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Binding Rulings on Securities Law
A Discussion Paper

CHAPTER 2    REASONS FOR CHANGE

Background

2.1

The Commission was established in New Zealand in the wake of a series of financial collapses, notably of the Securitibank group of companies in 1976, that left many investors with substantial losses. People had invested in Securitibank without the benefit of a registered prospectus or equivalent disclosure document.

2.2

It was decided in the aftermath of these losses to introduce wide-ranging disclosure legislation that would apply to all persons seeking to raise funds from the public, replacing the narrow disclosure requirements set down at that time in the Companies Act.

2.3

When originally drafted, the securities legislation contained detailed schedules setting out the disclosure requirements attaching to the security or scheme being offered and there was no provision for a Securities Commission. The Registrar of Companies was to administer the securities law, including that in relation to exemptions and enforcement.

2.4

Submissions on the securities bill highlighted that, in its draft form, the detailed statutory provisions would be unworkable and they focused on the need for a flexible regulatory environment so that growth and change in the financial markets would not be unduly constrained. They also expressed deep concern at the concentration of so much power in the hands of a public servant. In response to the submissions, the Commission was established as an independent "committee of the market", with Members chosen for their experience in the field of business and of securities law and practice.

2.5

The Securities Act and Securities Regulations have now been in force for more than 21 years and 16 years, respectively. During that time, it has become apparent that there are a number of ambiguities in the legislation. As well, there have been sophisticated developments in financial products that leave commercial and other fundraisers uncertain as to the requirements of the law. The structuring of the products and the methods by which they are offered continue to develop, often very quickly.

2.6

Exemptions are applied for at times because they can provide certainty, and can do so relatively speedily and at quite modest cost. However, exemptions are not always the most appropriate method for resolving ambiguity or other difficulties of interpretation, especially where the sensible view of the law is that it does not apply to the offer.

Examples Suitable for a Ruling

2.7

Some recent examples of questions that have been put to the Commission, usually in the form of an application for an exemption, that could be suited to being dealt with under a rulings power, include:

New Zealand Association of Credit Unions ("the Association")

The Association applied for various exemptions relating to offers to the public of securities in respect of credit union shares/deposits. The basis for the application was the Association's view that the shares may be participatory securities, and it wished to have the exemptions for the avoidance of doubt. (Since 1983 the Commission has had a class exemption for credit unions in which credit union shares have been treated as debt securities). In consultation with the Association, the Commission instructed a senior barrister to prepare an opinion on the issue. We concluded that the shares fall within the statutory definition of "debt security" and are properly classified as such.

The Commission declined to approve the exemptions.

Leveraging Securities ("ABC Ltd")

ABC Ltd applied for various exemptions in respect of a facility to provide loans to clients to allow clients to leverage their investments. Collateral for the loan would be provided by clients transferring securities to ABC Ltd, and gaining a contractual right of re-transfer of equivalent securities upon repayment of the loan. Under the terms of the loan and security agreement ABC Ltd would be entitled to deal in the securities in transactions with New Zealand Stock Exchange brokers.

It appeared to the Commission that this facility, in particular, the client's continuing claim in respect of the securities transferred, did not involve questions of compliance with Part II of the Securities Act. In consultation with the applicants, the Commission instructed a senior barrister to provide an opinion on the matter. The barrister was of the opinion that the facility did not involve an offer of securities to the public.

The Commission decided to decline ABC's exemption application, giving the following reasons:

1. The Commission formed the opinion that the proposed credit facility did not involve an offer of securities to the public such as would require compliance with the provisions of the Securities Act. In reaching this opinion the Commission took independent legal advice; and

2. The Commission will consider granting an exemption where there are differing views as to the application of the law and where the granting of the exemption will remove an impediment to the efficient functioning of the market for the investment. In doing so it is necessary to consider the perceived precedent effect of such an exemption. In the present case the Commission considered that granting the exemption might cause unnecessary doubts concerning compliance with securities law for other market participants offering the opportunity to the public to borrow on security.

Purpose of Binding Rulings Function

2.8

The Commission, when exercising its exemption power, must take a view on the manner in which the law applies. This can create difficulties of interpretation of the law when the Commission is under pressure to resolve legal uncertainties. Exemptions developed on this basis may leave the impression that, in the view of the Commission, the law did apply to the situation and the issuer would have been in breach to make the offer in the way it did, without the exemption. The Commission must weigh up whether an exemption might cast doubt on the legality of other issuers' similar transactions, or whether a more robust interpretation of the law should be adopted.

2.9

The examples given above demonstrate the types of situations where the Commission might have a power to make a ruling on the application of the law to the offerors' particular set of facts or, possibly, a more general ruling on how the law is to be interpreted. General rulings could be of a "pure law" nature. A general ruling might have been given in the credit unions example where the shares are defined by statute. Other "pure law" or general rulings might be made in respect of provisions of the securities legislation, or of exemption notices, that are difficult to interpret, for example the section 5(1) exemptions in respect of land.

2.10

In Australia and the United States of America there is no binding rulings regime for securities law. Rather, those jurisdictions rely on a non-binding "no-action letter" process whereby the views of the regulator's staff on enforcement in relation to particular transactions are made known to requestors seeking an advance statement of the regulator's likely approach to the proposed transaction.

2.11

In contrast to the situation in Australia and the United States, however, in New Zealand the Securities Commission is not the primary enforcer of the securities law, so the degree of certainty provided by a no-action letter process here would be only limited. At any time, despite having obtained a no-action letter from the Commission, a person might still have action taken against them by, for example, the Registrar or by an investor, on the very matter dealt with by the no-action application. Therefore it is considered that a binding rulings function for New Zealand's Commission may provide some additional certainty.

2.12

Of course, offerors could apply to the courts for a declaration where there is doubt regarding the status under the Securities Act of a proposed offer. However, that course appears to be rarely adopted, probably because of the need in the financial markets for speed in decision-making about how to structure, or whether to make, an offer. Moreover, much of the information that would require consideration in open court in respect of a declaration would be commercially sensitive. Thus, the two greatest barriers to using the courts for certainty will be delay and the possible availability to the public, and perhaps to competitors, of commercially sensitive information.

Benefits

2.13

Two likely benefits to fundraisers from introducing a rulings power for the Commission would be a reduction of uncertainty about the status of a transaction, and assistance to fundraisers to comply with the securities law: respectively, transaction certainty and compliance certainty. In addition, it would be likely to lead to greater consistency in the interpretation of securities law and may lead to a more authoritative basis for promoting law reform.

2.14

This increased certainty about the disclosure implications of proposed transactions would lead to increased efficiency, since fundraisers know the regulatory costs before deciding whether or not, or in what manner, to undertake a transaction. Compliance certainty, meanwhile, would be generated by a ruling that reassured the applicant that the Commission and Registrar will react in a particular way to the proposal or transaction, provided its terms are the same as those represented by the applicant. The risk of incurring enforcement action for non-compliance could be thus effectively eliminated.

2.15

Benefits to investors might arise from greater certainty that their investment decision will not be put unnecessarily at risk by conflicting views on the technicalities of the law, thereby increasing investors' transaction certainty. Meanwhile, lower transaction costs to the fundraiser could result in better returns to investors.

2.16

Subsidiary benefits of a rulings power could include reduced enforcement actions being taken against offerors, resulting in lower administrative costs to shareholders and various public bodies and lower compliance costs to fundraisers. Better and quicker flows of information to the Commission concerning trends in fundraiser-behaviour and grey areas in the law would be an additional subsidiary benefit of introducing a rulings function.

1. Is there a need for binding rulings to be available on aspects of the securities law?

2. If yes, on what aspects of securities law should rulings be available?

3. Would such a regime disturb the proper balance between the courts and an administrative agency such as the Securities Commission?

4. As the Commission has few lawyers as Members (and suggestions have been made that the Chairman should not be required to be a lawyer), is the Commission competent to make rulings on the interpretation of complex questions of the securities law?