FBIM612: ASSESSMENT 1 (CORPORATE GOVERNANCE)

CASE STUDY - FIDENTIA GROUP

SYNOPSIS OF THE FIDENTIA SCANDAL

J Arthur Brown, the mastermind of the Fidentia scandal, lavishly spent the funds of 47 000 widows and orphans, wasting nearly R500 million. On 1 December 2014, he was sentenced to 15 years in prison. Brown was arrested for the first time in 2007 as part of one of South Africa's largest financial scandals, in which he ran a pyramid scheme and misappropriated investors' money for his own personal advantage. Brown's firm, Fidentia, embezzled R1.1 billion from the Living Hands Umbrella Trust, previously the Mineworkers' Provident Fund, leaving mineworkers' descendants financially stranded while Brown continued to buy luxurious homes and automobiles and invest in his favourite sports teams.

1. DETAILS OF THE FIDENTIA SCANDAL

Fidentia entered the South African financial services industry as an active player in 2005, only a few years after its inception. This was accomplished through aggressive takeovers and a positive public image bolstered using well-known athletes and sponsorships of numerous sports teams, charities, and other events.

Under the leadership of Mr. Arthur Brown and his senior management team, none more notable than Mr. Graham Maddock, the Fidentia group seemed to grow from strength to strength.

Fidentia Asset Management (FAM) was the group's core business, and it attracted two of Fidentia's largest clients in 2003 and 2004. In 2003 the Transport Education Training Authority (TETA) invested R200,3 million and R1,2 billion of the Mineworkers Provident Fund was placed under its' management in 2004.

2. FIDENTIA GROUP STRUCTURE

Mr. Brown claimed to have a degree from the Nelson Mandela Metropolitan University (NMMU), which was formed by the merger of the University of Port Elizabeth, Vista University - Port Elizabeth campus, and Port Elizabeth Technikon. However, the university denied this, claiming that Mr. Brown enrolled and studied for two years but never finished his studies. Mr. Brown's fees had been unpaid for so long, according to the NMMU, that the university wrote it off in 2000.

Mr. Brown founded Brown Brothers (Pty) Limited in 1999 and served as its CEO until 2002. Direct Shelf (Pty) Limited was the company's official name. Brown Brothers was founded by Mr. Brown, his brother Zacharias, and Eastern Province cricketer Louis Koen.

Mr. Brown is incorrectly credited as the Fidentia group's founder. In January 2003, Mr. Brown and Mr. Hendrik Roedolf Bam joined Kerbyn (Cape) 10 (Pty) Limited (Kerbyn). Mr. Steven William Goodwin's company, Worthytrade 185 (Pty) Limited, was Kerbyn's sole client. Mr Brown was instrumental in renaming Kerbyn to Fidentia Holdings (Pty) Limited.

Fidentia Holdings was owned by Brown Brothers to the tune of 75%. Mr. Maddock (CA), through his company Maddock Inc., was one of Kerbyn's founding directors and the company's auditor. Mr. Sergeant felt that Mr. Goodwin, who formed Kerbyn, which later became Fidentia Holdings, was the true founder of Fidentia.

Name of Company

Shareholders

Percentage of Shares

Brown Brothers

J Arthur W Brown Family Trust

35%

Louis Koen Family Trust

12.4%

Z C Brown Family Trust

5%

HSM Family Trust

5%

Linde Schulz Family Trust

6.5%

Mini Moon Trust

5%

The Franzasan Trust

2%

The Silverlining Trust

2%

Baysands Trust

2%

The Jukelyn Trust

12.5%

BROWN BROTHERS SHAREHOLDING: Source: FSB inspection report 2007

Mr. Brown approached Mr. Hans Rnz, a German businessman, in 2002 to buy two multi-million-rand properties from Mr. Rnz. Mr. Brown ran Brown Brothers out of the garage of a rented Sunset Beach home at the time. "At the time, he was a very low-profile businessman with enormous ideas," Mr. Rnz was reported as saying. He approached me with an offer to purchase two of my houses that I had listed for sale. He claimed to own the house where he worked, but I later realized he was renting it." Mr.

2.1 EARLY STRUCTURE OF FIDENTIA 2.2 FIDENTIA HOLDINGS (PTY) LIMITED, FIDENTIA ASSET MANAGEMENT (PTY) LIMITED AND BRAMBER ALTERNATIVE (PTY) LIMITED

Brown claimed to be employed by Generali, a big European insurance conglomerate, according to Mr. Rnz.

Mr. Brown made good on his first failure to pay the deposit on the homes by paying in full in 2003. The Sunset Beach Trust owned the properties, which were registered in its name. Mr. Brown demolished one of the houses to make space for his home, but Fidentia was placed under curatorship and Mr. Brown was jailed before building began.

Brown Brothers served as the holding company for the Fidentia group, which includes Fidentia Holdings and its subsidiaries as well as shareholdings in other companies. Brown Brothers controls Fidentia Holdings (Pty) Limited with a 75 percent ownership. Fidentia Holdings purchased Fidentia Asset Management (Pty) Limited ("FAM") from asset manager Mr. Cliff Warren in March 2003 and owned 100% of the company. Mr. Brown was the Fidentia group's executive chairman and a director of Fidentia Holdings. Fidentia Holdings' Chief Executive Officer was Mr. Mulder. Number 1 Waterford Place, Century Boulevard, Century City, Milnerton, Cape Town was home to the Fidentia group.

Since 30 September 2004, FAM had been an accredited financial services provider and had been licensed as an investment manager under the Stock Exchange Control Act of 1985 and the Financial Markets Control Act of 1989. Mr. Brown and Mr. Maddock are the important personnel of FAM who were responsible for overseeing the Financial Services Provider's actions, as mandated by the Act. Mr. Bam applied for the position of key individual but was turned down by the Registrar. Mr. Bam served on

2.3 DR. DANISA BALOYI AND THE MINEWORKERS PROVIDENT FUND: LIVING HANDS AND THE LIVING HANDS UMBRELLA TRUST

the board of directors of FAM from 25 February 2003 to 11 September 2003, when he resigned. In 2004, Mr. Johannes Petrus Nicholaas de Jongh stated that FAM had R1.8 billion in its possession. Mr. de Jongh was the Head of FAM and a director until March 2006, when he resigned.

Mr. Brown and Mr. Maddock were the only directors during the time of curatorship. From 3 October 2003 to April 2006, Maddock Inc served as the auditors for FAM and Fidentia Holdings, following which Greenwoods Chartered Accountants (SA) took over. Maddock Inc was also the auditor for several of the other Fidentia firms.

Fidentia Holdings also purchased Bramber Alternative (Pty) Limited ("Bramber"). On 19 April 2006, Fidentia Alternative Investments (Pty) Limited changed its name to Bramber Alternative (Pty) Limited.

Fidentia also acquired several other businesses, with The Living Hands Umbrella Trust and Seta in the transportation sector among its biggest clients.

FIDENTIA HOLDINGS SHAREHOLDING: Source: FSB inspection report

Name of company

Shareholders

Percentage of shares

Fidentia Holdings

Brown Brothers

75%

Fidentia Trust

15%

SAWIH

10%

FAM

Fidentia Holdings

100%

Bramber

Fidentia Holdings (A class shares)

100%

FAM (B class shares)

100%

In a special report for Moneyweb, explored how R1.2 billion from the Mineworkers Provident Fund (MPF) ended up in Fidentia's account through forensic reconstruction. The Mineworkers Provident Fund (MPF) serves primarily to support the dependents of deceased members. Its members elect the fund's trustees, establish rules for the fund, and decide on its members' benefits.

2.4 CORNERSTONE: OVATION AND COMMON CENTS

About 46 000 widows and orphans were beneficiaries of the fund, who got monthly payments ranging from R75 to R700. Since 1998, the MPF donations, together with contributions from SAB Miller and Impala Platinum, had been invested with Mercantile. Mercantile held these stakes in the Matco trust.

When Mercantile decided to quit the business in 2001, a management buyout took place, and Mantadia Asset Trust Company (Pty) Limited was founded to take over the Matco Trust. Matco's investments were managed by the Old Mutual Unit Trusts.

Dr. Danisa Baloyi, who was introduced by Mr. Angus Cruickshank, entered into a BEE agreement with Mantadia in 2003. Dr. Baloyi bought a 50% share in Mantadia with the help of an Investec loan. As a result, she was given one vote and became a director of Mantadia on October 31, 2003. Mr. de Jongh (head and director: FAM), Mr. de Kock, and Mr. Linde (Head: Fidentia Alternative Investments) met with OMUT on 15 October 2004 and presented Mr. Maddock with a letter. The letter demanded that OMUT release R150 million in administrative funds to FAM. Mantadia spoke with OMUT, and on 19 October 2004, Mantadia sent a letter confirming FAM's designation as new administrator, as well as the resignation of seven Mantadia directors, including the Managing Director, Mr. Glover, Mr. Hjalmar Mulder, and Mr. Matjila. Mr. Linde (Head: Fidentia Alternative Investments), Mr. Tucker (trustee: Brown Family Investment Trust), and Mr. Phillip Malan were all named new directors in Mr. Glover's letter (a trustee of Matco, who became the Managing Director).

The funds were transferred as requested by OMUT.

Mantadia was renamed Living Hands (Pty) Limited (LH) in 2004, and the Matco trust was renamed the Living Hands Umbrella Trust (LHUT). Mr. William Leshilo, the chairman of the Living Hands fund, revealed to Personal Finance that LH halted payments to the LHUT due to beneficiary complaints about LH's administration. According to Mr. Mulder, there is a chance that the relationship will improve. LHUT's current trustees are Dr. Baloyi, Ms. Motsei Christine Komane, and Mr. Mulder (representing LH). Mr. Mulder is the Chief Executive Officer of Fidentia Holdings, whereas Dr. Baloyi was a director of both LH and Fidentia Holdings.

Mr. Cruickshank controlled Ovation and Common Cents through a holding company named Cornerstone. Ovation is a linked-investment service provider (lisp) company (Ovation Global Lisp). A lisp is used to help clients choose the best investment plan from a variety of options. The phrase is used to transfer funds between funds and fund managers.

Fidentia intended to purchase Ovation, however the deal was never completed. Fidentia, on the other hand, took over and controlled Ovation in June 2006. All of Ovation's employees were relocated to Fidentia's premises.

After the FSB discovered that R160 million had been taken from Common Cents, Mr. Cruickshank committed suicide by consuming rat poison in September 2006. This occurred just one day after Bramber arranged a deal involving Ovation's share purchase agreements.

In October 2006, parts of Common Cents were placed under curatorship. Mr. Horton Griffiths, a provisional curator, was appointed to locate lost investor cash in Common Cents. Fidentia, through Bramber, gave general cash to Ovation to satisfy obligations after parts of Common Cents were placed under curatorship, according to an FSB probe. Early in March 2007, Ovation was placed under curatorship.

Ovation's R4.4 billion in funds has been blocked. According to a Metropolitan employee, a portion of Ovation's life book was sponsored by Metropolitan, which had been doing business with Ovation without incident since the 1990s. As soon as Fidentia seized ownership of Ovation, signs of trouble began to emerge.

When Cruikshank bought Ovation, he was unrehabilitated and bankrupt. The Common Cents money market fund was then formed by him. "Common Cents was an investment option offered to Ovation," writes Wessels of the FSB's legal department. The Common Cents cash portfolio was primarily made up of cash, which was managed by Ovation.

The money that was supposed to be invested instead ended up in Mr. Cruickshank's private estate or organizations that he controlled. The FSB has issued a restricting directive, stating that none of the impacted assets may be traded. The executors and curators were able to track down as much of the money as possible because of this. The cash invested is the sole asset under Common Cents' management that is affected.

FSP licenses were held by both Ovation and Common Cents.

2.5 TRANSPORT EDUCATION TRAINING AUTHORITY (TETA)

TETA is a semi-government organization that collects skills levies from tens of thousands of transportation businesses. Following presentations by Mr. Goodwin and Mr. Bam, the Transport Education Training Authority (TETA) invested R200,3 million in FAM in 2003. TETA has withdrew R15 million, leaving FAM in charge of R185,3 million.

All TETA funds invested with FAM, except for cash in a current account. Acting Chief Executive Officer Mr. Johan de Beer, who took over for suspended Chief Executive Officer Dr. Piet Bothma, informed parliament that Fidentia management promised them big profits and convinced TETA management that their money was safe.

Standard Bank and ABSA both promised 8% and 8.5 percent returns on the TETA investment, respectively, while Fidentia offered 10.5 percent. TETA suspended Dr. Bothma in June 2007 pending the outcome of a disciplinary investigation.

Dr. Bothma was the third person detained in connection with the Fidentia case. On 6 August 2007, he was arrested and appeared in court. He was accused of fraud and embezzlement, as well as corruption involving about R5 million in alleged kickbacks. Dr. Bothma was released on R200 000 bail. On 31 August 2007, he appeared in court with Mr. Brown and Mr. Maddock.

Mr. Goodwin received compensation for facilitating several transactions for Fidentia through his company Worthytrade. Mr. Goodwin left for Australia shortly before Mr. Brown and Mr. Maddock were arrested, and then moved to London.

Required: b) Explain what curatorship is and how it worked in the Fidentia case, including what the curators discovered and how they responded. (30 marks) c) Explain how Fidentia's corporate strategy initially appeared to be working. The assets under administration grew from nearly nothing to nearly R2 billion. (20 marks)

Assume you are an auditing firm that has served as Fidentia's auditor for several years. For several funds, the business served as fund manager. Due to mismanagement and a series of fraudulent acts by the directors, the company was recently declared insolvent. As a result, several investors who put money into Fidentia based on the company's audited financial statements have said they will sue the auditors to recoup their losses.

d) Describe the legal requirements that must be met before a third party can file a successful claim against you as an auditing firm. (20 marks) e) Debate whether the auditors did a proper audit considering the Fidentia scandal in your opinion.

(20 marks)