New Zealand's business regulators are blaming dopey directors, b-grade auditors, and timid trustees for our finance sector bushfire. But where were they when the spark was lit?

Over the past week, New Zealand ’s Registrar of Companies and our Securities Commission have suddenly started playing the blame game. Their biggest problem, as we shall see, is that they are part of the problem.

Companies’ registrar Neville Harris pulled no punches in his scathing report to the Parliamentary Commerce Committee on the incineration of the best part of $6 billion worth of more than 100,000 investors’ funds in New Zealand ’s own home-grown finance sector crisis.

Here’s Harris on directors.

"Too often directors were not adequately informed, misled or failed to take sufficient interests in the affairs of the company.

“A number of the finance companies engaged in excessive related-party lending with investors funds … In some cases, the only objective of entering into one of these transactions was to benefit one of the directors (or interests associated with the directors) or prop up a poor performing investment.

“Nearly all finance companies engaged in the practice of rolling-up a non-performing loan into a new loan, which included the original principal and the principal/interest arrears. The effect of this was to reduce or eliminate loans in default, thereby masking the true performance of the loan portfolio.

“It is our understanding that a number of the failed finance companies were in the end acting in a similar manner to Ponzi schemes. In many cases, funds received for investment from new investors were used to repay the maturing loans of existing investors.”

Now, Harris on finance company trustees – particularly Perpetual Trust Limited and Covenant Trustee Company Limited – appointed trustees of at least 25 of the 45 failed finance companies,

“In our view, Covenant and Perpetual were slow to detect adverse financial issues developing and they responded too timidly to circumstances where investors’ interests were being put in jeopardy.

“Invariably breach notifications were only received by the Registrar on, or about, the date of the actual appointment of a receiver…. In these cases, little could be done in response because the company was already past the point of no return financially."

In many cases, trustees were hamstrung by Trust Deeds that lacked a description of “enforcement events”, leaving them with insufficient powers to take action when investors’ interests were threatened.

Auditors were next on the Harris list.

According to Harris , New Zealand ’s Big Four accounting firms (Deloitte, Ernst & Young, Pricewaterhouse Coopers and KPMG) are not particularly interested in finance company audit appointment.

“There was a significant concentration of audit appointments within second-tier accounting firms … Issues arose as to whether they had sufficient capability and experience to conduct the initial due diligence for the assignment and to audit such complex and elaborate company and business structures.

“As a general observation, the audits of many of these finance companies lacked the rigour and analytical depth one would expect for entities managing substantial public investments.”

Hard on the heels of the Harris Report, Securities Commission chairman Jane Diplock weighed in: directors of failed finance companies who failed to prevent management from indulging in risky practices and did not alert their trustees to problems will be “brought to book”.

She says that while there were indications of historical weaknesses in the trustee supervision regime, ultimately, "the buck has to stop with the directors … They have failed in many cases and there's been poor governance.”

However, the responsibility for making the buck stops in the right place belongs to the Securities Commission – and the responsibility for stopping some of those bucks burning in the bushfire sits with the Registrar of Companies.

In 2007, the Commission gained the ability to take civil action against company directors who would face fines of up to $1 million if their prospectus offer documents or advertising were proven to be misleading or deceptive. The commission was granted $2.9 million to fund its litigation. By June 2008, it had used just $139,000 of the vote.

The Securities Commission litigation fund for 2008-09 was reduced to $1.4 million – and it was given the go-ahead to use the fund to pay for criminal prosecutions.

Diplock says the commission is restricted to taking action only when a company's disclosures can be proved to be misleading. "Quite often with a finance company ... you can't see it's misleading until you see what they do."

By December 2008, after most of the 46 troubled New Zealand finance companies had collapsed, Herald business columnist Brian Gaynor drew attention to the strange silence of the Securities Commission.

“The Securities Commission must take some of the blame for these debacles, particularly where prospectuses and investment statements failed to clearly identify the risks associated with several public offerings,” he wrote.

“The Securities Commission must take some blame because one of its responsibilities is the oversight of prospectuses and investment statements.”

The SEC chairman was quick to take issue with Gaynor. She says “the Commission’s role is not and never has been to approve prospectuses or investment statements”.

She is correct, at least by my reading of the Securities Act. That role sits with the Registrar of Companies, Mr Harris.

Under Part 2, Section 42 of the Act, the registrar may refuse to register a prospectus if “he or she is of the opinion that the prospectus contains a statement that is false or misleading on a material particular or omits any material particular.”

However, Gaynor is also right when he suggests that the Commission has oversight of the approval of prospectus statements. The functions of the Commission include a requirement “to keep under review the law relating to bodies corporate, securities, financial advisers, and unincorporated issuers of securities, and to recommend to the Minister any changes thereto that it considers necessary.”

Some time – well before there were 46 finance company collapses and up to $6 billion incinerated in the finance sector bushfire – the commission should have blown the whistle.

It must have been as clear to the commission – as it was to registrar Harris – that misleading or inadequate statements in the investment reports and prospectuses were a root cause of a financial crisis of economy-stalling proportions.

If deficiencies in the Securities Act or their resourcing prevent the Registrar or the Commission from dealing with the problem of vetting finance company offer documents before they hit the market, it was the Commission’s job to point it out.

The regulators should shoulder some of the blame they so liberally apportion to others who stood back timidly and watched as the life savings of thousands of New Zealanders went up in smoke.

They should also take some of the responsibility for seeing it does not happen again.