Grand Theft Pension

Worried someone is making off with your pension? You are not alone. Many resent the lack of control over retirement savings, which is typically their largest financial asset. They can’t see their money, how much it is, how it is invested, who controls it and what return it has earned. It requires leaps of faith to believe that all is well with their savings and retirement plans.

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. Furthermore:

• 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 (i.e. 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 property group, Pinnacle Point, 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

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.