The near silence of Jane Diplock has been one of the great mysteries of 2008. The Chairman of the Securities Commission, whose main role is "to strengthen investor confidence and foster capital investment in New Zealand by promoting the efficiency, the integrity, and cost-effective regulation of our securities markets", has adopted a low profile even though investor confidence has been rocked by several disturbing developments during the year.
These include the failure of several finance companies, the Blue Chip debacle, the inability of many substantial retail investment funds to meet their redemption obligations and the revelation of poor advice by some financial planners, much of which was commission-driven.
The Securities Commission must take some of the blame for these debacles, particularly where prospectuses and investment statements failed to clearly identify the risks associated with several public offerings.
Diplock's low profile is in complete contrast to Commerce Commission Chairman Paula Rebstock who was on the front foot again this week with the announcement that she was taking court action against many airlines because of alleged cartel agreements regarding air cargo.
Most New Zealanders wouldn't recognise a cartel if they fell over one but more than 100,000 individuals have lost a high percentage of their savings through finance company collapses, yet Diplock has made little public comment on the debacle.
A search of the New Zealand Herald website, nzherald.co.nz, shows that Diplock's name was mentioned in only 14 of the paper's articles over the past 12 months whereas Rebstock's name was included in 42 articles.
The problem with the Securities Commission is that it has never clearly established if it is an enforcement agency or an adviser to the Government on securities industry law reform.
The second objective has tended to dominate for many reasons, such as large and influential public issuers having lobbied against the Commission developing strong enforcement powers; the organisation being underfunded; security industry enforcement powers being weak in New Zealand; and the fact that the Commission hasn't had a strong determination to intervene when malpractices occur.
This week's developments in the United States in relation to Bernard Madoff and his alleged US$50 billion ($86 billion) fraud offer an important comparison with New Zealand.
The Securities and Exchange Commission in the United States should have been on to Madoff at a much earlier stage as should our Securities Commission have identified problems with the finance company sector in this country.
But when the alleged fraud was unveiled in the US, Madoff was arrested, the SEC went on the front foot as far as the media was concerned and it immediately kick-started a major investigation. That would never have happened with our Securities Commission.
The other issue is that Madoff ran a Ponzi scheme and there is a strong argument that many of our finance companies were running similar schemes over the past year or so.
In simple terms, Ponzi schemes are where promoters offer high returns but these returns are paid out of capital contributed by new investors rather than from investment returns generated from existing capital.
It can be argued that many of our property-orientated finance companies were running Ponzi-type operations. This is because most of the interest due to be paid to them by property developers has been capitalised or added to the total value of the loan, rather than received in cash, and the interest paid to existing investors by finance companies was paid out of capital contributed by new investors.
In addition, repayment of capital to existing investors also came from capital contributed by new investors.
Ponzi schemes collapse when new contributions drop off sharply, which is what happened to our property-orientated finance companies.
The reason why most investors didn't recognise that many finance companies were running Ponzi-type operations was because prospectuses didn't disclose the amount of interest capitalised and the amount actually received from property developers.
In this regard, the Securities Commission must take some blame because one of its responsibilities is the oversight of prospectuses and investment statements.
The other issue is that moratorium documents for failed finance companies are also a form of offer document and are subject to the same rules and regulations as prospectuses and investment statements. These moratorium documents are reviewed by the commission, which can ban any document containing false or misleading information.
The extraordinary point about this is that the commission is effectively approving documents that allow operators of Ponzi-type schemes to remain in charge. These moratorium documents still do not differentiate between interest capitalised and interest received and some of the disclosure has been woeful, particularly on the property companies being sold by Mark Hotchin and Eric Watson to Hanover Finance.
The main way of determining whether an investment proposition has Ponzi characteristics is to be able to work out if investors are receiving their returns from genuine investment receipts or from capital contributed by new investors. If the commission doesn't insist that this information is made available in prospectuses, investment statements and moratorium documents, then full confidence in the country's capital markets will never be restored.
Another issue that the commission must address is the subtle changes made to prospectuses and investment statements that are difficult to pick up. This often occurs with large yield-orientated investment funds similar to those that have been closed to remittances in recent months.
Updated investment statements have the same cover and look the same as the original document but contain several changes to the investment mandate that increase the risk of the fund.
These changes should be clearly identified and explained while a notice should be sent to all existing investors outlining the changes in investment risk, if any.
Finally, one of the most important issues facing the commission is where it focuses its attention. In other words, what is the weakest link in the investment chain?
The three main sections of the investment chain are as follows:
1. Public issuers. These include finance companies, banks, companies that issue securities to the public, KiwiSaver fund managers and any other funds promoted by investment managers.
2. Investment advisers and financial planners that advise individuals which public issue to invest in.
At present, the commission seems to have a strong focus on the second group, the advisers and planners.
The latest copy of the commission's quarterly newsletter focuses on a new regime for financial advisers that will swamp this link in the investment chain with petty compliance issues that are unlikely to improve the investment returns of their clients.
The financial advisers sector has its weaknesses, but most of the problems in New Zealand are, and always have been, with the first group.
These are the public issuers. Public issuers were the main problem during the 1980s sharemarket boom and bust and they still are.
New Zealand's capital markets have been blighted by misleading and inaccurate prospectuses, poor corporate governance amongst public issuers, excessive related party transactions and more than a few Ponzi-type investment schemes dressed in fancy clothes.
There is no use trying to reform the financial advisers sector if all that they have to advise on are dubious public offerings promoted by the first group in the investment chain.
Diplock has to take a more aggressive stance towards the poor disclosure and malpractices amongst public issuers.
Hopefully she will start this campaign with renewed determination in the new year and, more importantly, communicate her strategy to the investing public.
Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.