The Queensland-based dealer group's collapse is a sensitive and emotional topic and has raised many queries that hopefully will be answered when ASIC and the FPA's investigations conclude.
Dealer groups and margin lenders in the meantime are at least obliged to fundamentally review margin lending and assess gearing levels and communication procedures so retail clients at the end of the day do not go into negative equity.
Some critical questions arising from Storm's failure include:
- Is margin lending a viable strategy for all clients?
- Who is responsible for telling the client they are in margin call?
- Have dealer groups designed client portfolios and buffers well enough to allow clients to withstand a stock market shock like the one experienced in 2008?
- Are margin lenders doing a good enough job in educating users about margin lending?
- Is now a good time to use margin lending?
Bendigo and Adelaide Bank-owned Leveraged Equities general manager of margin lending Eric Blewitt says margin lending certainly has a place as a genuine wealth creation strategy and has not failed just because of Storm's downfall.
"What we've actually seen is one firm, if we take the most recent one, which themselves have fallen into debt and been liquidated," Blewitt says.
"You are now looking at the suitability of advice and basis upon which the advice was provided. For example, were stress tests or scenario analysis conducted on the portfolio to assess the impact of reduced asset prices? They had a number of clients to whom recommendations have been made and accepted.
"Investigations will determine the outcome."
It is not margin lending that has fallen down; it is the advice that has potentially fallen down or a mismatch of risk taken and the impact of the outcome.
The failures of Opes Prime and Tricom also were not the failure of margin lending, Blewitt says.
"They operated stock lending businesses and utilised something that was purported to be margin lending, which was fundamentally stock lending. Again, failure of two retail stockbroking firms," he says.
"So you've not fundamentally seen failure of margin lending; you've seen the failure of two retail stockbroking firms and the failure of a financial planning firm."
But he says he does not shy away from the fact the margin lending industry has an obligation to assist advisers and clients with understanding the risks and benefits involved in the strategy.
Leveraged Equities with other key industry players has had conversations with clients to assess if they understand the risks involved and how a margin call comes about.
"Could we do it better? Certainly any organisation and industry can do things better," Blewitt says.
Overall, margin lending on a conservative basis has proven in the past to be a true wealth-building strategy, he says.
Suncorp executive general manager of advice solutions David Carter agrees with Blewitt, but says gearing needs to be tailored for each client and clients need to be well informed of the risks.
There are some great benefits of margin lending, which is just one gearing option, Carter says.
Gearing, and within that margin lending, is not for all clients and advisers.
If margin lending is deemed too risky for some clients, there are internally geared managed funds, instalment warrants other forms of debt. Suncorp has a policy that sets limits advisers cannot go beyond with clients (for gearing levels) unless pre-approved.
"We also have competency and educational requirements for our advisers," Carter says.
"In fact, there are some advisers in our various channels who are not authorised to give gearing advice at all."
Suncorp tailors the needs of the clients to the particular advice services.
"Some of our advisers focus very much on a young professionals' market where the risk appetite and the need is there and the advisers in that space have a lot of competencies and qualifications to give gearing advice," Carter says.
"Alternatively, we have some people who predominantly deal in our retirement market, you know, you're probably not going to authorise them to give gearing advice, the [clients] don't need it."
Suncorp's overall margin lending book has not had many margin calls and clients have been voluntary reducing their loan-to-valuation (LVR) ratios in the past 12 months to avoid margin calls, he says.
When asked whose responsibility it should be to inform the client if they are in or approaching margin call, he says clients with advisers have a level of obligation to monitor their margin call, but it should, ultimately, be the adviser.
"If you have clients with margin lending and you're an adviser, you have a responsibility to monitor and inform the client as they get close to a margin call," he says.
But Professional Investment Services (PIS) managing director Grahame Evans says that is not as easy as it sounds.
"Some of the institutions say 'you should just monitor the client's account and if it moves into margin call territory, well you should be aware of it', but that can happen in a matter of seconds," Evans says.
"And the thing that annoys us about when a margin call actually occurs is that clients get told before we do. We don't find out for days."
PIS's margin lenders include Colonial Geared Investments, St George Bank and Leveraged Equities.
"My advisers would love to know at the same time so they can work with the client on where to get the cash from and so the client doesn't sell the completely wrong investment, whether it's from a tax perspective or an investment perspective," Evans says.
Matrix Planning Solutions director of adviser services Allison Dummett's experience has been completely opposite to that of Evans.
"It's the margin lender's duty to notify clients and they certainly have done so in our case," Dummett says.
Matrix's margin lenders behaved excellently and both advisers and clients have been notified of impending margin calls at the same time, she says.
The firm uses Colonial Geared Investments, BT Margin Lending, Leveraged Equities and St George.
"I'm amazed if there is an argument between CommBank and Storm over who should have told the client that they're in margin call," Dummett says.
"I can't believe that both parties would not have actively informed the clients that there were pending margin calls. It's part of your duty of care as both adviser and lender.
"Maybe Storm had a more wholesale relationship with their lender; we don't."
An important point to keep in mind with margin lending is that it's an actively-managed strategy, she says.
Advisers cannot just set and forget it, and no adviser can take on too many margin lending clients unless they have a process for managing scale in their business. Like many margin lending clients, Matrix clients have experienced margin calls amid the global financial crisis, but the firm's planners have handled it, Dummett says.
"We use much more conservative gearing strategies than Storm. My understanding is that they had clients geared at 85 per cent," she says.
"We would never do that. Our maximum gearing percentage is 66 per cent and most clients would be lower than that at around 50 per cent."
Clients should only have enough debt to assist them to reach their goals and Matrix asks that they have a sum of cash in the bank as a buffer.
"When the market moves as much as it has moved, everyone's affected and most clients have been able to top up using the available cash," Dummett says.
"Naturally where possible we try to use cash flow rather than selling quality assets."
There won't be changes in the dealer group's margin lending strategy.
"As a matter of good corporate governance we asked ourselves are there areas which got Storm into trouble that we need to look at? Are there things we need to adjust? We've come up and said that no, there's really not," Dummett says.
"Where clients have gotten into buffer territory with their margin loans, more and more advisers are saying to them not just let's keep you in buffer, but let's get you down to a really, really safe level."
Unlike Matrix, PIS is overhauling margin lending for itself and pushing margin lenders to step up too.
"There needs to be some additional education with advisers and also probably some additional evaluation included in margin lending," Evans says.
"You'd have to consider that what we've seen is margin lending is quite a risky strategy for some people, therefore we will need to put a lot more warnings and there needs to be more education for our advisers.
"There needs to be more evaluation of underlying leverage. Is the product clients are investing in internally geared?"
How clients get the capital to invest also needs to be discussed. Advisers would need to question the aggression of clients who pump capital received through an equity release program and superannuation money into assets via margin lending.
There is also the issue with margin lenders being able to drop LVRs.
"The ability for institutions to drop LVR's to 0 per cent because they use it as an excuse that the market is actually changed and there's no liquidity . I would say is an abuse of their contractual power in that situation," Evans says.
"They're quite happy to take the guarantee that the government's given them. And it's not as if the mortgage funds were worth nothing; a majority of the mortgage funds are quite stable and in good position.
"You can actually say the market needs to drop 30 per cent till your client's portfolio gets a margin call. Then we get some sort of freeze of redemptions and the institution puts a 0 per cent LVR on it. It changes the [portfolio] dynamics completely."
Bell Potter Capital (BCP) director of investment services Rowan Fell says that with any loans there are always risks and it is not just advisers and margin lenders that can do things better. Many clients need more awareness of all the conditions attached to the loans.
There is educational material clearly explaining margin loans across the industry and BCP strongly encourages clients to fully understand all the risks and benefits associated with margin loans before they decide on a strategy in conjunction with their adviser.
"By and large we believe that margin lending is a concept which should be sold together with investment advice, so that basically the client is looking at the complete picture," Fell says.
Total margin lending loans in Australia fell to $27.5 billion at the end of the third quarter in 2008, down from $31.8 billion at the end of the June quarter, according to Reserve Bank of Australia data. BCP's margin lending book dropped 30 per cent from its peak, as clients sold shares to repay loans or used other resources to reduce their loans.
Key questions in relation to Storm are how did clients go into such deep negative equity and don't margin lenders have a safety mechanism where assets are sold off so only the clients' capital is lost without debt being incurred?
"I can't speak specifically on the conditions Storm operated under," Fell says.
"Speaking generally, however, if the collateral is highly liquid and the client is margin called at the right time and they acted on it, they shouldn't be a position where they end up with negative equity.
"Now negative equity would generally arise because the margin calls are not acted upon and the underlying collateral is very illiquid and either unable to be sold or gaps down so quickly that equity becomes negative."
Major index funds should have daily redemptions so clients can get out relatively easily if the market slides, so it will be interesting to see the outcome of the investigation into Storm and how it operated, he says.
Despite what has happened recently in the marketplace, there will be people who will see margin lending as an attractive way to buy shares of various major companies with high dividend yields.
There will also be people who will wait on the sidelines and people choosing to never use margin lending again after being burnt by plunging stocks.
And no matter the steps lenders take to inform clients of the risks of margin lending, no matter the depth of educational material available through the Internet, no matter the educational and self-help material available through ASIC and consumer groups - there were always be people who get greedy and lose it all from over-gearing.
"In the end, people have a right to invest as they see fit," Fell says.
Could Storm's collapse have been prevented?
The demise of Storm Financial was completely avoidable, according to the firm's co-founder, Emmanuel Cassimatis.
"Despite the fact that we had just been through one of the worst periods in history, we were in good shape and could have weathered the difficult times," Cassimatis told IFA.
Much has been reported about the robustness of Storm's business model, with many pointing the finger squarely at that framework as the key reason behind the collapse.
For Cassimatis, such a suggestion borders on the ridiculous.
"The Storm model had proven itself for many years - not just in good times. To call the Storm model risky in hindsight, when measured against the worst financial and credit markets since the '20s, is taking a very surface view," he says.
"Unfortunately, most media and competitors are taking advantage of seeing it this way as it makes for good press."
While Cassimatis's comments are by no means new, the fact he believes so passionately that the collapse of Storm could have been prevented raises an interesting and yet obvious question.
Could the collapse of Storm have been prevented?
"I don't think we're ever going to be able to full proof the system to such an extent that these sorts of occurrences won't ever occur again," FPA chief executive Jo-Anne Bloch says.
Bloch says the fall of Storm has brought a number of issues to the surface, many of which form part of the FPA's investigation.
One key issue is that some of the practices within Storm seem to have been within the confines of the law, but were pushed or stretched, she says.
Another issue to emerge is that Storm's advice model seemed devoid of diversification.
"So it might not be illegal, although one expects that an investment strategy is diversified, but per se it may not be illegal, but if all your eggs are in one basket you're going to be subjected to the possibilities that particular basket might crack and you've got nothing left," she says. "It appears very clear from our research that their fee structure was excessive; high upfront commissions, well above the industry average; high loan-to-value ratios, well above the industry average and again not necessarily illegal, but certainly leaving clients in a precarious position as we now see.
"From a client point of view they had statements of advice provided, they had a very slick client-servicing process, but when you talk to clients some of them still really don't know what happened."
Cassimatis admits that if he had his time over, Storm's model and advice structure would have been altered in the past 12 months.
"Of course. Hindsight is such a wonderful thing. The reality is that for most business, and you can see most governments even, the speed and depth of the calamity could not have been foreshadowed," he says.
"If it was that easy, all investors would have been out of the market on the 1st November 2007."
For the FPA, corporate regulator ASIC and Storm's receivers, KordaMentha, all that is left now is wading through the wreckage and salvaging whatever can be saved.
"We're not finished yet. I think the FPA needs to be allowed to run its investigation and come to a conclusion so that we meet the requirements of our constitution and the requirements of what's fair and reasonable for all members," Bloch says.
"But as with Westpoint, we brought all our investigations to a close very decisively and very effectively, and there would be no difference in Storm's case. We have been criticised unfairly because I think members would want to be treated equally because some cases are more obvious than others, but we have one process that has to apply."
Cassimatis would not reveal information on which parts of the investigation he was involved in, though he did confirm he had been contacted by both the FPA and ASIC.
"We no longer control Storm, so cannot say regarding Storm. Personally when asked, we have cooperated fully with ASIC on their enquiries," he says.
"We have nothing to hide and have acted appropriately for some collective 60 years in the industry. Up until this recent event, Storm has never had to our knowledge any complaint against us with either ASIC or FPA. We have been led to believe that this is uncommon given the years in the business."
KordaMentha has also done its share of salvaging, with Storm's receivers placing the client book of 10,230 clients in the hands of financial planning business broking specialists Kenyon Prendeville in late February.
A significant number of dealer groups and individual practices are vying for the client book of the collapsed advisory firm.
"Significantly, there is a lot of interest," Kenyon Prendeville director Stephen Prendeville says.
"Our preference is to find a single buyer, however, there is a lot of interest for individual locations and as nominated there is a real concentration of clients in the Townsville, Rockhampton, Gold Coast, Mackay areas, so we will be exploring all opportunities, both from national groups and single buyers to individual boutique practices."
The book has a market price of $3 million to $5 million, based on recurring revenue.
A sale price on this figure is usually three times recurring revenue. However, due to the nature of Storm's collapse, the sale is not expected to reach normal market price, Prendeville says.
A short list of interested parties is expected to be known by the end of March, he says.
"There's a real need for urgency on this. We need to help these clients, we need to get them good advisers as quickly as possible," he says.
As well as working on a short list, a set of criteria for interested parties is also being developed.
"We're looking for good, experienced and recognised advisers," Prendeville says.
Though it is not a prerequisite for potential buyers to be members of any association, such as the FPA, Prendeville says it is welcomed. As well as industry investigations into Storm, New South Wales Nationals Senator John Williams has called for an examination of banking and financial services practices in Australia.
Williams on March 11 will move to have a Joint Select Committee on Banking and Financial Practices established to inquire into the industry.
"Last week we had confirmation from Senator Williams that he had succeeded in getting approval in the opposition party room for a senate inquiry," Storm Investors Consumer Action Group (SICAG) joint chairman Mark Weir says.
"He didn't think there was going to be much difficulty getting support. However, we've had indications from that quarter that said they are probably not likely to want to have a senate inquiry whilst the ASIC inquiry is still going on.
"Although it was stated by Mr Williams that they probably wouldn't have to wait for the support of the Labor Party, they could probably have the numbers to call an inquiry anyway.
Commenting on Williams's move for an inquiry, Superannuation and Corporate Law Minister Nick Sherry said: "The government believes it is most important to allow ASIC and the administrators to proceed with their work.
"The government is aware of this case. The government has been getting regular updates from the regulator. I sympathise with all the affected investors, but I can't comment on the particulars of the case at this stage as the matter is the subject of an ASIC investigation. It is also important that we let the administrators do their important work."
Weir says the planned senate inquiry is a bit of a watershed for SICAG, which has more than 1000 former Storm clients on its registry.
"It was less than four weeks from our first meeting that encouraging news came through to us. So consequently that was very heartening," he says.
In the past few weeks, a number of former Storm clients have informed SICAG they felt they were taken advantage of by financial advisers through the pro-bono advice service provided by the FPA, he says.
"We've had a lot of requests from people and I've got no doubts that most of them are certainly genuine in them wanting to help. I wouldn't want to denigrate any of them," he says.
"However, we have had a few instances where even clients who have followed up the offer with the FPA for initial pro-bono consultation, the subsequent consultation has meant that they have been rendered a bill in some cases of nearly $1700 for not really in-depth advice. We're looking at perhaps reporting that to the FPA at the moment."
As well as clients receiving requests from individual planners, SICAG itself has been approached by a number of advisers, both individual and larger corporations, interested in gaining contact with former Storm clients, he says.
"I did write a proposal to the committee . suggesting that we have to have a policy on this," he says.
ASIC commenced an investigation into Storm on 12 December 2008 in connection with margin loans and related advice to Storm clients.
The corporate watchdog's investigation found about 3000 of Storm's clients had entered into a margin loan for market-linked investments.
ASIC found more than 450 clients owed their margin lender more than the value of their portfolios, equating to about $30 million.
Late last year, the FPA offered a free financial planner referral service to assist Storm's clients affected by the margin loan.
In mid-February, the FPA terminated the principal membership of Storm. The firm's membership was officially cancelled on 12 January.
Storm Financial closed its doors after receivers were appointed to the group on 15 January.
