THE RISKS OF INVESTING OUTSIDE THE FLAGS

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1 1 SuperGuard 360 SuperGuard360 is a first-of-a-kind service designed to safeguard against financial misconduct through targeted prevention and mitigation strategies. Launched in July 2016, SuperGuard 360 is a product from Professional Standards Mutual which forms part of the Rainmaker Group. THE RISKS OF INVESTING OUTSIDE THE FLAGS Protecting from financial misconduct SuperGuard 360 The SMSF story The rise of Self-managed superannuation funds () have experienced phenomenal growth over the past few decades, outstripping all other Australian superannuation sectors. With $591 billion in assets 1, the SMSF sector is now the leading segment, accounting for 29% of the $2 trillion superannuation assets under management. The growth of should be viewed in the context of Australia s strong superannuation sector which has been driven by compulsory contributions and high long term investment returns that have averaged 6% pa over the past decade. Reinforcing this, compulsory contributions due the Superannuation Guarantee arrangements only account for half the $130 billion that is contributed annually into Australian super funds. These metrics are so strong that, according to international pension fund consultant Willis Towers Watson, Australia has the fifth largest superannuation savings pool in the world 2, equivalent to 1 of Gross Domestic Product. See Figure 1. The Australian Superannuation industry comprises, retail funds, industry funds and public sector funds. While representing less than of super fund members, are the largest segment in terms of assets under management. At June 2015 there were 560,000 with an average of 26,000 new being established each year, representing a creation rate of 7% a year. 3 See Figure 2. The average balance of an SMSF now exceeds $1 million, and the average account balance for an SMSF member is around $553,000. Illustrating this growth, 10 years ago just 15% of had more than $1 million in assets but by 2014 this proportion had more than doubled to 32%. also dominate in the post-retirement segment, offering retirees greater control over their superannuation, particularly those with larger account balances. This trend is expected to continue with Deloitte forecasting will be managing assets close to $3 trillion by Who is the SMSF investor? Understanding exactly who SMSF investors are is not easy. We do know that people who choose to put their super into a self-managed fund are typically affluent, educated, mature and capable. Beyond that they cannot be pigeon holed. They are varied and the sector is extremely fragmented. What is clear, according to the SMSF Association, is that SMSF investors want flexibility and control in the investment of their retirement savings. 5 This is echoed in research by the UBS investment management group and Financial Services Council (FSC) that found 59% of were created because their trustees wanted more control and choice over investments. 6

2 2 The average age of an SMSF member is 57 years compared with 40 years for other superannuation funds. This reflects the fact that many SMSF members set up their funds as they approach retirement age. As a result, have historically had a strong allocation to income-generating investments such as direct equities, property, cash and term deposits. But the SMSF investor profile is changing. are increasingly being established by younger people. According to the ATO, the average age of people establishing new is 46 years resulting in 45% of new SMSF members now being below age 40. See Figure 3. The asset mix of has remained remarkably stable despite the influx of younger people into the sector, with 35% being invested into Australian shares, 26% into cash, 16% into property, 14% into managed funds, 7% into alternative assets, 2% into fixed interest and less than 1% invested into international shares. See Figure 4. The desire for control by SMSF trustees is also reflected by the fact that 86% of SMSF investments are allocated to direct holdings in shares, cash deposits and property rather than in pooled funds. 7 This figure rises to 90% for with balances of less than $500,000 or owned by younger trustees. SMSF portfolios also tend to be reasonably concentrated. According to market researcher Investment Trends in its 2015 SMSF report, 55% of hold less than 10 stocks in their portfolio. 8 This large weighting to direct holdings and high concentration of portfolios can make more vulnerable to misconduct and fraudulent behavior by third parties and means they need to be particularly vigilant about monitoring their investments. This was highlighted by the Trio Capital fraud, which saw 400 lose a total of $60 million when they invested in the Trio Capital Group. Over 6,000 investors were affected by the fraud. The government provided $55 million to more than 5,000 of those investors who were invested through their APRA-regulated super fund. However, nearly 1,000 individuals who were invested in Trio either directly or through their SMSF were not eligible for such compensation under the law. and the risks they face are on their own do not have the same level of protection from misconduct and fraudulent behavior as traditional super funds. This is because they are regulated by the ATO rather than APRA and so do not have access to the same government assistance or compensation as APRA-regulated funds. This is because, in essence, SMSF trustees in the eyes of the superannuation law are considered to be managing their own money and so do not need protection from their own decisions. Australia s corporate financial and consumer regulator, the Australian Securities and Investment Commission (ASIC), has long Figure 1: Australia s superannuation savings pool Figure 2: Number of and their net creation % $BILLION SMSF assets (LHS) Share of all super (RHS) % $THOUSAND Funds (LHS) SMSF net creation (RHS) % % Figure 3: SMSF age membership Figure 4: SMSF asset allocation 35% 25% 15% New members All members Chart contrasts the age distribution of all SMSF members in 2015 with the age distribution of members of etablished in the 2015 September quarter. Managed funds 14% Australian Equities 35% International equities 0% Property 16% Australian fixed 2% Other 7% Cash 26% 5% 0% LESS THAN YRS YRS YRS YRS 65 OR MORE

3 3 championed the concept that by their nature swim outside the flags and thus need to be much more vigilant and self-reliant than members of traditional super funds. But as regular consumers of financial services, SMSF members are confronted by the same challenges as every other fund member: how to invest their super so that it provides reasonable long term return without unreasonable risk. They also want to be able to access financial advice from sources they can trust. In this respect, SMSF trustees, as members of their own super funds, are no different to any other super fund member, albeit 36% of use a financial adviser compared to just 13% of members of other super funds. 9 This higher usage rate of financial advisers by SMSF members has made them more vulnerable to the financial scandals that have engulfed sections of the wealth management industry following the global financial crisis. These scandals triggered a wave of parliamentary inquiries that lead to massive policy and legislative reforms, some of which have been in place for a few years now and some of which are still being implemented. See Table 1. While these inquiries have led to reforms in superannuation and wealth management, they have not altered the fact that do not have the same protection or recourse to compensation as other super funds. In addition high average balances and proportion of direct investments, combined with the age and independence of SMSF members, makes them more vulnerable to financial misconduct and fraud. trustees and members who believe they have been a victim of fraud or wrongdoing can still lodge complaints with professional associations, financial regulators and police authorities but they do so as individuals rather than through official superannuation agencies set up explicitly to fast track these actions. As a result, many SMSF trustees and members can feel very isolated, alone and ill-equipped to pursue their legal rights, which industry commentators believe only further encourages fraudsters and scammers to target the sector. How real is the risk of fraud? The Australian Bureau of Statistics estimates that 1.6 million Australians were victims of personal fraud in , equivalent to 9% of the adult population. 10 Even more alarming is that this incidence rate is up 25% in four years. KPMG estimates Australian businesses may be losing up to about $6 billion a year due to fraud, while the Australian Institute of Criminology (AIC) and Australian Crime Commission (ACC) estimate losses due to organised crime could be in excess of $100 million. The Australian Crime Commission and Australian Securities and Investments Commission regularly warn consumers about the growing incidence of fraud, especially among superannuation investors. In its report on scams in 2015, the ACC points out older superannuation members are particularly at risk: Australians aged 55 and over are often in periods of transition or undergoing considerations that leave them potentially vulnerable to investment or dating and romance scams. These two scam types accounted for $12 million or 56% of the losses reported by this age group across all scams in Australians approaching retirement or recently retired will naturally be looking for opportunities to invest or increase their investments. This mix of available funds through superannuation payouts and a desire to maximise wealth for retirement, leaves the over 55s open to exploitation by investment scammers who offer false promises of high returns and phony assurances of low risks. Identity theft and investment fraud are two major threats to SMS- Fs. With identity theft fraudsters obtain access to a SMSF trustee s personal identity and use this to gain control of their fund s assets and transfer them into another entity. In cases of investment fraud scammers promote or recommend SMSF trustees invest in either non-existent or dubious assets. The ABS estimates that more than 1 million people each year are subject to identity fraud, including SMSF-related identity fraud while more than 30,000 each year are victims of financial advice and investment fraud. Table 1. Inquiry Conducted by Outcome Inquiry into Financial Products and Services in Australia, 2009 Parliamentary Joint Committee on Corporations and Financial Services Future of Financial Advice (FOFA) reforms such as the banning of advice commissions, improved disclosure, best interests duty for financial advisers, and introduction of formal professional standards. Super System Review, Review into the Governance, Efficiency, Structure and Operation of Australia s Superannuation System 2010 Commonwealth Treasury SuperStream including the introduction of enhanced administration protocols, MySuper, improved trustee governance standards, standardised disclosure for fees, returns and trustee remuneration. Scrutiny of Financial Advice inquiry, ongoing Senate Economics Reference Committee Ongoing. Performance of the Australian Securities and Investments Commission, 2014 Senate Standing Committees on Economics Improved regulatory standards and various tougher enforcement protocols. Financial System Inquiry, 2014 Commonwealth Treasury Wide ranging reforms to competition, performance, transparency and professional standards in financial services. Bitter harvest, Agribusiness Managed Investment Schemes, 2016 Senate Economics Reference Committee Reinforced the need for the FOFA reforms and echoed many issues raised in the FSI. Review into Superannuation Competitiveness and Efficiency Productivity Commission Ongoing

4 4 In 2013, the ATO Assistant Commissioner in charge of superannuation warned the Small Independent Super Funds Association (SISFA) SMSF Forum about the risk of investment fraud for : Given the size of the SMSF sector and the value of funds available over $500 billion and counting it s an attractive target for fraud. Investment fraud tends to manifest in two ways: Fraudsters target SMSF trustees encouraging them to make poor quality or fraudulent investments. We ve seen quite a few such instances and we re concerned by the success that fraudsters continue to have. Even the most experienced and financially literate trustees have lost their money. The other approach is to persuade SMSF trustees to assign control of their bank accounts and investments to a third party who is ostensibly assisting them. These third parties then use the access either to invest in assets that are found not to exist, or to just siphon off funds. Once again, it s worrying how successful some of these activities are and the types of trustees affected, although this kind of fraud does generally appear to target less informed trustees. I mention this to make sure you are aware of the potential for fraud and keep it in mind when considering investment options. Of course, these are not the only ways fraud can be perpetrated on. 12 These concerns echo the 2012 AIC and ACC joint report that described their growing concerns over boiler room fraud and fraudulent manipulation of market data and financial securities to distort the market and steal financial assets: Boiler room frauds use sophisticated techniques to solicit investment in non-existent or essentially worthless shares and other securities. The frauds are well organised and convincing, with constantly evolving modus operandi. They generally operate from an overseas location; however recent investigations have identified operations based in Australia. 13 These law enforcement agencies added that these frauds can involve many types of assets, including green energy investments, new technology shares, loans to fund new investments, selling and misrepresenting products, illicit lotteries and sweepstakes, advanced-fee loan and credit offers, mortgage or real estate investments, highreturn schemes, option trading and foreign currency trading. The report goes on to say these schemes can be so sophisticated that perpetrators may even operate what is known as recovery rooms : Some serious and organised investment fraud operators have also been identified operating recovery rooms. Once investors have realised they have invested in fraudulent or worthless shares a second arm of the operation the recovery room makes contact with victims and attempts to convince them that for a fee they can assist recovery of some of the investment. As a result ASIC s consumer MoneySmart website regularly advises SMSF investors of the warning signs that they may be dealing with a fraudster: They advertise promoting early access to super They offer to take control of your super They offer quick and easy ways to access or unlock super They utilise unlicensed operators or advisers that may be recorded on the APRA Registrable Superannuation Entity Disqualification register. What protection do have? There is a range of steps can take if they are victims of financial misconduct or fraud. These include: Lodging a complaint directly with the service provider Lodging a formal complaint through industry complaint agencies, professional associations or industry regulators Pursuing the matter through the courts or reporting it to the police. This process is described in Figure 5. Given the complexities of SMSF financial and legal arrangements, navigating this process may be complex for trustees unused to dealing with these types of matters and they may benefit from consulting an external adviser. Appealing to the Financial Ombudsman Service (FOS) As SMSF trustees are not eligible for assistance from the Superannuation Complaints Tribunal (SCT) their next port of call is the Financial Ombudsman Service (FOS). This service covers a wider variety of financial services providers than the SCT as its scope includes banks, credit unions, financial advisers, general insurers, insurance brokers, life insurers, stock brokers, accountants, warranty companies and investment managers. A key issue, however, is that SMSF trustees may utilise the services of FOS to pursue a complaint against a financial services provider only if it is a registered member of the FOS network, and is a willing participant in the FOS community that has consequently agreed to be bound by its Code of Conduct. Areas that the financial ombudsman will not consider include: 14 Alleged breaches of privacy including data security Fees and premium prices unless due to non-disclosure Investment returns unless due to non-disclosure of risks Credit assessments Insurance underwriting Management of the fund as a whole Accountancy services unless the accountant was acting as a financial adviser. In addition to these restrictions, the ombudsman also has the discretion to exclude disputes if: Figure 5: Complaints handling map for SMSF trustees wish to lodge a complaint Trustees should first complain directly to company they have the problem with Matter is resolved Is complaint against a financial services provider (FSP)? Lodge complaint with Financial Ombudesman Service (FOS) Is FSP member of FOS? Is compaint within FOS s scope? Proceed with complaints Matter is resolved Is complaint against a financial services provider (FSP)? Lodge complaint with regulators or police Consider pursuing independent legal proceedings Lodge complaint with that association Matter is resolved? Matter is resolved? No further action required

5 5 It believes there is another more appropriate forum, tribunal or avenue It does not believe the SMSF or its trustees are retail clients The dispute concerns the financial services provider s internal practices and policies rather than maladministration The complaint is frivolous, vexatious or lacking in substance The SMSF trustees have commenced legal proceedings against the service provider. Service providers, such as an accountant or external administrator, can also pursue a matter of misconduct or fraud against an SMSF. However, because the laws governing the Financial Ombudsman Service are designed to protect direct consumer rights rather than through a third party, they must be officially authorised to do this on behalf of their client. This does not simplify the procedure and unless accountants are familiar with the FOS processes they are just as likely as their SMSF clients to require support. Conclusion In conclusion, the self-managed superannuation funds (SMSF) sector has undergone enormous growth in the past decade and is expected to continue to expand substantially. The size of the investment pool, the independent nature of SMSF members and the fact that they operate outside regulation by the Australian Prudential Regulation Authority (APRA) makes a particular target for financial misconduct and fraud. In addition, when it comes to pursuing fraudsters and financial scammers do not have the same regulatory protection and assistance as traditional super funds. Since SMSF trustees are managing their own money they are not eligible to access government sponsored consumer agencies, such as the Superannuation Complaints Tribunal (SCT), and must pursue the matter as individuals. Given the complications of SMSF legal and financial arrangements, SMSF trustees may benefit from consulting an external adviser to monitor investments and flag potential issues, assist with mediation if fraud occurs, and provide support through litigation if it becomes necessary. fs Footnotes 1 APRA statistics as at March Global Pension Assets Study 2016, Willis Towers Watson. 3 ATO Superannuation statistics. 4 Dynamics of the Australian Superannuation System. The Next 20 Years: 2015 to 2035; Deloitte November Submission by the SMSF Association of Australia in 2014 to the Financial System Inquiry. 6 SMSF Insights, FSC/UBS SMSF Report, December Rainmaker analysis of SMSF statistics published by the ATO, May Highlights from the Investment Trends 2015 Self-Managed Super Fund Survey, Investment Trends, Self Managed Super Fund Report, Vanguard Investments Australia and Investment Trends. 10 Personal Fraud , ABS catalogue number Targeting Scams: Report of the ACC on scams in 2015; ACC May Speech by Matthew Bambrick, ATO Assistant Commissioner, Superannuation, to the 5th Annual 2013 Small Independent Super Funds Association (SISFA) SMSF Forum, 17 October 2013, Issues affecting : the ATO perspective. 13 Serious and Organised Investment Fraud in Australia; ACC & AIC joint report 2012.