The quick and the dud

Illustration: Pam Templeton

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IN the past two years, Australia's top financial regulator has begun 19 lawsuits aimed at recovering money for investors in the failed property finance and development group Westpoint.

Since January 2007, how many lawsuits to recover money for investors have New Zealand's financial regulators begun?

Three? Five? Plenty of money has been lost. Maybe 10?

The answer is none.

Does that mean our financial sheriff and his deputies are lily-livered milksops afraid to set foot in the saloon?

Let's see. The collapse of Westpoint, which imploded in January 2006, taking with it investors' cash of $A393 million ($495m), has some familiar features for New Zealanders. Westpoint was a complex group – it was a property developer with numerous projects on the go, but it also raised its own mezzanine finance through a series of special purpose companies. These issued promissory notes which paid more interest than the banks, and had the added advantage that they didn't require the onerous disclosure provisions of debenture funding.

Through a related financing company called Kebbel and a network of financial planners, Westpoint was selling millions of dollars of promissory notes – unsecured, high-risk loans that carried interest rates of 12% for investors and huge commissions to financial advisers.

As it turned out, the mums and dads who bought them didn't realise how risky a promissory note really was. As one lawyer subsequently put it: "You may as well fold it into a paper plane and fly it out the window."

In February 2006, the Sydney Morning Herald quoted shocked investor Graham MacAulay, a retired IT manager who thought he was financing two Westpoint property developments. Instead, his money was part of a giant money-go-round of kickbacks and subterfuge.

"I was straight-out burnt. There's no other way to describe what happened to me," he said. "This sucked in an awful lot of people."

A year before Westpoint collapsed, a barrister and former judge, Lynnette Schiftan, resigned from its board because of her serious concerns about its solvency, but failed to reveal those concerns to Asic or to the public.

The Australian Securities & Investments Commission estimates investors are facing potential losses of $A329m – its 19 lawsuits are aimed at recovering that money.

The grounds for legal action vary among the defendants. One of the biggest claims was filed against Westpoint's auditor, KPMG, in October last year, 2 1/2years after Westpoint's collapse. It alleges KPMG was negligent in its audit of Westpoint's finance companies by failing to identify solvency issues and failing to notify Asic that there were grounds to believe breaches of the Corporations Act were taking place, including breaches of rules against insolvent trading.

Other lawsuits include claims against five Westpoint directors, including Schiftan, seven financial advisory groups and the Victorian government's trustee company, State Trustees.

These claims don't include Asic's criminal prosecutions – three people have been convicted so far and more than two dozen financial advisers have been banned for their advice on Westpoint. Nor do they include privately funded lawsuits or investor complaints through the Financial Ombudsman Service.

The legal action is bearing fruit.

A week ago the Federal Court order financial adviser Professional Investment Services to pay compensation to investors of $A5.9m by November 30, representing 62% of the money they invested.

Asic first sued PIS in December 2007, long before anyone connected with Westpoint was convicted of anything.

Of course, being able to sue to recover money requires reasonable grounds – the existence of enormous losses for investors in, say, Bridgecorp, Blue Chip, MFS Pacific Finance, Capital & Merchant Finance, Nathans Finance, First Step or the Super Yield Fund doesn't automatically mean anyone did anything wrong, provided inadequate advice or was negligent in their professional duties.

Putting those questions aside, do our regulators lack Asic's powers to get money back for investors?

Yes. The Securities Commission has been empowered to take civil action to recover money on behalf of investors only since October 2006.

Those powers are limited to action against a company or its directors for issuing a misleading prospectus and do not extend to acting against auditors, trustees or financial advisers on any grounds whatsoever.

"There are various people responsible for any offer – directors and senior managers, auditors, trustees, independent experts – and there are various duties they might owe, but we can't enforce those," said Securities Commission general counsel Liam Mason.

"We are also a little different [from Asic] in our set-up in that we can't take public action against directors for breach of their directors' duties, such as trading while insolvent.

"We also can't usually take action against financial advisers, except for a breach of their disclosure obligation." And in the types of action investors might really want to take, such as advisers failing to take reasonable care, the commission can't sue on their behalf.

With a review of its powers now under way - a discussion document is due in a few months - it wouldn't be hard to change that.

"The usual way to do it would be to introduce some statutory duties," said Mason. "[For example] the securities regulations are deemed to apply to every trust deed and require a trustee to exercise reasonable care. That does set up a right for investors, and yes, you could just put in the statute that a regulator can exercise rights on behalf of or for the benefit of investors."

A bill allowing the commission to sue trustees is due in parliament by the end of the year, but the review does not include plans to allow the commission to sue auditors or financial advisers.

The Commerce Commission, meanwhile, also has some powers to recover money for investors through the Fair Trading Act. Has it used them at all since, say, January 2007? No.

Although the commission is investigating ING and ANZ over their Diversified Yield and Regular Income Funds, these are ironically the only loss-making investments to pay compensation since finance companies started falling over in 2006.

The commission won't say whether it is investigating other Fair Trading Act cases that could recover money for investors.

Some people think the Commerce Comission could do better – among them John Simmons of the Money Managers Action Group, who wrote to the commerce minister in September outlining his belief that the commission had unjustifiably refused to pursue allegations that Money Managers' First Step funds, in which investors are facing losses of $233m, were mis-sold.

"It is the Commerce Commission's job to investigate and prosecute breaches of the Fair Trading Act – and outrageous to suggest that instead of them doing their job, 7000 victims should take civil actions to recover their losses," he wrote.

Whether Simmons is right or not, his complaints are symptomatic of a widespread view among investors that authorities have not adequately recognised their plight.

Since New Zealand authorities have few powers compared to Asic and barely use those they have, it appears investors are right.

NZ ENFORCEMENT ACTIONS

BRIDGECORP

Civil action filed in December 2008 by Securities Commission seeking declarations of civil liability and penalties of up to $500,000 against each of the five directors.

NATHANS FINANCE

Civil action filed in December 2008 by Securities Commission seeking declarations of civil liability and penalties of up to $500,000 against each of the four directors.

In both cases, the action is a first step towards compensation for investors who invested under the December 2006 prospectuses.

A declaration of civil liability is conclusive evidence that can be relied upon by either the commission or investors themselves in any subsequent claims against the directors for compensation.

The commission has not yet decided whether to use its powers to pursue compensation claims on behalf of investors.