In the eye of the Storm

Townsville-based dealer group Storm Financial became noted in 2008 for its enthusiastic use of debt, or margin lending, to ‘optimise’ its clients’ personal wealth.

The group, jointly headed by Emmanuel and Julie Cassimatis, grew substantially from 2000 onwards by acquiring other financial planning practices before “converting” the firms’ existing clients (many of whom had no previous exposure to geared investments) to the “Storm model”. This saw clients geared into Storm-branded indexed products developed in conjunction with Colonial First State and Challenger.

In June 2007 the group had $4.5 billion of funds and loans under administration.

Many members of the financial planning industry have long been concerned with Storm’s approach to financial advice. The group’s failed attempt at a share market listing in 2007 was evidence that few were enthused by its practices. Storm marketed itself to prospective clients as a specialist provider of financial advice. But in its prospectus prepared in the lead up to the failed listing, Storm stated that its revenue model was not based on the provision of advice, but the generation of new investments.

Storm also stated in its prospectus that central to its success as a company was the conversion of clients to the Storm model. A failure to do so could adversely impact Storm’s financial performance.

Statements such as these do little to build a vision of a company whose foremost consideration is the individual needs and objectives of its clients.

In its prospectus Storm listed a sustained market downturn, potential lack of liquidity, and even a “sustained stagnant equity market” as risks to the company. But while it identified these risks, Storm’s current predicament suggests it did not adequately prepare for them.

Emmanuel Cassimatis said Storm and its “predecessor originations” had survived and prospered during the share market crash of 1987, the Asian Currency Crisis of 1997, and the bond market meltdown of 1994. Storm survived bear markets by pulling clients out of their index investments until the market once again returned to an upward trajectory.

In the wake of the dramatic fall in share markets in 2008 and the subsequent failure of the company, Storm has defended itself to its clients by blaming the unexpected and unique nature of the current financial crisis, while also taking shots at its financial backer and main product provider, the Commonwealth Bank of Australia (CBA).

The product provider

The relationship between Storm Financial and various arms of the CBA was mutually beneficial for many years. Storm’s model required the bank’s financial backing and services, while Colonial Geared Investments and Colonial First State took fees from the inflated sums being created by Storm’s geared investment strategies. Challenger was the responsible entity of the Storm Australian Indexed Trusts, while Colonial First State was the responsible entity of the Storm Financial Index Share Market Funds. Colonial Geared Investments provided the margin loans used to increase the investments in these funds. Meanwhile, Storm Financial Personal Superannuation (Storm Super) was provided through the Challenger Master Super Fund.

Storm provided the bank with substantial amounts of business, and it’s speculated Storm received benefits such as extended margin call periods, as well as discounted interest rates.

In December last year Colonial First State closed the index funds being offered to Storm clients. Colonial Geared Investments is now footing the bill for impartial advice being offered to Storm clients, facilitated through the Financial Planning Association (FPA). With the cost of each initial consultation paid for by Colonial suggested to be $250, and with up to 3,000 clients likely to be eligible for a consultation, the cost to Colonial could add up to $750,000.

The advisers

In 2007, Storm had 34 financial advisers consisting of 33 employee representatives and one authorised representative. Around four of these advisers were also Certified Financial Planners. The group said its authorised representatives were “hand chosen” for their “alignment with Storm’s philosophy”.

At the same time, the group said it had around 14,000 clients, which would suggest an average of 400 clients per planner. Meanwhile, the group boasted a higher volume of profit per planner than any other group in Australia.

The advice

Of these 14,000 clients, the Australian Securities and Investments Commission (ASIC) estimates that 3,000 held margin loans. Stories emerging from clients of Storm, and others close to the matter, suggest many of these clients were not appropriate candidates for such a strategy, in particular at the rates at which they were leveraged.

Many in the financial planning industry are strong supporters of margin lending, and in the right circumstances it can certainly be an effective wealth creation tool. The questions now surrounding Storm relate to whether the advice given to many of these clients was appropriate.

This will likely form the basis of the legal action currently being mounted against various defendants in the Storm case. The Statement of Advice (SOA) may be about to get its first serious test in court, and potentially used as the weapon against the planners who distributed them.

Questions will likely be raised about whether Storm’s advice from its self-described “production line approach” considered the client’s risk profile, investment time horizon, ability to meet a margin call and whether or not the loan to valuation ratio was appropriate.

There is the potential this situation could lead (in many years to come) to increased regulation around margin lending. Questions will be raised about who margin lending is appropriate for, and at what level. Is a definition of a ‘sophisticated investor’ (beyond the mercenary $250,000 description) required to sort the savvy from the vulnerable?

The clients

Storm’s strategy for attracting clients included offering free coffee, food and Internet access in their well-appointed offices. The group encouraged investors to attend its ‘education seminars’ during which they would not have to experience any “individual focus” while “group reviews” were also the norm.

Much of the concern around the group’s operations centred on the level of fees, with clients being charged around 7.5 per cent to be placed in index products. But Storm argued that its fees were “among the lowest” and “lower than average in the market”.

As FPA chief executive Jo-Anne Bloch noted last week, Storm (until very recently) continued to have members of its client base who remained loyal. Many were clearly strong supporters of Storm — the group that made them wealthy and with which some shared overseas holidays.

But many of these clients are now being forced to search for alternative advice, and Storm clients in the hundreds are now joining together in legal action against the group. Action is currently being prepared on the behalf of hundreds of Storm clients by the Brisbane office of Slater & Gordon and local firm Connelly Suthers.

Damian Scattini from Slater & Gordon said he would be examining whether or not the advice given by Storm was tailored to clients’ individual requirements, using SOAs issued to clients as well as verbal advice, as evidence.

Scattini said in each case there would likely be a number of defendants, with the group’s entry into voluntary administration unlikely to affect any insurance options available.

The legal action from clients is likely to begin next week.

The disagreement

Court documents filed in the case Storm Financial vs CBA show Storm put forward a bailout plan to the CBA a month before it collapsed. In early December Storm requested significant funding from the CBA to recover the funds lost by clients on the negative equity positions triggered by margin calls. The funding would allow clients to recover the negative equity positions without selling their own assets. The CBA rejected the offer.

In December, Storm also issued legal proceedings against the CBA in connection with margin loans from the CBA group. Storm is accusing the CBA of misleading and deceptive conduct. Clayton Utz is representing the CBA while Brisbane firm Russell and Company is representing Storm.

On December 31 CBA said Storm failed to meet obligations in regard to its debt facilities with the bank. As a result it demanded payment of part of the group's 'corprate indebtedness'.

But Cassimatis said the group recieved the demand on January 8, allowing a notice period of only 24 hours. With the group unable to raise the funds, Cassimatis said the directors of Storm Financial were forced to appoint administrators.

Cassimatis blames CBA for the company’s entry into administration, saying the group was “forced to this action” due to “CBA’s extremely aggressive demand”.

The administrators — Raj Khatri and Ivor Worrell of Worrells Solvency and Forensic Accountants — said their appointment was a result of “the insolvency of the company consequent upon the withdrawal of support by the company’s bankers, and other factors”.

The regulator

In the months prior to the ASIC’s acknowledgement of the Storm situation in December, many members of the financial planning community had been asking the same question: where is the regulator? In response to enquiries from Money Management, ASIC said it would not comment on whether it was investigating a company until a charge is made, but that it can and does make exceptions to that rule. On December 24 the regulator announced it had 12 days earlier commenced an investigation into the group.

ASIC’s investigation will examine the advice given to clients by Storm in relation to margin loans, and only this part of Storm’s business will fall under ASIC’s eye. ASIC is now waiting on the assessment of the voluntary administrators while also monitoring the legal proceedings between Storm and the CBA as part of its investigation.

ASIC said its team has been working closely with Storm, clients of the group, the margin lenders associated with group, which includes Macquarie Bank, and the FPA.

Storm is a member of the Financial Ombudsman Service (FOS), and as such the FOS won’t comment on whether or not it is receiving complaints about the group. The FOS had reported a 55 per cent increase in financial planning disputes and a 152 per cent increase in managed investment disputes in the six months to June 30, 2008. Two of the main areas of dispute within financial planning and managed investments in the period were inappropriate advice and misrepresentation.

The industry body

Storm Financial is a principal member of the FPA, and as such the FPA has commenced a formal investigation into the group’s conduct. But while the group itself was a principal member, FPA chief executive Jo-Anne Bloch said very few of the authorised representatives of the group were Certified Financial Planners.

The FPA took action by facilitating impartial advice for confused Storm clients, but has refrained from taking a hard line approach against the group thus far. Bloch said last week it was important not to jump to conclusions about the group, which still (prior to the closure of the business) had many loyal clients. Bloch defended the use of margin lending and pointed to the difficult times faced by many in the industry as a result of the financial crisis.

The future

The future of the Storm Financial group was effectively ended on January 15, when the group’s voluntary administrators officially closed the business and fired the group’s 115 staff members. The matter now rests with the courts and the regulator. It’s unclear at this stage what the ramifications will be for the directors and individual planners involved, or whether product providers will be assigned any responsibility. Storm’s significant client base is now on the move, either searching for advice elsewhere or swearing off advice altogether.

This will take some time to unwind. In the meantime, many of the group’s clients will suffer further stress and losses, and as a result the financial planning industry will have to endure another public questioning.