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Effects on the Securities Markets of certain statements made in May 2006 concerning telecommunications

25 July 2006

PART I - INTRODUCTION

On 12 May 2006 the Securities Commission announced an inquiry into the conduct and circumstances surrounding the release of the Stocktake paper on 3 May 2006.
On 18 May 2006, after receiving a referral from NZX under the Securities Markets Act 1988, the Commission announced that it had broadened its inquiry to include comments reportedly made during a media interview on 15 May 2006 by the Communications Minister, Mr David Cunliffe, regarding the dividend policy of Telecom.
This is the Commission's report on its inquiry into these matters.

The Commission's inquiry

The NZSX Market is New Zealand's principal market for equity securities. It features the securities of the majority of New Zealand's listed companies and a number of overseas companies. There are currently 179 companies listed on the NZSX with a combined market capitalisation of approximately NZ$67 billion. Telecom is the largest telecommunications company in New Zealand and the largest company listed on the NZSX board. On 3 May 2006 Telecom's market capitalisation was approximately NZ$10.9 billion¹ . It is the only company on the NZSX board to have stock exchange listings in New Zealand, Australia and New York. Telecom informs us that as at 30 June 2006, Telecom's shareholders were approximately 26.7% NZ resident, 25.4% Australian resident, and 47.9% resident in other overseas jurisdictions. As a result, any event having a significant impact on Telecom is likely to provoke a high level of comment and reaction amongst investors both in New Zealand and internationally.
On 3 May 2006 Telecom received from an unauthorised source a copy of a confidential paper concerning the Government's Telecommunications Stocktake and informed the Government of this. This paper was a partially masked version of the Cabinet paper that was considered by Cabinet on 1 May 2006² ("masked paper"). The Government became aware that the masked paper contained a near-final version of the Government's regulatory policy concerning telecommunications, the final form of which was approved on the morning of 3 May 2006. The market had been aware for some time that the Government was conducting a review of telecommunications policy, but it was not aware at this time of the outcome of that review.
Throughout the afternoon of 3 May 2006, Telecom executives endeavoured to obtain confirmation from officials of the authenticity and status of the document they had, and to determine their disclosure obligations. At the same time the Minister of Communications and officials were endeavouring to decide how best to deal with the situation. The circumstances for both parties were unusual and difficult, and both had a great deal to consider within a short time.
The events of the day concluded with the Minister releasing the Stocktake paper during a press conference late that afternoon after the New Zealand markets had closed. The Minister's announcement was followed by a sharp drop in Telecom's share price. This occurred immediately on the ASX which was still open at the time of the announcement, and was reflected on the New York Stock Exchange (the "NYSE") when it opened later that evening (NZ time) and the NZX the following morning. It appeared that trading on both the NZX and NYSE was orderly and informed when these two markets opened.
There was immediate and considerable disquiet expressed through the media at the manner and timing of the release of the information. Concern was expressed by various market commentators and participants, including the NZX, that the markets had not been evenly informed and that Australian investors had been advantaged at the expense of New Zealanders. There was speculation about the possibility of improper conduct such as insider trading during this period.
The Commission has a function under the Securities Act 1978 to review practices relating to securities and activities on the securities markets, and to report thereon to any appropriate body. The Commission's stated purpose is to strengthen confidence in New Zealand's capital markets (both domestically and internationally) and to foster capital investment in New Zealand by promoting the efficiency, integrity and cost-effective regulation of New Zealand's markets.
It appeared to the Commission that the events of 3 May 2006 had raised concerns among investors and market participants that were affecting confidence in New Zealand's sharemarket. It appeared that this was particularly so given the domestic and international profile of Telecom stock relative to other New Zealand listed companies and its significance to the capitalisation of the New Zealand sharemarket.
The Commission notes that some of the concerns expressed related to the drop in Telecom's share price per se. It is the Government's prerogative to announce changes to regulatory policy affecting the businesses of issuers of securities. Similarly, it is for Parliament to debate and enact (or decline to enact) legislation. Share prices will naturally rise or fall when price-sensitive information is released. Accordingly, the fall in the Telecom share price due to the change in Government policy is not of itself a cause for inquiry by the Commission. Rather, the focus of the Commission's inquiry is on the manner and timing of the release of the information and whether these matters affected the transparent and orderly functioning of the markets, and confidence in the markets, by creating information asymmetries or opportunities for misuse of the information. As these matters caused widespread concern, and as they involve practices relating to securities and activities on securities markets, the Commission decided that it was necessary and appropriate for it to inquire into these matters.
Markets price securities most efficiently when they have the best available information. This occurs when investors have equal access to material information, so that they can trade on the same information at the same time. Asymmetries in information in the markets can result in a deterioration of market integrity and investor confidence. Accordingly, asymmetries in information should be avoided whenever possible. To this end, most securities exchanges, in particular exchanges belonging to the World Federation of Exchanges, have rules requiring the timely disclosure of material information to the market, with penalties for failure to comply. Most exchanges operate centralised facilities for disseminating announcements to market participants and to the general public.
The NZX and the ASX have similar Listing Rules concerning the disclosure of material information to the market. Where information is material to the price of securities, subject to certain exceptions an issuer is required:
1. under NZSX Listing Rule 10.1, to immediately release that information to the NZX;
2. under ASX Listing Rules, Chapter 3.1, to immediately tell the ASX that information.
The Commission notes that although Telecom has securities quoted on the NYSE, the Commission does not propose to outline the relevant NYSE Rules in this report as the NYSE market was closed when the information in question was released.
Most exchanges also provide mechanisms such as trading halts to help ensure that participants will have equal opportunity to become aware of, and evaluate, price-sensitive information when it is disclosed. Trading halts operate as a temporary cessation of trading during which a potentially price-sensitive announcement is made. Orders may be placed and withdrawn during the halt as the information is assimilated into the price of the securities, but cannot be completed until the halt is lifted. The concept is that when the halt is lifted the market will have taken account of the price effect of the information and trades will take place at that price, without trading having occurred in the intervening period on the basis of unequal information.
Under NZSX Listing Rule 5.4.1, an issuer can request a trading halt where it is releasing or intends to release material information to the market. NZX listed issuers may request a trading halt of their quoted securities as a way of managing the disclosure of material information to the market.
There are two common types of trading halts. Where material information is released to the market a brief trading halt, usually 10 to 15 minutes, can provide the market with time to digest the information. This is intended to assist investors to trade on an informed basis. A trading halt may also be implemented whenever an issuer intends to release material information, but is not able to make an immediate announcement under Listing Rules.
The ASX Listing Rules have analogous provisions in respect of trading halts. Under the ASX Listing Rules, Chapter 17.1, an issuer can request a trading halt of its quoted securities.
On 18 May the Commission broadened its inquiry to include comments made by the Minister of Communications during a media interview on 15 May 2006 regarding Telecom's dividend policy. Telecom's share price dropped again following these comments, and further concerns were expressed that the Minister had disclosed price-sensitive information through the media, and this had adversely affected the orderly dissemination of information to the market. This was the subject of a specific reference to the Commission by NZX.
The Terms of Reference of the Commission's inquiry are set out in Appendix A. In its inquiry the Commission considered whether:
1. any person misused any price-sensitive information relating to securities contained in the Telecommunications Stocktake paper before that information was publicly available;
2. any Government and/or state sector policies and procedures for handling non-public price-sensitive information relating to securities were appropriate and properly applied; and
3. any person could or should have taken, or refrained from taking, any actions in respect of these matters to maintain the transparent and orderly functioning of the securities markets in New Zealand or elsewhere.
In terms of (a) above, the Commission inquired into whether any person may have misused the price-sensitive information in the Stocktake paper by trading in securities of Telecom before that information became public or encouraging any person to do so, whether this would have constituted insider trading or tipping under law or otherwise. That inquiry included all those persons who the Commission identified as having had access to the Stocktake paper prior to its announcement, including relevant personnel of both Telecom and the Government. The Commission's inquiries have revealed no evidence to suggest that any such trading or encouragement occurred.
The matters set out in (b) and (c) above concern events and actions on 3 May 2006 in the context of the importance of disclosure of price-sensitive information to the integrity of and investor confidence in the securities markets. The matters set out in (b) and (c) above also concern events and actions surrounding the comments attributed to the Minister of Communications in the Bloomberg reports of 16 May 2006 in the same context. These matters are discussed further in this report.
The Commission's inquiry is concerned with the events that occurred after Telecom had become aware of the nature and contents of the masked paper that had come into its possession. This is the point at which issues arose as to whether disclosure to the markets of the information in the masked paper was required. The conduct of any party or any event which occurred before that time is referred to in this report only by way of background or where necessary to give context to the Commission's comments. The genesis of the events which precipitated the Government's release of the Stocktake paper have been well canvassed by both the media and in the State Services Commission's 16 May 2006 report into the matter. A chronology of the key events which took place in the critical period is set out in Appendix B. Terms defined in the chronology are used with the same meaning in the body of this report.
This inquiry has been carried out under section 10(b), 10(c) and 10(caa) of the Securities Act 1978. These sections provide that it is a function of the Commission to:

10(b) keep under review the law relating to bodies corporate, securities, and unincorporated issuers of securities, and to recommend to the Minister [of Commerce] any changes thereto that it considers necessary

10(c) keep under review practices relating to securities, and to comment thereon to any appropriate body

10(caa) keep under review activities on securities markets, and to comment on those activities to the appropriate body

The Commission considers that the matters under inquiry raise issues of securities markets practice upon which it is appropriate for the Commission to comment. The Commission has decided to comment by way of this report. The Commission does not intend to recommend any changes to the law as a result of its inquiries.

Procedure

The Commission determined the procedures for this inquiry. A division of the Commission was appointed to conduct this inquiry.
In the course of the inquiry the Commission obtained sworn evidence from the following:
- Mr Michael Ryan;
- Mr Peter Garty, Group Financial Controller of Telecom;
- Ms Linda Cox, Company Secretary of Telecom;
- Mr John Goulter, Public Affairs and Government Relations Manager of Telecom;
- Mr Mark Verbiest, Group General Counsel of Telecom;
- Mr Geoff Brown, Products Group Manager of the New Zealand Exchange Limited;
- Mr Geoff Dangerfield, Chief Executive Officer of the Ministry of Economic Development;
- Mr Maarten Wevers, Chief Executive Officer of the Department of the Prime Minister and Cabinet;
- Ms Diane Morcom, Secretary of the Cabinet;
- Ms Heather Simpson, Chief of Staff to the Prime Minister;
- Mr Tim Preston, Managing Director ASB Securities (by way of affidavit);
- Mr John Whitehead, Chief Executive and Secretary to the Treasury (by way of affidavit).
The Commission also received correspondence from the NZX and ASX, and a copy of the State Services Commission's report into the disclosure of the paper to Telecom.
Ministers of the Crown cannot be compelled to give evidence in this inquiry. The Commission requested that Mr Cunliffe appear and give evidence at the same time as other persons. The Minister of Communications provided a voluntary affidavit, which was provided after distribution of a confidential draft report and transcripts of evidence.
Having received evidence from these people the Commission prepared a further confidential consultation draft report and invited comment from affected parties. Relevant transcripts of evidence were also given to affected parties. These parties were given the opportunity to respond with submissions and to provide further evidence.
Where an inquiry raises questions about the personal actions and intentions of affected persons it is important for the integrity of the inquiry process that every person with a material interest is afforded the opportunity to appear at a meeting of the Commission. Such an opportunity was given in this case. Confidentiality and privacy orders were in place throughout the inquiry. All witnesses were provided with the opportunity of being represented. Oral evidence was recorded and relevant transcripts were made available to witnesses.
The Commission has carefully considered all the evidence and submissions before it before publishing this report.

Footnotes

Following the release of the Stocktake paper, Telecom's market capitalisation on 4 May 2006 was approximately NZ$9.9 billion.
Telecom received a partially masked version of the Cabinet paper. The paper was masked by Mr Peter Garty, who removed the identifier numbering on the front cover page of the document. The paper received by Mr Garty and passed by him to Telecom included a cover letter from the Minister of Communications to the Prime Minister dated 27 April 2006.

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