Mr Jeremy Cooper, Deputy Chairman of the Australian Securities and Investments Commission (ASIC), today released the results of an intensive surveillance of high-yield debentures that was conducted in late 2004.

‘ASIC wanted to see if issuers of high-yield debentures were informing investors of the additional risks of investing in these types of investments’, Mr Cooper said.

By investing in debentures, an investor is lending money to the issuer of the debenture. Offers of debentures to retail investors usually involve the issue of a prospectus that must disclose all information necessary for an investor to decide whether to invest.

ASIC examined the prospectuses and selected advertising for debentures issued by 11 companies that were offering high yields, such as interest rates that were four per cent per annum above bank term-deposit rates.

‘High-yield debentures are typically a risky investment, and there is no guarantee that investors will get their money back’, Mr Cooper said.

As a result of its surveillance, ASIC prevented four offers that failed to disclose information relevant to the fundraising from proceeding until the defects had been addressed. One of the four prospectuses required a final stop order, which permanently stopped the offer from proceeding. (see Table 1)

ASIC also stopped two misleading advertising campaigns, and required companies to improve the information provided to investors in two other cases.

‘More vulnerable investors, especially retirees, have been the target of these riskier investments. Often they don’t have the information or resources to detect the extra risks. In many cases, they are offered investments that major financial institutions wouldn’t touch without greater security or higher rates of return࠼™, Mr Cooper said.

ASIC identified four common concerns that were especially prevalent, namely:

• aggressive or misleading advertising
• poor disclosure about property developments
• related-party transactions, and
• bad and doubtful debts.

This surveillance campaign follows an ASIC consumer alert relating to investment in debentures inJuly 2004 (Media Release 04-242: $1.8 billion at stake: warning to investors in high-yield debentures) and three previous warnings in 2003–2004 in relation to defective debenture prospectuses and the risks of investing in high-yield debentures.

ASIC initiated the surveillance campaign to assess the validity of concerns about high-yield debentures. The main objectives of the campaign were to:

• examine whether there were contraventions of the prospectus disclosure requirements and, in particular, to determine whether debenture issuers had properly and fully disclosed the nature of their business and associated risks;
• assess whether previous ASIC guidance on debenture prospectus disclosure was being followed; and
• pursue suitable enforcement action against issuers in the case of material and significant contraventions of the prospectus, debenture or other provisions.

ASIC discovered that many of its concerns relating to debentures were present in the marketplace. A summary of the results of the campaign is included in the attachment to this media release.

A copy of the report containing ASIC’s findings High-yield debentures - ASIC surveillance report is available atwww.asic.gov.au.

Investors are encouraged to visit ASIC’s consumer website FIDO at www.fido.asic.gov.au for more information and tips about higher-yielding interest-bearing investments.

End of release

Download a copy of the surveillance report

Attachment to MR 05-30

Common concerns in high-yield debenture prospectus and marketing campaigns

Aggressive and misleading advertising

ASIC was concerned that much of the advertising for high yield debentures was aimed at retirees, and featured images of happy older couples.

These advertisements played on many older people’s need for a fixed, secure income, and used words like secure or secured. They did not acknowledge that high yield debentures are high-risk investments, and there is no guarantee that investors will get their money back.

ASIC’s review of property development debentures frequently revealed poor disclosure about high risk factors in a risky industry, with no reference to the consequences of the residential property sector weakening.

Property development disclosure

Interest payments unsupported by real cash flows

ASIC was concerned that many investors were unknowingly entering into high-risk finance.

In many cases, the debenture issuers that ASIC examined lent money to property developers on a capitalised interest or pre-paid interest basis. In these circumstances, there is no flow back of cash from the developer to the debenture issuer until the development is completed. In the meantime, investors in these debentures are paid only from the cash raised from other investors. This is high-risk finance that can be sustained only if the development is completed successfully.

Inappropriate or over-optimistic valuations

Some debentures are marketed using a ‘Value As If Complete’ of a property development. There is no guarantee about the time and cost of a development, no guarantee of a profit and no guarantee that it will be completed and sold.

ASIC considers that best-practice debenture prospectuses should contain the market value at or about the date of the prospectus or, failing that, the most recently determined market value, and the purchase price of the property.

Inadequate detail about security over assets

In one case, the prospectus noted that first mortgages were preferred, yet the issuer did not hold a single first mortgage. Without a first mortgage to secure the loan, the debenture investment is riskier because someone else will get paid before the issuer if the borrower defaults.

Related party transactions

High-yield debenture issuers often lend money to related companies or other entities associated with the directors of the issuer. This increases the risk that arms-length lending procedures may not be used, which in turn, increases the credit risk associated with the debenture investment. Investors may not get their money back if the related party defaults on its loan obligations.

Bad and doubtful debts

Some debenture issuers did not disclose the extent of their bad and doubtful debts. Where borrowers don’t repay the debenture issuer, investors risk losing some of their debenture investment.

Table 1: Stop orders issued during the debenture campaign