Speeches: New Securities Law - About to Come Into Place

New Securities Law - About to Come Into Place

Neville Todd, Member of the Securities Commission
Speech to

Financial Markets Operations Association 2007 Conference
Wellington
Member of the Securities Commission
9 November 2007

Thank you for this opportunity to speak at your conference today. The Commission is always pleased to have the chance to meet people who are involved in the securities markets.

The Commission's job is to promote the efficiency and integrity of securities markets, and to ensure that regulation is cost-effective. Ultimately, our purpose is to strengthen market confidence and thereby foster capital investment in this country.

Our securities markets have undergone rapid development in the past few years. Along with this we have seen a number of changes to the regulation of the securities markets. Today I want to briefly summarise the changes that we have seen in the past seven years, and outline in more detail the most recent changes, which we expect to see in place before the end of this year.

These reforms are intended to boost confidence in our markets. They will require operational changes from some advisory firms, fund managers, and other market participants, to ensure that systems and procedures are sufficiently robust to meet the standards expected in a well-regulated market.

Since 1978 New Zealand has developed a framework of securities regulation based on disclosure of information to investors and the market. These rules have covered:

As a general rule, New Zealand has not imposed industry or occupational licensing on securities market participants.

New Zealand's approach to securities market regulation has been relatively light-handed compared with some of our major economic partners. This was seen as appropriate given the small New Zealand market and the high burdens that can be imposed by compliance costs.

As we entered the 21st century, New Zealand's light-handed regulation was no longer appropriate as technology made traditional national boundaries irrelevant and securities markets became global. To attract investment, and to be accepted in the international financial community, New Zealand needed to have regulation that aligned with similar jurisdictions overseas.

Law reforms were necessary, and were introduced. The emphasis was still on disclosure so that markets are fair and transparent, and investors can compare investment offers and have the information they need to make good decisions. However, there have been significant changes to the ways our laws are enforced.

A consistent theme of the recent reforms has been a move towards public enforcement of our securities laws by the Securities Commission. Where previously the law had largely left it to investors to pursue remedies or civil penalties for breaches of the law, the Commission can now take Court action itself, where it believes this is in the public interest.

Three major law reforms since 2000 have developed New Zealand's regulatory framework and brought it into closer alignment with international expectations. A fourth reform package, currently in the pipeline, is expected to complete that process.

The first reform was the adoption of the Takeovers Code in 2000. The Code ensures that all shareholders in a public company take part in any offer to take over that company.

The Takeovers Code is enforced by the Takeovers Panel, which is a separate independent agency. Like the Securities Commission, it is made up of Members with extensive market experience.

The Takeovers Panel is quite independent of the Securities Commission, however, its staff, premises, and administrative support are provided by the Commission, under a memorandum of understanding. Funding for this is obtained directly by the Panel, and paid to the Commission.

The second reform came in 2002, with the Securities Markets and Institutions Bill. This arose from the demutualisation of the New Zealand Stock Exchange. The NZSE was demutualised in 2002 after a Private Bill was passed by Parliament.

While that Bill was being examined by the Parliamentary select committee concerns were voiced by submitters that the future of New Zealand's national exchange raised important questions of public interest.

The third significant reform was the Securities Legislation Bill, passed in October last year which amends the Securities Act and the Securities Markets Act. Most of this legislation will take effect later this year, once regulations have been completed.

This new law makes important and wide-ranging changes, and I want to spend some time outlining these to you. The main changes are:

The new insider trading law focuses on the threat that insider trading poses to market integrity. Anyone who has inside information, regardless of their connection to the company, will be an "information insider".

An information insider is someone who has material information about a public issuer that is not generally available to the market, where the person knows or should know that the information is material and is not generally available.

Material information is information that would be expected to materially affect the issuer's share price if it were generally known.

Information insiders must not trade in securities, disclose the information to others to trade on, or advise or encourage anyone else to trade or hold securities.

Anyone who breaches the new insider trading law will be liable for substantial civil penalties, which will be sought by the Commission. The maximum penalty in any case will be the greater of:

For the first time in New Zealand, insider trading will be a criminal offence. Anyone convicted could face up to five years imprisonment or a fine of up to $300,000 for an individual and $1 million for a body corporate.

There are a number of exceptions and defences to liability, designed to encourage legitimate trading activity. These include:

Another change is that the safe harbour under the current law, for company directors and employees who trade in shares of the company under an approved procedure, will not be available under the new law.

The removal of this safe harbour is consistent with the focus of the new law, which views insider trading as harmful to the market as a whole rather than mainly to the company involved.

Directors and employees will still be able to hold shares in their companies. They will not have such broad immunity from insider trading law, but there will be a defence from liability if they trade securities under a trading plan.

To qualify for this defence the person must have entered into the trading plan at a time when he or she did not have inside information. The trading plan must be for a fixed period during which the investor has no right of withdrawal and no input into trading decisions.

The Commission has emphasised the importance of good information control for some time. It has published reports on this, including after its inquiry into trading in Wrightsons shares in 2005.

With increased enforcement powers for the Commission under this new law it will be all the more important that firms to ensure that they have good internal controls to limit the likelihood of insider trading.

They should also have robust Chinese walls between research, investment banking, and advisory groups, to prevent unauthorised transfer of price sensitive information. Operations staff will have important roles in implementing these controls.

The law on market manipulation is new to this country. Market manipulation is behaviour or practices likely to give a false or misleading impression about the supply, demand, price or value of securities traded on a registered exchange.

Any trade that does not result in a change of beneficial ownership will be presumed to give a misleading appearance of trading activity, unless it can be shown that the transaction took place for a legitimate reason. This also applies where a person places matching buy and sell orders for a security.

Civil penalties and criminal offence provisions for breaching the market manipulation laws will be the same as those for insider trading.

There is also a broad-ranging prohibition against any conduct related to any dealing in securities that is likely to mislead or deceive. This is similar to the prohibition in the Fair Trading Act 1986 for misleading or deceptive conduct.

Anyone who engages in misleading or deceptive conduct can be subject to prohibition or correction orders made by the Securities Commission and can be liable to pay compensation to anyone who suffers loss as a result of the conduct.

Substantial security holder disclosure aims to promote an informed market and to deter insider trading, market manipulation, and secret dealing in potential takeover bids. This is achieved by ensuring that all market participants have information about trading by persons who control or influence significant voting rights in a public issuer.

However, there have been some important changes. These include that a person becomes a substantial security holder by having a relevant interest in 5% of the listed securities in any class (rather than 5% of the total number of voting securities of an issuer).

Also, disclosure applies to listed voting securities only, not to unlisted securities; but the Securities Commission can require any person to disclose the nature and extent of any relevant interests in securities of a public issuer, including unlisted and non-voting securities.

The form for substantial security holder disclosure is also being redesigned, to simplify disclosure and to promote electronic disclosure of holdings. The new form will be available when the regulations come into effect, and firms will need to make sure they are up to speed with this change.

Failure to comply with substantial security holder obligations will be a criminal offence, with a fine of up to $30,000. Civil penalties of up to $1 million can be imposed by the Court, which can also make orders relating to any holding of securities, including orders to forfeit or dispose of securities.

The Commission also gains new administrative powers to prohibit or require correction of substantial security holder notices.

New Zealand has had laws requiring disclosure by investment advisers and brokers since 1996, but there has been no ability for the Commission to enforce this law, and most disclosure had to be given to investors only on request.

The new disclosure laws require more information to be given to clients, especially about fees and remuneration. Full disclosure must be made up-front by investment advisers before investment advice is given to members of the public and by investment brokers before receiving investment money from members of the public.

The disclosure is mandatory. It must be made in a disclosure statement, and provided without the client having to ask for it.

The more extensive information required about fees, commissions and other remuneration will extend to any benefits to be received by the adviser, whether from the client or another source, and include "soft" commissions and indirect benefits relevant to the advice being given to the client.

Disclosure statements must be kept up-to-date and must not be deceptive, misleading or confusing.

The new law also brings in rules for advertisements made by investment advisers and brokers. The term "advertisement" is broadly defined. Any form of communication can be an advertisement (as is the case under the Securities Act).

The law applies to advertisements for adviser services and to any communication by an adviser that contains or refers to investment advice.

Advertisements are likely to include newsletters, seminar presentations, paid advertising in newspapers, TV, or radio, and radio and TV broadcasts containing investment advice or promoting securities.

Advertising must not be deceptive, misleading, or confusing. Any advertisement for an adviser's or broker's services must say that a disclosure statement is available, on request and free of charge.

Misleading disclosure statements or misleading advertising will attract criminal penalties of up to $300,000. Further penalties of up to $10,000 per day can be imposed where offending

Lastly, it will be an offence to recommend an illegal offer of securities. The Commission recommended this in February 2002 and is pleased that it has finally become law.

There are substantial penalties for anyone who recommends an offer that does not comply with the law, and if they should have known that the offer was illegal they can face criminal charges. This doesn't mean that every investment adviser has to be a specialist in securities law, but it does mean that firms should ensure there are controls in place on the products being promoted by their advisers.

The Commission will have the power to enforce the new requirements and make prohibition orders, corrective orders, disclosure orders and temporary banning orders. The Courts will be able to make orders banning people from acting as investment advisers for up to 10 years.

The last parts of the reform programme are a wide ranging review of the laws regulating how various types of securities are offered to the public, and a review of the regulation of financial advisers.

The review of financial products and providers is likely to introduce changes relating to:

The Government has recently announced the results of the first of these reviews, which will see tighter controls on non-bank deposit takers, including credit ratings and more consistent trust deed covenants. The other reforms are still work in progress, and will continue over the next year or so.

There have also been announcements from the government about financial advisers. The intended reform is a co-regulatory regime for financial advisers. Investment advisers and others would be subject to supervision by one or more professional bodies, and these in turn would be accountable to the Commission.

This will create a significant role for "self regulatory organisations". They would need the knowledge and experience to set and monitor high standards of professional competency and conduct. The Commission's role would be to supervise and to enforce advisers' legal obligations - somewhat similar to the co-regulatory regime now operated with NZX.

Legislation for financial advisers will probably be introduced very soon. However, the extent of the changes to this industry makes it likely that the actual reforms will take a few years to come into force.

Each of the reforms since 2002 has strengthened the Commission's ability to enforce securities law through investigation, the making of orders, and taking civil proceedings in the High Court.

For example, we used grounds provided by the 2002 law change in the Tranz Rail insider trading action in 2004. This case settled earlier this year, with around $27 million available as compensation for shareholders.

Since 2002, we have also had powers to accept "enforceable undertakings" from companies and individuals who agree to remedy breaches of securities law. This avoids the time and expense of court action. However, the Commission retains the ability to take Court action later if necessary.

The latest reforms extend the penalties for breaches of the law. The Commission will be able to seek pecuniary penalties for serious breaches, compensation for losses suffered by investors, and management banning orders against individuals. We will have powers to make prohibition, corrective or disclosure orders in regard to market manipulation and disclosure.

Seven years ago, before these reforms began, the Securities Commission had a staff of around 14. With the added responsibilities since then we now have around 40. Today, our staff monitor market conduct and probe particular matters knowing that enforcement options are available to us.

We have a dedicated litigation fund that gives us the confidence to pursue investigations knowing we will be able to see a matter through. This is in contrast to a decade ago when the Commission's role was largely confined to review and comment on market trends and poor behaviour. It did not have the financial and legal resources to initiate further investigations or to directly pursue legal remedies. That was left to market participants to rely on competitive market disciplines or take their own court actions.

The Commission has always had powers to cancel false or misleading prospectuses and advertisements for securities offered to the public. And it can grant exemptions from compliance with securities law where unwarranted constraints or costs would be incurred.

Exemptions are always granted subject to conditions, which usually relate to providing investors with the information they need to make an informed decision on whether or not to invest. These powers vested in the Commission reflect the importance of well-informed securities markets and cost-effective regulation.

Although we have had major reforms of the law, there has been little change to the principles on which New Zealand securities regulation is based. We still focus on information and disclosure to investors, and on the open and fair operation of securities markets.

One driver for reform has been frustration - frustration with gaps in securities law and enforcement mechanisms that often proved ineffective. Another driver is globalisation and rising international standards in securities regulation.

Capital markets are global. Companies everywhere raise funds across national borders. Investors, large and small, increasingly allocate their capital outside their home countries, and that can be very positive for economic growth and prosperity.

We must recognise certain global realities for New Zealand. To attract investment to New Zealand there must be strong confidence in our markets - and that confidence depends on the international credibility of our regulatory regime.

The first important event to that end was a review of New Zealand's financial regulatory system by the IMF and World Bank in 2004. This was carried out under the Financial Stability Assessment Programme - known as FSAP - which benchmarks the laws, regulatory practices and institutions of a jurisdiction against global standards.

Fortunately, the reviewers took into account the 2002 Securities Markets and Institutions Bill reforms that were then in the pipeline. New Zealand was found to largely comply with the international benchmarks.

However, to no-one's surprise, the FSAP identified the regulation of financial intermediaries and collective investment schemes as areas where this country lagged behind. These are being addressed in the current reform proposals.

A second thrust to promote New Zealand as a market that is good for investment is through the Commission's association with international agencies. In particular, the Commission is a long time member of the International Organisation of Securities Commissions, IOSCO.

IOSCO is the global standard setter for securities regulation. Its members come from more than 100 countries and regulate over 90% of the world's securities markets.

IOSCO promotes consistently high standards of market regulation worldwide. It is a highly proactive body that identifies regulatory issues as they appear and delivers solutions in the interests of investor protection, and market efficiency and fairness.

New Zealand has been an active member of IOSCO for many years. In 2004, Jane Diplock was elected Chairman of the IOSCO Executive Committee - the decision-making body. Last year she was re-elected for a further two years.

This is not simply a personal honour, more importantly, it signals that New Zealand is a well regulated market in which investors can have confidence. It also enables New Zealand to "have an effective say" at international levels on regulatory matters.

New Zealand has come a long way on securities regulation in recent years. Major law reforms - the latest due to come into effect soon - have clarified our regulatory framework and made enforcement more effective.

The Securities Commission has increased responsibilities and powers, and is committed to using those powers proportionately to the risks and costs in any particular situation.

These changes are good for New Zealand's markets, and for the country's international reputation. However, reforms on this scale always bring practical challenges for all those involved in implementing them. As the Commission's staff has almost tripled in the last 7 years we have a very good understanding of this.

The fact that the reforms have taken place in several stages has helped the market, and us, to take a step-by-step approach to the parallel changes that are needed to implement the new standards.

The Commission is helping market participants to come up to speed with the recent changes by an education campaign for those who will be affected by the changes - investment advisers and other market participants.

Once the regulations for the new law are settled we will publish a guide that will explain the new law in plain-language. We have set up a new website, where you can register to be alerted of changes and updates, and to receive a copy of the guide when it is published. This website is www.newsecuritieslaw.govt.nz.

The work of industry bodies such as FMOA is very important to provide information and training so that your members and their firms are aware of the new law, and ready for the changes it entails.

These changes will be implemented most efficiently if firms in the market have effective internal operations that raise awareness and streamline procedures for the front-office staff.

These operational measures help raise a firm's standards of compliance. They are vital to give management and directors the assurance they need that the firm, as a whole, is ready to do business under the new rules.