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Report On disclosure By Finance Companies [2005] NZSecCom 3 (22 April 2005)

Last Updated: 10 November 2014

Report on Disclosure by Finance Companies

22 April 2005

TABLE OF CONTENTS

• INTRODUCTION
• SECTION 1 - KEY PROVISIONS OF THE ACT AND REGULATIONS, AND FINANCIAL REPORTING STANDARD 33
• SECTION 2 - RISK AND BUSINESS DISCLOSURE
• SECTION 3 - FINANCIAL REPORTING DISCLOSURE
• SECTION 4 - OTHER DISCLOSURE ISSUES
• SECTION 5 - ADVERTISING
• APPENDIX - LAW REFORM ISSUES

REPORT ON DISCLOSURE BY FINANCE COMPANIES

INTRODUCTION

Purpose of Report
1.

This report provides guidance on the Commission's expectations for disclosure by finance companies under the Securities Act 1978 ("Act") and Securities Regulations 1983 ("Regulations").
2.

It follows a Discussion Paper that was published by the Commission in September 2004 entitled Disclosure by Finance Companies. The Discussion Paper outlined the Commission's preliminary views on information that should be disclosed by finance companies in their investment statements and prospectuses under the Act and the Regulations, and sought comment on these preliminary views.
3.

This report provides guidance to finance companies to assist them in assessing their compliance with the Act and Regulations and making improvements where necessary. It sets out the Commission's understanding of certain aspects of the law and signals the approach that the Commission intends to take in its enforcement role.
4.

This report focuses on disclosure by finance companies under the Act and Regulations. It does not look at the prudential supervision or status of finance companies. The Commission does not have a role in relation to the prudential supervision of finance companies and does not comment on this.

Enforcement
5.

The Commission intends to review a sample of finance companies' disclosure documents later in 2005. This will take place as part of the Commission's routine surveillance work. The documents will be reviewed against the disclosure requirements of the Act and Regulations. If the Commission identifies breaches of the law it will raise these matters with individual finance companies. The Commission may take enforcement action, as appropriate in the circumstances of each case.
6.

The Commission continues to take enforcement action against issuers and their directors where material breaches of the legislation are identified. If material breaches by finance companies are identified in advance of the follow-up review, the Commission will take enforcement action as appropriate.

Disclosure may depend on the circumstances of the finance company
7.

Some of the matters identified in this report will be more relevant to the circumstances of particular finance companies than to others. Not every matter will need to be disclosed by every finance company. It is not the Commission's intention with this report to lay down any further prescription for disclosure by finance companies - the disclosure obligations for all issuers are set out in the law. Rather, we have identified high-level areas in which we consider disclosure by finance companies generally need to improve in order to comply with the law.
8.

The way in which a finance company interprets the disclosures required under the law and assesses the matters in this report is in each case a matter for the particular finance company to determine. The report is intended to serve as guidance for individual finance companies, each of which should carefully assess the information it needs to give investors in view of the particular context of its business, its lending activities, the types of debt securities that are being offered and the risks of the investments it offers.
9.

A number of the matters included in this report are likely to be relevant to other types of issuer as well as to finance companies. While this report focuses on particular disclosure issues that we have observed in the finance company sector, the prescribed disclosure for investment statements applies to all issuers, and our view of what the law requires will, in general terms, be the same regardless of the type of issuer.

The Discussion Paper and submissions
10.

This report is based substantially on the Discussion Paper and the submissions that the Commission received in response to it. The report refers at times to the Commission's Discussion Paper. The Discussion Paper includes examples and commentary in relation to disclosure issues that the Commission identified in carrying out its review. The Discussion Paper is available on the Commission's website www.seccom.govt.nz
11.

The Commission expressed the view in the Discussion Paper that some finance companies need to improve their compliance with the Act and Regulations and assess the quality of their disclosure.
12.

The Discussion Paper was circulated to around 100 interested parties in September 2004 and made publicly available on the Commission's website. The Commission invited comment from finance companies and interested parties on the preliminary views expressed in the Discussion Paper.
13.

The Commission received 33 submissions in response to the Discussion Paper. The Commission thanks respondents for the time and consideration spent in preparing these submissions. The Commission has carefully considered the submissions received.
14.

A number of respondents raised issues of law reform in their submissions. The Commission's Discussion Paper and this report focus on disclosure by finance companies under the current legal requirements. However, we have included a section on questions of law reform in the Appendix of this report to highlight the main issues that were raised by respondents. The Commission intends to look at these issues further, and in due course may recommend law reform to the Minister of Commerce. The Commission is aware that the Government intends to review the disclosure provisions of the Securities Act as the fourth part of its programme of securities and securities trading law reform.

Disclosure of financial information
15.

The Discussion Paper did not include detailed discussion about disclosure of financial information by finance companies. The Commission undertook a separate project on this and the results of that review were not available when the Discussion Paper was published. The Commission's key findings from that review work are included in this report.
16.

The Commission reviewed the financial statements of a sample of 16 finance companies. This review work indicated that there were 3 main areas where financial disclosure and financial reporting practices should be improved:

(a)

Disclosure of financial information relating to Financial Reporting Standard 33: Disclosure of Information by Financial Institutions (FRS-33) generally needs improvement;

(b)

Information concerning related party transactions needs to be adequately disclosed to enable readers to understand whether transactions are truly at "arm's length" and on commercial terms; and

(c)

Disclosure about items where there is no specific guidance in New Zealand financial reporting standards (for example, revenue recognition and the treatment of compound financial instruments) needs to improve. Finance companies need to look to available authoritative support to ensure that financial reports conform to best practice.
17.

The Commission encourages auditors to be vigilant in the audit of financial statements. High quality external auditing is critical to integrity in financial reporting. Investors rely heavily on the external assurance of an issuer's financial reporting.

*****

18.

The Commission cannot give rulings on the interpretation of the law or provide legal advice. Accordingly, this report is provided for guidance only and to indicate the view that the Commission has of the law as it will apply it in its enforcement work. The Commission may publish further comments or guidance over time. However, the Commission is not bound by this or any other report.

SECTION 1 - KEY PROVISIONS OF THE ACT AND REGULATIONS, AND FINANCIAL REPORTING STANDARD 33

Investment statement and prospectus
19.

The investment statement and registered prospectus are the key disclosure documents for any offer of securities to the public. The Act and Regulations set out the minimum disclosures that are required in these documents.
20.

The information required in any particular investment statement or prospectus will depend to a large extent on a finance company's particular business, lending activities, the types of debt securities offered, and the risks of the investment.
21.

The investment statement is generally the principal point of sale document on which investors base their investment decision. Its purpose under the Act is to:

(a)

Provide certain key information that is likely to assist a prudent but non-expert person to decide whether or not to subscribe for securities; and

(b)

Bring to the attention of such a person the fact that other important information about the securities is available to that person in other documents.
22.

The investment statement must contain the information required to be included in it under the Act and Regulations. More particularly, it must contain all of the information required to answer the questions of Schedule 3D of the Regulations. The eleven questions found in Schedule 3D must be addressed and all the information and statements required to answer each question must be set out in the investment statement under that question.
23.

The information in the investment statement must be presented in a "succinct manner". "Succinct" relates to how the required information is presented. Being "succinct" appears to have been interpreted by many finance companies to mean being "brief". The Commission notes that several of the Schedule 3D disclosure provisions refer to providing "brief descriptions". This means that issuers need to deliver information briefly. It does not mean that key information can be omitted in the name of brevity. While information should be succinctly (and, where required, briefly) stated, issuers must ensure that all required disclosures are sufficiently made. The investment statement can say that additional information about a matter in Schedule 3D is in the registered prospectus. This does not detract from the requirement to fully answer the questions in the investment statement.
24.

The registered prospectus must set out all material matters relating to an offer of securities. For an offer of debt securities the registered prospectus is required to contain all the information, statements, certificates and other matters set out in the Second Schedule of the Regulations that are applicable. If a statement required in the registered prospectus would be misleading without the addition of further information, then that further information must also be included.
25.

Finance company directors must certify that the investment statement complies with the securities legislation, does not contain any matter that is likely to deceive, mislead or confuse with regard to any particular that is material to the offer of securities and is not inconsistent with the registered prospectus relating to the security. Directors need to take these certification responsibilities seriously.
26.

The Commission can suspend or prohibit the distribution of an investment statement if it is likely to deceive, mislead or confuse in respect of a particular that is material to the offer, is inconsistent with any registered prospectus referred to in it, or does not comply with the Act and Regulations. The Commission has the power to suspend or cancel the registration of a registered prospectus if it is false or misleading as to a material particular, omits a material particular or does not comply with the Act and Regulations.

Financial Reporting Standard 33
27.

Financial Reporting Standard 33 prescribes "minimum standards of disclosure for financial institutions". While FRS-33 recognises that other entities also have exposures to risks, such as the risk of counterparty failure, funding and asset concentrations, interest rate movements and liquidity risk, it notes that "the magnitude of those risks is generally greater" for financial institutions. The commentary to FRS-33 notes that "as financial institutions are also generally more highly geared than other commercial entities, their capacity to absorb losses arising from such risks is not as great as other entities".

REPORT ON DISCLOSURE BY FINANCE COMPANIES

SECTION 2 - RISK AND BUSINESS DISCLOSURE

The risks of the investment must be made clear to investors
28.

For investors to make informed investment decisions the risks associated with the investment must be sufficiently disclosed. The investment statement must provide investors with enough clear information about the risk of the investment for the investor to comprehensively understand the risks involved and determine whether the returns offered are suitable for them.
29.

Inadequate risk disclosure is likely to mislead investors. It is not the role of the finance company to assess the risk/return relationship of the investment for investors. However, investors should be able to make their own assessment of this relationship from clear risk disclosure by finance companies.
30.

It would be expected that investments with higher risks would offer higher returns to investors. As such, the return offered on an investment is usually a useful indication of the risk of the investment. Finance companies invest subscriptions from members of the public in a range of investments such as property development or consumer financing. The finance companies will themselves demand a return from those investments relative to the risk of those investments. Once the finance company's margin is taken into account, a comparative measure should be able to be made of the risk of the investment by the member of the public who invests with the finance company. However, if finance company margins differ markedly, there may be a distortion of the risk-return equation and the rates of return offered by finance companies may not accurately reflect the risks the investor assumes. The fact that returns offered may not, in itself, be a firm indicator of the risks of an investment highlights the need for finance companies to make clear disclosures that will assist investors to assess risk.

Principal risks for disclosure in the investment statement
31.

Disclosure about principal risks needs to be tailored to the activities and circumstances of each finance company. Disclosure of principal risks in the investment statement should not be limited to generic and standardised statements. Disclosure about principal risks in any investment statement will depend on factors such as a finance company's particular lending activities, risk management procedures and the types of debt securities offered. Finance companies should assess the circumstances of their business in relation to the disclosure of principal risks.
32.

While insolvency will always affect the likelihood of investors receiving their promised returns, simply stating that insolvency is a risk does not particularly assist investors and does not meet the requirements of Schedule 3D. Finance companies must include specific statements describing, in the context of the particular finance company's business, the principal risks that may lead to insolvency.
33.

Risk disclosure in the investment statement should be addressed by finance companies on two levels.

(a)

Firstly, there should be a description of the principal risks that may apply to finance companies more generally. These risks may be reasonably generic, as among finance companies (and other issuers), and may include risks such as lending risk, liquidity risk and solvency risk. Some of these risks will be particularly applicable to finance companies due to the type of business they operate. Each finance company needs to assess what generic risks it considers to be principal risks for disclosure in the investment statement. It is likely that risks at this first level can be described in reasonably general terms. Some of these risks may be addressed more fully in the financial statements. Finance companies may wish to draw investors' attention to other important information on risk available in other documents.

(b)

Secondly, there should be a description of the principal risks that are specific to the particular finance company. This will vary among finance companies depending on any finance company's principal activities and exposures.
34.

The requirement of clause 11 of Schedule 3D is to provide a brief description of the principal risks. This means that every principal risk must be set out, but the description of each should be brief. Non-disclosure of principal risks that are specific to the finance company is likely to deceive, mislead or confuse investors about the risks associated with subscribing for the debt security.
35.

The degree of detail that the finance company includes in the investment statement on its specific risks will need to be carefully assessed. A practical balance is required, so that adequate disclosure about specific risks is provided, but avoiding so much detail that the investment statement becomes misleading with any small change in the issuer's business, and so requires frequent updating.
36.

Finance companies may need to state in the investment statement that they are disclosing the principal risks specific to the company as they exist as at the date of the investment statement. Unlike a prospectus where a memorandum of amendments may be filed, there is no provision under the legislation enabling an investment statement to be amended. If a material change in the principal risks of the company occurs, then the investment statement will need to be updated and reprinted.

Disclosure about company activities in the investment statement
37.

Clear disclosure about company activities is required for investors to be able to understand what their investment money is being used for and to assess the risks involved with the investment.
38.

Finance companies need to clearly state their principal activities. Generalised statements about a finance company's activities or its structure and history do not provide sufficient information for investors about the principal types of financing activities that the company undertakes or the sector-specific risks to which it is exposed.
39.

Many finance companies make loans to individuals or businesses that may not have been able to obtain funding from other lending institutions due to insufficient security or because the lender is prescriptive in terms of the security that it requires. Other finance companies focus on property financing activities. Where these activities are principal activities they must be appropriately disclosed to investors.
40.

Disclosure is required in the investment statement about how long the issuer has been carrying on its described principal activities. Disclosure about the length of time that a company has undertaken the described principal activities enables investors to ascertain the history of the company and its experience in providing finance to particular sectors.
41.

If certain activities of the finance company are not "principal activities" for inclusion in the investment statement, the activities may still be material matters for disclosure in the registered prospectus.

Use of rating information by finance companies
42.

Wherever a rating is used in a finance company's disclosure documents or any advertisement, then the Commission is of the view that the company is representing that the rating has relevance to investors and, as such, is material information. In such a case, the registered prospectus should contain sufficient information about the rating to allow investors to understand the rating and what it means. This applies to both solicited and unsolicited ratings. It may be helpful for the prospectus to refer also to the rating agency's website if appropriate information about the rating is located there.
43.

If a finance company has deliberately sought and obtained a rating, then, regardless of whether the rating is considered to be positive or negative, the rating is very likely to be material information that should be disclosed in the prospectus. Whether this is the case will depend on whether the rating is material to the offer of securities.
44.

Where a rating is disclosed as material, then any subsequent change in the rating must be disclosed and drawn to the attention of existing investors prior to the reinvestment or renewal of their investment.
45.

If a finance company chooses to compare the rating it has obtained to a rating system used by another rating agency, then the comparison of the ratings must not be misleading to investors.
46.

The Commission considers that a finance company that publishes a rating should provide investors with sufficient information about the rating to enable investors to assess what it means and the extent to which it can help them to work out whether the return on investment is appropriate relative to the risks of the investment.
47.

Where a report on the rating is provided by the rating agency and this report is published, the prospectus should draw investors' attention to the availability of this full rating report. It may be the case that a summary report, as agreed between the issuer and rating agency, is published.
48.

Finance companies should disclose whether the rating that they are referring to has been based solely on publicly available information or whether it is based on further information and analysis of the company.
49.

The Commission does not wish to express a view on the regulation of rating agencies at this point in time and considers that the issue is better addressed as a matter of law reform. The Commission notes that in December 2004 the International Organisation of Securities Commissions (IOSCO) published its Code of Conduct Fundamentals for Credit Rating Agencies. The Commission also notes that regulation of rating agencies is on the IOSCO agenda for 2005.

SECTION 3 - FINANCIAL REPORTING DISCLOSURE

Revenue recognition
50.

It is important that revenue from the different sources of a finance company's activities is clearly identified in the financial statements in or attached to a prospectus. Accounting policies adopted by finance companies to recognise each material revenue source should be clearly disclosed.
51.

The nature of the revenue earned may not be immediately apparent to readers of the financial statements. Where this is the case, the Commission encourages finance companies to provide more information about these revenue sources. The Statement of Concepts that underpins preparation of general purpose financial reports states that "information is understandable when users might reasonably be expected to comprehend its meaning". It also notes that the users' ability to understand financial information will depend in part on their capabilities and in part on the way the information is presented.
52.

The Commission also encourages finance companies to ensure that their accounting policy choices in this area of reporting comply with international best practice by reference to sources of authoritative support discussed in the Explanatory Foreword to Financial Reporting Standards.

Accounting treatment
53.

The Commission considers that an incorrect or inappropriate treatment of items in a financial report cannot be rectified by the disclosure of the accounting policies used, or by notes or explanations. One example is when property obtained through the enforcement of security is subsequently sold. SSAP 17 Accounting for Investment Properties and Properties Intended for Sale requires only the net gain or loss from the disposal to be recognised in the statement of financial performance. The Commission considers that it is incorrect and potentially misleading to recognise the proceeds from disposal of the asset as revenue and to include the cost of the property in operating expenses. While there is no impact on net income, the presentation may confuse readers of financial statements and cause a distortion in the rate of return.

Financial instruments
54.

The Commission's review of financial statements of finance companies also shows that information about certain compound financial instruments, such as convertible capital notes and subordinated shareholders' loans, has been omitted from some financial statements due to the compound financial instruments not being classified as debt instruments. Information that may be relevant to users of financial statements, and that is commonly omitted includes:

(a)

Any redemption options held by either party to the instrument, including the period in which, or date at which the option may be exercised and the redemption price or range of prices; and

(b)

Any options of either party to the instrument to convert the instrument into, or exchange it for, another financial instrument or some other liability, including the period in which, or the date at which, the options may be exercised and the conversion or exchange ratio(s).
55.

The Commission's review of financial statements has highlighted that improved disclosure is needed about the basis for recognising financial instruments in financial reports, or for treating them as unrecognised items. Some finance companies tend to overlook the following matters:

(a)

The accounting for sale and repurchase agreements, reverse sale and repurchase agreements or their option derivatives;

(b)

The accounting for financial instruments which are used for hedging purposes; and

(c)

The accounting for loan transfers and securitisation of financial assets.

Loan transfer arrangements
56.

The Commission encourages finance companies that engage in loan transfer arrangements to state the basis for recognising loans acquired and for not recognising loans that are 'sold'.
57.

The Commission also encourages finance companies to provide a clearer description of transfer arrangements, for example, whether the transfer is through an assignment, novation or sub-participation, and whether or not there is a repurchase arrangement in place. Often finance companies describe the transfer as a 'sale of loans'. This description does not adequately allow an investor to understand the effects of the 'sale' including the transfer of risk and return associated with the loan.
58.

Understanding the nature of the transfer is important because it may affect the overall risk profile of the finance company, either through the disposal of certain risks (and returns) or through the company assuming certain risks of the loans acquired.
59.

Improved disclosure is also required in relation to the entity's accounting policies for impaired assets, including the criteria used to classify those assets, and policies for recognising and determining their carrying amounts in the statement of financial position.

Disclosure about related parties
60.

The adequacy and quality of disclosure by finance companies about related party lending generally needs to be improved. If related party lending occurs this should be clearly disclosed and explained to investors. The identification and disclosure of related party transactions and the risks of the activities of related parties are material matters for investors.
61.

The Commission is of the view that:

(a)

Where significant levels of related party transactions exist, the related party's risk exposure may mean that the activities of the related party and the risks of its business become principal risks of the finance company and require disclosure in the investment statement, as well as being material information for disclosure in the registered prospectus.

(b)

In such cases the investment statement and registered prospectus should explain what criteria or restrictions govern related party lending and whether related party lending is on an arm's length basis.

(c)

Investors should be referred to the terms of the trust deed for further information on related party transactions as appropriate.

(d)

If one entity significantly finances the activities of another related party the investor should be able to judge the performance of the other entity.

(e)

The Discussion Paper sets out a range of issues for consideration in relation to related party lending. Disclosure in relation to these various issues is a matter for each finance company to determine in terms of its materiality, relevance, and the particular circumstances of the company. These issues may be of such a type or level to concern the principal activities of the finance company, be a key factor that determines returns, or be a principal risk for disclosure in the investment statement. If they are not of a type or level to require disclosure in the investment statement, then they may otherwise be material matters for disclosure in the registered prospectus (including in the financial statements).
62.

Statement of Standard Accounting Practice 22 (SSAP-22) establishes criteria for the disclosure of related party relationships between reporting entities and related parties. The Commission's review of financial disclosure by finance companies has highlighted that descriptions about related party transactions in the financial statements are often insufficient to constitute reasonable compliance with SSAP-22.
63.

Certain related party transactions were not disclosed because it was provided in the finance company's Trust Deed that these transactions do not constitute related party transactions. The Commission is of the view that, for financial reporting purposes, all transactions with related parties must be disclosed if they meet the definition of related party transactions and the criteria for disclosure set out in SSAP 22.
64.

In addition, certain related party arrangements are not disclosed because the relationship is with a third party via a related party. The Commission encourages disclosure of transactions where a related party has significant influence on a transaction between a finance company and a third party.

Conduit issuers and funding vehicles
65.

Where a special purpose company raises money from the public solely to pass it on for use by another entity, or a finance company is used as a mechanism for gathering subscriptions from the public to fund the activities of another entity, detailed information is required about that other entity.
66.

The Commission is of the view that:

(a)

The finance company's obligations to the other entity need to be fully disclosed.

(b)

The financial health of the other entity and the purposes for which the money is to be used are material to the risk of investing with the finance company and are likely to be principal risks of the investment that requires disclosure in the investment statement.

(c)

If a finance company acts as a conduit or funding vehicle, then this is likely to be a principal activity of the finance company for disclosure in the investment statement.

(d)

If the other entity is an "issuer", then full disclosure under the Act and Regulations is required in relation to that entity as an "issuer". If the other entity is not an "issuer", then the transactions between the conduit and the other entity are likely to be material to the business of the finance company and disclosure should be made in the registered prospectus about the entities involved, the amounts involved, the activities of those entities, whether there are any guarantees, the purposes for which the recipient will use the funds, and the ability of the entity to repay the loan.

(e)

Where there is a formal guarantor relationship, disclosures are required to be made to investors on request under section 54B of the Act or under the Second Schedule to the Regulations in relation to guaranteeing subsidiaries. If there is no formal guarantor relationship but the ability to repay the investor depends on the creditworthiness of the entity for which the conduit issuer is raising funds, then this is material information for disclosure in the registered prospectus.

(f)

Any relevant guarantee arrangement, even if not from members of the borrowing group, is likely to be material information for disclosure in the registered prospectus.

Policies on lending, outstanding debts and risk management
67.

Finance company policies in relation to the categorisation of debts are important in assessing the risks associated with securities and the impact of such risks on investor returns.
68.

Financial Reporting Standard 33 (FRS-33) requires disclosure in a financial institution's accounting policies about the company's categorisation of bad debts. The Commission noted in its Discussion Paper that information included in a prospectus under FRS-33 may not be sufficient to prevent a prospectus from being misleading and, if so, additional information may be required to be included in the prospectus.
69.

The Commission's review of financial disclosures by finance companies in relation to loans and credit risk has highlighted that some finance companies define and classify impaired and non-accrual loans in a way that is not consistent with FRS-33. If each finance company interprets which loans are categorised as impaired and non-accrual differently to what is defined in FRS-33, then there is a risk that the comparability of the disclosure required, especially on the quality of loans and the provisioning policies for bad and doubtful debts, becomes difficult to understand and potentially meaningless. For this reason, finance companies should ensure that the definitions or descriptions used are aligned with FRS-33.
70.

Information about a finance company's general lending policies is likely to be material to an investor's assessment of the risks of the investment offered. These policies may include the general processes that borrowers must go through to obtain loan approval (including whether or not borrowers are required to take on payment protection insurance), the extent to which the credit protection insurance covers the entity's loss should a loan go into default, the company's main debt collection policies, and whether borrowers are required to have guarantors. These matters may be relevant to the question of risk in the investment statement and are likely to be material information for disclosure in the registered prospectus. Some finance companies are currently making such disclosure in their investment statements, and the Commission encourages this.
71.

FRS-33 requires a financial institution to disclose its credit risk management policies. Paragraph 13.1 of FRS-33 provides guidance about how information about a financial institution's credit risk management policies could be usefully disclosed. The Commission's review shows that most finance companies fall short of providing meaningful disclosure on the company's credit risk management policies despite the guidance provided in FRS-33. While most finance companies state that they have a credit risk management policy in place, they do not disclose what those policies are. Few finance companies provide information about company policies to mitigate credit risks assumed in the different lending sectors. The Commission considers that this information is important if investors are to understand the risks involved in the business of the finance company and considers this to be an area where disclosure needs to improve.

SECTION 4 - OTHER DISCLOSURE ISSUES
72.

This section of the Discussion Paper attracted only limited comment from respondents and the Commission comments on it briefly in this report.

Description of ranking of securities in advertisements
73.

Finance companies must be clear about the terms and descriptions used to describe the debt securities being offered.
74.

Finance companies must state either that the securities are unsecured, or describe the nature of the securities, how they are secured and their ranking.
75.

Where an issuer refers to securities as "first ranking" it must be clear that this description of the ranking relates only to ranking among the securities offered by the finance company, and that prior charges under other legislation may take priority.
76.

Companies that offer more than one type of debt security in the same investment statement need to make clear details about the ranking of the security in respect of each type of security.

Disclosure about prior claims and equal ranking claims
77.

Finance companies must describe the claims on the assets of the issuer in the investment statement. It is not sufficient to note that the only claims that rank ahead of those of subscribers are "prior claims" without describing what these types of claims are.
78.

The description of prior claims on the assets of the finance company must enable investors to understand the effect of these claims (including any restrictions on these charges) in relation to the risks that the investor assumes. If there are claims that rank equally with those of subscribers, the investment statement must also describe these. Investors should be referred to the registered prospectus for further detailed information where relevant.
79.

Where there are material prior charges for fixed amounts that will affect the substantive precedence of the debt security, then these should be disclosed to the extent possible in the registered prospectus. Any precise claims on assets that may rank in priority should each be identified and quantified in the registered prospectus.
80.

Where more than one type of debt security is offered in an investment statement, the information in relation to prior claims, or equal ranking claims, must be described in relation to each type of security offered.

Consistency between the investment statement and the prospectus
81.

An investment statement must be consistent with the registered prospectus referred to in it.

Maturity of investments
82.

Finance companies must disclose the dates on which, or the frequency with which the returns from the securities will be due and paid.
83.

The Commission considers that finance companies should state clearly in the investment statement what, if anything, the finance company will do to advise investors when the investment is about to mature. Investors should have sufficient time to decide what they wish to do with the investment. Finance companies must provide investors with information about the options available to investors on maturity of the investment.

Early termination
84.

The investment statement must contain a brief description of any rights of the issuer, subscriber, or any other person to terminate the investment early.
85.

The investment statement must provide clear information about the effects of early termination and the circumstances in which early termination is permitted. It must be evident to investors that their money is locked in for a particular term and can only be terminated before the end of that term in particular circumstances. These circumstances should be made clear.
86.

Early withdrawal fees or adjustments to the interest rate on early termination need to be clearly explained as this affects the subscriber's right to obtain payment of the returns.

Date of the investment statement
87.

The investment statement must prominently state the date at which it is prepared. It is preferable that this information be clearly displayed on the front page or cover of the investment statement.

Payment of money by subscribers
88.

Details in the investment statement about the payment of money by subscribers for the securities must be very clear. The required disclosures cover the amounts payable, the person to whom and place where payments are to be made, and the frequency of payments. The application form should also be explicit about this.

Ordering of information in the investment statement
89.

Finance companies need to check whether information is required to be repeated or referred to in more than one part of the investment statement and take into account the context in which the information is to be provided. Enough information is required to be provided under each section of the investment statement to adequately answer the head questions and the specific disclosures under each clause of Schedule 3D. Some cross referencing to other documents may be useful and could be used to draw investors' attention to provisions of the trust deed, disclosures in the financial statements contained in the prospectus, or particular sections of the investment statement or prospectus.

Information on request
90.

The investment statement is required to include a statement to the effect that other information about the securities or the issuer, or both, is contained or referred to in a prospectus and the financial statements of the issuer. The investment statement must describe where a copy of these documents can be obtained free of charge.
91.

As well as the above, the investment statement must also include a statement to the effect that the prospectus and financial statements and other documents relating to the issuer are filed on a public register and available at the Companies Office for public inspection. The reference to "other documents" includes the trust deed. Finance companies must ensure that this information is clearly explained in the investment statement.

SECTION 5 - ADVERTISING
92.

The Commission has decided to comment only briefly on advertising in this report and to highlight the areas where issues often arise and improvements are required.
93.

Finance companies must ensure that all advertisements for securities comply with all applicable requirements of the Act and Regulations. An advertisement must not contain any matter that is likely to deceive, mislead or confuse with regard to any particular that is material to the offer of securities. The advertisement must be consistent with the registered prospectus referred to in it. It is the responsibility of the directors to ensure that these requirements are met. Directors must complete a certificate attesting to these matters for every advertisement published for an issuer.
94.

Areas where finance companies need to pay closer attention to the advertising requirements of the Act and Regulations are:

(a)

Ensuring regulation 17 directors' certificates are properly completed;

(b)

The definitions of "advertisement" and "distribute" in the Act and the scope of these definitions;

(c)

Prominence of the required information in advertisements;

(d)

Ensuring that it is made clear to publishers/broadcasters of advertisements what is required to be printed/displayed;

(e)

That reference to the availability of the investment statement is required in order for an advertisement to be an "authorised advertisement";

(f)

Statements about how the securities are secured;

(g)

Statements about safety;

(h)

Statements about the interest rate;

(i)

Statements about assets.
95.

Finance companies should consider whether they need to develop compliance plans or checklists in relation to the advertising of securities to ensure that all requirements of the legislation are met before advertisements are distributed for publication.

APPENDIX - LAW REFORM ISSUES
96.

Respondents to the Discussion Paper raised a number of matters that the Commission considers would be more properly addressed as matters of law reform. The Commission does not at this time make any recommendations on these matters. However, the Commission considers that it is useful to note the main law reform issues in this report so that these views are more widely known. The Commission will put these matters forward for consideration by the Government in its forthcoming review of the Securities Act.

The role of the investment statement
97.

Several respondents were of the view that the current form of investment statement may not be ideal as a disclosure document. Some respondents proposed various alternative documents which they considered would be better understood by investors.
98.

The view was expressed that Schedule 3D is a "one size fits all" approach to disclosure and that this may not be appropriate. It was suggested that a new schedule to the Regulations be created for debt security disclosure. Others suggested that as well as disclosure specific to the finance company, the investment statement could benefit from a standardised section for easier comparison between issuers. One suggested a section in the investment statement about tax treatment of the investment.
99.

It was also suggested that the investment statement should include a section where it is compulsory for the investor and their adviser to sign an acknowledgement that they have read the investment statement. A signed copy should then be provided to the finance company.
100.

The main shortcoming with the investment statement was identified by respondents as the lack of detailed financial information. Several respondents considered that the most recent financial statements should be attached to the investment statement and thought that this would address several of the concerns expressed by the Commission in its Discussion Paper. Some noted that they include their audited five year summary financial statements in the investment statement to indicate the financial history of the company. Some considered that the investment statement and prospectus should be combined.
101.

One respondent noted that debt issuers tend to see a limited role for investment statements and concentrate on selling their products through financial advisers, assisted with extensive advertising about the interest rate. While some saw investment statements as useful marketing tools, others considered there to be a limited use of investment statements as additional marketing material and considered that they had become little more than just a compliance document.

Advertising
102.

Some respondents expressed concern that regulation 12 of the Regulations restricts the financial information that can be provided to investors as it has the effect of limiting disclosure in advertisements about assets and liabilities to that shown in the most recent audited consolidated statement of financial position of the group. It was suggested that the Regulations relating to advertising should be modified so that disclosure of more up-to-date financial information on an unaudited basis could be included, so long as the financial statements from which it is drawn are filed at the Companies Office.
103.

The Commission notes that proposed amendments to regulation 12 may alleviate this issue. The proposed amendments will mean that it is permissible for advertisements to state the amount of net assets, or total assets and total liabilities, if the amounts shown appear in -

(a)

the most recent audited statement of financial position; or

(b)

an interim statement of financial position contained in the registered prospectus or accompanying a certificate registered in relation to the prospectus under section 37A(1A) of the Act.

The advertisement will have to state the date of the statement of financial position and whether the amounts have been taken from audited or unaudited statements.

The roles of the Companies Office and the Commission
104.

It was noted by one respondent that more clarity may be required around the enforcement roles of the Commission and the Companies Office in terms of reviewing and accepting offer documents, and consistency of interpretation between the two regulators.
105.

Some respondents also noted that, while a prospectus is reviewed by the Companies Office prior to registration, an investment statement is not, and, as a result, investment statements were often prepared "in house".

Intermediaries
106.

It was noted that the role played by the investment advisory industry and the quality of advice given to investors by advisers is a matter that requires serious consideration. Some thought that investors' understanding of the risk/return relationship was likely to be enhanced by the use of financial advisers. Others expressed concerns with the disclosures made by financial advisers and the information that they provided.

Industry action
107.

It was proposed by some respondents that the finance company sector should be responsible for improving the quality of its disclosure rather than more regulations and that the industry should set some standards to quantify the risks inherent in the industry.
108.

The view was expressed that strong growth in the sector in a relatively short time had led to a need for the sector to evolve professionally and be properly structured and governed.

Trustee Companies
109.

It was noted that there are a significant range of covenants used by trustee companies and that some trust deeds have not been updated for a number of years. It was considered that more work needed to be done by trustee companies to identify more closely the key covenants applying to particular industry groups and to amend trust deeds accordingly.
110.

Some submitters questioned whether the trustee oversight protections are delivering benefits for the costs involved with the oversight, and whether investors understand what those benefits are. Some thought that more prominence should be given in the investment statement to the role of the trustee.

Prudential supervision of finance companies
111.

While disclosure and financial reporting provide protections for investors, some respondents considered that more protection might be necessary. Some questioned whether there was a need for prudential supervision of finance companies.

Regulation of rating agencies
112.

Several respondents expressed concern that ratings agencies are unregulated and that there is no standardised rating system for finance companies. Several noted that for a rating to be meaningful the ratings agency had to be reputable and competent. It was also considered that there would be less confusion about the meaning of ratings if there was regulated disclosure of credit ratings.
113.

Respondents were also concerned that investors should be able to differentiate between a rating that results from an independent, in-depth assessment of the company and a rating that involves no detailed internal review of an entity and is based only on publicly available information.
114.

The expense associated with obtaining a rating was also of concern and several respondents noted that this cost meant most finance companies could not afford to be rated by internationally accepted credit rating agencies.
115.

It was noted that investors may place too much reliance on a rating alone and may not seek to confirm its quality and meaning. It was also noted that there are currently some issues with disclosure of rating information because some ratings agencies consider some of the rating information to be their own proprietary information.