Chinese walls between banks, funds are completely ineffective
State Comptroller Eliezer Goldberg sharply criticized the conflict of interests in the banks' operations in the provident fund sector.
State Comptroller Eliezer Goldberg sharply criticized the conflict of interests in the banks' operations in the provident fund sector. In the report published yesterday, the comptroller writes that regulations designed to create "Chinese walls" between the banks and the fund managers, are ineffective and unsuccessful. In commenting on the appointment of directors to the companies that manage the funds, he noted the banks appoint all the directors, including the external directors, as well as setting and financing the directors' wages.
The controlling bank's intense involvement in appointing the external representatives to boards and committees, damages their objectivity and weakens their ability to act only for the benefit of fund members. After completing their jobs at the funds, most directors return to former positions at the banks.
The comptroller concluded that - even before major legislation - the Finance Ministry's capital markets division should remove handling of the appointments and salaries for directors from the banks' hands.
The report also deals extensively with the provident funds' deals with "related parties," the banks that control them. It reveals that the capital markets division does not examine, even by sampling, this type of deal, nor does it maintain sufficient data on these deals, despite the many regulations governing them. The supervisor of capital markets does not maintain a database of who controls the banks or companies they own. In addition, he has no data on the banks' non-financial holdings. Consequently, he cannot examine if the funds associated with banks are fulfilling the regulations.
The Bank of Israel's supervisor of banks does maintain this information as the banks must transmit twice-yearly lists of related parties. The comptroller found there is no reason for the supervisor of capital markets not to maintain an up-to-date database. Goldberg notes Bank Hapoalim as an example: Hapoalim's controlling shareholders have stakes in more than 400 companies that are therefore included in the list of "related parties."
The data indicates that despite attempts to create "Chinese walls" - divisions which prevent insider information from changing hands - a large portion of the provident funds' investments are in entities that are interested or related parties. For instance, the three largest funds, Gadish (Hapoalim), Tamar (Discount) and Otzma (Leumi) had invested 12.6 percent to 19 percent of their assets in related parties at the end of 2002. This amounts to NIS 4.9 billion of NIS 33.3 billion in assets.
In addition to the 0.6 percent management fees the banks receive annually from the funds, they also profit from stock market deals the funds make using the banks' brokerages. The investigation revealed huge differences in the volume of fees paid by the funds.
For instance, Gadish, which manages NIS 15 billion in assets, paid 1.6 percent per mil to Bank Hapoalim in 2002, or NIS 24 million. This is eight times higher than what Otzma paid to Leumi. Otzma has NIS 9.3 billion in assets under management and paid 0.2 percent per mil or NIS 1.8 million. Gadish's fees were five times higher than Tamar's fees to Israel Discount Bank.
The report concluded that the fund managers are not taking necessary steps to save members' money - they do not comparison shop for services and hold no competition in order to ensure the lowest possible fees. In one instance, the comptroller found that the norm for TA-25 options transactions was NIS 4, but Gadish paid NIS 10 per option to Bank Hapoalim in 2001 and 2002.
Bank Hapoalim said in response: A comprehensive investigation by the bank into the provident fund sector found that members paid substantially lower management fees to the banks than to private entities or insurance companies. In a comparison of the major provident fund regarding the costs of investment management, the most important indicator for clients is the cost of investment management, and Bank Hapoalim was found to have a middle ranking.
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