It is good to see that more and more people of influence are concerned about combating practices that ought not to be taking place in the financial services industry.
One of these practices is the payment of kickbacks or rebates - call them what you may - particularly when the people receiving the kickbacks have a fiduciary duty to you, the member of a retirement fund.
The issue of rebates was raised at a recent meeting of the Pension Lawyers' Association (PLA) by Mike Codron, the chief actuary of the Financial Services Board, and the association's chairman, Jonathan Mort, a director at Edward Nathan & Friedland, a firm of corporate law advisers and consultants.
That the issue of rebates is receiving attention at such a high level should come as a relief to all members of retirement funds, particularly those who belong to umbrella retirement funds, retirement annuity funds and preservation funds. The reason is that some trustees and some service providers are clueless as to what constitutes a conflict of interest, why a conflict of interest is not in the best interests of the fund's members, and why a conflict of interest is wrong.
Mort says trustees and retirement fund service providers have a legal obligation - not just an ethical one - to avoid all conflicts of interest.
Many of the problems that give rise to conflicts of interest, including the payment of kickbacks, seem to occur in retirement funds that are managed by financial services companies.
Many of these funds seem to be managed in the same way that com-pany-sponsored retirement funds were run before the Pension Funds Act was amended to ensure that you have a proper say in the management of your fund through employee-elected trustees.
It is absolutely amazing that a recent survey by Personal Finance found that retirement funds sponsored by financial services companies mainly use the sponsoring company to provide all or most of the fund's services. In effect, the sponsoring com-pany is contracting with itself to provide the retirement fund's administration, asset management, group life assurance, actuarial and investment consultancy services.
What the law says
At the PLA meeting, Mort spelt out what the law requires of trustees and service providers. These requirements should be noted by all trustees and service providers - and particularly those running retirement funds sponsored by financial services companies, who seem to think they have been granted some special exemption.
Mort's presentation dealt with conflicts of interest in general and, in particular, with the payment of rebates between the service providers to retirement funds, without the benefits of the rebates being passed on to the funds' members.
For example, an administrator may receive a rebate from an asset manager for directing money into a particular investment, or an asset manager may obtain a higher money market rate by pooling the assets of various retirement funds, but fail to pass on the better rate to the funds.
Mort says the starting point for avoiding conflicts of interest is to understand what is meant by a trustee's "fiduciary relationship".
He says in a recent court case (Phillips v Fieldstone Africa) which dealt with a person in a fiduciary relationship who secretly made a profit, the Supreme Court of Appeal set out a number of principles concerning fiduciary relationships.
In particular, the court held that there is no "limited category" of fiduciary relationships, but that a fiduciary relationship exists whenever the following three circumstances apply:
- There is 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
- The beneficiary is peculiarly vulnerable to the exercise of that discretion or power.
Mort says other court cases and statutes, such as the Financial Institutions Protection of Funds Act, also define fiduciary relationships.
He says both statutory and common law place the service providers of retirement funds in a fiduciary relationship with a fund and its members.
In terms of the Financial Institutions Protection of Funds Act, a fiduciary obligation is imposed on the administrator, the investment adviser and the firm which keeps the fund's assets in safe custody.
This fiduciary obligation also extends to the directors and employees of any firm falling into these categories. In other words, the Act does not only apply to the trustees.
Mort says retirement fund service providers whose services do not fall under the Financial Institutions Protection of Funds Act - such as actuaries, lawyers or accountants - are still subject to common law.
In a case in 2001 (Jowell v Bramwell Jones), the court held that a trust's legal adviser, accountant, investment adviser and others were liable for a breach of a trust for the advice they gave to a trustee, and that this liability extended to the trust's beneficiaries who suffered a loss.
As the court found there was a breach of trust by these advisers, Mort says it follows that they were in a fiduciary relationship at least with the beneficiaries who suffered the consequences of that advice.
In the same way, service providers to retirement funds, such as lawyers, accountants, investment advisers and actuaries, satisfy the criteria for a fiduciary relationship as set out in the Phillips case, and, Mort says, would "be found to have a fiduciary relationship with the retirement fund to whom they give their services, as well as its members and beneficiaries".
Having established that all service providers of a retirement fund have a fiduciary duty, he says it is clear that all service providers as well as trustees "must avoid conflicts of interest in doing their fiduciary duty".
Mort says there are typically five types of conflicts of interest. Of these three are relevant to retirement funds. The three are:
- Existing client conflict. The service provider acts for two retirement funds, each of which has interests contrary to the other.
- Former client conflict. A retirement fund currently contracted to a service provider can profit, to the disadvantage of a fund formerly contracted to the service provider, because of the provider's knowledge of that fund.
- Personal conflict. The private financial interests of the service provider conflict with those of the retirement fund.
No benefit allowed
Mort says unless a conflict of interest is resolved properly, the service provider party to that conflict could receive a financial benefit which would otherwise accrue to the retirement fund. He says the law is quite clear that someone in a fiduciary position may not benefit from a conflict of interest. This is backed up by the judgment in the Phillips case, namely:
"The rule (precluding any secret profit by a person with a fiduciary obligation) is a strict one which allows little room for exceptions.
"It extends not only to actual conflicts of interest but also to those which are a real sensible possibility.
"The defence open to a fiduciary (the service provider) who breaches his trust are very limited: only the free consent of his principal (the retirement fund) after full disclosure will suffice. Because the fiduciary (the service provider) who acquires for himself is deemed to have acquired for the trust (the retirement fund), once proof of a breach of a fiduciary is adduced, it is of no relevance that the retirement fund has suffered no loss or damage; the retirement fund could not itself have made use of the information, opportunity; the retirement fund, although it could have used the information, opportunity, etc, has refused it or would do so; there is no contract between the retirement fund and the party with whom the service provider has contracted and the financial benefit would not have gone into the retirement fund's hands in the first instance; it was not part of the fiduciary duty to obtain the benefit for the retirement funds; or the service provider acted honestly and reasonably."
So far as rebates are concerned, Mort says, it is not permissible for a service provider that bulks the assets of its retirement fund clients to receive a wholesale rate from an asset manager or a bank, but to pass on only the retail rate to the individual retirement funds and to pocket the difference. Such a practice would only be permissible if each retirement fund agreed to the service provider taking the difference between the wholesale and the retail rates.
"It is quite clear that any profit which the service provider has received as a result of a conflict of interest to which the retirement fund has not freely consented, belongs to the retirement fund," he says.
I simply cannot understand why some financial service companies repeatedly try to rip off us ordinary mortals, instead of - as Finance Minister Trevor Manuel put it - "doing the right thing".