Summarised key points from a July 28, 2009 letter advising Stocks and Securities Limited (SSL) of the findings from on-site inspection done in May 2009 by the Financial Services Commission (FSC). The letter was signed by Everton McFarlane, the then senior director of securities at the regulator, and addressed to SSL’s then boss Mark Croskery.
– Preliminary findings presented to senior officers of SSL, including Mark Croskery, on June 12, 2009. Subsequently, FSC received several correspondences from SSL, which provided additional information relating to the areas of concern highlighted.
– Among the information requested was a sample of 16 client files. Know Your Customer documentation submitted for seven of the 16 clients selected. Croskery said other client accounts requested were “inactive” accounts, which were legacy accounts from an old system and these legacy accounts would be eliminated as no activity were recorded for seven years or longer.
–FSC said it viewed the information request as being largely unsatisfied. Croskery gave no clear indication as to why a complete set of relevant documentation for the so-called “inactive” accounts were not readily available or, if available, why they had not been submitted.
– Incomplete and/or inaccurate contract notes: from a sample selected, the majority of contract notes examined did not provide a proper description of the underlying securities (stocks and bonds) effecting repo transactions. In addition, the contract notes pertaining to transactions with persons who were not dealers did not state whether SSL was acting as principal or as agent. Contract notes indicated that SSL was a member of the Jamaica Stock Exchange.
– The examination team observed instances of possible fraudulent misrepresentation arising from inaccurate statements on client contract notes.
• Sample contract notes showed SSL’s inclusion of statement that “this contract note complies with the Financial Services Commission 5.00% margin requirement. But SSL did not apply a margin to all repo transactions as required by law. As such the statement was both false and misleading.
– Absence of stipulated committees: No audit committee or conduct review committees established.
– Securities verification: A review of the financial assets (namely, investment securities) and financial liabilities (namely, repurchase agreements) of SSL as at May 11, 2009 revealed no allocation of securities to some clients; poor record-keeping in relation to securities; very little, if any, checks and balances were performed; lack of a review function for internal control and a short in managed funds.
– No securities assigned for some corporate repurchase agreement clients. The corporate liabilities listing presented to the examination team indicated that no securities were allocated to 14 transactions, totalling US$6,625,022.03, and transactions totalling $71,027,995.70.
– The problem of unsecured corporate client funds is further exacerbated as discrepancies were identified in the futures maturities report for liabilities and the corporate liabilities listing for some clients.
– The Jamaican-dollar assets report showed securities being assigned to clients that were not on the liabilities listing. Examples include Jamaica Money Market Brokers Ltd, Mayberry Investments Ltd, and Sagicor Ltd. When enquiries were made by the FSC examination team, SSL staff indicated that the original listing presented to the FSC contained errors which had since been corrected.
– The foreign currencies-denominated assets report showed a security, specifically MIRANT 2016, that was not seen on any of the overseas broker statements provided. Enquiries revealed that the security had already been sold on May 7, 2009. The security was still being used to back repo transactions.
– Instances of securities identified on a client’s contract note being different from the securities assigned to the client in the system.
• An instance where global bond securities, GOJ 8.0000% due June 24, 2019, were over allocated.
– As at May 11 2009, there was a short in managed funds with total repo liabilities as per the futures maturities listing amounting to J$8.49 billion, while total assets available for trade/allocation was 4.32 billion. A short in funds of J$4 billion with 49% of repo liabilities being unsecured.
– May be concluded that SSL does not maintain proper records of its securities business. Shortfall of assets underlying SSL’s repo liabilities together with a practice of issuing incomplete or inaccurate contract notes expose SSL’s clients to unnecessary and excessive credit risk, for which capital has not been adequately provided.
– To the extent that client contract notes dispatched with descriptions of securities purchased, the repo shortfall highlighted in the securities verification exercise may also raise an issue relating to possible fraudulent and/or deceptive practices.
– FSC examination team observed that client funds were not segregated from proprietary funds. This lack of segregation results in funds being withdrawn from bank accounts designated as “client accounts” for transactions, which appear to be for the benefit of SSL.
– Breach was observed in SSL’s dealings with associated companies and in the absence of adequate payments control for the company’s bank accounts.
– Substantial amounts of monies were withdrawn from bank accounts SSL had designated as “client accounts” for transactions with, and investments in three companies – AP Capital Partners. West Indies Aggregates, and Island Ice and Beverage Company Limited.
– General ledger shows West Indies Aggregates’ investment accounted for $37.1 million, AP Capital Partners’ investment accounted for $88.8 million and Island Ice & Beverage’s investment accounted for $54.9 million.
– General ledger shows West Indies Aggregates’ investment accounted for $37.1 million (transactions spanned April to December 2008); AP Capital Partners’ investment accounted for $88.8 million through two transactions between June and July 2008 and Island Ice & Beverage’s investment accounted for $54.9 million through three transactions in October 2008.
– West Indies Aggregates appeared to have been the recipient of working capital assistance by SSL facilitated through the use of SSL client funds. These transactions include, but are not limited to:
• Payroll received by M.L., a loan client of SSL, amounting to J$1,562,459.72;
• Purchase of Project Materials through cheque payments of J$444,000 to Electro Mechanical Systems Ltd and J$999,900 to West Indies Aggregates;
• Purchase of bearings, screen sheets, rubbers, etc, amounting to J$3,572,500.00. This transaction appeared to have been facilitated via an SSL cambio transaction to effect a wire transfer;
• Purchase of Property from Arthur Williams & Company, amounting to J$2,300,000;
• Purchase of a truck, amounting to J$900,000; and
• Payroll and other operating expenses amounting to J$500,000.
– SSL explained monies provided to the companies as equity investment. In the case of West Indies Aggregates, the equity stake was acquired in tranches, whereby SSL provided financing for the operations of West Indies Aggregate in return for shares of an equivalent value.
– Sample of 76 payment transactions examined from both main client USD and JMD bank accounts. Approximately 41, or 54%, of these transactions displayed no evidence of supporting documents (e.g., client instructions/request forms or acknowledgement of payment by customer).
– Due to commingling of client and proprietary funds in SSL client accounts great uncertainty surrounds the extent to which proper control was being exercised over the payment function. This again raises the possibility that client funds are being misappropriated.
– FSC team observed three instances (4% of the sample selected) of transactions being conducted “on account” in which clients were allowed to withdraw monies and/or conduct transactions for value in excess of the amount of funds these clients had on their account.
– Finding suggests clients were being provided with loans funded by monies coming from either other client funds, or proprietary funds which are commingled with client funds in the client accounts.
– SSL explained that what appeared to be overdrawn client accounts were actually the result of inadequate reconciliation and integration of multiple accounts operated by some clients.
– SSL did not dispatch client statements at the end of each month in which the client effected a transaction or at least at the end of each quarter if the client did not effect a transaction over the period.
– FSC observed that client statements did not include a list of the securities held for clients nor an indication of which securities were held for safekeeping or in segregation.
– From a sample of 45 client files requested by the FSC examination team, SSL was only able to provide 23 three files within the examination period.
– SSL did not have an approved Master Repurchase Agreement (“repo”) document to guide its repo activity. Highlighted in the previous examination, and, in response, SSL submitted an amended Master Repo document to the FSC, dated July 21, 2008, for review.
– Based on a review of the company’s most recent audited financial submission as at December 31, 2008, SSL failed to meet the statutory requirements for both of the capital adequacy ratios in FSC’s Early Warning Tests Securities, namely the capital to total assets and capital base to risk weighted assets ratios.
– SSL appeared to be failing the FSC’s liquidity benchmark. The deficiencies with respect to capital and liquidity are areas of major concern, given SSL’s exposure to market risks, notably interest rate risks.
– Lack of adequate capital is also of paramount concern given the extent to which repo liabilities to clients are not fully backed by assigned assets.
– SSL’s capital base of $155.5 million (2007: $212.2 million) and total assets of $9.9 billion (2007: $4 billion) the ratio of capital to total assets was 1 56% as much as 4.44 percentage points below the FSC’s statutory requirement of 6%.
– Ratio of capital base to risk weighted assets was 8.4%, which was 5.6 percentage points below the FSC’s Early Warning Test benchmark and 1.6 percentage points below the FSC’s statutory requirement.
– Review of SSL’s liquidity gap report [shows extent of mismatch in the supply or demand for a security or the maturity dates of securities] as at December 31, 2008 revealed a negative cumulative gap of $3.8 billion on instruments maturing within 1 year. SSL’s one -year liquidity gap ratio was 55.3%, which is failing the FSC’s benchmark of less than or equal to 25.
– SSL did not implement regular programmes geared towards training employees on their responsibilities with respect to the Proceeds of Crime Act (POCA) and its attendant regulations. This is a violation of Regulation 5 (2) (c) of the Proceeds of Crime (Money Laundering Prevention) Regulations, 2007.
– Information on the clients’ source of funds was not indicated on seven of the reviewed requests for proposals. This is a breach of the FSC Anti-Money Laundering Guidelines.
– The SSL full board had never held a formal board meeting. SSL said an executive committee and a management committee were formed.
– FSC reviewed meeting minutes which revealed that no committee member, having read and reviewed the minutes, endorsed the accuracy of the contents.
– FSC said conduct of SSL, in respect of the management of its affairs and of its relationship with its clients, has not complied with regulatory requirements.
– Several regulatory violations are observed to be repeat violations which were uncovered in a previous examination.
– Aspects of SSL’s conduct constituted unsafe and unsound practices and exposes SSL’s clients and/or investors to unnecessary and excessive legal and credit risks.
– SSL committed to taking corrective actions, including appointing internal auditor; submitting outstanding documents; install International Private Banking System to improve record-keeping; sell long-dated assets.
– SSL said misrepresentations on client accounts to be removed immediately and that failing early warnings tests linked to market valuations.
– SSL maintained that placements in the three companies were for investment purposes. FSC reviewing documents submitted after on-site exam; request made of SSL banks for accounts just for company funds; To address liquidity issues, SSL’s strategy was to sell long dated assets, sell assets at a gain and earn interest on assets assuming rates increase.
– The FSC expects that all outstanding issues will be satisfactorily resolved within acceptable time frames. The FSC will continue to more closely monitor the activities of the company.