Dancing on the ashes of Westpoint

When Westpoint’s company secretary, Graeme Rundel, slipped $10,000 into the Western Australian and National Liberal Party’s coffers in November 2004, the donation was to be armour for the impending collapse. What the Westpoint network failed to appreciate was that Australia’s Liberal Party needed no economic inducement to revel in doctrines of self-regulation and non-intervention.

Under the auspices of Liberal Party market ideology, the Australian Securities and Investment Commission (ASIC) has become a blazing effigy of market regulation narrowly centred on commercial efficiency. Joe Hockey, who at the time was financial services and regulation minister, exquisitely encapsulated this spirit in an address to the Australian Corporate Lawyers Association in 2001:

Following the collapse of HIH and One.Tel some doomsayers were hopeful that the Government would panic about corporate standards in Australia and throw years of corporate regulation based on self-regulation out the window. They were wrong. Each corporate failure must take its course.

Chris Pearce MP, parliamentary secretary to the Federal Treasurer has also declared his dedication to throwing oversight of modern corporate governance to the whims of the market in an address to the ASIC 2006 summer school:

Just as we need to approach calls for yet more regulation with scepticism, we need to be highly critical of complex regulatory solutions to problems … Those of you who have met with me, or heard me speak before, will know that reducing the regulatory burden, and improving regulatory efficiency, are major preoccupations of mine.

But how many more large-scale corporate failures and backyard-managed investment scheme cons will it take for this government to reconsider the true efficacy of sacrificing stringent corporate regulation and oversight for “commercial solutions” to rectify deception, incompetence and business failure?

In the last ten years we have been besieged by the disillusioning spectre of:

• HIH: somewhere in the vicinity of $3.6 and $5.3 billion;
• OneTel: collapsed owing $600 million as of May 2001;
• Sons of Gwalia: a reconciliation of the trading accounts revealed exposure to losses of $125million;
• Harris Scarfe: at least $70 million owed to the ANZ Bank alone; and more recently
• Westpoint: touted to be in the $400 million ball park, but time and political expediency will tell the true magnitude of loss.

Without detracting from the moral wickedness of the cavalier charlatans behind these corporate collapses, ASIC’s non-interventionist stance has compounded corporate failure in Australia.

Westpoint: a case of politicised non-intervention or sophisticated con?

In May this year, a senate committee questioned ASIC in relation to its handling of Westpoint. The committee came to the conclusion, “that ASIC cannot be blamed for the deception and/or inept behaviour of the parties that contributed to this corporate collapse”.

While ASIC and its enforcement directorate cannot be blamed for Westpoint, regulatory intervention may have mitigated the extent of investor loss. The real point of contention is whether ASIC had the information, jurisdiction or bureaucratic will to pursue Westpoint earlier.

In 2000, consumer advocate Denise Brailey, of litigation funder IMF, held a meeting with ASIC in which she expressed serious concerns about Westpoint. The Department of Consumer and Employment Protection in Western Australia communicated similar concerns in 2002 and the Real Estate Consumers' Association put in their two cents worth in 2001. Westpoint just had to “take its course” as Hockey would say.

It wasn’t until 2003, three years later, that ASIC decided to start asking questions of Westpoint and its grand wizard, Norman Phillip Carey. Mark Steward, deputy executive director, ASIC Enforcement Directorate described the discussions to a Senate Economics Committee hearing in May 2006 as follows:

It would be fair to say there was a lot of toing-and-froing between ASIC and Westpoint and in particular their lawyers, Freehills - they might say “toing-and-froing”; we might say “cat and mousing” - over this issue. We eventually realised by the end of 2003 that we were being stalled, we were being given the run around.

Senator Watson, in extracting a detailed recollection from Mr Steward and Mr Jeff Lucy, chairman of ASIC, described the ASIC engagement with Westpoint as one that adopted a “softly-softly approach”. Mr Steward and Mr Lucy denied this, but the reality is that there was a massive deficit in effective regulatory responsiveness.

In the three to four years that ASIC stood on the sidelines nervously feeding rosary beads through their sweaty palms, praying for Westpoint to rise again like a phoenix through pragmatic commercial solutions, Carey managed to build a mezzanine finance mecca that quickly crumbled into a labyrinth of smoke and mirrors.

ASIC defended its regulatory behaviour over this period by stating, “the decision to deliberately carve out promissory notes greater than $50,000 was a deliberate decision taken by parliament. That position existed. At that stage, as we have said in earlier forums, the complaints which we received were to do with the jurisdictional issues; they were not to do with business plan issue or business model issues. People were not suffering financial hardship at that time through their investments.”

ASIC’s contention that complaints only related to jurisdictional concern seems strained. A complaint that raised the fact that the promissory notes issued by Westpoint fell outside the scope of the Corporations Act isn’t really a complaint but more an observation. The complaints directly related to lack of disclosure and the calculated manner in which Westpoint executed its fund-raising campaigns without proper disclosure.

In 1981, the Federal Government enacted an exemption for promissory notes with a face value exceeding $50,000 from the full disclosure requirements that other financial products and services adhere to. Westpoint exploited this loophole with the dual intention to exponentially expand its cash box and have direct access to investors without ASIC vetting the business model, liquidity levels and compliance strategies.

The rules of engagement, of Product Disclosure Statements and Prospectuses were methodically circumvented with pinpoint precision. Trendy buzzwords like mezzanine finance, secondary mortgages, high investment yields and promissory notes camouflaged the real risk and the sobering reality that mezzanine finance can be an unforgiving game.

Carey’s network didn’t have to explain the complexities or risks inherent in mezzanine products as his shark’s patrolled suburban shopping malls and planners pedalled pithy marketing brochures from ivory towers.

They were not required to inform retail investors that the legal status of a promissory note equated to no more than an IOU from a property development cabal geared to the eyeballs by secured financial institutions; that when the bottom fell out they would be last in line. Nor did many financial advisors even bother to investigate or obtain legal advice on the status of the unsecured promissory notes their clients were advised to invest in.

ASIC: the silent shepherd holding the balance between the market and gutter

I can’t help but let my indulgent cynicism build a white abyss. A room. A netherworld of radiant, ethereal walls sprayed with bright red blood. Mum and dad investors, self-funded retirees and various ethnic community’s trust and livelihoods lay slain at the hands of Carey’s machiavellian cavalcade of director plunder and misfeasance.

Forget about proactive, preventative regulatory action. A smoking gun has told me that blood on the walls is only impetus for action. Jeff Lucy confirms this by stating that “people were not suffering financial hardship at that time through their investments” as a justification for non-intervention.

ASIC’s 2004-2005 Annual Report sheds further light onto the magnitude of non-intervention. In 1999-2000, ASIC received 5,534 complaints of crime and misconduct and concluded 173 cases through litigation. Five years on, the ASIC 2004-2005 Annual Report states that 10,752 consumer reports of crime and misconduct were received and 193 cases concluded through litigation.

In five years, complaints have almost doubled yet the number of companies under ASIC’s jurisdiction in 1999-2000, approximately 1.2 million, has only increased to 1.4 million by 2004-2005. From these figures alone it would seem that we are witnessing an escalation in complaints of corporate misconduct and poor corporate governance that is greatly out of step with the growing number of companies.

Of the 10,752 consumer reports of crime and misconduct, ASIC proudly points out that 57 per cent of these matters were resolved by forcing company officers to comply with the law and giving consumers access to company information. A failure of police to resolve or address 43 per cent of reported crime would be considered a political travesty, yet such results by ASIC are considered adequate.

And when one attempts to reconcile what ASIC puts in its annual reports with candid comments allegedly made by Mr Lucy to finance journalist, Trevor Sykes, that below 8 per cent of all reports were followed up, the image of an corporate regulator flexing its muscle and nashing its teeth befalls a whimpering agency entrapped by a dizzying inertia.

The Australia’s Liberal Party answer to these issues has been to push on with the next enchanting instalment in our strident march, our holy pilgrimage to free market utopia. Westpoint will not derail that trajectory. Our pious corporate deity will atone by way of Liberal Party donations and retail investors will be handed corporate literacy programs wrapped in playschool paternalism to clean up their self-inflicted bloodletting.

As the coming months unravel the depth of mezzanine finance collapses in Australia, we may need to reaffirm primacy of shareholder rights and communication to ensure we stop this escalating deluge of corporate failure.