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Taking on the FAIS Ombud! What the Sharemax debacle teaches about Intermediaries’ Liability

01 November 2012 Robert W Vivian, University of the Witwatersrand

The unfolding litigation between D Risk Insurance Consultants and the FAIS Ombud is of considerable importance to the insurance industry. It stems from the latest in a long list of “failed” South African property syndication schemes – and the struggle by investors to recoup their losses.

For many years the late Deon Basson, an investigative journalist, warned the public against the Sharemax property syndication scheme. His pleas were largely ignored by investors, but challenged by the syndication. In 2006 Sharemax sued Basson for defamation.

And when Basson died, Sharemax moved swiftly to purchase the book he had been working on, from his estate, presumably to prevent it from ever being published. It came as no surprise when Sharemax collapsed… Estimated losses totalling R4.5 billion make it the largest failure of its kind in South Africa.

Turning the screws on IFAs

Numerous claims are arising from the collapse. Unhappy investors have claimed against intermediaries. In many of the complaints heard to date the FAIS Ombud has ruled in favour of investors against intermediaries.

The litigation which is discussed in this article stems from complaints against D Risk Insurance Consultants (Risk). Risk, which had Professional Liability (PI) insurance via a UMA with Santam, decided to challenge the FAIS Ombud’s jurisdiction, preferring to have court of law adjudicate the matter.

South Africa is a small market and thus much of the PI cover, if not all, probably ends up with same insurer. It can be anticipated that much of the R4.5 billion, if actions against IFA succeed, will land at the door of Santam, in which case in all probability much of this "liability” will in turn be borne by the international reinsurance market.

Professional negligence, or...

The outcome of the court challenge will therefore be under scrutiny of the international insurance community. The Risk matter centres on a professional liability claim based on negligence.

Lord Denning, the architect of the modern law of negligence, wrote several books on his experience in law as England’s most influential judge. He points out that the professional liability burden had increased dramatically during his lifetime due to the existence of insurance.

His reasoning was that since professionals could be insured they should be held liable in order that the burden of losses suffered by an individual could be spread to the community by way of the insurance mechanism and for that reason the judicial system had in his life-time widened the scope of professional liability.

Turning guilt to innocence

The modern system of professional liability is irrational. It is a system full of internal inconsistencies. One of these inconsistencies is that it ignores the guilty and convicts the innocent. It declares the innocent to be guilty and then soon loses the ability to tell the concepts of guilt and innocence apart.

Take the much publicised case of Old Mutual in the CAF Pension Fund matter in the mid-1990s. A company owner wanted to take the employees’ pension money and invest it in the business. Although this is prohibited by law he went ahead anyway.

The pension fund had for years been administered by the Old Mutual which would never have allowed the funds to be invested in the employer’s business. The employer instructed Old Mutual to hand over the pension fund, which it duly did, as required by law. The employer then took the employees’ pension savings and invested it in the group… But it was not long thereafter that the company was insolvent and the pension monies lost.

Introducing moral hazard

One would expect that the employer would end up in prison. But the criminal charge against the employer was quickly dismissed. Instead Old Mutual, which did nothing wrong, was held liable. A clear case of the innocent being declared guilty and the guilty ignored! The moral hazard implications are clear.

With the collapse of Sharemax claims have been made against various Financial Services Providers (FSPs). Some of these claims have predictably found their way to the FAIS Ombud, where, with equal predictability, the Ombud ruled the FSPs liable to compensate investors.

It is not clear how the Ombud determined the quantum of the loss since Sharemax has not been liquidated. Equally predicable is the idea that these claims will be paid for by the FSPs professional liability insurers. A problem of course is that the Ombud is not a court of law and does not conform to the due process of law.

Right to judicial hearing

Understandably legal advisers for the FSPs would prefer to have the matter adjudicated before a proper court of law following proper due process procedures. This is by no means an unusual request.

Persons who have a dispute have a right to have this dispute resolved before the ordinary courts of the land before ordinary judges. This right was laid down as a constitutional principle as far back as the Magna Charta in 1215.

What is novel is that a government institution, the FSB, has set itself up to take over the functions of the judiciary, thereby denying the centuries old right to have disputes resolved by the judiciary. This is a situation that I refer to as "Unitary States within States” [See FAnews October 2012].

An attempt at restoring order

We can view the matter D Risk Insurance Consultants et al (Applicants) v The Ombud for Financial Services Providers et al (Respondents) September 2012, heard in the High Court of North Gauteng, as an attempt to restore the fundamental right to have disputes resolved by the ordinary courts of the land – before ordinary judges – and not by government officials in a government institution.

The case had nothing to do with the merits of the dispute. The FAIS Act, S27 (3) makes provision for matters to be referred to the courts. And the Applicants merely approached the courts to compel the Ombud to refer these matters accordingly. Alternatively the Applicants sought to have sections of the FAIS Act declared unconstitutional.

It is interesting to note that when the Applicants approached the Ombud with a request to refer the matter to the courts they were threatened with charges of contempt of "court” and criminal proceedings (paragraph 19 of the judgement).

A "technical” victory

The court decided the matter on purely technical grounds. Legislation provides that if any person feels aggrieved by any decision by the Ombud, that person may appeal to the board of appeal established in terms of the FSB Act. The applicants had not done that. In other words, the Applicants had not exhausted all the internal remedies at their disposal.

The court also referred to a similar provision in the Promotion of Administrative Justice Act (PAJA) which precludes a court from reviewing any administrative action unless the internal remedies have been first exhausted. On the constitutional challenge the court concluded that it was either poorly formulated or simply does not arise.

The Sharemax litigation is important. If FSPs are held to be liable via the Ombud route, and this cost is transferred to PI insurers, a large portion of the estimated R4.5 billion will land up with insurers and their reinsurers.

No PI payment guarantee

This is reminiscent of the Lloyd’s litigation. First attempts were aimed at shifting the Lloyd’s multi-billion pound losses, which threatened the existence of Lloyd’s onto the professional liability insurers! The first case succeeded. PI cover for Lloyd’s quickly dried-up and in the end (to salvage) Lloyd’s Equitas was formed. At least in the Lloyd’s case the matters were heard in courts of law following constitutional due process.

It should be pointed out that even if the FSP is held to be liable this does not mean the PI insurer is liable as demonstrated by Przybylak v Santam Insurance Ltd 1992 1 SA 588 C. In this case Santam was the public liability insurer. It defended the insureds’, who were found to be delictually liable. Santam thereafter successfully denied liability in terms of their policy.

The "guilty” go free

It seems to me we are heading to the now common situation: The innocent (FSPs) being held liable and the guilty ignored, and soon no-one will be able to tell the difference. If anyone lost money it is not because of the FSPs they dealt with, but because of the collapse of the Sharemax scheme.

What will happen to the organisers of the Sharemax scheme? If history is anything to go by, I expect nothing. The tab will be picked up by the FSPs. The only difference is that the judiciary is excluded, having been replaced by a government institution as worldwide is becoming increasingly common.

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