Brian Gaynor: Regulators look after own backs

Recent reports and comments on the finance company debacle are extremely disappointing because they seem to be based on protecting the interests of a number of government agencies rather than looking after the best interests of investors.

The Registrar of Companies slammed a number of parties for their role in the finance company meltdown but it carefully avoided criticising prospectus disclosures, an area it has jurisdiction over.

Securities Commission chairman Jane Diplock has waved a big stick at directors and management yet the commission went AWOL during the debacle.

Finally Commerce Minister Simon Power announced that "the roles of corporate trustees in failed finance companies are to be addressed as part of a significant review into the Securities Act".

Why is the minister focusing on private sector organisations when two government agencies, the Registrar of Companies and Securities Commission, had finance company oversight roles?

The minister's comments are frustrating because it has all happened before, both before and after the 1987 sharemarket crash.

Prior to the '87 crash there was a great deal of agitation concerning shonky share floats, inadequate disclosure, creative accounting and excessive related transactions.

Yet the regulators, including the Registrar of Companies and Securities Commission, were nowhere to be seen at the time.

After the crash there was considerable debate about the best regulatory regime for our capital markets yet there was little reform because most of the oversight agencies were more interested in protecting their own interests than the interests of investors.

Developments over the past few weeks indicate that we will probably have a repeat performance after the finance company fiasco because most of the regulatory agencies are bent on protecting their own backs and seem to have little interest in effective regulatory reform.

The five-page review by the Registrar of Companies, which is called "Finance company failures - observations of the Registrar of Companies", slammed a number of parties and practices including:

Trustees: Because they did not appear to have sufficient experienced staff to deal with widespread failure within their finance company client list. This is correct but why has it taken the registrar nearly three years after the first collapse to come to this obvious conclusion?

Auditors: The big four accounting firms (Deloitte, Ernst & Young, PricewaterhouseCoopers and KPMG) were not particularly interested in finance company audits and the smaller ones, which had most of the mandates, may not have had the capabilities or experience to fulfil this role.

Where was the Institute of Chartered Accountants during this debacle? Doesn't it have a responsibility to ensure that its members are abreast of the latest accounting practices and standards?

Accounting policies: Finance companies masked their true performance by rolling-up non-performing loans into new loans that were classified as performing. Why did the oversight agencies, including auditors and trustees, not put a stop to these deceptive practices?

Lending practices: "A number of the finance companies engaged in excessive related-party lending with investors' funds. In some cases the only objective of entering into one of these transactions was to benefit one of the directors or prop up a poor performing investment."

The NZX cleaned up the sharemarket's related party excess of the 1980s but the Securities Commission, which should have the experience and knowledge to identify this issue as far as finance companies are concerned, did little to halt these destructive practices in the finance company sector.

Corporate governance: Companies were often dominated by their chief executive and "boards tended to lack the breadth of experience and skills required to oversee the scale, complexity and characteristics of financing operations".

The registrar made no recommendations regarding regulatory reform and, not surprisingly, the report made no comment on the quality of disclosure in prospectuses, over which the registrar has some jurisdiction.

On Monday the Securities Commission announced it "is now reviewing reporting by issuers on their corporate governance as part of its ongoing financial reporting surveillance programme". The commission is very good at this sort of media release as it gives the impression that the organisation is incredibly busy but there is rarely any effective outcome from these surveillance programmes.

Like most bureaucracies the commission is effective at claiming jurisdiction over certain activities but then argues that it doesn't have the power to act when problems are identified under its watch.

The departure of Commerce Commission chairman Paula Rebstock, who tested the full limits of her authority, gives the dreadful message that regulators who take this softly, softly approach have the best chance of surviving. The Securities Commission 2004 and 2005 reports on the disclosure of finance companies is a good example of its low-key attitude.

In September 2004 the commission published a discussion paper on finance company disclosure and seven months later released its final report, which identified many of the important disclosure issues. These included: better disclosure of accounting policies, revenue recognition, related party transactions, lending policies, activities and risks.

This disclosure monitoring role puts the commission at the front of the regulation chain because New Zealand has a disclosure, rather than a black letter law, regime. In other words the emphasis in this country is on giving investors sufficient information, both in terms of detail and simplicity, to enable them to make prudent and rational investment decisions.

The 2005 report stated that the commission would continue to review finance company disclosure as part of its "routine surveillance work" and "in due course may recommend law reform to the Minister of Commerce". There has been little further evidence of this "surveillance work" or "law reform recommendations".

Finally on Wednesday Commerce Minister Simon Power announced that the Ministry of Economic Development was looking at the role of trustees as part of a comprehensive review of the Securities Act. Power was quoted as saying that "one option I am considering is fast-tracking the development of a trustee supervisory model".

There was no mention of any review of the oversight agencies, particularly the Securities Commission and Registrar of Companies. The registrar is part of the Ministry of Economic Development, which is carrying out the review.

In addition Act MP John Boscawen is lobbying for an inquiry by Parliament's commerce select committee into the finance company debacle.

The important issue here is the terms of reference as an inquiry is only as effective as the mandate it is given.

The big problem with this committee is that it is chaired by former Commerce Minister Lianne Dalziel and she won't want terms of reference that look at the role of the oversight bodies that reported to her during the debacle. These include the registrar and Securities Commission.

One solution to the finance company debacle is to give the Reserve Bank the regulatory role over the sector. This is a patchwork solution because it means that we still don't have one primary regulator which has the full authority and experience to identify new problems.

For example property syndicates are beginning to mushroom and could be the next investment disaster costing individual investors hundreds of millions of dollars.

Some of these syndicates are characterised by false advertising, related party transactions, poor disclosure, exorbitant fee structures and the prospect that investors won't get their money back.

What organisation is monitoring and regulating the property syndicate sector?

Isn't it about time we established one regulator with the powers, personnel and financial resources to oversee all aspects of investment markets? Unless we do we will continue to repeat the debacles of the 1980s sharemarket and finance company collapses with property syndicates queuing up to be next in line.

The establishment of an effective investment industry oversight agency is one of the biggest challenges facing Power. Investment market participants are hoping he will make far more progress in this area than his predecessors.

* Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.