The Cooper Review’s recommendations on changes to the governance of superannuation funds’ boards of directors included fundamental changes to the governance of such funds. In the “industry” sector it recommended the abandonment of mandatory equal employer and member representation, and the imposition of the requirement that one-third of the directors be non-associated (“independent”). It also recommended that a majority of directors in the “retail” sector be independent, although this recommendation has not been at the forefront of recent debate in the run-up to the election. I have serious concerns about these proposals.

Implementing the recommendations in the industry sector will undermine member representation, a key factor enhancing trustees’ ability to address the conflicts of interest inherent in mature superannuation schemes. In addition, the justifications offered for the change offer: a weak, abstract explanation of its necessity; no elucidation of a concrete, measurable goal for the change; and, no persuasive narrative about why independence offers value in the context of superannuation fund governance. Member representation is important in an accumulation superannuation system because it is the members’ money that is being managed and they bear all of the risks. The choice of the trustee form of governance emphasizes the importance of protecting their interests in its fundamental requirement that trustees must manage their money in the members’ best interests and never allow trustee’s interests to conflict with their duties.

The benefits of representation are that it offers a cost-effective means of addressing conflicts of interest in an industry whose primary function is profitable investing of other people’s money. Where there are such conflicts, the governance system in place must ensure they are resolved in favour of those whose assets are invested in the scheme. In addition, representation: offers an alternative motivation to the financial incentives based on short-term performance offered to senior executives in or service providers; provides an antidote to democratic deficit in our important institutions; and offers an avenue through which the interests of plan members in better environmental, social and corporate governance performance can be pursued through the investment activities of superannuation schemes. Conflicts with members’ interests in Australia’s mandatory accumulation scheme reside primarily in their relations with the for-profit advisors and service providers to the scheme every dollar of whose profit reduces the members’ benefits by the same amount. The trustees’ responsibility is to ensure that the return on these expenditures exceeds the cost to the members. Reaching this goal is a much more difficult project in the retail sector, where there are associations between the majority of directors and the service providers. 

The Cooper Review cited the following rationale for equal representation by MP John Dawkins in 1992:

“One of the most important ways in which members are able to participate in the management and protection of their retirement savings is through representation on the board of trustees.”

 The Review then noted that:

• the replacement of single-employer defined benefit by multi-employer accumulation schemes and fund choice meant employer’s legitimate interests and identification with funds was greatly diminished;
• representative trustees were predominately appointed by employer organizations and unions that did not represent everyone in the fund; and,
• the current system left pensioners and non-union members unrepresented.

However, instead of investigating means of enhancing member representation, the Review opted to recommend that non-representative trustees be appointed based on the assertion that having independent directors was the best practice in corporate governance. While recent events at companies with these best practices in place may raise questions about this assertion, the need for independent directors in superannuation can be questioned on another ground.

The Review ignored an important difference between corporations and industry superannuation. In corporate governance, the problem is that shareholders face severe collective action problems in monitoring and disciplining the directors and management through the ballot. In the industry funds, these collective action problems are reduced because representative union organizations have the resources and coordination necessary to protect plan members’ interests in superannuation. To the extent that there is a concern that the union members’ superannuation interests are significantly different from members outside the union, some alternative organization could have been considered before determining that they, and other members are better off with trustees who are completely divorced from them and their representative organizations.

The Review offered no concrete, measurable goal that its proposal for a fundamental governance shift would achieve opting instead for the assertion that an “outside perspective” was vital for the industry funds by providing an “objective assessment of issues”. No illustrations of the failure of industry boards to objectively assess issues were offered, leaving one to wonder how this missing element had manifested itself in the 20 years prior to the Review. Indeed, the fact that industry superannuation funds have consistently out-performed retail funds over a long period of time ought to have raised the question: what is so fundamentally wrong with the governance structure that requires such a large structural change in response?

To summarize my concerns, these non-associated directors, adrift from all but the most formal legal ties to the scheme members, will gravitate towards those with the power of appointment, and be vulnerable to capture by the full-time management of the scheme, through insufficient resources and information to act as any effective constraint on their actions. The lack of a robust system of accountability to members in the Cooper Review recommendations will compound these problems. Similar concerns have been expressed regarding the effectiveness of independent directors in the US mutual fund industry, where directors are legally required to act in the interests of the investors, not the mutual fund company and it managers and independent directors are a majority.  Here again concerns about underperformance are found.

Member representation offers clear benefits in providing a cost-effective means of addressing both external and internal conflicts with the best interests of the members through the solidarity and accountability to the representative organization. In addition, it increases the social legitimacy of an institution vitally important to both present and future well-being of Australians. It also offers the potential for those affected by corporate decisions to add their voice to the factors considered by corporate directors through the exercise of the corporate governance levers that accompany substantial share ownership. The case has not been made for such a substantial change, neither in the Cooper Review nor the evidence about independent director effectiveness in similar settings. As a tool of corporate governance it is designed to address a problem that is not present in the industry funds. Reconsideration and further study seem more appropriate than immediate implementation.

Dr Davis was a participant in a workshop on Independence and Accountability in Superannuation jointly hosted by ASFA, Herbert Smith Freehills and the Centre for Law Markets and Regulation, UNSW Law.