• About
• Publications
• Exemptions
• Notices
• What's new?
• International
• Speeches
• Information for investors
• Contact us
• Site map
• Home

An Inquiry Into the Performance by NZX of its Regulatory Functions as a Registered Exchange During 2003 and 2004 Prior to the Collapse of Access Brokerage

PART III - NZX REGULATORY STRUCTURE AND COMPLIANCE STRATEGY Cntd.

NZX internal reporting lines

124. Supervision of the compliance team was initially assigned to Mr Brown due to his broking experience and his experience on the NZSE Board. At the time Mr Brown was also Head of Market Development. Ms Baker was viewed by Mr Weldon as the operational manager of the team. Mr Weldon viewed her seniority as important in terms of her capability to escalate necessary issues. Ms Baker was not a member of the NZX executive management team. The Commission received evidence from Mr Weldon that the effective functioning of the team lay with Ms Baker:

She was unequivocally and without doubt the operational leader of that team...it was very very clear, both in operation, both from Philip and Lynda's perspective and from instruction to Barbara that she was responsible for the management of that team on an operational basis.

125. Mr Brown gave evidence that:

Barbara was clearly the manager of that unit and that was a unit that I saw very much as her responsibility.

126. In her evidence to the Commission, Ms Baker said that she did not consider herself a manager of the compliance team. Ms Baker also told the Commission that she was offered the position of Team Leader, but did not accept the terms, and was not formally appointed to that position. Ms Baker told the Commission that she was a contractor, not an employee, and so did not consider herself to be a manager of the team. NZX said on this point that it did not wish to have a contractor in such a senior role. Ms Baker said she considered herself a peer of the other compliance team members, reporting to Mr Brown on Mr Weldon's instruction.
127. To some extent Ms Baker appears to have been uncertain of her status within the team. However it is apparent from the evidence the Commission received that the other members of the inspection team and management staff regarded Ms Baker as the operational team leader of the inspection team, under the supervision of Mr Brown. Matters tended to be reported first to Ms Baker who would inform Mr Brown.
128. The Commission was told that there was no formal line reporting responsibility to Ms Baker. The job descriptions for Ms Baker, Mr Rodrigues and Ms Koekemoer show that they all formally reported to Mr Brown.
129. Ms Campbell assumed supervision of the compliance team from Mr Brown at the end of September 2003. Closer association with the NZX legal team was considered desirable as the compliance team members were not legally trained. In addition, the rewrite of the Business Rules was to involve both the compliance team members and the lawyers in the regulatory team. The NZX participant compliance team continues to report to Ms Campbell.
130. Mr Brown and Ms Campbell each reported directly to Mr Weldon in relation to broker compliance. Mr Weldon reported to the Board.

Reporting to management and reporting expectations

131. When asked by the Commission about how he saw his role and whether this had been formally communicated to him, Mr Brown said:

132. Mr Brown told the Commission that to the extent that he was involved in issues it was in managing relationships with brokers rather than technical aspects.
133. Mr Brown received draft inspection reports and gave comments back to the compliance team. Mr Brown confirmed that he was to act as "a filter" for issues that needed to be brought to the attention of Mr Weldon. The Commission heard from Mr Brown that there were no specific requirements around the types of issues that needed elevation to Mr Weldon. He would raise issues to Mr Weldon if he considered an issue sufficiently serious.
134. Despite his role as a filter for issues, it appears that Mr Brown relied heavily on Ms Baker.
     
     He told the Commission:

Where I would raise issues with Mark is where I felt there was something of significant importance and I would rely on Barbara to identify those for me....

...I very much regarded Barbara as the person who made those decisions for which I signed off, you know rather than me having any major influence in determining - you know, I wasn't part of the inspection process, so I didn't know what they'd seen. All I was really looking at was identifying those as issues, agreeing with the priorities she had attached to them, and then looking at the timeframe in which they would be resolved.

135. This also seems to have been the experience of members of the inspection team. Mr Rodrigues told the Commission:

...I think the reporting was to Barbara, because...one or two times I did try to take matters to Geoff [Brown] where he said that you can probably discuss it with Barbara first.

136. Mr Weldon had established a management team of eight people when he joined NZX. The NZX management team met weekly to discuss issues. The Commission received evidence from Ms Campbell that where issues were raised with him, Mr Weldon would usually comment on the resolution of those issues, although he would generally follow her lead on NZX Regulation. Mr Weldon confirmed in his evidence that he would always provide input but would generally defer to Ms Campbell's judgement on operational matters within her expertise and that of her team.
137. The Commission received evidence that each manager holds weekly meetings with their direct reports. The Commission received evidence that weekly compliance team meetings were held. The meetings were attended by the compliance team members and Mr Brown. Later Ms Campbell attended the meetings. At that time Ms Baker stopped attending. Inspection issues would be discussed at these meetings, and work scheduling and priorities established.
138. Mr Rodrigues gave evidence that he regularly attempted to bring issues to the attention of Mr Brown and to keep the other compliance team members informed of developments with issues that he saw arising out of inspections. Issues tended to be communicated to Mr Brown by way of email correspondence. Many emails were copied to Ms Campbell. Some were copied to Mr Weldon. Emails were also copied to the general compliance email distribution list to which the compliance team members had access. The Commission has seen little evidence of responses to issues raised in emails, but was informed that issues were discussed at the weekly compliance team meetings. The Commission received evidence that deliverables lists were prepared and updated to track progress on inspections and record the actions to be taken.
139. Draft inspection reports were sent to NZX managers with responsibilities in respect of the compliance team. These were commented on prior to being sent out to the broking firms. However the compliance team received limited feedback from management on certain other information that they produced. The Commission was told by Mr Rodrigues that the compliance team reported to managers of the compliance team on the liquid capital information they had received from brokers to see if management had a view on how the compliance team should address issues. Mr Rodrigues said that while the liquid capital information was received by management, there was little feedback.
140. Given this situation, the compliance team continued preparing and sending the liquid capital information and tried to work on their own to deal with matters. When asked if the level of feedback caused him any concerns, Mr Rodrigues said:

...what concerned me is that...I'm preparing all these figures all the time...I'm giving all these figures to everyone all the time and... if I have missed something, someone else will pick it up. But..., it did not happen that way.

141. NZX told the Commission that escalating an issue to NZX management is done by voicemail, telephone call, or face-to-face conversation:

It is understandable that the Commission has not seen evidence of responses to issues raised in emails. This is because raising an issue by email at NZX is not a request for a response.

142. Issues arising from on-site inspections that the compliance team considered required further attention were raised with Mr Brown by exception based reports. Mr Brown gave evidence that he would discuss with the compliance team what had happened and explain what was required to be done in those instances. Mr Brown gave evidence that he monitored issues by receiving further reports. Ms Baker gave evidence that, when away from Wellington, her practice was to call Mr Brown from broking firms' offices if particular issues arose in the course of an on-site inspection or if she found deficiencies or had particular concerns that she thought needed his consideration or input at that time. When Ms Baker attended on-site inspections in Wellington she reported to Mr Brown on her return from the brokers' offices.
143. Mr Weldon's evidence was that NZX has clear internal procedures for escalation and that these are well understood. He gave evidence that the process for engaging executives on issues is also well understood. When asked about the level of discretion that the compliance team had in dealing with matters, Mr Weldon gave evidence that it was known throughout NZX that there were three main levels of reporting - matters that require escalation, matters that need to be reported and communicated, and matters that are communicated for information only.
144. The Commission received evidence from Ms Baker that an "escalation" template report was developed by the compliance team in July 2003 at the request of Mr Weldon. The purpose of the escalation template was for the compliance team to escalate urgent issues to Mr Weldon, Ms Campbell and Mr Brown. It was to be used by staff individually where an event occurred in their area. The Commission received evidence that no escalation report was prepared in relation to Access.
145. In his initial written evidence to the Commission Mr Weldon did not appear to be aware of any escalation template. Ms Campbell was also unaware of the escalation template. Mr Weldon wrote:

We do not use any particular template for the escalation of regulatory issues, and I do not recall ever seeing, or approving, such a template.

146. The Commission later received evidence from Mr Weldon that he had subsequently become aware of the existence of an escalation report template, although it was not something that he ever saw. The Commission received evidence from NZX that the escalation report had been used once in July 2003, by Ms Baker. It was used to elevate an issue regarding unqualified advisors at another brokerage to Mr Weldon and Mr Brown.
147. The inspection team produced summary spreadsheets of the liquid capital returns and internal control returns submitted monthly to NZX by brokers. The monthly summaries were provided to Ms Baker and Mr Brown. When asked by the Commission if the production of this information was part of a process that had been established, Mr Rodrigues said:

Basically it was on my own initiative because there was no sort of reporting being done...I thought there should be something that keeps a track of how people are keeping their capital so that, in case there's any problems with them we can see from the trends...since we are regulating the business we definitely need to keep track of how all the firms are doing.

148. The summaries highlighted where actual liquid capital was inadequate or was less than 120% of prescribed liquid capital. The evidence received by the Commission showed that ten broking firms were listed as having actual liquid capital as a percentage of prescribed liquid capital of less than 120% in several of these monthly summaries. Access was listed in two of these. Under the Rules, firms were required to notify NZX immediately if the liquid capital level fell below 120%.
149. The Commission received evidence from Mr Brown that information regarding liquid capital summaries had been provided to him and kept. The Commission received evidence from Mr Brown that he relied on the compliance team to ensure that brokers were meeting their obligations and expected the compliance team to investigate any issues that arose. He did not provide feedback on the monthly liquid capital reports that he was given. The compliance team was to exercise judgement as to whether explanations provided by broking firms were satisfactory or not satisfactory.
150. In his evidence, Mr Brown said:

151. The Commission received evidence that Access had, for a number of years, used a methodology for calculating liquid capital that was not consistent with the methodology adopted as a part of the Regulations and as a result had overstated the Liquid Capital. The issue was identified by the compliance team in August 2003, prior to the Access inspection. In August 2003, under the corrected methodology, Access' actual liquid capital was recorded as 38% of prescribed liquid capital. Mr Rodrigues revised the liquid capital information for Access for March to July 2003 under the corrected methodology and provided the realigned figures to Mr Brown.
152. In his evidence to the Commission Mr Brown was asked whether the liquid capital figure of 38% for Access under the revised methodology raised any questions with him about the ability of the firm to continue in business and take public money.

153. The Commission received evidence that the issue was followed up by compliance team staff and corrected by Access. Access recorded increased liquidity by also recording its NZX shares as part of its liquid capital calculation (as it was entitled to do under the Rules). Previously this had not been included in the calculation.
154. The Commission received evidence that Mr Weldon had significant input into reviewing the draft reports for the first four inspections conducted by the in-house compliance team. This level of involvement ceased after the first four inspections. Mr Weldon did not provide any comments to the compliance team on the Access inspection report.
155. The Commission received evidence from Mr Weldon that he did not read inspection reports as a matter of course but that he did read the report for one broker (not Access) after Ms Baker escalated issues. Mr Weldon gave evidence that he would read written material that personnel provided to him directly for his attention or directed him to read. The Commission received evidence from Mr Weldon that staff and managers at NZX are expected to draw matters to his attention if the materiality of the matter warrants it. Mr Weldon said that everyone at NZX was aware he would not necessarily read internal emails, emails that were copied to him, or attachments to copied emails. Copied emails to him meant "for your information" only. Voicemail was the preferred method of communication for alerting Mr Weldon to issues. Mr Weldon gave evidence that staff had been informed about these communication matters on many occasions.
156. When asked who was the executive accountable for ensuring that the findings in the inspection report were followed up, Mr Weldon gave evidence that in the first instance this was Ms Baker. Accountability also lay with Mr Brown who was overseeing the compliance team. Ultimate accountability lay with Mr Weldon as CEO. Mr Weldon gave evidence that he would consider it inappropriate if noone on the team had taken any action and followed up the issues at any point of time.

Comment

157. NZX's new in-house compliance function was still under development at the time of the Access inspection in August 2003. The compliance plan was put to the Board for approval. Development of inspection procedures was largely left to the compliance team, based on what they had seen when accompanying Deloitte, their previous experience, and what information they could acquire from research. None of the team members had experience in leading compliance teams or in designing inspection or audit programmes in the New Zealand context. The Compliance Working Group was consulted on the inspection programme but inspection procedures appear to have largely been developed as inspections were undertaken. These procedures were not documented, and there was no ability for supervisors to assess the methodology designed by the team.
158. The Commission does not suggest that NZX required a rigid inspection procedure. Such a framework is unlikely to be appropriate, and flexibility in processes will be needed to address specific situations. The conduct of inspections will also be reliant to a degree on the professional judgement of the inspectors. However the Commission is of the view that the NZX inspectors should have had the benefit of clearer procedures, sufficient to provide adequate guidance to the inspectors and a greater level of assurance for supervisors.
159. Broker compliance was a new task for NZX. There were no staff who had experience in conducting inspections under the NZX Rules. While members of the compliance team had experience with inspections, this appears to have been either indirect (Mr Brown and Ms Baker) or junior to mid-level at overseas exchanges (Ms Koekemoer and Mr Rodrigues). The Commission considers that executive management failed in their management responsibilities in leaving the design of the stock exchange's inspection procedures to these staff members.
160. Internal reporting procedures for the compliance team were not well established in 2003. The supervisor of the compliance team, Mr Brown, was responsible for identifying and assessing issues that required further elevation. In practice he appears to have relied to a great extent on issues being identified for him. He did not pay sufficient attention to the information that was reported by the inspectors. There was a lack of direction to the team as to how they should keep senior team members apprised of information from brokers. This is seen in Mr Rodrigues' decision to initiate a monthly liquid capital report for Mr Brown. There was a marked lack of attention paid by Mr Brown to information that was reported to him. This is apparent from the lack of reaction to a number of reports that showed Access' liquid capital to be below 120% and a lack of reaction to the information that Access had been using an incorrect methodology and appeared to have liquid capital of only 38%.
161. In the Commission's view a report identifying that a broker had liquid capital of only 38% should have, on the face of it, raised concerns with NZX management even if the methodology was later corrected and the issue remedied.
162. NZX told the Commission that:

It is not the role of a manager to review all information gathered by their team. It is the role of a manager to respond to issues which are escalated for their input. There was a clearly understood procedure for escalating issues to management at NZX. Where this procedure was followed, Mr Brown's involvement was forthcoming...

163. The Commission agrees that it is not the task of management necessarily to review all information gathered by a team. However, it is the role of management to supervise the work of a team. NZX appears to take the view that management's role is essentially passive: to respond to matters put to them using a specific escalation method. The Commission does not agree that this is the role of a supervisor, in particular the supervisor of a team carrying out a function that was new to the exchange at the time. NZX has, in its submissions to the Commission, placed weight on the fact that some important issues were identified in written reports, not by voicemail, NZX's preferred method of identifying material matters. In the Commission's view NZX management should be receptive and responsive to significant information communicated to them by the compliance team, regardless of the method by which this information was communicated.