Don't, do not, and I repeat, don't, do not invest in or through under-regulated companies that are not listed on a formal stock exchange or make investments that require you to give loans to an unlisted entity.
The only exceptions are if:
- You are investing money that you can afford to lose; or
- You have checked every aspect of the "investment" to ensure that you understand all the risks. Do not take the word of the person who flogs you the product that it is safe. Such people are normally paid an extraordinary commission and so are unlikely to point out the downsides of the "investment".
Today, Personal Finance reports on yet more unlisted, under-regulated "investments" that have gone awry.
This week, it is the investment vehicles of Dynamic Wealth and the imploded Corporate Money Managers. Last week, it was Platinum Investments - a clear case of a scam - which sold shares in a non-existent company. Last month, it was three property syndication companies: City Capital, Dividend Investments and King Financial.
The three property syndication companies are only the most recent in a long list of problematic pro-perty syndications. The probability that property syndications will fail increases when:
- The properties are given excessively high valuations;
- Excessive costs are taken out;
- Excessive commissions are paid; and
- An economic downturn sees defaults on purchases and rentals.
Why regulated is better
I am not saying that all unlisted entities are scams or even that all of them have unacceptable levels of risk. There are many stories of successful unlisted entities. For example, many of South Africa's blue-chip companies - of which Rembrandt is the prime example - started as unlisted companies. But you must understand the risks you are taking.
And I am not saying that regulated products have no risk. Of course they do. We have only to look at the collapse of linked-investment services provider Ovation, or at the implosion of Fedsure, or at how nearly every unit trust fund has been affected by the investment market meltdown. However, the risks are lower when products are regulated, because it is less likely that things will turn sour. And if they do, you have a better chance of obtaining redress.
For example, there are plenty of alternatives to property syndications, with all their potential pitfalls. The alternatives include:
- Property companies listed on the JSE;
- Property unit trusts listed on the JSE;
- Unit trust funds (collective investment schemes) that invest in property companies listed on stock markets here and abroad;
- Participation mortgage bonds, which are regulated in terms of the Collective Investment Schemes Control Act; and
- Life assurance endowment policies that have property in their underlying investment portfolios.
I find it amazing that financial advisers, often driven by extraordinary commissions, are still prepared to risk your savings and their financial services provider (FSP) licences by placing you in unregulated products at additional risk. It is even worse when the victims are pensioners.
Advisers should not think that their questionable activities will continue to go unnoticed in the light of what seems to have been a lack of vigour on the part of the Financial Services Board (FSB) in applying the full force of the Financial Advisory and Intermediary Services (FAIS) Act.
The Act, which was fully implemented from October 2004, is still comparatively new.
Bad advice under threat
But things are changing:
- The FSB, which is responsible for issuing FSP licences (and, more importantly, for withdrawing FSP licences), is getting tougher; and
- An increasing number of complaints are being scrutinised by the fine legal mind of Charles Pillai, the Ombud for Financial Services Providers (the FAIS ombud). But Pillai is only permitted to deal with complaints where the bad advice was given after October 2004.
The best thing about the FAIS ombud is that once he has decided that you have been advised inappropriately, he can rule that you be compensated. His rulings are equivalent to an order of the High Court.
If you are a victim of one of the investments that has collapsed recently, I would suggest that you take your complaint to the ombud, particularly if:
- The risks of the investment were not fully disclosed to you;
- You were not told that your money was being placed in an unregulated product;
- All the alternatives to the unregulated product, such as those to property syndications, were not fully explained to you; and
- The commission paid to the intermediary was not fully disclosed to you and you did not agree to it.
The principle that intermediaries can be punished for dispensing bad advice and bad products was established long before the creation of the office of the FAIS ombud.
It was firmly established in the 1997 court case Durr versus Absa that an adviser has a duty to conduct a proper due diligence. The case concerned an Absa broker who advised a client, Valerie Durr, to invest in the Masterbond scheme.
Most people cannot afford to go to court to seek redress in the event of bad advice, particularly if they have been fleeced as a result. This is the reason the FAIS ombud exists: it costs you nothing to complain.
Hopefully, as Pillai makes more and more rulings, it will focus the minds of careless, greedy and/or unscrupulous intermediaries.
*****
While on the subject of regulation, in terms of the FAIS Act, financial advisers are obliged to tell you whether they are registered FSPs or representatives of an FSP.
They must also tell you what category of product/s they are licensed to give advice on and sell. This does not mean, however, that registration is a stamp of approval for any product or any product provider. It is not.
Do not take comfort from the fact that most product providers highlight on their marketing material that they are licensed FSPs.
Dynamic Wealth not only trumpets the fact that it is a licensed FSP but also that it is a member of the Association for Savings & Investment South Africa.
Most property syndication companies also trumpet the fact that they have FSP registration.
The problem is that the licence may have little to do with the main product being sold.
For example, the licence may be restricted to risk life assurance, which has nothing to do with property syndications.
The regulation of property syndications does not fall under the FSB but (vaguely) under the Department of Trade and Industry.
The sooner the practice of misleading investors into a false sense of security is banned, the better.
DIVIDEND INCOME FUND STRUCTURES MAY BE LEGAL, BUT WHAT ABOUT THE MORALITY?
In last week's column I dealt with how, in structuring the controversial dividend income unit trust funds, taxable interest income appears to be converted into non-taxable dividend income.
I calculated that this bolt hole could be costing the taxman about R2 billion a year.
In the column I said that the underlying investments of dividend income funds were preference shares and that these preferences shares were created artificially by using some very complex and opaque structures.
Dividend income funds are currently the subject of a joint investigation by the South African Revenue Service (SARS), the Financial Services Board and the National Treasury.
Money continues to pour into the funds; at last count, they had R51 billion under management.
I raise this matter again because John Kinsley, the chief operating officer of Prudential, which has the biggest of the four dividend income funds, says I got it wrong with his fund.
Kinsley says his fund converts taxable interest into non-taxable dividends without using complex, opaque structures.
Kinsley's fund works as follows:
- The R23 billion or so in the fund is invested in money market instruments that earn interest;
- The interest is used to buy dividends from shareholders; and
- The interest earned by the fund does not attract tax, because collective investments, including unit trust funds, are taxed according to the conduit principle. This means that a fund manager can trade merrily without the tax consequences that would affect you and me if we did likewise. Tax comes into effect only when you cash in your unit trusts. So the purchase of the dividends is a non-taxable event.
Very neat, but I doubt the National Treasury, SARS or Parliament had this in mind when they approved the conduit principle.
Tax breaks for the wealthy
The main point of last week's column was not the methodology; it was the morality of the financial services industry taking advantage of gaps in the law to give tax breaks to the wealthy and corporates.
Although dividend income funds have smaller investors, investments of R51 billion mean some pretty big players must be getting the tax breaks.
Anyway, Kinsley's request for a correction got me thinking.
The question for me is who is selling the dividends? They must come from really big shareholders. The big shareholders are life assurers and retirement funds, the money of which is managed by asset managers.
If the dividends were coming from retirement funds only and the dividend income funds had been set up after March 2007, when the tax on interest in retirement funds was scrapped, things would not be so bad. It would simply be a case of utilising another tax loophole, possibly but not necessarily to the advantage of retirement fund members.
Post 2007, there would be no tax consequence in taking interest income on board, and if you sold something, you would do so at a profit.
However, the problems are:
- The Prudential fund was launched in 2005, two years before retirement fund tax was scrapped, so, depending on how the swap was treated, it could have been subject to income tax. It would not have been subject to capital gains tax (CGT), as retirement funds have always been exempt from CGT.
- Life assurance portfolios and other equity unit trust funds could be providing the dividends. The unit trust funds would be okay, because of the conduit principle. But life assurance companies pay tax at a rate of 30 percent on interest income, as well as CGT. Policyholders would be none the wiser.
- Remember the secret profits scandal in which retirement fund administrators and others made secret profits from bulking retirement fund bank accounts? That was not the only way in which secret profits were made, and one wonders whether retirement fund trustees whose funds may be affected have been informed of the significant trade in dividends and how much money is being made from it. One also wonders whether the trustees have given their approval to the trade. I would suggest every retirement fund trustee starts asking questions.
Kinsley, after much prodding, says the trade is conducted through the major banks, so he cannot say exactly from where the dividends emanate.
He also states that what is being done is perfectly legal. I am sure it is. I have not said otherwise. It is the morality of the issue that worries.
Tax schemes
It is not the first time that the financial services industry has created tax schemes. Some years ago, it created what are called blackhole endowment policies that allowed the wealthy to take advantage of tax breaks.
The policies were closed down by Gill Marcus, then the Deputy Minister of Finance, who simply told the financial services industry: "No way."
What is more worrying is that Kinsley says: "Our fund has been approved by SARS and scrutinised by the treasury, therefore we certainly don't regard anything about the fund as immoral. Without this approval, we would certainly not have gone ahead."
Vlok Symmington at SARS commented on Kinsley's statement as follows: "I am not sure what he means by 'approved by SARS'. We don't 'approve' products."
The point of all this is that if the wealthy pay R2 billion less in tax than they should because of loopholes, someone else has to pay more.
Although every taxpayer has the right to use every legal means to minimise his or her tax burden, it is repugnant for the financial services industry to create tax bolt holes, even if they are legal.
THE 'SATRIX WEBSITE' THAT IT ISN'T
Jan Kruger, the sole proprietor of a financial services provider that trades as JE Financial Consulting, thought he was on to a good thing until he was spotted by Dave Crawford, a Johannesburg-based financial educator.
Crawford wanted to make a direct investment in one of the Satrix exchange traded funds. He was not sure of the website address, so he googled "Satrix".
And then he almost fell into Kruger's little trap.
When the Google search page comes up, the first site listed is not Satrix but Kruger's, whose clever web designer has managed to upstage Satrix by using the title Satrix JSE Funds Online.
If you invest in Satrix through JE Financial Consulting's website, you will pay a needless upfront fee of 1.5 percent of your investment and a further annual fee of 0.25 percent.
The title of the official Satrix website is Satrix Home, with the address www.satrix.co.za
The deception did not stop there. When you open the JE Financial site, the front page is dominated by the Satrix logo with a reference to JE Financial Consulting in far smaller type.
Then the process of filling in the application form starts.
You need to go through eight steps, providing extensive personal details, before you reach any information about the additional costs that starts with the note: "These details are read-only and need only be confirmed by you." So, even though you are entitled to negotiate commissions, you are unable to change them on the website.
A note also states that the financial services provider or representative "certifies that he/she has personally explained all the features of the product to the investor" ... and has "personally explained all the fees and commissions including all risk ...".
Kruger, after the intervention of Satrix and the Financial Services Board, says he will reimburse anyone who has been misled. He is also ensuring that his website is legally compliant.