Issue: April/May 2007
Editorials

THE BIG ISSUE

Infidelity at Fidentia

It raises a host of regulatory issues, largely to do with capacity. While a fistful of civil actions and criminal charges beckon, the obvious question is how similar debacles can be avoided. An obvious suggestion is that widows and orphans of deceased pension fund members are afforded the protection of the Pension Funds Act.

Turn it whichever way one wants, and at the end of the day there’s a fact beyond dispute about Fidentia. It’s that, at month-end, there’s insufficient cash for the widows and orphans of deceased Mineworkers Provident Fund (MPF) members to be paid the benefits due to them.

From this fact, consequences flow. Forget, for a moment, the possible interest conflicts and cosy in-house arrangements between Fidentia (a financial institution, now under curatorship) and Living Hands (an umbrella trust company owned by Fidentia), which arises from Fidentia’s operations as an investment manager handling monies placed in trust by the MPF at Living Hands.

Forget, also for the time being, the arguments about whether monies have been misappropriated and assume for present purposes that every cent can be properly accounted for. Forget, too, the apportionment of blame because this will emerge in the acrimonious fallout of civil suits and counter-suits sure to come.

The indisputable fact of beneficiaries not being paid means, on the most benign construction, that the funds placed on their behalf were not invested with the due care that ensures sufficient liquidity for the payout of benefits. This flies in the face of the 2001 Financial Institutions (Protection of Funds) Act, which provides:

A director, member, partner, official, employee or agent of a financial institution or of a nominee company who invests, holds, keeps in safe custody, controls, administers or alienates any funds of the financial institution or any trust property

  • Must, with regard to such funds, observe the utmost good faith and exercise proper care and diligence;
  • Must, with regard to the trust property . . . observe the utmost good faith and exercise the due care and diligence required of a trustee in the exercise or discharge of his or her powers and duties; and
  • May not alienate, invest . . . or otherwise encumber or make use of the funds or trust property . . . in a manner calculated to gain directly or indirectly any improper advantage for himself or herself or for any other person to the prejudice of the...principal concerned.

To do otherwise is criminal:

  • A person who contravenes or fails to comply with any provision of this Act is guilty of an offence and on conviction liable to a fine or imprisonment for a period not exceeding 15 years;
  • A court may in addition . . . order that such person pay the institution or principal concerned any profit he or she made, and compensate the institution or principal concerned for any damage suffered as a result of such contravention or failure.

This is clear as daylight, leaving nothing between the cracks. On the issues of “good faith” and “due care” alone, it obviously leaves Fidentia directors and Living Hands trustees with a case to answer. In particular, those who served as both directors and trustees need to explain the objective criteria by which the investment management of assets under Living Hands was switched from Old Mutual to Fidentia. Unfortunately for the widows and orphans, however, neither guilty individuals rotting in jail nor being bankrupted by compensation payments might be adequate to restore their benefits.

The Financial Services Board (FSB), having put Fidentia under curatorship, is calling for additional regulatory powers. Whether these will help is another matter. There are all sorts of measures to prevent all sorts of criminal activity, such as armed robbery and car hijacking, which are ineffectual if the relevant authorities lack the capacity for enforcement.

The question is not whether the FSB lacks supervisory power, under the common law and the plethora of legislation supposed to offer investor protection, but whether it lacks capacity: from the outset, to properly scrutinise and licence applicants for their fitness and propriety to run financial institutions; then, to monitor their fitness and propriety on an ongoing basis as the Financial Advisory & Intermediary Services Act requires.

It falls apart when a Fidentia comes along. In its previous incarnation, Living Hands (then known as Matco) was one of the largest and most reputable trust companies in the land. Bought from Mercantile Bank in a management buyout, it was later onsold to little-known Fidentia, whose kingpin is acertain J Arthur Brown.

As explained by Fairheads Trust marketing director Giselle Gould elsewhere in this TT edition, the mechanics of moving from one trust administrator to another are inordinately difficult. Trustees of retirement funds normally decide on the appointment of a trust administrator for regular payment of benefits to widows and orphans of deceased fund members.

Once this appointment is made, and the financial entitlements of deceased fund members’ beneficiaries are transferred in lump sums to the trust administrator, responsibility for regular benefit payments from the lump sums passes from the retirement fund trustees to the trust’s trustees. Fidentia highlights several difficulties with this arrangement:

  • Fund trustees’ duty of care is in their selection of the trust administrator, and in their ongoing monitoring of its performance. If the fund trustees (in this case, the MPF) were remiss in these duties, they can be sued by the estate (practically, the curator on behalf of beneficiaries);
  • The Pension Funds Act requires that fund trustees carry professional indemnity insurance. From this source, there could be monies for recovery provided it’s accepted that the MPF trustees had actually acted negligently. Should they and the insurer dispute it, there’s the probability of litigation, whose costs would ultimately be borne by the widows and orphans;
  • Trustees of umbrella trusts, such as Living Hands, do not by law require indemnity insurance. Without such insurance, suing them in their personal capacities (again, at a cost to the widows and orphans) is unlikely to recover anything equivalent to the full amounts owed the beneficiaries;
  • Living Hands trustees owed a duty of care to the beneficiaries. Where there’s a conflict of interest, as by Fidentia owning Living Hands and managing the assets of beneficiaries entrusted to it, this duty is ostensibly compromised. Yet it hardly helps a civil remedy. Were the assets fully accounted for, but so illiquid that they cannot readily be turned to cash, beneficiaries might still have to wait years for their money.

Then there’s a regulatory issue. Trusts are regulated by the Trust Property Control Act, for which there is no regulatory body. They simply report to the Master of the High Court. For their part, retirement funds and asset managers fall under the FSB. So, once benefits are outsourced by a fund to a trust, the capital in the trust is removed from FSB oversight and the beneficiaries from Pension Funds Act protection.

Is there an obvious reason? No, according to two determinations by the Pension Funds Adjudicator.

In the 2004 complaint of Ramanyelo against the MPF, adjudicator Vuyani Ngalwana held that there was a “very onerous duty” on trustees of the fund to “carefully consider the facts of each case before depriving the guardian of the right to administer the monies on behalf of his/her minor child”. In this matter, the approach of the MPF board left “much to be desired”. It had “fettered its discretion by adopting a rigid policy” of placing the death benefit in a trust “regardless of the abilities of the guardians to handle such monies”.

He set aside the MPF board’s decision to place the death benefit in a trust and directed it to “re-exercise its discretion” on whether the guardian should be deprived of the right to administer the monies.

In the 2002 complaint of Lukhozi against Saccawu National Provident Fund and Syfrets Trust, part of Nedcor, then adjudicator John Murphy calculated that expenses represented 7,6 percent of capital paid into the trust. “Expenses in relation to the capital benefit far outweigh the advantages of placing the benefit in a trust arrangement,” he held. “It would have been more appropriate to either award the benefit to the guardian in her personal capacity or alternatively pay the guardian monthly instalments, thereby not incurring the excessive expenses.”

Saccawu had submitted that it didn’t have the capability or accounting facilities to administer the monies as part of its provident fund. Murphy was scornful. One need only state these reasons, he said, to show that the board of the Saccawu fund had breached its fiduciary duties:

“The mere fact that the fund does not have the necessary accounting structures or administrative arrangements to pay a benefit . . . does not in law provide a ground to deny a beneficiary this mode of payment (by opening an account on behalf of the beneficiaries). The fund could easily have held these monies in its own portfolios or invested them in a money market fund of its choice, and paid the benefits to the beneficiaries on an instalment basis.”

That the MPF trustees appear not to have acted in a manner consistent with the Ramanyelo and Lukhozi determinations, by having automatically placed lump sums with Living Hands, opens a whole new line of inquiry and of possible recourse against them. It also opens a whole new public policy debate on how those least able to help themselves are brought within the protective scope of the Pensions Funds Act.

Among these protections are:

  • Direct accountability to beneficiaries by fund trustees (who are obliged to carry fidelity insurance);
  • The prudential requirements of Regulation 28, which limits the proportion of investments in such illiquid assets as real estate and private businesses (for example, in the case of Fidentia, a health spa). The regulation also places responsibility squarely in the hands of fund trustees for formulating and monitoring investment strategies;
  • Right of complaint to the Adjudicator;
  • Oversight by the FSB as the regulatory authority.

The simplest solution for application of the Act, understood already to be floating at National Treasury, is perhaps for retirement funds to hold the lump sums themselves but buy the services of benefit administrators in the same way that they engage other service providers. In other words, up for consideration is whether fund trustees shouldn’t contract with, say, a specialist trust company (to trace beneficiaries and administer regular payments) rather than abdicate their responsibilities to outside trustees.

The beneficiaries ultimately pay, as they always do, one way or another. The best way is better protection at lower cost, one way or another.

WHAT THE FSB FOUND

Acting on information from a whistleblower, last June the FSB promptly launched an investigation into the affairs of Fidentia group companies including Fidentia Asset Management (FAM). The inspectors’ final report was completed in January, whereupon the FSB applied for curatorship. According to FSB executive officer Gerry Anderson in his founding affidavit:

  • FAM’s operating licence under the Financial Advisory & Intermediary Services Act restricted FAM from rendering discretionary intermediary financial services over shares in private companies;
  • More than 13 months after FAM’s audit began for the February 2005 financial year-end, its audited financial statements were still outstanding and the auditors were unable to issue a report to the Registrar confirming that client funds (trust monies held by FAM) were properly accounted for and segregated from its business assets;
  • The inspectors were unable to obtain records from FAM pertaining to client funds and were unable to reconcile all client funds received to investments allegedly made on behalf of clients by FAM;
  • No records were received from FAM that comply with basic accounting principles. It was “inexcusable” that by early 2007 FAM was unable to produce proper accounting records that should have been produced monthly since September 2004 or to submit audited financial statements that were due by August 2005;
  • The inspectors concluded that the client funds, unaccounted for by FAM, amounted to R689 million. They believed that these funds had been used for disbursements and misappropriations by the Fidentia group as well as the purchase of other assets not disclosed as part of the client portfolio;
  • At end-August last year, FAM had R135 million cash at hand. By the beginning of November, this had dwindled to R14 million. While FAM has a R10 million monthly obligation to Living Hands, a FAM client that in turn has to pay pension beneficiaries, FAM used these monies to fund its operations.