The regulatory shield is full of holes

South African investors are all too familiar with financial scandals. Thousands of individuals have suffered significant losses at the hands of MasterBond, LeaderGuard and LeisureNet. And more recently, funds intended for the benefit of widows and orphans

Sophisticated ruses aside, investors face a barrage of questionable get-rich-quick schemes on a daily basis. Pyramid investments, property syndications, dodgy charities and unsustainable low-interest bond schemes are regularly exposed in the media. Unscrupulous con artists will use any trick in the book to make an extra buck. The question is why such schemes are multiplying despite the massive presence of legislators and regulators in the local financial environment. Why are consumers still at risk?

Earlier this week we attended the Association of Collective Investments (ACI) 2007 convention where one of the panel discussions focussed on the security of investors money. The panellists included Ombud for Financial Services, Charles Pillai, Personal Finance editor, Bruce Cameron and Senior Manager Compliance and Prevention at the Financial Intelligence Centre, Christopher Malan.

Too many transgressions slip through the cracks

In his presentation, Cameron asked why, despite "a raft of legislation" and "regiment of regulators" so many questionable financial practices remain in the local financial services environment. He mentioned that Personal Finance was investigating as many as 18 individuals and companies for a variety of contraventions.

Cameron highlighted a number of issues which counteract the consumer protections introduced through various Acts and regulatory bodies. In this article we take a look at some of the issues he raised and offer some of our views on these issues.

The first point is that "the financial services industry does not seek to comply with both the letter and the spirit of the law." This comment does not single out a particular player in the industry. Instead it identifies the broadness of the problem in the financial services industry today. Disregard for the letter and spirit of the law does not occur exclusively among product providers or intermediaries and is confined to pockets among all stakeholders in the industry.

Greed, identified by Pillai as a major driver for irregular practices in the industry, was also singled out by Cameron. Unfortunately "an excessive interest in profit and bonuses" results in industry players forgetting that they are custodians of their customer's money.

Regulators are fighting on too many fronts

"Fragmented regulators" are a major cause for concern too. Nowhere is this fragmentation clearer than when one first tries to report a financial transgression. Who does one approach? The Financial Services Board, the National Credit Regulator, the Reserve Bank, one of the many industry Ombudsman? The list is endless and results in reported transgressions being pushed from pillar to post by regulators. Long delays in assigning ownership to a problem result in transgressors operating unchecked for far longer than they should. Regulators need to take collective responsibility for policing the financial services industry and should share the burden of investigating and prosecuting transgressors.

Regulators are also faced with "a lack of resource and capacity." They are understaffed and unable to effectively handle the volume of investigations that they should undertake to stop unethical industry practices. As an example, the FSB was initially so focussed on administrative issues and issuing licenses that it turned its attention from the irregular activities it should have been policing. To date the organisation is still not able to effectively police the licences it has issued.

Scams thus operate for months or years before appropriate action is taken. Fidentia is a case in point. Apart from the fact that J Arthur Brown should never have been granted a license to operate in the capacity he did, it took months from the time the FSB was alerted of a possible problem to the time a curator was finally appointed. The bulk of the damage may already have been done, but long delays allow perpetrators of financial fraud time to cover their tracks and perhaps squeeze a few additional pennies from their victims before being shut down.

"Weak media and poor consumer education" also contribute to the problem. Concerns about the media's ability to identify and investigate financial scandals were also raised by Professor Anton Harber, Caxton Professor of Journalism at Wits University. He believes the impact of modern technology (particularly the Internet) has severely impacted on the quality of investigative journalism in South Africa.

The final concern raised was that of "poorly skilled retirement fund trustees." Indeed, if these individuals were properly apprised of their ethical and moral obligations as custodians of investor funds many of todays pension fund scandals might not have occurred.

The industry is custodian of investor funds

It is clear from the panel discussion and ensuing question and answer session that all players in the financial service industry need to embrace the fact that they are custodians of investor money.  The fight against financial fraud and misrepresentation will have to move to the realm of ethics and morality. There are simply too many holes in the regulators defences for individual investors to feel completely protected at present.

Editor's thoughts:
When we were younger we soon learned that too much of a good thing was bad. South Africa has a staggering number of Acts and regulatory bodies with the specific role of protecting consumers. This is nowhere better demonstrated than in the financial services sector. Should we consider ways to streamline the regulatory environment by perhaps some of the consumer protection bodies? Send your comments to gareth@fanews.co.za