The Financial Advisory and Intermediary Act (No.37 of 2002) (FAIS) was promulgated into law in 2002 and its purpose, as per its preamble, is “to regulate the rendering of certain financial advisory and intermediary services to clients; to repeal or amend certain laws; and to provide for matters incidental thereto.” As per its purpose, the FAIS Act seeks to regulate the activities of all financial service providers, which includes the duties owed by financial service providers to its clients. Section 16 (1)(a) of FAIS read with section 2 of Part II of the General Code of Conduct for Authorized Financial Service Providers and Key Representatives (Notice 80 of 2003) (the Codes), issued pursuant to section 15 of the FAIS Act states:
“A provider must at all times render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry.”
The above requirement from the Code, is effectively a codification of the common law fiduciary duty expected of a person in a position of trust. For a person to discharge their fiduciary duty, they must be able to demonstrate that they acted with due care, skill and in the best interest of the person on whose behalf they are placed in a position of trust. This test is both objective and subjective and will depend on the facts of each unique case. Notably, the preamble to the FAIS Act aligns with the common law fiduciary duty, in that it only requires financial service providers to consider or act in the interest of its clients when rendering financial or intermediary services.
The conduct required of financial service providers goes one step further than that of the common law fiduciary duty, which would be limited to only considering the interest of person on whose behalf the financial service provider is acting in a position of trust, in that it requires financial service providers to also consider “the integrity of the financial services industry” when discharging their fiduciary duty.
This article will seek to ascertain whether as a result of codified fiduciary duty of financial service providers pursuant to FAIS Act and codes an unforeseen conflict may arise in certain situation. For example, a situation may require a financial service provider to act in the best interest of their client but also be required to consider the integrity of the financial services industry. This article will also explore how best can financial service providers navigate this potential conflict.
Is there a conflict of interest?
On the face of it, this additional requirement seems logical. Arguably financial service providers owe a duty to their clients to ensure that the integrity of the financial service industry is maintained but if we look at this a bit closer, there seems to an inherent conflict. On the one hand, the Code expects financial service providers to “at all times render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients” and on the other hand, requires financial service providers to consider “the integrity of the financial services industry”.
This conflict is best illustrated by an example: Company A, an authorised financial service provider, is a major fixed income investor for a range of clients and holds a large portion of Company B’s issued notes and commercial paper on behalf of these clients. Company B starts to experience financial difficulty and subsequently finds itself in debt restructure with its creditors. Company A, through its investments via notes and commercial paper of Company B, is a creditor and will be a party to this debt restructure.
As part of the debt restructure, Company A is asked to waive any interest and capital repayment for six months. This is the first potential point of conflict, as while this will assist Company B in preserving liquidity and potentially trading through its current situation, it is not necessarily in the best interest of Company A’s clients, as the cash return, they are entitled to receive will be affected. This issue is exacerbated if the client in question is a pension fund that is catering for members that are in dire need of the income. The counter to this argument is that by allowing the company to preserve liquidity and trade though the current situation, it will hopefully come out of the distressed state in which it finds itself and will be able to pay its debts as they fall due going forward.
Often in the case of debt restructures, creditors such as Company A, are asked to waive the rights afforded to it in the legal agreements it has entered into with Company B in relation to the investments – the failure to waive these rights could see creditors demand payment en masse, resulting in Company B being placed under business rescue or even liquidated. The waiver request Company B is not unreasonable, as it ensures that all Company B’s creditors are treated equally during the restructuring discussions and don’t have to fear that a creditor will demand payment ahead of the others, which could negate the rationale behind the restructure. However, a conflict arises when one considers whether it is in the best interest of Company A’s clients to waive these rights. In many instances the answer would be “yes”, as recoveries by creditors are generally higher in a debt restructure than under a liquidation scenario, thereby Company is preserving the capital of its clients by supporting the restructure of Company B. However, there may be circumstances where this might not be the case, such as where demanding payment might yield a better return for Company A’s clients or not agreeing to a waiver so as to preserve Company A’s clients rights, would be in the best interest of Company A’s clients but could result in the debt restructure falling over and Company B being placed under business rescue or liquidated, which, may depending on the situation, be detrimental to “the integrity of the financial services industry” .
Based on the above example, it can be said there is this the potential for conflicts of interest to arise, where a financial service provider needs to act in the best interest of their client but at the same time consider “the integrity of the financial services industry” when discharging their fiduciary duty and it is not clear from the FAIS Act which of these duties take precedence.
What does it mean to act in the interest of the integrity of the financial service industry?
From the above examples, it is clear that a financial service provider may be faced with the above conflict at some stage. There is a duty under FAIS to disclose conflicts of interest to your client, but the type of conflict created by the code of conduct is not the type of conflict contemplated to be disclosed under FAIS.
It is, however, important to consider what is meant by the obligation placed on financial service providers to act in the interest of the integrity of the financial service industry. The key word in this duty is “integrity”, which is not defined in FAIS but according to the Merriam-Webster dictionary is defined as:
“Firm adherence to a code of especially moral or artistic values; an unimpaired condition; the quality or state of being complete or undivided” .
From this definition, it is arguable that what is intended by requirement in the Code is that a financial service provider acts in a manner that maintains the ethical standard of the financial services industry but at the same time acts in a manner that will not cause instability. It is also worthwhile considering, always subject to the caveat “integrity” what is meant by “financial services industry”; it is submitted that this includes not only exchanges, but also other financial services providers and market participants.
So where does this leave financial service providers?
From experience, it is generally not in the interest of any party, whether it be the client or the company, to be placed under business rescue or liquidated. It makes more sense and is in the best interest of clients and the integrity of the markets, to work with all the concerned parties to assist the company in returning to a stable footing, thus saving jobs and being able to pay all, or a large majority, of its debts as and when they fall due.
In the ordinary course, a liquidation or business rescue process will not in itself cause instability in the financial service industry. However, it is conceivable that a large listed company being liquidated could have severe consequences that could detrimentally affect creditors and other stakeholders, which may include financial service providers, pension funds and employees. This may create uncertainty in the market, which could trigger investors in the sectors to act irrationally, which instability could threaten the integrity of the financial services industry.
It is also critical to bear in mind that there is more systemic risk in financial service companies being placed into liquidation or under business rescue than companies in other industries such as industrial or resources and this may need to be a factor in considering the “integrity of the financial services industry”.
It can be concluded from the above that there is this potential for conflicts of interest to arise, where a financial service provider needs to act in the best interest of their client but at the same time consider “the integrity of the financial services industry”. However, these two duties are not necessarily always in conflict and it will be incumbent upon financial service providers in situations where there may be a potential conflict to act in a manner which seeks to reconciles these two duties as complementary and will need to carefully navigate this on a case-by-case scenario.
Ashburton Investments as an authorised financial service provider, will too find itself in this situation and will need to carefully navigate the above potential conflict. However, we believe we are in a position to do so given the robust investment and credit processes in place and depth of expertise of the representatives and employees acting as fiduciaries of our clients’ funds. Ashburton Investments is a responsible and ethical financial service provider and we believe that maintaining the integrity of the financial service industry is instrumental to acting in the best interest of our clients.
 https://www.merriam-webster.com/dictionary/integrity accessed on 23 May 2020