Editorial | Who pays when oversight fails?
Prime Minister Andrew Holness last week warned clients of tottering Stocks and Securities Limited (SSL) – and any other financial entities that fall into trouble – not to look to his government for a bailout.
“Were we to do that it would send a bad signal to the banks and investment houses that they can be negligent and expect coverage of their negligence,” Mr Holness said at a conference hosted by the Jamaica Stock Exchange (JSE).
That’s a general principle with which this newspaper agrees. For, as Mr Holness reminded, the Government’s previous intervention that “socialised the debt” of a financial sector crisis imposed a heavy economic burden that worsened the country’s collective poverty, with which policymakers still grapple. In that regard, SSL represented for the government a potential moral hazard that it considered best to avoid.
That, however, is only one side of the ledger on the SSL issue. People who entrusted their money to SSL may well be on sound moral and legal ground in accusing Financial Services Commission (FSC), the government agency that regulates investment houses, of malfeasance and/or nonfeasance in its oversight of the SSL, and of implying to investors that it was a safe company with which to do business when the FSC knew, or ought to have known, better. In other words, an argument before the Full Court could well be that by failing to properly fulfil its obligations as a regulator, the FSC induced investors to put their money in a company that should have been red-flagged.
According to Finance Minister Nigel Clarke, SSL managed a portfolio around two per cent (J$29 billion) of the assets in the J$1.45 trillion securities industry.
For more than a decade, the FSC knew SSL to be a problematic institution with poor internal controls and flirting close to, if not over, the line of insolvency. By 2016, an FSC document revealed, the company’s accumulated deficit had reached J$1.5 billion. Its auditors questioned its ability to continue in operation.
If it is not clear that SSL received a capital injection, which, in the circumstance, would be expected to be a demand of the FSC for its continued operation. A 2019 reported deal for another entity to take a stake in SSL – a report of which was posted on SSL’s Facebook page – was apparently never closed.
The general investing public knew nothing of SSL’s problems. It remained free to operate and accept new clients’ funds, while ostensibly undertaking internal reforms guided by the FSC.
It seems that little really changed. Earlier this month it emerged that a long time employee confessed to stealing around 20 per cent (approximately J$150 million) from the accounts of clients that she managed. Subsequently the athletics star, Usain Bolt, confirmed that US$12.7 million (J$1.9 billion) was missing from his account, which two recent SSL CEOs claimed not to know existed, although Mr Bolt was a client for a dozen years and his investment amount to amount to nearly seven per cent of the assets managed by SSL.
There is an important context to this affair.
In the 1990s, as Jamaica rapidly liberalised its economy, the island’s financial services sector exploded. In the eight years up to 1994, it increased by approximately 129 per cent, to account for 16 per cent of gross domestic product.
By the late 1990s, however, the sector was in crisis, the result of lax regulation, a policy of high interest rates, and imprudent investments by financial firms.
With the companies crumbling under the weight of non-performing loans and other assets, the government, through the Financial Sector Adjustment Company (FINSAC), bailed-out banks, insurance companies and pension funds, issuing bonds to cover the cost of the intervention, which, in the end, amounted to 44 per cent of the island’s GDP. Jamaica borrowed US$150 million from the World Bank to help cover the cost of the bailout.
While individual debtors lost assets pledged as collateral for loans, depositors recovered both principal and interest on their accounts.
Indeed, the FINSAC intervention was a major cause in the spiralling of Jamaica’s national debt from 79 per cent of GDP in 1996 to 141 per cent in 2003.
In last week’s speech to the stock exchange conference, Mr Holness argued that the experience of the 1990s was a crisis which made “the entire country poor” and from which it required Jamaica decades to extricate itself.
It is not sensible that Mr Holness would want to revisit that period and therefore his implied warning to people of the inherent risks of investing.
However, one of the results of the 1990s meltdown was the creation of a new regulatory regime for the financial sector, including the establishment of the FSC. Its primary role is to ensure that investment houses operate by rules that reasonably protect the interests of investors.
The FSC is supposed to periodically review the operations of the firms it regulates and, by law, is required to report the findings of its assessments to the minister of finance, inclusive of its recommendations it proposes for correcting regulatory breaches. The minister – of which there were three over the period during which SSL was designated a problem institution – has the power under various laws to intervene or cause the regulator to take more extreme action if the reports raise serious concern.
In the case of SSL the regulators felt that drastic action wasn’t required. Their methods kept the public in the dark.