FSB passes the buck on Ponzi scams

PF 24Nov pg1 update3 IOL PF Illustration: Colin Daniel

The Financial Services Board (FSB) claims it is not the watchdog responsible for protecting you from scam Ponzi and pyramid investment schemes – and it also claims it is mainly the greedy rich who fall prey to scamsters.

The claims were made this week when the FSB was put on the carpet by the parliamentary finance committee against a background of ongoing scams and imploding so-called investment schemes in which billions of rands have been lost by investors, many of whom are pensioners.

The losses have been in everything from property syndications to unlisted share scams and structures that give the appearance of being regulated entities.

Even where there is regulation, the unscrupulous seem to slip past the eyes of the FSB. For example, there have been two significant cases in recent years of registered financial services providers managing to market illegal and unregistered money market funds.

And in replies to questions in Parliament, it is clear that the licences of errant financial services providers are often removed only when schemes have started to implode. For example, only five licences of property syndication companies have been withdrawn, and then only when they were already in a state of collapse.

Numerous determinations by the financial advice ombud, Noluntu Bam, have revealed that often the sales representatives of the property syndication companies were independent financial services providers who were not authorised or qualified to sell debentures or shares of these types of companies in their own capacity.

The syndication companies sidestepped the problem by simply appointing the representatives, knowing they did not have the qualifications. But there is no evidence that the FSB took action against these financial services providers.

On top of this, the FSB has kept no comprehensive record of determinations by the financial advice ombud for the almost 10 years of the ombud’s existence and is unable to say what action, if any, it has taken against financial services providers and/or their representatives who have been the subject of determinations by the ombud.

Since its establishment in 2004, the office of the ombud has handed down more than 200 determinations, mainly for contraventions of the code of conduct by which financial services providers and their representatives must abide in terms of the Financial Advisory and Intermediary Services Act. Thousands more complaints have been settled by agreements between the parties.

In total, more than R165 million has been ordered to be paid to investors or agreed on in settlements, with many cases involving scams or high-risk investments.

Over the past two years, the FSB’s administrative justice system, its Enforcement Committee, has made 12 orders against people who have contravened the code of conduct and certain board notices. The Enforcement Committee issued fines amounting to R770 000.

The FSB’s chief executive, Dube Tshidi, told the parliamentary finance committee this week that, currently, the responsibility for protecting the public against most of these scams lies mainly with the South African Reserve Bank in applying the Banks Act and the Department of Trade and Industry in enforcing the Consumer Protection Act and its regulations.

Most of the property syndication schemes that are imploding, resulting in losses of billions of rands for investors, are Ponzi schemes in terms of the FSB definition provided to the parliamentary committee (see “Where investors’ ‘returns’ are paid from capital ...”, below).

Tshidi, however, concedes that the FSB could do more to bring to book financial services providers who sell dud products.

Parliamentarians were annoyed by the FSB presentation, saying the FSB should have come to Parliament to tell the finance committee where there were gaps in existing legislation and what could be done to stop the ongoing incidence of scams rather than making excuses for why it has not taken action.

Tshidi replied that there can never be enough legislation, because people with the intention to defraud investors will always find their way around the law.

He says it will be easier to control scams when the new “twin peaks” management of South Africa’s financial sector comes into operation, with all market conduct regulation concentrated through one door, which will be controlled by the FSB.

But he says, in the end, the main way to halt scamsters is to increase financial literacy in South Africa.

Tshidi says the FSB has already embarked on a two-pronged approach: educating children at school in co-operation with the education authorities, and educating adults through various initiatives, such as through the South African Council of Churches.

Members of the parliamentary committee now want the FSB, the Reserve Bank and the Department of Trade and Industry to go to Parliament together to explain which entity is responsible for acting on investment scams and what they need to do to plug the gaps.

Tshidi says the other problem is that, apart from collective investment schemes, investment products in South Africa are not regulated. The question, he says, is whether they should be, with the regulators approving or rejecting products before they are brought onto the market.

Regulator ‘didn’t have power’ to act on complaints about Abante

The potential loss of R770 million in the collapse of the Abante Relative Value Arbitrage Fund – a Ponzi scheme operated by Herman Pretorius, who shot himself in July after killing a former partner, Julian Williams – sparked this week’s special hearing of the parliamentary finance committee.

Nick Koornhof, a Cope Member of Parliament, initiated the hearing, at which the Financial Services Board (FSB) was asked to account for how it had handled the issue. (Personal Finance had referred complaints about the scheme to the FSB more than a year before it collapsed.)

Gerry Anderson, the FSB’s deputy executive in charge of market conduct, repeated his earlier claims that the FSB did not have the authority to take action because the Abante structure was in a trust, and the FSB does not regulate products, apart from collective investment schemes.

Both he and chief executive Dube Tshidi said that the current FSB investigation into the Abante scam is essentially to find out what happened.

They say that where deposits are being taken by a scheme sponsor, as in the case of Abante and other pyramid schemes, and returns are, in effect, being paid from those deposits, it becomes a matter for the South African Reserve Bank.

No evidence was given to the committee about:

* Whether the FSB referred the matter to the joint committee of regulators to establish whether a matter might be the terrain of another regulator or where something may be falling between regulators; and

* Why – if, as the FSB has claimed, the Abante scheme was masquerading as a hedge fund and a collective investment scheme – it did not take action as it did against the now defunct Dynamic Wealth. Some years ago, Dynamic Wealth sold “investment clubs” that contravened the Collective Investment Schemes Control Act because they were marketed as products that pooled the investments of investors. In the Dynamic Wealth case, the FSB took years to take action, despite Personal Finance repeatedly raising the issue, and it did so only when promises to investors were not met.

Where investors’ ‘returns’ are paid from their capital …

A Ponzi scheme is a fraudulent operation that pays returns to its “investors” from their own money or the money paid by subsequent “investors”, rather than from profit earned from their “investments”, says Gerry Anderson, Financial Services Board (FSB) deputy executive in charge of market conduct.

This would cover investment schemes as diverse as the recently collapsed Abante Relative Value Arbitrage Fund through to most property syndications where investors are paid returns initially from either their own capital or that of others.

FSB chief executive Dube Tshidi says that Ponzi scheme operators entice investors by:

* Offering higher returns than genuine investments, with the returns being earned in a short period;

* Relying mainly on word of mouth, with the first people recruited being promised better returns if they recruit others; and

* Using confidentiality agreements and legal structures, such as trusts, to hide the details of schemes from regulators.

Tshidi says victims are likely to be:

* All members of an extended family, with one family member selling to others in the family.

* Affinity groups, such as church communities. Tshidi says that there is a particular problem in churches, with some churches even operating unlicensed funeral insurance schemes that eventually collapse. He says Herman Pretorius, who operated the collapsed Abante Fund, was a church elder who used his position to sell his Ponzi scheme.

* Greedy, well-off individuals. Tshidi says most victims tend to be the better off, and they fall for the schemes because they “are simply greedy”. He says this was obvious with the Tannenbaum scheme, which collapsed in 2009 leaving many of South Africa’s wealthiest captains of industry and commerce with red faces. Further evidence is that one person invested R9 million in the Abante scheme. He says poorer people such as pensioners, who have to rely entirely on a pension, mostly do not have discretionary funds to invest.

* Pensioners. Tshidi says pensioners are targeted because they often have insufficient money to maintain themselves and are lured by the promises of higher incomes.

Scheme that bust banks

Ponzi schemes are named after Charles Ponzi, an Italian who emigrated to Canada and then the United States. Ponzi did not invent the structure of the scheme, but his multi-million-dollar scam was so extensive that the structure has borne his name ever since. In 1919, Ponzi started offering investors huge profits by purchasing international reply coupons from other countries and redeeming them in the US for postage stamps at a better value. An ever-growing flow of new clients allowed him to pay existing investors from the money of new investors, while he pocketed millions of dollars himself. Ponzi’s scheme eventually collapsed, bringing down six banks with it.


sign up