Thursday, January 10, 2008

Unregulated lives

“The law should not be a shackle”. This is a statement attributed to a former Prime Minister, which I do not think he meant that people should ignore the law, but it really is representational of the way we approach our lives in Jamaica. It also is one reason why an investor will look on at Jamaica and see it as an undisciplined society where crime and unfettered behaviour rules. Why invest in an economy that does not subject itself to strict rules and regulations.

Nowhere is this type of behaviour more obvious today than in the area of the unregulated investments. There are many countries, developed and otherwise, that have been subjected to the effects of similar events. The more famous recently being Albania but certainly in the United States (US) they see their fair share of “unregulated investments”. The National Futures Association (NFA) reported in February 2007, in an investor alert on the “Risks of trading in the Retail….Foreign Currency Market”, that since 2001 25,000 customers lost US$395 Million in foreign currency (Forex) schemes. What is important to understand though is that the major Forex brokers do register with the Commodity Futures Trading Commission and are subject to reporting requirements such as capital adequacy ratios, which is similar to the indicators tracked by the FSC.

The US has also more recently seen the effects of the sub prime mortgage crisis, which one of the main issues is that these instruments were not subject to proper interrogation by the regulators. The result as we all know is that the whole global economy is slowing.

Unsupported regulators
The difference between Jamaica and the US, however, is that when the US regulators try to deal with such a situation to prevent a greater crisis, they are supported with constructive criticisms by the public. In our cases we do not just criticize but blame the regulators for what is happening, even though the regulators have been warning the public about the dangers for a long time. So how does the regulators have an impact on whether a company makes money or not? I just cannot understand the logic. I can only conclude, as I have been saying for a while, that the problem with Jamaica is mainly one of a breakdown of law and order.

But the situation we face today is not one that was unpredictable. Anyone who has been listening to my commentaries will know that for over a year I have been pleading with the companies involved and the regulators to ensure the unregulated investors were brought into regulation as soon as possible because I had foreseen that it would create social difficulties for many, as there will be some that enter the market that are not legitimate. Anyone who knows me will know also that I have always supported alternative investments such as Forex trading and hedge funds, but what I am not in support of is any investment offered to the public that is not transparent through registration and regulation. The risks to the less vulnerable are too great.

But like many other things we tend to ignore them, not having the foresight to prevent them. One such case in point is the FINSAC era. At that time I was not as much involved as I am today, but I remember clearly listening to Charles Ross saying every time he was on the Breakfast Club that prolonged high interest rates would damage the economy. But of course no one listened to him, as no one listens to me, because it was not in the interest of anyone to do so.

Similarly on July 29th 2006 my column was entitled “Oil: Jamaica’s main external threat”, where I wrote “Since 2000 fuel imports as a percentage of total imports has increased from 18.67% to 29.94%, an 85.6% increase…” and “The ever increasing oil price is a huge risk to Jamaica’s economic viability. For this reason it is very important that we develop and implement a plan to reduce our dependency on oil as a fuel source.” Eighteen months later we are looking at a serious threat to the economy from oil, which over that time all we have done is to write an energy policy. What can I say, I am just an accountant, and who am I to challenge the great intellects we have had leading us.

Government response
The government’s response to the unregulated investments is appropriate. Nothing more can be done than to ensure that the proper legislative framework is in place to accommodate these investments and have a proper definition of investment clubs. The US Securities and Exchange Commission (SEC) define an investment club as “a group of people who pool their money to make investment decisions.”

The SEC also addresses when an investment club has to register under the Securities Act of 1933, and that is when the membership interests are “securities”. It further states that generally a membership interest is a security “if it is an “investment contract” ” and “Generally, a membership interest is an investment contract if members invest and expect to make a profit from the entrepreneurial and managerial efforts of others”. But if everyone meets and participates in each investment decision then it would be precluded and under the current schemes with thousands of investors (across countries) it is a little difficult to do so.

The SEC further states that an investment club must register with them as an investment company under the Investment Company Act of 1940 if all of the following three conditions apply – (1) the club invests in securities; (2) the club issues membership interests that are securities; and (3) the club is not able to rely on an exclusion from the definition of an investment company. A private investment company does not need to register with the SEC if (1) if does not make, nor propose to make, a public offering of its securities, and (2) it does not have more than 100 members.

In addition to the above the advisor needs to register with the SEC if they are compensated for providing advice regarding the club’s investments. Also if one person selects investments for the club, that person may have to register. In general, however, a person who has US$25 million or more under management is required to register under the Investment Advisers Act of 1940.

Looking at the structure in the US it is clear that our own unregulated schemes would fall under the requirement to register with the FSC, not only by virtue of the number of investors and funds involved but also because in many cases the investors have contracts with the companies and are not directly involved in the investment decisions. So within this context the government’s response to these unregulated investments could not have been any different as at the heart of it all is the responsibility of the regulators to protect the investing public and how can they conceivably do that without having the proper information? How can the public make proper investment decisions without having proper independent information?

The lack of information is the problem and to be fair to the FSC they have never said that they are against alternative investments. What they have said is that these companies should come in and get regulated.

I have always agreed that the traditional financial institutions are suffering from the “fat cat syndrome’ and seems to lack the ability to create new products that give risk seekers a proper alternative to high interest bearing government paper, and this has helped to prevent the proper development of our capital markets and economy. But the real problem we continue to suffer from as a society is resistance to any structure and regulations in our lives, while trying to compete with markets that recognize how important it is.

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