Be Careful What You Wish For

It is now widely accepted that Labor’s proposal, to withhold the cash refund of franking credits is aimed squarely at SMSFs, while at the same time leaving members in industry funds completely unaffected. This will encourage many members of SMSFs to consider transferring their savings to an industry fund in the belief that this will continue to provide them with a cash refund from their excess franking credits.

Many industry funds offer a “self-invest” option where you control a parcel of shares and ETFs selected from an approved list and retain both the dividends and the franking credits. Unless you invest in the self-invest option, a transfer to an industry fund will see your money placed in a range of managed options and you will be treated the same as existing members who have no idea where their money is invested or indeed the franking credits they earn.

A transfer to an industry fund has some advantages and some less obvious disadvantages.

Advantages

You are not the trustee. That means you are no longer responsible for any paperwork in the form of compliance, investment strategies, audits, or tax returns. The “Self-invest” option, as is called in Australian Super, is just one of the investment options you can choose. You can allocate your money between other options as your needs change. As you get older, you may wish to move to more managed options offered by the fund.

Disadvantages

You are not the trustee. As a member of the fund, you do not have control of how the fund operates. You depend entirely on fund policy which can be easily changed. This can be seen in two ways.

Firstly, as a member of an industry super fund, the trustee of the industry fund owns the shares – not the member. You may think you own the shares in the self-invest option, but you don’t. This is evident in the fine print and also from the fact that the franking credit is paid to your account on the same day as the dividend. Clearly, the franking credit is not being paid from a tax return which would only happen after the end of the financial year.

The “dividend’ is actually paid by the fund, not the share registry, and the “franking credit” is also paid by the fund, not the ATO. The fund does this because the “self-invest“ member knows their “entitlement” to their franking credits whereas members invested in the fund’s managed options have no idea what they are invested in or their entitlement to any franking credits. But this arrangement depends entirely on fund policy, not legislation.

As the trustee owns the shares and not the member, it explains why these shares can be sold without the member’s knowledge or consent, e.g., if insufficient money is held in one of the managed options to pay the regular pension. It also means that the member does not automatically benefit from share ownership, e.g., Buybacks.

Finally, there is no advice - you are on your own. You take all the risk of the investment decisions and the fund accepts no responsibility for your investment outcomes. You are even charged extra to use your own stock broker. The rationale is simple - if you need assistance you should invest in one of their managed options, and that is their preferred outcome because that is where they charge their considerable fees.

Note that under Labor’s proposal, franking credits can only be used to pay tax, there will be no refund for excess credits. Why then, are some credits refunded to you in the self-invest option? Does that mean that other members of the fund are paying more tax? How sustainable is that?

One has to ask what happens when the fund is overwhelmed by large numbers of people from SMSFs seeking to keep their franking credit refunds. How sustainable is this generosity? It does not require a cancellation of this option, merely greater restrictions. All it takes is a change of policy, not legislation. By then you have closed your SMSF. Will you take the bait?

Secondly, the lack of control over the way the fund operates can be seen in the following example:

Cbus is an industry super fund set up for the benefit of workers predominately in the construction industry. According to the Royal Commission into Misconduct in the Banking Superannuation and Financial Services Industry, the evidence showed:

Cbus has ‘partnership agreements’ with many organizations. Its ‘partners’ include its shareholders who comprise both trade unions and employer organizations.

In 2015, a KPMG report found that Cbus had paid over $7 million to its shareholder organizations in five years. But it also found that Cbus did not have any formal way to determine whether it was getting value out of what it paid for. After receiving this report, Cbus introduced a number of process changes. It also hired an independent consultant to review the benefits of its industry partnerships program. Cbus ended up introducing a revised ‘Industry Partnership Strategy and Evaluation Model’. This model measured different variables and tried to assess the overall value of each partnership to Cbus. The model was put into practice in 2016/2017, and is applied to both shareholders and non-shareholder partners. (Vol 2. Page 244)

The Commission’s response was:

As I have emphasized many times in this report, a superannuation trustee promises its members that it will act in their best interests and exercise the same degree of care, skill, and diligence as a prudent trustee. Just as it must carefully choose how to spend members’ money, it must also take reasonable steps to make sure that its spending achieves the desired results.

On the limited information available, the changes Cbus made to its ‘partnership’ arrangements after the 2015 report are an example of such steps. Having identified that it could not tell whether it was getting what it paid for, Cbus introduced process changes and initiated a review of the relevant program more broadly. That review appears to have led to a more rigorous approach to its commercial relationships, not just with its shareholders but with other organizations as well. (Vol2. Page 249)

This is a clear case where an industry super fund is paying a large sum of money annually to its foundation shareholder, the union. This is in addition to any director’s fees refunded to the union. The Royal Commission approved this because, as long as the super fund has a “rigorous approach to its commercial relationships”, it satisfies the sole purpose test of meeting the needs of its members.

There are many other cases of conflicts of interest in industry super funds, where the benefits to members are suspect. These include the use of corporate credit cards, the purchase of corporate boxes at sporting events, and the expenditure on advertising.

Conflicts of interest in industry funds raise several points:

• The assets in a super fund are held by the trustees, not the members.
• None of these conflicts of interest over the use of those assets have come to light outside the Royal Commission because members of an industry fund (unlike shareholders in a company) have no mechanism of holding the trustees of those funds accountable for the management of their money, and the regulator has proven to be a toothless tiger.
• Super contributions are now compulsory at 9.5% of wages and are scheduled to rise to 12%. The bulk of that money flows into industry funds.
• From the fees they generate, industry funds are paying an annual dividend to the unions; money that clearly belongs to fund members.
• Industry funds can do this because the vast majority of their members are totally disengaged from their super.
• We can assume that all industry funds follow this practice and it now has the stamp of approval from the Royal Commission.
• Unions are unconcerned about falling union membership as they have a guaranteed income stream flowing from compulsory super.
• Union donations are the main source of funding for the ALP.

According to this logic, members of industry super funds are effectively making regular compulsory donations from their retirement savings to the ALP, without their knowledge or consent.

Labor’s Grand Plan becomes clearer

The Royal Commission has effectively killed off retail (for-profit) super funds by exposing a range of well-documented deficiencies. It is now only SMSFs that stand between industry funds and total domination of the whole superannuation savings pool.

For years SMSFs have been an anathema to industry funds. SMSFs have been accused of all sorts of things, but the main issue has always been that, because SMSFs represent about one-third of the total super pie, it means that industry funds (and by extension the unions and the ALP) are denied one-third of the money that could flow to them if there were no SMSFs. To make sure we do not miss the point that SMSFs are the villains, Australian Super, the largest industry super fund, is now calling for an Official Inquiry in SMSFs.

When industry funds achieve total domination of the superannuation savings pool, what can we expect? What happens when industry funds use their financial muscle on company boards, to dictate their social agenda rather than optimum financial outcomes? What happens when companies looking for additional capital are at the mercy of union-dominated industry funds controlling this enormous pot of gold?

Food for thought.

Jon Kalkman, AIA Director