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Law Reform: Investment Advisers
A Discussion Paper

CHAPTER 5 ADVICE ON ILLEGAL OFFERS OF SECURITIES: PROBLEMS AND POSSIBLE CHANGES TO THE LAW

5.1

As noted in the previous chapter the Investment Advisers (Disclosure) Act deals with disclosure. Currently dissatisfaction with the content of advice is generally dealt with by common law remedies. Nevertheless we are proposing that there should be rules against recommending illegal securities. We consider that such rules could strengthen the integrity of the investment process.

Recommending Illegal Offers of Securities

5.2	When looking at illegal offers of securities and the role of investment advisers it is useful to analyse the position that investment advisers occupy in the wider industry context of raising funds. Clearly monies should not be raised for securities where the offer does not comply with the law. We consider that the Securities Act and Regulations credibly regulate the role of the issuer and the promoter. However we consider that questions arise regarding regulation of the role of investment advisers in acting as a conduit for illegal offers of securities.
5.3	Problems can occur where an investment adviser recommends a product that does not comply with securities law. In such a case the investor may have subscribed to a product without having access to the information needed to make a prudent investment decision. Further the investment contract may be void under securities law. This will often lead to future problems for both the investor and the issuer.
5.4	The extent to which an offer of securities complies with the law can often be indicative of the more general integrity of the scheme and those who promote or advise on it. If an offer of securities does not comply with the law an investor may be dealing with an incompetent or dishonest investment adviser and an incompetent or dishonest issuer. We are proposing that investment advisers should not give advice on investment products to the public where at least with the knowledge of the investment adviser the offer documents do not comply with the law. We consider that, subject to appropriate defences, it should be an offence to do so.
5.5	We regularly see offers of so called investments that quite obviously will not provide the promised returns. Many of these schemes seem to us to be seriously suspect and likely to be fraudulent. We consider the central proposition, that the issuer and the promoter are responsible for the content of offer documents relating to securities, to be sound. The investment adviser is not responsible for offer documents. However we think that an investment adviser should be accountable under the law for recommending investment in a scheme that is non-compliant where this is done knowingly.

A Conduit for Rogue Overseas Products

5.6	Unconventional rogue products, or scams, that originate from outside of New Zealand are a significant problem. These are often fraudulent. While many off-shore investment documents which are distributed in New Zealand are not problematic, we receive a large number of complaints about offers made by issuers situated in overseas jurisdictions. It is difficult to impose discipline on these overseas issuers. Issues of jurisdiction and difficulties of enforcement often arise.
5.7	To solicit funds in New Zealand, and sometimes we suspect to enable the issuers to avoid having a presence in New Zealand, offers are often made through New Zealanders acting in a capacity of investment adviser. We consider that a provision for action under New Zealand law against any person acting as an investment adviser would help address this problem.
5.8	An example was recently brought to our attention where an individual was approached by two men calling themselves financial specialists. They recommended that he invest offshore with two schemes, one named the Quantum Advance Fund and the other named Big International. We had previously released media warnings about both these schemes. Neither had registered prospectuses or investment statements. Both promised outlandish returns. Advertising for the Quantum Advance Fund had been prohibited by the Commission. After investing on the basis of the recommendations the investor found that he was unable to retrieve his money. We have many similar examples.
5.9	Often these come in the form of so called "prime bank" schemes. Promotional material is provided which promises extremely high returns, sometimes between 10% to 40% per month. The promotional material states that investors' funds are used in the trade of "prime bank" instruments. These are allegedly traded on a secret market open only to the very rich and the large financial institutions. Investors are advised to keep their knowledge of the scheme confidential. They are told that the authorities do not like the schemes because they lead to money being sent offshore and consequently drain the tax revenue. Inevitably after investors funds are contributed it becomes practically impossible for the investor to retrieve them.
5.10	New Zealanders acting in the role of investment advisers are usually rewarded for their involvement in this activity by being paid commissions for each New Zealander they can influence to contribute to the scheme. New Zealanders acting as investment advisers use various means of eliciting investors' funds. Sometimes ethnic or religious ties are used to give legitimacy to the schemes. We have seen examples of promotional material claiming that profits from funds contributed to such schemes are used to help disadvantaged people around the world (as well as providing a tidy profit to investors). Promotional material for one scheme we encountered last year claimed that a Hercules aircraft had already been equipped with disaster relief gear from past profits.

An Offence to Recommend Illegal Offers of Securities

The Offence

5.11	We propose for consideration that it should be enacted as an offence, in certain circumstances and subject to certain defences, for an investment adviser in the course of business or employment to recommend, encourage or knowingly assist a client to acquire securities where the offer of those securities does not comply with the Securities Act or Regulations.
5.12	In deciding whether liability would attach the following questions could arise: Has the investment adviser recommended, encouraged or knowingly assisted a client to acquire an illegal offer of securities; Was that illegality in respect of matters which were material; Did the investment adviser know or should the investment adviser have known that that offer was illegal?
5.13	One defence to liability for involvement with an illegal scheme might be that the investment adviser considered on reasonable grounds that the offer documents for that offer of securities complied with the law. The standard for this would be that of the reasonable investment adviser, not that, for instance, of a practising lawyer. Alternatively it might be a defence that the investment adviser did not know that the offer documents for that offer of securities were not compliant with the law.
5.14	There could also be a defence that the securities were non-compliant only in respect of matters which were immaterial. This would put the offence on a similar basis to Securities Act offence provisions (sections 58, 59, and 60). These also deal with non-compliant securities.
5.15	The offence and defence provisions could be: "(1) Subject to subsection (2) of this section any investment adviser who in the course of business or employment recommends, encourages or knowingly assists a client to acquire securities where the offer of those securities does not comply with the Securities Act or Regulations commits an offence.   (2) No person shall be convicted of an offence, as set out in subsection (1), if the contravention of the law by the offer of securities was in respect of matters which in the opinion of the Court dealing with the case were immaterial; or the investment adviser considered on reasonable grounds that the offer documents for that offer of securities complied with New Zealand law."
5.16	In some cases there may be an overlap between such an offence and an offence of contravening an order under section 38B of the Securities Act prohibiting distribution of an advertisement to which securities law applies. The Commission may make an order prohibiting advertising for an offer of securities on the basis that an advertisement containing an offer of securities does not comply with the Securities Act. If the Commission has made the investment adviser aware of this order and the investment adviser continues to encourage clients to acquire the securities the investment adviser may be offending, both in regard to breach of the Commission's order and in regard to an offence of recommending illegal offers of securities. We consider that it is desirable to have a separate primary offence provision that does not depend on the Commission having made an order in respect of an advertisement to which the issuer of the securities is a party and having communicated knowledge of that order to the investment adviser.

Penalties

5.17	We raise for consideration whether penalty provisions for such an offence should be equivalent to penalties for breaches of securities law by issuers and promoters, examples of which we outline below (in doing so we also note that there is a question whether penalties for securities law should be reviewed). The Court will have discretion as to the culpability of the investment adviser. This can be reflected in sentencing.
5.18	Under section 58 the Securities Act criminal liability is imposed on issuers for misstatements in advertisements or registered prospectuses. Every person who commits such an offence is liable on conviction on indictment to imprisonment for a term not exceeding 5 years or to a fine not exceeding $25,000. On summary conviction every person who commits such an offence is liable to imprisonment for a term not exceeding 3 months or a fine not exceeding $15,000.
5.19	Under section 59 of the Securities Act criminal liability is imposed for offering, distributing or allotting in contravention of the Securities Act. Penalties include liability on summary conviction to a fine not exceeding $15,000.
5.20	The penalty provision for an offence to recommend illegal securities could include provision for the Court to order some of any fine payable to be paid to investors in the non-compliant scheme who invested on the recommendation of the investment adviser.