Why you can't take the ASC on trust
http://www.pierpont.com.au/article.php?Why-you-can-t-take-the-ASC-on-trust-473
Friday, March 29th, 1996
ON their way out of Canberra, the old gang left a few booby traps for the Coalition posse that rode in. One of these ticking bombs was left by the outgoing Attorney-General, Michael Lavarch, cunningly disguised as the Collective Investment Schemes Bill.
Pierpont recommends that the Howard gang should approach this particular draft legislation with great care. Indeed, its bomb disposal squad may be well advised to blow the whole thing up and start again.
Like many a potential disaster Pierpont has seen, the bill has impeccable credentials and is trying to do good for investors.
It sprang from the recommendations of the companies and securities advisory committee of the Law Reform Commission, which was trying to clean up the operation and administration of such collective investments as unit trusts, spurred by the collapse of Burns, Philp Trustee and various other disasters of the 1980s.
The bill would impose a new set of requirements upon fund managers (to be called "scheme operators"), abolish trustees and leave unit trust investors relying on the Australian Securities Commission to protect them.
Just in case you read the last sentence too quickly, go back over it slowly and see if any immediate flaw strikes you. No? Then let Pierpont elaborate a bit.
A shareholder in a company has a few safeguards. The company has to hold an annual meeting at which shareholders can question directors, criticise them and if necessary sack them. If the company starts heading down the wrong track it can - at least in theory - be corrected by its owners.
When a controversy arises, big institutional investors - who otherwise might go to sleep or do sinister side deals with the board - are forced to show their hands by supporting one side or another.
Heaven knows, the 1980s provide ample evidence that this system doesn't work well, but at least the mechanisms are there for vigilant investors to hold management accountable and exert their rights.
Investors in unit trusts have no such safeguards. Unit trusts are not required to hold meetings annually or any other time. The unit trust is not run by a board but by a management company. Unless the management company is doing such an awful job that the unit holders muster enough votes to hold a meeting and sack it, the manager can do anything it likes that is permitted by the trust deed.
The trustee is supposed to be the policeman. It is the trustee that signs all the cheques, not the management company. When the manager wants to increase his fees or buy a skyscraper, he has to persuade the trustee that it is in accordance with the trust deed. If the trust deed is drawn widely enough or the trustee is slack enough, the manager can get away with blue murder, as we saw in Estate Mortgage.
The Law Reform Commission, in its wisdom, decided that this was a good enough reason to abolish trustees. The draft bill effectively takes most of the standard provisions of trust deeds and enshrines them in legislation.
And instead of having a trustee, the management company will be kept honest by having a board upon which the majority of the directors have to be independent.
Note that there still won't be any annual meetings, nor any opportunity for unit holders to regularly question the manager. The managers, indeed, will be less trammelled than ever. The bill is relying upon the outside directors to ensure the management company acts properly.
However, the draft bill allows independent directors from the parent board to be considered independent on the management company board.
Thus Macquarie Bank 's recently formed management company has a three-man board of whom two are independent directors from the bank board. Pierpont is in no way questioning the independence of the two gentlemen in question and is sure they are doing a great job, but as a veteran of the financial markets he can think of ways in which a less scrupulous outfit than Macquarie might use such a waiver.
If you want a ghastly example of what is wrong with the concept, consider the case of Trustees Executor & Agency. That had a board completely comprising outside directors, who proved quite unable to control a strong-minded managing director.
One of TEA's biggest and most disastrous projects was The Quay apartment block at Sydney's Circular Quay.
The Quay must have been the most prominent building project in Australia, being highly visible to every ferry and Harbour Bridge commuter in Australia's biggest city. Almost the entire population of Sydney knew it was being built - but not the board of TEA, which was based in Melbourne and had decided not to proceed until it had satisfactory financing.
But The Quay went ahead without financing. Directors were not actually told it was being built until seven months after the first concrete pour, by which time the building had risen past the Cahill Expressway. When it reached the 14th level (two months later) TEA went into receivership.
Let's hope independent directors have lifted their game since then, because if they haven't, unit holders will have to fall back on the ASC as their last line of defence. In Pierpont's opinion, this is not a reassuring thought.
Pierpont keeps hearing disturbing stories from liquidators, trustees and others who, in the course of their profession, become aware of apparently criminal actions being committed in trusts and companies. When they write to the ASC drawing its attention to these crimes they never seem to even get a reply, let alone any action.
And a lot of the complaints to the ASC relate to trusts. Yet the bill envisages the ASC as the sword and shield of unit holders.
The facts of life are that the people with the best chance of stopping a trust manager from theft and corruption are the trustees, who deal with the manager on a day-to-day basis. It is unrealistic to expect the same vigilance from a board which might meet only a dozen times a year, or from the ASC which will only arrive on the scene - if at all - after the disaster has happened.
And if the ASC is the guardian of corporate governance, will someone please tell Pierpont what it was doing all through the great Coles Myer fight?
In the words of one trustee Pierpont spoke to last week, "We can act on little knowledge to stop a manager and, sure, sometimes we are going to get it wrong. We can negotiate and change our position.
"But the ASC cannot afford to do that. The ASC cannot afford to act until it has a perfect case, otherwise there would be a hue and cry in Parliament from some manager who couldn't make an investment. This bill means the ASC will only ever be able to act after the damage has been done."
So Pierpont recommends that Daryl Williams (he's our Attorney-General, in case you never heard of him) take a long, cynical look at the bill before letting it near Parliament. And if Daryl wants a constructive suggestion, Pierpont suggests that he throw the bill away and instead give every trust in Australia a deadline by which to convert into the same structure as Stockland, where the unit holders own the management company. Then the managers and unit holders will get rich together.
To simplify company law, ban companies
Friday, August 25th, 1995
http://www.pierpont.com.au/article.php?To-simplify-company-law-ban-companies-416
ONE of the most traumatic events in financial history was the South Sea Bubble of the early 18th century.
A host of companies were floated to exploit the supposed riches of South America. English investors flocked to subscribe for land companies, mining companies, a company to build a ship for the pursuit of pirates and even a company "whose purpose would be revealed in time".
All the companies collapsed, as boom companies will, and an outraged Prime Minister, Sir Robert Walpole, brought in the Bubble Act. This made it illegal to form joint stock companies except under special charter from the Crown.
This Act stayed in force for more than a century. The formation of Australia's first company (the Bank of New South Wales, in 1817) was greatly impeded by the restrictions of the Bubble Act.
A joint stock company, for all practical purposes is what today is known as a limited liability company. As every reader of this column knows, forming a limited liability company in Australia today is a routine transaction at the corner accountant's office for a few hundred dollars. If the accountant is up to speed and has all the boilerplate computerised, you can form a company in the time it takes to drink a cappuccino.
It is sobering to reflect, therefore, that less than two centuries ago limited lability companies were in such ill repute that they could only be formed by charter, which was rarely given.
The Bank of New South Wales did not get one and so was founded on what amounted to a false prospectus. It was not until halfway through the 19th century that limited liability companies really started becoming commonplace.
Nowadays limited liability companies are as prevalent as cockroaches and are run by the Australian Securities Commission, and instead of the Bubble Act we have a Corporations Law which is so complex that last week parliament was passing the First Corporate Law Simplification Bill 1995.
In Pierpont's lifetime he has seen companies legislation simplified four times, to the point where your correspondent has given up all hope of ever understanding it. And the word "First" in the Bill's title leaves Pierpont wondering how many more simplifications are in the pipeline.
Pierpont also notes that the Labor Party came to power with a promise to simplify the Tax Act. At that time it comprised 1,100 pages. Now it is three times that size.
So Pierpont is sceptical about Canberra's ability to simplify laws. But broadly the bill now before parliament is along the right lines, stipulating that small companies will still have to file returns but will be spared having to show balance sheet details.
These annual returns have been an exercise in futility because the ASC never had enough staff to check the hundreds of thousands of companies' returns. By just having accounts submitted by the relatively small number of larger private companies (with revenue of $10 million and 50 or more employees), the ASC will hopefully be able to check them properly.
This point was made during the Senate debate by Pierpont's old Croesus Club colleague, Senator Michael Baume, who cited Paul Keating's piggery group as an example of companies that should have been checked more closely.
"They kept putting in false and misleading annual returns, saying wrongly that they had earned profits when they had suffered losses and saying they had a surplus on shareholders' funds when they had deficits," Michael pointed out helpfully.
Michael is now waiting for the Bill to pass so that the ASC can start checking the piggery's annual returns. Somehow, Pierpont does not feel this will be a high-priority item for the ASC.
If you want Pierpont's opinion, the best way of simplifying corporate law would be to reintroduce the old Bubble Act and outlaw proprietary companies altogether. As the bulk of such companies are formed for the purpose of avoiding tax or avoiding creditors or both, this would be socially beneficial. The ASC, having no private companies to monitor, could concentrate on public companies.
But that would upset the real agenda. Private companies must be encouraged to multiply because their filing fees have become a juicy revenue item for the Government. So we're going to see more companies and quite probably more piggeries.