Every so often, a major financial scandal hits the headlines. We’ve had Masterbond, Fidentia, Barry Tannenbaum, Mirror Trading International and VBS Bank locally, to name a few of the big ones. Overseas, Bernie Madoff and Sam Bankman-Fried’s FTX stand out.

The latest one to emerge is the BHI Trust operated by Craig Warriner in Sandton. What’s odd about his “investment” was that the returns were fairly pedestrian – circulating news reports put the figure at about 13% a year since the 2008 financial crisis.

In a column following the recent United African Stokvel scam, which promised outrageous returns of three or four times one’s money back within six months, I cautioned that there was no such thing as a high-return, low risk investment. Risk and return go hand in hand: high risk, high return; low risk, low return.

It turns out, however, that there is such a thing as a consistently-moderate-return, high-risk investment, and here’s where you need to be cautious.

One of the hallmarks of most investment scams, which are invariably Ponzi schemes, is that the scammer appeals to people’s greed. Offering exceptionally high returns is one way of continually attracting investors to fund the returns of existing investors.

But it’s not the only way. In fact, if the returns are relatively in line with authentic investments, there’s less chance of prospective investors being suspicious and investigating further.

The notorious American hedge fund manager Bernie Madoff ascribed to the approach. The returns on his fund were above the market average, but not outrageously so. What caused his downfall was that the returns were too consistent. Financial experts worked out that it was impossible for a fund investing in the stock market, which is volatile by nature, to deliver such a consistent return over the years, even if it was low by Ponzi standards.

Like Warriner’s BHI Trust, Madoff’s hedge fund didn’t start out as a Ponzi scheme. It was only when financial markets turned sour that instead of passing the losses onto investors immediately, which would have resulted in a possible exodus of investors from the fund, he kept up the illusion of his investment prowess by dipping into the cookie jar of investor capital.

Madoff and Warriner operated their funds for years under a cloak of respectability, attracting high-net-worth individuals in their elite social circle – in Warriner’s case the old boys and staff of the prestigious St Stithian’s College.

There was nothing respectable about the BHI Trust. The details are sketchy, but it appears the trust had two trustees, Warriner and a friend, Christian Ashcroft. Warriner passed himself off as a representative of a registered financial services provider, Axiam Capital Management, who say they have no association with Warriner or his trust.

The trust itself was a nebulous entity managed by a stockbroking firm, and it appears to have operated illegally as a collective investment, supposedly investing in a handful of shares on the JSE.

In a statement, the Financial Sector Conduct Authority (FSCA) confirmed that none of the parties under investigation were authorised as financial services providers or licensed as collective investment scheme managers. The authority said it had extended its investigation to include regulated entities that may have promoted the BHI Trust. If so, they may be subject to a fine, debarment and the possible withdrawal of a licence, it said.

In a true collective investment scheme (CIS), which may be a unit trust fund, exchange traded fund or hedge fund, your money is ring-fenced. The portfolio manager will use the money in the fund to invest in securities according to the fund mandate, and the units you have bought will vary in value, but they remain yours, under the control of a separate custodian.

Let’s look at requirements of the Collective Investment Schemes Control Act, under which retail collective investments operate in South Africa:

• The CIS management company (manco) must be registered with the FSCA.

• The manco must fulfil certain fit and proper requirements and hold a certain level of reserve capital.

• The manco will typically outsource the investment function of its CIS to a portfolio manager, which must be a registered financial services provider, also subject to fit and proper requirements.

• Investors hold a participatory interest in the CIS in the form of units.

• The manco must maintain a separate operational trust account for the CIS, which is controlled by a trustee or custodian, normally a bank.

• Because the assets of the portfolio are separate, they are protected in the event of the manco getting into financial difficulties.

• The act imposes certain fiduciary responsibilities on any person who holds, keeps in safe custody, controls, administers or alienates any of the funds of a CIS.

Thus, the first thing to do when approached to invest in something that resembles a CIS is to check whether the fund, its manco, portfolio manager and custodian are registered with the FSCA.

* Hesse is the former editor of Personal Finance.

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