By Gareth Vaughan
The destruction of billions of dollars of "ma and pa" retail investors' wealth, through finance company meltdowns, was the inevitable consequence of at least three decades of unreadiness, unwillingness and inability of regulators, enforcers, courts, lawyers and accountants to fulfill their roles with integrity, according to a leading Queen's Counsel.
Tony Molloy QC, who provided independent specialist advice to Parliament's commerce select committee on its inquiry into finance company collapses, argues this in a hard hitting report he produced for the committee. Molloy's scathing criticism ranges from questioning why lawyers for investors in the ANZ-ING frozen funds apparently failed to point out to their clients that ANZ's advisers had breached their fiduciary relationship, to comparing comments from Inland Revenue Commissioner Robert Russell with the type of thing Hitler's propaganda minister Joseph Goebbels might have said.
The committee, chaired by Labour Party MP and former Minister of Commerce Lianne Dalziel, released a report on its inquiry last week. The parliamentary probe came after dozens of finance companies collapsed from 2006 onwards, costing hundreds of thousands of investors billions of dollars. See full details in our Deep Freeze List here.
Among other things, the select committee recommends the government launch a coordinated effort to improve New Zealanders’ understanding of financial matters, and that Parliament passes legislation to give disgruntled finance company investors the option of taking class actions against the likes of directors, trustees and auditors to try and recoup some of their losses. See more here.
'Systemic, high level forces stacked against New Zealand investors'
In their report the select committee members highlight Molloy's comment that: "Meaningful consideration of investor protection legislation is impossible without first identifying the culture of the New Zealand market that has treated investors as prey, rather than as fellow citizens engaged in an enterprise from which all might profit to the benefit of the nation as a whole."
Molloy's 38-page report also points to "systemic, high level" forces stacked against New Zealand investors, and therefore against capital raising in the New Zealand economy. Molloy served as tax adviser to the high profile Winebox Inquiry in 1994-1995, and was leading counsel for clients of law firm Russell McVeagh McKenzie Bartleet & Co in a six year battle against the firm over tax schemes, the experiences of which he wrote up in a book Thirty Pieces of Silver.
He advised the select committee there was no need to rush through new investor protection legislation because the lessons of the latest crisis are still being learned, billions of dollars of investor wealth has been "vaporised" and others have "over borrowed" against their homes meaning many people don't have anything to invest. On top of this, the next crisis is likely to be several years away.
Furthermore he points out every financial crisis is followed by legislation designed to prevent the meltdown that it had been hoped to prevent by the legislation passed after the last meltdown. That last meltdown in turn, had occurred in the face of the legislation passed after an earlier meltdown.
"And so on, in an almost infinite regression," says Molloy.
A major reason why legislation wasn't as effective as hoped was because Parliament wasn't content to describe the economic event that ought to attract censure/retribution/liability to make restitution, Molloy says. Because politicians like to be seen to be “doing something," Parliament has a propensity for tinkering with legislation and getting "far too far into detail."
"Parliament’s function surely is not to legislate just because, if it is not legislating, its Honourable Members will fear being seen to have nothing to do except have their moats cleaned on the public purse," Molloy says in an example he gave in a speech to a British tax conference.
"Parliament’s function surely is to refrain from legislating when, although it could, mature and properly informed consideration suggests that things would be better if it didn’t: if it was to show restraint."
Exhibit A: Feltex
He uses the demise of carpet maker Feltex, and an unsuccessful criminal case taken against its directors by the Registrar of Companies, as an example of this. Although there was a breach of Feltex's banking covenants in its about NZ$100 million ANZ loan, meaning the money was repayable on demand, this wasn't disclosed by the directors. And there was nothing to penalise them in the law for keeping this to themselves, notes Molloy.
This, he says, is because of a change to the Financial Reporting Act that meant financial accounts no longer had to be "true and fair" but rather needed to "comply with accounting standards."
"Parliament couldn't leave it alone. It decided to 'clarify' the law," Molloy bemoans.
Given a generation of so-called "ma and pa" investors had their faith in the sharemarket destroyed in the crash of 1987, the consequence of this was flight to the perceived relative safety of bank sponsored investments, and fixed interest investments in finance company lending on security perceived to be sufficient. Thus disillusionment with the sharemarket provided banks and finance companies with a captive market.
"The recent destruction of wealth by the finance company and investment product industry was the inevitable consequence of a failure to read the signs that were there for anyone to see: at least three decades of unreadiness, unwillingness, and inability on the part of regulators, enforcers, courts, lawyers and accountants, to fulfill their respective functions with integrity," Molloy says.
Exhibit B: 'ANZ advisers breached fiduciary relationship with clients'
Molloy looks at the ANZ-Commerce Commission settlement last year and outlines how he believes lawyers let down the investors.The bank agreed to pay NZ$45 million to settle a dispute over whether it misled 15,000 investors in two ING funds that were frozen in 2008. He points to the "lamentable fact" no legal adviser consulted by ANZ clients appears to have advised them of the existence of a fiduciary relationship, or of the bank's apparent breach of this fiduciary obligation and the client's right to complete compensation.
Given ANZ was then 49% owner of the ING business (it now owns 100% of the rebranded OnePath), part of its advisers' fiduciary duty was they shouldn't act for a client where the adviser, or any other person for whom the adviser acts or is associated with, has any interest in the matter that could be in conflict with the adviser's client.
Molloy says the "apparent clear breach" of this duty by ANZ advisers who put their clients into ING products entitled the clients to full compensation from ANZ via total repayment of the full amount of their original investment, plus compound interest from the date of investment to the date of repayment.
'IRD director's statement like something from Goebbels'
As for authorities letting down the public, Molloy tees off on the Inland Revenue Department (IRD). He looks at the IRD's December 2009, NZ$2.2 billion settlement with ANZ, ASB, BNZ and Westpac over structured finance tax disputes, or as he puts it: "The four major New Zealand banks' multi-billion dollar assault on the New Zealand tax system."
Molloy notes that the settlement saw the banks agreeing to pay 80% of what IRD said they owed, and that prior to settling the IRD had won two High Court cases, one against BNZ and the other against Westpac. He suggests the full amount IRD could have sought from the banks, if penalties were included, amounted to about NZ$2.75 billion.
"(So) effectively a gift was being made to the banks of at least three quarters of a billion dollars."
Yet Russell described the settlement as a very good result for New Zealand taxpayers.
"The 'taxpayers of New Zealand,' for whom the Commissioner was arrogating the right to speak, might have differed from his view that rewarding this anti-social assault on the New Zealand economy with a gift of three quarters of a billion dollars at their expense had been a 'very good result'."
"It is the sort of thing Dr Goebbels might have said," Molloy adds.
Beating up the little guys & accounting companies with 'disgraceful' records
Although apparently happy to allow "free riding by taxpayers who have massive obligations which they condescend to settle at a discount," our regulators and enforcers can be fearless in prosecuting people without power or standing, even when the amount at stake is trivial.
Here, Molloy points to the case of a taxpayer convicted in 1999 of misleading IRD. The man had put his five year-old son's name on a tax return stemming from him being paid NZ$50 as "expenses for return preparation." The man was fined NZ$500, plus NZ$400 costs, with the costs of the investigation and High Court prosecution coming on top of that.
Molloy also has a crack at the big accounting firms, noting the role of Deloitte as auditor of Italy's Parmalat, which became bankrupt under 14 billion euros of debt after discovering a 4 billion euro gap in its accounting. Deloitte coughed up NZ$149 million to settle a lawsuit arising from its auditing of Parmalat. Closer to home he notes the role of Ernst & Young as Feltex's auditor, where it gave the opinion accounts were true and fair even though they failed to mention a breach of banking covenants that made Feltex's bank loan repayable on demand to the ANZ.
"There is a major problem when firms with such disgraceful records are permitted to continue to practice in New Zealand," argues Molloy. "No sensible person would hire an individual with such a track record."
"It beggars belief that what would not be tolerated in an individual who cannot be trusted, should be tolerated just because it is a firm. The situation is truly a fantasy," he continues. "It is closely akin to the 'magic of the market' whereby a bunch of worthless sub-prime mortgages can be transferred from the lender's balance sheet to an investment fund assembled on the correct premise that there is a fool born every minute."
"The name of each of these international accounting firms should be recognised as a badge of shame."
Trustees giving 'deceptive' comfort to investors
Molloy also unloads on trustees, saying they can be disregarded as a source of any significant investor protection. Appointed to oversee securities issued by finance companies, trustees are "deceivingly" named, and lack the power, resources, and "judging by the few instances of trustee heads being raised above the parapets," the inclination to bite the hand of the issuer who feeds them.
"The appellation, 'trustee', is a snare giving deceptive comfort to investors. The knowledge that they were toothless or timid or both was a further incentive to issuers to cynically pillage their investors," says Molloy.
Directors like Bridgecorp chairman Bruce Davidson 'lacking expertise took up flattering invitations'
Next he trains his sights on directors, noting professional people, devoid of the relevant assumed expertise, proved easy targets for flattering invitations to serve on finance company boards.
"There is a major problem when entrepreneurs with 'form' arising from past failures can, by engaging and hiding behind that perceived integrity and assumed competence of such incompetent directors, lure investors into financial desolation."
Here he cites Bridgecorp chairman Bruce Davidson, now serving nine months' home detention at his Parnell house after Bridgecorp's 2007 collapse left more than 14,000 secured debenture holders likely to get back less than 10 cents in the dollar of their NZ$459 million.
"Mr Bruce Davidson unhappily was one of these," Molloy says of professional people becoming directors of perceived integrity. Davidson, had been a senior partner at law firm Minter Ellison Rudd Watts and chancellor of the Anglican Diocese of Auckland.
"He reached the conclusion that certain actions of the CEO involving the use of group funds to buy himself a very expensive boat had been 'dishonest and unauthorised', yet not withstanding non-compliance by the CEO with repeated board requests for written reports on various critical matters, he did nothing to bring matters to a head on this matter or on many others."
The CEO, Rod Petricevic, certainly had "form" dating from his days as founder of Euro-National in the 1980s. Petricevic, along with Bridgecorp's finance director Robert Roest, is now facing Serious Fraud Office charges.
"In August 1987 he (Petricevic) had net assets of NZ$70 million. After the sharemarket collapse in October 1987 and the dramatic fall in the listed market price of Euro-National shares he was insolvent. His commercial reputation was tarnished and his continued presence as chairman of the Euro-National board was seen as an impediment to the company."
Therefore, unless Petricevic could "hide behind an untarnished commercial reputation," he could go nowhere.
"So when he founded Bridgecorp, Petricevic quickly persuaded Bruce Davidson to join the board and to become chairman of the holding company."
Molloy concludes that there should be no room for caveat emptor when New Zealanders' savings are being handled, and notes the country can't flourish unless investors are protected - to the full extent realistically possible - by a clearly understood body of law.
"The finance and investment industries, the legal and accounting professions, the courts, and as the Feltex prosecution shows, even Parliament, are creating problems for an economy that cannot afford them."
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