Damien Grant: Deep misgivings over trust issues

Photo / Dean Purcell

I was reading the website of the Serious Fraud Office this week - it helps me keep track of what my clients are up to.

The SFO has under investigation 13 failed finance companies. Eleven of these companies had trustees.

Trustees are the forgotten story of the finance company failures.

According to Bernard Hickey's Deep Freeze List, 62 finance outfits have fallen into some form of strife and 38 of these had either Perpetual or Covenant as their trustees.

When you loan money to a finance company like Hanover there will often be a trustee company.

Their role is to act as the investors' agents, managing their interests collectively.

The trustee's rights and powers are negotiated upfront with the finance company by way of a trust deed.

The theory is the trustee will monitor the company on behalf of the investors.

The reality is finance companies appoint their trustee company. This is like asking the home team to appoint the (paid) referee. There is a certain moral hazard. When things go wrong, the trustees call in the receivers and this creates another moral hazard.

In 2009, the Registrar of Companies, Nigel Harris, laid part of the blame for the collapse of the finance industry at the door of two trustee companies, Perpetual and Covenant.

Harris was unsparing in his condemnation of Perpetual and Covenant and of the nature of the relationship between trustees and their finance companies.

Yet, no one has held the trustees to account.

Harris says it better than me: "Shortcomings in the performance of a trustee company are unlikely to be uncovered by receivers who are appointed by the trustees, and who look to trustees for further assignments."

As a result of the Harris report, the Government has a bill before Parliament to better regulate trustees and bring them under the supervision of the new Financial Markets Authority (FMA).

It would be imprudent to write of a cosy relationship between the trustees and their finance companies, so I will quote from the submission of Perpetual to the select committee for the new legislation:

"The current system fosters close working relationships between trustees and issuers, and allows small issues that arise to be dealt with discreetly before they develop into large problems.

"Those close working relationships between trustees and issuers do not present a 'problem' (sic) that the bill should seek to address."

Well, 23 of Perpetual clients failed, four are under investigation by the SFO, with close to $3 billion of impaired loans. The track record for Covenant is not much better.

Perhaps a more arm's-length relationship would have been appropriate.

The new legislation imposes licensing on trustees. Harris wrote that an analysis of events leading up to the collapse of some finance firms and any breaches of their trust deeds would be informative.

The FMA should do this before issuing any licences.

damien@waterstone.co.nz