Bombshell report unveils litany of SSL breaches

Below is a lightly edited publication of the February 2017 Financial Services Commission Report on Stock & Securities Limited.

Stocks & Securities Limited (SSL), a licensed securities dealer, has been closely monitored by the Financial Services Commission (FSC) for several reasons:

* Failing to file its annual report (Form PR.A) within 90 days of the close of SSL’s financial year ended June 30, 2016.

* Failing to file an audited account within 90 days of the close of the financial year.

* Granting credit to related parties and other persons in violation of directives issued by the FSC on October 22, 2013.

1. Over the years, SSL has had issues of capital adequacy. As a result of this, the FSC had issued a set of directives to SSL in a letter dated October 22, 2013, limiting its business activities and instructing it to cooperate with a specially appointed auditor.

2. SSL, in seeking to solve the issues affecting its capital, needed to strengthen its capital base. In 2015, with the assistance of its attorneys Patterson Mair Hamilton (PMH), SSL undertook a plan of reorganisation and recapitalisation, including the creation of a holding company and the conversion of bond obligations into equity preference shares.

3. In a letter dated March 2, 2016, PMH wrote to the FSC on behalf of its client indicating that the structural reorganisation of SSL had been completed.

4. In a letter dated March 4, 2016, SSL informed the FSC of a board resolution to move the company’s terminal year end to June 30 of each year based on consultation with its auditors, KPMG. This decision was carried out to ensure that SSL Jamaica was in line with its parent company SSL Barbados.

5. In a letter dated May 5, 2016, SSL informed the FSC that the reorganisation of the company caused SSL’s balance sheet to be “cleaned up” and that the company was consistently making profits monthly. The company also made reference to its collective investment schemes, stating that it had not yet got formal approval that it has met regulatory requirements. This, it said, placed them at severe competitive disadvantage.

6. In a letter dated May 16, 2016, from the FSC to SSL, the FSC made the company aware that it would be carrying out an on-site examination of SSL in accordance with the provisions in Section 4(3)(a) of the Securities Act.

7. In a letter dated June 8, 2016, from Peter Knibb, a chartered accountant/auditor, to SSL, a copy of which was forwarded to the FSC, the auditor noted a variety of issues that were a cause for concern.

· Assets held by broker that were not reflected in the assets book (Global Asset Under Administration).

· Assets on books (Global Asset Under Administration) that were not reflected on the broker statement.

· Assets on books (Global Asset Under Administration) not reflected in client holding (Holding by Depository).

· Assets in client holding (Holding by Depository) not reflected assets book (Global Asset Under Administration).

· Client IPBS statements and amounts reflected in client holding (Holding by Depository).

The auditor ensured he brought to SSL’s attention his view that such issues would no doubt cause the regulator to take enforcement action against the company.

8. In a letter dated October 5, 2016, SSL wrote to the FSC requesting an extension until October 30, 2016, for the completion and submission of SSL’s audited financial statements which were due for submission from September 30, 2016.

9. In response, FSC advised SSL, in its letter dated October 5, 2016, that it was unable to grant any extension for several reasons:

* The initial submission date of the report should have been March 31, 2016.

The FSC had not received any independent verification of the financial position of SSL for in excess of 22 months, which posed significant risk in the assessment of the entity.

Given the material restructuring that took place in November 2015, an audited position of the company is required to ascertain the financial health of SSL and its ability to remain a going concern.

10. The FSC had conducted the on-site examination of SSL between June 6, 2016, and September 14, 2016, which revealed several violations. By deficiency letter dated October 31, 2016, it informed SSL of the findings of the examination:

a. Unsafe and unsound practices.

b. Offering in unregistered securities.

c. Incomplete request for proposal.

The examination team requested 30 completed client agreement forms for inspection. Of the 30 forms reviewed, seven, or 23 per cent, did not indicate the risk appetite of the client. This constitutes a breach of Section 8(2)(d) of the Securities Regulations, which outlines that one should: ensure that the request for proposal explicitly states the risk appetite of the client, such as aggressive (high risk); medium (medium risk); conservative (low risk);

d. Contract notes/trade confirmation.

An inspection indicated that SSL contract notes/trade confirmation does not contain the name of the recognised stock exchange of which the dealer is a member, a breach of Section 38(3)(b) of the Securities Act. This section states that: “a contract note given by a dealer under Subsection 1 shall specify each recognised stock exchange (if any) of which the dealer is a member”

e. Securities verification

· The value of amortised securities which were not reduced by the part payment of principal, on the Global Assets Under Management Report, resulted in an overstatement in the funds under management reported to the FSC.

· There were instances where securities were recorded on the Global Assets Under Management Report and there was no evidence of ownership or pending settlement of these securities based on the broker dealer statements presented to the examination team.

· There were also instances where assets reported on the broker statements were not reported on the internal records of SSL (Global Asset Under Management listing).

· Inconsistencies were observed in the amounts reported for some assets.

· Securities reconciliation with statements from third party custodians were not prepared on a consistent basis.

f. Accounting records

The examination team was unable to confirm the value of the funds in the clients’ bank accounts as at April 30, 2016, due to inconsistencies between the general ledger presented and the general ledger balance recorded on the bank reconciliation statements.

g. POCA-record keeping/verification of identification

· Not all client opening forms indicated the source of funds.

h. Breach of directions

SSL was restricted from making loans to any related persons. During the examination, it was observed that SSL was carrying on loan business, a breach of Section 8(1)(a) of the FSC Act.

i. Segregation of funds

There was no segregation of the global bonds being held for brokerage clients nor did SSL’s internal records indicate that the securities were being held in segregation.

j. Statement of account

Statements issued to client were deficient as they didn’t clearly indicate which securities were being held in safe keeping or in segregation.

k. Several concerns arose as it pertains to the internal control environment which may be due to inadequate oversight or due regard to required internal procedures and controls.

11. In response to FSC’s letter, SSL, in a letter dated November 28, 2016, stated that it had reviewed the FSC’s concerns and it was working assiduously to address the violations identified in the deficiency letter.

12. The FSC, in a letter dated December 23, 2016, in response to SSL’s letter in the aforementioned, indicated that the responses provided were inadequate and did not clearly outline the corrective actions that have been or will be implemented to prevent a recurrence of the breaches identified. Further, FSC requested that SSL prepare and submit a revised action plan no later than January 16, 2017, outlining in detail the approach that will be used to address the deficiencies and/or concerns inclusive of the projected timelines.

Intended decision of the FSC

13. By letter dated November 30, 2016, the FSC informed SSL of its intention to suspend its securities dealer’s licence. The reasons provided to substantiate FSC’s intention are that

· SSL has failed to file its annual report for the year ended June 30, 2016, in contravention of Regulation 13(1) of the Securities Regulations. Regulation 13(1) requires that “every company licensed as a dealer or investment advisor shall file with the commission annual reports in the form specified as Form “PR.A” in the Schedule within ninety (90) days after the end of the dealer’s financial year”.

· SSL has failed to file its audited financial statement for the year ended June 30, 2016, in contravention of Regulation 13(2) requires that the annual audited financial statements be filed with the annual reports. The FSC has not received an independent verification of the financial position of SSL for in excess of 22 days.

· Given the material restructuring that occurred within the SSL Group in November 2015, an audited financial position of the group is required immediately to ascertain the financial health of SSL.

· SSL has failed to comply with FSC’s directives issued, in that SSL should refrain from granting credit to related parties or other persons, Section 8(5)(c) of the FSC Act. SSL was informed of its right under Section 9(7) of the Securities Act to be heard by the FSC before a final decision is taken to suspend the licence. If it wished to take advantage of this right, it was told to forward written submissions within 30 days of this letter.

14. SSL accepted the opportunity to be heard before the FSC in a letter forwarded by its attorneys PMH dated December 5, 2016.

15. On December 7, 2016, KPMG advised the FSC, on the instruction of SSL, that the finalisation of the audit of the financial statements for the period June 30, 2016, would be made available on or before December 19, 2016.

16. In a letter dated December 8, 2016, prepared by Sagicor Bank on the instructions of SSL, Sagicor indicated that SSL’s accounts were being handled in a satisfactory manner and that the company’s credit facilities were being serviced as arranged.

17. In a letter dated December 8, 2016, prepared by Citi Bank on the instructions of SSL, Citi Bank indicated that SSL’s accounts were being handled in a satisfactory manner.

18. By letter dated February 7, 2017, SSL informed the FSC of its corrective human resource actions that have been made. The following were actions that have been affected:

· As of Monday, February 6, 2017, Tamika Pennicott changed roles within the organisation from financial controller to compliance officer.

· Former accountant Ryan Cooper was appointed interim financial controller.

· Jai Jangir was recruited to fill the permanent role of SSL’s controller.

SSL’s recent financial statements

19. SSL submitted its audited financial report on January 5, 2017, long after its due date, which was September 30, 2016. In the report, the auditor KPMG provided a qualified audit opinion based on the audit evidence they obtained. The bases for their qualified opinion were as follows:

i. During the period, the company earned management fees of $134.9 million from managing its clients’ investment portfolios. The entity’s control over the initiation, processing and recording of management fees, through substantive procedures, were not effective and they were unable to obtain sufficient appropriate audit evidence about the completeness and accuracy of the amount reported as management fees, through substantive procedures. Consequently, KPMG was unable to determine whether any adjustments to the amounts shown in the financial statements for the reporting period might have been necessary.

ii. The group statement of financial position and statement of profit or loss and other comprehensive income include the unaudited 18 months results of its wholly owned subsidiary, Dolla Financial Services Limited, as at June 30, 2016. KPMG was unable to obtain sufficient evidence about the completeness, existence and accuracy of net margins from the foreign currency trades of $12.4 million, as the audit of the subsidiary’s results was incomplete as at the date of its report. As such, KPMG was unable to satisfy themselves by alternative means. Consequently, it was unable to determine whether any adjustments to this amount were necessary. KPMG also highlighted Note 2(f) of the financial statements in particular which described that the group and company incurred net losses for the period ended June 30, 2016, and as of that date, the group and company had accumulated deficits of $1,495.89m (2014: $982.739m) and $1,462.437 (2014: $974.075m) respectively. Those conditions, along with other matters as set forth in Note 2(f), indicate the existence of a material uncertainty that may cast significant doubt about the group’s and company’s ability to continue as going concerns.

20. In a paper from the securities division, which basically repeats the chronology of events, the staff detailed that “SSL, under its present management, has displayed a culture of non-compliance and mismanagement of client funds ... ; issue of poor record keeping and reporting which has given the auditors concern as it relates to SSL remaining a going concern should the status quo remain. The veracity of the financial information presented comes into question and this is serious for the FSC. The breach of directions also speaks to the lack of oversight necessary to give confidence in the management of SSL.

Written submissions of SSL

On January 26, 2017, SSL’s attorneys informed the FSC on the way forward to deal with the current issues. They are set out below.

A. Failure to file audited account within 90 days after the close of the financial year

SSL indicated that it took three specific measures which its board believes will assure that the problem of late submission of audited accounts and annual accounts will not recur.

i. Engagement of the company BDO (Jamaica) as internal auditors – in particular, BDO’s responsibilities included continuous internal audit functions and continuous internal control monitoring.

ii. Employment of two key additional executive team members to lead the finance and operations department. SSL stated that it had always had difficulties in attracting experienced accountants locally. As a result of this, it engaged two highly qualified Indians who will come on board in February and April 2017, respectively.

iii. Sage/Prospero Wealth Management System – SSL has indicated that invested in the Sage/Prospero Wealth Management System. So far, the system was successfully tested with the company’s international brokerage partners and their local staff was trained during 2016. They also outlined in their submissions that the system testing was in advance stages with Citibank N.A. (Jamaica Branch) and the Jamaica Stock Exchange. A KPMG 8 software audit was planned for March 31, 2017, in preparation for data migration to the Prospero System with a view to go live on the system on May 1, 2017. This would be followed by a further IT audit by KPMG on June 30, 2017, to ensure that the data migration was duly implemented. The Prospero system would automate a vast range of work flow activities thereby reducing the risk of human errors. The system had built in alerts to notify users of errors in the execution of transaction and allows for automatic reconciliation of cash and securities.

B. Failure to file Form PR.A. within 90 days of SSL’s financial year end

SSL outlined in its submissions that it had changed its financial year end from December 30 to June 30. This meant that the Form PR.A. should have been filed within 90 days after June 30, 2016. However, in accordance with its usual practice, SSL filed its annual report in Form PR.A. in January 2016, before it was due in 2016. SSL submitted that this filing arose because the company overlooked the fact that it was due for filing along with the audited annual financial statements. The mere fact that FSC did not reject the filing, the company formed the view it was accepted. In light of the company’s filing in January 2016, and the urgency of the audited financial statements, SSL inadvertently omitted to file a new form PR.A. with its audited annual financial statements for 2016. This has been remedied. The filing was effected on January 19, 2017. It meant that for the 18-month period, SSL filed two forms of Form PR.A.

C. Granting credit to related parties and other persons in violation of directives issued by the FSC on October 22, 2013

KPMG indicated that details of the alleged offending credit was not particularised in the FSC notice of proposed suspension of November 30, 2016. It is understood that the reference is to a related party loan of J$7.5 million. The loan should not have been booked in the company and has since been repaid in full. SSL highlighted the point that a suspension of the company’s dealer licence, even for a day, would inevitably lead to total destruction of the company and destabilisation of the financial [sector].

Opportunity to be heard

21. Before a final decision is taken on the matter, and in keeping with the requirements of the law, the commission will meet with SSL on February 17, 2017, to hear the SSL’s submissions as to why the intended action of the FSC should not be pursued.