The FMA has released its report on the lessons learned from the fraudulent activities carried out by Barry Kloogh, who was found guilty, convicted and sentenced to eight years and ten months imprisonment for running a Ponzi scheme.
A link to the FMA’s report can be found here.
Who should read this? Why?
The report helps to identify a range of actions that market participants can take to strengthen protection for consumers. The purpose of the report is to raise aware of these protections and strengthen understanding of relevant obligations. The report will be of particular interest to custodians (and client money and client property service providers) but all participants in New Zealand’s financial markets should familiarise themselves with the findings of the report.
What does it cover?
The report addresses how Kloogh was able to operate a relatively sophisticated Ponzi Scheme for 20 years without being caught, and provides the FMA’s view on how custodians should operate in order to fulfil their obligations and make fraud more difficult.
Kloogh’s Ponzi scheme involved Consilium NZ Limited (provider of the wrap platform to the companies used by Kloogh), FNZ Limited and FNZ Custodians Limited (contracted by Consilium to provide custody services) and BNZ (who provided banking services to one of Kloogh’s businesses, Impact Enterprise Limited). None of the parties involved besides Barry Kloogh were found to have breached their obligations in their respective positions or found of any wrongdoing.
During the time Kloogh’s Ponzi scheme was in operation, brokers and custodians were governed by the now repealed Financial Advisers Act 2008 (FA Act). Under the FA Act, FNZ had various obligations, both as broker and as custodian.
The obligation which was looked at in detail by the report was that of custodians to report on client money and client property.
In the course of carrying out its enquiry, the FMA identified the practice of custodians to send client custody reports every six months to addresses other than the client’s own verified address. The FMA state in the report that their view is custodians must send a custody report directly to a client’s physical or electronic address, and that the address specified by a client must be the client’s own address. In the FMA’s view, sending reports to a financial advisor’s address may facilitate the potential for fraud, as clients don’t have an independent record of transactions relating to their money and property.
In Kloogh’s Ponzi scheme, FNZ provided these custody reports to addresses associated with Kloogh’s businesses for 92 out of 118 of Kloogh’s clients as the “authorised representative” of the end investors.
While providing reports to financial advisers was, at the time, consistent with the practice of other custodians, and there was no evidence FNZ had breached its obligations as a broker and as a custodian, the FMA are now in the process of developing guidance on the best practice for custodians to ensure clients are being given the mandated custody reports and information.
The FMA also identified shortcomings in BNZ’s review of alerts triggered by its AML/CFT monitoring system of Kloogh’s transaction activity. In the FMA’s view, the BNZ’s review of the alerts was limited, and although no evidence was found to suggest BNZ knew or ought to have known Kloogh was operating a Ponzi scheme, the FMA has provided the information it received in respect of the Kloogh inquiry to RBNZ as BNZ’s AML/CFT supervisor.
Kloogh’s Ponzi scheme fraud was able to occur for as long as it did due to over 20 years due to its relative sophistication, which made it difficult to detect.
The fraud also occurred under the old FA Act regime, which has since been replaced by the new financial advice regime. The new regime has enhanced requirements of financial advice providers, including FSP registration and annual returns (from 2024), which will help FMA in its monitoring and supervision activities. The FMA is also better resourced under the new regime, which allows it to be more targeted in its vigilance against fraud.
In our view, the findings of the report and the future guidance for custodians are a step in the right direction to protect investors. We also agree with the FMA’s recommendation to MBIE to consider licensing custodians under the FMC Act in the same manner as other licensed market participants.
Fraudulent activity is always a risk, and sophisticated fraud in particular is becoming more prevalent, both locally and globally. Strengthening existing regulatory settings to create additional layers of protection, for consumers and providers alike, is a necessary measure to help build confidence in New Zealand’s financial markets.
If you have any questions regarding the report or information regarding custodial services and obligations please contact one of our experts.