No margin for safety

The collapse of Storm Financial and the likelihood that inappropriate advice was given to many of its retiree clients has called into question the effectiveness of the Australian Securities and Investments Commission in protecting consumers.

Storm had its head office in Townsville and had acquired financial planning firms down the east coast of Australia.

It collapsed late last year, leaving about 3000 investors facing big losses, including hundreds who stand to lose their homes. Investors have lost up to $1 billion.

Most of the investors were retirees advised by Storm to borrow heavily, or double-gear, into the Australian sharemarket.

They were advised to remortgage their home with a home-equity loan or to borrow against their superannuation and use these funds to take out margin loans.

Some of the highly geared investors were in their late 70s.

During the boom years of the Australian sharemarket their wealth soared, as did the private wealth of Storm's founders, husband and wife Emmanuel and Julie Cassimatis.

In 2007, at the height of the sharemarket boom, the Cassimatises became BRW rich-listers, with an estimated worth of $450 million.

But the potential for disaster was apparent from the moment the high-risk strategy was implemented.

Although Storm had a system whereby it would move investors' funds out of the sharemarket into cash should the market fall, its system was unable to cope with the crash of the past year.

The market has lost about half its value since it peaked on November 1, 2007.

Storm's failure comes after the high-profile collapse of property developer Westpoint at the end of 2005, which left thousands of retirees with losses of $300 million.

Financial planning firms, licensed and regulated by ASIC, had recklessly advised retirees to put their life savings into the property developer in exchange for high up-front commissions.

Despite these disasters, investors seeking sound financial advice continue to be left exposed, says Paul Resnik, the co-founder of FinaMetrica, which assesses investors' tolerance for risk.

"Individuals should expect to pay for advice that is in their best interests, not the planner's," Resnik says.

"They should expect that they will not walk out of a planner's office with a ticking time bomb in their hands."

Resnik, a 40-year veteran of the personal finance sector, says time and the courts will tell but it is likely that much of what is wrong in financial planning will be found in the way Storm Financial operated.

There was the riskiness of the financial plans that seem to have been unrelated to the tolerance of investors to manage such high risk.

And there were conflicts of interest with unusually high initial costs of more than 7 per cent on the sale of the investment products.

Clients accessed the Australian sharemarket through index funds, which mirror the sharemarket, from Challenger and the Commonwealth Bank. Commissions were taken from these as well as from the margin loans and the home-equity loans that were used to leverage the investments.

For each dollar clients put into the margin loans, they could borrow up to $9 - and then more gearing again against their houses.

The main lender was the Commonwealth Bank, which supplied home-equity loans and margin loans.

The Commonwealth Bank was also the main lender to the Storm business, which had borrowed heavily to acquire financial planning firms down the east coast.

The market crash was the beginning of the end for Storm as its clients suffered losses and new clients (and the sales and commissions) dried up. Storm was licensed and regulated by ASIC and the big question remains - where was the regulator in all of this?

For the old hands, the saga is confirmation that there is nothing in the regulatory filters to give consumers a reasonable level of confidence that they are going to obtain a positive outcome when they consult those sanctioned by the Government and regulator to give financial advice.

"You can go to an independent advice firm and get good or poor advice or you can go to a tied planner (a planner who works for a financial institution) and get good or poor advice," Resnik says.

Storm was a principal member of the Financial Planning Association and about one-third of its planners were individual members of the association.

Even the FPA's Certified Financial Planner designation - the "global symbol of excellence in financial planning" - was no guarantee of success, as four CFPs were working for Storm in Queensland when it collapsed.

In 2007, Storm released a prospectus and marketing material for its attempted listing on the sharemarket. The material is significant because it laid out how it intended to roll out its business model to its newly acquired financial planning firms.

It broadcast its business plan for all to see - to double-gear its clients, mostly retirees, into the sharemarket without any diversification of investments.

Its model took a production-line approach to its clients, with seemingly little regard for their personal circumstances.

This may breach the all-important "know your client" rule, which says advice should be appropriate to the individual.

It seems its business model meant the advice being given to clients took no account, or insufficient account, of the investors' ability to meet margin calls and whether or not the loan-to-valuation ratios of the margin loans were too high.

Section 945A of the Corporations Act says a planner must have a reasonable basis for the advice. But its effectiveness as an enforcement tool is limited because this law has not been properly tested in the courts.

The FPA now says it did have cause for concern at the time. Its chief executive, Jo-Anne Bloch, says: "We did review Storm's prospectus and some of the promises that were being made at the time.

"We worked with ASIC around the issues that emerged out of that based on information that we had received 18 months ago.

"There was no cause for us to do anything past that IPO [the proposed sharemarket listing] that might have suggested that there was a problem," Bloch says. "And nothing came up subsequent to that, that led us to investigate any further."

The FPA is conducting its own investigation into Storm Financial but Bloch acknowledges the outcome of the investigation will mean little to Storm clients who have lost their life savings and homes.

Can consumers, then, expect a financial adviser will act in their clients' best interest after this?

Bloch maintains the public can have every confidence its members will deliver quality advice. "FPA members inevitably put the client first. The vast majority who have signed up to the code and our standards of ethics do actually live that level of professionalism and will hold themselves out to be accountable if something goes wrong," she says.

ASIC will not comment on Storm while the financial planning firm is under investigation.

But ASIC chairman Tony D'Aloisio says: "If we find bad advice, we will act." He says ASIC has removed many bad planners in the past.

However, an analysis of the 44 decisions by ASIC to ban financial planners last year shows they are rarely banned for giving bad advice before investors have lost their savings.

Should investors be confident that when they see an adviser they will receive a minimum level of professional planning advice?

D'Aloisio says: "Retail investors can have confidence that financial planners are trying to do the right thing . . . we are working hard to lift quality and improve surveillance and compliance so that we can reinforce that confidence."

See also John Collett's column, Super and Funds, page 8

Mass marketing of debt ends in disaster

EMMANUEL CASSIMATIS, founder of Storm Financial, has repeatedly denied that his planners gave inappropriate advice to their clients, or encouraged them to take on too much risk.

Instead, he is pointing the finger at the Commonwealth Bank, which was the biggest lender - both to Storm Financial and its clients.

Storm Financial clients did better than their wildest dream when the sharemarket kept rising, because the high gearing magnified the gains.

The investors borrowed against the equity in their homes and tipped the borrowed money into the margin loan with their house as security.

All of these products generated out-sized, upfront sales commissions.

Providers of margin loans require a minimum loan-to-valuation ratio (LVR) to be maintained. Once the value of the shares falls and the LVR moves up towards the maximum allowed, the lender requires the investor to either sell shares or tip cash into the margin loan.

For reasons not fully explained, many Storm clients were not informed that their LVRs had blown out to dangerous levels when the Australian sharemarket crashed last year.

Most investors appear to have had a trigger point for a margin call of 90 per cent, which means for each dollar of the investors' own money, they owed the lender $9.

Conservative LVRs range from 50 to 60 per cent.

Had investors been told they were facing a margin call, many could have restored their LVRs.

The Commonwealth Bank and Storm are in legal dispute about who was responsible for the advice and who should have told the clients they were facing a margin call.

It appears the dispute between them in the lead up to Storm's collapse last year may have been a contributing factor in the clients not being informed of a margin call.

About the same time, as the Commonwealth Bank called in its loans to Storm, it contacted many Storm clients telling them it had sold their portfolios and left many clients owing hundreds of thousands of dollars.

Recently, Commonwealth Bank chief executive Ralph Norris said the bank did not accept any blame for Storm's failure.

"I believe that the situation that they've got themselves into is their responsibility," he said.

If used wisely, margin lending has a legitimate role in building wealth, particularly for secure, high-income earners.

But Storm's mass marketing of margin loans with such extreme LVRs to retirees and those on lower incomes, secured against their homes, was new.

Wiped out by high-risk strategy

AFTER following financial advice, Sean McArdle, his wife and young son stand to lose everything, including the family home.

The 42-year-old forensic police officer from south-east Queensland had built a sizeable nest egg from almost 20 years of saving and investment in the sharemarket.

He enjoyed a good relationship with his financial planner.

But almost three years ago his planner's firm was bought by Storm Financial, which has collapsed and is now under investigation by the Australian Securities and Investments Commission.

McArdle spent eight months questioning the advice Storm Financial had given as he was worried about the margin-lending part of their proposal to him.

The proposal was to double-gear into the Australian sharemarket. He was to borrow against his house, which he owned outright, and use the money to take out a margin loan and invest in the sharemarket.

The maximum loan-to-valuation ratio (LVR) of the margin loan was 90 per cent. An LVR of 90 per cent means he would borrow $9 for each $1 of his own. In other words, he was leveraged nine times.

"[My concerns] were eventually allayed by my adviser and his colleague with assurances that the margin loan was only a small component of the portfolio," he says.

McArdle also drew comfort from the fact the application for the loans would be vetted by the lenders engaged by Storm.

"My belief was that no bank would approve a loan that was not suited or was unsafe, especially without first addressing basic risk management and duty-of-care responsibilities and informing me of the risks," he says.

"At no time was I or my wife clearly advised by Storm or the by the bank that in the event of a margin call we could lose everything.

"Now my 18 years of saving . . . my son's education money, his inheritance, my wife's dreams, security and hopes, our home: [it's] all gone."

McArdle says no one told him the ultimate security for the lender was his home. He says he has always worked on worst-case scenarios and no one said the margin loan had the potential, in the worst case, to "wipe you out completely".

As the Australian sharemarket crashed last year, his LVR moved up and if he had received a margin call when he was supposed to he could have tipped in cash to restore it.

But he received no call and at the time his investment was sold by the margin lender, the LVR had moved to more than 120 per cent.

It is unclear why many Storm clients, including McArdle, had their portfolios sold so late without them being called first.

McArdle is "filthy" at Storm but also questions the role of the Commonwealth Bank, which provided the home-equity loan and, through its subsidiary, Colonial Geared Investments, provided the margin loan.

"For the sake of a 30-cent phone call from the Commonwealth Bank my wife and I would not be in this situation," McArdle says.

The bank has told him it kept Storm informed of his LVR and it was the responsibility of his financial planner to keep him informed.