New Zealand: A Regulator With Teeth: The Enforcement Capabilities of the FMA: Part 3

THE MECHANICS

The flowchart at Appendix II sets out in summary form the mechanics of the FMA's power to exercise a person's right of action.

That power may only be exercised "as a result of an inquiry or investigation carried out by the FMA". While the Act is silent as to whether this investigation or inquiry must be complete before the FMA exercises the power, equivalent statutory language in Australia has been interpreted as not requiring completion and, in any event, any such requirement is likely to be easily achieved.

The FMA then has three options: to take no action, to take direct enforcement action (such as a prosecution or pecuniary penalty) or to exercise a person's right of action. At that point, the "public interest" test, as discussed above, is triggered. Assuming the threshold is met, the real mechanics begin.

Consent

To initiate proceedings, the FMA must notify the person in writing of its intention and may proceed unless within 30 days, the person either gives written notice that it objects¹¹ or exercises its own right of action.

The process for taking over proceedings that a person has already commenced is, for obvious reasons, more stringent. In these circumstances, the FMA may proceed only with the person's written consent.

Leave

However, should a person object to the FMA commencing proceedings, or decline to give consent to the FMA taking over proceedings, the FMA has the ability to apply to the High Court for leave to overcome the person's objection or nonconsent, provided the person is not an individual.

The Act expressly states that if the person is an individual the High Court may not give leave. This exception was included reasonably late in the legislative process in response to submissions that allowing the Court to "overrule" an individual's objection was constituted an unwarranted interference in the rights of individual investors.

High Court leave is by no means a given. The Court must be satisfied that it is in the public interest for the FMA to initiate or take over the proceedings and for the FMA, rather than the person, to control the conduct of the proceedings. In considering these factors, the High Court must have regard to whether the person intends to commence or diligently continue the proceedings, the interests of the person, its shareholders, members, and creditors, and, if the person is an issuer, the holder of any securities issued by the person.

Presumably to ensure the Court receives a balanced view, the FMA is required to serve notice of an application for leave. The person may appear and be heard on that application and must, if it does appear, inform the High Court whether it intends to commence or continue the proceedings (one assumes the Court then makes its own assessment as to diligence or otherwise).

High Court orders as to proceedings

Whether the FMA is exercising a person's right of action by consent or by leave, the High Court may, on the FMA's application, make any order it thinks fit in relation to those proceedings. Such orders may include:

1. authorising the FMA to control the conduct of the proceedings
2. giving directions for conduct of the proceedings, and
3. requiring the person, or its directors, to provide information or assistance in relation to the proceedings.

It is worth noting that only the FMA may make such an application. The reason for this, according to the Commerce Select Committee, is to prevent applications being made for the purpose of slowing down proceedings or skewing the outcome.

In addition, while the FMA is required to consult with the person as to the conduct of the proceedings (subject to any order of the High Court), the FMA need do so only to the extent "it considers appropriate" and need not do so (and the High Court must not so order) if it considers that consultation would materially prejudice its ability to efficiently or effectively conduct the proceedings.

Money ordered to be paid

The High Court may order that any amount to be paid by a defendant in the proceedings must first go to pay, in whole or in part, the FMA's actual costs in commencing, taking over or conducting the proceedings. This was a reasonably late inclusion in the legislation which, as originally drafted, sheeted the costs of proceedings in whole or in part to the issuer (and, indirectly, to investors).

Similarly, the Court may order that such money be paid to a shareholder, member, or creditor of the person.

Time limits

A "gaming risk" raised during the legislative process was that court proceedings could be used to delay litigation by the FMA beyond the limits of the Limitation Act. To remedy this, the Act now provides that the date on which an FMA application for leave is filed must be treated, for the purposes of the Limitation Act, as the date on which the claim is filed.

The teeth bared?

Recent examples of action taken by the FMA against financial markets participants show the new powers that are available to it and its ability to co-operate with other enforcement and regulatory bodies.

GFNZ Group

On 15 June 2011, the FMA made an interim order to stop an allotment of securities by GFNZ Group Limited (formerly known as Geneva Finance Limited). This represented the first exercise of a new power, under section 43G of the Securities Act 1978, for use when the FMA is of the opinion that, for example, a registered prospectus may be false or misleading.

In this case, the FMA learned that GFNZ had breached a lending covenant with its primary funder. The FMA is now seeking further information from GFNZ to determine whether to order the offer documents to be corrected to the FMA's satisfaction or cancelled on the grounds that they are likely to deceive, mislead or confuse investors.

This intervention by the FMA demonstrates that it can take successful ex ante enforcement action against financial market participants.

Whimp partnerships

On 6 May 2011, the FMA ordered Mr Bernard Whimp under section 49 of the FMA Act to include a warning from the FMA, in the form set by the FMA, at the beginning of any unsolicited offer documents he makes. Mr Whimp had made several unsolicited "low ball" offers to investors to purchase their shares in NZX-listed companies for prices significantly below market values.

Separately, after legal action by the FMA, the High Court on 13 May 2011 ordered the cancellation of offers to purchase securities at above market price but with the payments spread over ten years. The Court agreed that this feature was not properly described and so the offer was misleading.

SuperLife

On 21 June 2011, the FMA issued a warning to SuperLife to overhaul its KiwiSaver sales practices after it became concerned about potential noncompliance with the law and apparent poor monitoring of the activities of SuperLife's sales force. The FMA had previously (9 May 2011) warned investors to be wary of SuperLife's unacceptable practices.

The FMA warned SuperLife that the door-to-door sale of securities was illegal under the Securities Act and would also be in breach of the Financial Advisers Act and that, if SuperLife persisted, the FMA would not hesitate to take action under that Act when the Act came into force on 1 July 2011.

Allan Hubbard

On 20 June 2011, the FMA closed its investigation into a series of companies of which Allan Hubbard was director, after the Serious Fraud Office (SFO) laid 50 charges against Mr Hubbard under sections 220, 242 and 260 of the Crimes Act.

The SFO and FMA had worked closely together on the Hubbard investigation and, although the FMA had authority to commence proceedings against Mr Hubbard for breaching section 59 of the Securities Act, it decided that this would be duplicative and has instead simply offered to assist the SFO with its prosecution if necessary.

Although it has decided not to prosecute Mr Hubbard, the FMA nevertheless retains the ability to take action on behalf of investors in any civil action against Mr Hubbard in his capacity as a director for compensation arising from any breach of his director's duties.

Hanover Finance and Mark Hotchin¹²

On 10 December 2010, the Court granted interim freezing orders over New Zealand assets held by former Hanover Finance director Mark Hotchin after an application by the Securities Commission. The FMA (taking over from the Securities Commission) successfully opposed an application by Mr Hotchin to vary or revoke those orders on 5 May 2011.

The action was taken under sections 60G and 60H of the Securities Act with a view to ultimately freezing sufficient property and assets of Mark Hotchin to meet any civil claims that may be brought by investors. Any such claims would relate to those who invested in the Hanover group of companies on the basis of disclosure documents that are proved to contain untrue statements.

The Securities Commission could apply for such orders only in relation to breaches under the Securities Act and the Securities Markets Act and for non-compliance with the Takeovers Act or Code. Sections 60G and 60H apply this remedy to breaches of all financial markets legislation.

Although the orders can be made before a liability is established and, indeed, before the evidence necessary to establish liability has been collected; the Court has held that it is "an extraordinary remedy to be exercised with caution".

APPENDIX 1

Summary of regulatory or investor protection bodies

Enforcement and prosecution responsibilities are spread around the Securities Commission, the Serious Fraud Office, the Commerce Commission, the Ministry of Justice (and the judicial system more generally), the New Zealand Police, Crown Law and the Registrar of Companies.

Responsibility for raising New Zealanders' level of financial literacy (i.e. investor education) is shared among the Securities Commission, the Retirement Commission, the Ministry of Education and the New Zealand Qualifications Authority. A number of non-governmental bodies such as Young Enterprise Trust, Grey Power and the Shareholders Association also do valuable work in this field.

Appendix 2

Click here to see flow chart attached to appendix 2

Footnotes

1. Refer Appendix 1 for a summary of the regulatory or investor protection bodies involved. Source: Prada and Walter, "Report on the Effectiveness of New Zealand's Securities Commission", September 2009.

2. Page 162, per Gallen J

3. Unlike the Commerce Commission, the Securities Commission did not have the ability to obtain a search warrant.

4. Which means "a body in another country that performs functions that correspond with, or are similar to, any of those conferred on the FMA". This definition appears to preclude provision of information or documents to overseas law enforcement agencies.

5. And the requisite written notice must specify that the power is being exercised at the request of an overseas regulator.

6. The Act gives the FMA power to exercise the right of "a person". "Person" is not defined in the FMA Act, but as per the Interpretation Act 1999 it includes "a corporation sole, a body corporate, and an unincorporated body"

7. The use of the term "inquiry" here is interesting. It suggests something less than an "investigation", which would presumably be subject to the threshold questions discussed above.

8. See the Explanatory Note to the Financial Markets (Regulators and KiwiSaver) Bill 2010

9. See Australian Securities Commission v Deloitte Touche Tohmatsu (1996) 70 FCR 93

10. Although note that ASIC has used the power more frequently in more recent times, notably in pursuit of the directors of the Westpoint Group to receover some of the A$288 million lost by investors after the collapse of the property investor in 2006.

11. Note the requirement is for written notice of objection, it can therefore be assumed that silence constitutes consent.

12. Chapman Tripp's Auckland office is acting in relation to this matter.

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.