KEY POINTS:
With 13 finance companies going out of business in two years, New Zealand might seem to have a monopoly over the investment disaster market.
But bad stuff regularly happens overseas, too.
In Australia, one of the larger, more recent investment disasters was property-development company Westpoint.
A number of
similarities can be seen between Westpoint and the biggest local finance company collapse, that of Bridgecorp. One big difference, however, is that in Australia the chief investment regulatory body, ASIC, is going after the financial advisers that lost Westpoint clients their money.
Perth-based Westpoint borrowed about A$1 billion ($1.14 billion) from 6000 or so Australian mums and dads. Like Bridgecorp, Westpoint's main source of funding was from small investors who had been advised by financial planners that Westpoint was safe and sound.
Westpoint would then build apartments with the money and sell them. Unfortunately, things didn't go to plan: apartments weren't built, investments went bad and millions of dollars were lost.
Like Bridgecorp, Westpoint Group's debt instruments were rated "investment grade" by some fringe rating agencies - of course, the proper ratings agencies wouldn't go near it. As with Bridgecorp, some financial planners pushed Westpoint because it paid higher commissions than anyone else - up to 10 per cent, apparently.
What may be of interest to local investors burnt by Bridgecorp, or those concerned at the quality of advice from their advisers, is that ASIC (Australian Securities and Insurance Commission) says it intends to seek compensation from the planning firms which promoted Westpoint to their clients. ASIC has already banned four individual financial planners from practising for terms of two years to five years and is hot on the heels of another 15.
The ASIC legal proceedings are also potentially of interest, as Australia has spent a lot of time and money setting out what is expected of a financial adviser. Such considerations could well be relevant to any assessment of culpability in local "bad advice" cases like Bridgecorp.
The ASIC prescription of what is unacceptable behaviour from a financial planner is also obviously a worthwhile read for investors and financial advisers generally.
The four Australian financial planners have been ordered to pack their bags because:
* They provided inappropriate advice to clients about investing in Westpoint products.
* They did not have a reasonable basis for the advice they gave.
* They didn't act in the best interests of the clients.
* They failed to disclose commissions and payments received.
* They made misleading or deceptive statements to their clients about Westpoint products.
ASIC's next move is to try to recover money from the financial planning companies involved. It alleges that in selling Westpoint debt products, the five financial planning businesses did not comply with their obligations under the conditions of their financial planning licences and under the law.
ASIC is seeking A$63 million from the financial planners based on the amounts their clients invested in Westpoint and its statements of claim have recently been filed in court.
These documents elaborate ASIC's position further: it alleges negligent behaviour in that the financial planning firms should have known that its clients relied on them to exercise reasonable care to provide them with financial services and advice in a proper and competent manner.
ASIC alleges that "by placing the Westpoint products on their approved product list without any adequate due diligence to investigate the characteristics of, and the risks associated with, the product" and by "failing to warn its clients that the product was high risk" the financial planning firms acted negligently and in breach of the duty of care owed.
ASIC further alleges that the financial planning firms engaged in misleading or deceptive conduct in that its officers advised the clients to invest in the products because they had checked it out properly prior to placing it on the APL.
ASIC finally contends that the financial planning firms had no reasonable basis for placing the Westpoint product on its APL.
Has the ring of familiarity, doesn't it? ASIC's first two points, that the advice was inappropriate and that there was no reasonable basis for the advice apart from the 10 per cent commission, could prove relevant in any New Zealand legal action regarding Bridgecorp's and the other finance companies' failures.
The bottom line is whether undiversified portfolios of high-risk finance-company debt make sense for small investors. Common sense and investment theory says they don't.
The number one rule with risky assets is diversify - Harvard University research tells us that you need a minimum of 50 stocks in a share portfolio. The usual practice, until recently, of financial advisers recommending mum and dad own four or five deeply subordinated debt instruments from companies in the same sector doesn't look all that sensible in that light.
The courts may be required to determine whether four or five finance company debentures can reasonably constitute the low-risk, fixed-interest component of a balanced portfolio. That such a strategy is grossly inappropriate was obvious before the meltdowns of Bridgecorp, Provincial and the rest.
The portfolios of a typical pension fund or balanced unit trust invariably have around 40 per cent of their funds in genuinely low-risk, fixed-interest type securities with government stock, SOE bonds and high grade corporates predominant. This "best practice" should obviously be the basis for most mums' and dads' fixed-interest portfolio.
By contrast, finance company debentures are conspicuous by their absence from most professionally managed portfolios. This is because low-risk bonds stabilise a portfolio in bad times, whereas high-risk bonds change their spots at the first sign of trouble and their prices fall in line with all other risky assets.
Under current law, New Zealand's Securities Commission has no powers to take action against financial advisers. This will change soon when the new Securities Legislation Bill becomes law.
