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2007 Annual Report

Monitoring and market oversight

The Commission monitors market activity to identify and investigate possible breaches of securities law. The Commission’s view is that compliance with the law is the minimum standard of market behaviour. To increase the integrity of the markets and in the interests of investors, entities and their directors are encouraged to strive for international best practice in corporate governance.

The Commission’s oversight includes NZX, the only registered stock exchange in New Zealand. The Commission and NXZ have co-regulatory roles relating to the exchange under the Securities Markets Act 1988. NZX is the front line regulator concerned with breaches of the rules of the exchange and the Commission is the statutory regulator concerned with breaches of the law. The Commission also gives advice to the Minister of Commerce on NZX’s rules and oversees NZX’s performance of its regulatory role.

Oversight of NZX
In September 2006 the Commission published Oversight Review of NZX 2005, a report of its first review of NZX’s performance of its regulatory functions as a registered exchange. The Commission concluded that NZX was satisfying its obligations to operate its markets in accordance with the conduct rules and that NZX’s performance as a registered exchange was good. However, improvements could be made in a number of areas. Recommendations for improvements were communicated to NZX, NZX Discipline and the Special Division. NZX agreed to take specific action on some of these by the end of the 2006 calendar year. On the remaining recommendations NZX committed to reconsider its position and report back to the Commission.

The Oversight Review of NZX 2006, published on 28 June 2007, also found that NZX was satisfying its obligations to operate its markets in accordance with the conduct rules and its performance as a registered exchange was good. The review reported progress made by NZX on implementing recommendations from the 2005 review. The 2006 review made a number of other recommendations and the Commission will observe progress on these in next year’s review. Annual reviews of the NZX are valuable for investors because they provide regular information about NZX’s performance to the Commission and to the public via the published reports.

Telecommunications Stocktake Paper
In July 2006 the Commission published its inquiry relating to the release of the Government's Telecommunications Stocktake Paper and comments reportedly made to the media by the Communications Minister, Mr David Cunliffe, about the dividend policy of Telecom Corporation of New Zealand Limited.

The Commission found no evidence of any trading or tipping in securities by persons who knew of the contents of the Stocktake Paper before it was made public. The Commission also concluded that the comments made by the Minister on 15 May 2006 in the interview with Bloomberg were not based on any confidential or price-sensitive information about Telecom's intentions or policies, nor did the Bloomberg reports of 16 May 2006 give the impression that they were based on such information. However, the Commission found that there was an avoidable asymmetry of information in the market for some 30 minutes after the NXZ closed and while trading was still underway on the Australian Stock Exchange. The Government and Telecom could have taken steps to avoid this. The Commission recommended that the Government and NZX develop guidelines for Government to disclose information which could be price-sensitive to listed securities, and that everyone, including Ministers of the Crown, who may be presumed by the market to possess non-public information about a listed issuer, should take care when commenting on matters that might affect the price of listed securities.

Reviews of financial reporting
Reports of two further cycles of the Commission’s Financial Reporting and Surveillance Review were published. The aim is to encourage high quality financial reporting so that investors can have confidence in the credibility of information provided by issuers.

Cycle 3 reviewed the financial reports of 45 issuers with balance dates from 31 March 2005 to 30 September 2005, for compliance with Financial Reporting Standards and other elements of Generally Accepted Accounting Practice and to assess the overall quality of financial reporting. As with earlier reviews, few serious problems were identified but 19 of the 45 issuers had matters that needed to be addressed. The Commission wrote to these issuers and to their auditors.

Cycle 4 considered reports of 40 issuers with balance dates from 30 June 2005 to 31 March 2006 and, as well as general compliance, looked at reports by early adopters of International Financial Reporting Standards. The level of compliance with NZ IFRS was generally good. A number of common nondisclosures were found and commented on to assist and guide issuers make the change to NZ IFRS. Overall 17 issuers had matters that needed to be addressed and we wrote to those issuers. The review identified issues relating to non-disclosure in annual reports of waivers granted by the stock exchange. One matter was referred to NZX and two were referred to the NZX Discipline Special Division.

The Commission is pleased with the cooperation from issuers and their willingness to improve the quality of their financial reporting.

Enforceable undertakings
Enforceable undertakings given to the Commission by those who breach the law are a cost-effective enforcement tool. They enable the breach to be remedied, address investors’ interests, and avoid court action. Undertakings are published and this communicates the standards of behaviour the Commission expects in the markets.

Enforceable undertakings were accepted from CMI and its directors. These were designed to preserve the interests of contributors until a High Court opinion is received on certain legal issues relating to CMI’s compliance and conduct in offering and managing contributory mortgages. Undertakings were accepted from property developers Kensington Park Properties Limited, Huka Falls Resort Limited and Patrick Marinus Fontein. The developers were unaware that their developments constituted offers of securities to the public and therefore required an investment statement and a registered prospectus. The published undertakings highlight the need for property developers to seek advice from a lawyer experienced in securities law.

Review of Feltex prospectus
In 2006 the Commission reviewed the prospectus of Feltex Carpets Limited, which was placed in liquidation in September 2006. The Commission’s review of the 2004 initial public offer prospectus found no breaches of securities law and no evidence that the prospectus was misleading. An inquiry is continuing into continuous disclosure and financial reporting by Feltex after its earnings downgrade announcement of 1 April 2005.

Finance company disclosure
The Commission announced the results of its second review of finance company disclosure in August 2006. This review followed the April 2005 report into finance company disclosure. Although shortcomings remained, there were marked improvements in finance company disclosure since the earlier report which aimed to give guidance to finance companies about the standards of disclosure required in offer documents. We were pleased with the cooperation received from the finance companies reviewed. Improved disclosure by finance companies is important so that investors can understand how their money is being invested, and the risks this carries.

Reviews of offer documents and advertisements
The Commission reviewed offer documents and advertisements, including some follow-up work from the review of finance company disclosures in 2005-2006. In many cases the identified shortcomings were readily addressed by companies amending their offer documents, or agreeing to improve future publications. Serious issues of misleading disclosure were referred for enforcement action, including banning offer documents. We continued to use inspections to investigate schemes that came to our attention and to ascertain where there had been breaches of the law.

Law reform

The Commission works closely with securities law and is well positioned to identify aspects of the law that are out of date, or not working effectively, or could be improved. As well the Commission seeks cost-effective regulation that does not impose unnecessary compliance costs on issuers of securities.

The Commission has a function under the Securities Act 1978 to recommend to the Minister of Commerce any changes to securities law that it considers necessary. It performs this function to recommend improvements to the law that will achieve a regulatory regime that is internationally acceptable but also cost effective and suited to New Zealand’s markets. Recommendations are based on the Commission’s experience with the operation of the law and its inquiries into market behaviour that reveal defects or inadequacies in existing law.

Regulation of financial products and providers and financial advisers
The Commission has been heavily involved in the Government’s review of financial products and providers, and its review of financial adviser regulation. Discussion documents were published in late 2006 concerning these reviews. The Commission was represented on industry advisory groups established by the Ministry of Economic Development to provide officials with advice and expertise on the development of options for these discussion documents, and on the costs and benefits of various proposals. We took part in working groups with other government agencies and regulators to help with policy development when public submissions had been received.

In June 2007 Cabinet decided on the first round of reforms arising from this work. These reforms will see:

registration of all financial service providers;
improved supervision of corporate trustees;
improved trustee-based prudential supervision of non-bank deposit takers, overseen by a single
prudential regulator;
regulation of financial advisers;
provision for a comprehensive approach to consumer dispute resolution and redress; and
the Reserve Bank of New Zealand to be the single prudential regulator for banks, non-bank deposit takers and insurers.

Further work is being done on the remaining areas of the review of financial products and providers. Officials will report back to Cabinet by 30 November 2007 with proposals to provide for:

a single regulatory regime for collective investment schemes (including superannuation);
improved trustee supervision of debt issuers;
an improved approach to disclosure for securities offerings;
necessary amendments to the law relating to insurance contracts and disclosure;
a comprehensive and simplified approach to regulating governance of mutuals e.g. credit unions, industrial and provident societies, and building societies;
the regulation of platforms and portfolio management services that perform investment discretions on behalf of investors; and
a comprehensive prudential regulatory regime for insurers.

The Commission continues to work with officials on these matters.

Securities Legislation Bill
The Securities Legislation Bill, passed in October 2006, made changes to the law relating to:

insider trading;
market manipulation;
investment advisers;
substantial security holder disclosure;
application of securities trading law; and
penalties and remedies under securities law.

Changes to the Securities Act 1978, increasing the Commission’s ability to bring Court actions for breaches of securities law, came into force in October 2006. The changes to the Securities Markets Act 1988 will come into force when regulations have been drafted. This is expected in the second half of 2007.

Accounting and auditing
The Commission made submissions on draft financial reporting standards to the New Zealand Institute of Chartered Accountants and the International Accounting Standards Board.

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