Robert Wynter, Contributor

Wynter

There have been several calls recently, by the Private Sector Organisation of Jamaica, the Jamaica Chamber of Commerce, journalists and others, for the Government to address the issue of non-regulate investment schemes. The central issue has been to demand disclosure of financial statements in the interest of investors. These calls follow legal action and advocacy by the Financial Services Commission (FSC) as well as rumours of complaints from the major banks.

The FSC is steeped in the letter of the law. - File

It is interesting that the only group not demanding audited financial statements are those taking the risks, the very investors themselves. It is also interesting that many of these schemes have been in existence for several years, but until recently, the FSC has been fighting a battle all by itself. Neither the previous nor current government has taken any decisive action, reiterating, however, that there will be no FINSAC-like bailout for any investor if any scheme comes crashing down. I would like to address four issues in relation to these unregulated, alternative investment schemes: viability, regulation, innovation and implications to the wider society.

VIABILITY

Are these schemes viable? Can they sustain the significantly high double-digit monthly returns? In the case of forex trading, I believe so; however, I cannot understand the other business models. To illustrate the former, let us assume a typical forex trader operating informally in Ocho Rios begins on Monday with J$69,000 and while hustling, buys US$1,000 from a group of tourists. Later that day, he sells the US$1,000 for J$71,000 to an ICI from the Ocho Rios Craft Market. Assuming $300 expenses for travel and lunch, in one day he has made J$1,700 on an initial capital of J$69,000 or a return of 2.46 per cent per day or about 54 per cent monthly.

His trading supports, and is supported by, the cross-border trading of goods and services (tourism and retail). The International Forex Trading Market supports world trade in goods and services which averages over US$1 trillion daily, including the New York Mercedes Benz retailer, the Berlin Cadillac dealer and the MoBay hotelier. It is the very short turnaround time of capital on low margins that generate the relatively high returns in forex trading.

Before analysing the issue at hand, I believe we should first discuss regulation in general. Are we regulating for the sake of regulating, or are we regulating to protect the interests of our target groups? Regulating the level of alcohol in a driver's bloodstream using a breathalyser seeks to protect the driver and others. However, there is no regulation of the amount of alcohol an individual consumes in the privacy of his/her home as adults are deemed responsible for their decisions in so far as they alone are being affected. The relevant authority provides warnings and other information on the risks associated with drinking.

The current regulations affecting organisations and individuals providing commercial trading in, or advice on, securities require that these organisations and individuals must be registered with the FSC; individuals must be deemed fit and proper; and financial statements must be provided. The regulations are intended to protect the investing public from risk inherent in commercial investment services.

CURRENT REGULATIONS

The current regulations do not cover 'investment clubs' and this has provided a loophole through which most of the alternative investment schemes have been able to operate. While it is true that this loophole facilitates unsavoury activities such as money laundering and pyramid schemes, these clubs are breaking no rules. It is my understanding that while there are legal limits to the size of investment clubs in the United States for instance, there are no such limits here.

Navigating through loopholes is practised by nearly all companies and organisations. In fact, many large corporations hire specialists solely to navigate loopholes.

While attending the 2007 CAIB conference in Guyana in December, a regional regulator spoke of the paradigm shift from rules-based to principle-based regulating or put more succinctly, a shift from the letter of the law approach to the spirit of the law. He argued that laws can be broken and loopholes can be created. However, while laws are very good at prosecuting bad behaviour, they are very poor at encouraging good behaviour.

He stressed the fact that the overall objective of regulations should be to give a fair deal to consumers. It seems to me that the FSC is steeped in the letter of the law approach by demanding that the investment schemes provide financial statements for investors to make informed decisions when there is hardly a whimper or complaint from the very investors themselves.

Had they taken the spirit of the law approach and the interests of the investing public were uppermost in their minds, officials of the FSC would have long ago been encouraging investors to demand information, teaching them how to use the information and perhaps been playing a more conciliatory role on behalf of the public whom they serve.

Non-regulation aside, could these alternative investment schemes be the new wave of innovation using the new-market disruptions and low-end disruption Model as outlined by Professor Christensen of HBS? In new-market disruption, new products and services are so much more affordable, simpler to use and convenient that they enable a whole new market. Examples are the personal computer and the desktop photocopier. In low-end disruption, new products take root at the low end of the market. Examples are steel mini-mills and discount retailers, eg, Wal-Mart and K-Mart. Hybrid disruptors such as Southwest Airlines initially targeted customers who weren't flying, but it pulled customers out of the low end of the major airlines' market as well.

In the early 1990s, JMMB and other new entrants disrupted the financial services market in a hybrid manner. On the one hand, they stole investing customers from mainstream brokers, while on the other hand, by becoming primary dealers for the Bank of Jamaica, they created the secondary money market and served a large group of customers who previously only put funds in low-interest bearing saving accounts. Today, the alternative investment schemes are disrupting the market, having addressed under-served customers in the commercial banks and the established security dealers as well as providing a financial service for customers who never invested before. The difference between the disruptions in the early 1990s and those today is the magnitude of the difference in the value provided, as well as the fact that these investment schemes today are not regulated. Back then, the disruptors provided returns at best twice what was available; however, today it is a factor of 10 times and more.

IMPLICATIONS

What are the implications if the majority of the schemes fail? Some investors will lose their hard-earned money, but I believe responsibility must rest squarely on the shoulders of the investors themselves. The prime minister has stressed that there will be no bailouts; enough warning has been given by the FSC and others and I really hope that the Government does not yield under any pressure to undertake any bailout. In fact, if any of these schemes fail, learning a lesson the hard way may not be such a bad thing. Some argue that in the financial meltdown during the 1990s, the cost of the solution was much greater than the cost of the problem. Therefore, had the then government provided lower levels of bailout rather than forcing taxpayers to absorb the losses, individuals would have been much more careful in the current dispensation.

Robert C. Wynter is partner in the firm, Growth Facilitators, and may be reached at robwyn@cwjamaica.com