WORDS ON WEALTH (OPINION)
Last week, the troubled financial services group Ecsponent issued an extraordinarily positive press release. “Ecsponent Limited successfully restructures balance sheet”, it crowed.
“Following extensive engagement and consultation with preference shareholders,” the release said, “R1.8bn debt was converted to ordinary equity, greatly improving solvency and liquidity and R0.5bn debt was converted to hybrid preference shares, which will also qualify as equity.”
The company is to be renamed and rebranded, and two new directors, representing the ordinary and hybrid shareholders, will be appointed.
“This outcome repositions the company and its underlying investments to extract maximum value for its stakeholders going forward.”
The release made no mention of the group’s share price: it was 6c at the time.
Also last week, the Financial Sector Conduct Authority (FSCA) released a notice saying that it had suspended a subsidiary in the group, Ecsponent Financial Services, “for breaches of financial sector laws”. This was following an investigation into how the company had marketed the preference shares of Ecsponent Limited to potential investors.
“During interactions with potential clients, Ecsponent Financial Services staff provided advice on the investment product, i.e. the classes of preference shares. Whilst the classes of shares that paid monthly dividends were popular amongst pensioners, as they mimicked a monthly pension payment, the one major difference between them and a pension investment was that they exposed investors to substantially more risk. It is the view of the FSCA that Ecsponent Financial Services paid insufficient attention to whether or not these shares were suitable investments for their clients,” the FSCA statement said.
Since Personal Finance first covered this matter in February, several readers have written in about their Ecsponent investments. They are all pensioners, and their stories are heartbreaking.
Mrs S, a widow, was left with very little to live on when her husband died and she had to sell their family home. She saw an Ecsponent ad on TV, offering a return of 12.5% a year – about one to two percentage points more than the banks were offering. Ms S did not invest blindly in the scheme; she put a number of questions to the adviser, JJ van der Merwe. On all points, he assured her that the investment was safe, so she went ahead and invested R1.6 million, the only money she had to live on. When things went awry, JJ disappeared.
Another pensioner, Mr K, invested a total of R3.75 million between 2015 and 2017. His earliest investment, of R250 000, would have matured this month. In the glossy brochure he was given when he invested, the preference share investments, on a scale from “conservative” to “aggressive”, were marked “moderately conservative”.
As I stated in a previous column, there was nothing “conservative” about these investments. A general equity unit trust fund, which invests in the stock market across a gamut of companies, will, on its minimum disclosure document, be classified as “medium- to high-risk”. How much more high-risk, then, is a share in a single company?
Monday May 25 was the deadline by which the investors were required to vote: they could turn their preference shares into hybrid preference shares or into ordinary shares in the company. With the hybrid preference shares the investors forfeited any guarantees to capital or returns, though they retained a preference to cashflow in the event of assets being sold off.
In two of the six of preference share classes, the investors voted for the hybrid option. In the other four classes, the voting threshold was not met, with the result that the default ordinary-share option kicked in.
In a single swoop, the Ecsponent group had purged itself of its obligations to these investors, with R2.3 billion of debt being expunged from its balance sheet. Hence the self-congratulatory, smug tone of the press release.
Back when they invested, the investors were promised a “guaranteed”, fixed-rate return plus their capital back at the end of the investment term. They are now sitting with an illiquid “penny stock” subject to the volatility of the market.
There’s also the question of Ecsponent’s ability to survive these torrid times. If the company goes under, ordinary shareholders are last in line for a slice of the pie.
Regulator’s role
Why did the FSCA suspend Ecsponent Financial Services only last week? They have been investigating this company since mid-last year. They knew high-risk investments were being marketed to pensioners. According to one investor who wrote in, last year the FSCA advised Ecsponent to grant pensioner investors access to their money if they wanted it. But not many investors were made aware of this.
The role of the FSCA is to protect consumers. It issues warnings every week about risky investments. So why no public warning about the high-risk nature of the Ecsponent preference shares, long before the company defaulted on its payments?
I believe the investors, if they act collectively, have a case against both Ecsponent Financial Services and the FSCA.
FSCA'S RESPONSE
Personal Finance invited the FSCA to respond to the above questions. It sent the following response, which is published verbatim:
1. It is correct that the FSCA was aware of the contraventions because of its investigation. However, before the product supplier announced its intention to default on the preference share dividend payments, the main priority of the Authority was to support the efforts of Ecsponent Financial Services to find a way to allow the unsuitable investors to redeem their shares without loss. Before unpacking this in more detail, it is necessary to draw your attention to the distinction between the product provider and the financial services provider.
2. The FSCA does not regulate the product provider, Ecsponent Limited, the issuer of the preference shares. The FSCA has no power to instruct the issuer to allow the investors to redeem their shares. Those investors that were already invested were locked in for a five-year period, and had no legal way of disinvesting. Theoretically those investors could sell their shares, but the preference shares did not trade at all on the market.
3. The interaction with Ecsponent Financial Services (Ecsponent FS), the financial services provider regulated by the FSCA, was on the basis set out below.
4. Ecsponent FS would immediately cease advising unsuitable investors to invest in the preference shares of Ecsponent Limited. This removed any risk of additional investors investing in the preference share, for whom the investment was not suitable.
5. The reference to suitable investors in this instance speaks to the requirement of Ecsponent FS to evaluate the clients’ risk requirements, and to discourage clients with low-risk requirements to invest in the Ecsponent Limited preference shares. The first priority was to ensure that no new unsuitable clients were advised to invest in the share. This was accomplished with the first undertaking.
6. Ecsponent FS, at the insistence of the FSCA also undertook to conduct a re-evaluation of the risk requirements of all the clients who were advised to invest in the product, and to compare their risk requirements with the high-risk nature of the product. This was necessary to provide the FSCA with a clearer picture of the situation, and a better opportunity to deal with it. Ecsponent FS immediately commenced with the re-evaluation and have progressed to a point where the re-evaluation was nearly complete. More than 2 000 clients were re-evaluated.
7. Ecsponent FS further undertook to engage the authority on a strategy to deal with those investors identified as unsuitable. More specifically the strategy would have enabled unsuitable clients to exit from the investment without loss or harm. Such a strategy would likely have included some action or agreement from the product supplier. Ecsponent FS was optimistic about the success of the project and had numerous discussions with the product supplier and the FSCA. Several possibilities were raised that could have solved the problem to a material degree.
8. The entire project was overseen by the external compliance firm of Ecsponent FS, at the insistence of the FSCA. Ecsponent FS fully co-operated with the investigation and the efforts to find a solution.
9. Unfortunately, recent events brought about a material change in the financial circumstances of the product supplier which also impacts the course of remedial action embarked upon by Ecsponent FS. This is because the change in circumstances has diminished the possibility of the unsuitable clients redeeming their investments without losses. This change in circumstances has required the FSCA to reconsider the regulatory actions.
10. For this reason, the authority has decided to suspend the licence of Ecsponent FS with immediate effect, and to consider further regulatory action. A further media release will be published soon with reference to additional enforcement actions.
11. It should also be appreciated that the action taken against Ecsponent FS is based on the view of the FSCA that Ecsponent FS breached the legislation. This view is disputed by Ecsponent FS on several bases. They are, inter alia, of the opinion that they do not have to conduct suitability testing, based on compliance or legal advice that they obtained. The FSCA and Ecsponent FS engaged extensively on this point in an effort for the FSCA to convince Ecsponent FS to amend its processes. Ecsponent FS eventually decided to accept the view of the FSCA.
12. For the reasons set out above and other reasons, the FSCA does not agree with your assessment of the legal position, to the effect that the investors have a claim against the FSCA.
Since this article was written, the FSCA has withdrawn the licence of Ecsponent FS and imposed a penalty on the company. See here.