Securities Commission Chair Jane Diplock wrote a column in the NZ Herald on Saturday calling for the government to fast-track the review of the Securities Act and create a 'super-regulator' to restore investor trust in the capital markets.
Here's a few of her points:
Firstly, she blames delays in fixing the act for some of the finance company debacle.
There's a clear consensus emerging - we need a single comprehensive regulatory agency with extended powers to offer real confidence to both domestic and foreign investors. The current review of the Securities Act began in 2004 before it stalled in consultation. The cost of that seven-year prevarication is a decent chunk of the $1.5 billion of investors' money that was lost in the loosely regulated finance company sector collapses of 2007 and 2008.
Those who point their fingers at the Securities Commission and the other New Zealand regulators for doing too little to prevent these collapses, should look instead at the regulatory framework in which we operate - a patchwork quilt of add-ons and bandaids cobbled together over the past eight years, none of which helped protect finance company investors.
The regulatory vacuum attracted opportunistic operators and the result was market failure of an entire industry and tragically the loss of retail investor confidence in New Zealand capital markets once again.
Despite warnings by the commission, it could do nothing to prevent this failure. A Government agency can only act within its warrant. The time has come to extend the warrant of New Zealand's regulators.
Diplock winds up with a call to get the regulatory framework right.
Finance-sector-led economic growth will take time to gain momentum. Great ideas, such as making New Zealand a hub for managed funds, and lifting our national savings rate are projects that will take years to realise. But they will not even start unless we get the regulatory framework right.
Jane Diplock has been the chairman of the Securities Commission since 2001. The buck stops with her on its performance.
It's surprising she is now blaming her tools for the failure of the regulatory regime to restrain finance companies and financial advisors from what we now know was a frenzy of kick-back commissions, inaccurate and misleading reporting of asset values and results, widespread capitalising of interest, endemic related party lending and Ponzi-like deposit taking.
How outspoken was she during 2004, 2005 and 2006 in pushing the government to reform the rules or on warning investors about finance companies? How many times did she act to block finance companies from raising money?
I had a look through her speeches on the Securities Commission website for 2004, 2005, 2006 and 2007 for evidence she was pushing the government to toughen the rules dramatically and give her the powers she says now that she needed.
This speech here in March 2007 on "Developments in New Zealand Securities Regulation" suggests she was quite happy with the increased powers she had at that stage.
New Zealand has come a long way on securities regulation over recent years. Major reforms - the latest will come into effect around the middle of this year - have clarified and strengthened our regulatory framework and made enforcement more effective. The Securities Commission has been given increased responsibilities and powers, and is committed to using its powers cost effectively. We seek the best means to achieve the best outcome for investors and the market.
Despite the substantial reforms, there has been little or no change in the fundamental principles on which New Zealand regulation is based. We continue to place the highest importance on timely, relevant and complete disclosure of information, and on competition among equally well-informed market participants. The reforms have brought the New Zealand securities markets further "into the light" where efficiency, integrity and, ultimately, confidence can flourish.
Earlier in the speech she said this to reinforce the strength of her powers:
Earlier reforms brought in substantial penalties for breaches of securities law and these are extended in the latest law changes. The Commission will be able to seek pecuniary penalties for serious breaches, compensation for losses suffered by investors and management banning orders against individuals in some circumstances. We will have powers to make prohibition, corrective or disclosure orders for market manipulation and disclosure failures. Under the insider trading law, we will be able to bring actions in the High Court.
It is interesting to contrast the capabilities of the Commission today with those of a decade ago. Then, the regulator's role was largely confined to inquiry and report writing on market trends and instances of poor market behaviour. Court action could only be taken by market participants..
The Commission has always had powers to cancel false or misleading prospectuses and advertisements for securities offered to the public. These are essential powers. We also have power to grant exemptions from compliance with certain aspects of securities law where unwarranted constraints or costs would otherwise be incurred. I would note though that any exemption granted is subject to conditions particularly relating to providing information for investors. These powers reflect the fundamental importance of having a well-informed securities market and of ensuring regulation is cost-effective.
So it's clear that back in 2007, before the worst of the abuses, Diplock had the power to cancel prospectuses or ads for 'first ranking secured debentures'. She could also ban individuals from issuing prospectuses. Yet the likes of Owen Tallentire, Mark Bryers and Rod Petricevic were allowed to go on their merry way. Prospectuses that talked about interest 'earned' actually misled many because much of that 'interest' was capitalised. Related party deals went unexplained and unchallenged by the Commission.
The accounts reported by finance companies were often nearly a year out of date by the time they were available to investors. These accounts were often rubber stamped by friendly auditors and appear to have been ignored by both Trustees and the Companies Office. How else would they let them through without being challenged?
Why didn't Diplock cancel the prospectuses? Did she commission investigations that spotted these problems? And how much of a warning bell did she ring?
Here's the August 26 press release Diplock is referring to when she said she warned investors. It was issued several weeks after the collapse of Bridgecorp.
You should be especially clear about who the finance company is lending money to, and how well the repayments are going. This is why it is so important for investors and their advisers to read a prospectus.
The Securities Commission does not have a prudential regulatory role over finance companies - it cannot step in to stop a finance company failing, or take action against a finance company that fails, or help investors recover their money.
The Commission's job is to intervene only if a finance company does not provide the required information for investors to make a decision on whether or not to invest.
If the investment statement, prospectus or advertising is not up to standard the Commission can require the finance company to correct the information. If necessary the Commission can take the offer off the market until any breaches are remedied. Once the offer is stopped, the Commission's role ceases.
With their higher rate of return than a registered bank, well-managed finance companies are still an investment option for mum and dad investors to consider.
But they must always understand the risks they take with their money. This includes assessing whether the promised return is high enough for the risk they are taking.
This doesn't look like a warning that would make a difference, and it didn't. It even included the comment that 'well managed finance companies are still an investment option for mum and dad investors to consider'.
Two days later in 2006 the Securities Commission issued another press release saying this:
Finance companies' disclosure of information for investors has markedly improved since the Securities Commission published a report on Disclosure by Finance Companies in April 2005. This is the finding of a Commission's review of offer documents of 20 companies prepared since the Commission's report.
The Commission's job is to intervene when finance companies do not provide the information required to enable investors to make informed investment decisions. The report set out the Commission's expectations of disclosure of information by finance companies.
This subsequent review focused on key areas identified in the earlier report such as disclosure of the risks of the investment, and the investment activities of the company. Each company's most recent investment statement, prospectus, financial statements, and advertising were reviewed for compliance with securities law.
Two finance companies had not followed the guidance in the report and still had poor disclosure, especially about risk. Ten others had improved their disclosure on the basis of the report but had fallen short in certain areas. The Commission required these 12 companies to rectify their disclosure deficiencies. All of them amended their offer documents and / or advertisements and one also amended its financial statements. Other companies have agreed to make improvements when next updating their offer documents or preparing advertisements.
"It seems that most companies had taken the report seriously and have been able to apply the guidance in it. On the whole we are pleased with the co-operation we received from the companies reviewed," Jane Diplock said. "The standard of disclosure in the finance company sector has improved significantly as a result of the Commission's work. However, there is still room for further improvement, especially with regard to risk."
Why won't these companies named? Why weren't there prospectuses cancelled? The comments in the speech delivered six months later (referred to above) emphasise her concerns about cost effectiveness for issuers, rather than protections for investors.
Jane Diplock's Securities Commission has not covered itself in glory, yet with this latest column she appears to be campaigning for a role in running the new Super regulator. We need a clean break with an awful past. Let's find a fresh face.
Purely FYI, here is a copy of a column I wrote in 2005 when I was the Business Editor of the Dominion Post. This is the sort of warning I would have like to have seen Diplock make. I wrote this column after speaking to various financial bureaucrats and industry leaders, none of whom were willing to go public then to rock the boat.
There's an elephant in the room and it’s getting bigger very fast. It’s now so big that it could stop economic growth in its tracks if it fell over. But trying to force it back into a safer place could actually trip it up. So everyone is waiting and hoping it can walk out the door without an accident. That could be a short wait with painful consequences.So what am I talking about? The sustainability of the amazing growth of finance companies. They have borrowed more than $10 billion from 'Mum and dad" investors in the past seven years.
They have then lent this money to all manner of property developers, used car owners, small businesses and basically anyone who can't borrow the money from a bank.They don't play by the rules of the banks. They don't put some of these deposits away into very safe securities for a rainy day. They don't have to make sure their shareholders have a good chunk of their own money at stake when they lend. Most of them are well managed and profitable. Some have been around for more than five years, but most have not.
Many have never had to survive an economic downturn and a property slump. Some have single loans worth eight times their equity. Some have equity-to-debt ratios of less than 5 per cent. They can do this because they are virtually unregulated. The big question is what happens when the economy cools and property prices fall? What happens when one of the bigger ones falls over? Will the flow of fresh money from mums and dads dry up for the rest? Privately, every financial bureaucrat and banker is deeply concerned. It's also a subject few politicians really want to tackle. Helen Clark and Michael Cullen are thought to be privately concerned about it. It is suggested it is one of the reasons they appear so keen to have an Australian-led joint banking regulator. That's because an Australian regulator would also oversee finance companies.
The danger for the Government is that, if it tries to impose tougher capital controls, it could push many out of business. Warning mum and dad voters about investing in them would be even more damaging. The best option is for mum and dad to check very carefully. Then they should cross their toes and hope the elephant doesn't squash them.
Your view? I welcome your insight and comment below.