Australia: Developments In Dollar-Based Materiality In Unit Pricing

Last Updated: 22 December 2008
Article by Jane Paskin

Key Point

  • The Guide clearly allows a fixed dollar minimum, but what about dollar-based materiality to fee errors, ongoing members and amounts for exited members above $20?

The joint guide from the Australian Securities & Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA), Unit Pricing - Guide to Good Practice, was updated on 28 August 2008. A number of changes were made to the part of the Guide that deals with managing errors and compensation, but the most important change was the inclusion of the following text:

"For exited unit holders a fixed dollar minimum can apply to compensation amounts. The following principles apply:
  • compensation should be paid where the amount of compensation is $20 and above. You can compensate below this level if you wish; and
  • if you apply a fixed dollar minimum, then disclosure must be made on your website and in the annual financial report for the relevant fund."

The Guide had previously stated that applying a fixed dollar minimum compensation amount would discriminate between unit holders with larger and smaller investments.

The move to allow fixed dollar minimums for exited members was welcomed by the superannuation industry. Many trustees will now be amending their policies and procedures to incorporate a fixed dollar minimum for exited members, if they have not done so already. The regulators expect trustees to have documented policies and procedures for managing unit pricing errors and addressing compensation issues.

Restrictions in the Guide

While the Guide clearly states that the regulators will allow fixed dollar minimums for exited members, it also seeks to place restrictions around their use. The quote above shows that a trustee that wishes to use a fixed dollar minimum for exited members and strictly comply with the Guide should:

  • set the minimum at not more than $20
  • disclose the minimum on its website; and
  • disclose the minimum in the annual financial report.

Further, the Guide indicates that when the regulators are notified of a unit pricing error, the information that they will seek will include the basis for determining any fixed dollar minimum for exited members. Consequently, if a trustee applies a fixed dollar minimum of $20, the trustee needs to be prepared to explain why it has chosen that amount. An estimate of the dollar cost to the fund of making a payment to an exited member (obviously, excluding the amount of the payment itself), when based on appropriate assumptions, provides an ideal basis for selecting a fixed dollar minimum. Industry standards and practice may provide an alternative basis for selecting a particular amount.

For trustees who are members of the Investment and Financial Services Association (IFSA), IFSA Standard No. 17.00 applies to restrict any fixed dollar minimum so that it is not more than $20, with the result that the Guide has not imposed an additional constraint on IFSA members by specifying $20 as the maximum. ASFA's Best Practice Paper No. 27 notes that, at the time it was prepared, the regulators considered that the use of a fixed dollar minimum may not have been appropriate, without making any comment regarding the size of fixed dollar minimums.

Trustees may find, when they investigate the costs of compensating exited members that, in some cases, the cost to the fund exceeds $20. This could form the basis for a trustee discharging its legal obligations by adopting a fixed dollar minimum which is more than $20, particularly in relation to a not-for-profit superannuation fund. The regulators acknowledge that there may be circumstances in which alternative practices to those set out in the Guide are appropriate and have indicated that they expect that the justification for adopting alternative practices will be documented.

Legal obligations

The Guide reminds trustees that they must take into account all relevant legal obligations when determining whether to pay compensation and stresses that the allowance of fixed dollar minimums by the regulators does not affect third party rights against trustees in relation to not compensating. When releasing the Guide, ASIC again highlighted that the legal rights of members remain a matter for scheme operators to assess.

Where compensation is paid out of fund assets, deciding which errors to compensate raises issues of fairness between beneficiaries who are impacted by the unit pricing error and those who are not. As part of the trustee's duty to act in the best interests of the beneficiaries as a whole, the trustee must act fairly (or impartially) between members who have dissimilar rights.

We think that trustees can justify adopting dollar-based materiality without recourse to the principle of de minimis non curat lex, but no explanation of the law in this area would be complete without some comment.

The application of the de minimis principle obviously depends on the factual matrix. Australian courts have applied the principle in a wide range of circumstances, including statutory interpretation, contract and criminal law. The following passage from Bennion's "Statutory Interpretation" has been cited in numerous cases and succinctly summarises the reasons for the principle:

It is essential to the working of a legal system that it should adopt the principle of the maxim de minimis non curat lex (the law does not concern itself with trifling matters). There are a number of reasons for this. Litigious persons and unnecessary litigation must be discouraged: doni judicis est lites dirimere (the good judge prevents litigation). Time must not be wasted. Costs must be kept down. The dignity of the law must be preserved. Parliament is presumed to have regard to all these matters and by implication to intend that its enactments shall not apply in a de minimis case. It is excepted from their operation as if excluded by an express proviso. (at p 868)

In our view, the de minimis principle most probably underpins dollar-based materiality thresholds in the context of unit pricing errors. Further, in our view, the reasons given above for why the principle is needed in law seems to equally apply to the realities of unit pricing in the financial services industry. Unit pricing is generally regarded as a much more equitable system for beneficiaries than the use of crediting rates, but it involves complex and highly sophisticated calculations, done on a very frequent basis. This complexity and frequency understandably increases the risk of errors, even where risk management systems and procedures are very good. To ensure the efficiency, expediency and viability of the unit pricing system across the financial services industry we think it is reasonable and sensible for participants to wish to adopt reasonable materiality thresholds so that small errors do not require expensive and time-consuming remediation projects.

Nevertheless, there are two issues that need to be overcome:

  • trust law is very strict in relation to the duties of fiduciaries. A beneficiary is entitled to be compensated for any loss the beneficiary has suffered as a consequence of a breach of fiduciary duty. Where a beneficiary has not been paid the correct amount of their benefit, trust law would entitle them to the amount they are owed from the trust; and
  • the de minimis principle has never been applied in Australia to a matter involving trust law or equity (and in particular to excuse a breach of fiduciary duty) and to invoke the principle in such a case would be novel. Even though we think there are very good reasons why the principle should be applied to unit pricing errors, it would be the application of the law in a situation that has not been previously been considered by a Court.

However, even though it would be a novel application of the principle to apply it to excuse a breach of fiduciary duty, in our view, there are good reasons why a court may decide that the principle should nonetheless apply in appropriate cases. Accordingly, in our view, it may be open for trustees to apply the de minimis principle to set a fixed dollar minimum below which unit pricing errors will not be compensated because of their small size.

Fee errors

The Guide includes a statement that errors arising due to the miscalculation of fees must be compensated in all cases. This statement is made in the context of the trustee needing to consider whether compensation should be paid where the impact on the individual unit holder is less than 0.3 percent of the value that would have accumulated without the unit pricing error. It is not included in the principles that the Guide lists as applying to fixed dollar minimums. Accordingly, it is not entirely clear from the Guide whether a trustee:

  • can apply a fixed dollar minimum to unit pricing errors arising from the miscalculation of fees (this would be an exception to the principle that those errors must be compensated in all cases); or
  • must not apply a fixed dollar minimum to those errors (this would be an exception to the principle that the trustee can apply a fixed dollar minimum).

One of the updates to the Guide was the insertion of a statement that the scheme operator must not benefit from a unit pricing error. That statement is consistent with IFSA Standard No. 17.00 and could be viewed as precluding a trustee from applying a fixed dollar minimum to an error arising from the miscalculation of its own fees.

However, the media release that accompanied the Guide states "if there is a net benefit from amounts not paid to exited members, that benefit is to remain in the fund - the scheme operator must not benefit from the process". That suggests that where an error arises due to the miscalculation of the trustee's own fees, the trustee may still be able to apply a fixed dollar minimum in deciding whether to compensate exited members, provided that the excess fees are not retained by the trustee. For example, the trustee might pay the excess fees into the affected investment option(s) or a reserve account, rather than compensating exited members for amounts below the fixed dollar minimum. In our view, remediation at the investment option level will be consistent with the trustee's legal obligations in most cases and should therefore be permitted by the regulators.

The statement that a scheme operator must not benefit from a unit pricing error, does not have any bearing on whether the trustee can apply a fixed dollar minimum to unit pricing errors arising from the miscalculation of fees, such as custody fees paid to an unrelated third party, that do not benefit the trustee. Again, we think that there is no legal impediment to trustees applying a fixed dollar minimum for errors caused by these types of fees and the regulators should allow this.

It will be useful if the regulators are able to clarify whether the Guide allows trustees to apply a fixed dollar minimum to:

  • errors arising from the miscalculation of the trustee's fees, provided that the overpayment is returned to the fund; and
  • errors arising from the miscalculation of other fees, if the fees do not benefit the trustee.

That would assist trustees with the task of updating policies and procedures to incorporate a fixed dollar minimum for exited members, which in many cases is already under way.

Ongoing members

The regulators indicate in the Guide that they are generally of the view that all ongoing members must be fully compensated, regardless of the amount. This opposition to fixed dollar minimums for ongoing members is reinforced by the accompanying media release which states that the fixed dollar minimum would only apply to payments made to exited members.

Our view is that the legal justifications for applying fixed dollar minimums for exited members (described above) are equally applicable to ongoing members, although the amount at which the fixed dollar minimum should be set is likely to be lower. Nonetheless, the regulators' decision to allow fixed dollar minimums for exited members, but oppose fixed dollar minimums for ongoing members, is reasonable if the regulators consider that the additional cost to the fund of compensating ongoing members without applying a fixed dollar minimum is effectively nil. This is a question of fact and may vary between funds.

Should a trustee test this and find that, in its particular circumstances, there are additional costs, the trustee could have a legal basis for applying a fixed dollar minimum for ongoing members. Where a trustee is entitled to be indemnified out of the fund for remediation costs, the trustee would need to be satisfied that it is acting fairly between the class of members who are affected by the error and the class who are not affected, before it incurred costs to compensate ongoing members for small dollar amounts. We think that it would have been better if the Guide, rather than opposing the application of fixed dollar minimums to ongoing members, had emphasised the importance of having, and documenting, a reasonable basis for any fixed dollar minimums for ongoing members.

Relationship to 30 basis points test and aggregation across options

Consistent with ASFA best practice and IFSA's standard, most trustees have adopted a materiality test for unit pricing errors that revolves around 30 basis points for most investment options and a lower percentage for cash options. Where a trustee is considering adopting dollar-based materiality, in addition to a basis point test, an obvious question is whether an error should be treated as material if it is only material under one measure.

Our view is that the Guide permits trustees to apply a fixed dollar minimum as an overriding negative screen, if they so choose. In other words, if the difference is 30 basis points or more, the trustee can apply a fixed dollar minimum and not compensate amounts below that dollar amount. The trustee's policy should be drafted to clearly articulate whether the trustee will apply dollar-based materiality that way.

Another issue that arises in the implementation of dollar-based materiality is what to do where errors impact more than one option in which a member has invested. Specifically, should amounts for an investor be aggregated across investment options before a fixed dollar minimum is applied?

Where two options have material errors and both disadvantage the member, there is a strong case for combining the amounts before applying the fixed dollar minimum. Aggregation is consistent with the reasons for adopting dollar-based materiality. Furthermore, it does not seem fair for an exited member who lost $19 in option A and $19 in option B to be denied compensation, especially where another exited member who lost $20 in option A will be compensated.

A more difficult issue is whether to aggregate amounts across options where the impact of the error was material in one option and less than 30 basis points in another. This is made more difficult where a member losses in one option and gains in another. For example, an exited member may have lost $20 in option A and gained $1 in option B. As basis point tests for materiality are premised on the degree of precision that can be attained in calculating unit prices, it is arguably more appropriate to disregard a gain or loss attributable to an investment option where the error was not material under the basis point test. The Guide does not go into this level of detail and there may be more than one decision that a trustee can make in the best interests of beneficiaries.

Conclusion

We welcome the regulators' decision to update the Guide to allow trustees to introduce fixed dollar minimums. Further, we anticipate that most trustees will be able reconcile their legal obligations with the adoption of dollar-based materiality.

In some circumstances, there may be a legal basis for trustees to extend dollar-based materiality to fee errors (an issue on which the Guide is unclear), ongoing members and amounts for exited members above $20. Documenting the basis for decisions that are made in implementing dollar-based materiality is the key to ensuring that policies and procedures are robust.

Where, as in most cases, the trustee has outsourced unit pricing, it must be remembered that the strongest legal basis for adopting dollar-based materiality is that it forms part of the outsourcing agreement negotiated with the service provider. Documenting this clearly in the outsourcing agreement can prevent unnecessary disputes and provide a foundation for policies and procedures.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions