Personal finance and investing columnist at the NZ Herald

Brent Sheather: Poachers turned game keepers

Sean Hughes (right), the former chief executive of the FMA got his hands dirty dishing out divine retribution for most, but sadly not all, of the local bad guys, says Brent Sheather.
Sean Hughes (right), the former chief executive of the FMA got his hands dirty dishing out divine retribution for most, but sadly not all, of the local bad guys, says Brent Sheather.

He came, he saw, he prosecuted.

Sean Hughes rode into town and blew the bad guys away with the FMA arguably doing more in a few years than the Securities Commission accomplished in a decade.

No dining out with contemporaries at overseas conferences every second week for Mr Hughes, he got his hands dirty dishing out divine retribution for most, but sadly not all, of the local bad guys. Not the FMA's fault that the silly Court system sentenced many to home detention.

So whilst it is high fives for the FMA so far, let's hope, to quote Winston Churchill "this is just the end of the beginning". Most of the bad element is gone - prosecuted, retired or left the country. So that is the criminals sorted.

The next, even more important job, is to rehabilitate the law abiding members of the investment community.

Its all very well to legislate, as Code Standard whatever of the Code of Financial Conduct for financial advisors states, that you have to put your clients interest first but, lets be honest, that is about as likely as John Key walking down the main street of Opotiki without a disguise and an armed escort.

Why so cynical dear reader might be thinking? Lots of reasons with the most obvious, of course, being profitability. Doing the right thing, with "the right thing" interpreted by a reasonable person as opposed to specialist securities lawyers or compliance officers who have long ago lost touch with reality, would mean much lower fees and much, much lower profits.

Consider for a minute how returns from international equities are currently allocated between the agent (finance sector) and the poor fool client. Prospective returns from international shares in the long term, according to the non conflicted independent experts and academics, are about 6% pa and fees, when they are disclosed, range between 2% pa and more than 3% pa.

And yes we all know the world stockmarket returned around 25% in calendar 2013 but what's more relevant - last year's 25% or the last 10 years return of 5.4%. Fees are forever so me thinks 10 years, obviously. Therefore the current "do the right thing" environment sees Mum and Dad assuming all the risk and accepting half the returns.

Hardly putting your client's interests first is it?

Still not convinced? Well what about this example of a performance fee which is payable without any, ahem, any performance?

A very popular locally managed unit trust has a performance fee which cuts in when the fund return exceeds the return of the 90 day bank bill index. The current yield of the 90 day bank bill index is 2.69%.

But, hello, the dividend yield of the fund is 4.8% so no performance is required to earn that fee. The manager can put the portfolio together and then it's off to the Gold Coast. What is more, 90 day bank bills are risk free whereas the portfolio is much more risky.

All together a totally fraudulent environment so it is easy to be cynical when our bankster brothers wring their hands and:

a) Worry on our behalf that we aren't saving enough for their retirement
b) Can't understand why residential investment is so popular

These are just a few examples of what is not right so things obviously aren't great for retail investors, despite all the backslapping, speeches, press releases and resource that has ostensibly been put into sorting things out. The question that has to be asked is "why so little progress?"

Patrick Jenkins writing in the London Financial Times has a theory and he calls it regulatory capture. He writes "there is an inescapable problem created by banks persistently poaching the regulators best people; the quality of supervision is likely to decline.

That might be just what a cynical bank might hope for but it is ultimately bad news for systemic safety.

Today the Bank of England and the European Central Bank are both headed by former Goldman Sachs bankers. Strings of US Government representatives and officials have likewise been through the Goldman ringer.

To critics of 21st century capitalism all this cross fertilizing makes it unlikely we will ever break out of the old ways of thinking about finance - old ways that ultimately benefit the big banks". Nice one Patrick but don't come out of hiding too soon.

Let's put the FMA under the microscope through this lens.

First off the new Chief Executive has worked for Merrill Lynch and if you look on LinkedIn you see that many FMA executives have worked for the banks and many will no doubt work for them again.

We even had the Minister of Commerce, Mr Simon Power, leave politics and join Westpac Private Bank. Hmmm.

According to the FT article Sheila Blair, former Head of the US Federal Deposit Insurance Corporation, says that regulators should be banned for life from working for any bank they have overseen. Now we should at this stage remind ourselves that the FMA only hires good people with strong ethics and there is no suggestion that anyone in particular has done anything wrong or is going to do anything wrong but the fact remains that the potential for bias is there.

If you see your job at the FMA as being for 5 years or so with the next move being back into the private sector are you going to upset your prospective employers? Who knows, but there is certainly less career risk involved in prosecuting the firms you are never going to work for anyway.

The fact is none of the big guys have been overly hassled as yet and "putting your clients' interests first" looks as far away as ever. Sheila Blair's idea has some merit but it probably wouldn't work in practice and there must be other alternatives available to the FMA Board.

Incidentally one of the people on the FMA board is a practicing fund manager but that doesn't appear to be keeping anyone awake at night either. In an email Craig Foss, Minister of Commerce responsible for the FMA said "A number of relevant factors are considered when appointing board members of a Crown entity.

The members must have the appropriate knowledge, skills and experience to govern the Crown entity in question. Consideration is also given to the desirability of promoting diversity in the board membership. Given this, some members or associate members of the FMA Board will naturally be participating in financial markets in their private capacity.

As a result, conflicts of interests may arise. To this end, I am satisfied that FMA has the appropriate processes in place to manage such conflicts."

That is a huge relief but has the Minister thought of hiring someone who has the experience but was retired and thus less potentially compromised?

I looked at the Board Members of the SEC in the US and the Financial Conduct Authority in the UK. At the Financial Conduct Authority, which is the UK equivalent of the FMA, no surprises that none of the 13 board members currently works in the financial services industry.

Indeed only two appear to have ever worked in the financial services industry previously with most board members quite sensibly being academics, lawyers or having direct experience in the regulatory and enforcement business.

Surprise surprise, it is the same story with the Securities Exchange Commission in the US with neither the Chairman nor the Commissioners being current members of the finance industry. In fact none of them even appear to have ever worked in the industry with academia, law and regulatory experience being de rigueur.

Perhaps Mr Foss should have a think about this if he genuinely wants to put "client's interests first".

If you still aren't convinced that changes are needed consider this humorous real life example illustrating the absurdity of the "putting your clients' interests first" rule:

A US stockbroking firm which will be well known to the new FMA Chief Executive had two clients - one a retail investor living in Auckland and, in the USA, one of the big three car manufacturers.

The car company paid the stock broker to sell a new bond issue to its clients and they sold about US$100,000 to their NZ client. Shortly thereafter the client came to me and asked for a portfolio review.

The client was aged about 80 and the contract note for the bond sale disclosed that the bond had a 100 year maturity. Yes, 100 years so the client would be about 180 when he would be repaid. He was not aware of the term of the bond or the fact that about a year later the car company would have to be bailed out by the US Government.

The lesson here is, to paraphrase George Orwell, that although all clients' interests are placed first some clients will inevitably be more first than others.

- NZ Herald

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request.

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Personal finance and investing columnist at the NZ Herald

Brent Sheather is an Authorised Financial Adviser and personal finance and investments writer

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