Why a Ponzi scheme can taint us all

Fiona Zerbst, FAnews Online Editor

For a variety of legal reasons, calling an investment scheme a Ponzi scheme can get you sued (even if it is, in fact, a Ponzi scheme). But the fallout from dubious schemes like Sharemax and the latest on our radar, Net Income Solutions (Also known as Defe

It is bad enough that investors are losing their life savings, but intermediaries, financial services providers and regulators, including the Financial Services Board (FSB) and National Treasury, get tainted by association. Questions arise: Why was something not said or done earlier? Why hasn’t our exhaustive legislation prevented these schemes from flourishing?

The fact of the matter is, it’s a complicated issue. “In the past, we have said that authorities haven’t acted fast enough, but if you act too early you risk potentially destroying a business,” cautions Gavin Came, chairman of the Financial Intermediaries Association (FIA). “If it’s a legitimate business and you destroy it, there’s a legitimate claim against you. So it is really difficult to get the timing right.”

For this reason, too, it is simply not feasible to have some kind of process whereby financial products are given a ‘stamp of approval’, as has sometimes been mooted. “For one thing, that would stifle free enterprise,” says Came. “For another, it’s potentially defamatory. And in addition, the Financial Services Board (FSB) doesn’t want to stamp products because they’re then saying these products are great to invest in but they may not, in fact, be appropriate for particular clients.”

Came says legitimacy is one thing but appropriateness is quite another and only a trusted financial advisors is in a position to make that call. “Your broker understands the industry better than you do because he operates within it,” says Came. “Unfortunately, the biggest targets of dubious schemes are retirees who are desperate for yield as well as out-of-work youngsters, who may borrow money to make an investment.”

Came says the FIA Watchdog was set up in the 2^nd half of last year as a warning system for FIA members, to advise caution when dealing with a particular supplier. He admits the FIA has to be really careful because of potential legal exposure. “You can’t tell intermediaries that a particular supplier appears to be acting illegally – you can only raise a red flag and suggest caution,” he says. He is pleased that FIA members have been proactive about investigating particular advertised products and he says that these matters are often raised with intermediaries.

When it comes to TCF, however, he says because it is an initiative and not a law, it is unlikely to prevent dodgy business dealings. “We want product suppliers to treat customers fairly when they design products, with the clients’ interests uppermost, but we cannot force them to do so. It may change the way current laws are enforced, though. For example, the Reserve Bank has acted quickly, using existing laws, to investigate the alleged Ponzi scheme Defencex. Early and rapid enforcement of the laws we already have works – you don’t need TCF to bring that about,” says Came.

It is not Came’s view, but there is some suggestion that new laws would simply make the gap between legitimate and illegitimate suppliers even greater. Legitimate suppliers are careful to comply with the law, but illegitimate ones will obviously try anything to dodge compliance and legislation.

Editor’s thoughts: Came says it is essential that intermediaries and financial services regulators keep their eyes on questionable financial activities, so consumers are alerted at the first sign that there may be something amiss. The price of not doing so is damage to the reputation of industry stakeholders. Policing the industry is a necessary evil, but one should also bear in mind that there are limits to what stakeholders can reasonably be expected to do. Financial advice doesn’t provide a guarantee against loss. It does, however, keep investment risk as low as possible by adhering to a regulated financial advice process, such as assessing appropriateness. Who should be responsible for policing dubious financial schemes? Let us have your comments below or email fiona@fanews.co.za.