New Zealand: Some things old, some new, some borrowed - any blues?

Among the key changes proposed in the draft Financial Markets Conduct Bill is a new single product disclosure statement (PDS) and online register of other information, to replace the current prospectus and investment statement.

When it comes to exemptions from disclosure requirements, the Bill retains many aspects of the existing framework.  But it also has some welcome additions and a few "tweaks" in the detail that could be significant for some.

In this Brief Counsel we discuss some of the highlights of the new disclosure exemption regime, point out the most significant proposals for reform, and discuss the impact they may have. 

How do the exclusions work?

Part 3 of the Bill sets out the new disclosure requirements (outlined in our earlier commentaries of 16 August and 24 August).  These apply to:

• offers of financial products for issue, and
• the following offers of financial products for sale:
  • the products were originally issued with a view to the subscriber dealing with them and the sale offer is within twelve months of issue
  • the issuer advises, encourages or knowingly assists the sale (or is the seller), or
  • certain sales by persons who control the issuer (or in some circumstances) persons who have acquired from such a controller. 

The first two largely reflect existing law (with some useful modifications, such as the twelve months brightline).  The third is new.

However, neither an issue nor a sale will require disclosure if one of the statutory exclusions under Part 1 of Schedule 1 applies.  The key exclusions are discussed below.  But it is important to realise that that the Bill is still relevant to excluded offers. 

Part 2 of the Act, which prohibits deceptive conduct and false or misleading representations, will apply to offers excluded from disclosure requirements.  Part 2 essentially replicates (for financial markets conduct) key provisions of the Fair Trading Act 1986 but brings offending conduct under the jurisdiction of the Bill. 

Turning now to the exclusions...

What's old?

A number of existing exclusions are retained.

Private offers – "wholesale investors"

The exemptions for "private" offers of securities under the Securities Act (principally "habitual investors" and "wealthy" persons) have been clarified, refined, and renamed as an exclusion in relation to "wholesale investors". 

• A person will be a wholesale investor by nature if they meet the investment activity criteria (discussed further below), are in an "investment business", are "large", or are a "government agency" (these terms are now defined, see the box below).
• A person will be a wholesale investor in relation to a particular offer if they are an "eligible investor" (discussed further below), or if they will pay or will have paid at least $500,000 for the securities on acceptance of the offer (retaining the current categories for minimum subscription amounts, but removing the 18-month time limit).

Business associates and relatives – "close relationship"

Usefully, a number of persons are now deemed "close business associates" of the offeror merely by virtue of their relationship (e.g. directors or senior managers of the offeror or of a related body corporate). 

Perhaps less useful is the catch-all provision for persons who have a close professional or business relationship with the offeror, or with a director or senior manager of the offeror, that allows the person to assess the merits of the offer and the adequacy of any information provided.  While the focus on an ability to assess the offer is welcome, the need for there also to be a "close business or professional relationship" retains some of the uncertainty in the present law.  A test which simply requires a pre-existing relationship beyond mere acquaintance might be preferable.

The "relatives" exemption has been narrowed in scope – while step relationships are recognised, relationships must be of the third degree or closer (rather than the current four degrees), and there are stricter rules about when the beneficiaries of trusts can be exempted as "relatives".  These changes may have implications for extended family investment arrangements and/or "friends and family" fundraising undertaken by small businesses (but see our comments on "small" offers, below).

Employee share schemes – "persons under control"

Conditions set out under current exemption notices, such as a requirement to provide information to investors, are not replicated in the Bill.  This means that the compliance requirements for employee share schemes are reduced.  However, the offer must:

• be made as part of an employee's remuneration arrangements
• not exceed an annual limit of 10% of that class of securities of the issuer, and
• not have raising funds for the issuer as its primary purpose.

Dividend reinvestment plan

This exclusion replicates the current exemption notice for offers under a dividend reinvestment plan, but reduces the information disclosure requirements. 

Also included are...

Exclusions for

• offers of renewals or variations of the terms of financial products 
• certain offers of retirement village interests
• contributory mortgages offered by solicitors
• issues by the Crown, local authorities and certain other public bodies.

What's new?

Amendments and additions to exclusions

The statutory exceptions can be amended or supplemented in a number of ways.

• The Minister may (consulting with the FMA) prescribe in regulations certain circumstances in which an exclusion does not apply or additional requirements that must be satisfied before an exclusion applies. 
• The FMA may prescribe frameworks or methodologies for the purposes of determining how certain defined terms or criteria (for example, whether a person is "large") are satisfied in order to qualify for exclusion.
• The FMA may make a declaration under section 512(1)(d) that a particular offer of financial products for issue requires disclosure, even if it would otherwise not.  
• Regulations may also set out some alternative form of disclosure to be provided, or prescribe other conditions applicable to an offer which would otherwise be excluded. 

Brightline tests for "investment activity"

New brightline tests ascertain whether a person is a wholesale investor by virtue of their investment activities.  They relate to the number of transactions carried out by the person of a particular value over a set period, the value of the person's investment portfolio, the person's assets or income, and involvement in an investment business. 

While these criteria replace the "habitual investors" and "wealthy persons" tests under the Securities Act, a person will be required to satisfy two or more of the following criteria:

• owned a portfolio of a value of at least $1 million in aggregate within the last two years
• carried out 10 or more transactions to acquire financial products where the price under each transaction was at least $20,000 in the last two years
• carried out five or more transactions to acquire financial products where the price under each transaction was at least $100,000 in value in the last two years
• have net assets of at least $2 million as at the last day of the person's most recently completed financial year, or an annual gross income of at least $200,000 for each of the last two financial years 
• have, within the last 10 years, been employed or engaged in an investment business and have, for at least one year during that time, participated to a material extent in the investment decisions made by the investment business.

The additional guidance provided by the criteria is helpful.  However, persons currently relying on the habitual investors exemption or the wealthy persons exemption will need to take a close look at their activities to see whether they will meet the new test.

Large persons

The Bill reflects a view that some people should be considered big enough and ugly enough to fend for themselves.  The new exemption for "large persons" is a sensible addition to the regime.  But the thresholds - $10 million for assets and $20 million for turnover – are significantly higher than the current "wealthy persons" test under the Securities Act ($2 million assets or $200,000 income), being based, instead, on elements of the framework for differential financial reporting.  In our view, it would be helpful for these thresholds to be reduced.

Safe harbour with "wholesale investor" certificate

A new "wholesale investor" certificate will provide a safe harbour for offerors unless they have reasonable grounds to believe that the certificate is incorrect.  While it is a useful addition to the Bill, it may be difficult to know whether or not a person has "reason to believe" that a certificate is incorrect, and this uncertainty may significantly reduce the efficacy of the safe harbour.  Actual knowledge would make it more workable.

Offers through licensed intermediaries and DIMS licensees

The licensed intermediaries and DIMS licensing regimes will be reflected in new exclusions for certain offers made "through" them – a sensible exclusion, given the level of oversight exercised through licensing.  MED has acknowledged that the discretionary investment management services (DIMS) licensee regime is the least developed part of the Bill.  And it would be helpful for there to be clarity as to what it takes for an offer to be made "through" a licensee.  Chapman Tripp has produced a separate commentary on the DIMS regime.

Controlled entities are also covered

Usefully, the Bill introduces an exclusion for offers of financial products to an entity, where an offer to a person controlling that entity would be excluded as a wholesale investor, a person in a close relationship, an offer through a licensed intermediary or DIMS licensee, or under an employee share purchase scheme.

Small offers

The Bill follows the Australian lead and introduces an exclusion for personal offers that fall underneath certain limits.  For an offer to be "personal", the offeror and the potential investor must be connected personally, professionally, through previous contact or through an expression of interest by the investor (see the full definition below).  

The limits restrict the number of investors (the "20-investor limit") and the value of the offer (the "$2 million limit") over a 12 month period.  This will be a helpful addition to the regime for those looking to fund start-up companies (and may more than compensate for the more restrictive "relatives" test discussed above).

Controlling interests

A new exclusion applies to offers of equity securities where five or fewer investors act jointly to acquire more than 50% of the voting products of an entity, and they are in a position to obtain relevant information from the offeror.  The exclusion is a useful addition (particularly given the application of disclosure requirements to certain sales by controllers, discussed above), but its drafting needs careful attention to ensure that the requirement that the investors be "in a position to obtain" the relevant information is not inconsistent with agreed limited due diligence arrangements (i.e. where both sides prefer speed of execution to detailed pre-transaction investigations). 

Small schemes

Managed investment schemes are subject to a new regime under the Bill, and a new exclusion applies to those which are "small" – with five or fewer participants – and which are not promoted by a professional promoter.  The FMA has powers to determine that the participants of a number of schemes must be counted together as though they were one – though it is not (yet) clear on what grounds the FMA will make such a determination.

Some other new additions

Exclusions for:

• no consideration offers (not including KiwiSaver or superannuation schemes), and
• derivatives not offered by a derivatives issuer.

What's borrowed?

Eligible investor certification

The new process for certification of an "eligible investor" has been borrowed from the Financial Advisers Act 2008.  It replaces the current non-wealthy "eligible persons" test in the Securities Act 1978, and requires "previous experience that allows the person to assess" a number of factors - including the merits and risks of the offer and their own information needs. 

Rather than requiring a confirmation by an "independent financial service provider" (as presently), an eligible investor certificate must now be confirmed by an authorised financial adviser (AFA).  From what we have seen under the financial advisers regime, this certification process will likely only be used in exceptional cases – the level of comfort required and the risks of relying on such a certification make it a less attractive option for issuers, investors and the AFA.

Any blues?

On the whole, Schedule 1 is to be welcomed – particularly the introduction of the small offers exclusion and the move towards self-certification.  It addresses a range of difficulties in the current exemptions regime, and introduces some helpful safe harbours.  However, there are some points which we think are worthy of further attention.

• New powers provided for in the Bill (for example, to prescribe additional circumstances which must be satisfied before an exclusion will apply) are broadly drafted and leave uncertainty around the ultimate scope of the exclusions.  Some greater certainty on when and how these powers might be exercised would be welcomed by the market. 
• Just who has a "close professional or business relationship" (see above) is not clear.  Does it matter what the nature of the relationship is, so long as the investor is in a position to obtain sufficient information to assess the offer? 
• Although it is intended to be a "brightline" test, reliance on certificates is still subject to the uncertain concept of where an offeror "ought reasonably to have known" that the certificate was incorrect.
• Employee share schemes are only exempted if the offers to employees represent 10% or less of the equity securities of the same class within a 12 month period.  This replaces the current 12-month cap of 5% and total cap of 15% for unlisted securities, but is problematic where a separate class of securities has been established for employee remuneration.
• While current exemption notices for employee share schemes clearly define "eligible persons" (for example, including labour-only contractors), the Bill does not define who is an "employee". 
• For technical drafting reasons, employee share schemes may lose the benefit of the exclusion if the issue is made to employees that are also "close business associates" of the issuer - though this should be easily rectified before the bill is finalised.
• The exclusion for dividend reinvestment plans only applies where the products are held on terms that "entitle" the holder to subscribe for them by applying all or any part of a dividend.  But many securities are not issued with such an inbuilt "entitlement" to subscribe.  The intent of this restriction should be clarified.

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.