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Jul 2003 - FSR

Approaching FSR Likely to Affect ALL Mining and Exploration Companies

Most members of the public should by now be aware that brokers and advisers are concerned about the SOA contained in the FSR (Statement of Advice in the Financial Services Reform Act of 12 March 2002), that is in its transition period before being formally fully implemented from 12 March 2004.

There have been a number of comments in the media about the SOA and its potential cost ranging up to A$150/trade above the current estimated A$100/trade (using advice), which was expected to be passed onto clients unless it is modified, and the software still has to be developed.

However, for mining and exploration companies, those are really side issues, the software has already been developed in some packages as could be seen at the last SDIA (Securities and Derivatives Industry Association) Stockbrokers’ Conference at the end of May 2003 in Sydney. The additional costs appear to be high as some discount brokers charge A$30/trade and can still be profitable. So, the new regulations could result in increased discount broking or signing some sort of agreement to trade without advice. At this stage the SOA is a separate document, but in practice appears likely to be incorporated onto the same page as a contract note.

The are probably four real issues to the SOA, namely : (in no particular order)

1. What has the advice been based on : The SOA requires a box to be ticked for what the advice given (say recommending a stock) has been based on, one of either in-house research or independent research. This is a major issue as not all trades have historically been based on research.

For example : “Joe in the Feddie (pub) in Kal (Kalgoorlie) says XYZ prospect has got drill core drizzled in vg (visible gold)” (a true story, I think it was one of the Raleigh drillholes), or “Stan at the petrol station in Leonora says ABC company has stopped having water trucks going to its property (a true story, it related to Mt Burgess), or “the management has changed in PQR company” (there have been many of those), or even more simply that the gold price has risen, or the A$ has fallen.

However, under the SOA / FSR, it appears that advising to buy or sell a company has to involve some form of research document.

At that Stockbrokers’ Conference, one of the global major brokers stated that the cost of their in-house research had improved from US$1bn in its heyday down to more reasonable levels of US$0.5bn world-wide per year. While they acknowledged that most research is in fact wrong based on a study in the US which found that on average, analysts that are right 50% to 53% of the time, are in the elite group, they thought that there is great value in great research. Consequently, they thought that it was essential for major brokers to pay for providing their own quality in-house research that they trusted.

However, it can be seen why some brokers have closed or dramatically scaled down their research departments to rely on either rebadged or independent research. There was also some debate at the conference as to whether research should include recommendations (this may still come) since advisers decide whether the stock is appropriate for the individual investor (based on their investment objectives, financial situation and particular needs).

The need for independent research hence becomes an issue for many of the small retail brokers that may not want to pay for independent research, but somehow may need to “tick a box” in order to comply with the SOA/FSR requirements.

The “tick a box” requirement could also be an issue for mining and exploration companies on which either research is not being written, or for one reason or another, is not available to advisers that want to recommend those individual stocks.

2. No one appears to have done the math : If an adviser writes on average 20 contracts per day, that amounts to 100 per week. For Bell Potter’s reputedly 300 or so advisers, that could amount to 30,000 per week or 1.5million additional documents per year. If the average increases to 30 contracts per day….etc, and that is just one retail broker.

3. Are there any legal implications : A “curly” one, can clients use the SOA if the advice appears to be incorrect, or the share or stock does not say rise and become profitable (not all of them rise and are profitable).

4. It is likely to initially be a “pain in the butt” : Filling out a form after every trade requiring advice, however, due to necessity it appears likely to become simplified, like contract note info.

Consequently, the progress of the SOA and what it may require could have important ramifications for ALL mining and exploration companies.

Also at that Stockbrokers’ Conference, a few comments were made along the lines that the regulatory changes juggernaut had already left the station, had gained momentum, was coming and nothing was going to stop it. Along those lines, another paper was discussed which affects all public and private companies, being IAS or IFRS or International Financial Reporting Standards and their implementation in the first complete financial year after January 2005.

What the IAS implementation means for say a company with a June year end is that although its first financial year would be to June 2006 for IAS reporting, it may need one or two years of comparative figures, starting from I July 2003 or 1 July 2004. Most overseas companies are already on IAS and are well aware of its limitations and requirements, where one of the big issues is hedge and derivative accounting, resulting in recognizing and accounting for mark-to-market movements.

There is also apparently no amortization and more financial instruments are classified as debt. The implications for analysts were that they would probably be increasingly required to decipher what a company’s accounts actually meant.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who has a Proper Authority with State One Equities, and with his associates, could be affected by some of the views in this article. The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Tuesday, 01 July 2003

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