More financial scandals rock the investment world
After a well-deserved December break we’d like to extend a hearty welcome to all our regular readers. We hope you enjoy a prosperous and successful 2009.
Now that the niceties have been dealt with it’s time to look at some of the stories that played out over the festive season. And where better to begin than the topic of financial industry regulation. When we pressed the send button on our year-end FAnews Online newsletter midway through December 2008 we fully expected a quiet holiday with a trickle of investment news. But we were wrong. During December a number of scandals rocked the international investment environment, while the FAIS Ombudsman had his hands full with financial services shenanigans on the domestic front. Each incident proves that the 21st Century obsession with ‘easy money’ beats commonsense every time.
On ‘Ponzi’ schemes and ‘Enron’ frauds
There were two financial scandals that rocked the world toward the end of last year. On 11 December 2008, Bernard Madoff was arrested for his part in masterminding the largest Ponzi scheme the world has ever seen. By the time the dust settles investigators expect around $50bn will have disappeared! Madoff’s investment company, which offered staggering returns and attracted funds from some of the world’s most respected fund managers and investment banks, was nothing but an elaborate pyramid scheme. Madoff paid returns to early investors from new capital inflows rather than from investment profits. When world markets slumped, new investments dried up and his existing investors discovered that their capital had disappeared!
The second disaster came courtesy of one of the largest listed Indian outsourcing companies, Satyam Computer Services. The company had significantly inflated assets and earnings over a number of years. Satyam chairman, Ramaling Raju, admitted systematically falsifying accounts with the result that approximately $1.04bn of the company’s listed assets did not exist. Quarterly earnings and operating margins were hopelessly overstated. The fraud has been compared to the goings on at Enron, a US-listed company which crashed spectacularly a couple of years ago. Shares in Satyam fell 70% on the news.
These revelations raise questions about the quality of financial controls at some of the world’s largest companies. How could investment specialists pour billions of dollars into Madoff’s company without completing due diligence? And how could auditors have missed the ‘smoke and mirrors’ financial practices at Satyam?
A busy December for the FAIS Ombudsman
On the home front, the FAIS Ombudsman has been extremely busy. On 19 December last year two determinations were published. In each case a broker was punished for failing to provide appropriate financial advice. In the first case the broker and his financial services firm were held “jointly and severally liable to pay their client his entire investment which was lost when the forex firm into which he invested” was declared insolvent. And in the second, FAIS Ombudsman Charles Pillai ordered the broker “who invested a substantial portion of a pensioner’s retirement capital in her own property business to repay the entire sum with interest.” The Ombudsman felt that the broker in each case “acted in reckless disregard of the general duty of a provider to act with due skill, care and diligence, in the interests of the client and the integrity of the financial services industry.”
The first determination was against broker Gavin Grobler and his company Plum Portfolio Solutions. Grobler invested R250 000 on behalf of Lindo Johan Esterhuyse with a company called Fulcrum Forex International. Upon investing in August 2005, Esterhuyse was promised a monthly return of R3 000 (paid quarterly). His suspicions were raised when the first quarterly payment was missed – and Fulcrum was subsequently liquidated in August 2006. Pillai flagged a number of concerns in making the judgement. He found that the respondent was not authorised to deal in forex services, turned a blind eye to the fact that the provider was not registered and hadn’t appropriately advised the complainant of the risk inherent in the ‘investment’. He awarded the complainant an amount of R250 000 plus interest at 15.5%.
In the second case, Mr Nebbe (a retired farmer) approached Muriel Oosthuizen (trading as Millenium Financial Advisory Services & Brokers) to assist him with investing the proceeds from the sale of his farm. As a result of this meeting and subsequent advice Nebbe invested R750 000 in Oosthuizen’s private property project. Pillai lambasted the respondent for inappropriate financial advice and for serious conflict of interest. Instead of providing appropriate advice “she took advantage of his lack of financial literacy and under the guise of placing him in a high interest paying investment, diverted the funds to her own property investment,” says Pillai. “The obvious conflict of interest between respondent’s own interests and those of her client are self evident.” He ordered Oosthuizen to pay Nebbe R800 000 – the maximum award the FAIS Ombudsman is allowed to make.
Editor’s thoughts:
The FAIS Ombudsman ended 2008 with a bang – reminding brokers of the standard of advice demanded in terms of the FAIS Act. In each of the above cases the broker placed their interests ahead of the clients’. Have we reached a stage where the majority of brokers can ‘see through’ investment scams? Add your comments below, or send them to [email protected]
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