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2002 Annual Report

ACHIEVEMENTS

ENFORCEMENT & SURVEILLANCE

Responsibilities

• intervene in the market in the interests of investors in accordance with statutory powers
• maintain oversight of securities market activity

Achievements this year

• acted to protect investors' money in respect of several contributory mortgages
• published a report on the 1 Parliament Street contributory mortgage
• published a report on certain statements about Air New Zealand Limited
• issued warnings about illegal overseas brokers and named them on our website
• published a report on Gideon Investments Pty Limited and Morison Guildford & Associates Limited completed 11 insider trading enquiries
• issued warnings and prohibited advertising of illegal investment schemes
• identified misleading and confusing offer documents which issuers withdrew or amended
• reviewed financial reporting aspects of Telecom New Zealand's interim financial statements
• published a discussion paper on proposed Conduct Rules of the New Zealand Stock Exchange

40.7% of expenditure

Enforcement

Contributory Mortgages
Several contributory mortgage schemes came to our attention during the year. More than $300 million is invested in these schemes which lend money to property owners to purchase, refinance or develop real properties. Investors' money is pooled and lent by a contributory mortgage broker to a borrower, usually at relatively high rates of interest. Often banks or other lending institutions will not lend the required funds and borrowers are prepared to pay the higher rates of interest charged by contributory mortgage brokers.

The Commission issued a public warning urging investors to seek independent advice and find out all the facts before investing in schemes paying higher than average interest rates.

Higher promised returns carry greater risks. Investors, attracted by higher interest rates offered by contributory mortgage schemes, may not realise that they might be taking a risk that a bank would not take. The Commission issued a public warning in November urging investors to seek independent advice and find out all the facts before investing in schemes paying higher than average interest rates. The Commission took action against several contributory mortgage brokers. We appointed chartered accountants Crichton Horne in place of two brokers, banned advertisements for two contributory mortgages, and banned two firms from acting as contributory mortgage brokers for specific periods. The work of Crichton Horne has been well received by investors.

We published a report on The Mortgage Financier Limited and Money Managers Limited in relation to the contributory mortgage for a development at 1 Parliament Street in central Auckland. The Commission was of the view that both companies and their directors could be criminally and civilly liable for breaches of securities law. We referred the report to the National Enforcement Unit of the Companies Office to consider whether to lay charges.

Air New Zealand Limited (Air NZ)
We published a report of our inquiry into statements in the media that led to the trading halts in Air NZ shares in September 2001. The report covered statements by the Prime Minister and by Mr Greg Terry, at that time a director of Air NZ, and media reports that the Office of the Prime Minister had approached broking houses about possible steps to be taken by the Government in relation to Air NZ. The inquiry gathered evidence from more than 70 people. Submissions by affected parties were carefully considered.

The Commission found

• no evidence that the Prime Minister's Office approached broking houses about possible steps to be taken by the Government in relation to Air NZ
• no evidence of insider trading by any person in the shares of Air NZ during the period covered by this inquiry
• the Prime Minister's statements about shareholders on 25 September 2001 did not constitute tipping under the Securities Amendment Act 1988
• Mr Terry's statements about the share price on 27 September 2001 did not constitute tipping under the Act.

The Commission considered that from a securities market perspective the Prime Minister's statements regarding shareholders on 25 September 2001 and Mr Terry's statements about the Air NZ share price on 27 September 2001 were inappropriate. The statements did not breach the law, but they were not appropriate given the status of the people involved and the intense public interest in Air NZ at the time.

Potentially price sensitive statements about listed companies made by insiders should be made through proper market information mechanisms, including those of the New Zealand Stock Exchange (NZSE). We recommended that guidelines be prepared for Ministers and their advisers regarding public statements about listed companies where the Government may have or be perceived to have inside information. We understand that such guidelines are being drawn up. The second part of the Commission's review will consider questions arising from the NZSE's decisions to impose and lift trading halts in Air NZ in September 2001.

The Commission declined a request, under section 17 of the Securities Amendment Act 1988, from Catharine Mary Franks, a shareholder in Air NZ, to approve the appointment of a lawyer to provide an opinion on whether there was an insider trading case to answer relating to trading in shares in Air NZ. The Commission found no evidence of insider trading in its earlier comprehensive investigation and after carefully considering the section 17 request concluded that there was no new evidence to warrant further investigation.

Insider trading
We have completed 11 inquiries into suspected insider trading and looked into a number of substantial security holder disclosure matters in the course of the year. Insider trading inquiries in particular occupy a lot of our time. There is often an expectation that when a share price moves ahead of an important announcement, insider trading must be involved. These cases are rarely as clear-cut as they seem. When all the evidence is examined the true position may not always be as initially suspected.

Overseas brokers
The activities of brokers from overseas cold calling New Zealanders reached new heights during the year. Based in Jakarta, Bangkok or Manila, the callers invariably try to persuade people to buy shares in low value technology stock listed on the NASDAQ. They are often very persuasive. The strong suspicion is that the brokers simply pocket the money or if stock is bought it cannot readily be sold. When a person attempts to realise the investment the broker becomes very difficult to contact. Some people are caught twice when they are approached by a new broker saying that they have a buyer for the shares but, of course, they need to pay more money to make this happen. One person remitted US$100,000 in response to such an approach. This is almost certainly part of the original fraud.

In reality these are "boiler-room" operations where people are crammed into a small room and they bombard people around the world with telephone calls, particularly New Zealanders, Australians and South Africans. They appear to target people in small businesses. Usually the brokers do not have any status or authority to conduct securities business in the country from which they operate. Authorities in these countries are starting to crack down on these activities. Arrests were made last year in Bangkok and Manila and the Taiwanese are holding a person they believe was the central figure behind an operation known as Mendes Prior.

Cold calling brokers are a major concern ... at least $14 million was lost out of the country in the last year and a half. We suspect this is only the tip of the iceberg.

Overseas brokers are a major concern for this Commission and for commissions around the world. The arrests in Thailand last year resulted in hundreds of telephone calls to us from New Zealanders who had sent money away. They revealed that at least $14 million was lost out of the country in the last year and a half. We suspect this is only the tip of the iceberg. Many who ring us prefer not to say how much they have lost, and probably many more do not contact us at all. We constantly warn New Zealanders not to do business with strangers who cold call them from overseas. We recommend that if people want to buy shares overseas, they do so through a New Zealand broker who is accountable under New Zealand law. Once money is sent away, it is very difficult to trace.

Our impression earlier this year was that the activities of overseas brokers were beginning to wane, or maybe that New Zealanders were being more wary. Recently, though, there are indications that unsolicited calls are on the rise again. Our website alerts people to this problem. We have the names of some 60 illegal brokers on our website and the list continues to grow. Other countries have followed this initiative. We liaise with our overseas counterparts and have been pleased when this has helped lead to action by overseas regulators against the brokers. Examples of this include the actions by the Thai and Philippine authorities and the securities fraud proceedings taken by the United States Commodity Futures Trading Commission against FX Advisors.

... the report highlights deficiencies in the behaviour of people committed to representing investors ... and the importance of rules of law about mandatory investment adviser disclosure ...

Gideon Investments Pty Limited
We published a report on fund raising by Gideon Investments Pty Limited and the role of Wairarapa investment advisers Morison Guildford and Associates Limited. We reported that Morison Guildford were incompetent and irresponsible. They obtained money from New Zealanders for Gideon. They did not question the lack of offer documents. Their formal evaluation and monitoring of Gideon was close to nonexistent. They withdrew investors' funds inappropriately, apparently without telling investors, and did not keep proper records. The Commission published the report as a review of market practice to highlight deficiencies in the behaviour of people committed to representing investors. The report emphasises the importance of rules of law about mandatory investment adviser disclosure and about recommending illegal offers of securities. We have recommended changes to the law relating to investment advisers.

Illegal offers of securities
In July we prohibited the promotion of a prime bank scheme, the Tri-West Investment Club. We issued a press statement about this which received wide coverage. In September the United States Securities and Exchange Commission (SEC) filed a securities fraud law suit against the scheme and froze all Tri-West's assets. The SEC said some US$30 million had been raised in and outside the United States. A Canadian living in Mexico appears to have been behind the scheme. Most of the investors' money appears to have been spent on supporting the lifestyles of this man and his associates.

We prohibited the promotion of a scheme whereby people paid money to offshore destinations as part of hire purchase arrangements for buying new cars. The promoter, Graham John Cumming from Tauranga, had been particularly active in the Bay of Plenty and Manawatu.

We gave evidence to the Finance and Expenditure Committee inquiring into the revenue effects of fraudulent investment schemes. We briefed the Committee on our experience of

• overseas brokers operating from boiler-rooms who telephone people in New Zealand with offers of low value technology stock
• fraudulent schemes, often based overseas, which do not comply with our law but are promoted by people in New Zealand for sizeable commissions
• how these relate to our recommendations on reforming the law on investment advisers.

We rely on the news media to help us warn people about scams and dubious investments. We are grateful when our warnings are published widely in newspapers and periodicals such as Consumer. There were several useful documentaries on television during the year and we are pleased to have assisted with these.

Telecom New Zealand
We reviewed certain financial aspects of Telecom New Zealand's interim financial statements for the half-year to 31 December 2001 and found no departures from generally accepted accounting practice (GAAP) in New Zealand. The review followed public comment on some aspects of Telecom's financial reporting. Telecom conducts operations and raises securities in a global setting. The company is listed on the New York Stock Exchange. Telecom reports not only according to New Zealand GAAP but also describes where its financial statements differ from generally accepted accounting principles in the United States. The matters demonstrated the importance of working towards international harmonisation of accounting standards.

Offer documents
We reviewed offer documents, advertisements, annual reports and financial statements of issuers of securities. As a result of our work 18 documents of 11 issuers were prohibited, withdrawn or amended because they were misleading or confusing. We issued three public warnings.

Surveillance

New Zealand Stock Exchange - proposed Conduct Rules
The NZSE is considering demutualising. If it does so, the New Zealand Stock Exchange Restructuring Act 2002 requires that its Conduct Rules must be approved by the Governor-General on the recommendation of the Minister of Commerce. The Minister has asked the Securities Commission to advise him so that he can make a recommendation to the Governor-General. In June we published a paper on the Conduct Rules and invited comment.

MARKET AUTHORISATIONS

Responsibilities

• authorise futures dealers and exchanges
• approve amendments to exchange rules
• approve trustees and statutory supervisors
• designate certain substantial security holders

Achievements this year

• authorised five futures dealers
• approved changes to the rules of the New Zealand Futures and Options Exchange
• considered the implications of the New Zealand Futures and Options Exchange's proposed move to Australia
• recommended an extension to the FASTER system of the New Zealand Stock Exchange
• approved four trustees and eight statutory supervisors
• adopted a new policy for authorising trustees and statutory supervisors
• consulted on policy for designating certain substantial security holders

3.1% of expenditure.

A new policy on approving trustees and statutory supervisors ... who must now report to the Commission each year on any changes that affect their approvals.

During the year we authorised five persons to deal in futures contracts. We approved amendments to the rules of the New Zealand Futures and Options Exchange (NZFOE) to make them consistent with the rules of the Sydney Futures Exchange (SFE) which owns the NZFOE. The changes related mainly to the SFE's new trade allocation and confirmation system. We were advised of the restructuring plans of the SFE which include moving the NZFOE's operations to Australia. This raises questions about the supervision of brokers in New Zealand. We are consulting on the future shape of regulation of this industry.

We recommended an extension to the NZSE's FASTER system to the Minister of Commerce. This extends the operation of the FASTER system to the NZSE's unlisted securities market. The extension was recommended after the NZSE introduced new conditions for companies on the unlisted market who choose to use the system.

We approved 12 persons as trustees or statutory supervisors. A new policy on approving trustees and statutory supervisors was published in January following a very good response to our discussion paper. The major change is that approved trustees and statutory supervisors must report to the Commission each year on any changes that affect their approvals.

We released a discussion paper on policy for designating certain substantial security holders. This relates to banks, financial institutions, sharebrokers, trustee corporations and nominee companies who hold shares in the ordinary course of their business. When designated, these holders do not have to comply with substantial security holder disclosure requirements of the Securities Amendment Act 1988 when they act in their ordinary business. Comments from interested parties will be considered as we develop the policy which we expect to publish early in the new year. The current list of designated persons is also being reviewed.