Advisors beware! Bitcoin and other virtual currencies

Anton Swanepoel, Chairperson of the Financial Planning Committee at the FIA.

Over the last 14 years many financial advisors in South Africa have been held accountable by the FAIS Ombud, the Appeal Board and our Courts after advising clients on high risk investments that failed. The question is whether history will repeat itself as more and more financial advisors buy into, and express “opinions” to their clients about virtual currencies such as Bitcoin, Darkcoin, Peercoin and Feathercoin? The Financial Intermediaries Association of South Africa (FIA) is concerned about financial advisors expressing opinions about virtual currencies to clients or potential clients, without understanding the potential implications. The Financial Planning Committee of the FIA have consulted the User Alert issued by National Treasury and the FAIS Department of the Financial Services Board to get clarity on the risks for advisors. The purpose of this article is to issue a firm warning to financial advisors, and what follows are important aspects advisors must consider as virtual currencies have clearly become the new flavour of the “decade”.

According to National Treasury, while virtual currencies can be bought and sold on various platforms, they are not defined as securities in terms of the Financial Markets Act, 2012 (Act No. 19 of 2012). Bitcoin and other virtual currencies are not regulated, and Treasury has stated that there are no specific laws or regulations that address the use of virtual currencies and consequently, no legal protection or recourse is afforded to users of virtual currencies.

According to the FSB, a virtual currency is not a financial product as defined in section 1(1) of the FAIS Act and the definition of “advice” has no relevance when it relates to a product that is not a financial product. However, although the FAIS Act does not apply to virtual currencies it does not mean that a person (who is also an FSP) advising a client to invest in a virtual currency cannot be held liable based on delict.

In our view, expressing an opinion, which is perceived by a client as an endorsement or encouragement to “buy” Bitcoin, for example, may attract liability for advisors. It is well published that the High Court in the Eastern Cape has previously held an advisor accountable for “giving advice” at a “braai” and advisors should therefore not be surprised if this happens again. It is fashionable these days for advisors to engage in conversations and some even encourage their clients to attend Bitcoin presentations, making statements such as “those that hold Bitcoin will become wealthy”.

In the Oosthuizen and Marisa Vogel matter (Case number 2858/2012), the High Court in Bloemfontein has recently stated that the principles in Durr v ABSA, (a matter that went all the way to the Supreme Court of Appeal and which preceded the FAIS Act with several years) are still relevant today. What is important to remember is that DURR v ABSA dealt with the duties of an advisor, which includes the duty to act with care, skill, and diligence. The principles in this matter have been used by the FAIS Ombud and the High Court on many occasions as the legal basis on which advisors have been held liable in the past and advisors will do well to consider it carefully.

The FAIS Ombud has frequently issued determinations against advisors who did not understand the “product” that they have “sold”. Very few people, if any, can explain exactly how virtual currency works. According to Treasury “a virtual currency is a unit of account that is digitally or electronically created and stored. Members of the virtual community agree to accept these units as a representation of value in the same way that currency is accepted. In contrast to traditional currencies, virtual currencies operate without the authority of central banks, and are therefore not regulated. The price of virtual currencies is based on investor sentiment and can rise rapidly, thus attracting investors looking for very high returns from investments. However, the prices of virtual currencies tend to be very volatile and can drop as quickly as they rise. This may encourage speculative behaviour, which in turn spurs more volatility. Financial risks are, therefore, limitless and claims cannot be made for such losses.”

One of the main arguments that the FAIS Ombud, the Appeal Board and our Courts have used in their findings against advisors, is the issue of due diligence. Currently, it is simply impossible to do a proper due diligence on virtual currencies and, if it was difficult to prove proper due diligence on property syndications, due diligence on virtual currencies are far worse.

The National Treasury, on behalf of the South African Reserve Bank, the Financial Services Board, the South African Revenue Service and the Financial Intelligence Centre, have warned members of the public to be aware of the risks associated with the use of virtual currencies for either transactions or investments. Treasury made it clear that there is no investor protection and no recourse, and because virtual currencies are not regulated, users are not protected and are at the risk of losing money. However, this does not guarantee that financial advisors may not be held accountable if it is perceived that they have expressed an opinion, which investors could allege may have been instrumental to buy into Bitcoin, for example. It is also important to remember that advisors do not have to be paid for their guidance for it to qualify as “advice”. Being paid a fee or commission is not a prerequisite for potential liability to exist.

Financial advisors who get involved in guiding clients in this area should therefore not be surprised if clients want to hold them accountable and they should not expect any mercy from the FAIS Ombud, the Appeal Board or our Courts, when clients complain or institute legal action against them should they lose any of their money. History may indeed repeat itself again if financial advisors are not extremely careful.