November 7, 2009
 By Bruce Cameron
Collective investments, which are generally well regulated in South Africa, mostly offer you, the investor, a safe and easy way to invest in the equity, bond, property and money markets. But recent financial disasters have forced the Financial Services Board (FSB) to tighten its control over certain aspects of the collective investment industry.
The Financial Services Board is moving to prevent further reputational damage and losses to investors in collective investment schemes in the wake of the international financial sector meltdown and the collapse of two non-compliant money market portfolios.
In a multi-pronged approach, the FSB is:
Limiting the growth of white label funds, which are increasingly being used by financial advisers to take another cut of fees out of the pockets of consumers without adding any real value;
Holding back on possible changes to regulations issued in terms of the Collective Investment Schemes Control Act (Cisca) that would have permitted investments in securities not listed on an exchange, including greater access to the derivatives market; and
Ensuring that collective investments are not provided outside of Cisca.
And, as a further warning signal to individuals and organisations that do not stick to the legal requirements when caring for the money of investors, John Levin and Barend Petersen, the curators of the collapsed Ovation linked investment services product company, state, in their sixth report to the Cape of Good Hope High Court, that they are considering suing:
The directors of Ovation and its nominee company, which was supposed to hold the assets of investors in trust;
Absa Bank, which opened the bank account through which the owner of Ovation, Angus Cruikshank, who committed suicide, stole more than R200 million in investors' money. The money was stolen from the non-Cisca-compliant Common Cents money market fund; and
The Ovation auditors, KPMG, for not reporting contraventions of various Acts.
The curators also suggest that people who were persuaded to invest in the fraudulent Common Cents money market fund could sue their financial advisers.
The curators have proof that some advisers accepted inducements of luxury foreign trips for getting clients to invest in the Common Cents fund.
The FSB is also investigating whether the advisers have contravened the fit and proper regulations. If they didn't, it could jeopardise their licences to do business.
Action against investors' clubs
The FSB has applied to the Pretoria High Court to place a number of business operations of Pretoria-based financial services group Dynamic Wealth under curatorship.
It is understood that the FSB's main concern is the group operating what the FSB considers to be illegal collective investment schemes under the guise of investment clubs.
The application is shrouded in secrecy. Documents lodged with the Pretoria High Court have been removed from public scrutiny. The exception is an application by Dynamic Wealth for disclosure of information. The document refers to the matter between the FSB and Dynamic Wealth, Dynamic Wealth Management, Dynamic Wealth Stockbrokers, The Bridging Factory and Specialist Income Fund, and associations known as Dynamic Wealth Investment Association, Retirement Fund Association, Multi-manager Association, Kwanda Association, MFI Association and Sasep Association.
Bert Chanetsa, the FSB deputy executive in charge of financial markets, says the FSB has applied to the High Court for curatorship of certain Dynamic Wealth entities.
"As there are a number of complex issues to be addressed, the application has been set down for argument in February 2010," he says.
Cobus van Wyk, the joint chief executive of Dynamic Wealth, claims in a statement that the FSB has not yet taken a final decision on whether to proceed with an application for the curatorship.
"We are of the opinion that, once they receive our opposing papers, the FSB view will change substantially, and the subjective, biased and incorrect inspection report will be set aside, and therewith the basis for any possible application," he says.
Van Wyk says the FSB's initial allegations are baseless, malicious and false, based on "factually incorrect information, fabricated evidence and assumptions transformed into fact".
He says that Dynamic Wealth has unqualified audit certificates from auditors PricewaterhouseCoopers for the investment clubs. He says the FSB has also blocked a Dynamic Wealth offer to convert the portfolios into its white label unit trust funds.
Dynamic Wealth manages the assets of seven investor clubs through which R500 million is pooled in 32 non-Cisca-compliant portfolios on behalf of more than 1 000 investors.
A current portfolio and a previous portfolio are in trouble. They are:
The Specialist Income Fund, which was sold as a low-risk investment offering "higher than money market returns", mainly to pensioners. The fund, which provided bridging finance for property developers, ran into problems when the property developers defaulted in the economic downturn. The portfolio was converted into a public company, Specialist Income Ltd, with investors given preference shares. But all income payments to investors have dried up.
The Dynamic Wealth Money Market Portfolio, which channelled investor money into the collapsed Cash Management Fund unit trust fund, with potential losses of R230 million for investors.
Clampdown on white label funds
The FSB has moved to limit the explosion of what are known as white label funds by implementing an unused 1999 recommendation of its advisory board.
White label funds are collective investment schemes (unit trust funds) managed and/or sold by an entity that does not have a licence to administer a fund, and makes use of the licence and often the administration services of a registered collective investment scheme (CIS) manager.
The main original intention of white labelling was to give start-up CIS managers ease of entry to the market.
However, increasingly the white label structure has been used by financial advisers to set up unit trust funds of funds into which they channel their clients' investments. This enables them to take both an advice and an asset management fee out of the pockets of their clients. Many of these broker white label funds have some of the highest fee structures in the market.
The FSB has launched a dual attack on broker funds. The first attack came with the publication of a code of conduct for financial services providers that stated it is a conflict of interests for advisers to place client money in a fund that they manage.
The code could make it easier for the financial advice ombud to order compensation where a broker white label fund of funds has under-performed its peers.
The second attack has come with the enforcement of an FSB advisory board recommendation that states that the white label business of a CIS management company may not be more important than its own business.
The first victim of the action is Metropolitan, which is the biggest purveyor of white label funds. Sanlam could be next in line to have its white label fund business curtailed.
Bert Chanetsa, the FSB deputy executive in charge of financial markets, says that in the aftermath of the collapse of the Cash Management Fund (CMF), a varied specialist fund that masqueraded as a money market portfolio, "we were constrained to take a primary risk-based review of the relationship between management companies and white label parties".
CMF operated under a white label provided by Ayanda, the CIS manager that was purchased from Mcubed by Fidentia shortly before it also imploded.
Chanetsa says the CMF debacle and the international financial crisis have persuaded the FSB to look more closely at the actual and likely relationship between a manager and its white label parties "when the latter becomes more significant.
"The fact of the matter is that where a manager allows a proliferation of white labels on its platform, it becomes less likely to be able to carry out oversight to the standard envisaged by the Collective Investment Schemes Control Act."
It is also understood that the FSB is scrutinising individual fund applications more closely and has recently rejected a number of applications because it is concerned about the parties involved.
Robert Walton, the chief executive of Metropolitan's management company, says he intends to appeal the FSB decision. Walton says that having 20 or 200 white label funds makes no difference, because the infrastructure is in place and the funds will operate more efficiently than would be the case if there were numerous small management companies.
Investment reforms on hold
The FSB has withdrawn a discussion document on significant amendments to the limits on the types of securities and assets in which collective investment scheme managers may invest.
The investment limits are set out in terms of Notice 1503 of 2005 issued in terms of Cisca.
The discussion document proposed a major expansion of the assets and securities that may be used, as well as easing the limitations on how much may be invested in any one security or asset. The intention was to bring South African collective investment schemes legislation in line with the European Union's standards for collective investments, known as UCITS III.
Bert Chanetsa, the FSB deputy executive in charge of financial markets, says the re-write of Notice 1503 started before the international financial crisis.
"Many lessons have been learned as the crisis has unravelled. The decision was taken to review the proposed changes in the light of these important lessons and the needs of the South African investing public."
At least one local unit trust management company has been affected by the change in tack: Coronation has been forced to close down a fund.
Pieter Koekemoer, the head of Coronation Unit Trusts, says Coronation launched the Irish-domiciled Global Latitude Fund on the basis of UCITS in anticipation of the changes in South Africa. However, it fell foul of the existing Notice 1503, because the fund was able to invest in any combination of regulated funds managed by third-party managers and direct securities, whereas local regulations do not allow this type of fund to have exposure to more than 20 percent of other funds.
No local investors had money in the Global Latitude Fund, but the fund has been closed and re-opened so that it meets the existing Notice 1503 requirements.
However, Koekemoer says he cannot fault the FSB's caution. "The current key concern with the UCITS framework relates to over-the-counter trades (the trading of assets outside of a securities exchange)," he says.
It is understood that FSB concerns also extend to the role of credit rating agencies, which have been blamed in part for the financial market meltdown of the past year. Rating agencies were destined to play a greater role in assessing non-listed securities in terms of the proposed changes.
  
 
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