Brian Gaynor: Red cards highlight a loss of control

Our markets will continue to underperform until a top-class referee is appointed. Photo / Supplied

The Securities Commission's decision to charge Nuplex and six of its directors for breaches of the continuous disclosure regulations would be humorous if it wasn't so serious for the individuals involved.

The charges are ironic because the commission is particularly poor in terms of disclosure and communications. One of its main objectives is "to promote public understanding of the law and practice of securities" yet its interpretation and enforcement of the rules are difficult to understand.

The Securities Commission should be no different from a good sports referee. A top class referee establishes control at the beginning of the game by setting clear rules and guidelines. A poor referee is weak and ineffectual, the game turns into a shambles and he is forced to red card numerous players to gain control.

The commission is now red carding a large number of business people, many of them with exemplary records, while missing many of the dirtiest players. This widespread red carding is a dreadful reflection on the commission because it didn't establish control earlier and is now sending more and more players to the sidelines in what appears to be a vain attempt to gain control of the proceedings.

Our capital markets will continue to underperform until a top class referee, with the courage to implement a strong set of guidelines, is appointed.

The Securities Commission was established on May 1, 1979 under Part 1 of the Securities Act 1978. It was given a wide range of functions although it was never quite clear whether its main role was to recommend better rules or referee the game.

Nevertheless two of its main objectives were the supervision of prospectuses and investment advertising. The poor standard of these, more than a quarter of a century after the commission was given specific jurisdiction, has been a major contributor to the finance company debacle.

The chairman of the commission is appointed for five-year terms and Colin Patterson, a Wellington barrister and solicitor, filled this position between 1979 and 1989. Patterson was more interested in recommending new rules than refereeing the game but he made little progress because the "free and unregulated markets are best" philosophy had gained the ascendancy among Wellington's political elite.

The commission had no awareness of the impending doom to engulf our sharemarket in October 1987. This is not the only time that the commission has failed to anticipate major capital market failures with the finance company debacle being the latest.

The 1987 crash, and our failure to introduce effective rules and appoint a strong referee in its aftermath, has contributed to the underperformance of our capital markets as follows:

* The total value of the New Zealand sharemarket is only $55 billion today compared with $42 billion at the end of 1986.

* Over the same period the total value of the Australian sharemarket has surged from A$137 billion to A$1408 billion.

In other words, after taking the NZD/AUD exchange rate into account, the ASX was 4.2 times the size of the NZX at the end of 1986 but is now 33.1 times larger.

We talk about Australia being a lucky country but you make your own luck. Australia has a mining boom, partly because individual savings are channelled through the country's capital markets into the mining sector where they generate an extremely good return for individuals and the nation.

Our capital markets are a pale image of Australia's because we have flawed rules, an ineffectual referee and little investor confidence.

This is reflected in the managed funds statistics in the accompanying table. These show we have only $62 billion invested through managed funds compared with A$1336 billion in Australia. Our lack of confidence in domestic capital markets and the sharemarket is reflected in the following figures:

* We have 44.1 per cent of our managed funds invested offshore whereas Australians have only 17.3 per cent.

* Only $7 billion, or 11 per cent, of our managed funds are invested in the NZX whereas A$506 billion, or 37.9 per cent, of Australian managed funds are invested through the ASX.

Large capital markets, that channel individual savings into the most productive areas, are a key feature of successful modern economies. Unfortunately the New Zealand economy has had below-average growth rates, partly because our capital markets do not have clear rules and a strong referee.

New Zealanders have an obvious preference for residential property because the rules around this asset class are clear and well developed.

Peter McKenzie, another Wellington barrister and solicitor, replaced Patterson as the commission's chairman but he also hit a brick wall because the "unregulated market" philosophy remained in the ascendancy in Wellington.

Ironically Sir Douglas Graham, who was Justice Minister in the Bolger Government and was prosecuted by the commission this week, was one of the great advocates of investor rights. He tried to introduce the Takeovers Code but was overruled by a number of powerful cabinet ministers, including Ruth Richardson and Bill Birch.

Richardson and Birch have had their fair share of involvement in unsuccessful companies since they retired from politics.

Euan Abernethy, yet another Wellington barrister and solicitor, replaced McKenzie in 1995 but he struggled to make progress in either the law drafting or enforcement areas.

The appointment of Jane Diplock in September 2001 was greeted with great enthusiasm because her background was in enforcement with the Australian Securities and Investment Commission. It looked as if the Government had finally appointed a strong referee.

However Diplock's comments in the commission's 2002 annual report gave a warning as to what was to come. She wrote that she was delighted to be appointed to the executive committee of the International Organisation of Securities Commissions as this "has put New Zealand firmly on the international regulatory scene".

She then spent a large amount of time telling international conferences that we had a great regulatory environment and yet she has been telling us the commission didn't have the enforcement rights to fulfil its regulatory obligations.

The commission's website contains a large number of her speeches extolling the merits of New Zealand's regulatory regime in Dubai, Brussels, Hong Kong, Bahrain, Tel Aviv, Paris, New York and at many other international conferences but there is little record of her telling audiences in Hamilton, Napier, New Plymouth, Timaru, Dunedin and Invercargill about the risks associated with the unregulated finance company sector.

The central issue is that the Reserve Bank, which regulates the banks, has set very strong ground rules and referees these according to the rules while Paula Rebstock fully tested the boundaries of her jurisdiction at the Commerce Commission.

The Securities Commission has been indecisive and the red cards issued in the past few days clearly indicate that it hasn't had full control of the game because of hesitant refereeing.

Most of the individuals issued red cards this week are at the back of the naughty boy queue - if they should be in this queue at all - whereas many of the dirtiest players have never received a warning or a yellow card from the commission.

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

bgaynor@milfordasset.com