Notes on Due Diligence

Failure to conduct a proper due diligence procedure is often used by the FAIS Ombud to find against financial advisers. Advisers involved in property syndications and Ponzi schemes, in particular, often felt the brunt of the Ombud in this regard.

In one particular case, the adviser indicated that the FSB had conducted an investigation, and found, initially, that the financial instrument did not qualify as a “financial product” as per the Section 1 definition of the FAIS Act. The Ombud was unmoved by this, and continued to make a number of determinations against this and other advisers who placed funds with the entity.

Due diligence implies a process where a person applies his or her mind as part of an investigation into a person or business prior to entering into a transaction with such a person or business.

Any such investigation must be performed with the reasonable standard of care, skill and expertise that may be expected from a person performing such an investigation.

Whilst the due diligence requirement in the financial services industry appears to apply mainly to investment type business, the requirement actually extends to all product providers, as well as licenced FSPs you do business with.

A search on the FSB website did not reveal meaningful information, although the topic was covered in a telematics broadcast a few years ago. A search on the internet, unfortunately, provided little guidance, specifically as it applies to financial services providers.

In our view, this is an area which requires much clearer guidance from the regulatory authorities and should have been addressed long ago to protect consumers and help FSPs comply.

Some years ago we made a document available to clients of Moonstone Compliance and Moonstone Protector Services to provide them with guidance on how to conduct such an exercise. The resultant document would then at the very least demonstrate that some sort of due diligence exercise did take place.

We also advise clients, as an added precaution, to extend their professional indemnity insurance to cover negligent omissions that may result from inadequate due diligence investigations.

Below are some samples of the questions contained in our guidelines to our clients:

Primary verifications – Product Providers

  • Verify that the product supplier is registered with the relevant authorities. For example, the FSB, Medical Schemes Council, or CIPC
  • Does the financial instrument qualify as a “financial product” and does it fall within one of the financial product subcategories regulated by the FSB?

Secondary Verifications – Product Providers

  • The financial instrument must be realistic: In your experience, is the product realistic in terms of its overall structure, coverage, investment returns, premiums and commissions?
  • The product supplier must preferably be of long standing. Is there any information that suggests that the product supplier has little to no experience with regards to the product?

Primary verifications when transacting with other FSPs

  • Is the entity authorised to render financial services? Are there any restrictions and/or conditions that apply to its license?
  • Does the product being marketed fall within the FSP’s authorised subcategories?
  • Is there a compliance officer linked to the FSP’s license?

These are but some of the basic checks and balances you may be required to conduct in order to enter into business arrangements with other entities.

If you make use of an outsourced compliance service, please approach them for assistance in this very important regard.

Some representative bodies also provide assistance in this regard, including the FPI’s Due Diligence Framework: A guide on selecting a service provider.

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