Editorial: Finance fiasco also a learning experience

Ex- Hanover Director Mark Hotchin leaves the High Court in Auckland. Photo / Brett Phibbs

The Serious Fraud Office's decision not to lay criminal charges against Hanover Finance has brought to an end one of our financial markets' more catastrophic episodes. This was the last of the SFO's investigations into many of the finance companies that fell domino-like between 2006 and 2011. In sum, 46 collapsed, affecting an estimated $6 billion of investments and 200,000 investors. Subsequently, the SFO investigated 15 of these companies, taking criminal prosecutions against nine.

This process has delivered a small degree of solace to investors who lost their savings. But badly shaken confidence, similar to that sparked by the 1987 sharemarket collapse, will endure until it is clear lessons have been learned and the right steps have been taken to prevent a repeat.

It is important that the finance-company sector survives in some shape or form. It is crucial as a source of loans to businesses and individuals who cannot get them from banks, a function especially significant when economic conditions are benign. Contrary to some commentary, the industry model has not collapsed. Rather, the failed companies shared similar flaws, a situation that in some ways makes the prevention of a recurrence easier.

The first of these was a shortcoming in corporate governance. Many directors failed investors by not doing their jobs properly, often in the monitoring of their companies' lending practices. The prison sentences handed to some and the fall from grace of the likes of former Cabinet minister Sir Douglas Graham sent a clear message about the extent of the care that directors will have to exercise in future.

What passed for a regulatory framework also failed investors. There was little protection for unsophisticated investors, many of whom were misled by glossy advertising, having had, in the first place, only a hazy notion of financial risk and reward.

One response has been the establishment of the Financial Markets Authority, a one-stop regulator that, in terms of surveillance and enforcement, combines the functions of the Securities Commission, parts of the Companies Office and the stock exchange's regulatory arm. Much of its initial work has involved looking backwards in investigating and prosecuting finance-company misconduct. But it must also be the orchestrator of fair and transparent markets.

This work has several strands. The authority must ensure information supplied to potential investors is clear and concise, not the gobbledegook that muddied the waters for many who put money into finance companies. It is also responsible for the effective working of the new licensing regime for financial advisers, especially the disclosure rules that are designed to enable investors to make informed decisions. All this is linked to perhaps its most important job, that of playing a leading role in educating investors. Financial illiteracy made securing investment far easier for finance companies with risky lending profiles. If it is not addressed, there is a far greater danger of further distress.

Regulation involves a balancing act. It must provide a degree of investor protection. But it must not stifle the potential for investment in companies that represent greater risk but which, often through innovation, also hold out the prospect of substantial reward. The regulatory framework introduced belatedly over the past few years should provide investors with greater confidence. But the psychological scars run deep.

Only now is the sharemarket showing signs of a full recovery from the trauma of 1987. The snail-like and palpably inadequate government reaction to that collapse undoubtedly delayed the return of confidence. The response to the finance company debacle has been quicker and more convincing. With better information more readily at hand, there is far less reason to run scared.