Opinion: Key empowering step missing from Govt's push to restore confidence of 'mum and dad' retail investors in financial markets

By Gareth Vaughan

Just departed Commerce Minister Simon Power made much of restoring "mum and dad" retail investors' confidence in the financial markets following the collapse of dozens of finance companies and loss of billions of dollars by tens of thousands of these investors.

After a whirlwind three years in cabinet Power has left - to head up Westpac's private bank. Whoever replaces him, both as Commerce Minister and in his other key role of Justice Minister, needs to push through a Class Actions Bill that was ignored by Power but is surely a key plank in any restoration, or establishment, of retail investor confidence. For it would empower the mums and dads to pool resources and take action themselves directly against those they believe have ripped them off, or those who were supposed to represent investors' interests but were too blind, timid, inactive or incompetent to intervene.

The Financial Markets Authority (FMA), established by the National Party-led government on May 1, is the cornerstone of this push to restore investor confidence. It replaced the heavily criticised Securities Commission and Government Actuary and took over some regulatory functions from the Ministry of Economic Development.

The FMA was given sharper teeth than the Securities Commission ever had including an Australian Securities and Investment Commission (ASIC) style power to seek financial compensation by exercising an investor’s right to take civil action, when it’s considered in the public interest to do so, against the likes of directors, trustees and auditors.

FMA boss cautious about using, maybe even reluctant to use, key new power

The new regulator is probing 16 finance companies that failed under its predecessor's watch but FMA CEO Sean Hughes says investors in these firms shouldn't get their hopes up about getting back any of the NZ$3.45 billion they lost when these companies snuffed it. This is despite the new ASIC style power, which the Aussie regulator itself used earlier this year to secure up to A$67.5 million for investors in property scheme Westpoint from auditor KPMG and four former Westpoint directors.

Hughes argues it wouldn't be in the public interest for the FMA to spend taxpayers' money pursuing compensation over finance company failures if there is little likelihood of any assets being available should the FMA's legal action succeed.

But I for one would like to see him try, at least once. Of all the dozens of finance companies that have collapsed in recent years there must be at least one where it's worth the FMA attempting to recover some money for out of pocket investors from any, or all of, the directors, trustee and auditor where negligence, default, breach of duty, or other misconduct, took place.

However, Hughes is no fool and won't want to risk ending up with egg on his face, taxpayer money down the drain and his shiny new regulatory regime publicly humiliated by taking this type of action and losing.

Select Committee recommended Class Actions Bill be passed

Therefore, the government needs to step in and pass a Class Actions Bill that's been languishing in the background since at least early 2009, (witness this high powered meeting attended by Chief Justice Sian Elias in March 2009).

Parliament's Commerce Select Committee, chaired by Power's predecessor as Commerce Minister Lianne Dalziel, recommended this in October in the report on its enquiry into finance company failures. The Select Committee said class actions could be an avenue available to finance company investors wanting to try and recoup some of the money they lost.

A specific law enabling class actions is needed because New Zealand law currently doesn't cater for them. Disgruntled investors, or customers, currently have to attempt such group action through what's known as representative action. This requires investors or customers signing up individually with a law firm or litigation funder. If an investor or customer doesn’t know the action is being taken and that there was a cut off date they had to sign up by, they would miss out.

In contrast under the proposed class action legislation, a litigant merely requires seven people’s support to bring proceedings. The court then controls the litigation and it becomes a class action in the sense that anyone who believes they have suffered loss and meets the criteria becomes eligible to potentially benefit from the litigation.

Feltex another case in point

Aside from finance companies, the spectacular demise of sharemarket listed carpet maker Feltex is another example of where investors deserve the opportunity, should they wish to, of launching a proper class action. Remember that Feltex was a household name, had been around for donkeys' years, and its shares were peddled to retail investors by sharebrokers as a safe, high yielding investment opportunity when its Credit Suisse private equity owners sold out in a June 2004 sharemarket float.

Within 27 months of the float, which raised NZ$254 million at NZ$1.70 a share, Feltex was gone, with its plug pulled by a fed up ANZ which was owed A$119.5 million. Feltex's demise spawned three court cases against directors and other parties of which only one remains live - a representative shareholder action - and is probably the least likely to succeed. This doesn't say much given the other two are dead in the water already.

This case is being led by former Fay Richwhite investment banker Tony Gavigan on behalf of Feltex shareholders who had to opt-in to the case. It alleges deception, misleading conduct and negligence under the Fair Trading Act.  Targeted are Feltex directors who signed the company's float prospectus in 2004, the float promoters Credit Suisse First Boston (CSFB), the vendors (CSFB Asia Merchant Partners), and the joint lead brokers, First NZ Capital and Forsyth Barr.

The key issue is whether the prospectus, which a 2007 Securities Commission investigation cleared of being misleading, painted a true picture of Feltex's accounts and future prospects.

Feltex's five directors at the time of its demise, the targets of the other two court cases, have successfully seen both off. One was taken by the Registrar of Companies against Feltex's directors and lost with the five directors awarded taxpayer funded costs of NZ$429,091. The second was taken by Feltex's liquidator and settled confidentially with no admission of liability by the directors.

Action - raking in a combined NZ$300,000 - was taken against Feltex by sharemarket operator NZX and by the Institute of Chartered Accountants of New Zealand (ICANZ) against Feltex's auditor Ernst & Young at the behest of the Securities Commission. But the upshot of both parties action was zero return on their 100% losses for Feltex's shareholders, who along with the firm's staff and creditors, were ultimately the losers in the collapse.

NZX stung Feltex for NZ$150,000 over a breach of continuous disclosure rules, which actually penalised shareholders because the NZ$150,000 came out of the company's, read shareholders', funds. And ICANZ ordered Ernst & Young's responsible partner Gordon Fulton to cough up costs of NZ$150,000 over the audit firm's erroneous debt classification, with this money used to cover ICANZ's expenses from running the prosecution.

Hard row to hoe

Even with class action legislation, it'd be a hard row to hoe for disgruntled consumers or investors as a means of recovering money. Looking to replicate the class action taken in Australia against ANZ by customers over avoidable penalty and late fees, for example, would involve a "reasonableness test" under New Zealand's proposed class action legislation. The customers would have to prove that the fee charged by ANZ exceeded the underlying costs associated with any customers' breach of contract.

But if customers and consumers at least had the option of taking a class action, it might act as a deterrent, making companies and professional service providers like auditors and trustees think harder about what impact their actions - or inaction - might have on customers and investors and whether these could come back to bite them.

In his quest to restore mum & dad investors' confidence in the financial markets Power pushed through a raft of legislation on top of establishing the FMA. This included the passing of a bill aimed at beefing up the regulation of auditors, another aimed at bolstering oversight of trustees, new financial advisor regulations, a review of securities law and a bill aiming to protect New Zealand's international reputation by tightening the rules around company directors and company registration.

But missing from all this is empowerment for small investors by letting them take direct action themselves through class actions. The challenge to the re-elected National-led government, and Power's replacement(s) as Commerce Minister and Justice Minister, is to enable such action.

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