29 April 2010
RIPPLES IN THE FINANCIAL SERVICES INDUSTRY
Since late last year, the financial and investor press has been dissecting the findings and recommendations of the Ripoll committee. Recently, the Federal Government has announced its response. In this edition of Investment News, we take a look why the committee was set up and what its recommendations were.
What was the Ripoll committee?
On 25 February 2009, the Rudd government announced its response to the collapse of financial product and services providers such as Storm Financial and Opes Prime. It established what became known as the 'Ripoll committee', with a mandate to inquire into the regulation of financial advisers of Australia.
Why was it called the 'Ripoll committee'?
The full name of the inquiry was the 'Parliamentary Joint Committee on Corporations and Financial Services - Inquiry into financial products and services in Australia.' Obviously, that is a bit of a mouthful, so it became easier simply to identify it by the name of its nominated chairman, Queensland Labour MP, Bernie Ripoll.
What issues did the Ripoll committee consider?
Perhaps the largest part of the committee's work was to review the collapses of Opes Prime and Storm Financial. The committee interviewed investors and key personnel involved in both collapses and took numerous submissions from key industry figures.
The committee also took detailed submissions from the industry regulator, ASIC (the Australian Securities and Investments Commission). ASIC made specific submissions in relation to the collapses, as well as more general submissions in relation to the current state of financial services regulation in Australia (with a particular emphasis of the roles of financial advisers).
What happened to Storm Financial?
The Ripoll committed spent a significant amount of time reviewing the collapse of the Storm Financial group. Storm was a financial planning network based in Townsville, Queensland. During the years of the market boom, its charismatic founders, Emmanuel and Julie Cassimatis, were so successful in promoting it that its clients regarded it as an honour to be a 'Storm person'.
Unfortunately, Storm's 'advisory' operations really involved giving the same advice to all investors - the 'Storm model'. In essence, they were advised to invest all of their money in the stock market and to take our very large loans via 'margin lending' so that they had even more to invest (again, in the stock market). Obviously, this is an extremely risky strategy. When the stock market dropped, the investors lost not only their stocks, but frequently their homes as well. Given that many of the investors were ordinary 'mums and dads' who were at or near retirement age, it is unlikely that they will ever recover their financial positions.
What happened to Opes Prime?
Opes Prime involved an essentially similar investment strategy to Storm (borrowing to increase the pool of funds to be invested). However, the investors in Opes Prime were frequently (but not always) more sophisticated investors who understood the risks of margin lending.
Unfortunately, the Opes Prime model involved a 'twist' that even sophisticated investors did not understand. Instead of being a 'standard' margin lending model, in which investors at least owned the stocks that they had purchased, the Opes Prime investors signed a complex agreement by which the stocks were transferred to Opes Prime. When Opes Prime collapsed, its banks sold the stocks to cover the amount Opes Prime owed to them. The investors were left with no entitlement to their shares.
What issues did the Ripoll committee consider?
In the course of its inquiry, the committee considered a range of issues relating to regulation of the financial services industry. These included:
- Whether ASIC had the appropriate powers and was being properly active in its protection of investors;
- Whether conflicts of interest in the financial services industry were preventing investors getting the best possible advice; and
- Whether investors were investing in financial products that they did not understand.
What recommendations did the Ripoll committee make?
To address these and other issues, the committee made a number of specific recommendations for regulatory reform, including:
- That ASIC be given additional powers and resources to exclude individuals from the financial services industry and conduct 'risk-based' audits of financial advisers;
- That financial advisers be made subject to a 'fiduciary duty' to act in the best interests of clients (similar to the duty owed by a solicitor or accountant). This duty would be supplemented by significantly increased training requirements and the establishment of an industry-based, professional standards board to oversee advisers;
- That financial advisers disclose any restrictions on the advice that they can provide in their marketing materials; and
- That ASIC develop and deliver more effective education programs for investors.
Over the ANZAC Day weekend, the federal government announced a package of reforms to the financial services industry in response to the Ripoll inquiry. In some respects, these reforms go even further than the recommendations of the Ripoll committee. Most notably, the governement announced that it will ban financial advisers from receiving commission income from July 2012 and that advisers will have a statutory 'fiduciary duty' to act in the best interests of their clients.
Given this, it is likely that the financial advice industry will look very different in three years. But some things will never change.
Clearly, the Storm Financial and Opes Prime collapses both show investors the dangers of investing in products and structures that they do not understand. Many of the world's most successful investors (people like Warren Buffett) make it an immutable law never to invest in something that they do not understand. And if something seems too good to be true, it always is.
Investors should also remember that there is no such thing as 'risk free' investment. Risk and return are always related. Sure, it is possible to enter complex margin loan arrangements. Some people make good returns doing it. But where there are high returns, there is also high risk. That's why getting rich slowly never goes out of fashion.