Image: Michael Noel The scandal has had a profound impact on thousands of investors, many of whom lost their life savings. The losses are estimated to range upward of R1,2 billion and is one of South Africa’s largest Ponzi schemes.
As shocking as the above revelations were, unfortunately, this is not the first time (nor will it be the last) that investors have been duped into investing into fraudulent schemes. Everyone has heard of Bernie Madoff, Alan Stanford or Jordan Belfort, but, closer to home, how many people have heard of Gary Porritt, J Arthur Brown, Mirror Trading, Lion’s Share Ponzi scheme or Sharemax?
And now, with rumours circulating in Northern Johannesburg of the collapse of yet another fraudulent investment scheme, this article seeks to understand why people continue to be deceived into investing in such schemes, and dives into the simple questions any investor should be asking before committing their hard-earned savings into an investment vehicle.
The role of a Financial Advisor
Financial Advisors in South Africa are regulated by various authorities to ensure that they operate ethically and in the best interest of their clients. The main regulatory framework is set by the Financial Advisory and Intermediary Services (FAIS) Act which is enforced by the FSCA. Most importantly, advisors are required to be licensed by the FSCA to meet competency, honesty and operational standards and to ensure their advice aligns with the client’s goals and risk profile. An advisor has a duty to disclose all fees, commissions and incentives associated with an investment product and any (and all) conflicts of interest. They are legally required to explain the risks involved, provide complete information of the products recommended and to disclose their qualifications, experience and any limitations of advice.
One wonders whether potential investors are aware of these requirements and their rights when making an important investment decision? If an advisor cannot produce the above information or is hesitant in explaining any fees, commissions, conflicts of interest or product features – walk away. The Financial Planning Institute of South Africa (FPI) is a professional body for advisors in South Africa and promotes the highest standards of professionalism, ethics and competency within the industry. Is your advisor registered with the FPI and a member of good standing? It is your right and responsibility to ask these questions and ensure that you are comfortable with the answer.
The role of a custodian
Ultimately, a custodian holds and safeguards financial assets, protecting them from loss. Custodial services include facilitating the settlement and clearing of trades and the timely and accurate transfer of securities and cash. Custodians also provide investment administration services and security lending services. However, their primary function is to safeguard your cash. A custodian will never, ever make payments to a third party or to any bank account other than your nominated bank account. Whenever news of a new investment fraud breaks, my first thought is “who is the custodian”, and the answer usually is, “there is none”. Too often investors have happily transferred funds to an “investment trust” bank account or company bank accounts where there is no protection or safeguards and where the Ponzi scheme manager has full access to their cash. Always ensure you know who provides custodial services and ensure there is an appointed custodian.
The role of the investment or fund manager
A Financial Advisor advises, a custodian safeguards, and a fund manager invests your cash in a portfolio/s that aligns with your agreed risk profile and financial goals. The fund manager could be a stock broking firm, an asset management firm or a discretionary fund manager. What they all have in common is that they will invest your cash in line with an agreed mandate in a portfolio/s of your choosing. As with advisors, they operate in a highly regulated industry and are required to uphold the utmost requirements of care and diligence and are also required to ensure they meet the legislated capital adequacy rules and hold the requisite insurances. Always ensure you know who the fund manager is, how they will be investing your cash and the fees they charge. As with advisors, all this information is required to be disclosed in simple, plain and understandable language. As an investor you have the right and responsibility to ask questions where anything is unclear.
The above role players provide an invaluable service to investors, operate in a highly regulated environment, and each have their place in the value chain. Onboarding a new client is not an easy task, and clients should draw comfort from the numerous checks and safeguards that are in place to ensure all is above board (as tedious as the paperwork can be). Simply transferring money to an “investment account” because the “fund manager” seemed like a “good guy”, or was recommended by a friend who said he could guarantee returns better than the market, is not good enough.
Ask the simple questions and double check the answers:
- Verify that the fund manager and advisor are regulated – check the FSCA and the FPI website.
- Ensure you know who the custodian is – who ultimately holds the cash and securities.
- Are those securities held in client money accounts separately from the bank/ platform’s assets?
- Be very sceptical of investments that promise huge or guaranteed returns for little or no risk.
- Avoid the investment if you don’t understand how returns are generated, or you cannot get complete information about them.
- Ensure you receive full disclosures (as required by law) from advisors and product providers and that you are comfortable with the information provided.
- Understand the risk return trade off and if you are unsure, consult with a reputable, experienced and qualified advisor. Managing money is difficult and there is no “get rich quick” scheme.
Above all, take responsibility for your money and try to avoid common investment biases once you have verified the credibility of the above industry role players.
Common pitfalls to avoid:
- Herding or jumping on the bandwagon.
- Confirmation bias –seeking out and emphasizing information that supports your decision making.
- Overconfidence effect – overestimating your ability and refusing to listen or take advice.
- Status Quo bias –being resistant to change.
- Familiarity bias – investing in products you are familiar with to avoid uncertainty.
- Anchoring bias – relying on one single piece of information and illogically sticking to it.
- Narrative bias – giving greater weight to a story than the facts.
- Restraint bias – the tendency to overestimate the amount of self-control you have.
The industry has come a long way in regulating the role players and providing information for clients to make informed decisions, but it is not always enough to prevent the scammers.
Always remember, if it sounds too good to be true, it generally is. DM