The collapse of agribusiness company Great Southern Plantations would have surprised few, coming only weeks after the downfall of listed rival, Timbercorp. Administrators Ferrier Hodgson have been appointed to the failed group, which manages 45 schemes on behalf of 43,000 investors. The company was unable to restructure a $100 million debt which was payable in October.
The Sword of Damocles had been looming ominously above the heads of Great Southern and Timbercorp since the onset of the global financial crisis, with both companies reliant of large amounts of leverage to fund their burgeoning operations. The inherent regulatory risk associated with their business models (which are essentially based on legal tax minimisation) and the decision by the Howard Government in February 2007 to restrict investors from being able to claim up-front tax deductions for investments in non-forestry projects was the death knell for the listed agribusiness operators. While the Federal Government’s moves many be eventually overturned in the courts, its initial decision cast the non-forestry MIS industry into a death spiral which this month has claimed its two biggest scalps.
The MIS collapses cast further light on the financial planning industry and the inherent conflict of interest which pervades much of the advice provided to often unsophisticated investors. While some more scrupulous planners, have shifted to a fee-for-service model (such as the Dover Group, operated by Eureka Report contributor, Adrian McMaster, and which have traditionally been used by accountants and legal practitioners), many planners are still beholden to a commission-based earnings profile. It is this inherent conflict which has played a role in investors losing billions in Westpoint, Bridgecorp, the MFS satellite funds, Fincorp and Storm Financial.
The common thread among the calamities has been the involvement of financial planners in raising criticial mezzanine-type finance to fund the ill-fated ventures. As James Chessell noted in the Financial Review this morning:
The planning industry was at the heart of the tax effective agri-business boom in the middle part of the decade. In return for encouraging their clients to take up the latest sandalwood, grape truffle or ripened tomato offering, they received up-front fees at around 10 percent. This helps explain how roughly 43,000 investors with a taste for tax engineering ended up plouging $1.8 billion into 45 Great Southern schemes.
It doesn’t take any great foresight to acknowledge that a product which requires a ten percent up-front commission to sell is probably not a product which one should be investing in. It would be extremely difficult for a financial planner to provide completely independent advice when they receive a ten percent commission on a product (managed investment scheme assets) and a two percent commission on another (market index funds).
While the risks and levels of fees/commissions are required by law to be provided to clients of financial planners, the degree of complexity of product disclosure statements and statements of advice, coupled with their length and the likely lack of sophistication of the investor, many clients would simply trust the advice of their planner, not fully understanding the extent of the conflict.
While some industries, like car or real estate sales, have earned a maligned reputation, there would be fewer industries which profit from their clients ultimate doom to a greater extent than commission-based financial planning. Be it managed investment schemes (like those offered by Timbercorp and Great Southern), leveraged products (Storm) or outrageously stupid property ventures (Westpoint) — the common thread is naive mum and dad investors trusting their financial adviser for expensive and ill-fated advice.