Edition: October / December 2016
Editorials

LITIGATION

The stage is set

In the quagmire of legal argument, at the core is possible financial prejudice to any members of over 4 000 ‘orphan’ pension funds whose registrations the FSB had cancelled. Also contentious is the opposing views of two prominent pension lawyers, erstwhile colleagues, on interest conflicts and fiduciary duties.

Be warned. What follows is not a leisurely browse. But such are the issues in the dispute between the Financial Services Board and Rosemary Hunter, until recently the FSB deputy executive officer for retirement funds, that they should be understood particularly by fund administrators and trustee boards. The litigation, due for trial in late-November (TT June-Sept), is also highly relevant to public policy for the light it shines on FSB operations.

The North Gauteng High Court will have mountains of documents to peruse. Below is an attempt to summarise, from the respective affidavits and annexures filed, some of the main areas being contested. To contextualise them and explain their background:

  • Although no longer at the FSB, Hunter has legal standing to pursue her court application because it was launched when she was at the FSB. Also, she will probably now ask the court for an award of legal costs in her favour. She has partly succeeded in her application by getting the KPMG and O’Regan reports released, but still wants to pursue the matter in the public interest.
  • In December 2013 Andrew Breitenbach SC was appointed by the FSB legal department, at Hunter’s request, to advise the FSB on the legality of various measures adopted by the Registrar for purposes of the cancellations project (see box). He delivered his first opinion in March 2014.
  • Dube Tshidi is the FSB executive officer and Registrar of Pension Funds. Prior to Hunter’s appointment in August 2013, Jurgen Boyd was the FSB deputy executive officer in charge of pension funds who handled the cancellations project. The FSB answering affidavit includes a critique by Loraine de Swardt, the main official for conduct of the project on behalf of the Registrar, of the KPMG report.
  • Appointed by the FSB board to advise it on aspects of the cancellations project, after Hunter had complained that Tshidi was attempting to terminate her employment because of her objections to the manner in which the project had been conducted, retired ConsCourt judge Kate O’Regan delivered her final report in December 2014. She recommended that the FSB appoint a firm of auditors to review the circumstances in which the registrations of a sample of funds had been cancelled.
  • Accepting this recommendation, the FSB board appointed KPMG Forensics. The first phase of its job entailed devising a means to select the sample and to formulate risk ratings. It began the actual review – a sample of some 542 cancelled funds in a total of 4 650 – in March 2015 and reported four months later.
  • The FSB board expressed its dissatisfaction with the final report but KPMG was not persuaded to amend it. The board then asked Justice O’Regan to review and comment on the report. However, she declined and proposed that an expert in pensions law be appointed instead.
  • In January this year the board appointed pensions lawyer Jonathan Mort to review and comment on the KPMG report. Assisted by actuary Jeremy Andrew on non-legal aspects, they were instructed to inspect nine of the funds subjected to the KPMG investigation and to express an opinion on whether any fund members, beneficiaries or dependants (not funds themselves) had suffered prejudice.

Mort and Hunter . . . both can’t be right

As a refresher on terms being used:

  • An orphan fund is a fund without a board of trustees, liquidator or curator i.e. without a ”directing mind and will”. Hunter and O’Regan refer to a fund without assets and liabilities as a shell fund, while the FSB refers to it as a dormant fund. The court will have to decide on the terminology it wants to use for the various categories of orphan funds.
  • An authorised representative was the term used by the FSB to describe a person appointed by the Registrar to act in place of a properly-constituted board of trustees in order that the business of an orphan fund could be finalised. The term doesn’t appear in the Pension Funds Act. From November 2010 the Registrar appointed persons known as section 26(2) trustees for the same purpose. However, it is argued that under s26(3) their role was restricted and their appointments should have terminated once they had found temporary board members to procure the establishment of properly-constituted boards.

Now for the nitty-gritty. First up are aspects of the cancellations project’s legality.

Did the Registrar have the power to appoint ‘authorised representatives’ (ARs) to act in place of the orphan funds’ trustee boards for disposal of any assets and liabilities that might be remaining in these funds?

Breitenbach: No.

FSB legal dept: No.

O’Regan: No.

Tshidi/Boyd: No. However, according to Boyd, ”the reality is that at the time there was in most instances no one to oversee the management and governance of orphan funds (be it the former trustees, employers etc) and it was more practical and efficient to appoint employees from within the administrators to do the job. After all, they were closer to the day-to-day operations of the funds than anyone else, so it would have made sense to appoint them”.

FSB: No, but it was necessary to appoint ARs because it would have been too onerous to go to court for it to make the appointments.

Mort: Only relevant if material financial prejudice demonstrated.

Hunter: No.

Did the Registrar have the power to appoint a s26(2) trustee, under the Pension Funds Act, to act in place of an orphan fund’s board for disposal of any remaining assets and liabilities?

Breitenbach: No.

FSB legal dept: No.

O’Regan: Arguable, but a real risk that a court might find the Registrar does not have this power.

Tshidi: Yes.

Boyd: Maybe not.

FSB: Yes.

Mort: Only relevant if material financial prejudice demonstrated.

Hunter: No.

Was the Registrar entitled to rely exclusively on representations by fund administrators that it was not possible for properly-constituted boards to be established when deciding whether or not to appoint an AR or s26(2) trustee?

Breitenbach: No.

FSB legal dept: No view expressed.

O’Regan: No view expressed.

KPMG: No. The Registrar should have checked whether the fund had been unresponsive.

Tshidi/Boyd: Yes.

FSB: Yes. The Registrar had required proof, that all reasonable steps had been taken to establish a properly-constituted board, but without success. KPMG had not shown that the Registrar’s failure to check, on whether the administrators’ representations were sound, was likely to have resulted in prejudice.

Mort: Registrar entitled to rely on representations by administrators because making a false statement may attract regulatory and criminal sanction.

Hunter: No. Proof given to the Registrar was only administrators’ representations that steps had been taken to form properly-constituted boards. Several such representations were found to have been incorrect. Some of the funds were still operating. The Registrar did not check with former participating employers, for example, on the steps that had in fact been taken. With some cases already identified, this failure to check resulted in prejudice.

Did the Registrar have the power, and was it reasonable for him, to exempt orphan funds from compliance under the Act with s12 (Registrar’s approval for rule amendments), s15 (submission of audited annual financial statements), s15B (surplus apportionments), and s16 (submission of triennial statutory actuarial valuation reports)?

Breitenbach: Yes

FSB legal dept: Yes.

O’Regan: No opinion on specifics but recommended increased supervision over transfers of unclaimed benefits.

FSB: Yes.

KPMG: No views expressed on specifics, but said that the mechanisms deployed during the cancellations project resulted in a lack of objective information in documents at the disposal of the Registrar. This lack created a factual position where the decisions taken could not be objectively supported and verified.

Mort: Yes. Registrar may grant exemptions in terms of s2(5) where compliance with the Act is not, in his or her view, necessary or appropriate for specific circumstances. KPMG did not substantiate its view that the exemptions increased the risk of prejudice to the funds and their members.

Hunter: No. While the Registrar is empowered to exempt a fund from compliance with s15 and s16, he cannot exempt a fund from the automatic consequences in the Act e.g. the invalidity of amendments not approved under s12, transfers not approved under s14, and surplus-apportionment schemes not approved under s15B.

Was the Registrar legally entitled, without more information, to rely upon representations by ARs, s26(2) trustees or others to the effect that a fund had no assets and/or liabilities when deciding that it had ‘ceased to exist’ for purposes of s27?

Breitenbach: No. The Registrar was required to conduct investigations to verify the correctness and completeness of these representations.

FSB legal dept: No. There was no reason to differ from Breitenbach’s advice on steps and procedures to be followed in order to be satisfied of proof that that a fund had ceased to exist.

O’Regan: No. The Registrar must take care to ensure that there is a reasonable basis for the conclusion that a fund had ceased to exist. Transfers must be scrutinised to protect the interests of members, beneficiaries and other creditors.

Tshidi/Boyd: Administrators took the project seriously so there was no reason to doubt the information given by them to the Registrar.

FSB: Yes. No reason why the Registrar should be unable to rely on information and/or documentation provided by an AR or s26(2) trustee without further investigation as to the correctness and completeness of the information.

Mort: Yes and no. No reason why the Registrar could not rely only on the representations (made on specified forms) when deciding whether a fund had ceased to exist as contemplated in s27, unless there is information to the contrary before the Registrar. Breitenbach was wrong to have said that the information should have been verified. A signed financial statement, indicating nil assets, is simply a different way of stating what the forms F and F1 required.

Hunter: No. The Registrar must consider all available information in deciding whether a sufficient basis had been provided for a reasonable person to conclude that a fund had ceased to exist. Statements by persons, who might be conflicted, should have been subjected to higher scrutiny. Mort’s contention, that a financial statement indicating nil assets is simply a different way of stating what the forms F and F1 required, is unsupportable.

Did the Registrar have the power, in the absence of a court order, to reinstate the registration of a fund after its registration had been erroneously cancelled?

Breitenbach: Probably not.

FSB legal dept: Does not disagree with Breitenbach.

O’Regan: No.

Tshidi/Boyd: Yes and no. Administrative decisions by the Registrar may be revoked until acted upon. On the other hand, those decisions will stand until set aside by a court following a review application.

FSB: Yes.

Mort: No view expressed on the specific issue.

Hunter: No.

Next comes the manner in which the project was conducted.

Could the Registrar reasonably rely on the absence of objections to proposals, published in the Government Gazette, as sufficient proof that a fund had no assets and liabilities (and thus had ceased to exist)?

Breitenbach: The default position -- where there was insufficient information to satisfy the Registrar on a balance of probabilities that the fund had no assets and liabilities – should have been not to cancel the fund’s registration.

KPMG: Implicit is that the Registrar should not have relied simply on the absence of objections.

FSB/De Swardt: Yes, because it was impossible to get information from other sources for ‘legacy funds’ i.e. old underwritten funds, funds of the old ‘homelands’ such as Transkei etc, and funds without administrators.

Tshidi/Boyd: Yes.

Mort/Andrew: No view on the specific issue expressed.

Hunter: No. Agrees with Breitenbach.

Was the appointment of fund administrators’ employees or agents as ARs or s26(2) trustees relevant to an assessment of possible interest conflicts and prejudice to funds/members?

KPMG: Yes, but the surveillance and enforcement division of the FSB’s Retirement Funds Department did not consider this when making appointments.

FSB/De Swardt: No, because they had the same legal duties as the fund administrators. They were expected to fulfil their duties with the care, skill and diligence required of a reasonable trustee. Also, if they were members of professions, they had to act in accordance with the standards of these professions. Risks of non-compliance were the same, regardless of conflicted status.

Tshidi/Boyd: No. The appointees were experienced persons. Although some may have worked for administrators, there’s no doubt that they all acted in good faith.

Mort/Andrew: Yes, but the Registrar must have been aware of the risks associated with ‘conflicted’ persons and put in place measures to mitigate those risks. ‘Conflicted’ status is only relevant if actual prejudice is determined.

Hunter: Yes. And there is no evidence of any measures by the Registrar to mitigate risks associated with ‘conflicted’ persons. Also, the Act requires trustees to avoid conflicts of interest.

Had the Registrar applied stated ‘assessment criteria’ in assessing whether a fund had assets and/or liabilities, and whether these criteria were reasonable?

FSB/De Swardt: Yes and no. Because the cancellations project was exceptional, some requirements weren’t enforced.

Tshidi/Boyd: Yes. Funds scheduled for cancellation were subjected to a number of checks. Supporting documents were loaded onto a database and information was updated. The Registrar had to apply a pragmatic approach, making some concessions to ensure that the project wasn’t stymied. Nonetheless, there was a proper process and sufficient documentation on which to base the cancellations.

KPMG: No. The lack of information in the Registrar’s records meant that decisions taken could not be objectively supported.

Mort/Andrew: Did not express a specific view but stated that the Registrar was entitled to rely on representations by fund administrators.

Hunter: No. The Registrar did not apply these criteria. Instead, he allowed deviations from them. Also, the criteria themselves were not always reasonable. The pace at which cancellation requests were processed meant that the Registrar’s staff could not have checked FSB records to verify the correctness of representations made by those asking for cancellations. In a number of cases, representations that funds had no assets and liabilities were later shown to have been incorrect. Some funds were still operative.

Is it likely that material financial prejudice was suffered as a result of the manner in which the cancellations project was conducted?

FSB/De Swardt: No. Taking policy prescriptions into account, it’s unlikely that funds wholly-underwritten (by an insurance policy) held assets when registrations were cancelled.

Tshidi/Boyd: No. Even if the project was unlawful in some respects, the steps taken were completely bona fide and did not result in any prejudice whatsoever to anyone.

Mort/Andrew: Probably not.

Hunter: Yes. An internal investigation revealed that the registrations of several funds were cancelled when they still had assets and/or liabilities. With some there were unresolved complaints before the Pension Funds Adjudicator. And the registrations of 29 funds were cancelled when there were, and still are, ”secret profit” refunds due to them.

What’s the relevance, as indicators of likely prejudice, that some funds’ registrations were reinstated?

KPMG: A reinstatement suggests that the cancellation was erroneous, that the fund had not ceased to exist.

FSB/De Swardt: Reinstatements were made necessary when evidence came to light, only after cancellation, that the funds had assets.

Tshidi/Boyd: Reinstatements are not indicators of prejudice because the administrators undertook to hold assets in suspense accounts and pay claims. A failure to reinstate a fund would have led to members and/or beneficiaries being prejudiced.

Mort/Andrew: Reinstatement of a fund’s registration does not indicate a likelihood of material financial prejudice. Rather, if the registration had not been reinstated, there would have been prejudice. Fund members/beneficiaries were protected by the fund administrator pending reinstatement of fund registrations.

Hunter: That steps are being taken to have 23 cancellations of one administrator’s funds set aside by a court does not mean that the members, beneficiaries and other creditors weren’t prejudiced. The contrary is true. Further, the setting aside by the FSB Appeal Board of three other funds’ cancelled registrations was necessary to remedy the prejudice from the manner in which the cancellations project was conducted.

What was the cancellations project and why is it so important?

Until the 1980s, most pension and provident funds (for convenience here, call them both pension funds) were standalones i.e. funds for the employees of a single employer. Many were established on the advice of brokers to employers.

Because the number of members of each of these funds was relatively low, the risk that some investments might perform poorly and thus threaten the financial soundness of the fund was high. So, to avoid these risks, the liabilities of most of these funds were wholly underwritten in terms of insurance policies. Fund contributions were paid to the insurer as premiums and the insurer undertook to pay benefits to fund members and their dependants in terms of fund rules as and when members became entitled to them.

Each of these standalone funds was a legal entity. In December 1998 an amendment to the Pension Funds Act required each fund to have a board of trustees and to give members the right to elect at least 50% of the board members (trustees).

Over time, presumably with encouragement from administrators/insurers, brokers started advising employers to stop contributing to these standalones and instead to enrol their employees as members of umbrella funds i.e. funds for employees of large numbers of unrelated employers. Assets held by the old standalones, to provide for their liabilities towards these employees, were transferred to their new umbrella funds.

But, in many cases, assets held to provide for other liabilities -- such as liabilities for unclaimed benefits and surplus assets -- were not transferred with them. Probably assuming that the businesses of the old standalones had been properly dealt with, their boards ceased to operate as such and the standalones became what were known as ‘orphan funds’.

This is what gave rise to the problem that the FSB appropriately sought to address through its cancellations project. However, some of the measures adopted by the FSB in the conduct of this project appear problematic.

There were more than 6 000 of these orphan funds when the cancellations project was started in 2008. Some of the orphan funds were ‘shell funds’ in that they had no assets and liabilities. Others were simply ‘dormant funds’ with assets and/or liabilities. Without boards of trustees, they had no one to realise their assets, or to trace and pay members entitled to them.

The problem could have been dealt with by court-ordered appointments of curators to these funds. Instead, the Registrar appointed persons who’d been nominated by the administrators of these ‘orphan funds’ to act as ‘authorised representatives’ or ‘section 26(2) trustees’. They took the place of these funds’ boards for disposing of any remaining assets and liabilities, thereafter asking the Registrar to cancel the funds’ registrations in terms of s27 of the Pension Funds Act.

Hunter alleges that the Registrar’s appointments of these persons were ultra vires his powers and were also improper as most of the appointees simultaneously held positions as employees or agents of the administrators. They were thus conflicted between the interests of their employers and their duties to the funds e.g. on payment of fees and pursuit of unclaimed benefits.

Between 2008 and 2013, registrations of some 4 600 funds were cancelled in these circumstances.