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Financial Advisors hit by more than just FAIS

19 July 2006 Rian Geldenhuys

Comments on the Inspection of Financial Institutions Act

Recently we heard that certain financial advisors were investigated for selling Leaderguard foreign exchange investment products. Three interesting aspects emerged from the media reports on the determination in the case of Mackrory v Naude, however before we expand on them we should give a brief background on the Ombudsman for Financial Services Provider's determination.

According to the facts of the case the broker sold a foreign exchange investment product to his client without fully explaining to the client the risks involved in that particular product. Subsequently Leaderguard ran into financial difficulties and the client lost his total investment in the Leaderguard forex product. He therefore laid a complaint with the Ombudsman for Financial Services Providers and subsequently the broker was order to repay the client the amount lost plus interest.

The first interesting issue that arises from this determination, as reported by the media, was that the Financial Services Board authorised a well-known auditing firm to investigate the practices of all financial services providers who sold Leaderguard products. Brokers are advised that this investigation does not happen under the auspices of FAIS, but indeed under another piece of legislation affecting brokers, namely the Inspection of Financial Institutions Act ("IFIA"). One may wonder why a broker or firm of brokers will fall under the IFIA as it does not seem that they are a financial institution. However in terms of IFIA one of the entities which is defined as a financial institution is any institution as defined in the Financial Services Board Act ("FSB Act"). According to the definition of financial institution in terms of the FSB Act, a broker will be treated as a financial institution. Brokers, and other financial services providers, therefore have to bear in mind that they are subject to more legislation than only FAIS.

Secondly, IFIA authorises the registrar of the FSB to appoint an inspector to inspect the affairs of a financial institution. In terms of IFIA, persons who are not registered as financial institutions may also be inspected if the registrar suspects that such persons are carrying on the business of a financial institution. The powers of inspection given to the appointed inspector are very wide and financial institutions may be vulnerable in the event that they are inspected, especially if their affairs are not in order. In addition the cost of the inspection, thus the cost of highly paid attorneys or auditors, may be recovered from the financial institution being inspected. This determination will be made by the registrar once the results of the inspection have been considered. It may very well be that if all your affairs are not in order that perhaps the cost of such investigation will be for your own account. The discretion however still lies with the registrar.

The third interesting aspect of the Ombudsman's determination is that the broker was not found guilty because he contravened the General Code of Good Conduct or the Code of Conduct for Forex Investment Business. Instead the Ombudsman warned that in terms of the common law one will be negligent if you engage in a potentially dangerous (risky) activity if you do not possess the necessary skill and knowledge associated with the execution of such activity. The Ombudsman then determines that the broker should repay the client's lost investment because he was not licensed to give advice on forex investment products. The broker was thus found negligent because he did not have the proper license and therefore he had to pay the client's damages.

Financial services providers should therefore familiarise themselves with the different pieces of legislation affecting them and should strive to comply with any such legislation as the cost of non-compliance invariably far exceeds the cost of compliance. Financial services providers should also only advise on products which are within their field of expertise, understanding and licence.

This article first appeared in Floor Inc Attorneys Newsletter. With special thanks to the author Rian Geldenhuys.

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