Private Member's Motion on last resort compensation for SMSF investors

sj_and_sb.jpgThe collapse of Trio Capital was the largest superannuation fraud in Australian history. Around $176 million of superannuation funds were lost and are unlikely to be recovered. Nearly 6,090 Australians invested in Trio and, through Trio, into a number of managed investment schemes. Two hundred and eighty-five of those investors put their money in Trio through self-managed superannuation funds.

Self-managed superannuation funds are the largest single sector of Australia's $1.4 trillion superannuation assets and are the fastest-growing sector. Many of the 285 SMSF investors in Trio are located in the Illawarra and, over the course of the last two years—almost the entire time I have been in this place—the member for Cunningham and I have been meeting with and corresponding with the many men and women who have lost some or all of their life savings as a result of this corporate fraud. That is, 285 personal stories of severe financial shock and the ensuing personal devastation that flows from this.

The facts are stark: by investing in SMSFs they were not eligible for compensation under part 23 of the Superannuation Industry (Supervision) Act. Most of the SMSF investors I have met have told me they were unaware of the difference between an SMSF arranged investment and APRA regulated superannuation. Indeed, that was the nature of the evidence that was given to the Parliamentary Joint Committee on Corporations and Financial Services that inquired into this fraud and collapse.

It is clear that the SMSF investors in Trio relied heavily on the advice of their financial advisers. They also had confidence in Australia's system of financial regulation. However strong a regulatory system we have, the challenges of dealing with deliberate and complicated, indeed sophisticated, fraud are substantial. This case demonstrates that we need greater fraud detection and prevention measures and I urge the government to work with regulators to take action in this area.

Since 2007 Labor has tightened the regulation of the financial services sector by putting in place better protections for consumers. The Future of Financial Advice reforms—the FOFA reforms—have implemented a number of important measures which, if they had been in place in 2007 might have prevented some of the Trio losses that we are talking about tonight. This is because they require a financial adviser to put their clients' interests first. They also ban kickbacks and commissions. For example, in the Illawarra it has been said that a local financial adviser, Mr Tarrant, received in excess of $840,000 in payments and commissions from Trio staff for putting his local investors into Trio through an SMSF.

While the Future of Financial Advice reforms are measures that greatly strengthen our financial system, I believe that more can be done. I believe that we should develop a last resort compensation scheme for cases of corporate fraud in order to provide better protections for SMSF and managed investment scheme investors. The question of a last resort compensation scheme is considered in a report commissioned by the Minister for Financial Services and Superannuation and conducted by Mr Richard St John and released in April last year. The recommendations by Mr St John were also discussed in the aforementioned PJC report.

One scenario where a last resort compensation scheme might apply is when there is a financial loss due to misconduct or insolvency by a financial services licensee. Such a proposal was supported by some industry bodies including the SMSF Professionals Association of Australia and the Association of Superannuation Funds of Australia, amongst others.

    In the case of Trio, a fraud occurred offshore where the investment funds were allocated to hedge funds with over-inflated assets that may or may not have even existed. The Trio scenario was a failure of the investment strategy of a managed investment scheme.  This failure can be the result of a number of causes—in the case of Trio, it was fraud. The investment itself was risky; the investment strategy was flawed; or, as in the case of Trio, a fraud was committed. Whatever the scenario, the outcome was the same from the investors' perspective: they have lost their money, in many cases their entire life savings.

I believe there is a flaw in our financial service sector when it comes to SMSF investors. In the case of failed investments SMSF investors are left to fend for themselves and to bear the cost themselves for any misconduct or insolvency by a financial services licensee for any corporate failure. The assumption here is that the SMSF investors are themselves the trustee and therefore they have both the power and the knowledge about their investments—the vehicles and the assets in which they invest their money—and therefore bear the risks associated with those investments, having both the power and the knowledge that separates them from those investors who invest through an APRA regulated fund in which they are not themselves the trustee. For that reason other insurance-like arrangements exist for those APRA regulated funds.

Under our existing system, some investors in Trio—those in APRA regulated funds—could get compensation while those in SMSFs got nothing. It is a pretty tough message for these investors to accept. Given the importance of Australia's system of workplace superannuation, occupational superannuation, and the personal devastation that results from these significant financial losses, I believe that SMSF investors need a last resort compensation scheme. There are many issues raised by such a proposition. Managed investment schemes in particular are under increasing scrutiny now due to a number of high-profile examples of investment failure. Many questions have been rightly raised about the lack of regulation and lack of accountability by trustees around these schemes.

In his report, Mr St John considers that the regulation of managed investment schemes such as those invested in by Trio are not yet on a sufficiently solid framework on which to transfer to other licensees the requirement to pay compensation. Improved regulation and accountability in this area should be a priority for ASIC and for government.

There is one important issue to consider, which was acknowledged in the PJC report: that providing full compensation for the failure of risky investments creates a moral hazard. That is, who should bear the cost of a failed investment? Some who have lost their money in Trio believe that taxpayers should now chip in to compensate them for the failure of their investment. This is a difficult proposition unless it can be proved that the loss was the direct result of government fraud or negligence, and I have as yet seen no evidence of this. Any determination of a claim such as this should be made by an independent body with access to all the relevant evidence. Indeed, that is why we have courts of law. It is proper that a court—an independent body—makes such an adjudication, not the government itself, particularly when an allegation may be raised against the government or government instrumentality.

Another question is: should investors in a scheme that is well managed and financially prudent bear the cost of compensation for failed investment schemes that were not. I believe one approach to this is to consider the approach adopted in the United Kingdom where a last resort compensation scheme already operates, known as the Financial Services Compensation Scheme. This UK scheme applies where claims for compensation through professional indemnity insurance, or minimal capital requirements for financial services licences, are inadequate. Under the UK scheme, payments of compensation are capped and calculated in accordance with a formula, such as 70 per cent of the first $50,000 lost, plus 70 per cent of the next $80,000 and 50 per cent for the next $80,000, or something along similar lines.

Therefore, in a similar vein to the conclusions of the PJC report, tonight I am calling for the federal government to take active steps towards developing a compensation scheme of last resort by placing a levy on managed investment schemes. This would operate in a similar way to the existing scheme for APRA supervised superannuation, where a levy also applies in the event of fraud and the activation of that part of the act.

For Australian investors to maintain their confidence in our financial system and for investors to be better protected against fraud and maladministration, it is time to look in more detail at these matters. Those on the other side have an inbuilt antipathy towards any sort of government regulation. Indeed many within the industry have a similar antipathy, but what is at stake is too great; it warrants a bipartisan approach. On this side of the House, we believe that it is the role of government to get the regulatory system right so that investors can invest with confidence.