Kloogh case adds urgency to custody licensing push

Almost four years since fending off again a long-standing International Monetary Fund (IMF) call to licence custody providers in NZ, the local regulator has put the issue back on the agenda.

In the wash-up from Barry Kloogh ponzi scheme scandal that saw the Dunedin-based adviser defraud clients of some $15 million, the Financial Markets Authority (FMA) referred the custody-licensing question for government attention, according to general counsel, Liam Mason.

“We have asked MBIE [the Ministry of Business, Innovation and Employment] to consider whether the regulatory settings for custodians in New Zealand should be reconsidered, including whether or not potential harms in this area indicate that increased regulation such as licensing is appropriate,” Mason said.

The FMA 2019 ‘thematic review’ of the NZ custody sector noted room for improvement but stopped short of endorsing the IMF recommendation issued two years prior to licence custodians in line with global peers.

While the IMF has been bugging NZ since at least 2017 to introduce licensing of custodians – the nominal owners of all retail fund money including the $100 billion in KiwiSaver accounts – the debate goes back much further.

Following the IMF report, for example, Hugh Stevens, former NZ country head of BNP Paribas Securities Services, noted the 2010 law review – the culminated in the Financial Markets Conduct Act – rejected licensing of custody providers.

“But very few people involved in the review had custody, operations or back-office experience to understand the risks New Zealand investors take with the safekeeping of their investments,” he said at the time.

“… Under the current licensing, the application form might go left and the cheque heads right,” which pretty much describes the Kloogh offences.

As the FMA Kloogh review details, the now-imprisoned financial adviser used a variety of fraudulent techniques including setting up deceptive bank accounts under labels such as Consilium (his platform provider) and faking non-custodial assets within the wrap.

He also managed to run the ponzi for at least seven years by directing custody account reports for 92 of the firm’s 118 investment clients to his own (or associated) addresses.

The FMA has recommended a legal clarification requiring custodians to only direct account reports to verified underlying investors but more fundamental changes such as licensing might be necessary, Mason said.

“We have highlighted that custodians of client assets and money in New Zealand are subject to very few conduct requirements – as is illustrated by the limited role that the custodian in this case considered that it needed to perform in respect of overseeing transactions on behalf of customers,” he said. “We have highlighted in particular that this case illustrates the gap in New Zealand’s regulatory settings compared to other jurisdictions because we do not have licensing or detailed regulatory standards that apply to the provision of custody services for financial products. This gap was identified in the International Monetary Fund’s report on New Zealand in 2017 as part of its Financial Stability Assessment Programme.”

The FMA exonerated Consilium, FNZ (the underlying custodial wrap provider) and BNZ from any legal blame – albeit, the regulator noted the bank could’ve followed up earlier on red flag activities in the Kloogh accounts.

Meanwhile, following a visit earlier this year, the IMF reported that the NZ regulator had implemented most of its 2017 recommendations.

According to a footnote in the IMF 2023 NZ report-card, the FMA had “received its outsourced thematic on custodial arrangements and is progressing work to consider whether there is a case for recommending the establishment of a regulatory regime for custodians”.

The government tweaked rules around discretionary investment management services (DIMS) and wholesale investor definitions in the wake of the Ross Asset Management ponzi in 2013 but the frauds kept on coming including the $17.5 million effort by investment adviser, Paul Hibbs, uncovered in 2018, and the $80 million wholesale fund blackhole that saw Penrich Global founder, Kelly Tonkin, jailed for eight years in 2021.

Kloogh investors received just 2 cents back in the dollar in a final tally-up of assets last month.