By Stuart Washington
I want the financial services licence that lets me pay off a mortgage by drawing the customers' money from the accounts I'm looking after.
What's that? You think I'm joking?
Well, that's exactly what was reported occurring in the case of the failed Victorian broker Sonray.
Alarm bells should be ringing when a financial services firm sanctions that kind of behaviour.
Sad to say, however, Sonray is not a standalone case.
Sonray is the fifth failure of what can be considered brokers of financial products in the past three years. Count them: Opes Prime, Lift Capital, Chimaera, the less well-known Chartwell in Geelong and now Sonray.
Tricom, now known as Stonebridge, is a dishonourable exception to the above list. Babcock & Brown loaned Tricom $35 million, saved it from the corporate graveyard, then B&B keeled over. After five closely spaced collapses, is anyone else starting to notice a pattern here?
Their combined travails are, however, not directly about the product. Opes Prime, Lift Capital and Chimaera can all be considered practitioners of the arcane art of stock lending.
Chartwell and Sonray were into flogging risky contracts for difference, among other services.
So the products were risky - that is common ground - but the type of product is not the common thread here. Nor is the common theme alleged dishonesty. Sure, Opes Prime's Laurie "Lirim" Emini is facing a raft of charges, and the antics of Sonray aren't looking too flash.
But the fallout from Lift Capital and Chimaera have the appearances of bad business models that went spectacularly wrong. And it isn't a crime to make stupid business decisions.
I'm not building here, either, to a sledge against regulators.
It is interesting to me that none of the failed brokers were "market participants", a group of brokers that experience a much higher degree of regulatory supervision.
"Market participants" is a term for brokers who have a licence to trade directly on either the Australian Stock Exchange or the Sydney Futures Exchange.
The extensive scrutiny from regulators is about maintaining an orderly market, and includes conditions such as making sure the market participants have enough money to fulfil their trades.
By contrast, our famous five are members of what is known as the "shadow banking" industry, with hundreds if not thousands of smaller brokers trading financial products, when necessary through market participants.
So all five have, to a degree, flourished in a regulatory system that was not focusing on them in the same way it was focusing on market participants.
It is tempting to simply say tighter regulatory oversight of the existing rules would have picked up these problems.
But I will return briefly to Tricom. It was a market participant and it was subject to all the same problems as the other five until it got its loan.
So, for the moment, I will disregard light-handed regulation as the essential problem.
Here I will lean heavily on John Hempton, a fund manager with Bronte Capital, who has a keen eye for picking up the abundant anomalies in the financial services world.
Hempton, on his Bronte Capital blog, has repeatedly raised a systemic issue with Australian brokers that goes to the heart of the problems experienced in the past three years.
Unlike other possible common threads, Hempton sees Australian brokers' ability to freely commingle their clients' money with their own as a root cause of broker instability.
In Australia, these brokers are largely free to use the money in their clients' accounts as they see fit - including using the cash to fund their business.
As a contrast, he cites a stringent US approach to client money that was born of the sour experience from collapses of stockbrokers in the Great Depression.
And the 1934 Securities Exchange Act he cites has had the effect of squelching much of the activity that has been promoted by the smaller players in the Australian market.
For example, the US approach means that contracts-for-difference providers simply cannot operate.
In a submission to the Cooper review on superannuation, Hempton wrote that US regulations cap a broker to using assets equating to 140 per cent of a client's borrowing as collateral.
For example, if a US broker's client pledged $1 million for a $100,000 margin loan, the broker could use only $140,000.
The other $860,000 is placed in a segregated client account.
In the case of Opes Prime, a borrower who pledged $1 million as security for a $100,000 loan became an unsecured creditor for the entire $1 million.
Now you might be thinking that if the US system is so great, how come all those stockbroking firms teetered or collapsed there.
Hempton has pointed out that the US broker-dealer within Lehman Bros survived into administration. Clients received much of their money, and their funds were not able to be pilfered for Lehman's disastrous forays into commercial real estate and the like.
US clients of Lehman Bros survived reasonably well. Hempton also writes of how the London Lehman Bros office had no such restrictions on the use of client money - and its hedge fund clients were badly burnt.
So far Australia has only seen relatively small brokers fall over. Hempton is writing about something that may prevent bigger problems.
It looks much better than your broker paying off his or her mortgage with your money.