Correspondence

[ copy of Joint Discussion Paper dated 15 October 2009 for consideration by the Capital Markets Development Taskforce]

A Discussion Paper in support of Changes to the Capital Markets Regulatory Functions

1. Introduction

Currently the Capital Markets Development Taskforce (CMDT) is gathering information about the state of the NZ capital markets and the requirements going forward. It is expected that the reports they issue will strongly influence the shape of a new Securities Act which will replace the Securities Act 1978, The Securities Market Amendment Act 1988 and the Securities Market Amendment Act 2002.

As part of that investigation the CMDT has been considering the legislative and regulatory framework governing the operation of sharemarkets in NZ. In effect this means the New Zealand Stock Exchange (NZX) which is the only exchange currently registered under the Securities Market Amendment Act 2002.
While the CMDT has attempted to consult widely, with the exception of the New Zealand Shareholders Association (NZSA), it has not actively engaged a number of groups that have a particular interest in good governance and appropriate principles based regulation but who fall outside the ambit of “market participants”.
This paper is written to ensure that the views of this group are heard.
In August 2009 NZX published a discussion document “The allocation of certain regulatory functions across New Zealand” (NZXreg). This sets out NZX’s view looking forward and outlines a number of recommendations for consideration.
However the NZX position cannot be viewed in isolation. There are interactions with the Companies Office, Reserve Bank and the Securities Commission to consider.
In September 2009 the Prada/Walter (PW) report into The Effectiveness of New Zealand’s Securities Commission was released.
Our paper is supportive of many proposals incorporated in the NZX and Prada/Walter documents, but argues that in some areas further change would be desirable.
We are also concerned that the pace of the current process is too slow. We believe significant adjustments can be made almost immediately to mitigate the most obvious problems at little or no cost.
Others solutions will require legislative change and are medium term in nature.
In the long term we see possible advantages in the super-regulator concept responsible for all securities and company regulation/enforcement, with the Reserve Bank handling the prudential aspects.
We favour an evolutionary approach to this process with each step tailored to progressively build a complete and comprehensive long-term solution that will serve New Zealand well as we move forward.

2. Executive Summary

2.1 Why is change required?

The basis of effective equity market regulation is that it should engender confidence in the process.
Where practical, legislation and regulation should be principles based with prescription being directed more at what is not acceptable rather than what is allowed.
The administration and enforcement of regulation should be free from conflicts of interest and the regulatory framework should be as simple and cost-effective as possible.
The current structure in New Zealand has none of these characteristics. This has resulted in a loss of non-institutional confidence as well as huge costs and uncertainty for participants and issuers trying to navigate their way through the confusion of the present fragmented framework. Change is both essential and well overdue.

2.2 Current Structure

The current situation is complex and inefficient as summarised in both the NZXreg document and in the Prada Walter report.
Essentially four different regulators SecCom, NZX, Companies Office and Reserve Bank (RBNZ) have unique or shared responsibilities depending on the issuer and the nature of their business. The co-regulatory arrangement between SecCom and NZX adds an additional layer of complexity to the whole structure.
This level of fragmentation is confusing and expensive for participants and allows little opportunity for scale or the development of centres of expertise and excellence. It also allows arbitrage opportunities in some areas whereby participants can choose their regulator and potentially enjoy a lesser level of oversight. We agree with these assessments and support the NZX and PW report view that change is necessary.
None of this is a criticism of NZX or SecCom but rather an indictment of a system that has become overly complex and grown in an ad hoc manner.

2.3 NZX and Conflict of Interest

NZX is a public, for-profit company which is listed on its own exchange. It has a role in the regulation of the market both in terms of its own rules (the Listing Rules) and as a co-regulator with the Securities Commission (SecCom). The role and nature of this co-regulation is outlined in a Memorandum of Understanding (MOU) between NZX and SecCom.
For some considerable time various parties including ourselves have been concerned that NZX has a conflict of interest inherent in its multiple roles of market participant, supervisor and regulator.
NZX for its part disputes that view. In NZXreg Cl 2.3 it states “There are a small number of vocal critics of the current model that point to a perceived conflict of interest. In particular, the assertion is made that being in commercial operations is a conflict with a regulatory role. There are however, strong and robust rebuttals to this assertion, both at the theoretical and the evidentiary level.”
The authors of this paper do not agree with that assessment and point out that no independent evidence is quoted to support the NZX view. There is however plenty to support the contrary view and this is detailed, along with some examples, in the background section of this paper.

2.4 Separation of NZX Enforcement Function

NZX claims that there is effective separation of its enforcement function via the New Zealand Markets Disciplinary Tribunal (NZMDT) which it funds but is outside the normal operational control of NZX.
However the basic flaw remains that NZMDT can only investigate cases referred to it by NZX. Under section 36D of the securities Markets Act 1988 NZX is obliged to report disciplinary action or significant breaches of its conduct rules to SecCom, but has discretion in all other matters. What constitutes a significant breach is not defined. It follows that in many cases NZX has the ability to control the enforcement process.
Whether or not NZX does so is not the point. It is the perception that NZX could have an influence or that an opportunity for influence is inherent in the structure that troubles many. In the words of Anais Nin, novelist, diarist and psychoanalyst: “We don't see things as they are, we see things as we are”.

2.5 NZX Listing Rules and Waivers

The concerns outlined primarily relate to enforcement of regulations and legislation external to NZX’s own listing rules.
NZX has a contractual arrangement with issuers listed on its exchange whereby they accept the rules NZX chooses to impose on them. This also includes the granting of waivers to those rules from time to time.
This arrangement is often very time sensitive and frequently of a minor nature. We accept that on balance NZX should continue with this function. However we see a need for a limited appeals process to SecCom to be available to both participants and investors.

2.6 The Securities Commission

The recently released Prada/Walter report gives a comprehensive and thorough examination of the role that the SecCom plays and it is not our intention to repeat its analysis. In general we agree with most conclusions and recommendations made.
However, the current modus operandi of SecCom will not be appropriate going forward. The PW report identifies this to the extent that it recommends adding new Commissioners who are experienced commercially, and the appointment of a CEO. It is pleasing to see that this process has already begun with two recent Commission appointees.
There is a basic difficulty with SecCom having a supervisory and regulatory role in that it has lacked “teeth”. This will require legislative change to fully address. Our concern is that if SecCom is to take over the role from NZX, not only must sanctions be made available to it, but these must be targeted at the guilty party and not just at the issuer. The current process has resulted in a double jeopardy for shareholders in most cases. We acknowledge that it is relatively recently that sanctions have been available against parties other than the issuing entity but see no evidence that they have been applied with any enthusiasm despite the woeful governance performance of a number of individuals and boards.
We also have concerns that SecCom must be staffed with commercially savvy people who appreciate that many decisions will need to be processed with some urgency.
In order to ensure that SecCom carries out its duties in an appropriate and timely manner, consideration should be given to having the Auditor General conduct annual reviews and that the results of these be made public.

2.7 Resourcing the Securities Commission

In our view a properly regulated financial market sector in which all participants, investors and the public have confidence it a key responsibility of Government and must be resourced accordingly.
There is no doubt that SecCom will require additional resourcing if it is to take on additional tasks and Government has to some extent recognised this.
In regard to changing the responsibilities for market oversight, we do not envisage a significant burden on the taxpayer as the process largely involves transfer of funding and to a greater or lesser extent staffing from NZX and CO to SecCom. We do note that SecCom is financially restricted in its ability to take legal action by virtue of having capped funds available. Further it is reported that these have recently been substantially reduced. In our opinion SecCom should be prosecuting cases based on merit rather than the balance in its legal fund.

2.8 Companies Office

Currently the Companies Office (CO) reviews Prospectuses and investment statements. This is also duplicated to a degree by NZX in regard to its listing rules, SecCom and in some cases RBNZ. This duplication is wasteful and unnecessary. This function should rest with SecCom as the supervisor/regulator with the CO initially retaining its responsibilities as a repository of information. The National Enforcement Unit is currently under the aegis of the CO. It may be more logical for this to also be removed to SecCom to strengthen its enforcement function. This would require careful assessment to determine if such a move would be more cost effective than the status quo. In the longer term, we favour the CO being merged with the SecCom which will greatly reduce compliance costs for public issuers.

2.9 How does the New Zealand situation compare?

Overseas jurisdictions utilise a number of regulatory models, each of which claims to be “best practise”. Several examples are canvassed in the NZXreg and PW documents. In our view New Zealand requires a model that achieves “best outcomes” and this is most likely to be a unique solution rather than a copy of some other model. This view is well explored in an NZICA paper entitled “The Cost of Being Different” which is quoted in the background section of this report.
The Minister of Commerce has signalled a desire to be more closely aligned with Australia in matters of regulation.
It is notable that recently the Australian government has announced that supervision and regulation will be removed from the ASX to ASIC

This decision has been motivated by the same conflict issues that we have identified in the NZX situation as well as the need to have independent supervision so that other markets that might be established are not then reliant on a for-profit competitor (ASX) to supervise and enforce them.

Due to the small size of the New Zealand securities markets we do not see this anti-competition move as a major issue at present, but note that it may become more important if moves by the Government and the upcoming proposals by the CMDT result in a growing and more vibrant investment landscape where other markets may be established.

Australia also differs in having an additional independent Australian Prudential regulation Authority (APRA). New Zealand has no equivalent of the APRA structure. Prudential supervision now resides with the RBNZ. We see this solution as reasonable for the smaller New Zealand market.

2.10 Long Term Goals

New Zealand currently has too many regulators. Issuers, market participants and investors are all confused as to where responsibilities rest. Legislation has developed in an ad hoc manner and is frequently contradictory.

In our view, all changes currently being contemplated should move in an evolutionary manner towards a framework which would allow the establishment of a “super-regulator” if this is held to be desirable. This would be a “one stop shop” with consistent principles based (descriptive rather than prescriptive) legislation, rules and regulations and would incorporate SecCom, the Companies Office and several smaller entities. This would handle everything except prudential matters which would vest with the Reserve Bank.

Once the budgets of the various bodies currently involved are amalgamated, we think any additional taxpayer funding requirements would be modest or possibly unnecessary.

The clarity and efficiency that would result in the whole capital markets and prudential regulation sectors would however be priceless.

3 Recommendations

1. That the advisory, regulatory and enforcement roles be removed from NZX to the Securities Commission. As a first step, the MOU between the parties should be terminated and these roles revert to the Securities Commission as soon as possible.

2. That as an initial step the NZX Disciplinary Tribunal should be moved to the direct control of the Securities Commission. This could be achieved by a revised Memorandum of Understanding until such time as the new securities laws are finalised.

3. That in the interim until new securities law is enacted, funding for the regulatory, and enforcement roles be provided to the Securities Commission by NZX at the average level NZX has expended in each of the last two years.

4. The Securities Commission should be expanded to become the primary regulator with responsibility for supervision and enforcement of the capital markets and their participants.

5. That prudential supervision be removed from NZX and reside with the Reserve Bank

6. That NZX retain oversight of its own listing rules and waivers, but that an appeal process accessible to both participants and investors is put in place.

7. That the Minister directs NZX to provide all market information to the Securities Commission in real time without charge to facilitate Securities Commission oversight.

8. That the Securities Commission be directed to take a proactive approach to its advisory, enforcement and participant / investor education roles.

9. That legislation should be enacted to give the Securities Commission sufficient powers to enforce or punish breaches of the regulations if it is held that these are currently inadequate.

10. That where possible, restitution be a primary consideration in enforcement proceedings and those proceedings should be directed at the offender rather than only the issuer.

11. That oversight reviews of market participants (including NZX) must be properly resourced to ensure they are completed in a timely manner

12. That as an initial step, approval of capital raising documentation should be removed from the Companies Office to become the primary responsibility of the Securities Commission, with input invited from NZX and the Reserve Bank where appropriate.

13. That consideration be given to the Auditor General having an oversight role in respect to the expanded Securities Commission.

14. The location of the National Enforcement unit of the Companies Office should be reviewed.

15. The overall structure of the New Zealand securities law be simplified and consolidated once the work of the CMDT is completed and legislation can be introduced.

16. As far as possible, legislation and regulation should be consistent for all capital market participants Therefore as far as possible, any legislation should be principles based rather than prescriptive in order to allow flexibility in enforcement.

17. That all changes should be made in a manner that does not preclude the establishment of a single “super-regulator” responsible for all capital market regulation and enforcement functions. All prudential supervision to be made the responsibility of the Reserve Bank.

4 Background

4.1 Current Structure

The multi-faceted arrangements already in place and detailed in the PW report are further complicated by the co-regulatory model operated by NZX and SecCom. The SMA requires the two to share the regulation largely because NZX as market operator needs to be able to set and enforce its own listing rules. For its part, SecCom is responsible for enforcing the legislation covering the operation of the markets. However it has arranged a Memorandum of Understanding (MOU) with NZX whereby it effectively cedes many of its responsibilities to NZX. There are some safeguards in as much as NZX is obligated to report certain breaches to SecCom. The MOU runs from February to February and is reviewed annually. It can be cancelled at three months notice by either party
The difficulties inherent in the current situation are illustrated by the time it takes for the annual SecCom overview of NZX to be completed. In NZXreg it states “This is an exhaustive process that, for example, in 2009 started in January for the 2008 year and is still ongoing”. In fact nine months later in mid September 2009 this review had still not been published.

4.2 Conflict of Interest

At the time that NZX was preparing for demutualisation in 2002, SecCom published a public consultation paper titled “The Proposed Conduct Rules of the NZ Stock Exchange”. This paper made the following observation:
Because the corporate structure will require the delivery of shareholder returns, and
because the NZSE’s shares will be quoted on the market which the NZSE regulates,
there is a risk that the NZSE may have an increased incentive to favour the interests of
itself and its shareholders over the interests of the New Zealand sharemarket in general.

It went on:

A recent report of the Technical Committee of IOSCO on demutualisation published in June 2001 identified the special issues that arise when not-for-profit and member-owned organisations transform, or demutualise, and become shareholder-owned enterprises.

“Commercial pressures or the governance structure may undermine the commitment of resources and capability of the Exchange to effectively fulfil its regulatory and public interest responsibilities to an appropriate standard.”

This pressure is considered to be even greater where the stock exchange performs significant regulatory functions and might be listed upon itself. The IOSCO Technical Committee report highlights the following potential ways of addressing these conflict of interest concerns (each of which is described briefly below).
(a) Corporate governance requirements, such as the requirement for
independent/non-shareholding directors on the Board, some objective oversight
of management, as well as restrictions on shareholdings.
(b) Separation of commercial functions from regulatory functions.
(c) Rigorous regulatory oversight.
(d) Enhanced transparency of decision-making
Despite the clear concerns at the time, the decision was made to proceed with a structure which to a greater or lesser degree relies on a number of “Chinese walls”.
More recently the SecCom Oversight review of NZX 2005 comments:
The Commission notes that it is largely the perception of conflicts of interest that can damage confidence.

And later:

There is no doubt that commentators in New Zealand and overseas, and many overseas exchanges, recognise that a listed exchange company's dual roles create the potential for conflicts of interest. The Commission is concerned that the unwillingness of the NZX Board to acknowledge that there is an inherent conflict within any demutualised exchange between commercial and regulatory functions may preclude the NZX Board from giving sufficient and necessary consideration to potential organisational developments within NZX regarding the regulatory function.
In the SecCom Oversight review of NZX 2007 (which is the most recently available), comments:
While we do not review NZX's commercial activities, we are concerned with the risk of potential conflicts that might arise between its regulatory and commercial functions as NZX expands its commercial activities.
It is significant that while the SecCom reviews have not found hard evidence of actual conflict of interest, the perception of the conflict is of itself sufficient to cause the Commission some unease.
This perception issue is also an issue faced in Australia and is one of the reasons that Treasurer Bowen has removed supervision there to ASIC. In a recent interview he stated:
Certainly the G20 leaders agreed that supervision should be as transparent as possible and should be free of conflicts of interest and there's certainly been a conflict of interest perception with the ASX, given their profit model depends on lots of people trading at the same time that they're supervising. So some people say that's a conflict of interest – I'm not saying that – the ASX would reject that. I'm saying there is a perception of that and that's one of the reasons for cleaning this up,
In fact in the New Zealand situation, we believe there are demonstrable conflicts. The most obvious is the fact that NZX has been unwilling in the past to provide full market announcements in real time while profiting from selling that same real time information to subscribers. This has clearly allowed insider trading opportunities to those with a twenty minute head start. It is disappointing that this practice has been allowed to continue for purely commercial reasons even though SecCom was aware of it. NZX recently informally announced that this would cease on 1 October 2009. While applauding this outcome, we are disappointed that it has taken several years to correct such an obvious problem.
The PW report also comments that provision of pricing in real time is not currently available to SecCom let alone the market and it is NZX’s intention that this will continue.
Compare this situation to the USA where the Securities Exchange Commission (SEC) has announced that “flash” trading is to be outlawed. This is a process whereby fast computers can obtain a 30 millisecond advance notice of trades yet to be announced, and automatically adjust their own trades to take advantage.
There is also the issue of disenfranchising investors by means of the so-called “auto-pilot” rule. Essentially NZX listing rule 1.3.1 allows NZX to change its listing rules at its sole discretion. Most companies required a 75% majority at an AGM or SGM to change their own rules, but with a once only alteration enabling the company to automatically adopt NZX rule changes, shareholders are subsequently disenfranchised as no vote is required on a case by case basis. In any event companies have no option as NZX listing rule 1.5.2 requires that any changes introduced to their listing rules by NZX must be incorporated into the company’s rules at the first opportunity. Therefore effectively NZX directors have an opportunity to change the rules of all listed companies without consultation, including those of NZX itself.
These are exactly the sort of problems that we see with NZX having commercial participation, supervisory and regulatory oversight of the New Zealand sharemarket.
The NZXreg document and to a lesser extent the PW report claim that SecCom will face the same conflicts when it becomes the regulator and enforcer with respect to the oversight of financial advice. We believe that such risk is greatly mitigated because unlike NZX, SecCom has no commercial imperative impinging its actions – either real or perceived. There may however be a moral hazard that requires careful staff management and separation of duties within SecCom.

4.3 Separation of NZX Enforcement Function

Currently NZX state that the New Zealand Markets Disciplinary Tribunal (NZMDT) has no operational or other interaction with NZX except that instituted by NZMDT.
In our view this is not correct and there is a clear channel for interaction.
NZX listing rule 2.3.4e allows that information obtained by NZX regulation personnel is able to be disclosed to the CEO and Board of NZX as well as to SecCom. We accept that decisions of NZMDT will necessarily be communicated to the CEO and Board, but this rule goes much further and shows a clear potential for interaction prior to any significant investigation occurring or SecCom being informed.
NZX listing rule 5.4.2 also allows that NZX may at any time refer the conduct of any issuer or any director or Associated Person of any issuer to NZX Discipline or any statutory governmental body. However, with the exception of Section 36 offences, there appears to be no compulsion on NZX to make such a referral. In our view, this degree of discretion is undesirable in terms of creating a transparent process.

NZX further state that regulation is not a profit centre. In a letter to the NZSA, NZX Chair Andrew Harmos stated:
For the record, regulation is not a profit-making area of NZX's business, and neither should it be.

It therefore follows that transferring the regulatory function away from NZX will not impact on the profitability of NZX even assuming the total cost of running regulation and discipline is levied from NZX and used to help fund an independent body such as SecCom.
We believe that this process could be promptly achieved at little or no cost to the taxpayer, possibly by means of an MOU whereby NZX transfers the NZMDT function to SecCom and changes its listing rules to allow the appropriate funding to meet NZMDT costs to be paid to SecCom from NZX listing fees.
Listing rule changes can be made via a consultation process which runs on a six month cycle and are subject to approval of the Minister.

4.4 NZX Listing Rules and Waivers

The relationship between NZX and its participants is a contractual one. Although there are over-arching laws and regulations that both sides of the contract must adhere to, the way in which NZX organises its own market is largely its own business. It requires participants to provide it with information, provides a trading platform, communicates information from its listings to outside parties and has a system in place to sanction participants who do not follow its listing rules. It also has the ability to grant waivers to these rules. This system has not always been transparent, but recent improvements ensure that all waivers are now notified to the market in a timely manner.
In most cases the waivers are administrative in nature and some arise because of the general way in which NZX rules are written. NZX claims with some justification that
The issuer rules are principle-based. They are deliberately drawn so that a range of conduct is brought within the remit of NZX........and the principles are flexible enough to be resilient to a multiplicity of situations and changes over time. It thus avoids the myriad issues with black letter rules.
They also point out the need for speed and intimate knowledge of the way their own market operates as factors for keeping this function in house.
On balance we agree, but with the caveat that waivers should be granted subject to review by SecCom on the application of a shareholder or affected party or by SecCom itself. Pending determination by SecCom the waiver may not be relied on by the issuer.
Complaints for breach of the listing rules should be able to be directed to SecCom who would investigate and report to the complainant and market if appropriate.
These investigations would have two phases. First to establish if there is a valid case and secondly to pursue the case if a prima facie breach or likely breach has occurred. To prevent vexatious complaints a moderate fee would be required from the complainant which would be forfeit if no breach is determined at the first step.
Once a case was made it would go to the independent disciplinary division within SecCom with power to determine. Any issuer or liable party would have a right of appeal to the courts if a penalty or restitution order was made. All outcomes at each step would be published via announcement through NZX.
To an extent this process is similar to Section 19 of the Securities markets amendments Act 2002 which gave SecCom far greater powers in regard to disclosure breaches. We note that under section 19.G.3 SecCom has the power to make an order “on the terms and conditions the Commission thinks fit”.
Section 19 also clarifies the role of the Courts and provides that penalties and compensation orders can me made against the guilty parties.

While we have reservations about the speed of the court process (also of concern in the Prada/Walter report), we think the principle-based section 19 concept is worth extending across the whole range of matters covered by regulation and discipline.

The role of the NZX Special Division (ZSD) in approving waivers for NZX itself is more problematical. Since this operates relatively autonomously, it could be moved to SecCom control in the same way as NZMDT. Or it could remain with NZX subject to the same provisions detailed above.

4.5 The Securities Commission

The Securities Commission was set up in the Securities Act 1978. It was originally conceived as an advisory body with some oversight responsibilities and an ability to advise and direct along with a public education mandate. However enforcement was not addressed and SecCom lacked “teeth”.
This began to change with the Securities markets Act 1988 where SecCom was given some powers in relation to insider trading and disclosure although penalties were either low or nonexistent.
The Securities Markets Amendment act 2002 finally gave SecCom some real power as a regulator with the ability to make enforceable directions along with much stronger penalties including costs, damages and compensation available through the court system.
Other amendments culminating in the Securities Markets Amendment Act 2006 have extended the powers of SecCom and the Courts to cover insider trading, continuous disclosure, market manipulation, substantial holdings disclosure, investment advisor responsibilities and broker responsibilities amongst others.
This gradual process into a front line regulator is now virtually complete with SecCom having the primary role in the regulation of financial advisors and anti money laundering legislation commencing in 2010.
A consequence of the past weak legislation and to some extent a lack of resources has been that SecCom is perceived very much as an ambulance at the bottom of the cliff by many commentators, sharemarket participants and investors. To some extent this is of their own making with a poor track record of prosecuting misconduct and a low profile, reactive approach to public education where a high profile proactive stance would be more effective.
Even when SecCom does investigate there seems to be a lack of appreciation regarding the need for timely resolutions. This is highlighted by the Plus SMS case which commenced in October 2005 and the results of which were not released until July 2009. Regardless of the merits of the arguments in this particular case, such performance was neither transparent nor timely.
Part of the issue is also a structural one with a relatively large number of commissioners being supported by a small team of professionals. The PW REPORT (recommendation 8) suggests that SecCom be restructured with a CEO and that the Chair be made non-executive. We support this proposal and go further in recommending that SecCom be restructured into a more corporate model. The new responsibilities already signalled will render the current structure unworkable where rapid assessments and actions will be the norm rather than the exception.
There is some concern in the PW report that internal conflict of interest between advice, regulation and discipline will need to be managed. As SecCom would have no commercial interest in outcomes, we see this as a much lower risk than the present situation. Individual staff however may be in a position to benefit personally and this would require adherence with a strict code of conduct.
The question of who checks the regulator is also raised in the PW report. We believe this checking process is very important. Even the largest market regulators such as the American Securities Exchange Commission (SEC) have demonstrated a remarkable inability to utilise their formidable resources and powers at times. This is most clearly demonstrated in the Maddoff case where despite clear evidence of a Ponzi scheme being presented to it several times over a five year period, the SEC was loath to investigate. This inaction (amongst others) has been very damaging to the credibility of the SEC and it is essential that processes are in place to avoid decisions being reached based on personalities or fear of mistakes.
In our view the Auditor General is best placed to undertake this role. This Office is separate from political or commercial interference and has a demonstrated record of “telling it like it is” without fear or favour. Any oversight should include checking on timeliness of actions, relevance of rulings to the complaint and where complaints originate as well as the usual fiscal and anti-conflict checks. Requiring the publishing of these reports would enhance public and participant confidence in the process and outcomes.

4.6 Resourcing

The SecCom is arguably under pressure in terms of resources. Partly this is a result of current regulation which has been developed via a series of relatively ad hoc Amendment Acts over 30 years. The result is a level of uncertainty and limitations on actions which complicate SecCom’s work and add unnecessary cost. There is a suspicion that even where SecCom has a reasonable case it is unwilling to test the law due to financial and staff considerations. Chair Jane Diplock was quoted in the National Business review as saying:
“Short of something being dead clear, it’s very hard for us”.
Whilst this comment was in relation to the SecCom pulling an unsatisfactory prospectus, it is an attitude that seems at odds with the Commissions existing powers. For example, section 42.I.1 of the Securities Markets Amendment Act 2006 gives the Commission powers to “make orders as it sees fit” with regard to a variety of offences. Certainly, there are processes to follow and the order can be tested in court, but commercial pragmatism suggests few offenders would be prepared to risk an adverse outcome (including potential costs being awarded against them) if SecCom had a sound case.
The Government has agreed to additional funding of $17.4m over the next four years to pay for the expanded roles already assigned to SecCom but at the same time is reported by National Business Review as having removed 70% of SecCom’s legal fund this year. Such a move appears to undermine SecCom’s ability to prosecute cases that are less than “dead clear” and contributes nothing to building a volume of case law which would clarify boundaries and responsibilities for participant conduct.
In our view, changes giving SecCom full responsibility for sharemarket supervision, regulation and discipline could be largely self funding by diverting the appropriate proportion of NZX listing charges to SecCom.
Similarly, the preparation of prospectus and investment statements would be funded by the fees (and funding provisions) currently collected by the CO to SecCom.
In terms of staffing resources, there may be a problem with the relatively small pool of qualified talent. While we cannot comment on the staffing requirements for new responsibilities already assigned to SecCom, there is no reason to believe that current staff at NZX, CMDT and the CO would not be willing to transfer to SecCom if it should be made responsible for market regulation and prospectus vetting. There may be an issue of pay relativity which would need to be addressed to ensure the right people can be attracted or retained.
Attracting staff with a relevant background would have the added benefit of introducing a more commercially minded ethos into the whole organisation and in particular a much greater awareness of the importance of timeliness in response and decision making. This would allay the fears of some market participants who are concerned that should a civil service mentality be allowed to pervade an expanded SecCom, it would create difficulties that are not present in the current system. We accept this is a valid concern, but believe it would be manageable with SecCom restructuring separating the executive and Commissioner roles.

4.7 Companies Office

The current situation where the CO has primary responsibility for approving prospectuses and investment statements relating to both equity and debt issuers makes no sense.
SecCom has the primary oversight of NZX, who in turn require these documents to be compatible with their own listing rules if they are to be quoted on the exchange. In a few cases where prudential requirements must be met the RBNZ also has input.
We can see no justification for a further body to be involved. This has the effect of spreading the necessary expertise too thinly rather than building centres of excellence.
The CO also appears to take a strictly legalistic approach to the contents of these documents by approving everything that “could” be in them rather than what “should” be in them. As a result relatively straightforward documents become over stuffed with pages and pages of repetitive information of dubious merit. The CMDT agrees that this approach undermines the value of the documents.
In our opinion the CO function of approving prospectuses and investment statements should become the primary role of the SecCom with it coordinating input from NZX where listing is involved, and the RBNZ as required. This one stop approach would be much quicker and more cost effective for issuers and regulators alike.
It would also facilitate the development of consistent rules to cover all issues whether they are equity or debt.
Moving the responsibility to SecCom would also overcome the situation where at present the CO is only obliged to pass qualified opinions of auditors to SecCom. The situation has arisen where auditors talk about “emphasis” on certain matters, but still give an unqualified report. While this may be strictly legal, it fails to provide the SecCom oversight that was envisaged in the legislation and consequently reduces the protection available to investors.
This matter is also alluded to in the MED/ARSB draft Statutory Framework for Financial Reporting where part 5.2 talks about forms of assurance (audit) over accounts.

4.8 How does the New Zealand situation compare?

The NZICA paper entitled The Cost of being different focuses on the need to ensure any solution to regulatory reform results in an outcome that is in New Zealand’s best interests. In particular, it warns of the risks inherent in simply copying an overseas solution:
Rather, it is important that we remain focussed on assessing the nature and magnitude of the problem, identifying and assessing the options to address that problem and amending the final option where necessary for best effect. This is particularly important for a small country like New Zealand, which cannot as easily as large economies afford the cost of poorly conceived and designed regulation. Within the context of all the factors that influence investors, developing sound regulation appropriate to New Zealand is, in our view, the best way for government to attract overseas investment and promote the objective of sustainable business growth.
And further on:
While some overseas reforms will be appropriate to the New Zealand environment, others will not. It is important that New Zealand not passively adopt a herd mentality to the most recent regulatory trend to grip the collective imaginations of overseas regulators.
There is clearly a move towards a similar regulatory framework to Australia given our close economic relations and the comments by Minister of Commerce Simon Power in a recent speech to the 5th Annual Securities Law Update conference.
“There are some very interesting ideas there, and I’m looking closely at them, particularly in the light of the Governments inclination towards further harmonisation with Australia”
The Australian model is currently in a change process with the Australian Stock Exchange (ASX) announcement on August 24th that
The change will mean that the supervision and enforcement of market participants currently performed by ASX and the independent Disciplinary Tribunal will become the responsibility of ASIC once the proposed legislation is passed by the third quarter of 2010. Importantly, ASX will retain responsibility for the supervision of entities listed on the market it operates. Speaking in August 2009, Australian Treasurer Mr Bowen said: For many years, each individual financial market – most prominently the Australian Securities Exchange – has supervised the operation of its own market. The Government has made a decision that this is no longer desirable or sustainable. Australia will have a single unified supervisor for market participants. That supervisor will be the Australian Securities and Investment Commission. This will bring Australia into line with international best practice and is consistent with decisions of the leaders of the G20 in relation to financial supervision.

The resulting structure from 2010 will see ASIC carrying full responsibility for sharemarket regulation, supervision and enforcement with the exception of individual exchanges own listing rules. This function will remain with the exchange themselves with some decisions subject to ASIC approval. ASIC also maintains the company register which is currently a responsibility of the Companies Office in New Zealand.

The Australian model has a two tier structure with regard to prudential oversight. The Australian Prudential regulation Authority (APRA) has the primary supervision and enforcement role with the Australian Reserve Bank (RBA) overseeing general fiscal settings and having the ability to provide emergency funding. RBA does not directly supervise individual companies.

The three Australian agencies have Memorandums of Understanding which enable sharing of information and encourage close working relationships. This mechanism allows for efficiency in the supervision of entities such as banks and insurance companies where crossovers between responsibilities do occur.

4.9 Long term goals

The difficulty with the Australian model in the smaller New Zealand environment is one of affordability. In our view the RBNZ has sufficient knowledge and skill to handle the APRA function with only a modest increase in resource.

There has been talk of developing a New Zealand “super-regulator” perhaps along the lines of the American SEC or the Australian ASIC models.

This would require significant legislation and be time consuming to establish. It has been pointed out by many commentators that the track record of some very large regulators leaves something to be desired, but balancing this argument is the fact that the New Zealand scene is miniscule on a world scale and has little if any of the extreme complexities faced by large overseas regulators on a daily basis.

In fact the problems in New Zealand arise partly because we are such a small capital market. The multitude of regulatory and enforcement bodies currently in place mean that finding senior staff who are not conflicted, at least in a minor way, is always difficult. The small size of each body (for example SecCom have a total of 40 staff) means that it is difficult to justify the kind of remuneration necessary to attract top performers who may well be overseas based. This also applies to the present SecCom Commissioners and NZXDT members who all have other jobs and handle the regulatory tasks on a part-time basis, often at below market rates.

For the reasons outlined earlier in this paper we believe New Zealand cannot wait for the time it would take to set up a super-regulator. Some changes are urgent and others already being worked on can be enacted in a reasonable timeframe.

We favour a consolidation and incremental approach with a view to expediting changes that will boost confidence and transparency and taking longer to ramp up other changes where legislation is required.

However all changes should be made within an overall framework that will allow the establishment of a super-regulator if this is ultimately be held to be desirable. On balance we think this might be a worthwhile objective if the benefits of simplicity, clarity, human resource availability and cost-efficiency can be shown to outweigh potential problems of bureaucratic inertia and “empire building”.

5.0 Bibliography
ASIC and APRA. (n.d.). Memorandum of Understanding between the Australian Prudential Regulation Authority and the Australian securities and Investments Commission. Retrieved from http://www.apra.gov.au/AboutAPRA/upload/MoU-ASIC-Australian-Securities-and-Investment-Commission.pdf
Boswell, D. (2004). Company Law. In CCH, Corporate Governance. A Directors Handbook.
Brookers. (2008). Company and Securities Law Handbook Volume 1.
Brookers. (2008). Company and Securities Law Handbook Volume 2.
conference, T. B. (2009, August). http://www.treasurer.gov.au/DisplayDocs.aspx?doc=transcripts/2009/021.htm&pageID=004&min=ceba&Year=&DocType=2.
Government N.Z. (n.d.). Securities Market Amendment Act 2002. Retrieved from http://www.legislation.govt.nz/act/public/2002/0044/latest/DLM161370.html
Government N.Z. (n.d.). Securities Markets Act 1988 (as at 02 May 2008), Public Act. Retrieved from http://www.legislation.govt.nz/act/public/1988/0234/latest/DLM139727.html
Government NZ . (n.d.). Securities Market amendment Act 2006. Retrieved from http://www.legislation.govt.nz/act/public/2006/0047/latest/DLM383067.html
Government, N. Z. (n.d.). Securities Act 1978 No 103 (as at 28 July 2009) Public Act. Retrieved from http://www.legislation.govt.nz/act/public/1978/0103/latest/DLM26800.html
Hanna, R. (2004). Securities Law. In CCH, Corporate Governance. A Directors Handbook.
Insider, T. (2009, October 2nd). National Business Review .
Ministry of Economic Development. (2009, July). Capital Markets Development Taskforce Progress Report. Retrieved from http://www.med.govt.nz/templates/MultipageDocumentTOC____41773.aspx.
Ministry of Economic Development. (2009, September). The Statutory Framework for Financial Reporting. Retrieved from http://www.med.govt.nz/templates/MultipageDocumentTOC____41975.aspx.
New Zealand Stock Exchange. (August 2009). The allocation of certain regulatory functions across new Zealand. New Zealand Stock Exchange.
NZ Institute of Chartered Accountants. The Cost of being different. Wellington: NZICA.
Prada/Walter. (September 2009). Report on the Effectiveness of New Zealands Securities Commission.
Securities Commission. (n.d.). Memorandum of Understanding between the Securities Commission and NZSE Ltd on regulatory cooperation. Retrieved from http://static.nzx.stuff.co.nz/legacy/mou.pdf
Securities Commission N.Z. (n.d.). Oversight review of NZX 2005 . Retrieved from http://www.sec-com.govt.nz/publications/documents/nzx/
Securities Commission N.Z. (n.d.). Oversight review of NZX 2007. Retrieved from http://www.sec-com.govt.nz/publications/documents/nzx-2007/
Securities Commission NZ. (July 2009). Commission Statement on Plus SMS. Retrieved from http://www.sec-com.govt.nz/new/releases/2009/030709.shtml
Securities Commission. (2002). The Proposed conduct rules of the New Zealand Stock Exchange. Retrieved from http://www.sec-com.govt.nz/downloads/nzse_rules.pdf
The Reserve Bank of Australia and the Australian Prudential Regulation Authority. (n.d.). Memorandum of Understanding. Retrieved from http://www.apra.gov.au/AboutAPRA/upload/MoU-RBA-Reserve-Bank-of-Australia.PDF
Transcript. (2009, August). Interview with Ross Greenwood. Retrieved from http://www.treasurer.gov.au/DisplayDocs.aspx?doc=transcripts/2009/023.htm&pageID=004&min=ceba&Year=&DocType=2.
Trotman, B. a. (2002). Company Law Enforcement. Theory and Practice. In B. R. Taylor, Company Law Writings. A New Zealand Collection.

6.0 CONTACT DETAILS FOR CONTRIBUTORS

• Document compiled and written by
J K Hawkins
Director, Strategic Liaison
New Zealand Shareholders Association
P O Box 6310
Wellesley Street
Auckland 1141
www.nzshareholders.co.nz

• New Zealand Shareholders Association
Chairman: B R Sheppard
P O Box 6310
Wellesley Street
Auckland 1141
www.nzshareholders.co.nz

• Chartered Secretaries New Zealand
Chairman: J Nimmo FCIS
P O Box 444
Shortland Street
Auckland 1140
www.csnz.org.nz