Brian Gaynor: It's time for regulators to take the lead

Hanover this week announced that investors can expect to get back only 70c in the dollar. Photo / Brett Phibbs

A number of issues over the past few weeks clearly demonstrate that our securities markets' regulation is a mess with none of the major agencies prepared to take a clear leadership role.

In a staggering development Consumer magazine is now considered to be a major authority on the investment sector while the Securities Commission, which claims to be "the principal regulator of New Zealand's securities markets" but was Awol during the Hanover Finance debacle, has effectively regulated itself to a secondary role.

The Hanover fiasco took another nasty turn this week when the company announced that investors can expect to receive back only 70c in the dollar.

Twelve months ago the company recommended a moratorium because this approach was more likely to achieve a full return for investors than a receivership.

PricewaterhouseCoopers backed the moratorium even though it believed that Hanover's loan recovery forecasts were too optimistic. PWC supported the moratorium because Mark Hotchin and Eric Watson, Hanover's two shareholders, were willing to provide financial support to repay investors.

Chairman Greg Muir, who has subsequently resigned, emphasised this support in a letter to investors.

Muir wrote: "Hanover's ultimate shareholders have agreed to provide further financial support of up to $96 million for the debt restructure plans [moratorium]. The support package comprises $36 million of immediate cash value, $40 million [based on the directors' valuation] of net property assets contributed from the shareholders' Axis Property Group, and up to $20 million of additional cash during the balance of the restructuring period."

These figures were just another smoke-and-mirrors show by Hanover, particularly the $40 million of net property assets received from Axis.

Axis had $97.9 million of assets, valued by Hanover's management, and $58.9 million of loans outstanding to the Hanover group. Axis assets were mainly property developments at Matarangi Beach Estates, Coromandel and the Highlands residential development at Jack's Point, Queenstown.

PWC wrote: "We cannot endorse the $40 million element of that proposed transfer value as necessarily being indicative of the current 'fair market value' of that equity. We believe the shareholders' [Hotchin & Watson] assessment of the value of the Axis Group ... is reliant on a significant recovery in market conditions."

Why did Muir use the $96 million support level in his letter to investors when PWC would not endorse this figure? It is highly unlikely that Hotchin and Watson will contribute anywhere near the $96 million indicated yet this figure was used to convince investors that a moratorium was a better option than receivership.

Hotchin has consistently promised more than he has delivered and, on this basis, the latest 70c recovery forecast may also be too optimistic.

But the important issue here is that the industry's main regulator, the Securities Commission, continues to allow companies to make optimistic and unrealistic comments in the front sections of a statutory document even though these statements are inconsistent with the main body of the report.

The integrity of these statutory documents is extremely important because shareholders and directors of insolvent companies will nearly always prefer a moratorium over receivership. This is because a receiver can take legal action against former directors, whereas there is far less prospect of a legal action under a moratorium.

Hanover, its shareholders and directors were particularly susceptible to legal action because of the $86.5 million of dividends paid in the two years to June 30 last year. The moratorium vote almost certainly removed the prospect of any legal action in relation to these huge dividend payments.

The response to Consumer's "Feathering their nest" report on financial advisers was quite extraordinary. The report was little more than a snapshot of the sector but the supporting press releases from Commerce Minister Simon Power, the Securities Commission and Commissioner for Financial Advisers were quite astonishing because it is these individuals and organisations that should be taking the lead in this area rather than Consumer.

The Securities Commission announced on Thursday that two members of the Code Committee, which is developing a Code of Professional Conduct for financial advisers, had resigned because they were employees of firms that gave poor advice, according to Consumer. Their resignation had been accepted "to remove the potential for loss of public confidence in the work of the Code Committee".

This simple statement probably best sums up the Securities Commission. It places more emphasis on style over substance while giving huge importance to a magazine article.

The Securities Commission was Awol when investors lost huge sums of money following poor advice from financial advisers. Yet individuals associated with organisations that receive a negative comment from Consumer are encouraged to resign from the Code Committee "to remove the potential for loss of public confidence".

Consumer concluded that only three of the 17 plans its mystery shoppers received were satisfactory. The remaining 14 were either disappointing or were rejected because they contained little relevant analysis. Consumer was critical of the poor analysis, inappropriate advice, lack of disclosure on costs, poor-value strategies and the lack of independence of many advisers.

One of the issues raised by Consumer was that potential investors weren't given information on the historical performance of the recommended funds or investment portfolios. Consumer indicated that this was an important consideration in any investment decision.

Fellow Weekend Herald columnist Mary Holm has a different view of this. In a column she argued that historic performance figures were distorted, unreliable and gave little indication of future performance. As far as KiwiSaver is concerned she suggested that investors should disregard the historical performances of investment funds and recommended they look at two major issues; costs and the right sort of fund in terms of risk profile. As far as costs are concerned, Holm advised investors to use the KiwiSaver fee calculator on sorted.org.nz.

The problem with this advice is that the fee calculator at sorted.org.nz does not appear to accurately reflect the actual fees charged by fund managers, particularly the additional costs.

In general terms there are four types of investment management fee structures:

Where the only cost charged against the fund is the management fee and all costs are paid by the manager out of this fee.

Where additional costs, including audit, trustee, custody, administration and registry are charged against the fund in addition to the management fee.

Start-up and establishment costs are also charged against the fund.

Where certain costs, in addition to the management fee, are charged against the fund by reducing the number of units held by investors. This inflates the net asset value per unit and the performance of the fund.

The first structure usually has the lowest fees but most fund managers use a combination of the other three alternatives.

The Securities Commission should be far less concerned about Consumer reports and its own image. It should be putting much more emphasis on catching the crooks and developing a standard way of measuring fund management fees and performance.

The latter would enable investors to compare investment funds on a like-for-like basis. But the Hanover debacle, the Consumer report and the resignation of two members from the Code Committee shows that one of the main problems with our securities markets is the absence of an oversight regulator willing to take a big-picture leadership role.

Hopefully the Capital Markets Taskforce, which is due to report next month, will make strong recommendations on this important issue.

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