Finance Companies Improve Their Disclosure

24 August 2006

Finance Companies Improve Their Disclosure But Risks Remain

Finance companies’ disclosure of information for investors has markedly improved since the Securities Commission published a report on Disclosure by Finance Companies in April 2005.

This is the finding of a Commission’s review of offer documents of 20 companies prepared since the Commission’s report.

The Commission’s job is to intervene when finance companies do not provide the information required to enable investors to make informed investment decisions. The report set out the Commission’s expectations of disclosure of information by finance companies.

This subsequent review focused on key areas identified in the earlier report such as disclosure of the risks of the investment, and the investment activities of the company. Each company’s most recent investment statement, prospectus, financial statements, and advertising were reviewed for compliance with securities law.

Two finance companies had not followed the guidance in the report and still had poor disclosure, especially about risk. Ten others had improved their disclosure on the basis of the report but had fallen short in certain areas. The Commission required these 12 companies to rectify their disclosure deficiencies. All of them amended their offer documents and / or advertisements and one also amended its financial statements. Other companies have agreed to make improvements when next updating their offer documents or preparing advertisements.

“It seems that most companies had taken the report seriously and have been able to apply the guidance in it. On the whole we are pleased with the co-operation we received from the companies reviewed,” Jane Diplock said. “The standard of disclosure in the finance company sector has improved significantly as a result of the Commission’s work. However, there is still room for further improvement, especially with regard to risk.”

Finance companies can be a high risk investment. Investors should read the investment statement and the prospectus so that they know who the finance company is lending money to, and how well the repayments are going.

Continued….

“Finance companies take in money from investors and lend money out for various ventures. People who borrow from finance companies cannot borrow money at cheaper rates from a bank usually because they don’t meet the bank’s credit criteria. Consequently there is a significantly higher risk of the repayments falling behind or stopping altogether and there is a risk that the finance company won’t have the money to repay investors,” Jane Diplock said.

Currently, investing $5,000 in a registered bank for a year gives a return of about 6%. Investing the same money in a finance company for the same term will return about 3% above the bank rate. That difference might seem small in percentage terms, but it may not be representative of the higher risk an investor takes with a finance company.

“People should realise that an extra 3% return is a 50% increase in interest and so must represent at least a 50% increase in risk,” Jane Diplock said. “Also, the governance of a finance company is very important and the skills and track record of its directors and managers, particularly their skills and experience in financial management and in pricing risk.”

Investments with finance companies are generally for a fixed term. Usually this means that investors can’t withdraw their money until the end of the term even if the company’s financial position deteriorates. If they can cash in the investment early they will probably have to pay a penalty.

The Commission does not have a prudential regulatory role – it cannot step in to stop a finance company failing or take action against a finance company that fails. It cannot help investors recover their money. Where appropriate the Commission refers possible breaches of securities law to the Registrar of Companies to consider prosecution. The Commission is working with the Registrar on matters raised in the review and on finance company issues more generally.

The Commission is continuing to review finance company disclosure in the normal course of its work.

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ENDS

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