Let the protected investor beware

By Peter V O'Brien

Thursday 17th April 2003

The welter of reports, discussion papers and proposed legislative and regulatory changes into and over all aspects of the securities industry, including the now trendy concept of "corporate governance," missed a fundamental point about investment.

Investors at some point must take responsibility for their decisions. That presumes the absence of fraud or other criminal and/or deliberate misleading actions on the part of companies, directors, promoters, brokers, investment banks and advisers.

The ancient legal concept of caveat emptor (let the buyer beware) was legitimately whittled when governments and their agencies acknowledged the rapidly increasing complexity of products and services. They required detailed, plain language descriptions and introduced compulsory guarantees and warranties, usually with a finite limit. Courts had already developed legal principles with the judicial concept of implied warranties.

Other aspects of caveat emptor remain. People must use common sense (the reasonable person approach) and exercise reasonable care when making decisions.

Definitions of "reasonable" are contentious issues, being a happy occupation for lawyers, judges and compilers of law reports, legal textbooks and journals.

Negotiation of the "reasonable" minefield reaches the goal of personal responsibility.

A file of comment about the securities industry from December to last week shows the investor protection bandwagon is in danger of overloading. The Securities Commission, the Stock Exchange, Commerce Minister Lianne Dalziel and her advisers, the Institute of Chartered Accountants and the Institute of Directors got aboard.

Predictable opposition came from people with vested interests in the current regime. Items on the file referred to New Zealand organisations' reactions to overseas experience, particularly several corporate, audit and broker-investment shambles in the US. They were ironical because the same organisations have said many times in the past that New Zealand's systems are apparently above reproach.

Sudden conversions to a new true faith surfaced in the past year. The organisations wanted to lead investors to a relocated promised land.

The Stock Exchange's views on getting more companies on its list and the Securities Commission's investigation into potential conflicts between promoters and researchers were pathetic. Commission chairwoman Jane Diplock may be unaware of at least a 30-year New Zealand history of research reports being written to order.

Having written investment reports and newsletters for eight brokers and investment banks on a sustained basis over that period, under their names, I vouch that favourable reports were published and the unfavourable ("sell" recommendations) unpublished.

The Stock Exchange's attempts to get small to medium-sized companies to its proposed AX list and to attract other groups were equally pathetic, smacking of some perverse private sector version of nanny-state handholding.

Readers can be excused for thinking that was less than altruistic. The exchange and its members benefit from new listings, whether through broker-inspired floats, the recent concept of non-broker "sponsors" or the brokerage available when people trade the new stocks.

A privately owned company seeking listing could be after new capital. Unlike "blue-sky" floats, where greenfields operations are sold, an existing group needs four basic elements for investor support:

* successful marketplace products or services;

* a strong financial history;

* proven management; and

* worthwhile prospects.

Any private company with those attributes would, as noted in previous assessments in The National Business Review, have easy access to finance without getting involved in the Stock Exchange, its costs and stringent listing rules.

If there is any case for going after them, the exchange should be after big private companies to redress its lopsided structure. Dairy group Fonterra could be a long shot but there seems no reason that the tightly structured private Todd organisation should go public, although anything is possible in a changing world where family trusts get more diverse.

The rush to protect people against excesses of "corporate governance" has validity but, perhaps paradoxically, could be another barrier to private companies listing on the exchange.

Investors need protection against crooks, of whom there have been many over the years.

The other protection issue relates to earnest supplications against funds diversifying overseas, in line with "weighted benchmarks." While there is no argument about fund managers' slavish adherence to international benchmarks and doubtful investment, calls for much higher investment in New Zealand securities have flaws.

That approach would drive up prices of New Zealand securities as demand outstripped supply, leading to potential excessive pricing. Returns would eventually fall, until managers decided overseas investment had better prospective gains.

All that comes down to individual entrepreneurial decisions. Current official activity could threaten personal entrepreneurship.

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