Ecsponent Financial Services and the financial advisers in its distribution network face “substantial” enforcement action from the Financial Sector Conduct Authority (FSCA) for marketing Ecsponent’s high-risk preference shares to pensioners, who make up a large portion of the investors who stand to lose their money in the embattled Pretoria-based financial services and private equity group.
In a Sens announcement last week, Ecsponent said it would default on its R188.3-million preference-share payment obligations due in March.
The advisers had aggressively marketed Ecsponent’s preference shares as safe, income-generating investments to retirees, many of whom used the monthly payouts to supplement their pensions. The investments paid returns of up to 12.5% a year.
Preference shares are superior to ordinary shares in that they pay investors fixed dividends. But, like ordinary shares, they are high-risk, and are only as good as the company issuing them. Preference shares are more senior than ordinary shares but more junior than loans provided by banks in terms of claims on a company’s assets in the event of liquidation. Investors have more than R2 billion invested.
Ecsponent says that, technically, there hasn’t been a default yet. “A default will only happen on the actual date for the payment scheduled in March. Ecsponent Limited’s Sens announcement Friday, 21 February 2020 did confirm that it will not be in a position to pay the dividend obligations due in March 2020.”
Ecsponent said it is currently exploring several options relating to capital restructuring and alternative forms of funding. "The options under consideration are: changing the terms and conditions of the current classes of preference shares to match the returns expected to be generated from the current asset base in Ecsponent’s portfolio; providing preference shareholders the opportunity to convert their preference shares into a new class of preference share, the returns profile of which will be structured to match the returns expected to be generated from the current asset base in Ecsponent’s portfolio; or converting all preference shares to ordinary shares, listed on the JSE.”
The group's ordinary JSE-listed shares fell to just 2c last week.
Gerhard van Deventer, the head of investigations at the FSCA, says it launched an investigation into Ecsponent Financial Services’ marketing of preference shares some time back.
“Every financial services provider is expected to do suitability testing when they advise on products,” Van Deventer says. “The question is whether the risk of the product matches your risk appetite.”
He says selling high-risk products to pensioners sets off alarm bells, and the FSCA had picked up that the data base “leant” towards older people. A small listed company’s preference shares are “distinctly unsuitable” for clients investing all their savings.
But Ecsponent denies targeting pensioners, saying the preference shares were open to the general public.
Two years ago, though, the FSCA moved to protect investors. Van Deventer says: “Our first priority was to get the clients safe so Ecsponent Financial Services undertook to give unsuitable clients an option to get out. That process hasn’t been completed though. It’s not about clients who can afford the high risk – it’s about the retirees, who can’t afford it.”
Prominent investment commentator, Magnus Heystek of Brenthurst Wealth, has been vocal in his criticism of Ecsponent. He says they had a very aggressive marketing campaign, punting their products as “safe, income-generating investments”. But Brenthurst failed to understand the business model so refused to touch it.
They also promoted their JSE listing. “They had top people in charge – very senior people in the industry,” he says. “What could go wrong?”
Heystek says investors weren’t questioning where Ecsponent was investing their money, nor how they would repay their investors: they were charmed by the promises of high returns.
“Ecsponent openly said they were investing in high-risk, small companies, which had to repay the loans. These companies, micro-lenders and bio-tech firms, were not risk-free investments. With a downturn in the economy, they couldn't repay the loans.”
Heystek blames the collapse on a combination of consumer ignorance and greed. “One client, an astute engineer, wasn’t happy with our 9% returns, so he took his money to Ecsponent – he’s lost his R20-million. So even smart people have been losing big money.”
Ecsponent was still trading on the JSE this week, despite the default announcement. The JSE failed to respond by deadline.
Van Deventer says it could have been worse, as some investors cashed out early or their investments matured, but “there’s no real good news here”.
“Our concern is that there are a lot of open positions, pensioners who cannot afford to lose this money.”
He says the authority’s enforcement action was uncapped, so management could be debarred and financial penalties imposed. It all depends on how Ecsponent Financial Services deals with investors, to ensure vulnerable clients don’t sustain losses.
“They sold the product, so they will be held liable and accountable. We’re not interested in why it happened; we’re only interested that it happened and that many people are likely to be exposed.”
Gradidge-Mahura Investments co-founder Craig Gradidge says he’s not surprised about the default. “There was a definite mismatch in terms of [Ecsponent’s] funding model and the attractive interest rates and investing in early-stage companies.”
Gradridge says retirees are increasingly desperate. “If there’s a cut in interest rates, they take a knock. High yields tend to attract retirees. They don’t have enough in their pensions to survive and [in this case] didn’t get the right advice.”
The best option now, for investors, would be to approach the FAIS Ombud and claim from the advisers’ professional indemnity cover. “I don’t see any other way,” he says.