The erroneous actions of SMSF advisers can have dire consequences. Grant Abbott outlines a situation a client recently experienced that highlights this point.
A death benefits scenario hit my desk recently and I wondered what readers would think of it.
An accountant had a client with an SMSF with two members – Mum and Dad. They had two daughters, neither of them in the SMSF as Dad did not trust them with money. They were both recovering heroin addicts and had squandered a lot of money over the years. In fact, Dad paid for the children of the eldest daughter to attend private school and provided them with food and clothing.
Dad died and left $1.3 million in his SMSF. There was no binding death benefit nomination. The eldest daughter, along with the accountant and the family’s lawyer, became trustees of the fund. They made $1 million of death benefit payments to the eldest daughter, who put it into a few failed ventures, gave lots of cash away to friends and, well, lost most of it. The younger daughter retained a lawyer who challenged the payment.
Further, Mum had been in a nursing home for three years with dementia, but of course was still a trustee.
The accountant was frightened of any legal action the youngest daughter’s lawyer could take and whether it would impact on him personally.
What do you think? Does he have a problem? Where would you start?
1. Start with the SMSF trust deed
The first place to start is always the fund’s trust deed. The deed was dated 2009 from a firm that said its deeds never need replacing as they are all-encompassing.
Within the deed the first port of call was to go to the appointment and removal of trustees.
In terms of the removal of trustees, the deed provided that any person who was unable to be a trustee because of mental capacity was to be removed and replaced by the member’s enduring power of attorney (EPOA).
In this case, Mum was unable to be a trustee because of her dementia, so her EPOA, that is, Dad, was to become her trustee. This accords with section 17A(3) of the Superannuation Industry (Supervision) (SIS) Act 1993. There was no formal documentation of the replacement of Mum as trustee, but in the scheme of things it was relatively minor. For most funds it would be a big compliance risk, but here, well, there are bigger fish to fry.
The trustee appointment clause also provided that only the trustees, and failing the trustees, the members, could appoint a new trustee.
And here was the problem. The only trustee was dead and he was also the only member with mental capacity. There was no clause in the deed that continued membership onto the executors of the member’s estate enabling them to have the power to appoint the trustees.
2. The result
The end result of this case was that the daughter, the accountant and the lawyer could not at law be appointed as trustees of the fund, meaning they were fake or fraudulent trustees.
So if the eldest daughter, the accountant and the lawyer could not be appointed as trustees, then what does that mean for the death benefits paid to the eldest daughter and squandered?
The payments made by the three purported trustees were made illegally and in breach of not only the deed, but also the sole purpose test under section 62 of the SIS Act. And that is where the fun starts because what recourse does the youngest daughter have against the accountant, the lawyer and her sister?
3. Multiple available actions against advisers
There are a whole lot of actions the youngest daughter’s lawyer, if they were SMSF savvy enough, could take against the three fake trustees. No doubt they would be targeted against the lawyer and the accountant as the eldest daughter has no cash.
3.1 Negligence
Negligence is an action under equity law and is defined in tort law, and applies to the actions of advisers when it comes to SMSFs: “Negligent tort means a tort committed by failure to act as a reasonable person to someone to whom she/he owes a duty, as required by law under the circumstances. Further, negligent torts are not deliberate, and there must be an injury resulting from the breach of the duty.”
There is a defence to the action that the advice was reasonable or the trustee of the SMSF contributed to the negligence.
In the recent SMSF negligence case of Cam & Bear v McGoldrick [2018] NSWCA 110, an auditor was found to be negligent by the New South Wales Court of Appeal for not characterising a loan as a loan in the accounts of the SMSF, but rather as cash. As such, the auditor was found liable for any loss occasioned in relation to the losses incurred by the trustee of the fund in respect of the borrower going into liquidation and not being able to pay back the loan.
In this case it would be argued the three parties and, in particular, the lawyer and the accountant should have been aware of the terms of the trust deed. Moreover they should have been aware they could not have become trustees of the fund.
As support for this situation, the lawyer should raise the case of Australian Prudential Regulation Authority v Holloway [2000] FCA 579 where the court held that ignorance of the law for a person who purports to be an SMSF accountant is no excuse. In that case, the Australian Prudential Regulation Authority (the SMSF regulator at that time) took accountant Anthony Holloway to court and charged him under the anti-avoidance provisions of section 85 of the SIS Act and was successful. The court dismissed Holloway’s claims he did not know the relevant sections dealing with a breach in detail. He promoted himself as an expert and should be held as such.
A negligence action is definitely on the cards, but it is a long, drawn-out process and very costly. And that is where the strict liability provisions of the SIS Act come into play.
3.2 Strict liability actions under the SIS Act
Section 55(3) of the SIS Act deals with the breach of the trust deed and section 218 deals with a breach of the SIS Act or SIS Regulations. As we shall see below, these sections empower a trustee of an SMSF or a member to sue and recover losses from an accountant, auditor, financial planner or any adviser for that matter who has breached the laws or the trust deed of the fund.
Importantly, these sections are federal laws and are laws of strict liability.
What is strict liability?
Under commonwealth law, strict liability is an offence where there is no necessity for the taxation commissioner or the party to the suit, the trustee or member to show fault. If there is a breach, and it can be shown, then the sections kick in and the only determination needed is the quantum of damages. That is, what have the members or trustees lost as a consequence of the breach of the laws? A breach also includes an omission of considering the laws.
Section 55(1) of the SIS Act provides:
1. A person must not contravene a covenant contained, or taken to be contained, in the governing rules of a superannuation entity.
3. Subject to subsection (4A), a person who suffers loss or damage as a result of conduct of another person that was engaged in contravention of subsection (1) may recover the amount of the loss or damage by action against that other person or against any person involved in the contravention.
In Dunstone v Irving [2000] VSC, Justice Hansen addressed the fact the trustee of the fund did not make a lump sum retirement payment as required under the fund’s trust deed to finance member Chester Irving within a reasonable period of time. It was held there was a breach of the fund’s trust deed and at paragraph 143, Hansen said “the other aspect of relief is a claim for damages, being the loss suffered by the plaintiff as a result of not having the use of his entitlement. The plaintiff sought damages either under s55(3) of the SIS Act or on account of the defendant’s breach of his obligations as trustee”.
The court looked at the amount of Irving’s loss, given he was deprived of his lump sum of $1,365,478 from February 1998. By the time of the action, in November 2000, it was assessed that the amount his entitlement could have earned if withdrawn at that time, in a conservative portfolio, was $248,862. These damages were awarded against the trustee.
In our case, the three fake trustees have appointed themselves outside of the scope of the SMSF’s deed and governing rules and consequently the fund has lost, at a minimum, $1 million plus earnings. All three fake trustees are jointly and severally liable. Importantly, there is no need for the matter to go to court, but if it did, based on Dunstone’s case, it would be a very expensive case to lose.
Section 218(1) of the SIS Act provides:
If a civil penalty provision in relation to a superannuation entity is contravened by a person other than a trustee of the entity, a trustee of the entity may, by proceedings in a court of competent jurisdiction, recover from the person, as a debt due to the trustee:
1. if that or another person has made a profit because of the act or omission constituting the contravention – an amount equal to the amount of that profit; and
a. if the entity has suffered loss or damage as a result of that act or omission – an amount equal to the amount of that loss or damage;
b. whether or not:
c. the first-mentioned person has been convicted of an offence in relation to the contravention; or
d. a civil penalty order has been made against the first-mentioned person in relation to the contravention.
In our case there are several breaches of the SIS Act, ranging from the sole purpose test, the payment of death benefits under SIS regulation 6.21, the requirement of the fund to have a trustee (sections 19 and 17A), plus a whole lot more. In our case, section 218 would follow the lines of a section 51(1) case.
Important: strict liability is a breach of a federal law and potentially a commonwealth crime and may not be covered by an adviser’s professional indemnity insurance. The accountant and lawyer should check with their insurance company.
3.3 Criminal action
I am not sure the taxation commissioner would get involved, but given more than $1 million has effectively been stolen from the SMSF by the three fake trustees, they may step in and use section 202 of the SIS Act.
Section 202: When contravention of civil penalty provisions is an offence
- If a person contravenes a civil penalty provision, either:
a. dishonestly, and intending to gain, whether directly or indirectly, an advantage for that, or any other person; or
b. intending to deceive or defraud someone;
c. the person is guilty of an offence punishable on conviction by imprisonment for not longer than five years.
If the commissioner does take action against the lawyer, the accountant and also the eldest daughter, then section 216 of the SIS Act provides that the criminal court may award compensation to the fund.
4. The final word
If the accountant was licensed, then the SMSF or whoever is looking after the fund could take an action post-1 November 2018 with the Australian Financial Complaints Authority, which is a no-cost option but would be limited to $500,000 in compensation.
In the end, the accountant and lawyer should never have got involved in dealing directly with an SMSF. Even if they were executors of Dad’s estate, the SMSF is a no-go zone. Their actions have the potential to embarrass them professionally and ruin them financially or, at worst, all of this and imprisonment – a lesson to be learned for all SMSF advisers, accountants, lawyers, financial planners and auditors.
