Too often, this faith is tested by reports of fraudulent investment schemes that leave many pensioners destitute. But invariably, these reports involve personal savings, outside the formal structures. The reality is that retirement investments are highly regulated and supervised. Service providers – administrators, managers and advisors – require a license to practice. The FSB subjects their systems and credentials to a due diligence review; key individuals must be in good standing. Regulation 28 sets our prudential investment limits and prescribes permissible asset classes. Each retirement fund is a separate legal entity with its own bank account, and is audited annually. All investments are held in the name of the fund; the fund is overseen by a Principal Officer and a Board of Trustees, who ensure that all legal and prudential requirements are met.
Still, the concerns persist, especially among those who are not financially educated. Presenting to companies with blue collar workers, the differing risk perceptions of management and workers become apparent. Management will typically focus on our value proposition, credentials, past performance and administrative competence. Shop floor workers have far more fundamental concerns. How can they be sure we won’t steal their money? And how will their dependents get hold of it should something happen to them? There is a real fear – possibly borne from personal experience and anecdotes – that retirement funds are black holes that suck up their contributions, never to return them.
More often than not, these problems relate to poor record keeping and communication. But it reflects a broader perception that fly-by-night operators regularly pilfer members’ hard-earned savings.
This perception is sustained by a few high profile cases. But the incidence of fraud in the industry is actually quite low; and ironically, the few cases that have been reported involved some of the most respected names in the industry. The two most notorious incidents relate to “surplus stripping” and “bulking”.
The “surplus stripping” scandal
A pension fund surplus arises when the assets (investments) of a pension fund exceed the actuarial liabilities at any given point in time. The actuarial liability estimates how much each fund member will receive in retirement, by way of their monthly pension. Legally, such surpluses must be allocated to present and past members once the fund is closed or transferred.
Peter Ghavalas, a former Nedcor senior executive, along with four other businessmen, designed an elaborate scheme to misappropriate surpluses for personal gain. They did this by transferring the members of the targeted funds (seven in total) to an associated retirement fund, to isolate them from the surplus. The funds then successfully applied to the FSB to transfer the remaining assets (the surplus) to another fund, to the eventual benefit of the various parties involved in the scheme. The total surplus involved was around R175m at the time (the estimated current value is R1.2bn).
The case implicated Alexander Forbes, South Africa’s largest retirement fund administrator, who allegedly facilitated the section 14 transfers knowing they may be fraudulent; and Sanlam, one of the country’s largest life companies, who facilitated and benefited from the surplus stripping. Both companies have paid over large amounts to the curators of the stripped funds (Alexander Forbes settled a civil claim for R342m).
The Alexander Forbes “bulking” affair
During the course of this investigation, another malpractice came to the light: Alexander Forbes were compensated by banks for bulking (ie joining) the bank accounts of their clients, in order to attract higher interest rates. Although the higher rates benefited members, Alexander Forbes failed to disclose this fee to clients, thus breaching its agency obligations. In compensation, the company set aside an amount of approximately R385 million.
Trilinear’s “misguided” property investments
More recently, an inquiry was launched into the disappearance of around R420m from the Clothing Worker’s Pension Fund. Trilinear apparently lent R100m to Canyon Spring Investments, a company that was subsequently liquidated. It used a further R250m to buy into “a struggling luxury property group, Pinnacle Point“[1], which was then also liquidated. This investigation is only just getting underway, and will likely be with us for the next few years. But it appears that the fund members will suffer a significant loss.
Fidentia
Then there is the widely-reported collapse of Fidentia. This case, too, is still ongoing. The fraud does not actually relate to a retirement fund, but rather a trust, the Living hands Trust, which looks after deceased mine workers’ windows and orphans. Over R1bn was reportedly embezzled from this fund.
Industry fees
The total alleged embezzlement in these cases is probably around R3bn, in today’s money. That is an obscene amount in absolute terms; but relative to South Africa’s private retirement savings (approximately R1.5tr), it represents a drop in the ocean (approximately 0.2%), especially in the context of a 20-year review period.
So the risk of falling prey to pension fund fraud appears low. And yet, chances are high that someone is pocketing a big part of your pension. The problem is they are doing it legally.
Consider these two numbers: total private pension savings of R1.5tr and total annual fees of around 2% per annum. That’s R30bn in retirement savings paid over to a handful of investment managers and administrators and a small army of advisers – every year. Multiply that by 20 to get an idea of how much pension money is diverted into private hands, and how this dwarfs official pension fund fraud. “Obscene” does not remotely describe the magnitude of this plunder.
And yet it happens in full view of the regulators. Yes, admonishing noises have been made, most recently by Mr Gordhan in his 2012 Budget speech, but there are no veiled threats of a regulatory response, let alone signs that real action will be taken against the industry.
That would be for too simple. Instead, the FSB plans to instill the industry with a sense of fair play. This should take no more than a few years to effect, more or less. But while the regulators are tuning their fiddle, retirement investors are burning.
In the context of a 5% real (after inflation) return earned on a balanced portfolio, an average fee of 2% diminishes the investor’s real return by 40%. Compounded over a working life, it effectively halves the real value of their pension at retirement. For retail investors, who play close to 3% pa on average, the outcomes are even worse.
Be afraid
Much like plane accidents, pension fraud is over-reported in the media, because of the life-threatening consequences and the subliminal fear it could happen to anyone.
But the real risk does not lie with the few miscreants who embezzle investors’ money; it lies with the industry’s high fee structures, and the regulator’s failure to curb these excesses. Worried someone is making off with your pension? If not, you should be.
[1] Mail & Guardian, 6 March 2012.
