The Australian Securities and Investments Commission (ASIC) today released information on its surveillances relating to debenture prospectuses.

From 1 July 2003 to date, ASIC has taken action on 14 debenture prospectuses with the issue of 5 final stop orders, 11 interim stop orders and the extension of the exposure period on one prospectus. The action was taken to protect investors from making a decision based on inadequate information in prospectuses seeking to raise a total of more than $1 billion.

Six of the interim orders have been revoked following the lodgement of replacement or supplementary prospectuses that addressed ASIC concerns. One company lodged a replacement prospectus during the extended exposure period to address ASIC's concerns, prior to the issue of an interim stop order.

‘In the current low interest rate environment, ASIC wants to ensure that debenture issuers provide adequate disclosure to enable investors to make an informed investment decision. In particular, ASIC is concerned that debenture issuers make explicit disclosure on the risk associated with their offers and that they do not mislead investors as to the risk return profile on their products’, ASIC Executive Director of Policy and Markets Regulation, Mr Malcolm Rodgers, said.

The significant defects identified in debenture prospectuses included:

• Failure to comply with the Corporations Act (the Act) requirement for a debenture trust deed and trustee. Five fund raisers did not establish a debenture trust deed or appoint a trustee despite offering debt instruments that fell within the definition of a ‘debenture’ under the Act. The debenture trust deed and trustee provisions are important protection mechanisms for investors as they allow retail investors interests to be aggregated under a trustee who has a duty to act in if there is a breach of the debenture trust deed.
• Lack of disclosure on bad and doubtful debts provisions and experience. Two fund raisers failed to disclose information on bad and doubtful debts incurred in relation to its lending activity. Another company provided incorrect information on its loans in arrears. Information on bad and doubtful debts is important in assessing the risk faced by and prospects of a debenture issuer.
• Inadequate disclosure on lending policies, loan approval process and borrowing limitations. Several fund-raisers did not make adequate disclosure on their lending policies, loan approval process and borrowing limitations. Investors need such information to assess the prospects of a debenture issuer. Where lenders are on-lending to higher risk borrowers or to borrowers with poor financial track records or on security of more speculative assets, investors will have difficulty making an accurate call on the risk/reward returns in the offer.
• Inadequate financial information. One fund raiser did not disclose current financial information on the performance and profitability of the company. Another fund raiser had wrongly classified a large investment in a mortgage managed investment scheme as debt receivables owing to the company. A third issuer raised funds for the purposes of on-lending to related companies who would in turn on-lend to third parties for property development purposes, but did not include information about the financial position of the related companies and their capacity to repay the loans. Investors need current and accurate financial information in order to make an informed investment decision.
• Inadequate disclosure regarding the use of funds to be raised, especially where the issue was not subject to a minimum subscription condition. One fund-raiser issuing debentures for the purpose of extinguishing existing debt and carrying out capital projects did not disclose the impact upon its operations and its capacity to satisfy obligations in respect of the debentures if the issue was not fully subscribed.
• Incorrectly describing the debentures. Under the Act, an issuer is only allowed to describe a debenture as a mortgage debenture or a debenture if the instruments are adequately secured against land or tangible property, respectively. All other debentures must be referred to as unsecured notes or unsecured deposit notes. Several issuers incorrectly referred to unsecured notes as debentures. This can be misleading and deceptive as it leads investors to believe the instruments are more secure than they actually are.

‘Not all debenture offerings are the same. While the general rule that a higher return means a higher risk remains true, investors need to read the prospectus carefully to determine if the risks involved in the particular offering are suitable for them’, Mr Rodgers concluded.

ASIC has previously issued an investor alert ‘Fixed Interest products – higher returns mean higher risk’ (MR 03-158).