Brent Sheather: Bad advice, when IPOs make sense and conflicts of interest

Bill English speaking at the launch of pre-registration for the Government's share offer in Mighty River Power last year. Did everyone get a fair chance to get shares in the power SOEs? Photo / NZ Herald

The new regulations as regards how financial advisors should behave, rules on money laundering and goodness knows what else are a depressing nuisance for many financial advisors including this writer.

It wouldn't be so bad if they actually improved outcomes for Mum and Dad but their biggest effect so far seems to have been to propagate a huge compliance industry, largely populated by failed advisors and casualties from clean outs at the regulatory authority, designed to fulfil legal requirements whilst maintaining the flawed business model and profitability. However it's not all doom and gloom, indeed the financial advisory industry can be relied on to make one laugh from time to time.

A case in point occurred about a week before the election where a private banker advising a client with more than $15m in assets said "we need to have a strategy for the election and I think what we should do is, if National wins, buy some electricity stocks on the Monday following the election because National is perceived to be more friendly to the electricity company than everybody else". This caused some amusement and I remarked to the beneficiaries of the investment guidance that the advice was a very good idea provided of course no one else realised that National had won the election!

Critical to the success of this not-so novel strategy was a further assumption that no one would know that National were more pro the electricity providers than everybody else. Hilarious.

The reality was that the advice was worse than useless because immediately when the market opened, if National did win, the prices of the electricity companies would be higher reflecting the new reality and indeed, as the polls have this week signalled that National hasn't been hurt by Mr DotBomb, the prices of the electricity companies had already strengthened well ahead of the election.

Stockmarket trading on Monday morning, post the National win, confirmed that the private bankers advice was indeed silly because Meridian shares, for example, immediately opened at $1.60, a rise of 10 per cent on Friday's last sale. No one had an opportunity to buy any shares at a lower price - first sale on the day was at $1.60.

This is not a surprise because, whilst it is currently fashionable to attack the efficient market hypothesis (part of which says that share prices immediately react to new information) an understanding of the EMH does allow one to recognise silly advice for what it is and given the choice the EMH is probably a better bet for Mum and Dad than broker newsletters.

Incidentally, after opening at $1.60 Meridian shares fell back to $1.55 within an hour of the start of trading and closed the day at $1.53 thereby delivering a loss of 4 per cent to anybody following the "buy immediately when the market opens" strategy.

Moving on but staying with the electricity sector: as noted electricity companies' share prices moved sharply higher, post election, so it's timely to calculate what the public of NZ have lost thus far by selling Meridian, Mighty River, Air NZ etc at what has turned out to be low prices. Just how low is "low" is revealed if we estimate the total difference between the price the Government got after fees and the current market price of the companies. Even excluding dividends the difference sums to almost NZ$1.3 billion.

As a general rule one reasonably good way to make money from IPO's is to avoid them unless of course the vendor happens to be the Government in which case the rule of thumb is "fill your boots". This heuristic has been confirmed by the Government's fire sale of electricity companies. Whilst the "spin" was it was an opportunity for Mum and Dad to buy shares the reality was quite different in that many private individuals with good relationships with stockbrokers managed to get huge holdings in the electricity companies that Mum and Dad couldn't get.

In a recent story, Herald columnist Mary Holm, responding to a mum and dad investor who applied for 30,000 Genesis and got just 3,000, asked for a response from Treasury. The Treasury official, who may well have been a politician in a former life, said "661 applications were received for 30,000 or more shares and the majority were allocated to institutions". At first glance that seems to be fine however it may be that the Treasury official is being a little bit economical with the truth here.

To get the facts I obtained a printout of all the shareholders in Genesis on the day before it listed. It makes for interesting reading and it is quite clear that the banksters allocated large numbers of shares, shares that were sold by all New Zealanders, to a small number of wealthy New Zealanders.

So, whilst someone who applied for 30,000 shares ended up getting 3,226 shares and a "sorry about that mate" letter from the Treasury, one of NZ's richest people whose name I won't mention got more than 600,000 shares in the issue at a price of $1.55. That has delivered a gain of almost $250,000, a transfer of wealth from all New Zealanders to someone who is apparently worth $500m or more.

This story is repeated time after time if you look down the list of shareholders in Genesis. We see the names of ex stockbrokers, brothers, sisters, aunts and uncles of stockbrokers, fund managers, ex-fund managers, executives, solicitors and the wealthy all receiving huge allocations of shares simply because they have a relationship with a stockbroking firm.

Last but not least two comments in the media may help to explain an anomaly that has puzzled some members of the financial planning community who frequently bemoan the fact that their profession is not viewed in as high regard as other professions like lawyers, doctors etc.

First off Chris Moore, Law Society President (and ex Whakatane resident) was quoted as saying in the Herald in the matter of the sentencing of a dodgy lawyer that "it is rightly expected lawyers act for their clients without conflict of interest or any form of bias".

Contrast this with the reality of the financial planning industry where as we saw two weeks ago "if you disclose anything goes".

The disparity between Mr Moore's view and what financial advisers think best practice as regards conflicts of interest looks like was highlighted by an article on the Good Returns website about a week after Mr Moore's comments.

Continuing Professional Development (CPD) provider David Greenslade of Strategi Consultants said as regards financial advisors that "conflicts of interest are not wrong in themselves but they should be properly identified and effectively and transparently managed".

It's popular for financial advisers to wring their hands and wonder why they are not viewed as being as professional as other professions like lawyers.

Well hello! The different approaches to conflicts of interest might be a clue.

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