Edition: Sept - Nov 2013
To have cake and eat it
There’s more to the battle than the R500m fight between the Saccawu fund curator and Standard Bank. If the FSB can be merely an interested observer now, it cannot be if similar disputes arise in the future.
In the proposed ‘twin peaks’ structure, the Financial Services Board will become the regulator of financial institutions’ market conduct. It’s charged with oversight of their ethical behaviour. But who’s to oversee the conduct and behaviour of the FSB?
It’s asked not because of a hypothetical proposition, on whether there should be a guard of the guardian, but because of an occasion to test theory with practice on the performance by the FSB of its oversight role. The particular occasion is found in the protracted arbitration proceedings of Tony Mostert, as curator of the SA Commercial Catering & Allied Workers Union national provident fund, against Standard Bank (TT March-May and June-Aug).
Bluntly, it’s whether the FSB approves the numerous market-conduct issues that this matter reveals: from attempts to set aside an agreement once the benefits had been enjoyed, to accepting a fund’s report that its shares are in safe-custody with a bank whilst allowing that fund to contend in court that no custody agreement exists, to the risk of exposing a fund to huge costs should the attempts not succeed, and to the control of those costs.
More broadly, there’s the FSB’s expectations in the behaviour of financial institutions when their relationship with retirement funds turns adversarial.
Legal battles often reflect acceptable conduct by the one party and unacceptable by the other. If not in its existing role, then in its new role the FSB would presumably take a view on when and how to intervene.
In this fund versus bank arbitration, which involves four retired Appeal Court judges and silks on both sides, costs could exceed R15m. On a costs award against Mostert, who’s instructed his own law firm, the fund would have to pay these millions. Should he win, the bill will be for Standard Bank.
Additionally, the bank would be hit for more than R500m (inclusive of a fee for the curator?) representing the present-day value of certain MTN shares. These are the shares that, should the bank lose the arbitration, it would have to deliver to the fund.
The money stakes are high. The FSB, which oversees curatorships, was content for the curator to institute proceedings against the bank for delivery of shares. The grounds are that the underlying contract -- concluded before the curator was appointed and implemented by him for a number of years -- was invalid because it was signed on behalf of the fund by its principal officer and not by three trustees or himself.
Screeds of documents filed at the arbitration indicate that the agreement ran for its full five-year term until mid-2007. They also show that Mostert reported this to be the case in his communications with the FSB and fund members. Only in July 2005 did Mostert issue summons. Only once the agreement matured, two years later, was it possible to calculate that the fund had given away about R300m of upside to buy the downside protection.
On maturity, the bank delivered to the fund all the shares due to it except some of the MTNs. These had been sold by Standard, having exercised its call option, since the MTNs had by then exceeded the ceiling price in terms of the agreement.
Brown . . . sore wrist
Had the price of the MTNs instead fallen below the agreed floor, the curator could have implemented the agreement in the fund’s favour by forcing the bank to buy them.
Where the FSB stands in all this focuses on two Acts for which it’s responsible: first, the Financial Institutions (Protection of Funds)
They provide, under threat of serious penalties, that any person who holds shares in a trust capacity must hold them strictly in accordance with prevailing agreements.
In this case, prior to the appointment of Mostert, WIP Capital was given a mandate by trustees of the Saccawu fund to protect the value of the fund’s share portfolio. WIP came to Standard and an agreement was concluded. If after five years the shares had dropped below a certain floor price, the fund could compel the bank to buy them (a “put” option). If the price exceeded an agreed ceiling, the bank could buy them (a “call” option).
As security, should the bank need to exercise its call, the shares had to be pledged and lodged in custody at the bank. To protect itself from the shares dropping below the floor price, Standard hedged its risk in the market. At the end of five years, were neither the put nor call exercised, the bank would return the shares to the fund at zero cost; if the put were exercised, the bank would buy at the floor price; if the call were exercised, the bank would buy at the ceiling price.
So the fund gave away the possible upside in exchange for a guarantee against the downside. The options were agreed, the documentation was completed, the shares were electronically transferred to the bank as custodian and the right of the bank to deal in the shares was formalised. All instructions to the bank came from the fund’s principal officer who’d produced a minute of the fund’s investment committee as evidence of his authority.
In July 2002, the bank began to trade in the shares. In September 2002, Mostert was appointed as the fund’s curator. He requested, and was given, a detailed explanation of the agreement. It made clear that trading was part of the hedging strategy, and that he could contact the bank if he had further queries.
Each time the bank dealt, it sent him confirmations. He requested, and was given, monthly valuations. Johnnic shares were included in the portfolio.
Around April 2003, Johnnic announced that its MTN shares were to be unbundled. Mostert was notified and, having made no objection, the shares were taken into the transaction with the bank. He reported this to the FSB and fund members.
In July 2005, Mostert issued summons to the effect that the 2002 agreement was void from the outset. He contended that the principal officer had no authority to bind the fund because, under the fund’s rules, agreements had to be signed by three trustees. He also contended that his actions in implementing the agreement and agreeing to the unbundled shares being included in the transaction were of no consequence because he had never signed any contract document. Accordingly, Mostert wants back all shares plus the dividends on them from 2002.
The bank insists that the agreement was validly entered by virtue of the trustees having delegated authority to the principal officer. At worst, the agreement was voidable (valid until the trustees/curator decide to set it aside) but not void (because no attempt had been made to void it) and the bank had fully implemented the agreement because of the relevant Acts’ requirements.
If voidable, then the party entitled to void it must elect to void it within a reasonable time period. It can’t be voided after the benefits of the contract have been accepted. The bank says that, by his words and conduct, Mostert had elected not to set it aside and had been party to its implementation during the five-year period. Mostert says the contract was void because he never signed it.
First time round, the arbitrator (Judge Harms) found for Mostert on the basis that no agreement with the fund is binding unless signed by three trustees or the curator. Harms held that ownership of the shares sold into the market had never passed and that all the shares should be handed back to the fund.
Then the appeal tribunal (Judges Howie, Smalberger and Nienaber) found that the agreement was voidable but not void i.e. valid until set aside. It also found that, because Mostert was appointed to the curatorship by court order, he was not bound by the fund’s rules that contracts be signed by trustees and he had powers to commit the fund by his words or conduct. The tribunal referred the matter back to the arbitrator.
Next, the arbitrator reconsidered. He dismissed all claims against the bank except for the claim to the MTN shares. These were the only shares, subject to the agreement, that had exceeded the price ceiling.
Now the bank is going back to the tribunal. It argues that, in light of the tribunal’s decision that the agreement was voidable but not void, the ruling of the arbitrator on the MTN shares is inexplicable. This hearing is scheduled for November.
Whichever way the dispute is resolved, there’s a striking lesson for financial institutions in entering scrip-lending and hedge-transaction agreements with retirement funds. It’s to ensure that they attend meticulously to the literal wording of funds’ rules, delegated authorities and contracts, not to allow any chance for the sort of time and money-consuming bother opened in this arbitration.
The FSB has cause for reflection too.
CONTROL OF CURATORS
By its absence of intervention, it would appear that the FSB supports the action by curator Tony Mostert against Standard Bank. But its basis for doing so is unclear.
The proceedings have already made it evident that the FSB was at all times fully apprised of the agreement in operation for five years between the Saccawu fund and the bank. Had the FSB sniffed an irregularity, there’re ample weapons within its arsenal that could have been used. None were.
On the other hand, the Financial Institutions (Protection of Funds) Act provides at s5 for the curator to act under the Registrar’s control. Thus all Mostert’s actions are under the FSB’s control. Logically, this would include his litigation against the bank.
Once the dispute is resolved, perhaps the FSB would explain the ostensible contradiction between neither suspecting an irregularity nor controlling Mostert. If it was correct on the former, it cannot be correct on the latter.
In nutshell, the incongruity is this: The FSB (being in control as per the Act) allowed the curator to sign, submit and publish audited financial statements as well as actuarial valuations in which the fund’s contract with Standard was stated to be of full force and effect. Yet the FSB then allowed the curator (employing his own law firm, at cost to the fund) to sue Standard on grounds that from the outset this same contract was invalid and never implemented by the curator.
FROM THE RECORD
I would like to establish an estimate of what the effect of the investment has been on the fund. . . I would imagine that you take into account the present value of the. . . shares plus the dividends that would have been earned from inception. . . compared to the value of the investment at present. The person from whom I receive the periodical performance statements is Nicola Taylor of SCMB (Standard Corporate & Merchant Bank, as it then was). . . ”
3 Dec 2003
The fund does not benefit from corporate events attaching to these securities (including MTN) as these have been ceded to SCMB, on an ongoing basis for the duration of the options, as payment for the derivate instruments. . . (These instruments) comprise dividend-fund collars entered into with (SCMB). The collars, which expire during July 2007, have been traded over. . . 3,9m shares in MTN Group.
Financial statements of the Saccawu fund for the year to end-Dec 2003
I might not necessarily wish to attack the validity of the SCMB transaction. I might however wish to negotiate a better deal from SCMB using the (commission) payment to Saccawu Administration Company (SAC) and seek damages at least in respect of the commission.
Mostert to Deputy Registrar of Pension Funds, 14 Jan 2004
The transactions relating to the investment of the fund’s shares continues. It is anticipated that an action will be instituted against (WIP Capital and SCMB) in due course.
Mostert to FSB, 30 April 2004
SCMB will probably argue that they set a “market price” for the transaction and that the fund was not obliged to accept this price. They may also be able to produce evidence that the values they placed on the dividend streams in July 2002 and May 2003 were derived from “market consensus” dividend forecasts.
I am personally inclined to say that any fault lies with WIP Capital in their capacity and agents of the fund. . . I think it is clear that the standard of advice given was appallingly low, given the exorbitant commission (R4,3m) that they received. . . The “economic loss” that the fund has incurred, as a result of giving up the dividend rights, would have to be measured as the degree to which SCMB “loaded the dice” against the fund when valuing the dividend streams in 2002. . . Was this a suitable transaction for the fund? Absolutely not. Were the terms of the transaction market-related and fair to the fund? Possibly not.
Fax from Erich Potgieter of consultancy Fifth Quadrant (now Towers Watson)
to Mostert, 16 Aug 2004.
The WIP Capital/Standard Bank/SAC “hedging agreement” has now come to an end. The fund is presently taking delivery of the . . . shares. Had the transaction not been entered into, the fund would not have lost some R300m and more from this transaction. The circumstances form the subject matter of litigation between the fund, WIP Capital, Standard Bank and the SAC.
Mostert to Registrar, 30 July 2007.
In prior years the value of the derivative instrument held at SCMB were reduced, to allow for a reduction in the value of the asset should the agreement (with Standard) be terminated before the end of its term. As the asset matured in September 2007 without any discontinuance penalties being applied, the full value of the asset can now be used in the valuation.
Statutory actuarial valuation by Old Mutual of the Saccawu fund as at 31 Dec 2006.
We hereby certify that, to the best of our knowledge and belief, the information furnished to the Valuator for the purposes of the Actuarial Valuation Report as at 31 December 2006 is correct and complete in every material respect.
Certificate submitted to the Registrar, under s16(8) of the Pension Funds Act, signed by Mostert and Pat Ngqola (respectively curator and principal officer of the Saccawu fund).