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REPORT ON DISCLOSURE BY FINANCE COMPANIES

INTRODUCTION

Purpose of Report

1.: This report provides guidance on the Commission's expectations for disclosure by finance companies under the Securities Act 1978 ("Act") and Securities Regulations 1983 ("Regulations").
2.: It follows a Discussion Paper that was published by the Commission in September 2004 entitled Disclosure by Finance Companies. The Discussion Paper outlined the Commission's preliminary views on information that should be disclosed by finance companies in their investment statements and prospectuses under the Act and the Regulations, and sought comment on these preliminary views.
3.: This report provides guidance to finance companies to assist them in assessing their compliance with the Act and Regulations and making improvements where necessary. It sets out the Commission's understanding of certain aspects of the law and signals the approach that the Commission intends to take in its enforcement role.
4.: This report focuses on disclosure by finance companies under the Act and Regulations. It does not look at the prudential supervision or status of finance companies. The Commission does not have a role in relation to the prudential supervision of finance companies and does not comment on this.

Enforcement

5.: The Commission intends to review a sample of finance companies' disclosure documents later in 2005. This will take place as part of the Commission's routine surveillance work. The documents will be reviewed against the disclosure requirements of the Act and Regulations. If the Commission identifies breaches of the law it will raise these matters with individual finance companies. The Commission may take enforcement action, as appropriate in the circumstances of each case.
6.: The Commission continues to take enforcement action against issuers and their directors where material breaches of the legislation are identified. If material breaches by finance companies are identified in advance of the follow-up review, the Commission will take enforcement action as appropriate.

Disclosure may depend on the circumstances of the finance company

7.: Some of the matters identified in this report will be more relevant to the circumstances of particular finance companies than to others. Not every matter will need to be disclosed by every finance company. It is not the Commission's intention with this report to lay down any further prescription for disclosure by finance companies - the disclosure obligations for all issuers are set out in the law. Rather, we have identified high-level areas in which we consider disclosure by finance companies generally need to improve in order to comply with the law.
8.: The way in which a finance company interprets the disclosures required under the law and assesses the matters in this report is in each case a matter for the particular finance company to determine. The report is intended to serve as guidance for individual finance companies, each of which should carefully assess the information it needs to give investors in view of the particular context of its business, its lending activities, the types of debt securities that are being offered and the risks of the investments it offers.
9.: A number of the matters included in this report are likely to be relevant to other types of issuer as well as to finance companies. While this report focuses on particular disclosure issues that we have observed in the finance company sector, the prescribed disclosure for investment statements applies to all issuers, and our view of what the law requires will, in general terms, be the same regardless of the type of issuer.

The Discussion Paper and submissions

10.: This report is based substantially on the Discussion Paper and the submissions that the Commission received in response to it. The report refers at times to the Commission's Discussion Paper. The Discussion Paper includes examples and commentary in relation to disclosure issues that the Commission identified in carrying out its review. The Discussion Paper is available on the Commission's website www.seccom.govt.nz
11.: The Commission expressed the view in the Discussion Paper that some finance companies need to improve their compliance with the Act and Regulations and assess the quality of their disclosure.
12.: The Discussion Paper was circulated to around 100 interested parties in September 2004 and made publicly available on the Commission's website. The Commission invited comment from finance companies and interested parties on the preliminary views expressed in the Discussion Paper.
13.: The Commission received 33 submissions in response to the Discussion Paper. The Commission thanks respondents for the time and consideration spent in preparing these submissions. The Commission has carefully considered the submissions received.
14.: A number of respondents raised issues of law reform in their submissions. The Commission's Discussion Paper and this report focus on disclosure by finance companies under the current legal requirements. However, we have included a section on questions of law reform in the Appendix of this report to highlight the main issues that were raised by respondents. The Commission intends to look at these issues further, and in due course may recommend law reform to the Minister of Commerce. The Commission is aware that the Government intends to review the disclosure provisions of the Securities Act as the fourth part of its programme of securities and securities trading law reform.

Disclosure of financial information

15.

The Discussion Paper did not include detailed discussion about disclosure of financial information by finance companies. The Commission undertook a separate project on this and the results of that review were not available when the Discussion Paper was published. The Commission's key findings from that review work are included in this report.

16.

The Commission reviewed the financial statements of a sample of 16 finance companies. This review work indicated that there were 3 main areas where financial disclosure and financial reporting practices should be improved:

(a): Disclosure of financial information relating to Financial Reporting Standard 33: Disclosure of Information by Financial Institutions (FRS-33) generally needs improvement;
(b): Information concerning related party transactions needs to be adequately disclosed to enable readers to understand whether transactions are truly at "arm's length" and on commercial terms; and
(c): Disclosure about items where there is no specific guidance in New Zealand financial reporting standards (for example, revenue recognition and the treatment of compound financial instruments) needs to improve. Finance companies need to look to available authoritative support to ensure that financial reports conform to best practice.

17.

The Commission encourages auditors to be vigilant in the audit of financial statements. High quality external auditing is critical to integrity in financial reporting. Investors rely heavily on the external assurance of an issuer's financial reporting.

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18.: The Commission cannot give rulings on the interpretation of the law or provide legal advice. Accordingly, this report is provided for guidance only and to indicate the view that the Commission has of the law as it will apply it in its enforcement work. The Commission may publish further comments or guidance over time. However, the Commission is not bound by this or any other report.

SECTION 1 - KEY PROVISIONS OF THE ACT AND REGULATIONS, AND FINANCIAL REPORTING STANDARD 33

Investment statement and prospectus

19.

The investment statement and registered prospectus are the key disclosure documents for any offer of securities to the public. The Act and Regulations set out the minimum disclosures that are required in these documents.

20.

The information required in any particular investment statement or prospectus will depend to a large extent on a finance company's particular business, lending activities, the types of debt securities offered, and the risks of the investment.

21.

The investment statement is generally the principal point of sale document on which investors base their investment decision. Its purpose under the Act is to:

(a): Provide certain key information that is likely to assist a prudent but non-expert person to decide whether or not to subscribe for securities; and
(b): Bring to the attention of such a person the fact that other important information about the securities is available to that person in other documents.

22.

The investment statement must contain the information required to be included in it under the Act and Regulations. More particularly, it must contain all of the information required to answer the questions of Schedule 3D of the Regulations. The eleven questions found in Schedule 3D must be addressed and all the information and statements required to answer each question must be set out in the investment statement under that question.

23.

The information in the investment statement must be presented in a "succinct manner". "Succinct" relates to how the required information is presented. Being "succinct" appears to have been interpreted by many finance companies to mean being "brief". The Commission notes that several of the Schedule 3D disclosure provisions refer to providing "brief descriptions". This means that issuers need to deliver information briefly. It does not mean that key information can be omitted in the name of brevity. While information should be succinctly (and, where required, briefly) stated, issuers must ensure that all required disclosures are sufficiently made. The investment statement can say that additional information about a matter in Schedule 3D is in the registered prospectus. This does not detract from the requirement to fully answer the questions in the investment statement.

24.

The registered prospectus must set out all material matters relating to an offer of securities. For an offer of debt securities the registered prospectus is required to contain all the information, statements, certificates and other matters set out in the Second Schedule of the Regulations that are applicable. If a statement required in the registered prospectus would be misleading without the addition of further information, then that further information must also be included.

25.

Finance company directors must certify that the investment statement complies with the securities legislation, does not contain any matter that is likely to deceive, mislead or confuse with regard to any particular that is material to the offer of securities and is not inconsistent with the registered prospectus relating to the security. Directors need to take these certification responsibilities seriously.

26.

The Commission can suspend or prohibit the distribution of an investment statement if it is likely to deceive, mislead or confuse in respect of a particular that is material to the offer, is inconsistent with any registered prospectus referred to in it, or does not comply with the Act and Regulations. The Commission has the power to suspend or cancel the registration of a registered prospectus if it is false or misleading as to a material particular, omits a material particular or does not comply with the Act and Regulations.

Financial Reporting Standard 33

27.: Financial Reporting Standard 33 prescribes "minimum standards of disclosure for financial institutions". While FRS-33 recognises that other entities also have exposures to risks, such as the risk of counterparty failure, funding and asset concentrations, interest rate movements and liquidity risk, it notes that "the magnitude of those risks is generally greater" for financial institutions. The commentary to FRS-33 notes that "as financial institutions are also generally more highly geared than other commercial entities, their capacity to absorb losses arising from such risks is not as great as other entities".

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