Let the Investor Beware: Lessons from Tannenbaum
As the saga involving the Tannenbaum Ponzi scheme continues to unfold, numerous issues are being thrown up in the media and in public debate. If the allegations in the media are true, the scheme has been running for three years, and is probably the largest in the history of fraud in South Africa.
As the saga involving the Tannenbaum Ponzi scheme
continues to unfold, numerous issues are being thrown up in the media
and in public debate. If the allegations in the media are true, the
scheme has been running for three years, and is probably the largest in
the history of fraud in South Africa. Among the questions it raises is
the role of institutions mandated to supervise banks and non-banking
financial institutions in South Africa, such as the Reserve Bank and
the Financial Services Board (FSB). According to the 2008 annual report
of the Financial Intelligence Centre (FIC), the Financial Intelligence
Centre Act (2001) binds accountable institutions to a regulatory
framework for client identification, record keeping and reporting
suspicious transactions. A broad range of financial and non-financial
accountable institutions are required to comply with the Act. How did
such a scam, which seems to have been well exposed to regulated
institutions, escape the attention of the FSB and the FIC for as long
as it did?
We now generally know that Ponzi schemes typically rely on the
constant inflow of money, using new investors to pay ‘returns’ to
existing investors. The problem occurs when the volume of new
investment falls below the volume of returns expected by existing
investors, or for some reason, new investment dries up. Barry
Tannenbaum and his associates, three of whom have been named in the
press, is the director of the alleged Frankel Investment Scheme. Frankel
operates as an importer of Active Pharmaceutical Ingredients (API) for
generic medicines in South Africa. Incidentally, Barry has family
ties to a large pharmaceutical drug distributor, being the grandson of
one of the founders of Adcock Ingram. The nature of the investment
scheme was discovered when Frankel was unable to pay its investors for
over a year. Tannenbaum blamed the current global recession for the
company’s problems, but analysts believe that the reason was that there
was no basis for the promised returns. Many parallels have been drawn
between Tannenbaum and Bernie Maddoff ‘s investment scheme in the
United States. Both provided somewhat unrealistic returns for their
investors.
The mission of the FSB is to promote sound and
efficient financial institutions and services, and to monitor
mechanisms for investor protection. The FSB regulates insurers,
retirement and pension funds, capital markets and collective insurance
schemes. Yet a large number of pyramid schemes go undetected, causing
huge losses. The Financial Advisory and Intermediary Services (FAIS)
Act, enacted in November 2002, is meant to protect gullible investors
from situations such as the Tannenbaum Ponzi scheme by:
- Protection against improper conduct by financial service providers (FSPs)
- Making provision for FSPs to be licensed and authorized by the FSB. The FSPs license must be prominently displayed
It seems that Ponzi schemes are able to thrive in
the country on account of sloppy regulators or regulators who collude
with them. Even more common is the possibility of complicity in fraud
by professional intermediaries. The FSB needs to step up to the plate to
make sure that FSPs comply with their obligations. Under the Act, FSPs
are supposed to:
- disclose relevant material information to the client;
- disclose the service provider’s actual and potential interests in the investment to the customer;
- maintain adequate and appropriate records;
- advertise, canvass and market honestly;,
- have professional indemnity or fidelity insurance cover.
In virtually every case of fraud by an FSP, it has been revealed
that most of these obligations have been ignored. It is also disturbing
that fraudulent investment schemes are usually only exposed after an
investor has lost money or becomes suspicious for some other reason.
It is rare for them to be found out by a supervisory body or regulatory
authority.
The FIC relies on financial institutions to provide
them with information on suspicious transactions. This means that the
FIC can only become involved in retrospect and not before. Heavy
compliance and vigilance responsibilities are therefore placed on banks
and other financial institutions. In the case of Barry Tannenbaum, it
is alleged that the Rand Merchant Bank reported at least one suspicious
transaction in 2007. The fate of the report is not known. It appears
that by that time, it could have been established that the transactions
cited by Tannenbaum as supporting the high returns for his investors
did not make economic sense. He subsequently went on to transfer some
of his funds overseas through a bank account in Hong Kong. Two
features of the Tannenbaum scam are the gullibility and dishonesty of
the central figures involved. Investors, many of them in the high net
worth category, appear to have been taken in by a stratagem that did
not make much financial sense. This was achieved with the collusion of
professionals that should have known better.
One can conclude then, that while the regime of laws
in terms of which the FSB and FIC function are adequate, it needs to
be implemented diligently and with a bit more imagination. Of course
this will be with some great difficulty if the process of getting
information to these bodies is compromised by corruption, collusion or
dishonesty. The education of investors is also important. The FSB
has, with the aid of the national treasury, gone as far as to set up a
service, which allows the public to investigate whether, they are
investing in a legitimate company. If the business is not registered
with the FSB, yet deals with pension funds, provident funds, insurance
and investment, then it is possible that it could be illegal. The
information that was picked up by a private investigator engaged by one
of the investors, which blew the lid on the scam, could have been drawn
out of the promoters of the investment scheme earlier. Common sense
and the law require it. Only such information will enable investors
to report a suspicious investment scheme before it is too late.
Hopolang Selebalo, Intern, Organised Crime and Money Laundering Programme, ISS Cape Town
