ASIC spotlight on compliance with client money rules in superannuation

5 min read

ASIC has recommended all superannuation trustees should review their compliance with s1017E of the Corporations Act after a thematic review found widespread 'deficiencies'.

ASIC recently completed a thematic review of compliance by superannuation trustees with the requirements in section 1017E of the Corporations Act 2001 (Cth) for holding client money where a financial product (or increased interest in the product) is not issued immediately.

According to ASIC, 11 of the 12 superannuation trustees reviewed had failed to ensure their practices or disclosure complied with s1017E. The regulator recommended that all trustees review their systems and processes to ensure compliance with the section and warned of future regulatory action if deficiencies are not properly addressed.

In this Insight, we take a look at ASIC's review and what it means for trustees.

Key takeaways

• ASIC identified four concerns in its thematic review:
  • use of non-compliant accounts to hold money
  • failure to hold money in a s1017E account for the required time
  • failure to identify money subject to the s1017E requirements
  • inadequate disclosure to consumers.
• In light of ASIC's warning of future regulatory action in relation to s1017E (and the potentially significant penalties attached), trustees should carefully review their processes and procedures to ensure compliance with s1017E requirements.
• Trustees will need to grapple with interpretative and practical difficulties that have long plagued s1017E. Further clarity and engagement from ASIC may assist trustees.

A refresher on section 1017E

Section 1017E applies (subject to limited exceptions) to money that is paid to an issuer or seller of financial products (in relation to which the seller has prepared a product disclosure statement) to acquire a financial product or an increased interest in a financial product, where the product or increased interest is not issued immediately upon receipt of the money (1017E Money).

A superannuation product is a financial product for the purposes of s1017E. In a superannuation context, the following key protections are afforded to 1017E Money (subject to certain exceptions):

• The money must be paid into an account with an Australian ADI or another kind of account prescribed in the Corporations Regulations on the day of receipt or on the next business day.
• The account must be designated as an account for the purposes of s1017E, and must also be designated and operated as a trust account. The money must be held on trust by the trustee for the benefit of the person who is entitled to the money (eg the relevant applicant or member).
• Any money may be paid into the account, provided that 1017E Money (along with any interest standing to the credit of the account) is separately identified and held in accordance with the provision.
• The money must only be taken out of the account if the product is issued to, transferred to, or in accordance with the instructions of, the person by whom it was paid—or in order to return the money to that person.
• The money must be taken out of the account for one of the permitted purposes within the prescribed time.
• Where the benefit of interest earned on money held in accordance with s1017E is to be retained by the superannuation fund trustee, this must be appropriately disclosed (eg as part of the relevant product disclosure statement).

What did ASIC's thematic review find?

In summary, ASIC identified four key concerns in its s1017E thematic review:

• Use of a non-compliant account to hold 1017E Money for some or all of their superannuation products (eg where the account was not a designated trust account).
• Failure to hold 1017E Money for the required period. Several trustees did not hold members’ money on trust in a compatible bank account until the time an interest in a product was issued or increased. ASIC noted that this occurred, for example, where incoming money was being moved or ‘swept out’ of the prescribed account daily and invested as part of a general fund strategy before a new or increased interest for a member was issued.
• Failure to identify 1017E Money. Some trustees reported that they could not, or did not, identify money subject to s1017E requirements. ASIC observed that this situation could arise where a trustee did not have daily monitoring arrangements in place, or did not check how service providers handle money for a member, when first received.
• Inadequate disclosures. ASIC stated that disclosure materials it reviewed did not clearly explain who received benefits of interest earned on incoming money before a product is issued (or increased), nor did they explain when no interest would be payable.

The trustees reviewed represented a mix of industry, retail and corporate superannuation funds, with both internal and outsourced administration arrangements. According to ASIC, only one of the surveyed trustees had complied with the provision. This is a surprising result. There of course may be a number of reasons for this conclusion. However, it does seem at least possible that one contributing factor was differing interpretations of s1017E and its application in a superannuation context.

Some issues with the interpretation of s1017E

ASIC's media release did not provide much detail on the legal analysis that informed its observations in the thematic review. However, the following excerpt from the release may provide some clues as to ASIC's views on the scope of 1017E Money (emphasis added):

A product issuer that fails to hold incoming money in trust for the sole benefit of the person entitled to it, until a product is issued or increased, could place unallocated money at risk if a product issuer or their service provider pause or cease operations for any reason. The obligations extend to dealing with money received for a super fund member (such as contributions and rollovers into a fund) during the time it takes to issue an interest for a new member, or increase the interest of an existing member.

While this excerpt is far from a clear statement, it seems to suggest that ASIC might consider all contributions, rollovers and transfers received by a trustee that cannot be allocated to a member immediately to be 1017E Money. Only ASIC can confirm one way or another—but either way, this statement is likely to be a (further) source of confusion for the industry on the application of s1017E.

The difficulty of legal interpretation and practical application of s1017E in a superannuation context has long been the subject of discussion.^[1] For example, there is uncertainty as to:

• When an increased interest in a superannuation product is issued. The reference in ASIC's media release to 'incoming money' and 'unallocated money' does little to clear up this uncertainty. Is ASIC proceeding on the basis that money must be 'allocated' to an individual person before an increased interest (or even an interest) is considered to be issued? Or does it take some other view?
• Whether ASIC is suggesting that 1017E Money is able to form part of the assets of the superannuation fund—is it saying that s1017E applies to rollovers received into the fund in the ordinary course? Trust law and the broader legislative framework may support the view that s1017E has a separate and sequential application and operates only in limited circumstances where money is received by the trustee and has not yet been accepted into the fund.

What should super funds do next?

Trustees can expect to be subject to further scrutiny by ASIC of their compliance with s1017E, and would be well advised to review their processes and procedures.

There are certain aspects of the provisions that are likely more easily reviewed, eg:

• whether the s1017E account is a compliant account
• whether disclosures are adequate
• arrangements for allocating and identifying money that is very clearly 1017E Money.

The review of other aspects may run up against some of the uncertainties raised above. As such, it would be helpful for superannuation trustees to be provided with a clear statement by ASIC on its interpretation of s1017E and the basis for that interpretation. Any changes to policies and procedures for 1017E Money may result in trustees incurring substantial administrative and operational costs. They may also impact member returns more broadly—s1017E operates to the effect that member money cannot be invested (outside a s1017E account) until the relevant interest or increased interest is issued, resulting in potentially significant opportunity costs if applied more broadly than is needed. In the meantime, it may be prudent to consider what steps can be taken to minimise the amount of money that could potentially be considered 1017E Money (eg ensure internal allocation processes occur as quickly as possible).

If you would like to discuss the issues raised in this Insight, please contact any of the people below.