Part 1 is here.
We were starting to really get stuck into the the sheer carnage caused by the collapse of Westpoint, Fincorp and ACR.
In part 1, we looked at a couple of burning issues created by these debacles:
1. The role that adviser commissions played in the collapse of these businesses and the loss of investor savings;
2. Mezzanine finance and portfolio theory - how is it that advisers can spot a wildebeest when it walks and quacks like a duck? and;
3. Financial literacy and retirees. Is it wrong to target a vulnerable sector of the community when pushing risky products?
The media has been completely enjoying this horrific financial pile-up. And why wouldn't they? There are thousands of angles to explore this from - advisers, investors, the companies involved, the executives, the trustees, the
And why not? They all had a role to play in this. Whether good or bad, savoury or otherwise.
I'll do my best to cover some of the angles, but I'll re-iterate the important lesson to be learnt from this:
"If it looks too good to be true, that's normally because it is."
Let's look at some interesting stats from this. According to an article in the Fin of Saturday 2 June, 2007 by Robert Harley, the following numbers come up. There were:
- 20,000 investors burnt; and
- AUD $800 million lost.
No matter which way you crunch the numbers, this adds up to serious money and serious lost dreams.
The financial regulator, ASIC, is looking very battered and bruised after some fire from both sides of Parliament. But was ASIC being made a scapegoat?
This blogger thinks that they were. And these are the reasons why:
4. Mezzanine finance is a risky proposition.
Even though the issue of debentures and unsecured notes are done through a trustee, there is very little recourse available through a trust deed for investors. The trust deed itself is normally written by a the company who is issuing the paper.
Trustees are usually appointed through a tendering process whereby the one that offers their services most cheaply will win out. Not only that, but during the tendering process, preference will be given to trustees who promise no questions asked.
Trust Company, the trustee appointed to look after ACR's investors maintains that ACR did all that was required from Trust, and met all their obligations under the trust deed right up until the bitter end.
Is this a conflict for trustees?
I don't really think so - provided that there is proper disclosure given up front. If this is done, then the job of the trustee is mostly done. The trustee just needs to look after the rest, but they still have a duty to act on behalf of the investors.
How about ASIC?
ASIC polices the issue of these investments, but really only up to the point where disclosure is concerned. If the issuer of this paper is meeting their disclosure requirements, then ASIC's job is done.
How the company that has issued the debt then operates in servicing their debt obligations is between the trustee, the company and their investors.
This is a bit different to a bank or a superannuation fund.
Banks and super funds have their day to day activities policed by a number of bodies, all of whom ensure that their prudential and regulatory duties are being upheld.
For banks, the regulatory side of things is monitored closely by the Reserve Bank, and APRA monitors their prudential undertakings to ensure that all is good.
Super funds also have APRA keeping tabs on their prudential requirements, except for DIY super funds which are looked after by the ATO. The ATO also looks after super funds' regulatory arrangements.
In the case of debentures, unsecured notes and other debt instruments, there is no body that looks after the prudential goings on of the company that issues them - it really is caveat emptor.
This adds a whole new level of risks that banks and super funds don't have.
Where disclosure is inadequate, this is pretty much the only area where ASIC can step in and so something about it. And in fact, ASIC did so - the article in the Fin reports that ASIC stopped ACR from issuing capital raisings three times until they fixed stuff up. Which ACR did.
ASIC also issued 11 warnings about Fincorp's goings on both before and after their CEO, Eric Krecichwost resigned as CEO (and as a director) in 2005.
This would appear to point the finger of blame in an entirely new direction, and in a direction that investors will not like, at least for investors who didn't use financial advisers:
5. Investors really only have themselves to blame
This really only applies to investors who just saw the advertisements and went berzerk. It doesn't really apply to investors who sought financial advice.
ASIC appeared to be doing everything short of double-checking the disclosure given by these companies for mistakes and errors.
But the whole deal looked too good to be true for retail investors.
What happens in the institutional world?
Harley's article mentions that where professional lenders, like the ubiquitous Macquarie Bank are concerned, rates of 20% or higher are the norm.
(By the way, just once I'd like to do a post where I don't mention Mac Bank. How in the name of Crikey do these guys end up in everything that I write?)
Anyway, you can bet that where professional lenders are involved, all sorts of caveats are written into the contract to ensure that the lender has some recourse.
Retail offers simply don't have this kind of bargaining power. These investors were pretty much sitting ducks for the walloping that they got, and I hate to say it, but they really only have themselves to blame.
6. How do we protect investors from this sort of thing happening again?
Well this is an age old question.
Investing, much like supply, demand, democracy, revolution and innovation only works because of two base human emotions - fear and greed.
I would also add laziness to this, but I'll detail why on another day.
Investors who got burnt were basically shovelling everything that they had into these investments. In a nutshell, they got greedy.
Of course, where advisers were involved, this complicates things a little, and the blame shouldn't be sheeted home to investors entirely.
Portfolio theory says that putting large slabs of your cash into the one asset is a very silly thing to do, and history has borne this out. Diversification, while it won't protect people from market nosedives, will protect people from problems with particular parts of a portfolio.
But if you throw everything into one asset that goes belly up, you are in deep trouble.
Tony D'Aloisio, the new chairman of ASIC, says that all products like these coming on to the market should all be professionally rated.
This is possibly a constructive solution, but D'Aloisio knows only too well that investors will bear the cost of such risk ratings.
D'Aloisio's other solution is better, though:
7. Can we educate investors about risk?
I think that risk is so important that I honestly believe it should be taught at school as the fourth 'R'.
I'll do a Financial Tip on risk a little down the track, hell possibly even three, but risk is so important, and it's through misunderstanding of risk that people go on to get burnt in the way that they have.
I believe that we can educate investors about risk, but this should start in secondary school.
Trying to educate mature Australians about risk is shutting the gate after the horse has bolted type stuff. It really is.
Australians' financial literacy is shocking. But risk would be an excellent place to start fixing this discrepancy up. And I for one will support any initiatives that ASIC puts in place to improve this particular piece of general financial knowledge.
It's the most important piece there is.
Edit 13/06/2007: I lay the blame for quite a lot of this squarely at the feet of investors, which oversimplifies things a little bit. In the case of Westpoint investors (and some others), however, quite a lot of them sought financial advice, and the advisers in question recommended the debt in question. I've done a couple of edits to rectify this, but I may explore Westpoint's situation in a future post - it warrants some additional comment space.Disclosure: This blogger owns shares in Macquarie Bank Limited.
Standard but necessary disclaimer: This is not advice. Only a complete idiot would think that any of this constituted advice. It's not even vaguely reasonable to consider this to be advice. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.