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2003 Annual Report

ACHIEVEMENTS

ENFORCEMENT

Responsibilities

enforce the law
carry out inspections
maintain oversight of securities market activity and supervision of exchanges
inquire into suspected breaches of securities law
intervene in the market in the interests of investors in accordance with statutory powers

Achievements this year

reported that the initial public offer document of Wakefield Hospital Limited was misleading and the prospective financial information was likely to mislead investors
reported that the offer document of Vertex Group Holdings Limited was likely to mislead investors
completed 20 insider trading inquiries
successfully prosecuted Benjamin Jean Mauerberger for failing to appear in response to a Commission summons
recommended statutory management for eight companies involved in property buy-back schemes
accepted enforceable undertakings from three parties in respect of offer documents and advertisements for a forestry investment scheme
removed Harts Contributory Mortgages Limited and General Mortgage Limited as contributory mortgage brokers
successfully opposed an application by General Mortgage Limited to suspend Commission orders and stop publication of a news release
signed an MOU with the NZX on co-regulation of capital markets
recommended that the Minister of Commerce approve the Conduct Rules for the NZX
undertook inquiry work in New Zealand on behalf of overseas regulators

39.9% of expenditure

The enactment of the new law on 1 December 2002 brought important changes in relation to the enforcement of securities law in New Zealand. These changes include:

increased powers of inspection for the Commission. These enable the Commission to undertake its own inspections in addition to asking the Registrar of Companies or another authorised person to act;
a legislative basis for continuous disclosure for public issuers and the ability for the Commission to order issuers to make disclosure or corrective statements. The Commission can make these orders itself (and it is an offence not to comply) or it can obtain these orders from the Court and seek pecuniary penalties and compensation;
oversight of the activities of the NZX and legal obligations on the NZX to notify certain matters to the Commission including suspected contraventions of the law;
a power for the Commission to initiate court action on insider trading;
an obligation on directors and officers of a public issuer to notify (within five days) trading in the shares of their company. It is an offence not to do so. The Commission can make orders requiring disclosure and it is an offence to fail to comply with such an order. This law is not yet in force. It is expected to come into force before the end of 2003;
a power for the Commission to accept written undertakings from market participants and the ability to enforce these undertakings in Court;
a power for the Commission to require witnesses to answer questions notwithstanding that the statement may be self-incriminating (although not admissible as evidence in subsequent criminal proceedings); and
an increase in the maximum fine to $300,000 for breaching securities law.

These changes are a significant step in bolstering the effectiveness of our regulatory framework.

The year was extremely busy in terms of our enforcement work.

Wakefield Hospital Limited and Vertex Group Holdings Limited
Our inquiry into Wakefield Hospital Limited related to the initial public offering (IPO) of shares at the time of its flotation in September 2001. The Commission came to the view that the offer document itself, and the prospective financial information in the document, were deficient. We referred our report to Wakefield shareholders for any action they might take, and to the Companies Office to consider taking criminal action. An IPO was also considered in the case of Vertex Group Holdings Limited. The Commission again found the offer document to be deficient. We again found deficiencies with the prospective financial information that was used, in particular, its presentation as forecasts instead of projections. The report was referred to ICANZ.

Wider Issues
The Commission has no mandate to bring civil actions on behalf of shareholders or to bring criminal prosecutions. There was criticism of this in the news media after our inquiries into Wakefield and Vertex. The Commission has effective and efficient powers to act against offer documents while an offer is open. The position is quite different once an offer has closed and the securities have been allotted. In this situation the Commission's power to act against misleading activity is limited to review and comment, hence our actions on Wakefield and Vertex. The Commission has made recommendations to the Minister of Commerce for a civil penalties regime for false or misleading statements in offer documents and advertisements (similar to the regime for continuous disclosure contraventions in the Securities Markets Act). This would improve confidence that our securities laws are workable and enforceable.

Failures in corporate governance and directors' duties are at the core of many of the shortcomings that we see in the course of our inquiries. At present only shareholders can take action for breaches of core directors' duties. This is out of step with Australia and other jurisdictions. There is public good in ensuring a high standard of corporate governance on the part of our directors in New Zealand. For this reason we consider that a civil penalties regime should also be available for breaches of directors' duties.

Under the Companies Act 1993 the Court can ban people from acting as directors for up to ten years. An application can be brought by the Registrar of Companies, the Official Assignee, a liquidator, a shareholder or a creditor. We are of the view that the Commission has an interest in director conduct that is distinct from these people. The Commission is particularly concerned with directors of public issuers who are accountable for the funds of members of the public. In the course of many inquiries we have come across examples of repeated incompetence or reckless performance of duties by directors. We have recommended that the Commission be empowered to bring an action in Court asking to prohibit such people from acting as directors.

Insider Trading
We have completed a significant number of inquiries into suspected insider trading, mostly as a result of referral from the NZX. Many cases are referred to us from the NZX's SMARTS system which detects abnormal trading patterns. We take these matters very seriously and these cases are examined closely. In most cases we are not able to conclude that insider trading has occurred. We are committed to this work and intend, in appropriate cases, to take court action under our new power in section 18A of the Securities Markets Act. This enables us to directly exercise a public issuer's right of action against an insider.

Cold Calling
The Commission has some 80 cold calling brokers named on its website. We have issued many warnings about these activities. While the activities appear to have shifted from Asia they continue from other parts of the world. We reiterate the dangers of dealing with these people who do not have any regulatory status in the jurisdiction they purport to operate from. Invariably they operate from boiler-rooms solely preoccupied with contacting as many people as possible around the globe. They telephone people out of the blue and exhort them to buy shares in overseas companies, often in speculative technology stocks in the United States. Our experience is that people who invest will lose their money. Either no shares are bought or if shares are bought they cannot be readily traded. A great deal of money has been lost from this country as a result of these activities. The simple reality is that once money is sent overseas it is usually lost. We counsel people not to do business this way. Those wishing to buy shares should work through a reputable local intermediary.

We have also seen many examples of people being approached a second time, purportedly by a new broker. These are people that have invested previously and lost their money. The fresh approach involves a new transaction such as an offer to take up other shares in consideration for the old shares. The approach invariably involves the payment of more money to consummate the deal. Again our experience is that this money will also be lost. It is a perpetuation of the original fraud and is only designed to extract more money from the original victims. It is a particularly insidious method of fraud preying on people who have already suffered loss.

We have unfortunately seen the appearance of cold calling operations based in this country. Mauer-Swisse Securities operated from Auckland and targeted people in this country and in Australia. It held a sharebroking licence from the District Court under the Sharebrokers Act 1908. They touted this in their dealings with the public. They did not belong to NZX. While the operations of this broker have ceased the Commission remains concerned with the ease that sharebroking licences can be obtained in this country. One benefit of a system like that in Australia is the ability to move effectively against illicit operators. This was shown by the Australian Securities and Investments Commission's action against Alan Goldman (a director of Mauer-Swisse Securities) and its recent action against the Sydney-based broker Morgan Price Limited.

The Commission nonetheless achieved certain success in relation to the Auckland-based broker. Benjamin Jean Mauerberger was convicted of failing to comply with a Commission summons and fined $30,000 in the Auckland District Court in May 2003. He had been summoned to appear before the Commission to answer questions on the activities of Mauer-Swisse and a related company Bergers Securities. He left the country without appearing before the Commission. The District Court decision indicates that the judiciary will take a firm line against people who do not cooperate with the Commission. The Commission also will do as much as it can to discourage this type of activity in New Zealand.

Corporations (Investigation and Management) Act 1989
The Commission has the power to recommend to the Minister of Commerce that a corporation be placed in statutory management. It is a measure of last resort. It applies to a corporation:

that may be operating fraudulently or recklessly, or
where it is desirable to preserve the interests of shareholders, creditors, beneficiaries or the public interest, and
there is no other lawful way to adequately protect these interests.

On 19 June 2003 we recommended that eight companies involved in property buy-back schemes be placed in statutory management. The names of the companies were: CH Finance Limited (In Liquidation), ICMG Leasing Limited (In Liquidation), The Independent Creative Management Group Limited (In Liquidation), Toi Te Atatu Limited, Opol Limited, ICMG Holding Limited, ICMG Property Company Limited, and Sleinad Finance Company Limited. The companies were placed in statutory management the following day after an urgent meeting of the Prime Minister and senior Cabinet Ministers.

Undertakings
Enforceable undertakings are a welcome new power for the Commission. They are an effective enforcement tool in overseas jurisdictions. Enforceable undertakings can be tailored to fit the circumstances of a particular situation. They are cost-effective in that they avoid formal proceedings. They can be enforced in the Court if a party fails to fulfil the undertaking. The Commission used this power for the first time on 18 June 2003 when it accepted written undertakings from NZFIL 3 Limited, NZ Forestry Investment Limited and Ross Anthony Collins (all of Papamoa, Tauranga). We expect enforceable undertakings will be important in our enforcement work in the future.

Illegal/Dubious Investment Schemes
We continue to see investment schemes promoted around the country that do not comply with the law. In some cases there are fundamental concerns about the bona fides of the investment arrangements and the people behind them. The Commission banned advertisements for one scheme which had no registered prospectus or investment statement. It offered improbably high returns (10% per month) and had all the hallmarks of a "prime bank" scheme. Such schemes are known to be fraudulent. On the information available some $14 million had been collected from New Zealand investors. The scheme appeared to flourish within a church group.

The perpetrators of schemes like this take advantage of the trust that exists within such groups (they can also be ethnic or community-based groups). They abuse this trust thinking that they will not be reported to the authorities if they are found out and they will simply be expelled from the group. Then they will be free to move on and start up again somewhere else. This is known as "affinity fraud". In many cases the money merely goes to repaying other investors, thereby lulling them into a false sense of security. It also goes to supporting the lifestyles of the scheme's promoters and organisers.

In general people should be extremely wary about any investment that is not backed by an investment statement and a registered prospectus. These documents give important information about the people involved in the investment and how the money is to be invested.

Inspections/Prohibitions
Inspections are undertaken on behalf of the Commission where we suspect that an investment scheme may not comply with the law. A significant number of these have been undertaken this year. We are particularly grateful for the work of the Companies Office in this regard. Inspections are an important way of determining whether further regulatory action should be taken, whether by prohibition action by the Commission and/or prosecution actions by the Companies Office.

We have made a number of prohibitions under section 38B of the Securities Act which entitles the Commission to make an order prohibiting the further advertising of a scheme. Usually we act because of the absence of the requisite offer documents (an investment statement and a registered prospectus).

Contributory Mortgage Brokers
We continued to receive complaints about contributory mortgage brokers. The Commission ordered two companies to cease to act as contributory mortgage brokers and appointed Crichton Horne & Associates Mortgage Brokers Limited to act in their place.

Harts Contributory Mortgages Limited had contravened the Securities Act (Contributory Mortgage) Regulations 1988 by failing to deliver its 2001 annual report to the Registrar of Companies. It also acknowledged previous breaches of securities law under prior ownership and management. Harts by this time was in liquidation and was unable to fulfil its duties as a contributory mortgage broker. Crichton Horne has now settled almost all of the Harts contributory mortgages. Their work continues to be appreciated by investors and by the Commission.

General Mortgage Limited had, in the Commission's view, failed to meet the standards of care and governance expected from those who raise funds from the public. It repeatedly failed to comply with the law, including requirements to prepare and file financial statements on time and to provide information to investors. General Mortgage has also been prohibited from offering contributory mortgages to the public for two years. The Commission successfully opposed General Mortgage's application to the Court to stay the Commission's orders and to stop publication of a news release pending appeal and judicial review applications.

International Surf Day
Securities law applies to internet activity in the same way as it does to other advertising and promotion of offers of securities. We joined five other jurisdictions in the Asia Pacific region in an internet surf day in October 2002. More than 4000 websites were examined and 285 suspicious sites were identified. The Australian Securities and Investments Commission co-ordinated the results and referred suspicious sites to the relevant regulator. Four New Zealand websites were identified. We checked these but did not consider further action was necessary.

MOU: Surveillance
A memorandum of understanding was signed between the NZX and the Commission in March 2003. The impetus for this came from a willingness by the two organisations to work more closely together as well as the law that came into effect on 1 December 2002. The MOU covers, among other things, the monitoring and surveillance of the securities market by addressing:

compulsory referrals by the NZX to the Commission (disciplinary actions, significant contraventions of the NZX's Conduct Rules or securities and takeovers law);
discretionary referrals to the Commission arising from the NZX's oversight of trading activity, in particular, in relation to insider trading, disclosure failures and market manipulation. Unusual movements in share price and volume are normally a trigger for this;
the referral of matters from the Commission to the NZX relating to compliance with the NZX's Conduct Rules or the application of those rules; and
the procedures or process for these referrals.

MOU: Other Matters
The MOU addresses other statutory matters. It covers:

consultation on waivers from continuous disclosure;
procedures relating to the Commission's power to give directions to the NZX; and
procedures to consult on new NZX Conduct Rules and amendments to these rules.

For the latter the Minister of Commerce is required to approve the Conduct Rules of the NZX unless it is not in the public interest to do so (effectively a power of disallowance). The Minister is obliged to seek the Commission's advice on this. In practical terms the NZX will consult with the Commission before seeking the Minister's formal approval. In October 2002, following extensive consultation with the NZX, we advised the Minister that it would not be contrary to the public interest to approve the proposed Conduct Rules on the demutualisation of the NZX. We are currently engaged in similar discussions with the NZX about their recent proposal to restructure the NZX, in particular the disclosure and conduct areas and the Market Surveillance Panel.

BT/Westpac
BT Funds Management was purchased by Westpac last October. BT offers securities in New Zealand under the Securities Act (Australian Registered Managed Investment Schemes) Exemption Notice 1999. In April 2003 Westpac notified the Commission that conditions of exemption requiring documents to be filed with the Registrar of Companies had not been complied with for certain BT funds from 1996 to 2002. The Commission considered that investors should be informed of the situation and the steps the company was taking. The matter is of considerable interest to investors because if the conditions of exemption were not met the company could be required to return investors' funds with ten percent interest.

Subsequently we became aware of another issuer which also may not have complied with the conditions of the exemption for overseas issuers on which they were relying when offering their products to New Zealand investors.

BT has initiated proceedings in the High Court to determine the validity of the contracts of investors. We have written to all issuers who we know have used the exemptions for overseas collective investment schemes to identify the extent of non-compliance.

Cooperation with Overseas Counterparts
We responded to requests for assistance from the Financial Services Authority in London, the United States Commodity Futures Trading Commission in Washington DC and the Australian Securities and Investments Commission. We sought assistance from several of our counterparts overseas.

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