If Housing Finance (HF) had accepted to be the trustee of Cytonn Investments properties, the controversy-hit firm would have managed to transition into a fully regulated firm and avoided the pitfalls facing it.
The Capital Markets Authority (CMA) told Parliament that since 2016 it has sent Cytonn several reminders and held meetings asking them to move their illegal businesses into the regulated space.
Most importantly they needed to appoint a licensed entity to undertake the role of a REIT Trustee over their real estate holdings which they failed.
“Specifically, vide letter dated January 17, 2020 to Cytonn Investments Ltd and copied to the Authority, HF terminated its contract to offer REIT trustee services to the proposed Cytonn D-REIT,” CMA Chief Wyckliffe Shamiah told the National Assembly Finance Committee.
Following the failure by Cytonn to take advantage of the grace period for the conversion of the cash management business to a regulated Collective Investment Schemes (CIS) CMA forwarded the matter to Capital Market Fraud Investigations Unit (CMFIU) – which is under the Directorate of Criminal Investigations to investigate the action of CIML of obtaining money through false pretense and raising money from the public without proper licensing.
The regulator has had trouble explaining how Cytonn Investments pooled Sh13.5 billion from thousands of investors without attracting iota of regulatory scrutiny.
The investment entity operated two funds—Cytonn High Yield Solutions (CHYS) and Cytonn Project Notes (CPN)—promising high rates of return from primarily real estate investments but failed to pay investors when the funds matured.
The regulator said it discovered that Cytonn operated ‘a cash management product’ in 2016 where firms pool funds from the public for a guaranteed return.
The regulator deemed Cytonn’s cash management illegal, resembling fund management and CIS that need to be regulated.
However, the authority gave them ample time to transfer funds into regulated space including setting up fund management business, a CIS and a Development Real Estate Investment Trust (D-reit).
While Cytonn successful in setting up the first two regulated products it hit a brick wall when it came to its most controversial asset—real estate.
Real estate has high returns but is very illiquid and requires long term funds, Cytonn had taken people’s money promising the highest return in the market, guaranteed, yet this was almost impossible to achieve and it constantly needed high sales and new clients to offset old ones, something that looked like a Ponzi scheme albeit with assets.
By 2018, CMA was running out of patience with Cytonn and demanded the company stops taking new clients, effectively killing the goose that was laying the golden eggs.
“Cytonn indicated that if they stopped onboarding new clients they would not be able to complete the presold units that are still under development — that implies defaulting on the clients,” Mr Shamia said.
Cytonn proposed to wind up the fund slowly and transition clients to its regulated products on condition that it is allowed to bend the law on CIS’s on concentrating money in one portfolio instead of spreading to reduce risk.
Regulations only allow pooled fund to invest less than 25 per cent in one single entity. Further the law prohibits CIS funds from investing more than 10 per cent in related parties.
CMA compromised and allowed Cytonn to put 25 per cent in related parties and spread the rest of the CIS funds in real estate that was owned by other investments as well as shares, fixed income and cash to manage liquidity.
But the firm stretched the handshake to the elbow and instead of putting the money in real estate projects across the market, they put 64 per cent in their own projects, a risky incest that angered the regulator.
It also reneged on a 12-month calendar to shut down the cash management business and worse still, decided to use the courts to fight with the markets regulator.
But it was the Reit product that sealed its fate since it failed to take off completely. The regulator has asked Cytonn to hire qualified staff and trustee.
Housing Finance Company that was the proposed REIT Trustee, however, HF subsequently indicated their unwillingness to continue offering such services to Cytonn.
The regulator said it was also handling about 500 cases that have lodged complaints of loss of up to Sh1 billion through online forex frauds, illegally pooled funds, crypto currency, real-estate and ponzi schemes and has ordered refunds while also instituting criminal charges.