MEMORANDUM
TO: HONOURABLE MEMBERS: PARLIAMENTARY COMMITTEE ON FINANCE
SUBJECT: BULKING AND SECRET PROFITS UPDATE
INTRODUCTION:
1. On 24 March 2006 the Registrar
of Pension Funds issued a general circular requiring all pension fund
administrators to disclose voluntarily all bulking and other practices whereby
secret profits were made at the expense of the pension funds whose assets they
administered.
2. Responses were received from
sixty six (66) pension fund administrators, which included all the major
pension fund administrators. There are approximately 200 pension fund
administrators approved in terms of section 13B of the Pension Funds Act, No.
24 of 1956 (the Pension Funds Act). The majority of these administrators only
administer one fund and the practice of bulking different clients' funds is
therefore not available to them. Having considered the responses the Registrar
was satisfied that all the major administrators cooperated and responded to
the general circular.
APPLICABLE PRINCIPLES:
3. In assessing the aforesaid
responses the Financial Services Board adopted the following approach in line
with applicable legal principles:
3.1 The practice of bulking client funds is not per se unlawful or
objectionable. On the contrary, it is expected of administrators in
fulfilling their fiduciary duties towards pension funds, to achieve the best
possible return on investment for the funds.
3.2 The relationship between a pension fund and its administrator is one of
agency, which encapsulates the principles of trust, confidence and good
faith.
3.3 An agent is not allowed to make any profit from its agency
relationship except for the agreed remuneration with its principal. Any profit
derived from the relationship belongs to the principal. Accordingly, the
benefit which an administrator derives from the retention of a portion of any
enhanced interest earned on bulked accounts, amounts to a secret profit.
3.4 It is only permissible for the administrator to retain a portion of such
profit with the prior free consent of its principal following upon a full
disclosure by the agent of its practice and the benefits resulting therefrom.
3.5 An approved pension fund administrator is a financial institution as
defined in section 1 of the Financial Services Board Act, No. 97 of 1990. The
pension fund administrator, its directors, officials and employees have certain
fiduciary duties towards the pension fund whose assets they administer,
including the requirement to observe at all times the utmost good faith and to
exercise the care and diligence required of trustees in the exercise of or
discharge of their powers and duties. It is the FSB's view that an agent must
make the necessary disclosure and obtain the informed consent of its principal
before sharing or receiving any benefit or part of the profit. Retrospective
agreement by the principal to a practice employed by the agent in the past will
not suffice to discharge the duty of trust and confidence that is required of
an administrator.
ALEXANDER FORBES:
4. Alexander Forbes engaged the
Registrar in discussions on the issues of bulking and secret profits before the
issuing of the circular on 24 March 2006. Following these discussions,
Alexander Forbes subsequently agreed to repay an amount of R368 million to
those pension funds whose assets it administered from the inception of its
bulking practice (approximately a 10 year period).
5. Alexander Forbes (AF) also instructed independent auditors, Ernst &
Young, to conduct a wider review of all its business practices. AF made
provision for a further R 100 million in its 2007 financial statements for any
irregularities that may be uncovered as a result of this wider review. The
review has been completed and the report was provided to the Registrar during
September 2006. The Registrar of Pension Funds and the Registrar of Financial
Services Providers are currently considering the content of the report for
further supervisory and regulatory action.
6. AF also donated an amount of
R12 million to the FSB's Consumer Education Trust for the specific purpose of
funding training for trustees of pension funds.
ANALYSIS OF RESPONSES:
7. Of the sixty six (66) responses
alluded to above, thirty six (36) administrators reported that they do not bulk
their clients' funds; did not make secret profits and had "nothing to
declare" following the invitation in the Registrar's general circular.
The FSB has no reason to doubt the veracity of these reports. However, the
continued surveillance of pension funds and their administrators by way of
on-site visits by the Pensions Department's Compliance Division will endeavour
to verify these reports.
8. Eleven (11) administrators
reported that they do bulk their clients' funds but that the full credit of the
enhanced interest rate is passed on to their clients or that the prior approval
of trustees were obtained for any benefit accruing to the administrator from
the practice of bulking funds.
9. One of the eleven administrators mentioned in paragraph 8 subsequently
reported that it had uncovered a practice that required disclosure to the Registrar
in view of the general circular. As part of its wider review of all practices
the administrator discovered that during 1997 it had assisted in arranging
fidelity guarantee cover for trustees of Pension Funds via a short-term
insurance broker. The broker shared 50% of its fee with the administrator. Over
the period 1997 to June 2006 a total amount of R859 700 had been earned. The
administrator proposed to have the amounts verified by its auditors and
thereafter to make full restitution. This process is closely monitored by the
FSB and verification of the exact amount and repayment thereof is expected
shortly.
10. Three (3) administrators declared that they derived some benefit byway of
other practices such as undisclosed scrip lending fees and commission sharing
arrangements with brokers or others. These administrators submitted proposals
on how to deal with the benefits they derived from these practices. The
Registrar of Pension Funds is monitoring the position of the administrators
concerned.
11. The Registrar identified sixteen (16) administrators whose responses
required further explanation and has subsequently met with these
administrators. The discussions with these administrators focused not only on
the issue of bulking, but also explored all other possible scenarios in terms
of which the administrators might have made secret profits as a result of its
agency relationship with pension funds, such as commission sharing with
brokers, scrip lending fees, margin sharing arrangements etc.
11.1 Having engaged these administrators in discussions and having received
further information, the FSB is satisfied with the responses from 5 of these
administrators and the Registrar of Pension Funds does not intend to take any
further action at this stage against these administrators.
11.2 The secret profits made by 10 of these administrators amount to an
estimated R31.2 million.
11.2.1 The estimated benefit for 6 of the aforesaid 10 administrators amounts
to R 10.1 million. The estimated benefit for the remaining 4 administrators
amounts to R21.1 million.
11.2.2 The aforesaid 6 administrators undertook to repay the full amounts by
which they benefited, with interest, to the pension funds concerned. The
process of verifying the amounts concerned and the repayment thereof is being
monitored by the FSB on an on going basis.
11.2.3 Of the 6 administrators, 4 offered to donate amounts totaling R3,25
million to the FSB's Educational Trust Fund over a three year period with the
aim of utilising such funds for trustee training.
11.2.4 The responses of the remaining 4 administrators can be summarised as
follows:
(a) One estimated that the benefit it derived from the practice of bulking
amounted to R1.8 million. An investigation is still being conducted to
determine whether or not proper disclosure was made of the bulking practice and
the sharing of the benefit by the administrator prior to the implementation of
the practice. The administrator undertook to repay all amounts with interest to
those pension funds to whom there was no or inadequate disclosure. The progress
on this investigation is being monitored by the FSB on an on-going basis.
(b) One (estimated benefit of R450 000 over a 4 year period) has not responded
satisfactorily to the Registrar's enquiries and further information and
documentation is awaited.
(c) One made special provision for an amount of R2.9 million and proposed to
undertake a detailed investigation into the relationship which existed between
it and each of its clients in order to determine the exact nature of that
relationship and whether or not sufficient disclosure was made to those clients
with regard to the practice of bulking.
(d) One indicated from the outset its unwillingness to repay any amount to any
of the pension funds whose assets it administered. The total benefit derived by
this administrator from the practice of bulking is estimated at R 16 million.
The administrator justified its position on the basis that the pension funds
derived a benefit (of a higher interest rate) from the practice of bulking than
would have been the case if funds were not bulked. The administrator indicated
its intention to engage the pension funds whose assets it administered in order
to obtain their retrospective ratification of the past practice of making a
secret profit from bulking clients' funds.
11.3 The last of the sixteen administrators identified by the FSB for further
investigation received a commission from a trust in respect of death benefits
paid in terms of section 37C of the Pension Funds Act by a number of retirement
funds. Receipt of the commission was disclosed in some but not all instances.
The administrator indicated that it would disgorge the total amount of
commission received, estimated to be R20.5 million. Such amount is to be paid for
the benefit of the beneficiaries, all of whom are currently experiencing
hardship as a result of the Fidentia/Living Hands matter.
12. CONCERN
12.1 Whilst the majority of pension fund administrators tendered
repatriation and repayment of all amounts to the pension funds concerned, the
FSB is concerned by the approach adopted by some administrators to engage their
clients in order to obtain the retrospective agreement of the trustees of those
pension funds to ratify their past actions. As already indicated the FSB is of
the opinion that an agent should obtain its principal's consent before receiving
or sharing in any benefit or profit, or else make full restitution.
12.2 However, it may be argued administrators and the pension funds whose
assets they administer enjoy contractual freedom and that there is no provision
in law that prohibits the retrospective ratification of the actions of the
administrator.
12.3 Such an approach would, however, be of concern to the FSB not only because
current trustees may expose themselves to personal liability for failing to act
in the best interests of the pension fund and its members, but also as such
actions may reflect negatively on the "fit and proper" requirements
of administrators. In view of these concerns, the Registrar of Pension Funds
issued an information circular addressing these issues on 26 February 2007. The
circular was also necessitated by a number of trustees of pension funds
communicating directly with the Office of the Registrar in order to obtain guidance
on how to deal with the proposals put forward by administrators on
retrospective ratification of past actions.
13. EXISTING REMEDIES AND REGULATORY INADEQUACIES
13.1 The FSB's interaction with the aforesaid administrators has highlighted
the need for further regulatory measures in order to address similar situations
in the future. Current legislation only affords two regulatory remedies to the
Financial Services Board to address secret profits.
13.2 The first is a referral of the matter to the National Prosecuting
Authority for investigation and possible criminal prosecution on the basis of a
contravention of the provisions of section 2 of the Financial Institutions
(Protection of Funds) Act, No. 28 of 2001 (FI Act). This section requires
members, directors, officials, employees and agents of financial institutions
with regard to the trust property they hold, to observe the utmost good faith
and to exercise the care and diligence required of a trustee in the exercise or
discharge of their powers and duties.
13.3 Section 10 of the FI Act provides that a person who fails to comply with
the provisions of the FI Act is guilty of an offence and on conviction is
liable to a fine or imprisonment for a period not exceeding 15 years. Upon
conviction a court may, in addition to any penalty it may impose, order the
person to pay the institution or principal concerned any profit made and to
compensate the institution or principal concerned for any damage suffered.
13.4 The second remedy at the disposal of the Financial Services Board is to
withdraw the approval of an administrator in terms of section 13B of the
Pension Funds Act. There is, however, a need for administrative powers for the
Registrar of Pension Funds to deal with administrators who may have breached
their fiduciary duties under circumstances where such breaches do not warrant
the withdrawal of approval in terms of section 138. The disclosures that were
made by administrators pursuant to the general circular were of a voluntary
basis and those administrators who undertook to repay the amounts to their
clients, did so . on a voluntary basis. The Registrar has no powers to compel
an administrator to repay any amount or to impose a penalty on the
administrator.
13.5 In view of the lack of regulatory measures at the disposal of the FSB,
discussions are taking place between the FSB and the National Treasury with
respect to potential draft legislation that will provide for the creation of an
administrative enforcement committee that will be empowered to impose penalties
on all financial institutions, including pension fund administrators. The
Financial Services Board believes that this will provide an effective
administrative remedy to address similar situations in future.
13.6 In addition a Pension Fund Amendment Bill is pending which, inter alia,
seeks to strengthen and extend the Registrar's enforcement powers.
14. MATTERS REQUIRING FURTHER INVESTIGATION
The FSB's investigation has also identified an aspect that will be investigated
further. Where a Life Insurance Company, who is also approved in terms of
section 13B of the Pension Funds Act, provides policy contracts for
underwritten funds, the Life Company finds itself in a dual capacity. Not only
does it have a contractual relationship with the funds and or the members of
those funds, it also acts as agent for administration purposes. The dual
capacity and the manner in which Life Companies conduct themselves requires
further investigation by the Registrar of Pension Funds so as to ensure that
Life Companies comply with all of their fiduciary duties, especially as it
pertains to the use of pension fund assets in practices such as scrip lending.
FINANCIAL SERVICES BOARD