REVIEW OF FINANCIAL REPORTING BY ISSUERS
CYCLE 7

Matters under other standards

111. The following matters were also raised with issuers in Cycle 7, either as a matter raised or as an other matter. In some instances the Commission wrote to more than one issuer on each of the matters.
     1. NZ IAS 1 in respect of:
        1. the current/non-current classification of liabilities (paragraph 60);
        2. the non-disclosure of the level of rounding used in presenting the amounts in the financial statements (paragraph 51(e));
        3. the non-disclosure of the identity of the parent and, if different, the ultimate parent of the entity producing the financial statements (paragraph 138(c));
        4. the non-disclosure of the total amount of donations made (paragraph NZ 105.2); and
        5. the non-disclosure of the nature of audit services (paragraph NZ 105.1(ii));
     2. NZ IAS 7 Statement of Cash Flows in respect of:
        1. the non-disclosure of the reasons for presenting cash flows on a net basis (paragraph NZ 24.1); and
        2. the inclusion of a non-cash item in the Statement of Cash Flows (paragraphs 43-44);
     3. NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets in respect of:
        1. the recognition of provisions that might not meet the definition of a provision (paragraph 14); and
        2. possible non-disclosure of material provisions separate from other provisions (paragraph 85);
     4. NZ IAS 38 Intangible Assets in respect of the possible non-disclosure of the aggregate amount of research and development expenditure recognised as expense during the year (paragraph 126);
     5. NZ IFRS 2 Share-based Payment in respect of the possible non-disclosure of information relating to:
        1. the number and weighted average exercise prices of share options and the number of share options outstanding at the end of the period (paragraph 45);
        2. the expected volatility of the fair value of the share options (paragraph 47(a));
     6. FRS-10: Statement of Cash Flows in respect of:
        1. possible incorrect classification of investing and financing cash flows as cash flows from operating activities (paragraphs 4.7, 4.10 and 4.15); and
        2. non-disclosure of the reasons for presenting cash flows on a net basis (paragraph 5.33);
     7. SSAP-18: Accounting for Leases and Hire Purchase Contracts in respect of:
        1. the possible non-disclosure in the books of the issuer as lessor of the unguaranteed residual values of leased assets (paragraph 5.18); and
        2. the non-disclosure of certain information in the financial statements of the issuer as lessee, including significant financing restrictions, classification of lease liabilities by periods, and the disclosure of finance charges relating to lease liabilities separate from lease and rental charges on operating leases (paragraphs 5.14 and 5.15).
112. In relation to finance companies there was also non-compliance with other standards. These included:
     1. the non-disclosure of information from which it is possible to identify and evaluate the entity's exceptional risks of operating (FRS-9, paragraph 8.14);
     2. the possible incorrect classification of operating lease assets as lease receivables rather than as fixed assets in the books of the lessor (SSAP-18 and FRS-3: Accounting for Property, Plant and Equipment); and
     3. the inconsistent and unclear current/non-current classification of financial assets between the financial statements and in the notes.
113. There were also two issuers whose financial statements contained inconsistencies. One related to applying a depreciation accounting treatment that was inconsistent with its stated accounting policy. Another issuer's financial statements had numerous typographical errors. The Commission considers it unacceptable that the financial statements of a public issuer should contain such errors and inconsistencies. The Commission urges all issuers to ensure that their financial statements are properly reviewed before publication to avoid the impression that other aspects of the financial statements might also contain errors and inconsistencies.

Interim financial statements of finance companies

114. In Cycle 7 the Commission selected five finance companies that had published interim financial statements that were prepared for the first time under NZ IFRS. The Commission was interested to preview the quality of finance companies' financial statements, particularly in relation to NZ IFRS 7 disclosures.
115. Overall, the quality of disclosures of the five companies was mixed. The Commission was prompted to write to two of the five companies. The matters raised in relation to another finance company are being considered as part of the Commission's enforcement work on finance companies.
116. The Commission wrote to the two finance companies relating to the completeness of disclosures in their interim financial statements on the following matters:
     1. NZ IFRS 7 relating to the non-disclosure of:
        1. fair value of collateral held (paragraph 15(a));
        2. concentrations of funding (Appendix E, paragraph E11(a));
        3. priority of creditors' claims (Appendix E, paragraph E4);
        4. credit risks (paragraphs 34, 36 to 38 and Appendix E, paragraphs E5 to E7 and E17); and
        5. methods and assumptions used in sensitivity analyses (paragraph 40);
     2. NZ IAS 39 relating to:
        1. incorrect accounting policy adopted to account for available-for-sale financial assets (paragraphs 55(b) and 67 to 70);
        2. incorrect accounting policy adopted for loans and receivables (paragraph 46(a));
        3. incorrect accounting policy adopted for held-to-maturity investments (paragraph 46(b));
        4. trade date vs. settlement date accounting (paragraph 38); and
        5. absence of an accounting policy for derivative financial instruments (paragraphs 85 to 101); and
     3. Other standards relating to:
        1. NZ IAS 24 - non-disclosure of key management personnel information and the sale of investments to a related party;
        2. NZ IAS 1 - non-disclosure of gain on sale of investments;
        3. NZ IFRS 1 - non-disclosure of the effect of transition to NZ IFRS (equity); and
        4. NZ IAS 27 Consolidated and Separate Financial Statements - unclear policy on consolidations.
117. Agreement was reached with the finance companies on 14 out of the 15 matters written. The remaining matter was closed off through a second letter reiterating the Commission's comments. The Commission will assess whether the appropriate disclosure is made when the issuers are reviewed again in the next round of reviews.
118. The Commission took no enforcement action in relation to these matters as they related mainly to incomplete disclosures. They did not cause the financial statements to be misleading.
119. The Commission is concerned to note the response from one of the issuers that their internal systems are not set up to capture some of the information required under NZ IFRS 7. (This is discussed further in paragraphs 184 to 187.)
120. NZ IFRS 7 requires entities to report summarised information based on that used internally by management to manage financial instrument risk. This includes both qualitative and quantitative information. The Commission notes, while the issuers included qualitative information, there was a tendency amongst the issuers to report similar information, particularly quantitative information, as reported under previous NZ GAAP. Issuers should note that this will not meet the requirements of NZ IFRS 7 in a number of instances. This is evidenced by the numerous other matters that were raised with two finance companies.
121. The requirements in these standards, both qualitative and quantitative, are particularly relevant to a financial institution and are necessary to ensure that the core activities and transactions of a finance company are explained, recognised, measured and presented for the information of users.

Auditors' reports and audit firm referral

Other services provided by an auditor

122. In past Cycles the Commission had written to issuers about not disclosing, or not separately disclosing, in the financial statements fees paid to auditors for services other than audit services as required by FRS-9 (paragraph 6.13) or NZ IAS 1 (paragraph NZ 105.1).
123. However, in Cycle 7 the Commission wrote to two auditors about the disclosure in their respective audit reports that they had no other relationship with the issuers or any of their subsidiaries other than in their capacity as auditor. In both cases the issuers' financial statements made the necessary disclosures about the nature of the relationship and the amounts involved. However, the audit reports omitted the disclosures.
124. The Commission drew the auditors' attention to paragraph 25(e) of New Zealand Auditing Standard AS-702 The Audit Report on an Attest Audit. The Standard requires auditors to make a statement as to the existence of any relationship, other than that of auditor, between the auditor and the entity in their audit report.
125. In both cases the auditors agreed to ensure better disclosure in future.
126. The Commission considers it important for auditors and issuers to ensure that there is disclosure of all fees paid to the company's auditor. It is important that there is transparency in the types of services (other than audit services) and the related fees that are paid to an entity's auditor. The provision of other services, particularly where the amounts involved are large in relation to the total fees paid to an auditor, could compromise an auditor's independence in carrying out audit work.

Referral of audit firm

127. The Commission has referred an audit firm to NZICA for it to consider if there is sufficient independence between the audit firm and two related issuers that it had audited.
128. The Commission was concerned with a possible threat to the independence of the audit firm. The Commission considered that the size of the audit fees paid by the two related issuers together in relation to the size of the audit firm raises the question of whether the total fees generated by the audit firm from the issuers represented a large proportion of the firm's total fees. There is a concern that there might be an undue dependence on the issuers by the audit firm that could create a self-interest threat on the part of the audit firm.

Market matters

129. The Commission raised several matters relating to disclosures of substantial security holder information, directors' interest, and director share dealings with issuers.

Substantial security holder information

130. Section 35F of the Securities Markets Act 1988 requires every public issuer¹⁰ that is a company to send a notice to each of its shareholders with or in its annual report (sent under section 209 of the Companies Act 1993) or, in a notice sent under section 209, stating the following:
     1. the names of all persons who, according to the file kept under section 35C of the Securities Markets Act, are substantial security holders in the public issuer at the record date¹¹ ; and
     2. the number and class of voting securities of the issuer (as per the register) which forms part of each substantial holding in the issuer as at the record date; and
     3. the total number of each class of the issuer's listed voting securities as at the record date.
131. For every other public issuer, the information is to be sent not later than 30 June in each year.
132. The Commission wrote to four issuers about their non-disclosure or inadequate disclosure of substantial security holder information. These related to:
     1. the number of substantial security holdings disclosed in the annual report being inconsistent with those in the notice filed with NZX;
     2. no substantial security holder information being disclosed in the annual report in respect of some substantial security holders;
     3. no substantial security holder notice being filed with NZX; and
     4. non-disclosure in the annual report of the date of the substantial security information and the total number of voting securities in the issuer.
133. The Securities Markets Act imposes certain obligations on a person who is a substantial security holder in a public issuer. A substantial security holder is a person who has a relevant interest in the listed voting securities of a public issuer that comprises 5% or more of a class of listed voting securities of the public issuer (section 21(2)). The substantial security holder is required to disclose changes in that relevant interest (in number or nature) to the issuer and to every registered exchange on which the securities of the issuer are listed (sections 23 and 24).
134. The primary obligation is on the substantial security holder to file such notices to ensure that the market is kept informed at all times, but the Securities Markets Act also imposes obligations on the public issuer of the securities. Section 35C of the Securities Markets Act requires the issuer to maintain a register of substantial security holder notices received.
135. Two out of the four issuers written to confirmed that their annual reports contained errors or omissions relating to the disclosure of substantial security holder information and committed to make the necessary corrections. Matters relating to two other issuers were resolved. In one instance, and in relation to one of the matters resolved, the issuer clarified that a substantial security holder's holdings was not required to be disclosed in the annual report as the holdings were held in the name of a trust which complied with the substantial security filing requirements and whose holdings were disclosed in the annual report (Securities Markets Act, section 30).
136. The Commission wrote to two substantial security holders in an issuer who had not disclosed their substantial security holdings to the issuer or to NZX. They assumed that they were exempted under section 30 of the Securities Markets Act from the disclosures. This was because a substantial majority of those shares were held by related trusts that had complied with the substantial security filing requirements.
137. Section 30 of the Act states that a person (A) need not comply with any of sections 22 to 25 of the Act in relation to a substantial holding in a public issuer if another person is required to comply and does comply and that person (A) has that substantial holding merely for one or more of the reasons in section 30(b).
138. In this case, however, the relevant interests of the two substantial security holders were not held merely for one or more of the reasons in section 30(b). As such, the section 30 exemption did not apply to their substantial holdings. Both substantial security holders have now made the necessary disclosures to the NZX and to the issuer.
139. The Securities Markets Act provisions relating to substantial security holder disclosures were amended by regulations approved by the Cabinet on 3 December 2007. These regulations came into force on 29 February 2008 and are explained on the website www.newsecuritieslaw.govt.nz.
140. The failure to comply with substantial security holder obligations is now a criminal offence, subject to a fine of up to $30,000. Civil penalties of up to $1 million can be imposed by the Court, which can also make a range of orders relating to any holding of securities, including orders to forfeit or dispose of securities.
141. The Commission reminds issuers to take their obligations under the Securities Markets Act seriously, notwithstanding that the primary obligation for such disclosures is on the substantial security holders. Issuers should ensure their annual disclosures are accurate and comply with the Securities Markets Act. The Commission intends to review these disclosures more closely in future and take action where appropriate.

Directors' interests and share dealings

142. The Commission wrote to five issuers in relation to the non-disclosure or inadequate disclosure of directors' interests and share dealings in their annual reports as required by the Companies Act, the Securities Markets Act and NZX Listing Rule 10.5.3(c).
143. The Commission wrote to the five issuers on the following matters (some issuers had more than one matter raised with them):
     1. the non-disclosure of directors' share dealings in the annual report;
     2. the inconsistent disclosure of total share holdings between the current and previous annual reports without any disclosure of share transactions having taken place during the year;
     3. the non-disclosure of shares issued and date of issue to directors in lieu of directors' fees in the annual report;
     4. the non-disclosure of consideration paid or received for directors' share dealings;
     5. the inconsistent disclosure of the total number of shares held by a director between the annual report and the notice filed with the NZX; and
     6. the non-filing of NZX notices for changes in the holdings of persons associated with the directors.
144. The Commission also wrote to an issuer on three instances of typographical errors in the information on directors' interest and share dealings.
145. In all instances, the issuers agreed that their annual reports contained the errors that were drawn to their attention.
146. The Companies Act (section 211(1) (e)) requires that the annual report of a company states the particulars of entries in the interests register made during the accounting period. Section 148 of the same Act requires directors to disclose their share dealings to the Board and ensure that those disclosures have been entered into the company's interests register. The Securities Markets Act (section 19U) also requires the directors of the issuer to disclose their relevant interests and acquisitions or disposals in the interests register.
147. NZX Listing Rule 10.5.3(c) requires the annual report of a company to contain the information required by section 211 of the Companies Act.
148. In disclosing the particulars of the interests register, as required by the Companies Act, the issuer is required to state the following (section 148(2)):
     1. the number and class of shares in which the relevant interest has been acquired or disposed of; and
     2. the nature of the relevant interest; and
     3. the consideration paid or received; and
     4. the date of the acquisition or disposal.
149. Many of the above matters related to less than full compliance with all the requirements of the law. The Commission reminds issuers to ensure that all aspects of these requirements are complied with.

Update on enforcement of a market matter

150. During Cycle 5 a matter related to a suspected breach of continuous disclosure provisions of the Securities Markets Act was removed from the FRSP and treated as an enforcement matter. This inquiry has been concluded and no further action taken.