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IFA Financial Planning Seminar
Christchurch
Tuesday 8 April 2008
Investment Adviser Disclosure & the Securities Commission
John Holland
Member of the Securities Commission
Good morning and thank you for the opportunity to be here today.
We at the Securities Commission recognise that this is a challenging time for advisers. At this stage no-one can be sure what form a new regulatory regime for investment advisers will take. Decisions on that will be made by Parliament at some later date, and it is not for the Securities Commission to offer any public opinion or prediction about that.
I note that the Minister of Commerce, Hon Lianne Dalziel, is talking to you later today and I expect that she will explain the situation and process from here.
Today I will touch on several areas. Firstly, a look at the evolution of the new law for investment advisers and brokers - up to the new disclosure law which came into effect a few weeks ago. Then I will talk about some other aspects of the new law - in particular insider trading and market manipulation - which came in at the same time. Thirdly, I'll speak about the guidance work the Commission has done ahead of the new law. I'll also explain how the Commission is approaching its responsibilities as the enforcement agency for the new law, and the penalties and remedies that are available for non-compliance. And finally, I will clarify aspects of the new advertising requirements that some advisers have asked about.
Evolution of adviser law
Proposals for regulating your industry have been around for a long time.
One of the Commission's statutory functions is to keep under review laws relating to securities, and make recommendations to the Minister of Commerce on changes that we this will assist the markets and make the law work better. We make these recommendations from our observations of the markets and our enforcement work.
The Commission called for reforms to investment adviser disclosure laws in August 2001. It published a discussion document following an investigation into a firm of advisers called Morison and Guildford. This firm, based in the Wairarapa, had recommended Michael Bastion's Gideon Investments. Many people invested in what was an illegal investment offer, and they lost a lot of money.
The introduction to the Commission's discussion paper read:
"Investment advisers are important. They help people decide who to invest with and how to select investment products that best suit their needs. The law about investment advisers is important. We consider it timely to review this law."
The main matters then raised in the paper were:
- the two tier disclosure structure which had been in place since 1997;
- the disclosure of all material benefits to the adviser;
- that recommending an illegal offer of securities should be an offence; and
- strengthening enforcement of investment adviser disclosure law.
After analysing submissions, the Commission made recommendations on law reform to address these matters to the then Minister of Commerce, Hon Paul Swain, in February 2002.
Mr Swain welcomed these proposals, and in a break with tradition, asked the Commission to publish them. The paper is on our website, together with the letter from the Minister asking for their publication. Incidentally the website also carries a Case Study on the Morison Guildford affair which makes compelling reading.
Our recommendations arose from concern that the "on-request" disclosure under the Investment Advisers (Disclosure) Act was difficult both for investors and advisers to understand. It was not achieving its goal to give investors the important information they need to help them choose an investment adviser or investment product. By some it seems to have been interpreted as "if they don't ask, don't tell".
We were also concerned that the law should place some basic responsibilities on professional investment advisers not to recommend that their clients invest in scams and illegal offers of securities. This recommendation came from examples we had seen of incompetent advice that lost millions of dollars for investors - incompetent advice given by people who claimed to be investment professionals.
The new law places an onus on an adviser wherever he or she knows, or ought to know, that an offer is illegal. This doesn't require every investment adviser to become an expert in securities law, but it does say that where investors seek advice relying on a person's expertise and professionalism, it falls on that adviser to be reasonably able to spot an illegal scheme.
Perhaps the most important distinction between the old investment adviser law and the new is its enforceability. The new law includes powers for the Commission to take both administrative and Court action against breaches of the law.
This element of enforcement seems to have already provided a strong incentive to the industry to raise their standards of disclosure.
I say this from our experience in the past 12 months as we have worked to raise market awareness of the new law. Many of the queries we have received have been about aspects of the law that have not changed since 1996. Presumably they were previously seen to raise so little risk of sanction that some institutions or advisers did not put any effort into compliance. The possibility of real enforcement has already served as an incentive to advisers to pay due attention to what is required of them.
As you all know, these reforms were passed by Parliament in late 2006, and have come into force at the end of February.
When the Commission made these recommendations to the Minister in 2002 we also told the Minister of further issues about investment advisers. We did not make formal recommendations on these, but raised them as issues for further consideration. These included:
- Should there be licensing or registration of investment advisers, or compulsory membership of industry bodies?
- Should educational and competency standards be introduced for investment advisers?
- Should there be easier access to dispute resolution facilities for clients of investment advisers?
- Should "know your client" rules be introduced for advisers to ensure that advice is suitable for the client's needs?
We were pleased when the Minister of Commerce set up the Task Force for Regulation of Financial Intermediaries in 2004. The Task Force called for submissions in January 2005, held meetings around the country, and reported later that year. Their recommendations form the basis for the reforms in the Financial Advisers Bill.
As I have said, I cannot speak today about the detail of legislation that is before Parliament. I will say, however, that the Commission sees it as essential that retail investors can approach their financial adviser with confidence, knowing that this person has attained a level of proficiency and competence, and is subject to ongoing professional conduct standards and proficiency requirements. Some in the industry at present belong to professional associations that provide these things. But without clear and consistent standards it is very difficult to communicate to investors how they can confidently choose an investment adviser.
The Financial Advisers Bill aims to foster consumer confidence in financial advisers; and confidence that those who claim to be professionals advisers are held accountable for their performance, integrity and competence. We strongly support these aims.
Other new law
Other new law that came into force in February amends the rules on insider trading and brings in completely new law on market manipulation.
Insider trading
The insider trading regime now focuses on the threat that insider trading poses to the integrity and confidence of the market, rather than on the duty owed by officers or agents of a company to that company. Liability for insider trading is not limited to those who are connected or related to the issuer.
A person becomes an insider by possessing inside information, rather than by being connected to the company to which the inside information relates.
An information insider is someone who has material information about a public issuer that is not generally available to the market, where the person knows or should know that the information is material and is not generally available. Material information is information that would be expected to materially affect the issuer's share price if it were generally known.
Information insiders must not trade in securities, disclose the information to others to trade on, or advise or encourage anyone else to trade or hold securities. Anyone who breaches the new insider trading law will be liable for substantial civil penalties. The maximum penalty in any case will be the greater of:
- the consideration paid for the shares;
- three times any profit made or loss avoided; or
- $1 million.
Knowingly breaching this law will be a criminal offence. Anyone convicted could face up to five years imprisonment or a fine of up to $300,000 for an individual and $1 million for a body corporate.
There are a number of exceptions and defences to liability, designed to encourage legitimate trading activity. These include trading under a fixed trading plan, underwriting agreements, certain takeover-related activity, and trading where information is protected by Chinese Walls.
The safe harbour under the old law, for company directors and employees who trade in shares of the company under an approved procedure, is not available under the new law.
The removal of this safe harbour is consistent with the focus of the new law, which views insider trading as harmful to the market as a whole rather than mainly to the company involved.
Directors and employees can still hold shares in their companies. They do not have broad immunity from insider trading law, but they have a defence from liability if they trade securities under a trading plan.
To qualify for this defence the person must have entered into the trading plan at a time when he or she did not have inside information. The trading plan must be for a fixed period during which the investor has no right of withdrawal and no input into trading decisions.
Market manipulation
Market manipulation is behaviour or practices likely to give a false or misleading impression about the supply, demand, price or value of securities traded on a registered exchange.
The new market manipulation law prohibits making false or misleading statements or spreading information which is likely to induce a person to trade or which might affect the price of the securities. It also prohibits creating a false or misleading appearance of securities trading.
Any trade that does not result in a change of beneficial ownership will be presumed to give a misleading appearance of trading activity unless it can be shown that the transaction took place for a legitimate reason. This also applies where a person places matching buy and sell orders for a security.
Penalties for breaching the market manipulation laws are similar to those for insider trading and include criminal offence provisions.
There is also a broad-ranging prohibition against any conduct related to any dealings in securities that is likely to mislead or deceive. This is similar to the prohibition in the Fair Trading Act 1986 for misleading or deceptive conduct.
The regulations set out procedures to provide a safe habour for market stabilisation after an initial public offer. The regulations also clarify that short selling and crossing trades are not, in and of themselves, considered to be market manipulation.
Anyone who engages in misleading or deceptive conduct can be subject to orders made by the Securities Commission and can be liable to pay compensation to anyone who suffers loss as a result of the conduct.
Education
When the Securities Legislation Bill was passed in October 2006, it was plain that all market participants would be affected to some degree. I want, now, to spend a moment talking about the Commission's efforts to engage with market participants and to provide guidance to help people prepare for their new obligations.
The Commission has always had an education function. Our principal focus in this role has, in the past, been to provide information and assistance to retail investors to help them to understand securities and investments. We continue to do this. However, with the broad changes to trading and investment adviser law in the Securities Legislation Bill the Commission decided to undertake a concerted programme to help industry participants with the changes.
In late 2006, we set up a website to explain the new law in broad terms. This website was added to over the next year as details of the Regulations were settled.
The Commission ran articles and advertising in industry publications to alert people to the website. We offered members of our team to speak to industry organizations and institutions about the new law, and took part in workshops held by market participants.
Once the Regulations were made the Commission published a Guide to the New Law. Copies have been sent free of charge many advisers and other market participants. This is a plain-English introduction to the law, and a practical guide for advisers in particular, to help them to come up to speed with what is required of them. I should mention that copies of this guide are still available, free of charge.
Judging by the feedback this programme has been successful, and is something that we intend to do more of as further reforms roll out.
Enforcing the adviser disclosure law
With the law now in force and the Commission established as the responsible regulatory agency, our attention has turned to enforcing the law.
It is clear that the new disclosure obligations have long been heralded. For the rest of my time today I want to bring you up to date with the Commission's enforcement powers in relation to adviser and broker disclosure and advertisements and how we are going about our new responsibilities.
As you know, all advisers must now have a disclosure statement that complies with the new requirements and must give this to every client who is a member of the public before they give any advice to, or take money from the client. It must be dated and signed and it must contain specific information. It must not be misleading, it must be kept up-to-date, and it must be given to the client - it is not enough to refer people to a website. A client should not have to ask to receive a copy. Adviser advertisements must refer to the disclosure statement.
The Commission believed that, come 29 February this year, there was no excuse for advisers to not know about the new rules, in view of the extensive publicity, and the long period that the industry had been given to prepare. In mid-February we published a warning that we expected advisers to have their disclosure statements ready once the new law came into force.
As well, of course, other organisations such as the IFA have been notifying their members of the new requirements and giving advice on how to comply with them.
The week after 29 February we sent a letter to advisers asking for a copy of their disclosure statement and their most recent client newsletter or advertisement. As there is not yet any registration or licensing requirement for investment advisers we have no easily accessible or comprehensive database of people who practice in this industry. However, we have been gathering information from a variety of sources over the past year to build a list of advisers. In this first round we contacted more than 1400 people.
I am pleased to report that disclosure documents have literally poured in. I should note here that the Commission is not, at this time, vetting all these disclosure statements and advertisements for compliance. Also, no implication can be taken by those who have sent in their disclosure statement and advertisements that the Commission has approved or endorsed those documents in any way.
We are taking a triage approach to assessing the responses so that our resources are well targeted. We will review a sample of disclosure documents for compliance with the law. In appropriate circumstances the Commission will take enforcement action against any adviser who does not have a disclosure statement and who is giving investment advice or receiving investment money. We may also take enforcement action against those whose disclosure statements or advertisements do not have the required information, or whose statements or advertisements are deceptive, misleading or confusing.
When advisers fail to comply with the law the Commission can make orders and it can take advisers to court to seek compensation and penalties.
The Commission is empowered to make various orders. By making a prohibition order it can ban or restrict an adviser from making statements or distributing documents that would contravene the law or would further contravene the law if there has already been a breach.
A corrective order can direct an adviser who has breached the law to publish a statement correcting the breach. The Commission decides what the statement must say, and how and when it must be published. The adviser must bear the cost of publishing the statement.
A disclosure order can require the person to disclose information to comply with a disclosure obligation or make a corrective statement at their own cost. If an adviser persistently contravenes the law or persistently engages in misleading conduct the Commission can make a temporary banning order. The order can ban a person from giving investment advice or receiving investment money from the public; or stop a person from acting as a director, promoter, or manager of an adviser entity; or stop a person from acting as an employee or agent of an adviser.
A temporary banning order can also be made against a person who has been banned from being an investment adviser or broker overseas.
A temporary banning order prohibits or restricts the person from doing things set out in the order for up to 14 days. The purpose of this is to require the adviser to cease business until seriously deficient disclosure is fixed, or to give the Commission time to go to Court to seek an injunction or a banning order of a longer duration.
Criminal offences
Certain matters are now criminal offences. An adviser commits a criminal offence if they are aware, or ought to be aware, of information that must be disclosed and do not disclose that information. An adviser who makes a disclosure statement that is deceptive, misleading or confusing commits a criminal offence.
The maximum fine for these offences is $100,000 for an individual and $300,000 for a body corporate.
It is also a criminal offence if an advertisement is deceptive, misleading or confusing. The maximum fine is $300,000 and, if the offence continues, a further fine can be imposed not exceeding $10,000 for every day which the offence continues. This also applies to investment product advertisements.
An adviser who recommends that a member of the public invest in securities which have been offered illegally commits a criminal offence if they know, or should know, that the offer is illegal. The same applies to a broker who accepts investment money for an illegal offer. These offences have a maximum fine of $300,000 and a further $10,000 per day if the offence continues.
And if an adviser contravenes a Commission order it is also a criminal offence, which carries a fine of up to $30,000.
Civil remedies
Civil remedies can also be sought by the Commission or by an adviser's client. The Commission can seek pecuniary penalty orders from the Court for up to $1 million where an adviser has recommended an illegal offer or where advertising is misleading. If the order is made the money is paid to the Crown.
An adviser's client can apply for a civil remedy order if the adviser contravened the disclosure obligations. The person must satisfy the court that if the adviser had complied with the law this would have affected the way in which a reasonable person would have acted on the advice, or would not have used the adviser or followed their advice. The court can order a payment of $100,000 for an individual and $300,000 for a body corporate. It is worth noting that the client does not have to prove that loss was caused by the failure in these cases.
And there is more. The court can ban a person who is convicted of certain criminal offences; or incurs pecuniary penalties under the Act; or persistently contravenes the Act; or has been banned overseas.
A banning order can ban a person for up to 10 years from being an adviser; or being a director, promoter or manager of an incorporated or unincorporated body. A banning order can also be made for deceptive, misleading or confusing advertisements; or recommending or receiving money for an illegal offer; or persistently contravening the law about investment advisers or brokers.
A person convicted of certain criminal offences under the Securities Markets Act or found liable for a pecuniary penalty under that Act is automatically banned for 5 years.
It is a criminal offence to contravene a banning order.
These are strong remedies which reflect Parliament's concern that giving investment advice is very important and the public needs to be protected from advisers who do not comply with the law.
It is too early to give you any indication of the standard and quality of disclosure statements. The Commission will, from time to time, review samples for compliance with the requirements of the Securities Markets Act. We will act on complaints and on information we receive about advisers.
The Commission will also made news releases about enforcement actions and any significant issues that it considers the market and the public should be aware of.
Advertisements
I will finish with a couple of matters about investment advice and adviser advertisements that have raised queries from the industry.
The first matter is how the law applies when someone is communicating to the public at large - such as in a television broadcast or a newspaper column. Some advisers have queried whether the new law stymies their ability to appear on television or to write columns at all, because of the need to provide a disclosure statement before advice is given to a member of the public.
Our response has been that this is the precise situation for which the "advice advertisement" provisions were included. We interpret the obligation to hand over a disclosure statement to apply before advice is given to an identifiable member of the public.
A general communication that contains or refers to advice is an "advice advertisement" under the law. The requirement for these advertisements is that they include a statement telling people that a disclosure statement is available on request from the adviser.
Of course, broadcasts or articles written by full-time journalists are not investment advice at all under this law. However, that exemption only applies to people whose principal occupation is that of a journalist. Any adviser who writes guest columns in a newspaper or appears on television to give investment advice or promote advisory services must include reference to his or her disclosure statement.
The second matter which I know has been raised by members of the IFA concerns billboards and signage. There was I think some concern in late February that everyone's promotional signs would need to be taken down or amended to refer to disclosure statements.
We then reassured advisers that the new obligations only apply to advertisements made after the law comes into force, so no panic was needed concerning existing signs. There is a question, however, that needs to be carefully considered in future promotional material. An advertisement under the law includes any communication that is likely to induce a person to seek investment advice. We don't think that basic signage, such as the business name and description, falls into this category. However, material that goes further, and that includes claims about expertise, independence, or performance may well fall into the category of advertising. The same thing goes for other corporate communications, and the issue does need to be considered by advisers on a case by case basis. If we become concerned about practices in this area we will look at enforcement action.
In summary
In closing, I reiterate the points made by the Commission in August 2001 - investment advisers are important because they help people decide who to invest with and how to select investment products that best suit their needs.
The magnitude of this responsibility is becoming reflected in the law and in the penalties for those who fail to comply with it.
This is particularly important in current times when initiatives such as KiwiSaver are encouraging more and more people to become investors. Many of these people have little or no experience of financial products or of investing to save for their futures.
Investment advisers have a very significant role in this respect. People should be able to rely on their adviser, and should be given information that fully explains how qualified the adviser is, what associations they have, what products they give advice on, and how they get paid.
Investors can then compare one adviser with another on a fair basis and make well informed decisions on choosing their adviser and their investments.
Thank you.
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