New Zealand: A Regulator With Teeth: The Enforcement Capabilities of the FMA: Part 2

This article is part of a series: Click A Regulator With Teeth: The Enforcement Capabilities of the FMA: Part 1 for the previous article.

Investigation

An essential prerequisite to effective enforcement is comprehensive investigation. The FMA's investigatory powers are similar to those of the Securities Commission, but much enhanced.

The legislation divides these powers into three categories:

  • information, documents, and evidence
  • power of entry and search
  • sharing with other agencies.

Each of these is discussed briefly below.

POWER TO OBTAIN INFORMATION, DOCUMENTS AND EVIDENCE

The FMA, if it considers it necessary or desirable for the purposes of exercising its functions, powers, or duties under the FMA Act or any provision of the financial markets legislation, can require any person (by written notice served on that person) to:

  • supply information
  • produce any document
  • reproduce in usable form the information recorded or stored in any document
  • appear before the FMA to give evidence and produce any document.

This is a consolidation of the powers the Securities Commission had under the Securities Act 1978. It is also similar to the Commerce Commission's power under section 98 of the Commerce Act 1986 to seek information "where the Commission considers it necessary or desirable for the purposes of carrying out its functions and exercising its powers under the Act".

Helpfully, the threshold test in the FMA Act is almost identical to the test under the Commerce Act so there is a reasonable amount of judicial guidance as to interpretation.

In Telecom Corporation of NZ Ltd v Commerce Commission [1991] NZAR 155, Telecom successfully challenged a section 98 notice on the grounds that the documents sought were not relevant to the Commission's investigation. The High Court found that section 98 gave the Commission "power to seek information only where it is relevant to the investigation which itself must be one authorised by the Act".2 In practice, it is debatable how useful this limitation has been when the powers being exercised are plainly within jurisdiction.

However, in AstraZeneca Ltd v Commerce Commission (2008) 12 TCLR 116, Panckhurst J confirmed the continued application of this approach and added that:

...although the power is couched in terms of what the Commission considers is necessary or desirable, that formulation does not render its exercise immune from review. In the end the subjective consideration of the Commission must also be capable of withstanding objective scrutiny.

Panckhurst J's decision was upheld by the Court of Appeal and, although it was subsequently overturned by the Supreme Court, that Court did not disagree with Panckhurst J's statement and quashed the section 98 notice issued by the Commission, holding it was ultra vires and thus invalid, because:

The Commission is certainly not entitled to proceed on the basis that it can issue a notice first and then have its power to do so judged retrospectively by what it might find concerning some other conduct [that it found in the documents seized] ([39]).

A similar judicial approach is likely in relation to the FMA such that it will only be able to require information which is relevant to the legislative function relied on to trigger the power.

Two further points regarding the FMA's investigatory powers are that:

  • the power to receive evidence is very broad. It extends to any statement, document, information or matter, whether admissible in a court of law or not, and is limited only by the requirement that the FMA considers the evidence will assist it in dealing effectively with any matter before it, and
  • privileges that would apply in a court, including that against self-incrimination, apply to any person required to provide information and documents or answer questions before the FMA. Similarly, counsel appearing before the FMA have the same privileges as they would in court.

POWER TO ENTER AND SEARCH

The FMA's search and seizure powers are a prime example of the legislative intent to give the new regulator the 'teeth' that the Securities Commission lacked.3

The FMA may enter and search a "place, vehicle, or other thing". A "thing" includes "an intangible thing (for example, an email address or access information to an internet data storage facility)" and a "vehicle" encompasses all those forms of vehicle that one might expect a regulator to wish to search, and even extends to bicycles.

Again, however, a threshold must be met before the FMA can exercise this power. The FMA may only enter and search if:

  1. doing so is for the purpose of ascertaining whether a person has engaged in or is engaging in conduct that constitutes or may constitute a contravention of any provision of the financial markets legislation, and
  2. the FMA is satisfied that there are reasonable grounds to suspect that:

    1. the person has engaged in or is engaging in conduct that constitutes or may constitute such a contravention, and
    2. the search will find evidential material in or on or part of the place, vehicle, or thing, and
  3. the FMA obtains a warrant from a Judge of the High or District Court who is also satisfied as to (2), or
  4. the occupier of the place, or person in charge of the vehicle or thing, consents (but note that (1) and (2) must still be met in consent situations).

While this is a reasonably broad power, the threshold for its exercise (particularly in circumstances where a warrant is required) is somewhat higher than for other agencies. The Commissioner of Inland Revenue, for example, does not need to establish reasonable grounds for suspecting contravention before obtaining a warrant from a judicial officer (in this case, any District Court Judge, justice, Community Magistrate, or Registrar of a District Court) under section 16C of the Tax Administration Act 1994. Such a warrant may be issued if the officer is satisfied that the warrant is necessary for the exercise of the Commissioner's functions (although note that the search power under section 16C is limited only to removing books or documents and retaining them for a full and complete inspection).

CODIFIED SEARCH AND SEIZURE PROVISIONS

Detailed provisions as to the manner of exercise of the FMA's entry and search power are set out in Schedule 2 to the Act. This 'code' largely draws on provisions from the pan-governmental Search and Surveillance Bill, and may be subject to amendment upon that Bill becoming law.

It is unnecessary for present purposes to explore in great detail the provisions of Schedule 2, but a few points warrant mention.

Concern has been expressed that the need for the FMA to satisfy a judge that (1) a person has engaged in or is engaging in conduct that may constitute a contravention, and (2) a search will find evidential material, will be detrimental in situations where the FMA needs to move quickly to obtain evidence. The Schedule alleviates these concerns to a degree by excusing the written application requirement and allowing warrant applications to be made orally (such as by telephone call) or by personal appearance when delay would compromise the effectiveness of the search.

A person exercising the search power may seize any thing that may lawfully be seized, as provided for in the warrant. If, however, there is uncertainty as to whether an item comes within the authority of the warrant, and it is not practicable to determine legality on the spot; the item may be removed for the "purpose of examination or analysis to determine whether it may be lawfully seized". Said object having been examined or analysed, and the seizure found to have been unlawful, the item's return is unlikely to provide the subject of the search with a great deal of comfort!

The Schedule also makes provision for "seizure of items in plain view". A person who is lawfully in any place as part of his or her duties, may seize any item that he or she observes at that place. The power may only be exercised if the person has reasonable grounds to believe that the item could have been seized under any search warrant that could have been obtained.

Further, the FMA may copy any document that may lawfully be seized, use any reasonable measures to gain access to any computer system or other data storage device, create a forensic copy of any material in that computer or device, and take photographs, sound and video recordings, and drawings of a search site and of anything found there.

SHARING BETWEEN AGENCIES

As outlined above, part of the perceived problem with the previous regulatory framework was the inability of different agencies to work together in investigation and enforcement. Although the Securities Act 1978 did provide for the Securities Commission to share information with the Takeovers Panel and Commerce Commission, its arrangements with other agencies were fragmented such that contraventions slipped through the gaps.

The FMA Act seeks to address this by giving the FMA an overall and express power to provide any information, or a copy of any document, to a law enforcement agency, regulatory agency or overseas regulator4 in circumstances where it:

  1. holds the document or information in relation to the exercise or performance of its functions, powers or duties under any Act, and
  2. considers that the document or information may assist the agency or regulator in performance or exercise of its functions, powers, or duties under any enactment (or, in the case of the overseas regulator, foreign law).

Documents or information shared with other agencies will not be entirely unprotected. Before transfer, the FMA must ensure that appropriate confidentiality protections are in place, particularly where personal information is involved, as defined in the Privacy Act. The FMA may also impose conditions on the use of any information or documents it provides.

The reverse of this arrangement is also available to the FMA. In performing or exercising its powers, functions, or duties under any enactment, the FMA may use any information or document provided to it by a law enforcement or regulatory agency, or an overseas regulator.

Finally, the Act permits the FMA, at the request of an overseas regulator, to inquire into any matter related to the functions of that regulator. If the FMA accepts such a request (it may refuse for any reason, including that the overseas regulator would be unlikely to reciprocate), it may exercise its powers to obtain information, documents, or evidence that it considers likely to be of assistance.5

Enforcement

Perhaps the most notable extension of power given to the FMA is the ability to initiate, or take over and control, civil actions on behalf of investors6 against financial markets participants. These provisions are modelled on section 50 of the Australian Securities and Investments Commission Act 2001 (the ASIC Act) although, as will be discussed below, the FMA is on a tighter leash than its Australian counterpart.

This new power sits alongside the power the FMA has to prosecute for criminal breaches of the financial markets legislation and gives the FMA very broad criminal and civil enforcement powers. Examples could include:

  • prosecuting a financial market participant for fraud under the provisions in the Crimes Act
  • seeking a pecuniary penalty order against a company that distributes an advertisement or a registered prospectus that includes an untrue statement contrary to the Securities Act, or
  • seeking damages on behalf of an investor arising from a financial adviser failing to exercise care, diligence, and skill in providing advice to that investor as required by the Financial Advisers Act.

The range of actions that may be exercised by the FMA on an investor's behalf consists in two categories:

  • any causes of action arising under, or in respect of, any of the financial markets legislation listed in Schedule 1 to the Act, which encompasses the Companies Act, Financial Reporting Act, Securities Act, Securities Markets Act and numerous others (but does not include criminal proceedings), and
  • any proceedings seeking damages or other relief for fraud, negligence, default, breach of duty, or other misconduct that is committed in connection with an inquiry7 or investigation carried out by the FMA.

Importantly, the right of action on behalf of an investor will be applicable retrospectively to conduct that predates the coming into force of the Act.

The policy intention behind these broad new powers is twofold:

  • to provide a remedy for small-scale retail investors who lack the resources to fund expensive litigation by themselves. (In such situations, the FMA will be able to step in and provide a regulator-backed class action proceeding to pursue the wrongdoing. It has been stressed that the primary objective of the power is to promote the public interest, rather than to obtain redress for investors, although redress will often follow if the FMA's action is successful),8 and
  • to restore public faith in New Zealand's financial markets and in the regulatory regime which governs them by equipping the regulator with strong and visible powers of enforcement.

The power to bring civil actions on behalf of investors is a new string to the FMA's bow, but it should remembered that these provisions simply give the FMA standing to take up existing rights of action against certain persons in certain circumstances. They do not create any additional rights, liabilities or causes of action.

That said, the potential for civil litigation has obviously increased. Even without taking into account the significant resources available to a government regulator, a decision by the FMA to take action is expressly guided by different criteria to what would inform a private individual in the same situation.

THE THRESHOLD

The FMA is not given carte blanche to take action on behalf of any investor at any time and is subject to tighter constraints in this regard than is ASIC. Both ASIC and the FMA must apply a public interest test but the two tests are subtly different. The FMA (section 34 of the Act) may exercise its power only if "the FMA considers that it is in the public interest to do so" and must, when making this assessment, apply the following considerations:

  1. its main objective (i.e. promoting and facilitating the development of fair, efficient, and transparent financial markets)
  2. the likely effect of the proceedings on the future conduct of financial markets participants in connection with the financial markets
  3. whether exercising the powers is an efficient and effective use of the FMA's resources
  4. the extent to which the proceedings involve matters of general commercial significance or importance to the financial markets
  5. the likelihood of [the person whose right is taken over] commencing the proceedings (if those proceedings have not yet been commenced) and diligently continuing the proceedings, and
  6. any other matters it considers relevant.

ASIC by contrast may begin proceedings "where it appears to ASIC to be in the public interest to do so" and has no factors for mandatory consideration. The Full Federal Court of Australia has interpreted this as conferring upon ASIC "an extremely wide discretion", the application of which is "essentially one of fact and degree, and by its very nature...something that is not easily susceptible to judicial review".9

But although the power to take action has been available in some form in Australia since 1961, it has been relatively rarely used (just 21 times between 1991 and 2007).10 This is thought to reflect the existence in Australia of both a civil and criminal penalty regime, which allows ASIC to pursue breaches of directors' duties and other market misconduct directly. Also of potential relevance is the availability and higher frequency in Australia of private class action proceedings.

The more limited enforcement options available in this country may force a greater reliance on, and more frequent use of, the power here despite the more rigorous New Zealand version of the public interest test.

Continue in Part 3

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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This article is part of a series: Click A Regulator With Teeth: The Enforcement Capabilities of the FMA: Part 1 for the previous article.
This article is part of a series: Click A Regulator With Teeth: The Enforcement Capabilities of the FMA: Part 3 for the next article.
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