Surveying the wreckage

The Westpoint collapse has indiscriminately taken many casualties — the most obvious being the 4,300 investors who collectively invested over $300 million only to see the property giant collapse.

However, investors are not the only ones feeling the aftershocks.

The financial services industry is feeling and will continue to feel (although in a different way) the aftermath of the Westpoint collapse, with investigations being conducted, banning orders issued and compensation proceedings looming.

With these widespread ramifications set to shake the financial services industry, it is essential to go back to basics and learn from the Westpoint debacle, not hide from it.

Background

Several companies associated with Westpoint (Group Companies) sought to raise funds through ‘mezzanine finance’ for a number of property developments by issuing promissory notes to the general public.

Mezzanine finance is a form of fund raising frequently used in property transactions, whereby the funds raised cover the difference between the first mortgage (usually 60 per cent to 80 per cent of total development costs) and the actual cost of the project.

Such funding can be of high-level risk and result in adverse affects for investors, including loss of capital if the project is unsuccessful.

On the plus side, mezzanine financing is attractive to some investors because of the relative high yields it promises on capital.

Collectively, more than $300 million was invested through the Group Companies by 4,300 investors. Approximately, $200 million of the funds invested were placed in Westpoint by financial planners.

In early 2006 Westpoint collapsed, with the Group Companies as well as Westpoint Corporation (the entity at the centre of the Group Companies) going into liquidation.

Since the Westpoint collapse, the Australian Securities and Investments Commission (ASIC) has undertaken 62 investigations and commenced 29 proceedings to wind up various entities and preserve assets.

In particular, ASIC has sought to preserve assets by placing travel restrictions on persons of interest, notably former directors and officers of Westpoint, winding up various entities associated with former directors/officers, and freezing assets.

In fact, ASIC has recently announced that it intends to commence compensation proceedings and thus seek damages from directors and officers of the various Westpoint Group Companies.

While ASIC concedes it is yet to fully formulate and qualify any claims, it has to date identified potential claims of up to $245 million.

Similarly, the financial services industry is also in the firing line, with ASIC not only banning a number of advisers (discussed in more detail later), but recently announcing it will seek compensation from a number of licensees/advisers for their alleged failure to comply with their obligations under the conditions of their Australian Financial Services Licence (AFSL) and under the law in general.

At this stage, ASIC will be seeking a total of approximately $63.2 million in damages from five different licensees whose clients invested in Westpoint products.

However, ASIC’s inquiries into the role and conduct of advisers is ongoing and, therefore, further proceedings against additional licensees/advisers may be imminent.

It should be noted that ASIC’s compensation proceedings are separate and, therefore, in addition to the legal proceedings currently on foot, notably the class action commenced against two licensees by law firm Slater and Gordon for and on behalf of the investors who lost millions of dollars in the Westpoint collapse.

Recent ASIC banning orders

As at November 16, 2007, ASIC has banned five financial advisers who were involved in promoting Westpoint products, with a further 11 banning briefs relating to advisers currently under consideration. The banning periods for the five advisers range from five to eight years. The reasons behind the banning orders reveal a number of recurring themes including:

n inappropriate advice to clients about investing in Westpoint products;

n not having a reasonable basis for the advice provided to clients;

n failure to act in the client’s interest;

n making statements about Westpoint products that were misleading and deceptive;

n advising clients to invest in Westpoint products that were not on the approved product list of the relevant licensee;

n failure to adequately assess client’s tolerance to risks;

n failure to provide adequate disclosure to clients, including commission and payments received;

n recommending and facilitating investments in Westpoint products through an unlicensed entity after the products had been removed from the approved product list of the relevant licensee; and

n carrying on a financial services business without an AFSL or being a representative of a holder of an AFSL (in this instance the adviser received an eight-year ban).

These themes reveal that the advisers did not adhere to their basic obligations under common law and legislation.

With this said, advisers should revisit their advice process to ensure compliance with the law.

Likewise, licensees should revisit their internal business systems and implement operational strategies that will ensure compliance with their obligations under the Corporations Act 2001 (Act).

Back to basics

While the adverse ramifications from Westpoint are continuing for some, advisers in general need not run nor hide from it, but rather embrace and learn from it.

The following lessons can be learnt by all advisers:

n Know your product. It has been revealed that some financial advisers advised clients that the Westpoint promissory note was capital guaranteed and secured against specific property projects when this was not the case.

TIP: Always read the Product Disclosure Statement (PDS) yourself and evaluate the product and its suitability to your client independently.

n Know your client. Section 945A of the Act provides that an adviser must only provide advice if the adviser has determined the client’s relevant personal circumstances in relation to giving the advice and the advice is appropriate to the client.

TIP: Evaluate your client’s tolerance to risk, their understanding of the risks associated with the investment, and the nature of any speculative investment.

n Fiduciary duty: As with all professionals, financial planners have a duty to act in the client’s interest and thus have in place adequate arrangements for managing conflicts of interest should it arise.

In the Westpoint matter it has been alleged that some advisers recommended Westpoint products to clients because of the high commissions they would receive (10 per cent as opposed to the standard 2 per cent) and not disclosing such information to the client.

This conduct may constitute a conflict of interest and a breach of the adviser’s fiduciary duty to their client.

TIP: When in doubt, err on the side of your client’s interest and not yours.

n Disclosure! Disclosure! Disclosure! Ensure that the Statement of Advice details the nature of the investments recommended, the risks associated with these investments, why these investments are suitable to the client’s needs, objectives and circumstances.

TIP: Ask yourself: “Have I explained:

(i) Why I have recommended the product?

(ii) What the risks are?

(iii) How it links to the investment strategy and the client’s objectives?”

Regardless of the legal outcomes of this uphill battle for investors, it is imperative that advisers review their advice process to ensure compliance with their legal duties and obligations.

Similarly, licensees should review their internal business systems to ensure compliance with their obligations under the law.

Further, by going back to basics, advisers (and licensees) will safeguard themselves and their clients from future Westpoint debacles.

Mary Nicole Ferizis is a solicitor with The Argyle Partnership.