Publications: OVERSIGHT REVIEW OF NZX 2005


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OVERSIGHT REVIEW OF NZX 2005

SPECIAL DIVISION - SUPERVISION OF NZX AS A LISTED ISSUER

Conflict management

As a Listed Issuer, NZX must comply with the Listing Rules. This requires it, like other issuers, to make certain applications and potentially be subject to disciplinary proceedings before NZX Discipline. To deal with the obvious conflict that arises for NZX in these situations, it has formed a Special Division of NZX Discipline. The Special Division is an independent body. It deals with regulatory matters concerning NZX as a Listed Issuer and its related entities.
The Special Division plays a vital role given NZX's dual functions as a market regulator and commercial listed entity. The Special Division is integral to conflict management and the integrity of the NZX structure. The oversight review showed that the system of using the Special Division was working effectively and seemed to achieve separation between NZX's commercial and regulatory functions. We are satisfied that the Special Division adequately carried out its function in the 2005 review period.

Jurisdiction and powers

The Special Division is established under the NZX Discipline Rules. The Special Division is empowered under the NZX Discipline Rules to "stand in the shoes" and exercise the powers and functions of NZXR in respect of NZX as a Listed Issuer that NZXR exercises in respect of other issuers listed on NZX's markets. The Chairman of the Special Division confirmed its understanding of the role. Given the key role that the Special Division plays in NZX's conflict management, we expect it to assert its jurisdiction clearly and actively.
The objective of the Special Division under the NZX Discipline Rules is to foster market confidence that the Listing Rules, NZX Participant Rules and NZX Discipline Rules are applied in respect of NZX, or a related entity, in an impartial and independent manner.
The Special Division operates independently of NZX. It comprises four independent members approved by the Securities Commission. Special Division members must have no conflicts of interest as regards NZX. The role of Chairman of the Special Division is separate from the Chairman of NZX Discipline. In the 2005 review period the Special Division dealt with a total of nine matters. These included document approvals, a waiver application and a continuous disclosure matter. The Special Division did not deal with any complaints about NZX as a Listed Issuer.
The Special Division's jurisdiction to deal with a matter is in the first instance seen as a matter for the Chairman to determine. In the review period there were no formal written delegations by the Special Division to the Chairman of the Special Division in relation to jurisdictional matters. If the Chairman is to have authority to determine whether matters are referred to the Special Division we think that the delegation from the Special Division should be formally recorded. However, given the importance of the Special Division's role, we consider it preferable that determination of the Special Division's jurisdiction to deal with matters be assessed by the Special Division, rather than any one member.
In 2005 NZXR sought information from NZX on behalf of the Special Division regarding the CEO's remuneration. The information related to an application for a waiver. NZX declined to provide the Special Division with the requested documentation. The Chairman of NZX was clear that NZXR would simply demand any information it sought from issuers. NZX advised in its submissions that it considers it does not have powers to compel disclosure of information. In the context of a waiver application, NZX advises that it may instead consider whether, in the absence of the information sought, it has sufficient information to make a decision. If not, NZX advised that it will decline to grant a waiver. We consider that in practice NZX does have the power to compel production of information by otherwise refusing to grant waivers where relevant and requested information is not provided.
The Special Division believes it pursued the matter and obtained sufficient information by other means. The Special Division was satisfied that it had managed to obtain an assurance from NZX in relation to the information that it sought and granted the waiver. The Special Division exercises the powers of NZXR in respect of NZX as a Listed Issuer. The Special Division should be aware of these powers and exercise them as appropriate. NZX should comply fully with all lawful requests and directions from the Special Division. We do not consider it was appropriate for NZX to refuse access to the requested documentation.
The Special Division's view is that NZX is not bound to a higher standard under the Listing Rules than any other Listed Issuer. Nor is there a lesser standard for NZX. However, the Special Division encourages NZX to set a higher standard of disclosure and compliance as a matter of practice and has provided comment to NZX about this.

Resources

The Special Division is dependent on NZX for resources. The Special Division considered that it was adequately resourced in 2005 to carry out its function. The level of resource is established on an as-needed basis. The Special Division has access to independent counsel and experts. The Special Division invoices NZX and is paid. The Special Division did not request additional resources in 2005. While resource needs have not yet been tested, we think the Special Division should give critical thought to its likely and contingent resource needs. We expect the Special Division to discuss its resource requirements with the Board of NZX.
The Special Division has not considered with particularity what would happen in terms of process and resources if the Special Division were to take a case against NZX to NZX Discipline. Security of funding in advance of initiating such an action has not been discussed between the Special Division and NZX. The NZX Board informed the Commission that it would guarantee funding for the Special Division should such a situation arise. The Commission considers it appropriate that a guarantee of advance funding for such an action be formalised between the Special Division and the Board of NZX.

Communication

The first point of contact for external correspondence with the Special Division is NZX. This includes confidential complaints about NZX as an issuer that are sent to the attention of the Special Division. No separate contact details for the Special Division are made publicly available. The Special Division sees benefit in separate contact details being published. We recommend this be done. The Board of NZX agrees that communication about the existence and role of the Special Division needs to improve. Market feedback received by NZX suggests that the role of the Special Division is not well understood. NZX intends to develop a communication strategy in this area. We support the development and timely implementation of a communications strategy concerning the Special Division, including capacity for complaints to be addressed directly to the Special Division rather than through NZX staff.

Appointed solicitor

An NZX Solicitor is appointed to act as the liaison between NZX as a Listed Issuer and the Special Division. Most matters are referred to the Special Division by NZX via the appointed solicitor. The Special Division advised that the appointed solicitor is not to make recommendations to the Special Division. On occasion in 2005 the appointed solicitor did make recommendations. NZX advised that it had not been told that the appointed solicitor was not to make recommendations and no concerns were expressed by the Special Division about the solicitor's performance during the year. The appointed solicitor provides the Special Division with relevant information and documents and is the main "pivot point" between NZX and the Special Division. This process appeared to function efficiently during the review period, although it seems there were differing views about the role of the appointed solicitor.
Special Division members may at times initiate matters based on market knowledge. The Special Division itself does not monitor the trading activity of NZX. The Special Division relies on the appointed solicitor to report unusual trading information generated by the SMARTS surveillance system.
In the 2005 review period the appointed solicitor, as nominated by the Head of Regulation, did not perform any commercial work for NZX. The Special Division considers it of key importance that the appointed solicitor be independent of the commercial activities of NZX. The Chairman of the Special Division advised that he had sought and received an assurance from the Head of Regulation that the currently appointed solicitor would not perform any NZX commercial work that would require the Special Division's involvement. In submissions, NZX and the Special Division were of the view that it would be suitable if the solicitor was not involved in commercial work that had Listing Rule content but could carry out other commercial work.
In the Commission's view, any corporate advisory work undertaken by an employee of NZX in relation to NZX's own business as a Listed Issuer has the potential to raise a conflict of interest for the employee concerned where that person also provides advisory services to the Special Division. The appointed solicitor should be free to carry out other work for NZXR, but we consider that this person should not undertake corporate advisory work for NZX. In the Commission's view, either an assurance to this effect should be settled between NZX and the Special Division, or NZX should revisit the use of an NZX Solicitor for the appointed solicitor role.
Even with an assurance that the appointed solicitor will not carry out corporate work for NZX, we think that the conflict for the appointed solicitor as an employee of NZX is potentially acute. In dealing with more contentious issues such as complaints handling, or matters where there is disagreement between the Special Division and NZX, or any potential Listing Rule breaches or disciplinary matters, we think that there is a serious risk that an appointed solicitor would be placed in an unreasonable position of conflict as the "pivot point" between the Special Division and his or her employer, NZX.
We consider that the appointed solicitor should have no role in such matters (beyond any initial transmittal of a matter to the Special Division). The Special Division should engage external advisers to assist it in dealing with these matters, including accessing NZX's facilities and regulatory precedents and consulting as needed with NZXR. We consider that in respect of any waiver and ruling applications that raise contentious matters, the Special Division should also use external advisers rather than the appointed solicitor.
We acknowledge that the appointed solicitor is likely to continue to have a role in relation to SMARTS surveillance and the referral of alerts as the Special Division does not have access to this system. We think that the Special Division should formalise its expectation about the referral of data generated by the SMARTS market surveillance system concerning NZX's listed securities. Where alerts from SMARTS are below the threshold set by the Special Division for referral to it, the appointed solicitor should regularly advise the Special Division of the number of alerts received in the period and a summary of any alerts that were not referred.
The Special Division has delegated administration of compliance checks of advertisements and amendments to trust deeds to the appointed solicitor. Under the NZX Discipline Rules the Special Division is not permitted to delegate certain key functions, such as the cancellation or suspension of the quotation of NZX securities, and the power to make rulings and give waivers. The Special Division advised that it had retained all substantive listing rule compliance. File reviews evidenced this. The Special Division expects to be advised by the appointed solicitor if there are particular issues with matters dealt with under delegation. The Special Division does not otherwise expect to receive reports from the appointed solicitor on matters dealt with under delegation. There needs to be a complete record of the Special Division's business and appropriate periodic review of the delegation. We recommend that all matters dealt with by the appointed solicitor under delegation be recorded and reported on to the Special Division regularly.

Process

The NZX Corporate Counsel, or an NZX Solicitor acting in a commercial capacity, prepares applications for referral to the Special Division. As noted above, the Chairman of the Special Division determines whether the particular matter can be dealt with by the Chairman of the Special Division or should be referred to a division of Special Division members. If a division of members is required the Chairman determines the composition of the division. There is no written conflicts disclosure policy for Special Division members, however the Special Division has received external advice in relation to independence and avoidance of conflicts of interest. Conflicted members are expected to disclose the conflict and remove themselves from consideration of the matter.
The appointed solicitor provides NZX's applications and supporting material to the Special Division, accompanied by the appointed solicitor's comments and views on the application. The appointed solicitor also refers the Special Division to precedents. The Special Division's practice is that NZX is bound by the precedents and policy that NZXR sets for other issuers.
File reviews evidenced that Special Division members were actively engaged in matters referred to them. The Special Division made it clear that it required receipt from the appointed solicitor of all relevant documentation associated with applications. Comments were exchanged between Special Division members. Responses and decisions were conveyed to NZX through the appointed solicitor.
The Chairman of the Special Division has a copy of a procedures handbook used by NZXR, however the Special Division does not make use of procedural material such as handbooks and checklists that NZX uses in respect of other issuers. The Chairman of the Special Division advised that the Special Division relies on the appointed solicitor to use the correct procedures. If NZXR operates in a certain way then the Special Division considers its procedures should be the same. We expect the Special Division to formally communicate its expectations to the appointed solicitor. The Special Division should have and use the same procedures manuals in respect of NZX's compliance as a Listed Issuer that are used by NZXR in respect of other Listed Issuers. The Special Division should not rely on the appointed solicitor to use the NZXR procedures. We also suggest that the Special Division consider the internal procedures that it would use (including procedures for communicating with the market) if it were in the situation where it needed to pursue a serious compliance matter regarding NZX.

Reporting

The Special Division reported on its work to the Annual Meeting of NZX Discipline in 2005. We think that the Special Division should report to NZX Discipline all material findings that it makes. We think that NZX Discipline should incorporate that information into its Annual Regulatory Report. There is no particular reporting process for the Special Division to comment to NZX on the Special Division's view of NZX's compliance as a Listed Issuer. However, the Special Division may note concerns or issues in its communications with NZX.

Recommendations

The Special Division operated adequately during the review period, however the Special Division has not yet been tested in a significant matter. In light of the substantive and procedural issues identified, including NZX's refusal to provide requested information, we have reservations as to how the Special Division would deal with a contentious situation with NZX. We make the following recommendations:
1. The Special Division, as a body, should determine whether the Special Division has jurisdiction to deal with matters referred to it. Any delegations from the Special Division to its Chairman should be formally recorded.
2. Given the important role of the Special Division in respect of NZX's compliance as a Listed Issuer, the Special Division should take steps to ensure that it is fully aware of the powers available to NZXR under the Listing Rules in respect of other Listed Issuers, and should exercise those powers as appropriate in relation to NZX as a Listed Issuer.
3. Given NZX's position as both a Listed Issuer and regulator of all other Listed Issuers listed on its markets, NZX should set an example by full compliance with all lawful directions or requests from the Special Division.
  
  NZX considers that it is entitled, as is any other issuer, to decline to provide information sought where NZX does not consider it relevant or appropriate to provide such information. NZX considers that NZX should only comply with those requests or directions necessary for the Special Division to undertake its enforcement role (as opposed to the role of considering a waiver or ruling application) and within its powers and jurisdiction. NZX is of the view that it cannot compel production of information by issuers in relation to waiver applications.
  
  The Commission considers that in practice NZX does have the power to compel production of information by otherwise refusing to grant waivers if relevant requested information is not provided. We remain of the view that NZX should set an example of full compliance with all lawful directions or requests of the Special Division.
  
  NZX will consider the matter again and has undertaken to report back to the Commission by the end of this calendar year.
4. The Special Division should discuss its resource requirements with the Board of NZX. The NZX Board should have a formal guarantee of funding for the Special Division should the Special Division need to take NZX to NZX Discipline.
  
  NZX has advised that it will request a meeting between NZX and the Special Division to discuss resource requirements and the guarantee of funding.
  
  NZX has committed to do this by the end of this calendar year.
5. NZX and the Special Division should develop and implement a communication strategy about the role of the Special Division. Communication should include publication of separate contact details for the Special Division.
  
  NZX has agreed to implement a communication strategy about the role of the Special Division. NZX considers that the Special Division should have considerable involvement with this. The Commission agrees.
  
  NZX has committed to do this by the end of this calendar year.
6. The Special Division should formalise its delegation to the appointed solicitor and should receive regular reports on work dealt with by the appointed solicitor under delegation.
7. The Special Division should have and use the same procedures manuals in respect of NZX's compliance as a Listed Issuer that are used by NZXR in respect of all other Listed Issuers. The Special Division should satisfy itself that the appointed solicitor uses the NZXR procedures, including where matters are delegated to that solicitor.
8. The Special Division should settle internal procedures that it would use, including procedures for communicating with the market in dealing with a serious compliance matter regarding NZX.
9. The Special Division should formalise its expectation about the referral of data generated by the SMARTS market surveillance system concerning NZX's listed securities. Where alerts from SMARTS are below the threshold set by the Special Division for referral to it, the appointed solicitor should regularly advise the Special Division of the number of such alerts received in the period and a summary of any alerts that were not referred.
10. To avoid a situation of conflict for the appointed solicitor, the appointed solicitor should have no role in matters that raise contentious issues, including complaints handling (beyond an initial transmittal of a matter to the Special Division). The Special Division should engage external advisers to assist it in dealing with such matters and be funded to do so. The external advisers should have access to NZX's facilities and regulatory precedents and be able to consult with NZXR.
  
  The Special Division agrees that it would be appropriate for it to handle such matters without the involvement of the appointed solicitor or for the Special Division to engage external counsel if necessary. In respect of waiver and ruling applications the Special Division is of the view that the appointed solicitor should, at the Special Division's request, be able to provide analysis and comment to the Special Division on precedent applications under the Listing Rules.
  
  The Commission considers that in respect of waiver and ruling applications involving contentious matters the Special Division should use its external advisers, and that these advisers should be given access to precedents and other relevant information.
11. NZX should either formally assure the Special Division that the appointed solicitor will not perform any corporate advisory work for NZX or should revisit the use of an NZX Solicitor for the appointed solicitor role.
  
  NZX and the Special Division consider that it would be suitable if the appointed solicitor was not involved in any commercial work that had Listing Rule content but could carry out other commercial work.
  
  The Commission does not agree. The appointed solicitor should be free to carry out other work for NZXR, but we consider that this person should not undertake corporate advisory work for NZX.
  
  NZX will consider this matter again and has undertaken to report back to the Commission by the end of this calendar year.
12. The Special Division should report to NZX Discipline all material findings that it makes. NZX Discipline should incorporate that information into its published Annual Regulatory Report.
  
  NZX notes that the Special Division's decisions are published in the same way as NZXR decisions and that this recommendation is unnecessary.
  
  The Commission notes NZX's response but considers that benefit will be derived by both NZX Discipline and the market if the Special Division's activities are included in NZX Discipline's Annual Regulatory Report.

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