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FINANCE PORTFOLIO COMMITTEE
31 JULY 2007
FAIS OMBUD DETERMINATION IN COMRIE MATTER: FINANCIAL SERVICES BOARD BRIEFING
Chairperson: Mr N Nene (ANC)
Documents handed out:
Financial Advisory and Intermediary Services Act (Act 37 of 2002)
Financial Services Board (FSB) presentation
Ombud for Financial Services Providers website
The Financial Services Board was asked to give a briefing about the Financial Advisory and Intermediary Services (FAIS) Ombud determination in the Comrie matter where the Ombud had ruled that a financial advisor must pay back the complainant the investment that had been lost. The financial advisor had since claimed that since the Ombud had in his determination criticised the FSB for granting an exemption to Leaderguard Spot Forex, the FSB should, therefore, be held liable for the loss. The FSB presentation focussed on the FAIS legislation and the registration of financial service providers.
The FSB talked about the status of applications of financial service providers up to the implementation of the FAIS Act as well as the recognised bodies which were being used by the FSB to assist them in processing applications. The exemption of applicants and the process of their licensing were discussed. The role of Mr Chris de la Guerre was discussed and the conflict of interest that had arisen given his role.
Questions focussed on what recourse victims had who lost money during this process. Committee members wanted clarification on the application process and the capacity of the FSB to manage this process. Questions related to the blanked exemption given by Section 44(1) were discussed as well as the different legal opinions of the FSB and the Ombud.
Financial Services Board (FSB) presentation
Mr Ron Barrow, FSB Executive Officer, gave a briefing on the FAIS legislation and the registration of financial service providers. This had been developed because it was recognised in the past that non regulation of financial intermediaries was a major gap in the regulatory structures when benchmarked against international standards.
The FAIS legislation had intended not to cause major disruption in the distribution chain of financial products and also aimed not to inhibit entrepreneurialism. The FSB had anticipated in excess of 15 000 applications and had made an effort to encourage early applications. It had been anticipated that a large number of applications would be received just before the cut-off date, and thus section 44(1) was incorporated to provide exemption to financial service providers. Section 44(1) aimed to cater for the huge number of applications that could not be processed before the law became effective. If Section 44(1) had not been introduced, a large number of intermediary businesses would have had to stop operating.
Mr Gerry Anderson (Deputy Executive Officer) continued the presentation looking at the status of applications of financial service providers up to the implementation of the FAIS Act. The application window had opened on October 2003 and closed on 30 September 2004. Only 3 000 applications had been processed by the end of September 2004. By the beginning of 2007 applications from September 2004 were still being processed.
Mr Anderson also focused on the recognised body concept. Recognised bodies were being used by the FSB to assist them in processing applications. The FAIS Act enabled the use of these recognised bodies. They assisted the regulator in developing the framework for foreign investment applicants. The recognised bodies assisted the FSB in analysing and perusing applications but they had no decision-making powers.
Mr Anderson explained that there was no regulation before the FAIS legislation. The principal regulators were the FSB, Department of Trade and Industry (DTI) and the Registrar of Banks who consulted with each other as to where forex trading providers should fit in. It was agreed that forex traders were akin to normal investment managers and that the FAIS Act would be the place to bring them into the regulatory framework. A Forex Investment Association (FIA) had been developed by the industry as well as a code of conduct for forex investment providers.
Mr Anderson indicated that Chris de la Guerre became known to the FSB as the Chief Executive Officer of the FIA and at that time FSB did not know he was connected to Leader Guard Securities.
The Chairperson said that some organisations took advantage of the exemptions. He asked the FSB to what would they attribute the unfortunate debacle where people had lost money. He asked what the chances were that the victims would be compensated. What was the cause of organisations abusing the exemptions?
Mr Barrow said that that the unfortunate debacle could be attributed to the greed of the people operating schemes. The majority of Leader Guard Securities money was taken from the public before the FAIS legislation came into operation.
Mr Barrow said that the money had gone to Mauritius and was then forwarded onto international foreign exchange traders. It appeared as if the money was lost in bad trading. Commissions and administrative costs paid to intermediaries were higher than normal and that the operators were looking after themselves.
Mr K Moloto (ANC) asked if the FSB would make an effort to trace or recover the moneys lost in the legal debacle.
Mr Fanie Rossouw said that there were two companies who were being investigated, Leader Guard Securities (South Africa) and Leader Guard Forex (Mauritius). There were two liquidators who were trying to recover money. The Mauritian investigators have been recognised within SA and have led an investigation within SA. The focus of investigations would be looking at auditors and principal members including directors and would use remedies available in terms of the Companies Act to recover money lost through reckless trading.
Mr Maloto asked if the FSB investigated what had happened especially with regard to their internal processes. Did the FSB use some of the remedies within the FAIS Act to recover the money? He also asked whether the FSB interacted with Leader Guard Securities before declining their application and what the nature of their discussion was. What were the reasons for declining the Leader Guard Securities application.
Mr Rossouw focussed on Section 33 and the remedies available to Registrar. He said that the Registrar did consider remedies when it received the inspection report. In terms of the administrative process the registrar listed all remedies and then send this out to all brokers involved asking for their comments. Section 33 was framed in such a way that the Registrar could institute a class action to recover money. Every case need to be scrutinised on a case by case level to determine if money lost was as a result of advice or whether it was as a result of fraudulent action by an organisation.
Mr Maloto asked if the FSB interacted with the Mauritian regulator when they received the application of the Leader Guard Securities, given that they were a marketing arm of a company in Mauritius. Did the FSB interact with Leader Guard Securities only afterwards?
Mr Anderson indicated that there was interaction prior to declining the application with the Mauritian regulators. He did not have the information on him that Mr Maloto asked for. He could not say offhand what the content of the interaction with the Mauritian authorities was. Mr Barrow said that even if the Mauritian authorities brought it to the attention of the FSB, it would have occurred during the lead up to the declining of Leader Guard’s application. It would have only have confirmed the necessity to decline the application. The only time that it would have been considered would have been when the licence application was considered.
Mr Anderson indicated that the application of Leader Guard Securities was received on 29 September 2004. The FSB scrutinised every application and after the FSB process the applications ended up with the licensing committee. There were many interactions in writing with Leader Guard Securities during the scrutiny process up to the point where the decision was taken to decline the licence. Interaction took place with their management in correspondence and meetings and there was documentation of these interactions. Although Leader Guard Securities indicated that they intended to change their modus operandi, the FSB was not satisfied and also felt that Leader Guard Securities did not comply with the forex code of conduct. Mr Anderson said that the whole structure of Leader Guard Securities fell outside of what was put in place for investor protection. Questions of solvency were also picked up the FSB. Prior to Leader Guard Securities filing for liquidation, the FSB declined their application.
Mr Anderson said that the FSB had asked one of the big five firms to investigate Leader Guard Securities. The investigation took place over many months whereafter a comprehensive report was given to the FSB. Due to the content of the report, the FSB handed the report over to the National Prosecuting Authority to take action against Leader Guard Securities
Dr G Woods (IFP) was not sure if Section 44(1) was included in the explanatory memorandum of the legislation. He indicated that the Act made mention of a blanket exemption which was a discretion which, when exercised, could have undermined the central tenets of the Act.
Mr Barrow said that he did not know whether the interpretation of 44 (1) was included in the explanatory memorandum of the legislation but could get that information for the Committee.
Dr Woods also said that thousands of applications that had to be dealt with on a case by case basis had resulted in a crisis situation. He wanted to know from the FSB how they approached the crisis situation and dealt with the applications on a case by case basis. Dr Woods also wanted to know if all applications had now been processed.
Mr Anderson said that 15 000 applications had been expected but that applications were still coming in to the FSB. Just under 17 000 applications had been submitted of which 16 350 had been scrutinised. Applications were being processed as fast as possible.
Mr Anderson said that the FSB foresaw that they would have a bottleneck with the application process and therefore they had used recognised bodies to assist. Ten recognised bodies assisted the FSB in the application process.
Dr Woods said that his understanding was that Chris de la Guerre was a compliance officer and a director of Leader Guard Securities. He wanted clarification from the FSB because it seemed to him that they indicated that Chris de la Guerre was not a compliance officer and a director of the Leader Guard Securities.
Mr Anderson replied that it only came to the attention of the FSB that Chris de la Guerre had a different role when they scrutinised the application. Representative bodies like the FIA were usually made up of people who came from the industry. The FSB had interaction with him until the publication of the code of conduct.
In a follow up question Mr Maloto indicated that on 2 July 2003 Leader Guard Securities was already having problems with the Mauritian regulator and it had been instructed to cease trading. He asked if that did not ring a bell with the FSB and how they could allow the situation to reach such a stage without intervening - if there were already problems.
Mr Maloto noted that the FSB had said that, in terms of Section 33, proper legal consideration had to be made on this matter. In terms of the FSB response, a legal consideration had not yet been made and he asked why it had not been made.
Mr Rossouw responded that any action that the Registrar would institute had to be proved in a court of law. He said that it is not an administrative but a court action. Brokers would need to be individually scrutinised to determine if the requirements of Section 33 could be met.
Mr Rossouw said that from the beginning of 2004 trading losses were made by the traders who started to churn and they produced fraudulent benefit statements to clients. Fraud was committed by individuals within Leader Guard Securities which was another action which was not pursuant to the contravention of the FAIS Act. Mr Rossouw indicated that as the administrative process of scrutinising individual brokers was unfolding to, appropriate action could be taken, whether it be administrative, or in terms of Section 33.
Mr Rossouw said that 210 individual brokers were inspected. He referred to 92 brokers who advised their clients to invest prior to 2004 when the Act was instituted. Some brokers also invested their own funds. There could not be court action against these 92 brokers because the Act only came into operation after these brokers had given their advice.
Mr S Marais (DA) asked what the procedures were in place to follow the activities of the organisations which were exempted during the window period up to the date of the final declining of their application. Were there intervention measures to stop the activities of organisations? Were there procedures to detect if there was a conflict of interest? If not, what was being done to rectify that?
Mr D Gibson (DA) said that Section 44 was there as a type of rubbish basket for the applications that the board was not going to consider timeously. He asked if in retrospect the problem was that the Minister was wrongly advised regarding the cut-off date. Mr Gibson said that his impression was that the timetables were not realistic and that estimates of work to be done had been out by 40%.
Mr Barrow replied that if the implementation date had been delayed then those applicants who would have been approved, would have been outside the regulator net. A large number of applications had taken a long time to process because the standard of the applications was poor. A lot of time was spent getting more information by the FSB.
Mr Gibson said that the Ombud reported that the savings of the South African public were consistently exploited not withstanding the regulatory framework. The ordinary members of the public were entitled to think that there would be protection for them. He asked if there was provision for the Board to re-look at applications that might have been approved in haste.
Mr Barrow replied that the process has been thorough and that there were compliance reports and ongoing supervision of applicants. If the FSB became aware that information supplied in an application was incorrect, they would react
Mr B Mguni (ANC) asked for clarification about the conflict of interest of Mr de la Geurre who exploited the situation created by the exemption. He felt that the FSB did not properly regulate. He agreed with the Ombud’s view that Section 44 needed to be reconsidered.
Mr Barrow indicated that the delegated bodies might have made recommendations and they had helped with processing, but the FSB took the decisions. He said that applications went through a rigorous process and the FSB were properly doing their job. Mr Anderson said the FSB went through a rigorous process and that over 8% or over 1 000 applications had been declined at the initial step.
Mr Nene asked if the FSB had raised the issue of capacity and the call for assistance by recognised bodies. He asked for any documentation to help the Committee understand the role of the recognised bodies.
Mr Anderson said that a lack of capacity was not raised. He said it was realised at an early stage that the FSB would make use of the capacity of the recognised bodies. A lack of capacity was raised regarding ongoing supervision. Many tools were in place to address this issue. The challenges were greater when one dealt with the volumes of entities. Risk based supervision was adopted by the FSB to deal with this issue. Compliance visits were made to companies and annual financial and compliance reports were also required.
Mr Y Bhamjee (ANC) said that anyone investigated would leave a paper trail. He asked why a forensic audit was brought on board and if it was available for public scrutiny. The Committee would want to look at the forensic audit.
Mr Barrow said that the forensic report was not available to the public but only to government organisations.
The Chairperson formally requested Mr Barrow to supply the forensic report to the Committee and Mr Barrow indicated that he would do so.
Mr Bhamjee asked if systems were in place at the FSB to ensure that the institutions maintained credibility within the South African economic arena. He asked the FSB if any weaknesses had been identified in their processes.
Mr Anderson replied that with the implementation of the FAIS Act, weaknesses had been identified and lessons had been learnt. Certain amendments were proposed. For instance the Act requires that any material irregularities must be reported to the Auditor. The amendment to that Act would be considered by the Committee later during 2007. The compliance officer would also then be required to report any material irregularities.
Mr Maloto said that the two legal opinions were not helping him to understand the issues and implications. When he read the FAIS Act it seemed to him that the determination of the FAIS Ombud should be regarded as a court order and challenging a court order raised serious issues. According to the FAIS Ombud determination on 3 October 2003, the FSB issued a form which indicated that the Registrar would consider a special exemption on a case by case basis. He asked the FSB if they received applications for special exemption and what had changed their mind to go for a blanket exemption as opposed to a special exemption. What had been the FSB’s original intention as to when the special exemption was issued.
Mr Barrow said that the FSB did not have the right to take a finding on appeal. He said it was a matter between Comrie and the Union Trust. The FSB were named in the determination but that did not give them the right to challenge the determination in court.
Mr Maloto asked if the mandate given to one of the big five for the forensic audit was explicit.
Mr Barrow indicated that Ernst & Young had been commissioned by the FSB to do an inspection on Leader Guard Securities. A comprehensive inspection report was submitted to the Registrar. By the time Ernst & Young did the inspection, the money were gone. The company was put up for liquidation and it was the liquidator's duty to follow up and recover money. He did not know if money would be recovered but he thought that the possibility of recovery was remote.
Mr Maloto asked if the FSB had double checked the shareholding of Leader Guard Securities. He noted that Leader Guard Securities did not attach company resolutions and financial statements with their application. He asked if that did not ring an alarm bell and motivate the FSB to take action against Leader Guard Securities. It took the FSB six months to come to a resolution.
Dr Woods said that there seemed to be three perspectives about Section 41. The first one was from the Ombud who said that Parliament did not intend blanket exemptions to be granted. The legal opinion of the FSB indicated that the Section did not prevent an exemption. Mr Barrows argued that the Section did in fact intend a blanket exemption. He wanted to know how Mr Barrows came to his interpretation. Dr Woods said that he could not see after reading the Section how a blanket exemption would be possible.
Mr Anderson said that a part of the application form was intended for those circumstances where the applicant could not meet the requirements and where there was a justifiable reason for exemption. Epilepsy South Africa was for instance exempted from paying the prescribed application fee for its licence. A number of generic exemption were allowed. There might have been cases where a particular applicant wanted a particular exemption.
Dr Woods noted that about 8 000 of the applications went through outside bodies. He said that there was a danger when people within an industry processed their colleagues' applications. There was a possible conflict of interest. He asked what regulatory guidelines informed this process.
Mr Gibson asked for further clarification on the outside recognised bodies which assisted the FSB. He said that these bodies did have some decision-making power given that they could decide that they were not going to throw out an application. If the FSB had looked at the application at the initial stage it would have immediately chucked out the application.
Mr Anderson said that the FAIS Act enabled the FSB to delegate functions to recognised bodies.
Mr S Asiya (ANC) said that it was the role of the Committee to focus on matters relating to the vulnerable. He felt that there had not been an adequate responses or assistance from the FSB to help the Committee in the protection of the vulnerable.
Mr Mguni wanted to hear further legal opinion given that the credibility of the Ombud had been damaged by the remarks of the FSB. He indicated that the legal opinion said that the Ombud had acted outside his regulatory framework. What legal recourse did the victims have to recoup their money?
Mr Barrow replied that the determination with regard to the liability of the Union Trust in the Comrie matter was under appeal at the FSB Appeal Board. The party had the right to appeal but the FSB did not have a right to appeal. With regard to other legal recourse, they have a right to claim against the insolvent estate of the South African entity of Leader Guard Securities and the Mauritius one.
Mr Barrow said that affected parties could take action against the intermediaries who introduced them to Leader Guard Securities on the basis that the intermediary had not performed their functions properly.
Mr Rossouw said that the FAIS Act provided that the Ombud could make a ruling to provide for compensation to a victim who had lost money. Victims who can hold the broker liable for negligence, could use the inexpensive procedure provided for in the FAIS Act.
Mr Mguni asked, without considering Section 44(1), what preventative measure could be put in place to ensure that the same situation did not occur.
Mr Anderson replied that Section 44(1) fell away after September 2004. Section 44(1) could not come into operation again after September 2004.
Mr Asiya requested that when the FSB provided the Committee with the forensic audit that they should also indicate what they had asked the forensic auditors to check on. He asked the FSB to comment on what was currently happening with the case. Mr Barrow indicated that they would do that.
Advocate Koleka Beja (Parliamentary Legal Advisor) commented that the Registrar had acted within the FAIS Act when he granted the blanket exemption.
Mr Bhamjee asked why two respected institutions should be at loggerheads. Such institutions should talk to each other rather than talking past each other.
Mr Gibson asked whether Senior Council’s opinion has been submitted to the Ombud and whether he got the opportunity to comment.
Mr Barrow replied that he met had with the Ombud on a number of occasions and that they were putting in place protocols to ensure proper communication.
The Chairperson thanked the FSB for their input.
The meeting was adjourned.