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Strengthening Confidence in New Zealand's Capital Markets

A Statement on Certain Aspects of Corporate Governance and Financial Reporting

28 November 2002

CONTENTS

The Securities Commission
The Purpose of this Statement
The International Scene
The New Zealand Scene
Relevance of International Practice
Disclosure of Information
Corporate Governance
Financial Reporting and Audits
Regulation and Enforcement
In Summary

The Securities Commission

The Commission's purpose is to strengthen investor confidence in New Zealand's capital markets and thereby foster investment in New Zealand. It does this by promoting the efficiency and integrity of these markets and their cost-effective regulation. While the Commission is mainly concerned with entities which offer securities to the public and the interests of investors, this statement addresses issues relevant to all participants in New Zealand's capital markets.

The Purpose of this Statement

The Securities Commission has decided to publish its views on principles it believes are important to the debate on corporate governance and corporate transparency.

These principles, together with high ethical standards, should underlie the practices of issuers and other participants in New Zealand's capital markets. Application of these ethical standards and principles should increase investor confidence in the markets.

The Commission's immediate goal in making this statement is to indicate its thinking in relation to certain principles of corporate governance and financial reporting. It also aims to encourage market participants to make voluntary changes to incorporate these principles into their practices.

This statement is not a recommendation for changes to the law at this stage. The Commission recognises that after full public debate some aspects may require changes to the law.

The Commission looks forward to the continuing debate on corporate governance and financial reporting in New Zealand, including the role of shareholders, recognising that the debate encompasses a broader range of issues than are considered in this statement.

The Commission will continue to publish its views on aspects of corporate governance and financial reporting as it considers appropriate.

THE INTERNATIONAL SCENE

Events in the corporate world in the past year have had a profound effect on investor confidence world-wide. As a result, issues of corporate governance, financial reporting and audit quality are being vigorously debated. Governments, boards of directors, advisers, regulators, and other market participants in developed capital markets are working to restore investor confidence through changes to practices and by new legislation.

Some examples of these developments include, in Australia the Corporate Law Economic Reform Programme 9 which addresses corporate disclosure and strengthens the financial reporting framework. The Joint Committee on Public Accounts and Audits has recommended changes to various practices. Australia has decided to adopt international accounting standards by 2005.

The Sarbanes-Oxley Act in the United States increases the powers of the Securities and Exchange Commission, creates a Public Company Accounting Oversight Board and makes changes to the law relating to audit committees and audit independence. The new law enhances financial reporting transparency and increases responsibilities and penalties for company chief executives and financial officers.

In the United Kingdom the Hewitt Report (July 2002) addresses audit committees, auditor independence, and financial reporting and auditing standards. This is an interim report of a joint initiative by Treasury and the Secretary of State for Trade and Industry following high profile corporate failures. Other UK initiatives are the Higgs Review, which is taking a best practice approach to reforms of the role of non-executive directors, and a white paper by the Department of Trade and Industry on a wide range of corporate governance and transparency issues.

The Canadian Senate Committee on Banking, Trade and Commerce is inquiring into the financial reporting infrastructure in that country, and an independent oversight body, the Canadian Public Accountability Board, has been set up to monitor audit standards and quality and the independence of auditors of publicly listed companies.

In Hong Kong a government Standing Committee on Company Law Reform has issued proposals to improve corporate governance and corporate transparency to meet international standards.

New regulation in Europe requires that all European Union listed companies comply with international accounting standards from 1 January 2005.

A number of stock exchanges, including the New Zealand Stock Exchange, have revised their listing rules relating to continuous disclosure, the timeliness of financial reporting, audit committees and other governance responsibilities.

National accounting standards setters have increased their efforts to adopt or converge with international financial reporting standards.

The International Organisation of Securities Commissions has encouraged national accounting and audit standard setters to move towards convergence, and has continued its move towards endorsement of international audit standards.

THE NEW ZEALAND SCENE

Corporate governance, financial reporting and audit quality are issues of core importance for New Zealand's capital markets, as they are for markets internationally.

The Government has a policy of making our capital markets more attractive to investors. It has introduced a Takeovers Code and the Securities Markets and Institutions Bill (SMIB) - the two most important pieces of securities legislation in the last decade. When SMIB comes into force on 1 December 2002 New Zealand law will for the first time require continuous disclosure as a feature of an informed public securities market. The debate on corporate governance, financial reporting and audit quality is well underway in this country. The Institute of Chartered Accountants of New Zealand released a discussion paper in August 2002 and will present proposals for consideration by the Minister of Commerce. The New Zealand Accounting Standards Review Board and the Financial Reporting Standards Board has recommended that New Zealand adopt international financial reporting standards for domestic financial reporting purposes by 2007.

The NZSE has proposed significant changes to its listing and business rules. Its proposals to address corporate governance standards for listed issuers have contributed significantly to the debate in New Zealand.

Various advisers, analysts and commentators have published articles, comment and recommendations on the issues.

The Securities Commission has commissioned independent research by Professor Keitha Dunstan of Victoria University of Wellington to inform the debate on development of financial reporting for New Zealand securities markets. Professor Dunstan's paper is published on www.seccom.govt.nz.

RELEVANCE OF INTERNATIONAL PRACTICE

A continuing challenge for New Zealand's capital markets is to attract overseas investment.

Convergence with international best practice in financial reporting, corporate governance, and market regulation will enhance the reputation of our capital markets.

Principles relating to international practice

The environment for investment in New Zealand's securities markets should be such that investors can be confident that it is a developed and well regulated securities market.
The standards of corporate governance for New Zealand issuers should be comparable with those required in our neighbouring capital markets and in other developed capital markets.
The information disclosure expected of New Zealand issuers should be comparable with that required in our neighbouring capital markets and in other developed capital markets.
Financial reporting and auditing standards and practices in New Zealand should be aligned with international best practice.
The special aspects of New Zealand capital markets should be recognised.

DISCLOSURE OF INFORMATION

Principle for information disclosure

Full and fair disclosure of information to investors is fundamental to good corporate governance. Issuers should provide information to enable investors to make informed decisions when raising capital, in periodic and annual reports, and by continuous disclosure. The information provided to investors should be relevant, reliable, complete, unbiased and timely.

Application of the principle for information disclosure

To apply the principle of disclosure of information New Zealand needs:

a capital market infrastructure that supports sound corporate governance, financial reporting and audit assurance practices by issuers;
effective monitoring of compliance with laws and standards;
rigorous enforcement of the law and prosecution of offences;
transparency in regulatory and oversight processes; and
effective civil remedies for investors.

It is important that the current debate leads to decisions and changes which implement or strengthen these elements in the capital markets.

CORPORATE GOVERNANCE

Principles for corporate governance

A high standard of corporate governance can be achieved when:

boards and management have high ethical standards;
directors act in the best interests of the company;
entities (companies and others) who issue securities to the public are always mindful of their responsibilities to their investors;
directors are competent;
the board effectively monitors management's performance;
there is a proper balance between independence of directors and good communication between the board and management; and
the board's governance processes are transparent, and fully disclosed to investors.

Application of principles for corporate governance

To apply the principles of corporate governance the Commission is of the view that:

boards should have an independent audit committee to monitor external financial reporting and external and internal audit issues. Members of the audit committee should have appropriate skills.
boards should have a majority of non-executive directors.
entities should disclose all benefits, including remuneration of directors and key executives and all related party transactions with directors and key executives in the annual report.
directors should disclose details of other directorships in the annual report.
boards should disclose their corporate governance practices in the annual report.

FINANCIAL REPORTING AND AUDIT

Principles for financial reporting and audit

High quality financial reporting can be achieved when:

financial reports are accurate and not misleading, and present a true and fair view;
boards provide information in periodic financial reports that is useful to investors for informed investment decision making;
financial reports are audited by independent, external auditors;
boards establish and maintain independence between the auditor, and the entity and its management;
boards disclose information in financial reports concerning the independence of the auditor to enable investors to include this factor in their investment decision-making.

Investors should be able to have confidence in the quality of audits.

Application of principles for financial reporting and audit

To apply the principles for financial reporting and audits:

financial reports should be prepared on the basis of generally accepted accounting practice.
directors should be required to certify that the financial statements presented in periodic financial reports are true and fair and comply with generally accepted accounting practice.
directors should disclose all material information that is likely to affect investment decisions in line with international best practice for continuous disclosure.
auditors should be independent, in line with international best practice.
auditors should make a statement to the board concerning their independence at the time the audit report is issued.
the audit committee should monitor:
- the auditor's appointment or removal;
- the auditor's remuneration and scope of services;
- the reporting of the audit findings and the audit opinion; and
- the retention of the auditor to provide non-audit services.
the board should disclose the scope of the audit, the nature of any non-audit services provided by the auditor, and the remuneration for these.
the board should disclose how auditor independence has been maintained where the auditor has been approved to provide any non-audit services.
an independent oversight body should monitor issues of audit quality and auditor independence.

REGULATION AND ENFORCEMENT

Principles for regulation and enforcement

A rigorous regulatory approach to monitoring the securities markets and enforcing the law is needed to enhance investor confidence in the markets. Co-ordination between the various regulatory agencies with responsibilities for law applying to participants in New Zealand's capital markets is important.

Company, insolvency, criminal and common law, as well as financial reporting and securities law, are all relevant to an efficient legal and regulatory regime for the capital markets.

Application of the principles relating to regulation and enforcement

For effective regulation and enforcement the Commission is of the view that:

regulators should make the best possible use of existing legislation to identify wrongdoing and enforce compliance.
regulators should identify regulatory gaps and recommend reform.
regulators should act promptly on suspected market misconduct.
regulators should identify and act on instances of non-compliance with GAAP and with the law.
effective civil remedies and penalties should be available.

IN SUMMARY

The Commission is publishing this statement on certain aspects of corporate governance and financial reporting to contribute to the current debate.

The Commission believes that, while recognising special aspects of New Zealand's capital markets, it is important to adopt practices which are comparable with neighbouring and other developed capital markets.

The Commission:

encourages New Zealand market participants to make changes to improve their corporate governance and financial reporting in line with international best practice.
encourages the adoption of standards that are comparable with other developed markets.
will continue to make best possible use of existing law to identify wrongdoing and to take action against breaches of the law.
will identify regulatory gaps and recommend appropriate reform of the law.
will seek ways to work co-operatively with other regulators to achieve effective monitoring and enforcement of securities law.

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