Why is Everyone So Surprised With the Storm Financial Fiasco?

This morning your editor thought it would be a good opportunity to take a look at a subject we’ve neglected – Storm Financial.

The reason we’ve neglected it isn’t because we think the story is boring or irrelevant. It’s just that there’s nothing about it that surprises us.

A bunch of financial advisers telling clients to borrow money against their home and then using that cash to buy shares – well, show us a financial adviser or planner that doesn’t recommend utilizing the ‘dead equity’ in your home.

In fact the one thing that does surprise us about the Storm Financial fiasco is that everyone seems so surprised at what happened.

It’s as though the finance reporters feel cheated that their heroes in the finance sector and business world have betrayed them.

I wrote earlier in the week that the relationship between finance reporters and the business and finance industry is bizarre. There’s nothing like it that I can see in any other industry.

When Reserve Bank of Australia (RBA) governor Glenn ‘Thunderbird’ Stevens opens his mouth the mainstream journalists swoon with excitement and admiration – “Did you hear what Glenn said? He said the economy is getting better… hooray for Glenn!”

Contrast that to how a sports reporter reacts when AFL chief Andrew Demetriou opens his mouth. Barely a second later the sports reporters are dissecting every word and berating the man for ruining the game – it doesn’t matter what he’s proposing, he’s “ruining the game.”

Like we say, it’s bizarre. Even the interviewing technique is structured so that the interviewer can show off how smart they are rather than actually asking a question. And the CEOs and financial services people know this.

You can see the contempt in their eyes. I mean, when was the last time you saw a CEO or an analyst receive a real grilling from a business reporter? We certainly don’t remember an occasion.

Perhaps one of the best examples of their ineptitude is the interview between CNBC and Sir Allen Stanford in September 2008. The interviewer is mesmerized that Stanford was able to avoid the subprime bust.

So mesmerized that he finishes the interview with…

Well, I’ll let you watch the video, click on the link above to view it. The key moment is one minute and eight seconds in when the interviewer asks Stanford the ‘Question of the Year.’

Of course, six months later and Stanford was indicted on claims of an $8 billion fraud, including a possible ponzi scheme.

Look, we’re not saying that CNBC should have smelled a rat. Or that they should have tried to beat a confession out of him prior to the fraud being made public.

But surely the fact that Stanford was prepared to appear on a worldwide broadcast business channel in between “allegedly” defrauding his clients of billions of dollars shows he had no fear of being exposed.

The situation with Storm Financial may not be the same as Stanford’s case but it does highlight how easy it is for crooks to get with stuff for so long.

So, whose fault is it? Is it the regulators fault?

ASIC is copping a lot of the blame for allowing Storm Financial and Opes Prime to happen. In reality, we can’t blame them entirely. And no, it’s not because they are underfunded, it’s because it just isn’t possible for a regulator to do anything about it.

Regulators can’t prevent things from happening when they don’t know what’s happening. And they also can’t prevent things from happening when they don’t know what will happen.

But if we ignore Storm and Opes for a second, you only have to look at the regulation of the banks. APRA are labeled as heroes for their tight regulations. If that’s the case how is it that Australia’s banks came within a whisker of collapsing last year?

As I’ve written before, if it wasn’t for the retail and wholesale funding guarantees and the manipulation of the property market, Australia’s banks would be on their knees right now.

Not that they’re in any better shape for it. Arguably they and their customers are in worse shape. But we’ll leave that for today as we plan on scouring through the NABs results later on today. I’ll let you know tomorrow if there’s anything worth looking at.

Anyway, so if we can’t blame the regulators for the collapse of Storm Financial who can we blame?

Although I said we can’t blame ASIC entirely, we can shift a bit of the blame their way.

You see, the existence of ASIC or any regulator creates more problems than it solves. It’s similar to the moral hazard argument. You know the one, that’s where banks take risks because they know the government will bail them out.

It’s the same with regulators. Regulators don’t reduce risks for investors, they actually increase the risk to investors.

The most due diligence 99% of Storm Financial clients would have done is to check the firm had an Australian Financial Services Licence (AFSL). Once that box is ticked the investors would have been happy.

After all, if Storm is regulated by ASIC then it must be OK.

But when these collapses happen, the kneejerk reaction is to insist on more regulation. All that does is ensure a bigger blow-up as more investors do even less due diligence based on the fact the regulations are tighter than before.

What could possibly go wrong?

The fact is there are only three things that can reduce the odds of an unsuspecting investor being caught out: free markets, a free press, and freedom of speech.

Now, that doesn’t guarantee investors will be saved from crooks. Whether you have regulators or not, there will always be dodgy characters that will rip off money from investors.

That’s just a fact of life, and it can’t be stopped.

The problem is, cases such as Storm, Opes Prime, Bernie Madoff and Sir Allen Stanford have happened where there are regulations. What they have also shown is that regulations actually get in the way of the crooks being caught.

As far as we can recall, in these four cases at least, it wasn’t the regulators that caught them out, it was the market.

In each case it was either investors becoming suspicious and sounding the alarm, or the complicit banks finally deciding they’d made as much money out of it as they can and they didn’t want to play anymore.

Only then do the regulators ride in to try and claim the spoils.

But this is where the mainstream media are also coming up short. Rather than fawning over RBA governors, CEOs, analysts and advisers, they should be grappling with them to find out what’s really going on.

Take the following stories from The Australian newspaper. In November 2007, journalist Tim Boreham wrote:

“Unlike its rivals, Queensland-based Storm works on the notion that, like companies, clients should leverage their personal balance sheets and gear up to the extent they sensibly can, and buy up big during market troughs… According to founders, owners and joint CEOs Emmanuel and Julie Cassimatis, Storm enjoyed record inflows in March, when the local market tanked on the back of the Shanghai stock exchange, and then in August when the sub-prime stuff hit.”

But then he goes on to write:

“While we can’t really see how Storm or its clients would fare any better than others in a prolonged bear market, Storm has so far managed 100 per cent average annual growth… Criterion urges caution on Storm. Call us old-fashioned, but we’re unsettled by any growth-through-gearing mantra and the industry buzz is that Storm’s fees are a tad on the high side. We’re not contending the offer lacks merit, but perhaps there’s not enough value to justify rushing the IPO. We’ll avoid and have a another look after the December 13 listing.”

Boreham could have had a scoop on his hands. “100 per cent average annual growth” is surely something worth following up on for an investigative journalist. But Boreham seems more worried about their fees being “on the high side.”

Of course it’s easy to say in hindsight. And you could say, “Well, where were you then smarty pants?”

That’s a fair call too. We’ve being trying to catch bigger fish by calling out the banks as institutionalized fraudsters. But the mainstream press doesn’t even have that as an excuse.

So, what is their excuse? We don’t know for sure. But our guess is they like the kudos of interviewing CEOs and analysts and experts. They like being invited to lunches and corporate functions.

Anyway, less than two months later The Australian wrote:

“The Australian reported last month that the corporate regulator was investigating Storm Financial after hundreds of investors were left owing millions of dollars to margin lenders when the stock market tanked… The Australian Securities and Investments Commission claims 300 Storm clients owe their margin lenders a total of $20 million, with many investors liable for more than the value of their portfolios, it was reported.”

It’s a perfect example of how it’s not possible for regulators to prevent incidents like this from happening.

At what point does the financial advisory firm go from providing high risk investment advice to breaking the law? It’s impossible for any regulator to be that close to a company that it can pick that precise moment.

In the case of Storm it was only after everything had hit the fan that ASIC came to the rescue.

But another line from Boreham’s story reveals more:

“Storm suffered an odd last-minute hiccup last week when Macquarie Bank withdrew as underwriter.”

You have to wonder whether Macquarie withdrew because they were worried about being left with a truckload of unsold stock, or whether they were more worried about being left with a truckload of worthless stock when everything came out into the open.

Look, as I say, it’s easy to use Harry Hindsight two years after the event. But the fact remains that if the mainstream press and regulators think the likes of Storm Financial are isolated events then they’re kidding themselves.

There’s much bigger fish out there waiting to be caught, only they’ll only be caught after the event.

Because when you think about it, there’s very little difference between what Storm Financial was doing for its clients and what the banks do to their clients – the savers.

I’ll have more on that tomorrow!

Tagged as: Andrew Demetriou, Australian Securities and Investments Commission, CNBC, dead equity, finance sector, financial advisers, Glenn Stevens, Macquarie Bank, Ponzi, reserve bank of australia, shares, Sir Allen Stanford, Storm Financial, subprime