Transcript Document

BULKING BY RETIREMENT FUND
ADMINISTRATORS
Presentation to Pension Lawyers Association
Quarterly Sessions June 2006
By
JONATHAN MORT
(with acknowledgement to Adv M Wallis, SC)
Circular by FSB to Administrators dated 24 March
2006
“2.
Administrators are financial institutions in terms of
the FSB Act, and as such fall to be supervised by
the FSB and are in particular subject to the
provisions of the FI Act and the FAIS Act.
FSB Circular (cont)
3. When dealing with pension fund monies under their
control, institutions like administrators are required by
the law to observe the utmost good faith, to exercise
proper care and diligence, to refrain from gaining directly
or indirectly improper advantage for themselves for the
prejudice of their principals (the pension funds
concerned) and to avoid conflicts of interest. The
motivation for these requirements is that administrators
stand in a relationship of trust vis a viz the pension funds
whose money they administer.
FSB Circular (cont)
4.
By way of example, the following practice would be unlawful:
an administrator consolidates or “bulks” credit balances of
pension fund bank accounts under its control and thereby
procures a higher rate of interest from the bank. All interest
yielded is not passed on proportionately to the pension funds
entitled thereto and the additional interest derived from the
consolidated amount, goes for the benefit of the administrator.
This “secret profit” is also not disclosed to the boards of
management of the pension funds.”
Registrar confirmed that bulking itself was unlawful.
Administrators’ Views
View of administrators varies –
– don’t do bulking – each fund receives the same interest as an
individual entity;
– a fund receives a higher rate of interest through bulking but the
administrator benefits, either through an agreed fee or not;
– bulking takes place but each fund receives the full benefit of that.
FAIS Act
• Section 45(1)(a)(iii) – FAIS does not apply to section 13B
PFA administration “to the exent that the rendering of
financial services is regulated under the PFA”.
• Cannot determine the extent to which FAIS applies to
bulking by administrators.
• Purpose of FAIS Act is to require that persons who act
as FSPs are licensed to do so.
• There are special provisions relating to corporates.
• The conduct of FSPs is strictly regulated under
prescribed codes of conduct.
FAIS Act (cont)
• Per section 16(1) codes of conduct must prescribe that
FSPs “act honestly and fairly, and with due skill, care
and diligence, in the interests of clients and the integrity
of the financial services industry”.
• This is the same standard in the common law (Durr v
ABSA 1997 (3) SA 448 SCA).
• FAIS is not relevant to bulking by administrators.
FI Act (Financial Institutions (Protection of Funds)
Act, No. 28 of 2001)
• Both the administrator and a retirement fund fall within
the definition of “financial institution”.
• Definition of “trust property” –
“Any corporeal or incorporeal, moveable or immovable
asset invested, held, kept in safe custody, controlled,
administered or alienated by any person, partnership,
company or trust for, or on behalf of, another person, or
partnership, company or trust, and such other person,
partnership, company or trust is hereafter referred to as
principal.”
FI Act (cont)
“Section
•
2 – Duties of Persons Dealing with Funds of, and with Trust Property
controlled by, Financial Institutions:
A director, member, partner, official, employee or agent of a financial institution…who
invests, holds, keeps in safe custody, controls, administers or alienates any funds of
the financial institution or any trust property –
(a)
must, with regard to such funds observe the utmost good faith and
exercise proper care and diligence;
(b)
must, with regard to the trust property and the terms of the instrument or
agreement by which the trust or agency in question has been created, observe
the utmost good faith and exercise the care and diligence required of a trustee
in the exercise or discharge of his or her powers and duties; and
(c)
may not alienate, invest, pledge, hypothocate, or otherwise encumber or
make use of the funds or trust property or furnish any guarantee in a manner
calculated to gain directly or indirectly any improper advantage for himself
or herself or for any other person to the prejudice of the financial institution or
principal concerned.”
Note criminal sanction in section 10.
FI Act (cont)
• Is it correct that the FI Act applies to the bulking issue?
• Section 2 applies to individuals, not the administrator.
• Sections 3, 4 and 5 also apply to individuals only.
• Why should the Act distinguish between individuals on
the one hand and financial institutions on the other?
FI Act (cont)
• Administrator already owes a fiduciary duty at common
law as agent to its principal (the fund).
• This fiduciary duty to the fund does not extend at
common law to the employees of the administrator.
• FI Act appears to fill a gap by imposing a fiduciary duty
on the employees and goes further by holding the
employees criminally liable.
• Can it be said that by implication if the employees are
liable in terms of the FI Act then the administrator is also
liable?
FI Act (cont)
• An employer is only vicariously liable for the actions of its
employees which are within the course and scope of
their duties.
• The provisions of sections 2, 3 and 4 are aimed at
conduct of employees for which an employer may not be
vicariously liable.
• Section 2(c): an employee may make a secret profit but
the employer is not liable for this.
• Also criminal sanction.
FI Act (cont)
• Reference to the FI Act in the Registrar’s circular
appears to be incorrect.
• The issue of whether bulking is lawful must be decided
according to common law principles.
• The relationship between the administrator and the fund
is one of agency.
• The administrator accordingly owes a fiduciary duty to
the fund.
Fiduciary Duty of Administrator
• What is the content of “fiduciary duty”?
• Per Philips v Fieldstone Africa (Pty) Ltd 2004 (3) SA 465 (SCA) –
“There is no magic in the term “fiduciary duty”. The existence of
such a duty and its nature and extent are questions of fact to be
adduced from a thorough consideration of the substance of the
relationship and any relevant circumstances which affect the
operation of that relationship. While agency is not a necessary
element of the existence of a fiduciary relationship, that agency
exists will almost always provide an indication of such a
relationship.”
Fiduciary Duty of Administrator (cont)
• Also, per Philips v Fieldstone Africa (Pty) Ltd, supra –
“It is the nature of the relationship, not the specific category of act
involved that gives rise to the fiduciary duty. The categories of
fiduciary, like those of negligence, should not be considered
closed… (the) relationship in which a fiduciary obligation has been
imposed are marked by 3 characteristics –
(1)
(2)
(3)
scope for the exercise of some discretion or power;
that power or discretion can be used unilaterally so as to affect
the beneficiary’s legal or practical interests; and
a peculiar vulnerability to the exercise of that discretion or
power.”
Fiduciary Relationship and Secret Profits
•
Per Robinson v Randfontein Estates 1921 AD 168 –
“Where one man stands to another in a position of confidence involving a duty to
protect the interests 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. The principle underlies an extensive field of legal relationship. A guardian to his
ward, solicitor to his client, an agent to his principal afford examples of persons
occupying such a position…the doctrine is to be found in the civil law, and must of
necessity form part of every civilized system of jurisprudence. It prevents an agent
from properly entering into any transaction which would cause his interests and his
duty to clash. If he is employed to buy, he cannot sell his own property; if employed to
sell, he cannot buy his own property; nor can he make any profit from his agency
save the agreed remuneration; all such profit belongs not to him but to his principal.
There is only one way by which such transactions can be validated, and that is
by the free consent of the principal following upon by a full disclosure by the
agent.”
Fiduciary Relationship and Secret Profits (cont)
• There is one rule only, that a fiduciary may not receive any benefit
than the agreed remuneration, and only one exception to this: on
the fully informed consent of the principal.
• Per Philips v Fieldstone, it is no defence by the agent (administrator)
to say that –
– the fund did not suffer a loss;
– the fund could not have made use of the opportunity, or probably would
not have done so;
– the fund, although it could have used the opportunity, has refused it;
– there is no contractual relationship between the fund and the third party
from whom the benefit was received, and the benefit would not have
accrued to the fund anyway;
– the administrator was not obliged to obtain the benefit for the fund.
– the administrator acted reasonably and honestly.
Standard of Care Required of an Administrator
• What is the standard of care required of an
administrator?
• This is relevant to the issue of whether bulking is lawful
or not.
• The standard of care is that of a reasonable competent
administrator.
• This is a specialized task which is regulated (by the FSB)
and to which the courts would require to involve a high
level of skill and care.
• Van Wyk v Lewis 1924 AD 438
• Durr v ABSA Bank 1997 (3) SA 448 (SCA)
Lawfulness of Bulking
• Bulking is not unlawful in the sense that it is prohibited
by law or contrary to legal obligations.
• Sackville West v Nourse 1925 AD 156
• Estate Richards v Nichol 1999 (1) SA 551 (SCA)
• A competent administrator, having the requisite high
level of skill and care, and operating within a financial
services environment, should be aware of the benefits of
bulking and should endeavour to obtain it.
How Does Bulking Take Place
• The bank treats all the flagged fund bank accounts as one for the
purpose of determining the interest rate applicable to each, and all
that interest is then credited to each bank account by the bank. The
administrator may then debit an additional fee from the bank
account; or the bank may make payment of a rebate, which would
otherwise have accrued to each fund bank account as interest,
direct to the administrator so that it does not appear in the bank
account of the fund.
• A sweeping arrangement, whereby all the interest attributable to
each account of all the funds administered by the administrator are
paid into a single bank account in the name of the administrator, and
then allocated from there by the administrator amongst the bank
accounts of each fund after deduction of the fee by the
administrator.
Problem Areas
• Administrator adding its own funds to the pool of monies
of the funds also to receive the high rate of interest that
the funds receive.
• The bulking arrangement requires a minimum total
amount and the administrator adds its own funds to
ensure that this limited is obtained; but also benefits from
this.
• The bank concerned is an associated entity of the
administrator.
• The fee is a proportion of the interest, and the amount of
the benefit for the administrator may not bear any
relationship to the cost of the service.
Problem Areas (cont)
• How should a bulking arrangement be structured.
• Administrator should disclose to the fund –
– that the fund bank account will form part of a portfolio of accounts to be
bulked for the purpose of negotiating interest rates with the bank;
– some indication should be given of the extent of the enhancement in
interest rates through this, and a rough indication of the extent of the
potential benefit (in Rands);
– if the administrator proposes to retain a proportion of the enhanced
benefit for itself to compensate for the additional costs involved in
putting the arrangement in place then that additional costing must be
determined and made available to the fund;
– the fund must be able to decide whether it would prefer to pay an
enhanced administration fee to retain all the enhanced interest (a large
fund may be eligible to receive in its own right a very good rate of
interest without the bulking arrangement).
Other Problem Areas (cont)
• Scrip lending;
• Rebates;
• Soft commissions.
Approach of Trustees
• Trustees themselves owe a fiduciary duty and must
therefore be very careful about agreeing to, or ratifying,
any additional benefit which a service provider may
seek.
• With the current bulking issue, trustees should ask the
question of their service providers whether they have
received any benefit in respect of their services to the
fund other than the agreed remuneration. “Any benefit”
should be interpreted broadly.
Approach of Trustees (cont)
• As with every aspect of the remuneration due to service
providers, any benefit which the service provider
receives should bear some relation to the services
rendered to the fund; and should also be competitive.
• As a general principle, every contract between a fund
and its service provider should include a warranty by the
service provider that it will not accept any benefit from
any source in respect of its services to or administration
of the fund, other than what is set out in the contract,
without the agreement of the fund.
Approach of Service Providers
• There cannot be too much transparency.
• If in doubt make the disclosure in writing to the trustees
and seek their agreement. If the trustees give it then you
are protected.
• There is a competitive advantage today in complete
transparency and good governance.
Thank You – Jonathan Mort