Poking Maltese investors has made them very cross

Having just started the year 2015 we look back and nostalgically reflect on how the global scene has witnessed a string of accounting scandals which exploded with a bang – starting with Enron and the reverberations  following the dot-com collapse in 2002/3 which dwarfed the gravity of scandals of late connected with the sub-prime banking crisis, in tandem with the Madoff Ponzi scheme and the unaccounted high sovereign debt latently discovered by the Mandarins in Brussels in cooked public accounts in Greece.

Thus, readers may be curious to read more on such travails, hoping to discover how and why fraud persists, why it happens and how it permeates itself into various scenarios.

It is a foregone conclusion that fraud is contagious and its implications on managers/political masters to try and detect and finally eradicate it are paramount. Every organisation is potentially vulnerable to fraud, and those responsible for corporate / state governance  must know how to detect it or at least when to suspect it.

It is not surprising that both political and business leaders have to be vigilant as fraud, sleaze and corruption is a threat to the entity’s own existence. Enter the latest occurrence of alleged fraud (including misappropriation and manipulation) in the investment company Maltese Cross Financial Services Ltd.

On 5 September, 2014, the Malta Financial Services Authority wrote to investors in Maltese Cross over a shortfall of between €6 million and €7 million due to an alleged misuse and manipulation of clients’ assets.

Police have charged Jean Claude Bugeja, one of the active directors involved in the running of the company investment policy, who has admitted to the shortfall in clients’ assets – conveniently absent from the company’s books. The other two directors, Robert Cutajar and Stephen Spiteri, said that Jean Claude Bugeja had admitted to them that there was a black hole in the audited books hiding a shortfall in clients’ assets of about €6 million.

Taking the witness stand, prosecuting inspector Ian Abdilla said things started to go wrong in July 2008, when the accused lost some €250,000 in a €1 million investment. As a gambler faced with huge losses tries to gamble more dollars in a desperate attempt to tempt Lady Luck to smile and recoup, Jean Claude was sinking in a vortex of losses reaching over €6 million.

He boasted that no checks and balances were in place ever since the MFSA’s last inspection of the company’s books in 2008. Bugeja told police he gave auditors a summary of what the clients had and not what they were meant to receive.

In his opinion there was weak control methodology used by the MFSA inspectors since there was no direct confirmation with clients themselves and instead only a desk top audit was carried out.

A judicial protest by some 40 clients was recently filed against the MFSA, the Investor Compensation Scheme, and the Registrar of Companies claiming to have been defrauded of their nest eggs, having lost about €6.2 million. A successful claim under The Investor Compensation Scheme pays out 90% of all claims made by each investor, limited up to €20,000.

They argue that they were afforded no protection from any source on how to recover their losses so they decided to sue the authorities above mentioned, particularly the MFSA as the principal financial regulator, holding it responsible through gross negligence and alleged “Male Fede”.

As has happened with other accounting scandals in Malta, the judicial protest alleges that the regulator closed the barn doors after the horse had bolted in alleging that the MFSA acted only when it was far too late to be of any practical assistance towards the safeguarding of the capital of the general investing public.

MaltaToday reported inter alia that an MFSA spokesperson said on behalf of director-general Marianne Scicluna and chairman Joseph V. Bannister that “notwithstanding the Authority’s supervisory effort, the chance that a licensed entity may fail cannot be eliminated. No supervisory system is waterproof and it is therefore unreasonable to expect supervisors to prevent all failures, particularly when we are dealing with humans whose behaviour might change during the years, together with their circumstances”.

This resounds the landmark maxim of caveat emptor, or ‘buyer beware’, whereby while the investor generally acts from a lesser position of strength in comparison, he must always take heed and be alert when making investment choices as he alone bears the risk for the same going awry.

This changes somewhat where the loss is proven to have been the direct result of foul play, as it is alleged to have been in this case.

In a counter judicial protest the regulator was quoted to have rebutted any responsibility for such losses in performance of its official duties as a supervisor of Maltese Cross Financial Services, directing the entire responsibility onto auditors PricewaterhouseCoopers, (PWC) – the external auditors since inception of the bankrupt investment company.

They issued clean audit reports and failed to suspect any wrongdoings by the promoters in their confidential management letters, which were regularly copied to the regulator. The MFSA said that the auditors positively confirmed each year that Maltese Cross had adequate systems in place to safeguard clients’ assets.

PWC never identified any internal control issues in the annual reports so based on this assurance it was not expected by the MFSA to be more vigilant and consequently decided not to conduct on-site inspections to counter check the positive picture revealed by the external auditors throughout the entire history of the company.

Naturally reference was made to the 240 qualified supervisory staff at its disposal but the regulator rebutted any accusation of negligence by saying that “the fact that on-site visits to the Maltese Cross offices were not carried out does not mean that it did not carry out its supervisory duties… off-site oversight and monitoring was done on the basis of the documentation from Maltese Cross and its external auditors”.

In their reply to the protest by aggrieved class of investors the MFSA was silent on whether it was ready to renounce its statutory immunity: the investors say the MFSA failed to perform its fiduciary duties by proper on-site inspections at Maltese Cross.

As it turned out the regulator never visited the premises of the said moribund company in the seven years of its operation. Readers may ask what is the position regarding the liability of external auditors (if proven in court). The answer is that under 1994 civil code there is no capping to liability under Maltese law for those who have bound themselves personally, and hence auditors could be liable with all assets present and future if found to be liable.

Maltese jurisprudence has to date only given us reference to auditor negligence in Price Club and here too no decision obliging auditor to repay any damages was given. As rare as it may be for auditor liability to be imposed, it is by far rarer for a regulator to be found liable, for the simple reason that as regulator the overriding principle remains that the MFSA should never be a party to an action, as so doing would hinder its ability to retain its supervisory independence, and this is in line with the sense that is required to enable a properly functioning regulator.

Quoting the MFSA Act, section 29, it states inter alia that: ‘The Authority, the members of the Board of Governors, of the Co-Ordination Committee, of the Supervisory Council, of the Board of Management and Resources and of the Legal Office and the officers and employees of the Authority, shall not be liable in damages for anything done or omitted to be done in the discharge or purported discharge of any function under this Act or any other Act administered by the Authority, or otherwise in the exercise of their official duties, unless the act or omission is shown to have been done or omitted to be done, as the case may be, in bad faith’.

Otherwise, the MFSA may investigate a complaint if it qualifies the nearly airtight article 19. (1) The Authority may investigate any matter which: (a) relates to the functions exercisable by the Authority under this Act or any law, and (b) is the subject of a representation (other than one appearing to the Authority to be frivolous) made to the Authority by or on behalf of a person appearing to the Authority to have an interest in that matter.

The conditions hereunder are cumulative and exceedingly onerous to satisfy. Whereas the MFSA was accused of breaching its fiduciary duties, the term ‘fiduciary’ does not feature anywhere in the MFSA Act, thus making it conspicuous by its absence.

However, potentially tied with this is the observation that of all the functions of the MFSA under the Act, the one which perhaps might fit the bell of the aggrieved would be paragraph (d) of section 4 which states that the MFSA is responsible to: ‘monitor the working and enforcement of laws (including performance of auditor duties?) that directly or indirectly affect consumer or financial services and to undertake or commission such study, research or investigation which it may deem necessary in this regard’ but the law still gives the MFSA prerogative in deciding what it ‘deems necessary’.

In conclusion it appears that 2015 did not bring much joy to a number of hapless investors who were hoodwinked into letting their life long savings in the slippery hands of an administrator who made them feel very cross indeed. The story continues in court as more will be revealed by the sworn testimony of the actors.