Speeches: Securities Commission and Corporate Governance


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Securities Commission and Corporate Governance

KPMG Directors' Breakfast -Christchurch
Jane Diplock AO
Chairman New Zealand Securities Commission
Executive Committee, IOSCO

3 September 2008

Introduction

Good morning. Thank you for coming along this morning. I very much welcome the opportunity to talk to you all. This breakfast provides a setting for some useful dialogue on matters of interest to us all.

The last year has seen a significant credit crunch in New Zealand markets and world wide. The collapse of finance companies started as a domestic issue but has been compounded by the international financial environment as the effects of the sub-prime crisis, which commenced in the US mortgage market, have reverberated around the world. The reduction in liquidity, combined with declining economic conditions and a falling New Zealand property market, began to influence the New Zealand capital market more generally.

It is not only our job to regulate the market and enforce the securities laws but also to consider the interests of the business community. We work hard to formulate cost effective regulation, and it is important for us to share thoughts on this with you at these sorts of forums.

Today I take the opportunity to share with you some of what the Commission has been doing and what it intends to do to strengthen market confidence and foster investment in New Zealand.

Corporate Governance

I'm going to start with issues around corporate governance, a topic I am sure is of acute interest to you all. International research shows that fundamental aspects of corporate governance can play a key role in corporate performance. At the Securities Commission we have seen many examples which support this theory. Most cases of corporate failure and breaches of securities law are in the Commission's view at least partly attributable to a failure of governance at some point. Certainly in the work we have been doing recently in relation to failed finance companies we have seen many examples of what we consider to be poor governance.

Stepping back in time for a moment, in New Zealand, the Securities Commission published a set of principles to give guidance to the market in February 2004, entitled Corporate Governance in New Zealand-Principles and Guidelines. The intention was to contribute to high standards of corporate governance in New Zealand, to be achieved when directors and boards implement the Principles through their structures, processes, and actions, and demonstrate this in their public reporting and disclosure.

The Principles were developed taking into account the views expressed during an extensive process of public consultation. The Commission was assisted by other work done in New Zealand, in particular by NZX Limited, the Institute of Directors, and the New Zealand Institute of Chartered Accountants. It also drew upon international developments, particularly from the OECD, and in Australia, the United Kingdom, and the United States. The Principles are consistent with international best practice and reflect the views of most people who took part in the project.

The Commission's corporate governance principles are intended to apply to entities of all types not merely issuers or listed companies. They are not part of the law. Extensive consultation indicated to the Commission a definite lack of appetite in New Zealand for law based rules on corporate governance.

Implications of poor corporate governance

Breaches of the Principles of good corporate governance do not of themselves always constitute a breach of the law, as the laws relating to this field are specifically addressed in the New Zealand Companies and Securities legislation. However poor corporate governance does very often directly or indirectly result in situations where the law is found to be breached. Indicators of poor corporate governance include directors not having adequate control of a company, not putting in place adequate systems to control the company, or failing to keep an adequate eye on executives and staff. The consequences of these inadequacies can lead to criminal or civil liability in terms of the legislation.

Directors need to be as informed as they can be about their roles and responsibilities and ensure they have effective systems in place to control and guide the company. This is important as it not only impacts the performance of the company but also the potential personal liability of the directors. At this point I should also note that there is no distinction in the law between executive and non-executive directors. Rules apply to both equally.

Turning to the events of the past year, as I mentioned we have seen instances of poor corporate governance in failed finance companies. There is no common thread across all finance companies, but there are a range of aspects where good governance was lacking. As you will appreciate with investigations underway I cannot be specific but I would like to share with you some general themes evident in the troubled finance companies.

Finance Company Failures and Corporate Governance

These have included the failure to ensure that disclosure and financial reporting were accurate, particularly as to related party lending and/or asset quality.

We have seen situations of companies which were poorly capitalised; which had no liquidity buffer for a downturn.

We have seen some fairly heroic valuations in a declining market. While directors are entitled to receive and rely on expert advice, I don't believe they should do so blindly. Directors need to critically assess valuations and other external reports and exercise common sense and good judgement.

There have been instances of too few directors, even sole directors, and times when there were no independent directors on the Boards of these companies. In some cases independent directors failed to ensure they were adequately informed or took insufficient interest in the business.

Sometimes we have seen an ineffective (or no) audit committee. We have seen the poor handling of growth or expansion of the business. There has been an evident failure to recognise or act on warning signs in a timely manner

We are not saying that finance company failures have been solely due to poor corporate governance. But in our view, this has been a contributing factor in many cases.

The Commission's actions

As I mentioned, poor corporate governance does very often directly or indirectly result in situations where the law is breached. Where breaches of the Securities Act occur the Commission will take action, and I'd like to take a moment to review the work we have done in this sector.

The Commission has been extremely energetic in pursuing those who appear to have breached the law in relation to these companies and has cooperated with other regulators to an unprecedented degree. We are determined to ensure that those whose actions have led to investor losses and to the ensuing loss of confidence in the market are brought to account. Where companies had offer documents registered or advertisements distributed after October 2006 the Commission has the powers to take civil actions under the new law that came into force in February. We can apply to the court for pecuniary penalty orders and in some circumstances orders to compensate investors.

Recently the Minister of Commerce announced her agreement to the Commission using its litigation fund for criminal prosecutions under the Securities act, as well as for civil action.

We are working closely with the Register of Companies to progress criminal proceedings in a number of cases. Investigations into collapsed finance companies remain high on our enforcement priorities. Over 150 charges have been laid against the directors and others involved in failed finance companies and there are more to come.

To date, charges have been laid under the Securities and Companies Acts against Bridgecorp Limited and its executive directors, Rod Petricevic and Robert Roest. Bridgecorp through its receivers has pleaded guilty to breaches of the Securites Act. Mr Petricievic has been declared bankrupt on application by the receivers. Also, charges have been laid against the directors of Five Star Finance limited and Five Star Debenture Nominees Limited for issuing debt securities without a registered prospectus.

While there is a great deal of work currently underway which cannot yet be brought into the public arena, I am able to share with you some details.

There are currently 4 investigations completed which are with the Crown Solicitor for advice on prosecution, and we anticipate further charges will be laid in the next few weeks. Another 4 are at interview stage and 5 more are well advanced. These numbers are impressive but there are many more matters in the pipeline. The Commission is looking at all finance companies which have run into difficulties, including those in moratorium. While from the outside it may look as if little is happening let me assure you the work pace is intense and the results are rapidly emerging.

Our Role and Impact

I would like to make the point here that no regulatory framework can or should prevent failures. Where there is a poor business model, or fraud, no regulatory framework will save a business. Similarly where there is poor corporate governance, poor risk assessment or poor capital management, businesses will fail.

Our task is to ensure that risks are properly disclosed so that the prudent investor can assess the risk in light of the return that is offered.

There has been some criticism that regulators didn't warn of the impending failure of some of these companies. Our regime on these companies relies on disclosure. The regime relies on the directors of finance companies to ensure that offer documents contain all information material to the securities being offered and that the advertising does not mislead, deceive or confuse investors. The Commission did offer warnings about risk and return and advised investors to look closely at the risks involved. We wrote to all finance companies to require them to confirm that their prospectuses were still accurate. If in our investigations we discover untruths in their responses to us, or in the information they gave investors, we will take enforcement action.

Finance company collapses in the past year or so have illustrated the need for a comprehensive regulatory framework. Over recent years the government has undertaken a series of reforms affecting securities markets which aim to bring New Zealand's regulatory framework up to the standard that is needed in order to strengthen confidence in the market.

Other priorities- Reforms

Laws in New Zealand have come a long way. We now have a regime which is fast approaching international best practice.

In February this year, new laws requiring increased disclosure by financial or investment advisers came into force. This new disclosure regime is an important step in the right direction. To enforce the law the Commission has also been given new powers which allow us to take both administrative and Court action against breaches of the law.

As part of our surveillance and enforcement role we wrote to over 1400 investment advisory firms and advisers, in March, requesting copies of their disclosure statements. We received over 2000 documents and have been taking a triage approach to assessment of the responses so that our resources are well targeted. However, we will not hesitate to take enforcement action on unacceptable standards of disclosure. Interestingly, and encouragingly, our early analysis indicates quite a high level of compliance.

Other laws that came into force in February included tightening of insider trading and substantial security holder disclosure, and new law on market manipulation. Our surveillance and enforcement work in these areas is ongoing. This year we also completed the third annual oversight review of NZX's performance of its regulatory functions and the 7^thcycle financial reporting surveillance programme. Our surveillance programme has received positive feedback for its use as a training tool for directors and auditors. We are pleased to report on the generally good standard of reporting by listed issuers.

I have already mentioned some of the changes that came into force recently. Several important reforms are still underway. The Commission is providing advice to the government in developing the new regulations.

One of the main reforms before the Select Committee is the Financial Advisers Bill. This Bill addresses a shortcoming pointed out in the Financial Sector Assessment Programme carried out by IMF in 2003. It is an important reform for retail investors and consumers.

The proposed Bill will aid investor confidence in seeking advice on investments from financial or investment advisers by making advisers more accountable.

Advisers should be able to understand offer documents and have detailed knowledge of the products which they advise their clients about. Investors will be able to have the confidence that the advisers are subject to ongoing professional conduct and proficiency standards.

Other important areas of reforms are policy on deposit takers and regulation of collective investment schemes. We are also working on an inter-agency project aimed at strengthening New Zealand's anti money laundering laws.

Implementation of the reforms includes market awareness work like the education project we recently completed about securities law and reforms. Industry feedback on this was very positive. We see benefits, as a regulator, in helping market participants get to grips with new obligations as early as possible, reducing uncertainty and assisting with transition costs. The Commission also works with Enterprise New Zealand Trust which offers financial education in schools. We sponsor their projects with the aim of developing a generation that will be financially aware and able to invest confidently.

Ultimately our main aim is that these reforms will give New Zealand a world class regulatory environment that provides confidence to both retail and institutional investors, both domestically and internationally.

Speaking of confidence in the worldwide community brings me to the Commission's international work.

Our market benefits from greater international participation as it brings increased opportunities for New Zealand investors and local firms raising capital.

The Commission has been a member of IOSCO, the international standards setter for securities regulation, for over 20 years, and it has been my privilege to be the chair of the executive committee of IOSCO since 2004. Our presence at IOSCO has significantly raised New Zealand's profile in the international community and provided the opportunity for us to promote New Zealand as a well regulated capital market to international business audiences. We work to maintain our good standing through continuing contributions to many aspects of IOSCO's work, internationally and regionally.

We want to raise awareness of the New Zealand market and promote cross-border co-operation, which benefits our law enforcement work. The global nature of securities means that there are more choices for investors, but at the same time more chances of international financial crime.

To combat this, regulators must be able work together across borders. To facilitate this IOSCO has developed a Multilateral Memorandum of Understanding to which New Zealand is a signatory. The MMOU has helped the Commission in cases like Tranz Rail and Provenco. The Commission also has several other bi-lateral memoranda of understanding with individual countries that allow information exchange and sharing.

You may be aware that in June this year the Ministers of New Zealand and Australia signed an agreement on Mutual Recognition of Securities Offerings (MRSO). This is a part of the Closer Economic Relationship the two governments have been working towards over the last 25 years. It is an unprecedented agreement which marks Australia and New Zealand as global leaders in reducing costs for businesses raising capital across borders while maintaining the existing protection for investors.

I am pleased that one international investment bank has already given notice of its intention to use the scheme for 24 Australian managed funds to be made available to New Zealand investors.

There are a number long standing class exemptions which the Commission had in place for Australian issuers to offer investments in New Zealand. Since the MRSO is now in force the Commission is looking to review these exemptions. We will consult the markets in this review.

Concluding Remarks

To conclude, I should reiterate that the Commission is fully committed to investigating failed finance companies and taking action where required, although of course not all failures are a result of breaches of the law. .

As to good corporate governance, I cannot overemphasise its importance. In our view, complying with the law is the minimum requirement. We urge all market participants to aim for best practice.

Thank you.

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