The Securities Law Review has played a good first half and all the indications are that it will maintain form through the game.
The Government's response to the reform options, outlined in the Cabinet Paper released on Thursday, is measured and an extensive consultation process is planned which should minimise the risk of legislative error.
In prospect is a regulatory framework which will still be at the lighter end of the international spectrum, reflecting the small size of our market and the need to be competitive relative to other regimes – particularly Australia. This should nurture innovation but, as the Cabinet Paper acknowledges, will make it more difficult to achieve full mutual recognition.
This Brief Counsel summarises the key changes with additional Chapman Tripp analysis where appropriate. You can also read our commentary on the Discussion Document of June last year.
Officials will engage with industry on the drafting of the Bill and will release an exposure draft in August for formal public consultation. A Bill will then be introduced to the House in late October for final passage by December 2012. The intervening elections should not disturb the Bill as it is not controversial between National and Labour.
The Government has honed the detail of some of the reform proposals but has kept faith with the broad reform themes, in particular the strong focus on disclosure and governance obligations. Some of the knottier issues, such as the regulation of exchanges and certain aspects of the proposed liability regime, have been deferred to the end of May.
We urge you to take full advantage of the platform the Government is providing for engagement. There is a chance here to produce leading edge law which reflects international best practice modified to the New Zealand circumstance.
Structure of the new Act
The new Act will define the purpose of securities law as:
The Act will replace the Securities Act 1978 and the Securities Markets Act 1988. Those provisions within these Acts which are not affected by the review will be tweaked as necessary and carried over into the new Act.
Defining regulated financial products
The proposed product categories, and the associated regulatory requirements in addition to the requirement to make disclosure to investors, are:
- equity securities
- debt securities (have a trust deed and a trustee)
- collective investment schemes (have an external supervisor, who would also have responsibility for the custodianship of the scheme's assets)
- derivatives (dealers to be licensed by the Financial Markets Authority (FMA)).
The FMA will have the power to designate financial products or services to a particular category and to shift them from one category to another. Such designations would not be retrospective and could be made only if the FMA:
- was satisfied that the product or service was in the nature of an investment or a hedge against financial risk and that designating it was in the public interest
- had consulted with the affected parties, and
- had published a statement of its reasons within 30 days of designation.
Products will be defined primarily in relation to their economic substance rather than – as now – according to their legal form. But the definitions are no longer driven entirely by accounting concepts and have been refined to retain some elements of formalism. The Cabinet Paper expects further refinement to flow from the drafting and consultation processes.
Further, the Act will now provide for two categories of regulated financial service:
- non-pooled investment schemes (e.g. wrap accounts), and
- specified intermediary services (e.g. peer-to-peer lending).
Regulated intermediaries will need to be authorised by the FMA and, where better placed than the issuer to do so, will be required to meet certain regulatory requirements on the issuer's behalf, such as disclosure, record keeping etc.
The proposed exemption regime is clear. Exemptions will be provided for:
- offers to sophisticated investors (refer below for more detail)
- offers to persons with a close relationship to the issuer - relatives and close business associates (a senior manager, an investor with an equity stake above 10%, directors, senior management and major shareholders in related companies, a partner under the Partnership Act and family members of the above)
- offers of equity as part of employee share schemes – capped in value at 15% of the gross assets of the issuer, requiring short form prescribed disclosures
- small offers of equity or debt securities in non-property companies (up to $2 million over 12 months and up to 20 investors with a cap of $100,000 per investor unless the investor is sophisticated), and
- narrow exemptions relating to specific entities or products (most of which are already provided for in the Securities Act and will be simply carried over).
Sophisticated investors are defined as "a person who has previous experience in investing in securities that allows them to assess the merits of the investment, the value of the securities, the risks involved, their own information needs, and the adequacy of the information provided by the issuer". Bright line safe harbours would be included for:
- investment businesses and persons whose principal business ensures expertise in investment-related activities
- persons who can satisfy at least two of three criteria: have worked in the past ten years for at least one year in a role requiring specialist financial knowledge; or have within the last two years either owned a portfolio of at least $1 million or conducted ten or more transactions of over $20,000 or five or more transactions of over $100,000; or have within the last two years had income of more than $200,000 a year or assets of more than $2 million
- large entities (gross assets of $10 million or annual turnover of $20 million)
- local authorities, Crown entities, SOEs, the Reserve Bank and the National Provident Fund, and
- persons who are investing, or have previously invested, more than $500,000 in the same entity or assets.
The Paper is explicit that this is a working definition only and will be further refined.
Calculation of the asset or revenue tests would be extended to include assets and revenue of related entities and, if a person is sophisticated, related entities would also be exempt.
Responsibility for ensuring that investors meet the safe harbour requirements would lie with the issuer. Issuers can require that an investor certify his or her eligibility in writing or produce an approval from an Authorised Financial Adviser (AFA). Investors who do not qualify under any of these bright-line safe harbours may still take advantage of the sophisticated investor classification but they will have to have their qualification approved by an AFA.
As expected, the requirement to prepare a prospectus and investment statement will be replaced with a Product Disclosure Document (PDS), which will incorporate at the front a key information summary (KIS) of no more than two pages.
The PDS will only contain information that is essential to an investor's decision, be targeted at retail investors and will be heavily prescribed for mainstream or simple products. The content will be established by regulation but is proposed according to the table below.
|Equities||Brief description of the issuer's business, class and type of security, whether listed or not, price, dividend policy, how investors can get their money out, summary of the purpose of the issue (e.g. retiring debt, new acquisition).|
|Debt||Brief description of the issuer's business, type and structure of the security, credit rating (if any), interest rate or how it is calculated, term, whether it is possible to withdraw before maturity, purpose of the issue.|
Collective investment scheme
|Details of the people involved in the fund's management, investment options (conservative, etc), returns policy, asset classes and minimum contribution rates, historical return information, withdrawal options.|
|Derivatives||Details of the counterparty, underlying commodity, index, asset or security, how the derivative makes/loses value, withdrawal options and (potentially) a statement that this is a complex financial product that should be entered into only with financial advice.|
The PDS will state the date on which it is printed and where to look for updates on the new electronic Register of Securities Offers provided for in the FMA Bill currently before the House. This will enable issuers to disclose any other material relevant to the offer in addition to the prescribed disclosures, including matters which change frequently or which are not key for investors – e.g. directors' addresses.
Debt issuers will be required to update information relating to the likelihood of default on the Register. The Government also proposes to extend the periodic reporting regulations now being developed for retail KiwiSaver schemes to other collective investment and non-pooled investment vehicles.
The current mass of highly prescriptive rules governing the content of advertising in relation to offers will be replaced by a requirement that an advertisement must not contain any matter that is likely to deceive, mislead or confuse. And options are being explored to deal with celebrity endorsements, including making the celebrity liable to investors for any untrue statements they make in the endorsement.
Collective Investment Schemes (CIS)
Chapman Tripp will produce a dedicated commentary on this section of the review. For now, we simply note the following proposals:
- all CIS's to be required to have an external supervisor licensed under the framework established by the Securities Trustees and Statutory Supervisors Bill and responsible for the oversight of the scheme manager and the custodianship of the scheme's assets
- provision of an open ended investment company form (OEIC) for CIS's in which investors can purchase shares either from the OIEC itself or through a broker. The issue and redemption of shares would be subject to specialised rules to provide for ease of entry and exit but OIECs would otherwise be required to comply with the same basic rules as apply to other New Zealand companies
- requiring fund managers to be registered by the FMA. Registration would require meeting a 'fit and proper person' test, the details of which will be provided for through regulation. The Treasury advised against this, on the basis that sufficient protection is already provided through other legislation, and the Minister acknowledges that the decision to regulate is "not clear cut". However, he says he does not believe it is "in the interests of our financial markets...to leave a sector of the market unregulated and to create an area for the less scrupulous to congregate"
- any future insurance contracts with an investment component and any future employer-based superannuation schemes will be covered by the CIS regulatory regime (existing arrangements will be exempt).
Only egregious offending, defined as deliberate or reckless conduct, will be the subject of serious criminal offences, including the possibility of lengthy prison sentences. Lower level contraventions (e.g. a minor and inadvertent mistake in a prospectus) will attract civil pecuniary penalties only. The Minister says that, if set at a high enough rate, these should provide adequate deterrence.
Securities-specific offences will be included in the new Act – a departure from current practice which has some breaches prosecuted under the Crimes Act.
The question of where liability should properly fall is also being reviewed. Now it lies mainly with directors but it is proposed that:
- issuers be primarily liable for contraventions relating to the issue of securities, with directors also primarily liable for some contraventions (yet to be finalised), and
- the person responsible for the misconduct be primarily liable for secondary market contraventions, such as insider trading.
In addition, all investors will have a right of compensation for a material misstatement in an issuer document, even where they cannot establish that the misinformation was influential in their decision to invest (a requirement which may cause real difficulties for some investors in the finance company collapses).
The draconian consequence of all securities being automatically rendered void, or voidable, on a failure to make required disclosure is to be replaced with affected investors having a right to cancel their investment and seek a refund where an offer is made without an appropriate disclosure document or where the offer document is materially misleading or deceptive.
Public enforcement of directors' duties
Criminal sanctions will apply for serious and deliberate contravention of directors' duties by directors in issuer companies. Submissions on this were mixed with some (including Chapman Tripp) expressing concern that public enforcement might discourage individuals from taking up directorships. But the Minister considers that this risk can be avoided by only criminalising egregious and intentional misconduct.
Because information from whistle-blowers can be vital for exposing this type of behaviour, people inside the company who volunteer information regarding a director's wrongdoing will be protected against prosecution.
These provisions are additional to the power of the FMA to exercise a person's right of action against a financial market participant where this is in the public interest.
These are to be substantially strengthened. The five year limit for regulator-imposed bans will be extended to ten years and the High Court, which can now impose bans for a period of up to 10 years, will be given the discretion to impose indefinite banning orders.
No action letters and rulings
The FMA will be able to issue 'no action' letters where there is uncertainty over how the law applies to security products and it will be open to issuers to engage with the FMA about the product and/or transaction and how they propose to treat it.
The FMA will not, however, be given a power to issue binding rulings. Some submitters argued for this on the grounds that it would provide increased certainty, but the Minister said that in practice the rulings would be subject to appeal and that there were issues around the scope of determinations depending on how they were interpreted.
Public access to securities registers (discouraging improper use)
This issue is again in the headlines courtesy of the activities of Bernard Whimp. The Minister considered the 'proper purpose' test applied in Australia would be too restrictive and might prevent legitimate access. Instead, it is proposed to:
- provide a strict liability offence for the use of data obtained from a register to contact people or send them direct marketing material unrelated to securities dealing, and for companies disclosing investor details to third parties knowing that the disclosure is likely to be abused, and
- require persons making unsolicited offers (a là Whimp) to provide in the offer document a fair estimate of the value of the relevant securities and a cooling off period.
Where to from here
Chapman Tripp will continue to monitor and to provide commentaries on developments relating to the review.
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.