Background

The discussion paper follows on from the work of the Capital Market Development Taskforce (CMDT) which reported late in 2009.  The paper discusses possible reforms intended to improve safeguards for non-professional investors.  However, the paper echoes sentiments of the CMDT, including placing considerable emphasis on designing a statutory scheme that makes New Zealand's securities markets more efficient and accessible for both investors and issuers, leading to more investment opportunities and giving businesses better access to debt and capital.  A spin-off could be that New Zealand's financial offerings, and the industry supporting those offerings, will be more internationally competitive.

The proposals dovetail with the establishment of the new Financial Markets Authority (FMA), which will replace the Securities Commission and a number of other agencies as the frontline securities market regulator.  The FMA is expected to be functioning by early 2011, prior to the implementation of most of the proposals in the paper.  The pace at which the FMA was announced and the establishment board appointed, and the relatively short turnaround of the CMDT's recommendations by the MED suggest that improving securities regulation is high on the government's agenda.  With the fallout from the 2008 financial market collapse still being played out in the media, there will be considerable political momentum for reform.

What is proposed?

Overall, the principles underlying current securities regulation are proposed to be retained.  That is, the scheme is intended to minimise the incidence of market failure by correcting the imbalance of information available to issuers on the on hand and less sophisticated investors on the other.  The failure of the market to value properly the risk of finance company debt leading up to 2008 is a commonly used example.  Despite this, few aspects of the regulatory regime for securities markets in New Zealand would be unaltered if the MED's proposals are enacted.

The proposals discussed in the paper are relatively complex, and we imagine that particular industry stakeholders will be keenly interested in the detail of most of the 200 page paper, however we have listed a few highlights of general interest below:

• Application of the regime and product categorisation  A broad definition of "Investments" is proposed to replace the concept of Security in the Securities Act.  The new regime will apply to transactions or products that fall within this definition.  Investments will be categorised as equity, debt, derivatives or collective investment schemes and the FMA will have the power to bring new products under these categories.  Categorisation will be based on the "economic substance" of the product, probably with reference to current accounting treatment of a product.  A product's categorisation will determine the initial and ongoing disclosure obligations of its issuer (among other things)
• Excluded transactions  Transactions which are not motivated by financial return or the hedging of financial risk will fall outside the regime (e.g. donations and other philanthropic "investments", club and society subscriptions, subscriptions for shares in certain co-operative companies, pre-pay cards etc).  The intention is to exempt such transactions from the regime altogether, subject to the FMA's power to designate specific transactions as falling within one of the investment categories
• Product specific exemptions  Most of the current exemptions of specific products or offers from certain procedures and documentation requirements of the Securities Act would be carried forward into the new legislation and in some cases clarified (e.g. shares in flat or office owning companies, professional practices, contributory mortgages, employee share purchase schemes, retirement villages, convertible securities, dividend reinvestment plans, previously allotted securities etc).  Licensed brokers might in some cases bear the regulatory burden for investments transacted through them (futures dealers, contributory mortgage brokers, peer to peer lending)
• Exempt offers  Existing statutory exemptions for offers to certain types of investors (wealthy, sophisticated, NZ$500,000 minimum investment etc) are likely to be retained in concept but enhanced by clarifying definitions and in some cases setting out procedures to give issuers reassurance that the exemption applies.  The paper discusses some significant new concepts including the possibility of exemptions from initial disclosure requirements for small offers (<NZ$2m and <20 persons over 12 months), for investments recommended by an independent financial adviser and a practical mechanism for investors to voluntarily opt out of some of the protective aspects of the regime.  The overall, and in our opinion correct, view of the MED is that the intention of many existing exemptions is unclear and as a result they are almost universally underutilised 
• Voidable issues  Another significant change discussed in the paper is a reversal of the current presumption that if an offer is received by a member of the public without there being a registered prospectus, it will be presumed to have been made to the public, with the consequence that the entire issue is void unless relief is granted by a court on application by the issuer (even if the issue is predominantly offered to "exempt" investors).  The option favoured by the MED is that an allotment is voidable in these circumstances, and at the insistence of the subscriber
• Prohibition on misleading and deceptive conduct  Irrespective of the procedures and forms that apply to a particular product, issuers and promoters will always be liable for false and misleading statements.  There is discussion as to whether that should extend to criminal liability where offers are made under the exemptions for investment businesses, sophisticated investors and large entities
• Registration  A new "Register of Securities" is proposed which will include a range of information and key documents and disclosure material relating to products and their issuers.  The paper also raises the possibility of a register of exempt investors to whom offers of securities may be made without complying with the prescriptive requirements of the Act
• Revamped offer documents  The paper discusses different approaches to the regulation of disclosure documents with a preference towards prescribing a general format of offer documents for each of the 4 "investment" categories
• MED proposes to address perceived problems with the present investment statement/prospectus requirements, including the tendency to mask pertinent risks and key terms with unnecessary statements, including statements motivated by a desire to minimise liability of promoters, and marketing "fluff".  MED favours a single PDS style document in 2 parts.  Part A would contain a brief (2 page), standardised summary of the terms and key risks of the product followed by more detailed information and analysis in Part B of the document.  The paper emphasises the need to make disclosure documents concise, and accessible to investors, and where possible to enable quick and easy comparison between products with similar characteristics
• Advertising  The MED favours a loosening of pre-prospectus advertising.  In particular, there is sympathy for issuers who may wish to adjust the terms of an offer in line with feedback from prospective investors following initial advertisements relating to the offer
• International standards  A common thread in the discussion document is the potential adoption of standards such as the International Disclosure Standards for Cross-border Offerings (IOSCO) and the potential adoption of the European Union Undertakings for Collective Investment Transactions (UCITS), which are seen as a pre-requisite for positioning New Zealand as an international financial services hub
• Collective Investment Schemes  It is proposed that managed funds, property syndicates, unit trusts and similar structures will be categorised as "Collective Investment Schemes".  A single regulatory framework will apply to these products, with specifically tailored disclosure documents. It is also proposed that Collective Investment Schemes follow a similar governance model comprising a "supervisor", a "fund manager" and in some cases a third party custodian.  Arrangements between the entities would be either standardised or subject to compulsory statutory safeguards.  This structure will be familiar to those involved with unit trusts.  A key proposal under consideration is the potential adoption of the UCITS as either the compulsory standard, or an option for New Zealand collective investment schemes.  This is seen as a prerequisite for the establishment of New Zealand as an international financial services hub.  This proposal would call into question the current role of security trustees which are not part of the UCITS model
• Enforcement  Several fairly radical suggestions for the enforcement of director's duties and related law are discussed, including the possibility of enforcement of breaches of directors duties by the FMA, a specialist securities tribunal and powers for the FMA (or a related rulings panel) to make binding rulings on securities related issues.  Changes of this nature could reduce the cost and time involved in enforcing securities law, and in practice could mean that the law is more often brought to bear on miscreant directors and others.

Putting together a submission

It is clear from the discussion paper that reform at some level is imminent.  The paper elicits discussion at a range of levels, from the underlying philosophy and principles of regulation, to the exploration of key concepts and regulatory mechanisms, right through to proposed wording that might make its way into the new legislation.  This creates opportunities for submitters to influence the law-makers before draft legislation is promulgated and the proposals become more concrete.  It seems likely that cogent arguments, backed by real world experiences, particularly with overseas regimes, will be well received and carefully considered. 

There will not be a better opportunity for stakeholders to influence the shape of the new legislation.  Issuers, professional investors and corporates with an interest in capital raising (whether from the public or privately) are encouraged to put their views to the MED in August.

We would be happy to assist you in formulating your submission, or to provide general advice on how to go about doing so, and we have a team of lawyers who are familiar with the discussion document and the underlying legislation - Sacha Judd, Simon Vodanovich, Sarah Roberts, Peter Owles, Gene Turner, Mark Odlin, Jeremy Blake, Ash Hill, Montie Baskett or Matthew Farrington.