Performance fees could have legal sting in the tail

Financial advisers and superannuation fund trustees can be exposed to legal risk from disgruntled fund members and clients if investment returns fail to reflect the performance fees paid to fund managers.

That is the analysis of leading financial services barrister Noel Davis, who said it was open to courts to determine that performance fees paid to fund managers significantly in excess of the returns delivered to members of superannuation funds were “unconscionable”.

He said the Australian Securities and Investments Commission Act permitted a person who had suffered a loss through a breach of any of the provisions of the legislation to claim compensation for the amount of the loss.

Davis said it was possible for a court to take account of the relative strengths and bargaining positions of an investment manager and a superannuation fund member, and that often the fund member would have no bargaining position because the selection of investment options had been made by a superannuation fund trustee.

“A court may well take the view that, in those circumstances, it was unconscionable for an investment manager to be entitled to a significant percentage of the investment return generated by the member’s superannuation money,” he said.

Davis said superannuation fund trustees needed to select the investment options to be offered to members with the same care an ordinary person would use when looking after another person’s money.

He said the Administrative Appeals Tribunal had held in a recent decision that one way for a trustee to determine whether that obligation had been met was for the trustee to ask: “What would the members have done to protect their own positions and to promote their own financial welfare in these circumstances?”

Davis said fund members would be able to argue a trustee or adviser had breached their obligations if the performance fees paid to an investment manager were excessive.

“A member … may be able to submit, with some force, that the member, in selfishly looking after his own interests, would not have knowingly agreed to give away 20 per cent or 30 per cent of his investment return, above a base level, to an investment manager,” he said.

Davis said that this would be particularly the case if there were an investment loss and there was no reimbursement for that loss.

“The fact that an investment manager, rather than the trustee, has received the performance fees would not prevent a court from deciding that the trustee should pay compensation,” he said.