Can lawyers foray into investment?

There has been considerable publicity surrounding the state of the lawyers' private mortgage industry.

Much of the attention has focused on two issues. Firstly, the loss of capital suffered by a number of investors due to sloppy due diligence from the lawyers. Secondly, there is the issue of lawyers having a special exemption to solicit money from the public without a prospec-tus.

By Peter Drake

There has been considerable publicity surrounding the state of the lawyers' private mortgage industry.

Much of the attention has focused on two issues. Firstly, the loss of capital suffered by a number of investors due to sloppy due diligence from the lawyers. Secondly, there is the issue of lawyers having a special exemption to solicit money from the public without a prospec-tus.

While the history of the private mortgage industry in Australia stretches more than 70 years, and is estimated to have more than $2 billion under management, it seems the industry could be on the edge of extinction thanks to a policy delivered on July 20 from the Aus-tralian Securities and Investments Commission (ASIC).

Before becoming a funds management company licensed as a responsible entity under the Managed Investments Act (MIA), LM Investment Manage-ment grew its initial $100 million under management as a law mortgage practice using the solicitors' exemption under the MIA.

From day one, the group has taken a funds management approach to the business. We have implemented all of the due diligence and prudential management standards to develop a book of business which was 100 per cent healthy when we became the first private mortgage company to be licensed as a responsible entity.

We now offer two mortgage income funds, which are governed strictly by ASIC which, among other things, involves producing a compliance plan and a constitution.

While my personal background is in funds management and insurance, I cannot help but wonder how a large number of mortgage law firms are ever going to understand or embrace fundamental funds management pre-requisites.

Some of the old, established mortgage firms without any disasters on their books will find the move to responsible entity status to be a logical step forward. However, for most law firms, a return to prac-ticing law will be the most logical answer to the ASIC policy state-ment.

Most lawyers engaged in private mortgage lending are very responsi-ble, legal people. However, most lawyers are not equipped to deliver a safe managed return for investors.

To bring all of the compliance steps into line, a lawyer must start concentrating on funds under management as a goal, rather than focus-ing on legal fees, margins and default fees. To grow funds under man-agement by using a mortgage product, you need to retain the interests of the borrower and the investor over the long haul.

If a lawyer is able to obtain responsible entity status, they can continue to offer the public an excellent income investment by fol-lowing some basic rules:

* Only lend to bank-type borrowers.

* Never use the borrower's valuation as a basis for lending. Instead you should refer to an internal credit committee.

* Collect and use a PD-C authority which includes collection of in-terest, adviser remuneration and manager fees.

* Allow the investor to select their own mortgage security.

* Receipt and report accurately.

* Provide the option for redemptions.

Only if all these conditions are met can a select mortgage investment product provider be sure they are offering a robust investment to the public. Advisers should be wary to check that the fund in which they place their client's investment dollars has the processes in place to avoid some of the problems in non-prospectus mortgage investments.

Peter Drake is a director of LM Investment Management.