Saturday, May 31, 2008

Saturday Morning Musings - blogging, Opes Prime and a flight of swallows

Welcome to visitor 31,000 who came from Toowoomba in Queensland.

In an email to me, KVD wrote in part:

And I also wish to make the point that I have now come to think that blogs are a very good means of skimming current issues, but somehow seem to lack the ability or inclination to pursue any issue to conclusion.

Bloggers seem to flit onto the next crisis or issue du jour. And, again, no criticism -just continuing angst....

Finally, a question:  is it better to assist in the resolution of one problem (however small the problem or the contribution), or to comment upon many problems, proffer solutions, but then simply move on?

Now I thought that these were fair comments. I responded:

You point about blogs as a skim is well taken, your point about not pursuing to a conclusion is even stronger. My feeling is that we bloggers, me included, go round like a flock of  swallows circulating round the latest food source, the current issue.

I try to maintain a consistency over time on issues, but the blogging environment is essentially an immediate ephemeral one. This is still important because the swallow's peck does affect things. However, it does not affect a single issue unless that issue is sufficiently sustained over time or has a very particular profile to accumulate pecks.

I will come to the immediate cause of KVD's angst in a moment. First, a brief follow up comment on the strengths and weaknesses of the blogging environment.

I find blogs invaluable in keeping me in touch with the world around me. Like most time short bloggers, I tend not to read posts in detail unless there is something there that demands my immediate attention. Skim and move on.

This blog displays the same reader pattern. Thirty three of the last forty visitors came for 0.00 seconds, just long enough to scan and move on. The remaining seven stayed for periods from twelve seconds to seven minutes twelve seconds.

As I scan, I find issues repeating and also spreading to a degree between blogs, hence my analogy of  a flight of swallows.

Most blogs, this one included, follow particular lines reflecting the interests and biases of their writer or writers. This affects the way we read.

I tend not to read Larvatus Prodeo, for example, because it is too much like the faithful talking to the faithful in a church to which I do not belong.  Instead, I rely on others to attract my interest to LP posts that I should read. I know that the same type of thing applies to this blog.

The overall impact of blogs and blogging is difficult to measure. My feeling is that it's far greater than people realise and has been growing. However, it is the distributative (spread from one to the other) and aggregate effects that are important.

None of this is much comfort to KVD who is especially concerned with the issues raised by the Opes Prime case.

KVD is not an investor, nor does he have particular sympathy for the wealthy and high profile investors caught in the collapse. His focus is on the failure of regulation and compliance, the way in which the case appears to indicate that c0mpliance is mandatory who cannot afford to get around it.

The broad facts of the case were set out by Legal Eagle  in Opes investors fail at first hurdle.

In simple terms, and as I understand it, investors "loaned" their shares to Opes Prime, using them as security for margin loans from Opes to fund share purchases. Opes then used the shares as security to borrow from the ANZ Bank and Merrill Lynch to fund the  loans  to its clients. Investors who exited the arrangement with Opes were provided with equivalent shares.

Opes ran into financial difficulties. The ANZ Bank and Merrill Lynch seized and then sold the shares held as security, forcing down values and creating market confusion.

I am not a lawyer, nor do I know the full facts of this case. Instead, I want to pose a few simple questions based on first principles.

To begin with, what does the case tell us about disclosure rules?

In aggregate, these were large blocks of shares, large enough for their sale to affect markets for individual stocks, large enough to trigger compulsory notification procedures

Accepting for a moment that investors did not own their shares, then who did? If Opes Prime did, and this seems to be the effect of the legal agreement signed by its clients, then it had a disclosure requirement. 

However, there is a linked question. What level of interest in shares is required to trigger disclosure?  The agreement between Opes Prime, ANZ and Merrill Lynch appears to have given them final control of the shares. At what point were they required to disclose this?

Regardless of questions of law, the Opes Prime case raises some important questions about the operation of the disclosure arrangements.

Turn, now, to the agreement between Opes Prime and its clients.

One of the points that KVD made was that, in law, a transferred title is only as good as the initial ownership. As a simple example, if you buy a car that is stolen , ownership remains with the original owner even if you have acted in good faith.

The agreement between Opes Prime and its clients is quite remarkable in that Opes retains ownership of the shares so long as you owe even one dollar.

Take the reported case of  David Regenspurger. Having sold his house, he invested $320,000 in blue chip stocks. He also took out a loan of $100,00 from an Opes Prime affiliate. The effect was to transfer ownership of his entire portfolio to Opes Prime. His blue chip shares were seized and sold.

As best I can work out, he is now an unsecured creditor of Optus Prime for the difference between his loan and the overall value of his portfolio. I have no idea, however, just how that differential might be calculated when shares in aggregate have been seized and put on the market in a forced sale. 

I suspect that the very speed of action may have created something of a legal quagmire in areas like valuation. 

Mr Regenspurger's case is interesting in another way in that he is clearly not, or would appear not to be,  a sophisticated investor. If he could establish this, then he might be able to claim ownership of his shares. In this event, action would be opened up against either Merrill Lynch or ANZ or both.

Now here there is another issue that I do not understand, the difference between ML and ANZ. Both seized shares, only one has so far been sued.   

I think that we can simplify all this as follows.

First, the nature of the agreement between Opes Prime and its clients. Was it fair?

Secondly, the management of Opes Prime, including lack of control and the favouritism awarded certain certain clients as compared to others.

Thirdly, the relationship between Opes Prime and its lenders.

Fourthly, the responses of Opes Prime lenders to the company's problem. including the way they reacted to protect their own interests to the disregard of everything else. 

In considering all this, KVD suggests that Opes Prime shows (among other things) failure of compliance at the big end of town. His view is, if I understand it correctly, that when it comes to failures like this compliance breaches often get classified as simply technical or even ignored because it is simply too difficult to unscramble the egg.

From observation, I think that he is right. This then leaves our system with just two responses. Pursue hard those elements that you can where the broader costs are not too high. Then add to regulation to patch up obvious holes.

The alternative response is to enforce compliance regardless of the costs. None one will in fact do this because our overall system would simply come to a halt. So we come back again to selective compliance across the whole sphere of law and regulation.

In my arguments about compliance I have complained not just about compliance costs, but also about the selectivity it creates. This acts to discredit not just the specific compliance area, but more broadly the law itself.

In Australia today, the judgement that we all make on a day to day basis is which areas of law or regulation to ignore. I stand to be corrected, but I doubt that there is a single Australian that has not broken a law or regulation in the last ten years. 

14 comments:

Legal Eagle said...

Very interesting post, Jim.

The requirement of formalities and compliance in law is a balancing act. On the one hand, we want to make sure people know what they are entering into when they enter a transaction. We also want to publicise transactions to the world (which is in part what the disclosure rules were designed to achieve). That way, people know who owns what and where they stand.

On the other hand, too much formality or compliance will drive up the costs of entering into a transaction, and may result in unfairness if people do not know or understand a formality or do not know that it applies. Or where they think they know what the law is, but don’t really.

Personally, I do think rules like disclosure rules should be taken seriously. But I also think there should be a little flexibility in the law to take account of individual circumstances where a breach of compliance may be explicable or understandable.

This is why I like Equity law so much - as Aristotle argues, it is “a rectification of law where the law falls short by reason of its universality.” So sometimes it is unfair to expect the law to cover every eventuality and you have to make allowances for individual circumstances.

On the other hand, I think there's really no excuse for experienced commercial actors such as Merrill Lynch and ANZ to fail to comply with the rules!!!

Legal Eagle said...

P.S. I do find that issues in blogging recur - it might look like I drop a topic, but then six months later, up it pops again - so there is some continuity.

Also, I think both you and I have particular concerns and viewpoints which remain consistent throughout our analyses.

ninglun said...

I agree with Legal Eagle that we tend to have our particular lenses through which we see the ephemeral issues, and probably those instruments are refined and modified as we go; so there is some consistency of voice or viewpoint after all.

As for visits of zero seconds: visits register a time only when the visitor goes somewhere else in the site, or opens the entry as I have just done. For what I call "generic reads" there is no way of knowing how long or carefully someone was reading.

Jim Belshaw said...

LE and Neil, I am breaking my response into two parts just to keep the topics separate.

Neil, thank you for the information on the o.oo issue. I did not know that. So I may in fact be under-estimating the readership issue.

Jim Belshaw said...

LE and Neil, turning now to the compliance issue.

To make my own views absolutely clear, to me compliance is a sub-set of a broader issue that has grown in importance in my mind especially since I started doing some work within the NSW system. As a nation we are choking to death in our obsession with risk aversion, regulation, compliance and control.

I have tried to illustrate this over time with a whole series of posts. The near collapse of the NSW child welfare system,and I use these words advisedly, is an example. The mandatory reporting system was really the final blow. The NSW 120 hours driving license requirement is another.

All this links to my concerns about the decline in the standard of management performance. I usually write about it on this blog in a public sector context. However, the same arguments apply in the private sector.

LE is right that in blogs like ours there is a consistency. This consistency is not imposed by a formal adoption of an overarching position, but by the core themes in our own views.

In terms of David's (KVD's) comments on blogging, I found them interesting in the context of getting our own views across.

I had not focussed on the OP case before David raised it, although I had read the reporting with interest.

Now I understand the points that LE made re balance and compliance. There are in fact some issues here worth pursuing including the extent to which a selective degree of rules ignoring is necessary to make the whole system work.

The thing that stood out to me in OP was that the breach of the non-disclosure rules was (and ignoring legal definitions) no mere technicality.

If ML and ANZ had been forced to disclose, it would have had major market impact. At the very least, it would have triggered real interest in the OP arrangements. Now this, or so it seems to me, was important to an informed market including knowledge of OP clients.

I can feel more posts coming on!

Anonymous said...

Jim

First up – thank you for a balanced and thoughtful analysis of the continuing quiet rage I feel about this issue.

Without any personal involvement – I again assure you – it seems to me outrageous that 1200 relative innocents (give or take a high profile lawyer or two) should be so abused.

Nothing has changed, and I expect nothing ever will.

I have several comments to make, and I apologise in advance if you feel that I am seeking in some way to hijack your blog.

The reason I make these comments here is that you seem, to me, somebody willing to entertain polite discourse on a consistency of subjects. I thank you for that – and I hope what follows is polite.

Opes Prime:

1) There was a quite interesting article in the SMH today (31 May 08) setting out the timeline in this matter. I understand from that article that ANZ secured for itself security over the ‘whole’ within weeks (days?) of Opes imploding. By ‘whole’ I mean something like 10 times the paltry $90m advanced that day. Paltry $90m? - that is what it is, when the total securities (such a lovely word) so gathered amounted to over $1bn. I will accept correction on the odd $100m or so.

I think this particular action is very (very, very) questionable. And will be eventually found to be illegal. Never mind dotting i’s or t’s – ANZ apparently was exposed for heaps, and within weeks (days?) of the collapse, managed to cover its position by throwing another (mere pittance $90m) into the pot.

2) I am not a lawyer, but I can sort of understand the fascination lawyers seem to find in the exact meaning and legal intent in each single word. Legal Eagle is absolutely correct in his/her/their first analysis of the first sortie in this saga (for that is what it is) and in his/her/their latest commentary above.

But the mention of ‘formalities and compliance in law is a balancing act’ sort of loses my interest in terms of ‘right and wrong’. Balancing act? Right or wrong.

I would appreciate in this case a comment on just two words: ‘law’ and ‘justice’; and the occasional, accidental connection between same. Hint: justice to me is just another word for equity – as in - let us deal fairly with each other.

3) And we won’t mention Super Fund Trustees, and their non-existent ability to pledge members’ assets for Ferraris.

End (very much abbreviated) of rant. And I know it is very easy to rant – so…..

Solutions: (one easy, one really out of possibility I guess)

1) It should be illegal to do what ANZ has done, in the simplest, clearest terms:

Upon declaration of insolvency (administration?) the assets of the entity should be frozen until the receiver/administrator issues the first report. No ability by any party to deal (sell) any asset affected, secured, mortgaged, garnisheed – pick a word. The commercial arrogance of ANZ in this matter is quite obscene. And still continues.

2) Declare ‘Futures Trading’ illegal. The idea that somehow it is legal to forward sell something which one does not presently own or possess is a nonsense. It is not an ‘investment’, it is a gamble.

Farmers wishing to secure a forward price for something they will produce sounds fine. But some smart fellow sitting in New York or London or Melbourne on-selling their wishes hopes and dreams on a 0.0001% margin – 24x7 – is so removed from reality as to invite disaster. And commonsense contempt.

Summary: Freeze ( really mean this) assets of troubled companys. Declare ‘futures trading’ to be what it is – a casino.


Sorry Jim – I suppose I have now overstayed my welcome. But this thing matters so much that somebody (everybody) should retain at least an interest – or at least some indignation.

kvdnecnyfd

Jim Belshaw said...

David, please do not ever feel that you can hijack this blog. It is not just my view alone, it is a platform for discussion on issues.I have the power to block were I to ever think that you or anyone else were to cross the line.

I will come back to you in the morning. In the meantime, I would be interested in LE's comments when she comes back to these comments.

Jim Belshaw said...

David, I have just read the SMH article. Now I really want LE's comments. What a mess.

Legal Eagle said...

If it were easy to answer whether something was "right or wrong", we wouldn't need lawyers, judges or courts. We'd know exactly what to do all the time, and we'd know exactly when we had transgressed the law.

It is frustrating that lawyers often can't give a straight answer on whether something is right or wrong, but there are many reasons for this. First, we need to work out on the balance of probabilities what has happened before we can work out how to apply the law to it. Secondly, we need to work out what the law actually means in a given circumstance. Thirdly, we then need to see how that law applies to the situation.

I am not an expert in insolvency law, but in my understanding, there are provisions in the Bankruptcy Act that if you take out security too close to an insolvency, that security is voidable. I would be interested to see how this applies to ANZ's situation if the facts reported in the SMH are true. Another question being explored by the investors is whether ANZ was guilty of duress in forcing OP to give the charge.

By formality, I mean the process by which you create a particular kind of agreement or interest. You can actually have too much formality - so that people don't know how to properly create a particular kind of agreement because the process is too expensive, too time-consuming, too complex and requires too much expert input. On the other hand, you can have too little formality where people can create an agreement without meaning to or without understanding the consequences of what they do. That is why it is a balancing act - you need to make the formality complex enough that people know the import of what they are doing, but not so complex that it's impossible to comply with.

Compliance rules are a little different. You have to make them simple enough so that people not get put off by red tape. They should not be too expensive or difficult. But they should also be sufficiently strict to fulfil the purpose for which they are created. If you want to them to be taken seriously, you also have to enforce them, or else they will be a dead letter.

This isn't a legal argument, just a practical argument - knowing the way people behave.

Jim Belshaw said...

I understand your points, LE. I find all this very interesting from a professional viewpoint. Will respond further tonight.

Anonymous said...

Thank you LE for your comments. I did not, and do not, seek to complain about the role of lawyers in all this, just the outcomes forced upon us by the application of inadequate laws to some situations – your comment re Aristotle was most apt.

The thing that sets apart the Opes model from most stockbroker-client arrangements is the pooling of client funds whereby each investor lost his direct responsibility for his investment decisions, and became jointly responsible for the outcomes of all the other investors.

I understand this ‘business model’ is quite rare. I believe the regulators failed us by allowing this business model to be established in the first place, or at the very least by failing to ensure this very significant variation was adequately explained to each investor.

Secondly, I believe the very speed with which ANZ and ML proceeded to sell down has contributed to the size of the client loss quite significantly. I think that regulators should look very seriously at some sort of rule change as the result of this – a cooling off period as suggested above.

Lastly (whew!) I continue to have doubts as to the ownership claimed by ANZ over some if not all the shares it has sold.

Thank you Jim for allowing this discussion and for your later summation.

kvd

Jim Belshaw said...

Good morning, KVD. Your hours appear to be as funny as mine. Or Lexcen's for that matter.

We appear to be working our way through the issues on this one. I must say that I feel pleased with the interaction. It's nice to have what amounts to a more sustained conversation.

I did a blog search to see to what extent the Opes Prime matter had attracted attention in the blogosphere. Not a lot. I think that it is too far outside the expertise/interests of most bloggers.

Legal Eagle said...

As far as I know, I'm one of the few bloggers to be passionately interested in it (along with Jim) - I'm following all the cases with great interest.

I do agree that the corporations law failed in this regard. There should be strict regulation of the risky business of securities lending. If you read Finkelstein J's judgment, you will see that he refers extensively to the kind of regulation of trading present in the US. Apparently this kind of securities lending agreement started in the US in the 1950s, and they seem to have more time to get used to it and regulate it. I think that Australian Corporations Law should introduce controls similar to the US law on the subject. These kinds of arrangement just strike me as a disaster waiting to happen. I'm obviously not a risk taker.

Secondly, the speed with which ANZ sold the shares once it obtained its charge most definitely contributed to the losses of the investors. If you sell large tranches of shares on the market, obviously you are going to create "fire sale" prices. I would need more information on the exact way in which ANZ gained title to the shares...

It may be that ANZ's title was voidable because of insolvency laws, in which case it didn't really have ownership of the shares after all...we will watch this space.

I do get very angry in regard to these cases of investors being ripped off. I have been involved in cases where families and pensioners lost their life savings as a result of terrible investment advice. The kind of advice which had me pulling my hair out when I read their evidence. Some of the investors were intelligent educated people, they had just been taken in by the scams of the directors/investment advisors. I have written a post on how a high IQ doesn't necessarily mean that you're good at making decisions about money!

In some instances, the investment advisors had even managed to delude themselves, and also lost substantial amounts of money when the whole thing collapsed.

All I can say to people is: potential gain is directly proportion to the risk. Therefore, something with the potential of high gains is high risk, whereas something with the potential for only low gains is low risk. There is no such thing as a low risk investment with high gains!

I have speculated and speculated as to why companies keep trading when they know that they are on the brink of ruining their investors. All I can think is that the directors desperately hope for a stock exchange windfall to plug up the giant holes developing in their books. As I say, I'm not a risk taker, so it seems inconceivable to me that someone would keep doing that, but it must be sheer desperation coupled with the entrepreneurial personality (about which I have also written a post).

Legal Eagle said...

BTW, I can listen to people say that they like Equity for days. A sure way to my heart.

Have a read of this post here if you want to know more about the operation of the law of Equity. You don't need to read to the end to my rant about Justice Heydon - just first paras.