A need for financial services providers to reinforce monitoring mechanisms over representatives

Home/A need for financial services providers to reinforce monitoring mechanisms over representatives

By Bright Tibane, Senior Associate, Banking and Financial Services Regulatory, Bowmans

Section 13(1)(b) of the Financial Advisory and Intermediary Services Act, 2002 (FAIS) requires a representative of a financial services provider (FSP) to provide clients with  a prior ‘confirmation’, certified by the FSP, that the representative has a service contract or mandate to represent the FSP. The confirmation must also state that the FSP accepts responsibility for the activities of the representative that are performed within the scope of, or in the course of implementing, any such contract or mandate.

Against that backdrop the finding of the Financial Services Appeal Board (Appeal Board) in First National Bank, a Division of FirstRand Bank Limited (FNB) v The Registrar of Financial Services Providers and the Ombud for Financial Services Providers (FAIS Ombud) is significant in that it arguably undermines section 13(1)(b) of FAIS, and highlights the need for FSPs to reconsider the manner in which they monitor the activities of their FSPs.

In the FNB case, the Appeal Board upheld the finding of the FAIS Ombud that FNB (in its capacity as an FSP) was liable for the fraudulent conduct of its representative, despite the representative having acted outside the scope of his employment. The representative’s employment contract explicitly set out the scope and ambit of his authority when rendering financial services and advice, and stated that he was only permitted to deal with investments or services authorised by FNB. Acting contrary to this the representative had marketed a product which emanated from a pyramid scheme. The complainant in the matter suffered loss after investing a substantial amount in this scheme on the advice of the representative. The Appeal Board found that FNB was obliged to compensate the complainant for the loss suffered as a result of the actions of the fraudulent representative.

What was interesting about the finding is that the Appeal Board relied on the common law doctrine of vicarious liability – a doctrine long forgotten by FSPs. According to this doctrine, an employer can be held liable for the wrongful culpable acts of his/her employees where those acts caused harm to third parties. In Feldman (Pty) Ltd v Mall 1945 AD 733, the doctrine was described by the Appellate Division as follows:

“It appears …that a master who does his work by the hand of a servant creates a risk of harm to others if the servant should prove to be negligent or inefficient or untrustworthy; that, because he has created this risk for his own ends he is under a duty to ensure that no one is injured by the servant’s improper conduct or negligence in carrying on his work … It follows that if the servant’s acts in doing his master’s work or his activities incidental to or connected with it are carried out in a negligent or improper manner so as to cause harm to a third party the master is responsible for that harm.

 It is within the master’s power to select trustworthy servants who will exercise due care towards the public and carry-out his instructions. The third party has no choice in the matter and if the injury done to the third party by the servant is a natural or likely result from the employment of the servant, then it is the master who must suffer rather than the third party”.

The court in Feldman made it clear that an employer may be held accountable even where an employee commits unauthorised acts or acts outside the scope of employment. The court pointed out that:

“In all these cases it may be said, as it was said here, that the master has not authorised the act. It is true he has not authorised the particular act, but he has put the agent in his place to do that class of acts and he must be answerable for the manner in which the agent has conducted himself in doing the business which it was the act of his master to place him in”. (emphasis added).

In the FNB case, the representative was contracted to provide financial services and advice in relation to investment products. Because it was not within the scope of his or her contract to provide financial services in relation to a pyramid scheme, the FSP’s liability could not flow from the confirmation contemplated in section 13(1)(b) of FAIS. However, because the nature of his employment was generally to render financial services in relation to investment products, if he caused loss as a result of doing that ‘class of act’ then vicarious liability arose on the basis of the employment relationship. Had the loss been suffered as a result of him selling stolen cars (to use an extreme example), it is arguable that no vicarious liability could follow as selling cars was not within the class of act he was employed to perform.

The application of the vicarious liability doctrine has potentially serious consequences for the financial services industry. It means that an FSP may be liable for the actions of a representative who acts unlawfully outside the scope of his/her employment or mandate. It therefore gives less weight to the confirmation contemplated in section 13(1)(b) of FAIS in terms of which the FSP would ordinarily only accept responsibility for the representative’s activities if these were performed within the scope of, or in the course of implementing, any such contract or mandate.

In addition to the risks of vicarious liability, FSPs also need to be mindful of the risks arising from the common law doctrine of ‘ostensible authority’, which was also considered in the FNB case. According to this doctrine, where a third party understood that an agent had authority to act on behalf of a principal, the principal is bound by the agent’s actions even if the agent had no actual authority. The doctrine was described, among others, in Glofinco v ABSA Bank t/a United Bank 2002 (6) SA 470 (SCA), where the Supreme Court of Appeal said:

By establishing branches for the conduct of its business the bank represents to the public at large that the bank conducts its ordinary business from those branches and that its manager is authorised to conduct that business on its behalf. No doubt there are generally internal limitations placed upon the authority of the manager (as there were in this case) but… those limitations are immaterial if they are not brought to the notice of the public. Members of the public are thus entitled to assume, when they transact business at the branch which is of the kind that falls within the scope of the ordinary business of the bank, that they are dealing with the bank and not with an unauthorised third party”.

Applying this doctrine, an FSP may be stopped from denying an unauthorised transaction concluded by its representative, so long as a third party can show that he or she was misled by the FSP into believing that the representative had authority to conclude the transaction and that the third party, reasonably, acted on that belief to his/her prejudice. Among other things, the confirmation contemplated in section 13(1)(b) of FAIS may arguably lead a third party to believe that a representative has authority, even where he/she has no actual authority.

Certainly, the approach of the Appeal Board in the FNB case was never envisaged by FAIS in requiring FSPs to accept responsibility for the activities of their representatives only in respect of the activities within the scope of, or in the course of implementing their employment contracts or mandates.

Not only is the finding of the Appeal Board in the FNB case a wake-up call to FSPs who do not have robust monitoring mechanisms, it is also a reminder that the old and well-established vicarious liability and ostensible authority doctrines still subsist and extend to the financial services sector.

FSPs should be reviewing their business practices and their monitoring mechanisms to assess whether they are adequately managing the risks, and whether there might be ways to limit risks or deter non-compliant behaviour, for example through indemnities.