Betting On A Sure Thing
Sydney Morning Herald
Wednesday November 29, 2006
The Western Australian public servants who were able to make a quick buck, risk-free and without much effort, due to the slack procedures of their super fund, probably couldn't believe their luck.
Their fund, the WA-based Government Employees Superannuation Board, created a loophole when the accumulation scheme changed from crediting rates to daily unit pricing in November 2004.As with an ATM where no PIN is required, sooner or later word gets out that free money is available. And in this case the word spread quickly. Over about 18 months 171 members, including 15 employees of the fund, raked in $6 million (see story, p11).The money came from the accounts of the 240,000 members in the fund's accumulation scheme. Each of them lost, on average, $28 and would have been none the wiser had the fund not uncovered the abuse in July.Best of all for the ethically-challenged public servants and 15 employees is that their market-timing activities are entirely legal. And there is nothing to stop other members of major funds that have loopholes in the way their units are priced from indulging in the same market-timing abuse.Market timing involves switching from one investment option to another within the fund - from cash to shares or vice versa - after sharemarket volatility, exploiting the fact that the unit pricing will be based on two days prior.The participants have added tens of thousands of dollars to their accounts by exploiting historic pricing. The fund moved to close the loophole as soon as it discovered the problem and will compensate members from its operational risk reserve.The reserve has $77 million in it and is well covered to meet the $6 million that will be repatriated to members' accounts. But that is $6 million no longer in the operational risk reserve to meet future contingencies.The Government Employees Superannuation Board is not alone. The potential for market-timing abuse exists in many major super funds. It occurs when unit prices are calculated using backward or historic pricing, rather than the prices existing at the time that the request to switch investment options is made.The chief executive of the fund, Michele Dolin, says: "In retrospect, it would have been preferable that the whole thing had not happened. People went in looked for ways to arbitrage the process."Hindsight is a wonderful thing. But by applying a bit of foresight the market timing could have been avoided. There is competitive pressure on funds to offer a large number of investment options and the WA fund, like many others, offers its members unlimited free switching between investment options. Most members, if they switch, do so once in a blue moon. It is hard to think of a situation where members need to switch funds more than two or three times a year.Doubtless in a competitive environment it looks good for funds to say to members in their marketing material that they have free unlimited switches. But it is a bit like health insurance policies making a big deal of offering cover against an exotic tropical disease - no one ever needs it. Most members stick to their investment option. One way of reducing the risk of market timing would have been to restrict the number of switches.The WA fund would have been aware that the loophole existed at the time it was created in November 2004, when the accumulation scheme was changed from crediting rates to daily unit pricing. But it is expensive to implement "forward" pricing and the fund believed it had in place adequate safeguards.At this stage, the extent of staff involvement in the trading is unknown. Other examples of market timing in the US have shown that it can be harder to detect if staff are involved.Super funds are for long-term savings and were never intended to be used for trading. Other funds with accumulation schemes that have backward unit pricing should be checking that they have procedures and systems in place to protect members from such abuse.
© 2006 Sydney Morning Herald