No matter how much goes on behind the scenes by regulators in investigating and monitoring, they will be judged on how they protect markets and individuals from damaging collapses such as that of large Australian stockbroking company, BBY Ltd.
The company entered voluntary administration on 18 May 2015. The Australian Securities and Investment Commission (ASIC) has suspended its Australian Financial Services Licence and that of two other BBY Group companies (s 915B(3) Corporations Act) and on 22 June at the second creditors meeting the creditors voted to wind up several companies in the BBY group including BBY Ltd.
At the June 22 meeting, creditors also approved a Deed of Company Arrangement involving AIMS Financial Group and two other companies in the group, Smartrader and BBY Hometrader. A further meeting to deal with the remaining BBY companies is yet to take place.
Clients of BBY are understandably angry, with some forced to close positions and with no access to share portfolios. They blame BBY but they also take aim at ASX, and while investors and creditors may have been surprised by the appointment of an administrator, ASX perhaps should have been less so, as the problems with BBY had been obvious to ASX for some time.
In disciplinary proceedings of June 2014 the Chief Compliance Officer of ASX Compliance Pty Ltd found that BBY did not comply with ASX Clear Operating Rules on a number of occasions between 11 and 16 June that year. A total fine of $180,000 was imposed.
In two instances during that period ASX had delayed making calls on BBY (one of $15 million and the other of $22 million) resulting from the relevant series of transactions, as “the delay would prevent BBY from committing an event of default and a possible insolvency event.” A Trust Account breach was also identified.
Now less than a year later BBY Ltd is in liquidation – and the question must be asked as to whether the regulators did enough to protect the market.
ASX Operating Rules give it significant powers where a breach occurs. In June 2014 ASX understood the precarious position of BBY. In a situation where a substantial amount was outstanding and, as ASX noted in its Disciplinary Matter report, BBY had confirmed that all funding lines were exhausted, and that it couldn’t pay its debts as they were due, ASX waived compliance and BBY lived another day. This, even though ASX labelled the contraventions “serious”, “reckless”, and “without having appropriate systems and processes in place”.
The report noted there was “weaknesses in BBY’s risk management and compliance framework” and “management oversight” all of which could have had “a serious impact on the market, the clearing and settlement facilities, BBY and BBY’s clients and employees”.
ASX required a remediation plan and BBY engaged independent experts, Lazorne Group, as to its risk management framework. According to the Administrators Report the review raised several important issues including an existing inadequate governance and risk framework, inherent conflicts of interest, unclear project ownership, tight timeframes, need for staff training.
Together with the independent review, during the first part of 2015 the ASX investigated BBY’s management of client monies and found deficiencies. A raft of concerns were put by ASX to BBY in April 2015 (including potential breaches of the ASX Clear Operating Rules) and conditions imposed. In May 2015 an event of default was declared in regard to a failure to pay interim margins and the winding down of the options clearing business required.
Red flags were there
On 8th May BBY advised options clients that it was exiting the business. As soon as ASX were notified of the appointment of an administrator, ASX Clear declared a default event and suspended BBY’s participation in the market prior to the market opening on 19 May. Many BBY investors expected a longer time frame and were reportedly caught by surprise.
What were the danger signs? Clear red flags were the ASX disciplinary matter in 2014 and the consistent failure of the BBY board to remedy the issues raised by the independent reviewer or by ASX during early 2015.
Further, the Administrators Report noted a lack of independence on the board (two of the three directors were siblings) and suggested that related party transactions will be investigated in relation to all directors in the liquidation. The records of the BBY companies were unreconciled and in a poor state, and there were numerous inconsistencies in the directors statements in the Report as to Affairs.
Now that BBY is in liquidation, the liquidators will consider matters of insolvent trading and the directors conduct more generally, as well as recovering property or compensation for creditors under Part 5.7B of the Corporations Act, including the possibility of unfair preferences and unreasonable director related transactions.
But this is after the fact, and is unlikely to help BBY clients or unsecured creditors who are owed around $8 million,and who, according to the Administrators Report can only look forward to an estimated return in the dollar of between 0 and 24%.
Should regulators have acted earlier?
Should ASIC have acted prior to the appointment of administrators? Certainly now, with the doubt cast on the company’s management by the administrators/liquidators, ASIC should initiate an inquiry.
BBY had come to ASIC’s attention on a number of occasions – in 2005 a warning was issued for failing to manage conflicts of interest; ASIC would have been aware of the ASX Disciplinary matter of June 2014 (there was also an earlier ASX Disciplinary matter in September 2011); in August 2014 ASIC’s Market’s Disciplinary Panel issued an infringement notice with a penalty of $90,000 for contravening ASIC Market Integrity Rules (s 798H Corporations Act) and there were suggestions that BBY clients contacted ASIC in 2015.
Where the investing public are relying on competent management of their funds the risk of failure takes on wide significance. BYY’s failure is not about one or two clients and creditors left in the lurch. ASX had pointed out the serious impact on the market where BBY didn’t meet its obligations in its Disciplinary Notice in 2014. As an options clearing business BBY carried particular responsibility. A wait and see policy may not suffice.
Appoint a Financial Regulator Assessment Board
The BBY failure, the Commonwealth Bank financial scandal, and the recent trouble at IOOF suggest that a Financial Regulator Assessment Board, as proposed in David Murray’s Financial System Inquiry, could create a more pro-active, interventionist outlook and re-claim investor trust.
Specifically the Inquiry called for more clarity around the expectations of regulators, including addressing the market’s appetite for risk in the financial system and the need to develop better performance indicators.
It is possible that from a regulatory perspective punishing corporate failure has historically seemed more attractive in its certainty than preventing it. Regulators need to re-think this history as increasingly the widespread fallout and loss to individual investors and creditors from company failure outweighs the benefits of the deterrent message sent to directors by enforcement.
“Sudden” corporate failure is rarely sudden, and where regulator intervention succeeds and cuts investor and creditor losses, all the good work of regulators won’t end up being lost in the fallout of corporate failure.