SMSFs and the F word
No, not that F word. The F word we’re talking about regarding SMSFs is fraud.
It’s hard to imagine why anyone robs banks anymore. By comparison SMSFs offer a $400 billion prize, they are a soft target, and the chance of being caught is small.
Fraud is one of the hidden risks and costs of SMSFs. For those being sold an SMSF, it all looks like upside – control, (allegedly) lower costs, and the potential (unlikely though that may be in reality) of beating the professionals.
But as the just released Parliamentary Joint Committee report into the collapse of Trio Capital makes clear, the costs of SMSF fraud can be huge. The report should be compulsory reading for those working in the wealth industry – both in terms of what happened, and to appreciate the tragic stories of individuals caught up in it. It’s also important to appreciate that a Trio has disastrous consequences for the reputation of the entire funds industry and the willingness of investors to engage with it.
Very few come out of Trio looking good, from the regulators to the AFP, auditors, financial planners, and research houses. It can be found here: http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=corporations_ctte/trio/report/index.htm.
So what has been the cost of Trio to SMSFs? Well it’s not 100% clear, but the main figures are:
– The total amount lost in Trio is about $176 million, relating to 6,090 investors.
– $55 million of this related to 5,400 investors who were members of APRA regulated funds, and this amount was compensated via an industry levy.
– $121 million related to 415 apparently non-super investors (some of whom were geared via margin loans), and 285 SMSFs. The report does not allocate losses between these two groups, but the implied average loss is about $175,000, suggesting SMSF losses in the region of $50 million.
A host of questions remain, ranging from how Trio got onto a margin lending APL, to how an SMSF comes to invest a very large portion of its assets into something so exotic, and satisfy investment strategy requirements.
Although Trio may be the largest SMSF fraud, it’s far from the only one. There have been many smaller frauds reported, both the sophisticated – eg the art gallery selling the same painting to multiple SMSFs – to the brazen, such as a relative withdrawing the cash and fleeing overseas, or using it to support a drug habit.
As far as we are aware, SMSF losses to fraud are not collected. But they are big. If we take Trio and add on just what makes the press (no doubt the tip of the iceberg), we must be looking at SMSF fraud costs of $70-100 million. Maybe this is a bad year. Maybe not. But that’s 2 basis points of the entire SMSF segment. And that’s not the total cost – for frauds which constitute illegal withdrawals for example, there can be severe tax penalties as well.
The PJC report recommends that the ATO publish warnings on its website and in guidance material highlighting the fact that SMSF investors are “off the reservation”; ie that in the event of fraud, there are no prospects of compensation. It is clear from investor submissions that many had no idea of this.
This is unlikely to be the whole answer, and FoFA does not specifically address it beyond the best interests’ test. We believe that promoters of SMSFs should have to highlight the loss of protection when members shift from a collective APRA-regulated fund to an SMSF, and ideally should obtain a signed acknowledgement from the member accepting this risk.
Fraud risk should be a bigger competitive issue than it is at present. For collective funds searching for strategies to hold back the SMSF tide, protection from fraud is a largely unappreciated benefit, which they could do much more to promote as part of their value proposition.
On the flipside, as major advice businesses owned by financial institutions start recommending SMSFs more frequently, they will need to take great care to fully disclose the risks involved – including the loss of protection against fraud. Otherwise mis-selling law suits and yet more regulation almost certainly wait down the road.