their representatives who provide personal advice to retail clients in relation to SMSFs. It provides tips to help advisers comply with their legal obligations when giving advice about SMSFs, including factors to consider when advising a client to withdraw their superannuation from a fund regulated by the Australian Prudential Regulation Authority (APRA) to set up an SMSF.

For each of the subjects covered by INFO 274, we’ll review the content through the lens of the Code of Ethics (Code) and the 12 standards that make up the Code (figure two).

Understand obligations when giving SMSF advice

Any adviser providing SMSF advice to their clients must comply with numerous laws, including:

• the conduct and disclosure obligations in Parts 7.7 and 7.7A of the Corporations Act 2001 (Corporations Act)
• the Financial Planners and Advisers Code of Ethics
• the Superannuation Industry (Supervision) Act 1993 (SIS Act)
• the Australian Securities and Investments Commission Act 2001 (ASIC Act).

Importantly, when providing personal advice to clients – including advice about establishing and managing an SMSF – advice providers must meet the best interests duty and related obligations:

• act in the best interests of the client (section 961B)
• provide appropriate personal advice (section 961G)
• warn the client if advice is based on incomplete or inaccurate information (section 961H)
• prioritise the interests of the client (section 961J).

The first standard of the Code requires advisers to comply with all relevant laws including the Code. While acting in accordance with all laws applies to all areas of financial advice, there are additional regulations specific to SMSFs that advisers must comply with.

In regulating SMSFs, while ASIC considers contraventions of all applicable laws, it specifically targets the following:

• dishonest conduct and fraud (section 1041G of the Corporations Act)
• misleading and deceptive conduct (sections 769C, 1041E, 1041F and 1041H of the Corporations Act; sections 12DA–12DC, 12DF–12DG and 12BB of the ASIC Act)
• unlicensed advice (section 911A of the Corporations Act)
• contraventions of the relevant conduct and disclosure obligations, including the best interests duty and related obligations (sections 961B, 961G–961H and 961J of the Corporations Act)
• contraventions of the Code of Ethics (section 921E of the Corporations Act), and
• contraventions relating to SMSF auditors (sections 128D–128H and 130F of the SIS Act).

Use professional judgement to assess suitability of an SMSF

When determining whether an SMSF is appropriate for a client, advisers need to consider the client’s existing super fund/s and whether that or other retail or industry super funds may be better placed to meet their long term retirement funding goals.

Your need to consider your client’s relevant circumstances and be sure that your client understands the implications of your SMSF advice recommendations. Establishing an SMSF may have serious consequences for your client, their retirement savings and their insurance cover. When providing clients with SMSF advice you should consider a range of factors, including the following:

What types of professional advice are appropriate?

Clients considering the suitability of an SMSF may benefit from advice from various professionals. When referring clients to SMSF specialists, it is important to comply with standard three and avoid any conflicts of interest that could arise as a result of the referral.

When referring to a third party SMSF professional, compliance with standard seven requires that you do not derive any benefits from that referral.

Is an SMSF suitable for your client?

You must assess whether an SMSF is the right retirement savings vehicle for your client based on their circumstances before your client transfers their retirement savings from an APRA-regulated superannuation fund to an SMSF. Doing so will ensure you meet the requirements of standards five and six; to ensure the SMSF is in your client’s best interest and that you have reasonable grounds to be satisfied and in making that judgement, ensure you have taken into account the client’s longer-term interests.

Suitability is important for many reasons, not least because without it, you would not be acting in the client’s best interests. As well as being in breach of the Corporations Act (and therefore standard one), acting in a client’s best interests is explicit in standards two and five, as well as implicit in a number of other standards in the Code.

Providing personal advice to clients about SMSFs requires specialist knowledge, so before providing SMSF advice it’s important that you have and maintain SMSF knowledge and expertise, which will ensure compliance with standard ten.

ASIC provides the following as factors to consider when determining the suitability of an SMSF for your client:

• your client must understand and accept that although they may outsource their SMSF responsibilities to professional advisers (such as accountants or audit specialists), as the SMSF trustee your client is responsible for ensuring compliance with superannuation, corporations and tax laws
• your client must have the time, skills, general interest, and experience to meet their trustee responsibilities
• the cost-effectiveness of an SMSF considering your client’s existing arrangements, relevant circumstances and other SMSF members
• any relevant vulnerabilities your client may be experiencing, such as cognitive impairment, accessibility constraints or coercion/elder abuse
• other arrangements that may provide some of the benefits of an SMSF, such as ‘a member directed investment facility’ within an APRA-regulated superannuation fund.

Finally, you must be satisfied that your client understands the advice, as well as the benefits, costs and risks of establishing and running an SMSF, and you must have reasonable grounds to be satisfied.

An area of concern for ASIC is where an SMSF has been recommended to a client and there’s been no consideration of whether the client has the time, skills and knowledge to operate an SMSF, or whether they are able to appropriately develop their skills and knowledge to operate an SMSF.

SMSF versus an APRA-regulated superannuation fund

ASIC requires advisers to consider whether the client understands and accepts the risks and differences of an SMSF when compared to an APRA-regulated fund. As well as helping meet the best interests duty and related standards, this will ensure you meet standard four – without an understanding of the differences between an SMSF and APRA regulated fund, as well as the somewhat onerous obligations of SMSF trustees, it could be argued that informed consent was not obtained.

There are a number of differences between SMSFs and APRA-regulated funds each clients need to understand before establishing an SMSF; a failure to follow regulations can see the client breaching one or more of the requirements set down by the ATO.

A failure to ensure that each client understands these differences, as well as their obligations as an SMSF trustee and the penalties that can apply for non-compliance, could also be a breach of standard six, that you fail to consider the client’s broader, long-term interests.

Some of the differences between SMSFs and APRA-regulated funds to discuss with clients include:

Protections:

• Access to statutory compensation will differ; an SMSF does not have the same protections as an APRA-regulated fund and is not eligible for government compensation.
• While the client may have legal options in these circumstances, there is no certainty that compensation will be awarded; members of APRA-regulated funds are generally eligible for compensation in the event of theft or fraud.

Client’s legal responsibilities as trustee:

• You must be confident your client understands and accepts that, as trustee, they are personally responsible for running their SMSF according to its trust deed.
• Importantly, your client must understand that:
  • as the SMSF trustee, they are responsible for ensuring the SMSF complies with superannuation, corporations and taxation laws
  • while trustees can use professionals or rely on other trustees to help run their SMSF, responsibility for SMSF compliance remains with the trustees
  • all trustees share responsibility equally
  • SMSFs are regulated by the ATO
  • professionals who provide tax agent services must be on the Tax Practitioners Board register
  • SMSF auditors must be registered with ASIC as an ‘approved SMSF auditor’ on the SMSF auditor register before they can sign off on SMSF audit reports
  • all financial advisers who provide personal advice on SMSFs must be licensed by an AFS licence and registered with ASIC.
• Clients need to understand that a failure to comply with their obligations under superannuation and taxation laws can have significant consequences, such as the loss of tax concessions. All trustees are equally required to comply with trustee responsibilities and obligations and are liable for the actions of other trustees.

Trustee complaints:

• SMSF trustees (and members) may be required to resolve their own complaints.
• Clients should be aware of situations where disputes may arise, including:
• in the event of trustee relationship breakdown
• where member death benefits must be paid
• if trustees consider they have received unsuitable professional advice.
• Access to AFCA is only available to SMSF investors in certain circumstances, such as if they received advice from a licensed financial adviser and their complaint relates to the financial advice about the suitability of an SMSF, the SMSF investments or insurance products.

An SMSF trustee can be penalised for non-compliance in several ways:

1. Their fund losing its concessional tax treatment.
2. Being disqualified from their role as trustee – this means they can no longer be members of the SMSF, and they are unable to start a new one.
3. Fines or imprisonment, depending on the seriousness of the breach.

The ATO can disqualify an SMSF trustee, or director of a corporate trustee, if:

• The trustee has contravened the rules.
• The ATO considers the trustee not to be a ‘fit and proper’ person for the role, having regard to the trustee’s personal character and circumstances.

SMSF costs

It is crucial that your client understands the costs of an SMSF throughout its lifecycle. These costs will vary based on your client’s relevant circumstances; examples are set out in figure three.

The second part of standard five requires you to be satisfied that the client understands the costs, risks and benefits. With an SMSF, there can be a cost-benefit trade-off between the time taken to appropriately administer the SMSF versus the expected returns and benefits. To comply with this standard, you need to have reasonable grounds to be satisfied this cost-benefit trade off.

The starting balance of an SMSF is one of a range of factors you should consider when recommending an SMSF for your client as this is relevant to the cost-effectiveness of an SMSF (and compliance with standard five).

There may be circumstances when an SMSF with a higher starting balance is not in your client’s best interests because it does not meet your client’s objectives, financial situation or needs. It’s common that SMSFs with a lower balance find that fund expenses are proportionally higher, resulting in lower net returns lower. Neither situation would be in the client’s best interest and a breach of standards two and five. Standard nine also comes into play as it requires all advice to be offered in good faith and with competence.

Suitable trustee structure

To provide appropriate advice that’s in your client’s best interests, you should discuss the appropriate trustee structure suitable for their circumstances. Selecting the most appropriate structure – a corporate or individual trustee structure – can have tax and succession planning implications for clients. It can be costly to change structures, ownership of assets and trustees once the SMSF has been established.

ASIC takes a keen interest in whether clients have been adequately advised on SMSF structures and are likely to be concerned where there’s no evidence of consideration of the appropriateness of the SMSF structure, or if the client has been directed to a particular type of SMSF structure without consideration of its appropriateness.

This should include providing your client with a comparison of the risks and benefits of each structure; this will demonstrate compliance with a number of ethical standards, including those related to best interests (two and five), consideration of the client’s long-term outlook (six) and competent advice (nine).

Factors to consider may include:

• cost, including the potential cost of changing the trustee structure later on
• compliance with the SMSF trust deed, superannuation, corporations and taxation laws, the company’s constitution and the Corporations Act
• administration and reporting requirements
• trustee succession planning for your client
• SMSF asset ownership considerations.

Trustee succession planning and exit strategy should be considered at establishment; this can help to reduce the impact of ‘unexpected’ events. They also need to understand the steps required to wind up an SMSF. This is relevant to standard six of the Code.

It can be helpful for clients to be aware of the reasons why they may need to wind up their SMSF. These may include:

• the SMSF proves not to be cost-effective
• trustee responsibilities become too onerous or costly
• a trustee dies or becomes incapacitated
• trustee disputes.

The investment strategy

SMSF trustees must develop an investment strategy to provide the basis for the SMSF’s investment decisions and ensure the SMSF is likely to meet members’ retirement needs. The trustees are responsible for their fund’s investment strategy and make all investment decisions, even if those decisions are advised by professionals.

SMSFs can only have six members, which can limit the number or type of assets the members can invest in. For example, a public super fund with hundreds of members has the scale to invest in private equity or direct infrastructure, investments that generally require significant investment capital to access.

You need to ensure your client understands that:

• they must have an investment strategy before they make any investments
• the investment strategy must be reviewed regularly
• they should consider whether to hold insurance cover
• the investment strategy should be in writing and any changes documented.

While you can assist your client to develop appropriate investment objectives and investment strategy for their SMSF, the client must understand that they’re responsible for managing the investments in the best financial interests of the SMSF’s members and in accordance with the law.

When documenting the SMSF’s investment strategy, the following points should be considered and discussed with your client:

• the fund’s investment objectives
• investment strategy and whether it is consistent with the trust deed
• members’ risk tolerance
• the types of investments the fund can make, including the likely risk/return profile of these investments
• implementation of investment decisions
• diversification
• death benefit nominations
• liquidity requirements to meet fund expenses, including retirement benefits.

ASIC’s guidance notes the importance of adequately consider and inform your clients about:

• the benefits associated with diversification
• the restrictions that apply to SMSF investments
• whether to hold insurance cover
• prohibited transactions, including lending the fund’s money or providing financial assistance to a member of the fund or their relatives.

Importantly, you ought to ensure your clients understand the costs associated with implementing your SMSF advice recommendations, including ongoing fees. As well as best practice, standard five explicitly requires you to be satisfied your client understands the costs associated with your advice.

In an audit situation, ASIC is likely to examine the advice clients receive about their SMSF investment strategy and whether this advice was appropriate to the clients’ risk appetite and investment goals.

A failure to provide appropriate advice about the SMSF’s investment strategy will likely breach a number of ethical standards including: a failure to meet best interests (standards two and five), the broad, long-term effects of the client acting on your advice (standard six) and financial product advice must be offered in good faith and with competence (standard nine).

Case studies

The following case studies are based on real events; however, the names of people and organisations have been changed, and some details altered. The case studies have been drawn from ASIC and for each, potential breaches of the Code of Ethics are identified.

Case study one: A failure to meet best interests obligations

In 2022, ASIC undertook surveillance of advice provided by Roger, an authorised representative, responsible manager and director of Australian financial services licensee ACME SMSFs. ASIC found that Roger had recommended that several of his clients set up SMSFs with low superannuation balances.

As a result of this advice, Roger exposed his clients to financial harm because the ongoing SMSF costs were higher than the costs of their existing APRA-regulated superannuation funds. Further, Roger failed to make reasonable enquiries to ascertain his clients’ relevant personal circumstances before giving advice and failed to conduct a reasonable investigation into alternative products before he recommended that his clients establish SMSFs.

Roger is the ultimate owner and beneficiary of the SMSF administration service he recommended and the investment manager of a fund he recommended his clients’ SMSFs invest in. ASIC found that he failed to prioritise his clients’ interests before his own.

In statements of advice to his clients, Roger failed to disclose his interests in entities related to him and the associated benefits and remuneration he would receive that could influence the advice he provided.

ASIC banned Roger from providing financial services for five years for failure to meet best interests obligations when providing advice on self-managed super funds (SMSFs). Despite an appeal to the Administrative Appeals Tribunal (AAT), the decision was upheld.

From the details provided in the case study, Roger potentially breached the following standards in the Code of Ethics.

Case study two: Failure to prioritise clients’ interests

Adviser Jim was an authorised representative of ACME Financial Advice in Melbourne when he recommended several clients establish SMSFs for the purposes of either investing into property or property development companies. Jim had a conflict of interest because his clients were looking to invest through his brothers who were in the property development business.

Jim referred his clients to an SMSF administration business to facilitate the establishment of their SMSFs without providing advice. He then provided advice to those clients to rollover their existing super funds into their recently established SMSFs.

ASIC found Jim failed to prioritise his clients’ interests and failed to act in the best interests of his clients because he:

• did not scope the advice to be consistent with his clients’ circumstances and subject matter of advice sought
• failed to make reasonable inquiries to obtain complete and accurate information about his clients’ relevant circumstances
• did not address how an SMSF property investment strategy would meet his clients’ retirement objectives
• focused the advice to his clients on rolling over to SMSFs without adequately considering alternative options, such as whether his clients would be better off retaining their existing super funds
• failed to adequately consider and provide information about significant risks and consequences when recommending his clients rollover their existing super funds to SMSFs for the purpose of investing into property
• was told by his licensee that he did not have the required expertise to advise on SMSFs generally, but still proceeded to provide SMSF advice to his clients.

As a result, ASIC has banned Jim from providing financial services for six years. From the details provided in the case study, Jim potentially breached the following standards in the Code of Ethics.

With over five million Australian baby boomers set to retire over the next decade, the significance of retirement planning has heightened. Superannuation funds are under pressure to improve retirement income options, a challenge that will also face SMSFs as members move into the pension phase.

While an SMSF can serve as a valuable investment vehicle for many, the time, expense, and expertise required to oversee one’s own superannuation might outweigh the advantages. The regulatory framework governing SMSFs places a substantial level of duty and liability on those managing one, making it potentially unsuitable for some clients.

When proposing the establishment of an SMSF, as with any financial recommendation, it is imperative to prioritise what is in the client’s best interests, both today and in the future.

 

 

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CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.75 hour.

Legislated CPD Area: Professionalism & Ethics (0.5 hrs) and Regulatory Compliance & Consumer Protection (0.25 hrs)

ASIC Knowledge Requirements: SMSF (0.75 hrs)

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Notes:
[1] Class Super, 2023 Class Annual Benchmark Report, August 2023
[2] Class Super, 2023 Class Annual Benchmark Report, August 2023