Corporate Collapses in the Australian Financial Advice Industry - Essay Example

Introduction Storm Financial Limited was based in Queensland Australia. The company was established in 2004 by Julie Cassimatis and Emmanuel Cassimatis as a financial advice company. In early 2009, the company was placed in liquidation. By 2008, the company had more than AU$4.5 billion share funds invested in the company by the investors (Anthony, 2009). However, by the end of 2008, the figure had significantly dropped to AU$3.4 billion due to the significant drop in the value of shares. Towards the end of 2008, the company had 13,000 investors that held share funds in the company. The essence of the company’s business was to provide clients with financial advice and invest on behalf of their clients through well developed investment plans (Anthony, 2009). In addition to providing financial advice to the clients, Storm invested the clients funds to products developed by a sister company (Anthony, 2009). The product range comprised of managed funds which were operated and managed by companies such as Challenger and the Colonial (CBA). According to a report released by ASIC the advisory model under which all financial planners in Australia operate on was also applied in Storm Financial (Anthony, 2009). For example, the advisory model required financial advice companies to provide clients with personal advice based on the client’s circumstances and after reasonable enquiries have been made regarding the client’s circumstances. The other requirement placed on financial advice companies by the advice model developed by ASIC was that the adviser had the obligation to determine the client’s personal circumstances before providing any advice (Anthony, 2009). Reasons for Storms collapse According to the report released by ASIC and as stated above, Storm Financial applied the advisory model in providing financial advice to its clients (Kirby, 2008). However, vulnerability for the company’s collapse was created by the fact that the company failed to take into consideration some important aspects which, if well observed and taken into consideration could have prevented the collapse of the company. First, marginal loans were used by the company to add client leverage. This was done for a large number of clients (Kirby, 2008). It is important to note that the use of marginal loans to add client leverage is a common phenomenon in the market and so the management of the company was confident that this mode of client leverage would work positively just like in many other financial advice firms (Kirby, 2008). The essence of leverage is to enable the clients to increase the level of their investment by combining their funds (owners’ equity) and borrowed funds (marginal loans) (Kirby, 2008). For example, if a client has $200 (equity funds), the client can decide not to buy shares worth $200 and instead to buy shares worth $500. In this regard, the client has to borrow $300 (marginal loans) (Kirby, 2008). All the shares worth $500 purchased by the client would be the security for the borrowed funds. Marginal loans facilities are used across the board by many financial companies and therefore it was not just limited to Storm Financial (Kirby, 2008). Of great importance is that marginal loans enable investors to increase their returns particularly in a bull or rising market. However, marginal loans multiply in a falling market and investors experience multiple losses (Kirby, 2008). The reason for this is that lenders seek to make margin calls in a share falling market in order to protect themselves from huge losses (Kirby, 2008). Margin calls are witnessed every now and then when stock market shows some negative trends. The essence of a margin call is to allow the clients to maintain or reach the loan to value ratio (Kirby, 2008). This means that clients are required to add to their equity so that they can be able to repay their loan. In order to reach the loan to value ratio, in many instances clients are forced to liquidate their investments or shares or even other assets. In 2008, the global financial crisis hit the global market and the stock prices were greatly affected (Osborne, 2009). This led to extensive margin calls as lenders fought to protect themselves from the impending losses as a result of the fall in stock prices. Storm investors were pushed to the wall to raise their loan to value ratio and many of them opted to liquidate their assets including their homes (Osborne, 2009). Many investors experienced negative equity that meant that they had lost everything they owned in terms of shares in the company and also in terms of personal assets. The number of investors in Storm Financial dropped significantly and by 2009 when the company was at the collapse stage, most of the clients were in a bad financial state (Osborne, 2009). Hence, the aggressive leveraging model pursued by Storm Financial was one of the main causes of the company’s collapse in 2009 (Osborne, 2009). The aggressive leveraging model applied by Storm put its clients at a tight spot because the clients had no spare equity to meet the urgent margin calls that were coming from lenders such as Macquarie Bank and Commonwealth Bank (Osborne, 2009). The company’s liquidators also found that Storm Financial focused primarily on monitoring the loans held by its clients and making more profits rather than providing clients with advice that could have protected the clients from the fall in share prices (Osborne, 2009). Liquidators noted that the company applied the aggressive leveraging model that proved riskier than the normal models applied by other financial advice companies (Osborne, 2009). Based on evidence from different hearings, the liquidators found out that Storm lacked the required capacity to monitor and manage the portfolios and debts held by its clients (Osborne, 2009). The company focused on monitoring the position of the investor with an objective of increasing the borrowing capacity of the investors in order to gain more fees. As a matter of fact, details indicated that Storm management relied heavily on the data provided by the lenders to manage the margin loans of the clients (Osborne, 2009). As a result, many clients were not informed in time about the deteriorating trend in their investment value. This meant that the clients failed to take urgent action to reduce losses because they were not provided with the required financial advice. Hence, lack of capacity to monitor and manage the portfolios and debts held by the clients was another major cause of the company’s collapse in 2009. A part from the technical and complex issues that revolved around the aggressive leveraging model applied by the Storm Financial, there are other factors that led to the collapse of the company (Osborne, 2009). Experts held that the model used by the company was not strong to withstand the pressure brought by different business cycles. For example, impressive returns were recorded in early 2007 and investors were advised to amplify their portfolios performance by borrowing heavily from the lenders (Osborne, 2009). The company’s model thus worked positively when the markets were performing well. However, the fall in share prices and the turn in market performance in 2008 resulted into huge losses due to increased margin calls from the lenders (Stuart, 2010). Hence, the aggressive leveraging model was only suitable when market performance was positive but was not strong enough to withstand the effects of the global recession in 2008. The other reason attributed to the fall and collapse of Storm Financial was lack of proper procedures for expenditures (Stuart, 2010). Experts established that most of the company’s funds were used in expensive staff trips and hosting clients in expensive locations. Although, such practices were deemed necessary for team building purposes, the over-focus on trips and other activities outside the company’s scope stole the focus of the entrepreneurs from the company (Stuart, 2010). This explains partly the reason why Storm Financial lacked the capacity to monitor portfolios and debts of the clients and failed to provide timely financial advice regarding the deteriorating nature of the clients’ investments. Experts noted that the other reason that sparked the fall of Storm Financial was the poor timing of the company’s attempt in 2007 to list in the Australian Stock Exchange (Stuart, 2010). The reason for this is that the company attempted to list when the global financial crisis begun to have effect on financial markets. The debt-fueled model applied by the company had already begun to feel the hit of the financial crisis and the model had started to wobble (Stuart, 2010). Additionally, the company’s procedures and organization of the listing in the stock exchange was poorly done. This led to the delay of the company’s IPO for a period exceeding one month due to conflicting dates reported as the possible time for floating its shares in Australian stock exchange. The company’s corporate advisers and the executives clashed on the same matter. Reports from fund managers indicated a form of disorganized and shabby sales pitch which affected the company’s floating in ASE (ASIC, 2009). The failure by the company to successfully float in the stock exchange resulted into a further drop in its share price which generated intensive margin call as lenders begun to protect their investments. Furthermore, the liquidators found an amazing reason why storm financial collapsed. The founders admitted to have had not prior experience in financial advise and thus concentrated their efforts on the the old segment of the population that had little to do with the retirement benefits than to consume (Stuart, 2010). During an interview with the ASIC, the founders admitted that they had no other alternative avenues they thought best for people to invest their funds. In other words, the company was founded on reasons for making quick profit from the most vulnerable segment of the population, that is, the old segment of the population. The strategy applied by the founders was to increase the customer base by encouraging house mortgages and margin loans as a way of making quick fees which translated into quick profits. In this regard, it can be construed that Storm Financial was not founded on the platform of long term operation but was founded on a simple investment model which could only last for a short term. Additionally, the withdrawal of the Commonwealth Bank was also another factor seen as having contributed significantly to the collapse of Storm Financial. The Commonwealth Bank was the main credit provider for Storm's clients. This means that the abrupt withdrawal of the bank from providing credit to the clients resulted into a shortfall in the ability of Storm to meet most of its financial obligations because Storm relied heavily on credit obtained from the bank. The funds were used by the company to pay for salaries and other financial obligations (Stuart, 2010). Without a substantive lender, the bank's financial statement fell below the obligations that the bank had to meet and thus the financial position of the company continued to deteriorate with time towards the end of 2008 when the financial crisis was at its climax. References Anthony, K. (2009). “Storm Financial inquiry gets go-ahead”. The Australian. News Limited. “ASIC welcomes court decision on Storm” (2009). Media Release AD09-50. Australian Securities and Investments Commission. Kirby, J. (2008). “On the brink of collapse”. The Age (Melbourne). Osborne, P. (2009). “Storm financial collapse plan outlined”. The Age (Melbourne). Stuart, W. (2010). Collapse of financial planner was inevitable. BusinessDay. . Read More