ISSN 1174-4758
ISSN 1177-7184 (online)
The Quarterly Newsletter of the New Zealand Securities Commission
No.49 October 2009
This issue
The passing of the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 in October means that issuers of securities, collective investment schemes, trustee companies, brokers, financial advisers and futures dealers, will have start taking steps ensure customers are not participating in money laundering or financing terrorism.
The new law is based on the recommendations of the Financial Action Task Force (FATF), an inter-governmental body that has spearheaded global efforts to counter criminal use of the financial system.
The Task Force's framework requires money laundering and terrorist financing to be criminalised, and their detection and prosecution to be investigated and enforced,with controls over the movement of money across borders. Businesses must carry out customer due diligence and strengthen measures in respect of customers, business relationships and transactions presenting a higher money laundering/terrorism financing risk. They should maintain records, report suspicious transactions, and carry out staff training and audits.
It also recommends financial institutions and various non-financial sector entities are supervised to ensure they comply, and that a financial intelligence unit receive, analyse and disseminate suspicious transaction reports and other information. National compliance is routinely evaluated.
New Zealand has been an active member of the Task Force and is committed to implementing its recommendations. Earlier this year New Zealand was subject to a review by the Task Force of its adherence to the Task Force's 49 Recommendations.
The new Act takes a risk-based approach to detecting and dealing with money laundering and terrorism financing. The focus will be on customers and products presenting the greatest risk, thus allowing entities to keep compliance costs to a minimum.
The Act sets out reporting requirements, and arrangements for supervising financial institutions and casinos to ensure they comply. It also establishes an enforcement regime,with new civil and criminal offences.
The Securities Commission will supervise issuers of securities, trustee companies, futures dealers, collective investment schemes, brokers and financial advisers. The Reserve Bank will supervise banks, life-insurers and nonbank deposit takers. The Department of Internal Affairs will be responsible for casinos, non-deposit-taking lenders and money-changers, and any financial institutions not supervised by the Reserve Bank or the Commission.
The Commission has begun consulting with the industry to determine the money laundering and terrorism financing risks across all entities it is now responsible for supervising. This exercise will be informed by the national risk assessment of money laundering and terrorism financing currently being undertaken by the Police Financial Intelligence Unit.
Supervisors' first responsibility under the Act will be to guide and monitor businesses, but their powers will also extend to enforcement. They will be able to require independent audits, conduct on-site inspections, issue restraining injunctions through the Courts, investigate, search and seize with a warrant, and refer civil and criminal breaches to the Courts.
Supervisors will work closely with the Ministry of Justice, which has been leading reform efforts. The AML/CFT Coordination Committee will form policy and coordinate operation of the regime.
The Police Financial Intelligence Unit will receive and analyse suspicious transaction reports.
The Act obliges financial institutions and casinos to administer a compliance programme and conduct a risk assessment. They must also conduct more rigorous customer due diligence than before. They must continually monitor accounts and transactions, keep account activity records for five years, and more systematically report suspicious transactions to the Intelligence Unit.
The Commission intends to start consulting with industry on developing regulations and codes of practice to supplement the Act's high-level principles and help entities comply. Regulations are likely to cover exemptions, determining beneficial ownership, and adequate ID verification. The Commission has appointed Geoff Brown as its AML/CFT Establishment Manager.
Codes of practice will not be mandatory, but set "safe harbours" for complying with relevant codes that will constitute a legal defence to prosecution.
The Act will be implemented in stages to give supervisors and entities time to develop compliance systems and procedures. Aspects taking immediate effect are Police intelligence, supervisory functions and powers, AML/CFT Coordination Committee work, and activation of regulation and exemption-making powers.
Entity obligations will come into force on a date to be set by Order in Council. The second phase of implementation will involve coverage of other entities, including real estate agents, accountants, lawyers, and precious metal and jewellery dealers.
Find out more about the Anti-money Laundering and Countering Financing of Terrorism Act at www.seccom.govt.nz/aml-cft
Listed issuers will no longer have to provide both a full prospectus and an investment statement for every securities offering since the Securities (Disclosure) Amendment Act came into force in October.
Companies already bound to continuous disclosure will be able,under certain conditions, to supply just one simplified disclosure document. This will save duplicating informational ready disclosed to the market, significantly reducing costs to the company floating the offer.
It is designed to give companies easier access to raising capital without compromising investors' rights to full, accurate, timely disclosure, both of which are vital.
The Act allows for two kinds of simplified disclosure. The first applies to a listed company offering shares of the same class as those already listed; the second, to one offering securities that either rank equally with, or take priority over, its listed securities.
In the first case, the document maybe no longer than a page or two but has to include a clear indication that it is a simplified disclosure, along with the issuer's name and registered office address, names of directors, and names and addresses of every promoter of the securities being offered.
It must also include details of any experts and underwriters the prospectus mentions, the offer's main terms, its relationship with listed securities, any information not generally available to the market or that needs updating, the latest available financial records, a statement that these are filed with the Companies Office, and a director's statement.
This shorter document relies heavily on the obligation for continuous disclosure. Since listed companies must release straightaway any information that may affect the share value, potential investors can make use of the market reaction to the information to help themselves decide on whether to take up the securities at the price the company is asking.
In this situation, investors should study the simplified disclosure, look at how the company is doing on the stock exchange, and consult the company's own website and that of the Companies Office. Taken together, these sources will help an investor decide whether or not to invest.
Where a company is proposing to raise capital through a security different from what is already traded on the market, the company must provide all of the above information as well as additional details. Since the shares being offered differ from those listed,investors need to know more about the offer and the new securities. This extra information must cover preliminary and expense issues, returns,insolvency, alteration of securities,early termination, and the right to sell securities, the financing of projects,and any other relevant material.
The Act ushers in new powers for the Commission. It may prohibit a company from using a simplified disclosure document if it is not satisfied with the way the company has met its continuous disclosure obligations.
The Commission may also step in to defer allotment of securities in if it believes an offer period is too short to allow the market to adjust to new information. It can require a company to delay its issue up to two weeks to give investors time to assess the market. It can also, under its existing powers,prohibit, suspend or ban offers likely to mislead or deceive investors.
In October, Commerce Minister, Simon Power, announced the appointments of David Mayhew as Commissioner for Financial Advisers, and Simon Botherway and Mark Verbiest as new Members of the Securities Commission.
David Mayhew is a returning New Zealander who is recognised internationally as a leading practitioner in financial services regulatory work. He will assume the role from January next year. He also becomes a Member of the Commission.
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Commenting on forthcoming challenges David Mayhew said "One of the key challenges is to forge a partnership with the industry to ensure buy in to the new regime."
Both Simon Botherway and Mark Verbiest are also well recognised for their work in the financial sector in New Zealand and have vast experience and knowledge of commercial and securities market.
Mark Verbiest joined the Commission in October stepping in for Mai Chen, while Simon Botherway will be replacing Colin Beyer in February.
The Commission investigated Guardian Trust's Cash Plus funds that were frozen in November last year. The investigation found breaches of the Securities Act, but the Commission decided not to prosecute because it considered the breaches were not material.
The reasoning went like this. Investors were informed in the initial prospectus that Cash Plus consisted of cash and mortgages. The mortgages enabled an enhanced return over the cash (mortgages were the "Plus").
The Cash Plus fund was frozen on 5 November 2008 asa consequence of the announcement of the Crown retail deposit guarantee scheme. As the Cash Plus fund held mortgages it was not eligible for the guarantee. Guardian Trust, concerned there might be a flight to guaranteed funds, froze the fund until it could be restructured so that the cash part could benefit from the guarantee.
The fund was restructured into a cash only fund and a mortgage fund. There was an indemnity from Guardian Trust in respect of the mortgage fund. The Cash Plus fund re-opened to investments on 10 December 2008. The Cash Plus fund received a Crown guarantee in mid-2009.
The Commission considers that it was poor governance for the directors not to have disclosed the transfer of the mortgage portion from direct mortgages to a mortgage fund. If material, it was also a breach of the law.
So why didn't we prosecute? Because we are convinced that we would lose the case in court.
The Commission would only succeed at law if this were a material change, resulting in investors being placed ina worse position than that advertised in the prospectus.
Was it a material change? Our experts who contributed to our decision - the Commission's in-house lawyers and some of New Zealand's leading commercial lawyers, accounting and market experts who sit on the Commission - considered that it wasn't.
The change actually moved the mortgage portion to a situation of lower loan to valuation ratio. It did not affect the liquidity. These were already illiquid assets. This is presumably why the statutory supervisor signed off the transaction.
We remain convinced that any prosecution of Guardian Trust on this issue would be unlikely to succeed. To win the case, we would have to show that the investors were materially disadvantaged by the changes that were undertaken in the fund. We do not believe we would be able to prove this in court.
Court actions are expensive and time consuming. The Commission has demonstrated that it will take on the hard cases where this brings benefit to investors and market confidence. We will not go to court where there is a cogent defence which means that we are unlikely to succeed. We believe doing so would bring no benefit to investors and would be a waste of Commission resources.
Door-to-door KiwiSaver salespeople need to brush up on their legal obligations. Complaints to the Securities Commission about door-knocking practices suggest some salespeople are unaware of the law designed to protect investors from high-pressure tactics under their own roof.
Salespeople and the public need to know that KiwiSaver schemes are a form of superannuation fund. They are covered by the Securities Act and the Securities Markets Act. They must not be sold house-to-house.
It's also important people fully understand any product they are considering investing in - its expected risks and returns, and whether it suits their own financial goals and appetite for risk.
Buying an investment from a door-to-door salesperson risks making a decision too fast and under pressure. People should resist being pressured or bullied. Instead they should carefully read and consider any offer, and get independent advice if they have any questions or doubts.
Anyone in the business of recommending or advising on investment products must give a potential investor a disclosure statement before any advice is given.
The disclosure statement must include the adviser's contact details, their qualifications and experience, whether they are a member of a professional body, whether they have professional indemnity insurance and whether dispute resolution services are available to clients. They must disclose whether, in the past five years,the adviser has been convicted of certain criminal offences, been declared bankrupt or placed in receivership,been prohibited from managing a company or from membership of a professional body,or been subject to any adverse Court findings in a case involving their professional capacity.
The statement must also disclose the types of securities the adviser can advise on, and any relationships or associations the adviser has with anyone connected to the investment,or that might in any way influence the advice to be given.
The disclosure statement must also, of course, include the adviser's remuneration details.
This means any fee or commission they will get for selling a specific product, and what, if anything, the adviser intends charging for their advice. In each case, it must be clear if the fees will be deducted from any client money the adviser holds. If a fee cannot be calculated until later, the statement should describe how it will be calculated. An investor is legally entitled to know up front the total amount an investment will cost them.
The disclosure statement must be in writing, be up to date and must not be misleading.
The Securities Commission can halt distribution of a misleading or incorrect disclosure statement, order an adviser to correct or amend it, or ban them from giving advice for a short term. A court may also ban them for up to 10 years.
The Commission may lay criminal charges in the case of a serious breach of disclosure law. The maximum fine for a criminal breach is $100,000 for an individual and $300,000 for a company.
Anyone can seek a civil remedy from a court if they think their adviser has failed to meet any their disclosure obligations. The minimum civil remedy is $100,000 against an individual adviser and $300,000 against a company.
Some KiwiSaver and other securities are sold by people who mainly distribute information provided by the issuer of the securities. These salespeople may not be investment advisers under the law and will not give independent advice. It is a good idea to seek independent advice before making a decision to invest on offers made by someone who says they are just a distributor.
The Financial Advisers Act, likely to be in force by late next year, makes superannuation funds a category 1 product. This means only authorised advisers will be able to advise and sell them. Authorised advisers will have to be suitably qualified and meet professional and conduct standards. Members of the public will be able to consult an online register to see what individual advisers are allowed - and, by implication,not allowed - to do.
It's not illegal to sell securities by telephone or email,or into office buildings. Prospective investors need to carefully consider the offer and get independent advice.
"The Commission's latest surveillance cycle of 20 companies' financial statements has shown a widespread lack of transparency", Chairman Jane Diplock said.
Ms Diplock said, "all directors should remember that ensuring financial statements comply with the law is a primary duty of company directors. NZ IFRS have been mandatory in New Zealand since 2007."
"New Zealand companies have had long enough to comply with NZ IFRS. The standards demand greater transparency and if their financial statements are not fully compliant, then company directors should be concerned that they are failing one of their basic duties to shareholders.
"Company directors are personally responsible to ensure that financial statements tell an entity's story completely and transparently. They should remember that they can be prosecuted under the Financial Reporting Act if their company publishes non-compliant financial statements.
If misleading financial information is published in a prospectus, directors can also face prosecution under the Securities Act," she said.
The Commission is concerned about the lack of transparency around the underlying assumptions used to value assets, disclosures about transactions with related parties and the composition of unexplained expenses.
Ms Diplock said, "The assumptions used to value assets have become particularly relevant because of the global recession. In many cases the recession has caused significant revaluation of assets,but too often investors aren't being given enough information to make informed judgements on whether a revaluation is fair.
"We are concerned that the underlying assumptions being used to revalue assets are not stated in some financial statements. For example for intangible assets, such as goodwill, investors have a right to know what trading projections a company is using to value their assets. How much sales grow this being projected?
Do the projections vary in different markets? In most cases this level of information is not provided, which means investors cannot make informed judgements about asset valuations.
"We are also concerned about the lack of transparency in related party disclosure, particularly where directors and other key management personnel are involved. The Commission has not seen any significant improvement in this area from previous reviews. In our most recent surveillance cycle, we were prompted to write to six companies asking for explanations.
"The high level of unexplained expenses in financial statements is another matter requiring attention. In this cycle, we wrote to five companies asking them to provide more detail on these expenses. We also requested that they revise their financial statements to be more transparent in future."
The Commission will continue to use the surveillance cycles to educate companies about the greater transparency requirements under the NZ IRFS.
An in-depth review of the Commission's effectiveness found that it is discharging its responsibilities effectively and highly professionally, its Chair provides strong leadership and is supported by a high-calibre Commission and high-performance staff, that it processes a large volume of work efficiently and well, and follows good standards of practice. It also makes several suggestions of how the Commission could do better to meet market expectations.
The Commission is, however, constrained by out-of-date law that is uneven in coverage and heavily prescriptive. Its effectiveness is also limited by a narrow mandate and lack of powers, the proliferation of regulatory bodies and bottlenecks in the judicial process.
Chair Jane Diplock welcomed the report for its positive findings and for pinpointing what the Commission might do better. "This is an important moment in our history to be thinking strategically about where to go from here - how we organise ourselves and how we communicate with our stakeholders", she said.
"This is a good report card and a great opportunity."
The review was conducted by Michel Prada, the former chair of France's Securities Commission and Neil Walter, the former secretary of Foreign Affairs and Trade. The report follows KPMG's review of baseline funding of the Commission for the Ministry of Economic Development published in March 2009. It recommended an independent assessment of how well the Commission was achieving its regulatory objectives.
The authors say that, compared with corresponding overseas agencies, the Commission is delivering good value for money. Even allowing for this country's size, though, its resourcing levels are comparatively very light.
They recommend the Commission continue to focus on education, advice and persuasion, since most market participants willingly comply with accepted norms, but note it is also important to provide effective deterrence, with abuse and fraud being punished and being seen to be punished.
Along with more extensive powers, better resourcing,and a comprehensive overhaul of the system of market regulation, the report recommends a "future watch"function, advising the government on trends in international securities regulation.
Recent research found that issuers using the Trans-Tasman mutual recognition of securities offerings regime have saved on compliance costs for offering securities in the host country by up to 95 percent.
It found that the mutual recognition regime has reduced the additional legal and documentation costs to issuers offering securities in the host country by between 55 and 95 percent. The time to go to market was also significantly reduced - in one case by 25 percent.
Chairman Jane Diplock said, "The findings were encouraging.
"This is a world class example of how regulation can facilitate business. Mutual recognition is intended to aid Trans-Tasman business by giving investors more choice, and giving issuers deeper markets without higher issuing costs. The research confirms that this is the experience." she said.
The research was conducted by the Australian Securities and Investment Commission (ASIC) in consultation with the New Zealand Securities Commission.
Since coming into force in June 2008, the regime has been used by New Zealand companies seven times for capital raising in Australia. Australian companies have used it 253 times, predominantly for offering managed funds in New Zealand.
The research was conducted via interviews with key management and staff of 10 issuers in Australia and New Zealand of varying size. Participants said the regime was straightforward, transition had been easy and there was no evidence of additional compliance costs.
The research found broad support for developing similar mutual recognition arrangements with other jurisdictions, although the potential cost savings were not expected to be as great as with Australia and New Zealand because of greater differences in regulatory requirements between home and host regimes.
In meetings hosted by the Swiss financial regulator FINMA, securities regulators discussed how best to address gaps in the regulatory landscape post financial crisis.
"One of the major challenges faced by the international standard setter for securities regulation is to ensure its core regulatory principles are also relevant for a post crisis world,"Jane Diplock said.
At the meeting, IOSCO's governing body, the Executive Committee,decided to form a new stand alone principle dealing with systemic risk.
Jane Diplock said, "This is an important development reflecting global concerns regarding financial stability and recognition that securities regulators have an important contribution to make in this area."
IOSCO is currently consulting on its recent Technical Committee reports on Transparency of Structured Finance Products for comments by 13 November; and Transparency of Firms that Audit Public Companies,Auditor Communications, and Exploration of Non-Professional Ownership Structures for Audit Firms for comment by 1 December.
Further details can be found at www.iosco.org