Accordingly, there is a fair chance that a beneficiary of the fund might be disappointed with the investment performance of the SMSF where derivatives are used.
The beneficiary could seek to bring an action. The cause of the action could be that the trustee has failed to exercise the requisite degree of care, skill and diligence by holding derivatives not to hedge, but to speculate.
In an SMSF it is unusual for beneficiaries to sue trustees, as they are often one and the same. However, it is possible for a beneficiary to sue a third party (for example, the financial planner) if certain criteria are met (Barnes v Addy (1874) LR 9 Ch App 244, 251-2). One such set of criteria is as follows:
• breach of duty, even if a totally “honest” breach (for example, speculating using derivatives);
• some act of assistance or participation (for example, the financial planner advises regarding the derivatives); and
• knowledge of the breach of the fiduciary duty (for example, the financial planner knows of the derivatives).
We also note that beneficiaries of SMSFs are a very broad class. They include not just members, but also anyone who might one day benefit. This can include members’ children and grandchildren. See Kafataris v Deputy Commissioner of Taxation (2008) 172 FCR 242.
Accordingly, if:
• the financial planner has the trustee of an SMSF as a client; and
• the trustee holds derivatives for anything that might be seen as speculation; then the financial planner is at risk of being sued by a large class of people.
We note that there is some case law that suggests that even if an SMSF makes money through the use of derivatives, if a fully diversified “modern portfolio theory” based investment would have made more money, beneficiaries can sue for the difference. See Re Mulligan (Deceased) [1998] 1 NZLR 481 and Nestle v National Westminster Bank plc [1993] 1 WLR 1260.
It is possible for SMSF trustees to hold derivatives. However, derivatives should only be used conservatively and not for speculative purposes. If a financial planner has a client who wishes to speculate using derivatives, this will expose the financial planner to risk.
Bryce Figot is a senior associate at DBA Lawyers – www.dbalawyers.com.au
Bryce can be contacted at bfigot@dbalawyers.com.au.
