Presentation on

1
Presentation on secret profits and related
matters to the Parliamentary Portfolio Committee
on Finance

• Bruce Cameron
• Editor Personal Finance

2
Agenda

• Reasons for Personal Finance focus on Alexander
  Forbes
• The extent of the problem
• The role of senior executives
• Action required

3
Four quotes

• We have already stated that, in relation to the
  historic income earned for the practice of
  bulking we have not met the disclosure
  standards to which we aspire- Peter Moyo in an
  open-letter advertisement. May 2006
• Anyone who controls the funds of a financial
  institution, which includes a retirement fund
  "must, with regard to such funds, observe the
  utmost good faith and exercise proper care and
  diligence" - Financial Institutions (Protection
  of Funds) Act.
• Any profit made by an agent in agency
  transactions may be claimed by the principal
  despite the fact that the agent may have acted in
  good faith and without the intention to deceive
  the principal. The agent is required to show it
  made complete disclosure to the principal and
  that the principal acquiesced to the transaction.
  The principal can acquiesce to a transaction
  before or after the event, but the waiver by the
  principal of its right to claim the value of any
  undisclosed profits from the agent must be given
  freely and with full knowledge of the material
  facts - The Common Law of Agency
• "Where one man stands to another in a position of
  confidence involving a duty to protect the
  interest of that other, he is not allowed to make
  a secret profit at the other's expense or place
  himself in a position where his interests
  conflict with his duty." - Judgment in Robinson v
  Randfontein Gold Mining Company (1921).

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Alexander Forbes A Case Study

• Alexander Forbes is the biggest single retirement
  fund administrator in terms of funds/members/asset
  s under management (950 funds. 1.4 million
  members)
• Nearly every unacceptable and not lawful
  practice in the industry pertains at Alexander
  Forbes.
• Evidence in the possession of Personal Finance
  indicates a pervasive culture of unacceptable
  corporate governance and an alarming lack of
  ethical behaviour. It is substantially more than
  a failure to properly disclose bulking activity.
  
• Personal Finance does not have the resources to
  investigate every retirement fund administrator,
  service provider and product provider.
• Personal Finance has evidence of unacceptable
  behaviour at numerous other companies that has
  been passed on to the FSB

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The extent of the problem

• Alexander Forbes mercilessly plundered retirement
  funds it administered over a period of at least
  10 years by
• Deliberately misleading naïve, ill-trained fund
  trustees
• Conspiring with employers (mainly over surplus
  distribution)
• Creating a false sense of security with a massive
  on-going campaign, claiming that it is
  independent and acts in the best interests of
  consumers, while the opposite was true
• Failing to properly declare and manage serious
  conflicts of interest
• Failing to act with fairness, due care and
  diligence towards the funds to which it had and
  has a fiduciary duty
• Failing to observe both the spirit and the letter
  of the law. This includes the laws of this
  parliament, common law and case law.
• Using bully-boy tactics on its staff, other
  industry players and even service provider
  companies (e.g. Information Technology), to get
  their retirement funds into the AF web

6
Attempted Cover-up?

• Alexander Forbes has in the process of the
  Personal Finance investigation
• Subjected Personal Finance to legal threats and
  other pressures in an attempt to prevent or limit
  publication of the secret profit reports.
• Given Personal Finance false information on a
  number of occasions.
• Attempted to discredit reports in Personal
  Finance by claiming in statements to retirement
  fund trustees that the reports were among other
  things vindictive, sensational, biased and
  incorrect.
• Failed to answer many questions on issues of
  unacceptable activity that have been unearthed by
  Personal Finance.
• Final test of any cover-up will come with the
  joint report of Ernst Young and Deloitte into
  unacceptable practices. A further test is whether
  the full report is released to trustees and
  members of retirement funds and their members

7
The Alexander Forbes Business Model

• Build a client base of retirement funds by
  offering comparatively low administration fees.
  Low fee structure is made possible by a wide
  range of secret and not explicitly disclosed
  costs and profits
• A one-stop-shop, from trustee training to
  provision of all products and services by itself,
  associated companies and what are called
  preferred providers. Alexander Forbes claims it
  provides independent advice and services. In
  effect it offers inter-dependent rather than
  independent advice and services.
• Incentivises AF and other consultants with a
  wink-and-a-nudge bonus system based on the
  amount of business directed to Alexander Forbes,
  its associated companies and preferred service
  and product providers. These bonuses were/are not
  explicitly declared to fund trustees. Example
  For Investment Solutions business the bonus is an
  average of 0.03 percent of assets.

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The Business Model Consequences

• Retirement members are disadvantaged by
• Secret or not explicitly disclosed profits/
  commissions/ rebates/ discounts/ fees across a
  wide range of products and services (Not limited
  to bank accounts)
• Inappropriate advice as a result of substantial
  unmanaged conflicts of interest leading to the
  use of inappropriate products and services
  resulting in
• - Indirect opportunity costs and
• - Additional direct costs.
• Note The issue is not how well retirement funds
  have done but how much better they would have
  done

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Secret Profits 1

• Secret or not explicitly disclosed profits
  have been made by Alexander Forbes in many ways
• Pernicious 3D Assurance investment policies
  (Exposed by Personal Finance in 1998). Double
  cost (once for asset management and then
  commissions) with potential tax liability for low
  income members.
• Bulking of bank accounts (Exposed by Personal
  Finance in February 2006). Continued for two
  years despite legal opinion that it was not
  lawful and secret settlements with some large
  funds that found out.
• The FIHRST imprest accounts. Benefits and
  contributions channelled through a third party.
  Interest earned and attributed to shareholders of
  FIHRST. Initially Alexander Forbes and Standard
  Bank then Alexander Forbes alone. (Exposed by
  Personal Finance in April 2006). Contravention of
  Pension Funds Act

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Secret Profits 2

• Insurance
• - Cash flows from premiums and benefits on
  both short and long term insurance. Payment of
  contributions to underwriters are delayed by as
  long of 45 days. Interest is earned in the
  intervening period. Insurers remain at risk for
  intervening period so may charge higher premiums.
  (still being investigated by Personal Finance)
• - Broking of reinsurance made a condition for
  directing risk business to a preferred provider.
  Alexander Forbes earns commission on the
  re-insurance contract.
• - Commissions/ rebates/ administration fees
  paid for directing out-sourced pensions. This may
  result in a higher capital (guarantee) charge and
  lower future pension increases for pensioners.
• - Alexander Forbes-owned broker companies
  directing business to AF-owned short-term
  underwriter, Guardrisk

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Secret Profits 3

• Delayed benefit payments
• - Risk benefits (death and disability
  payments).
• - Withdrawal benefits
• - Retirement benefits (particularly lump
  sums)
• Housing loans to retirement fund members.
  Virtually obligatory to use Alexander
  Forbes/ABSA joint venture company. Use of another
  bank results in an administration charge of
  about two percent making it uncompetitive.
• Disability assurance screening service for a fee
  on behalf of underwriters before payment of
  disability assurance benefits (secret fee and
  conflict of interest)

12
Secret Profits 4

• Asset management
• Investment Solutions multi-manager
  subsidiary. While a listed company its profits
  were seen as excessive in relation to fees
  charged to retirement funds. Additional profits
  come from
• - Arrangements with underlying asset
  managers. These arrangements include
• Investment Solutions fee to funds
  relatively high (up to 0.75 percent)
• Fees paid by IS to underlying asset
  managers (up to 0.25 percent)
• In return underlying asset managers
• Charge performance fees that are
  often not disclosed or
• agreed by retirement fund trustees.
• Churn portfolios, often without
  proper controls by the multi-
• manager and retirement fund
  trustees, increasing costs and
• reducing returns and allowing for
  rebates on stockbrokers fees.

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Secret Profits 5

• Asset management (Continued)
• - Lending of scrip (at a price) owned by
  retirement funds and individual investors in the
  derivative markets. (This also entails counter
  party risk)
• - Dividend sales (part of a tax avoidance
  scheme). Could have tax consequences for
  retirement funds as they then earn interest
  instead of dividend income
• - Additional asset management charges at
  multi-manager and underlying manager levels (e.g.
  administration for collecting dividends)
• - Transitioning of assets. Charges for
  changing the asset composition of a new
  retirement fund client. (Rebates of stock broker
  fees)

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Secret Profits 6

• Asset management (Continued)
• - Structured products (Biggest offender is
  NMG). Full costs/commissions were seldom
  declared. Fee split arrangement with Morgan West.
  Products mainly inappropriate for retirement
  funds
• - Joint venture agreements
• Caveo - an Investment Solutions/Peregrine
  hedge fund multi-
• manager (Mainly inappropriate investment
  fad for retirement funds need hedging,
• not hedge funds)
• Frank Russell for international
  investments (not necessarily
• bad but cost structures are unclear)
• - Increased investment choice. Most members
  are unable to exercise choice
• properly. Costs higher and not fully
  disclosed.

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Profit-driven advice 1

• There are a number of areas where advice
  provided by Alexander Forbes (and other)
  consultants was often questionable, inappropriate
  and not in the best interests of retirement fund
  members. These include
• The drive from defined benefit to defined
  contribution funds. Consequences
• - Risk transferred to members
• - Opened the way for creative ways to raid
  surpluses. Some examples
• Transfer of member contributions only
  to DB funds
• Contribution holidays
• Lifecare (Ghavalis) arrests. The role
  of senior Alexander Forbes executives still to
• be explained
• Inappropriate use of surplus to avoid
  medical aid liabilities
• Transfer of only member contributions
  leaving surpluses in DB funds for improved
• pensions for executives remaining as
  members
• - Opened the way for more business to
  Investment Solutions

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Profit-driven advice 2

• Encouragement of wide investment choice for
  individual fund members (often too conservative
  or aggressive) at additional cost
• Use of products/services of Alexander Forbes, its
  associated companies and preferred providers.
  (Examples Short-term insurance, including
  Guardrisk risk assurance products and
  investment products, such as structured
  products). Issue is the opportunity cost.
• Move to high cost umbrella funds with significant
  conflicts of interest
• Advice on annuity (pension) products (e.g.
  out-sourcing of funds and high risk living
  annuities)
• Health insurance products, which could be
  contrary to the Medical Schemes Act, create
  penalties for someone when they finally join a
  medical scheme.

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The role of senior executives

• Some background (The listing of Investment
  Solutions)
• Forbes Life (a company with a limited, linked
  life licence) 100 owned by Alexander Forbes.
• Ownership changed by more than 25 percent
  (Registrar of Long Term Insurance not notified
  timeously as required)
• New minority shareholders all senior executives
• Alexander Forbes Board approved change of
  ownership retrospectively
• Name of Forbes Life changed to Investment
  Solutions
• Assets sold/transferred from Alexander Forbes to
  Investment Solutions pre-listing
• Questionable valuations. Example AF subsidiary,
  Multirand valued at R60 million was changed to
  R20 million and sold to Investment Solutions. The
  role of PWC in the valuation changes.
• Limited linked life licence, means all profits
  less administration fees, must go to retirement
  funds. This includes profits from scrip lending
  and dividend sales

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The senior executives The minority shareholders

• The new minority shareholders of Forbes Life
  (Investment Solutions)
• Graeme Kerrigan, former chief executive and
  chairman of Alexander Forbes 11 million shares
  at par. Makes more than R100 million
• Leon Lewis, former joint managing director 11
  million shares at par. Makes more than R100
  million
• Rael Gordon, first CEO of Investment Solutions,
  and who has resigned as CEO of Alexander Forbes,
  without making a single statement on the secret
  profits issue Makes more than R50 million
• Dick Wood, former senior executive Makes more
  than R50 million.
• Gary Herbert, former senior executive Makes more
  than R50 million.
• And.this is only with Investment Solutions
• Kerrigan, Lewis and Gordon have to a greater or
  lesser extent received free stakes in other
  associated companies, significant share options
  etc.
• They are wealthy beyond the imagination of
  ordinary fund members, at the expense of those
  fund members

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The role of senior executives

• Many of the unacceptable practices were
  conceived, driven and maintained by some senior
  executives
• Personal Finance has been told of wide-spread
  bullying of staff into accepting the unacceptable
  practices
• Senior staff leaving Alexander Forbes were forced
  to sign secrecy agreements
• Senior executives were aware of the adverse legal
  opinions (bank account bulking and the imprest
  account) but did not halt the practices

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An Equation to Ponder

• Secret profits/Poor Governance
• equals
• Higher company profits
• equals
• Higher share price
• equals
• Massively enriched executives
• equals
• Poorer Pensioners

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Action Required

• 1. Alexander Forbes
• A full Financial Services Board investigation
  into Alexander Forbes. If necessary Alexander
  Forbes should be placed under judicial or joint
  management for the duration of the investigation
  if it fails to co-operate fully. The Alexander
  Forbes self-investigation is not sufficient.
• An investigation into whether any individuals
  contravened laws, such as the Financial
  Institutions (Protection of Funds Act, the
  Pension Funds Act, the Long Term and Short
  Insurance Acts, the Companies Act and the extent
  of their personal liability

22
Action Required

• 1. Industry-wide
• It is clear that the retirement funding industry
  has treated the retirement savings of millions of
  individuals as a ready source of profits and for
  the massive self-enrichment of avaricious senior
  executives. For this reason
• FSB investigations are required into all
  companies with similar practices
• A judicial commission of enquiry into the
  retirement funding industry is required.
  Rationale is high costs, Pension Fund Adjudicator
  rulings, secret profits, unmanaged conflicts of
  interest and the need to ensure retirement fund
  members receive reasonable retirement benefits
• Consideration should be given by the National
  Treasury to
• - Establishing fully-funded industry sector
  retirement funds (e.g. Government Employees
  Pension Fund) with services and products
  out-sourced to private sector. Funds to provide
  minimum pensions
• - Allowing private sector to provide top-up
  retirement products.
• - Establishing an independent academy for
  the training of trustees

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In Conclusion

• Personal Finance could not have done it alone.
  Thank you to the people who have assisted in
  exposing this scandal, including
• To this committee for holding this meeting
• Finance Minister, Trevor Manuel, and his deputy,
  Jabu Moleketi
• The Financial Services Board, in particular, Dube
  Tshidi
• The many people who provided Personal Finance
  with information but who must remain anonymous
• The legal team that supported Personal Finance
• Senior executives of Independent Newspapers who
  provided the backing to Personal Finance

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Questions?
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Questions Alexander Forbes needs to answer
include

• 1. Were the members of the Alexander Forbes Board
  informed of the legal opinion provided by
  Routledge Modise Moss Morris in 2002 saying that
  the bulking of retirement fund bank accounts to
  make secret profits was not lawful and of the
  settlements made with the Amplats and Bidvest
  retirement .
• 1.1 If the board was not informed, why not.
• 1.2 If the board was informed, the board members
  should individually explain why they did not
  insist on an immediate halt to the practice.
• 2. Peter van Niekerk, the lawyer from Routledge
  Modise Moss Morris, who gave the not lawful
  opinion, shortly afterwards became a member of
  the Alexander Forbes board. He needs to explain
  what he did to stop the practice of not lawful
  bulking as a board member.
• 4. Who initiated the not lawful secret profit
  schemes and who in senior management approved the
  schemes?
• 5. Was VAT paid on fees charged by Alexander
  Forbes to banks in the later stages of the bank
  account bulking exercise. If not, why not?
• 6. Whether retirement fund members who were
  placed in 3D policies were compensated for any
  tax liability that may have arisen (i.e. anyone
  with a marginal rate of less than 30 percent) as
  well as for any additional costs, including
  commissions, over and above the normal fees paid
  by funds/members for the AF services.
• 7. What valuations were applied and what
  adjustments were made to the valuation of assets,
  particularly those of Multirand, that were
  transferred from Alexander Forbes to Investment
  Solutions at the time of the listing of
  Investment Solutions.
• 7.2 If the valuations were altered what was the
  reason for this and who initiated and approved
  these changes.
• 7.3 What role did PWC play in these revaluations.
• 7.4 Did any employee of PWC involved in these
  valuations later join the staff Alexander forbes
  or its associated companies. If so who was the
  person/s
• 8. What share ownership and share options were
  senior executives of Alexander Forbes given in
  Alexander Forbes and its associated companies,
  particularly at the time of the listing of
  Investment Solutions.
• 9. Why the FSB was not informed timeously of the
  ownership changes at Forbes Life changes.
• 10. The role of Alexander Forbes in the Lifecare
  surplus affair, including
• 10.1 Which senior executives were aware of the
  scheme at the time
• 10.2 When Peter Martin, a former actuary, and
  Neil van Hees, the former marketing left the
  employ of Alexander Forbes did they receive
  agreement that Alexander Forbes would pay legal
  fees involved with any legal action over
  Lifecare. If so, why?
• 11. Who owns the Alexander Forbes head office
  property in Katherine Street and what rentals
  were paid by Alexander Forbes. Were any
  alterations made to these rental flows contrary
  to any lease agreement. If so why?
• 10. Why Alexander Forbes ignored at least one
  legal contract (Cape Municipal) with a retirement
  fund on obtaining the best interest rates for a
  fund. In how many other cases did this happen.
• 11. Whether the company will lay criminal charges
  and/or make civil claims against any of the
  people involved in any not lawful activity. If
  not, why not.

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Questions that all retirement fund
administrators, including Alexander Forbes, need
to answer include

• What direct or indirect profits have been made,
  both lawful and not lawful, by retirement fund
  administrators, their associated companies, joint
  venture and preferred providers that were not
  explicitly declared and approved by retirement
  fund trustees by way of
• 1.1 Bulking in an area including bank
  accounts, cash flows, money market accounts,
  asset management, broking
• 1.2 Commissions/fees on any product or
  service
• 1.3 Rebates/kickbacks paid on any product or
  service (e.g. from other service or product
  providers, such as long and short term insurance
  companies, stock brokers)
• 1.4 From cashflows, which may or may not
  have been bulked (E.g. contributions, payment of
  benefits, long and short term insurance premiums
  and benefit payments).
• 1.5 Delays in payments of contributions,
  premiums and payment of benefits
• 1.5 Scrip lending
• 1.6 Dividend sales
• 1.7 Transitioning of assets
• 1.8 Structured products
• 1.9 Steering business to associated companies
  where profits are made (e.g. banks, short and
  long term insurance companies, asset managers,
  trust companies)
• The names of each of the companies, institutions
  or preferred providers involved in any of the
  above (1)
• What action has been taken in each of the above
  cases (1) to
• 3.1 Asses the amount of money involved.
• 3.2 Assess what is due to each retirement
  fund/individual
• 3.3 Assess the interest rate will be paid
• 3.4 When the amount owing will be paid
• 4. Conflicts of interest.
• 4.1 What incentives are provided to consultants
  to direct trustees towards and use services and
  products provided by the administrator, its
  associated companies and preferred providers.