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Law Reform: Investment Advisers
A Discussion Paper

CHAPTER 4 THE DISCLOSURE REGIME: PROBLEMS AND POSSIBLE CHANGES TO THE LAW

4.1

The principle of disclosure holds a central position in securities law. It is considered that the better informed a market is, the more efficient and the more fair it is likely to be. A free flow of reliable information is likely to encourage investment. This principle has been applied in New Zealand in particular to the primary market by the Securities Act which requires all material information about an offer of securities to the public to be disclosed.

4.2

Consistent with general securities policy, the purpose of the Investment Advisers (Disclosure) Act is not to prescribe what advice an investment adviser should give or to evaluate that advice (the standard of advice given is dealt with to some extent by the rules of common law such as negligence and contract). Rather the Act's purpose is to ensure that the public has access to sufficient information about the advisers they deal with to be able to make informed decisions as to whether to ask them for investment advice and whether to rely on investment advice received.

Investment Advisers Need Only Provide Full Disclosure on a Request

4.3	As previously noted, the Investment Advisers (Disclosure) Act provides a two-tier disclosure regime for investment advisers. We understand that this regime was enacted in a two-tier form due to concerns that certain information currently in the second tier would only be available after advice had been given and a product had been purchased. In particular it was considered that there may be difficulties in providing investors with information regarding any direct or indirect pecuniary or other interest (being an interest that is reasonably likely to influence the adviser in giving the advice) in initial disclosure. Many investment advisers now have a single standard disclosure document containing the information for both the first and second tiers of disclosure. They distribute this before giving investment advice.
4.4	It is not always easy for investors to understand and compare the natures of services offered to them. They may not know what questions to ask. An investment adviser disclosure statement will assist in providing key information on the nature of advisory services offered. It will indicate the types of investments with which an investment adviser has had experience and the qualifications he or she holds.
4.5	With relevant information the potential client can decide whether to engage the investment adviser and what weight to put on any investment advice received. It gives a basis for a client to decide. However the law creates a distinction between initial disclosure and request disclosure. The client will not receive all the prescribed information unless he or she asks for it. Many people are unaware of their right to request investment adviser disclosure. Accordingly a client may come to a mistaken view about the adviser and may, for example, treat someone with limited qualifications and experience as more knowledgeable then he or she actually is.

Conflicts of Interest

4.6	The investment adviser may have two functions, to advise the client on investment products and to market investment products for the issuer. They are both important. However placing both functions in one person can create conflicts of interest. It is all the more important that the client should have access to all prescribed information. Otherwise conflicts of interest, for instance, may remain unknown.
4.7	Often a significant portion of an investment adviser's remuneration is from commissions provided by issuers of investment products. To the extent that an individual is a self-interested and self-maximising unit, the incentive on an investment adviser to recommend the product that will bring him or her the highest commission is a relevant consideration. This economic interest may conflict directly with a client's interest in making an investment that results in the outcomes that he or she is looking for (for example higher returns or greater security or long term savings or readily accessible money).
4.8	We do not think that an interest in, or a bias towards, a particular product is always a problem. If the interest or bias is disclosed, investors can take this into account in weighing up advice given by the adviser. This may be accomplished if an initial disclosure document containing all material matters is provided.

Mandatory Disclosure Statements

4.9	The two-tier system appears arbitrary. We consider that the information currently in the second tier of disclosure should be merged with that in the first tier so that all material matters prescribed are disclosed to an client before investment advice is given. We consider that an investment adviser should not be free to give investment advice to a client until disclosure has been made.
4.10	Such disclosure will provide the investor with a better basis on which to evaluate the competence of the investment adviser and the quality of any advice to be given. This mandatory initial disclosure would be analogous to an investment statement. Currently an issuer may not allot securities unless the subscriber has received an investment statement.
4.11	It is our impression that there should not be any particular difficulties in providing additional disclosure of matters. We would like to proceed on the basis that all material information can be disclosed before advice is given and that the disclosure is sufficient to reveal both the cost and the benefit to the investment adviser in providing the service. If this is not so we would like to hear about it. If this is not so we would be interested to receive proposals consistent with our proposed single-tier investment adviser disclosure regime.
4.12	Extending the commitment to initial disclosure would make the investment advice more useful and practical. The change would provide greater information upon which to base investment decisions. An investment adviser disclosure statement would be required before advice is given in all cases.
4.13	We do not think an obligation to provide further initial disclosure would be a major or onerous change for the industry. We understand that the Financial Planners and Insurance Advisers Association already encourages its members to provide a full disclosure statement containing the information from both tiers of investment adviser disclosure to potential investors before advice is given. As one disclosure document is likely to be sufficient for all clients in nearly all cases, the additional ongoing costs will be minimal.
4.14	A further question is whether a disclosure update should be provided to an investor if the circumstances of the investment adviser change? Should relevant new information be disclosed if the client is in an ongoing relationship with an investment adviser and is continuing to receive advice or act on the investment adviser's previous advice? The new information could be used to reassess the reliance a client places on the investment adviser's previous advice.
4.15	If preliminary mandatory disclosure is necessary then should advertisements for investment advisers state that an investment adviser disclosure statement is available? This would be analogous to the current situation under the Securities Act for advertisements for offers of securities. Generally advertisements for offers of securities must refer to an investment statement.

Exclusions from the Definition of Investment Adviser

4.16	The definition in the Investment Advisers (Disclosure) Act of investment adviser expressly excludes issuers or promoters of the securities to which the investment advice relates. This exclusion applies to employees of the issuer or promoter. This exclusion was the subject of discussion in the original development of the legislation. It was considered that employees of an issuer were sufficiently regulated by their contracts of employment and the terms of general securities law.
4.17	This exclusion removes a large part of the investment advisory industry from the scope of the Act. It may exclude bank officers and advisers connected with managed funds, life insurance and superannuation. We would like to raise the question whether such an exclusion remains appropriate, in the case of employees of the issuer or promoter. Are the matters within the scope of the Investment Advisers (Disclosure) Act matters that would appropriately apply not only to the employees of the investment advisory firms but also to employees of issuers who give investment advice on their employer's product? Are the qualifications and experience of an employee of an issuer giving investment advice relevant to the decision whether to rely on the investment advice?
4.18	There is also an exclusion from the definition of investment adviser for persons who only transmit investment advice relating to the particular securities given by the issuer or promoter. Has it been clear in practice when people just transmit advice rather than give investment advice? Does this exclusion fit with the purposes of the Act?

Updating the Contents of Disclosure Statements

4.19

We consider that a disclosure statement should include the matters currently included in the two levels of disclosure in the Investment Advisers (Disclosure) Act. We also think that there is a good case for considering whether to expand the prescribed contents of disclosure by adding additional prescribed categories. We consider that those who use investment adviser disclosure statements both in the industry and as consumers are in a good position to comment on the usefulness of disclosure information. We would welcome expressions of opinion from the community generally as to whether further matters should be included in disclosure statements and if so what. There may also be opinions on the workability or non-workability of any possible additions and on matters in the existing list that should be amended.

Disclosure of Direct or Indirect Pecuniary or Other Interests and Remuneration

4.20	Subsections 4(1)(e) and (f) oblige investment advisers to disclose on request any remuneration and any direct or indirect pecuniary or other interest "that is reasonably likely to influence the adviser in giving the advice". We understand that there have been some difficulties in applying these subsections. Should these provisions be amended?
4.21	We think that all material benefits should be disclosed. Do these subsections catch all material benefits?
4.22	We understand that there are widespread practices within the industry of providing trailing commissions. We understand that last resort financing facilities are also available in some cases in Australia if not in New Zealand. We consider these matters to be material to the decision to take investment advice. Are these matters sufficiently covered by the Act? Are there any other types of benefit that may not be sufficiently covered by the Act? Could the Act be amended to better cover these?
4.22	Is the expression "reasonably likely to influence" difficult to apply in practice. Would it be better to refer to any "benefit" that is reasonably likely to influence the adviser in giving advice? Should disclosure be made of any "material" benefit rather than any benefit that is "reasonably likely to influence" the adviser? Is there any better way of handling this matter?