Presentation on “secret profits” and related matters to

the Parliamentary Portfolio Committee on Finance

Bruce Cameron

Editor: Personal Finance

Agenda

• Reasons for Personal Finance focus on Alexander Forbes

• The extent of the problem

• The role of senior executives

• Action required

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).

Alexander Forbes: A Case Study

• Alexander Forbes is the biggest single retirement fund administrator in terms of funds/members/assets 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

The extent of the problemAlexander 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

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

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.

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”

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

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

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)

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.

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)

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.

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

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.

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

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

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

An Equation to Ponder

Secret profits/Poor Governance

equals

Higher company profits

equals

Higher share price

equals

Massively enriched executives

equals

Poorer Pensioners

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

Action Required1. Industry-wideIt 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

In ConclusionPersonal 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

Questions?

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/s8. 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 time10.2 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.12. Why are the data bases of Alexander Forbes asset management consultants merged with those of Investment Solutions? 13. Who were the board members and chief executive officers/managing directors of Alexander Forbes six months before and six months after :13.1 the ownership of Forbes Life was changed13.2 Peter van Niekerk of Routledge Modise Moss Morris gave the “not lawful” legal opinion13.3 settlements were reached with Amplats and Bidvest funds13.4 the ownership of Forbes Life was changed13.5 The Alexander Forbes legal department provided a legal opinion of the FIHRST imprest system

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

1. 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, broking1.2 Commissions/fees on any product or service1.3 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 benefits1.5 Scrip lending1.6 Dividend sales1.7 Transitioning of assets1.8 Structured products1.9 Steering business to associated companies where profits are made (e.g. banks, short and long term insurance companies, asset managers, trust

companies)2. The names of each of the companies, institutions or preferred providers involved in any of the above (1)3. 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/individual3.3 Assess the interest rate will be paid3.4 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.4.2 Whether these incentives are explicitly disclosed and the implications explained to trustees and approved by trustees.4.3 Identification of business flows between administrators and associated companies that is not explicitly disclosed to trustees4.4 What products and services are required in terms of contracts, or indirectly by imposing penalties/fees in terms of any contracts/Agreements with

retirement funds (e.g. housing loans for fund members)5. Trustee training. In trustee training courses provided by fund administrators are trustees explicitly trained to:5.1 Identify and manage conflicts of interest (both personal and of service providers)5.2 Assess all costs including secret profits5.3 Obtain maximum benefit for their funds5.4 Draw up a code of conduct5.5 If not, why not6. Does any administrator or associated company or short term insurance company provide cell captive/self insurance which permits:6.1 Any company to pay premiums at its discretion (which are held and earn interest) effectively deferring tax.