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Report on the effectiveness of New Zealand's Securities Commission [2009] NZSecCom 6 (1 September 2009)

Last Updated: 15 November 2014

Report on the Effectiveness of

New Zealand’s Securities Commission

Michel Prada

Neil Walter

September 2009

Contents

1 Introduction and acknowledgements

In June 2009 the Securities Commission established an independent panel to assess its overall effectiveness in achieving its regulatory objectives. Such a review had been recommended in a baseline funding review carried out by KPMG for the Ministry of Economic Development earlier in the year. Michel Prada, formerly Chair of France’s Securities Commission and of IOSCO’s Executive and Technical Committees and Neil Walter, a former Secretary of Foreign Affairs and Trade and former Chair of New Zealand’s Environmental Risk Management Agency, were appointed to the panel. KPMG was contracted to provide administrative and secretarial support for the panel, including assistance with research and the preparation of the report.

The panel’s terms of reference are attached at Annex A. In summary, they required the panel to evaluate the effectiveness of the Commission’s securities regulatory work, its governance structure and practices and its relationships with key stakeholders.

The review was conducted over the period 15 June to 31 August 2009. During that time the panel held meetings with a wide range of external stakeholders, Commission members and senior staff members (some 65 individuals in total). It reviewed a large number of documents and papers and attended two meetings of the Commission and its Divisions as observer. It also conducted desk studies on market regulation in selected overseas jurisdictions. Lists of people interviewed and key documents are attached at Annexes B and C. A summary of the approaches taken to market regulation in other countries is contained in Annex H.

It is worth noting that this review has taken place at a time of considerable change and uncertainty for the Securities Commission and New Zealand’s securities market more generally. The global economic crisis has had a major impact on capital markets around the world. The situation facing New Zealand’s capital market is currently under review by a Capital Market Development Taskforce. Recent and planned changes in the legislation and architecture of market regulation in New Zealand are also driving significant changes in the regulatory landscape.

We wish to record our thanks to all interviewees for giving so freely of their time and views. Without exception, we were accorded full cooperation by all with whom we met. We take this as strong testimony to the shared interest of market participants and regulators alike in promoting confidence in the integrity and efficiency of New Zealand’s capital market and in protecting the interests of investors.

We owe a special debt of gratitude to Mark Hodson and his colleagues at KPMG for their unstinting help throughout the review. We are also appreciative of the work done by staff of the Securities Commission to facilitate our task.

Michel Prada Neil Walter

Paris, FRANCE Wellington, NEW ZEALAND.

2 Executive summary

2.1 Effectiveness of the Securities Commission

Our brief was to evaluate the overall effectiveness of the Securities Commission. Our finding is that, within the limitations of its powers and resources, the Securities Commission discharges its responsibilities efficiently and to a high professional standard. The current Chair provides strong leadership. She is supported by a high-calibre Commission and a small but well- performed team of professional staff. A comparison with counterpart agencies in other jurisdictions confirms that New Zealand's Securities Commission delivers good value for money.

This is not to say that the Commission is seen by all stakeholders as fully effective. We heard a number of complaints and suggestions for improvement in the way New Zealand’s markets are currently regulated. This is partly explained by the inevitable tension between market regulators and market participants. Moreover the full range and complexity of the Commission's work is visible to only a very small number of market participants and few, if any, members of the public. Nevertheless there are some important lessons to be taken from our meetings with stakeholders. At the risk of oversimplification, investors want better protection while issuers and other market participants want less red tape and greater clarity and certainty about how the market should operate.

Having analysed the concerns raised with us, we conclude that the main constraints on the Commission’s effectiveness lie outside its direct control. They stem from weaknesses in the current legislation; the Commission’s narrow mandate and lack of powers; the proliferation of regulatory bodies; inadequate resourcing; and bottlenecks in the judicial process. Equally, there are some changes that could be made by the Commission to improve its effectiveness, primarily through exploring ways of using its existing powers more proactively but also in its communication with the market, the media and the public. A comprehensive overhaul of New Zealand’s system of market regulation is however required if the Commission is to play the role expected of it.

We do not advocate a move away from the current “twin peaks” approach to market regulation whereby prudential and conduct matters are dealt with separately, neither do we recommend either a shift away from a disclosure-based regime or a more heavy-handed approach to regulation. It remains the case that the majority of market participants willingly comply with the accepted norms of behaviour. Thus, much of the regulatory system’s focus should continue to be on education, advice and persuasion. At the same time, it is important to provide for effective deterrence: abuse and fraud must be punished and be seen to be punished.

The Commission’s responsibilities have increased markedly in recent years. Additional duties are now being placed on it in such areas as financial adviser regulation and the prevention of money laundering. It will struggle to maintain its current level of performance, let alone cope with these new responsibilities, unless action is taken on a number of fronts. If the package of recommendations set out in this report is accepted - and we emphasise that a piecemeal approach is in our view unlikely to be fully effective (for example, there is little point in increasing the Commission’s powers if it lacks the resources to apply them) - then the next 18 months will see wide-ranging changes in the way New Zealand’s securities market is regulated.

Our principal findings relating to the Commission’s overall effectiveness follow.

2.2 New Zealand’s regulatory system

Much of the current securities market legislation is uneven in its coverage, heavily prescriptive and in many areas badly out of date. It should be replaced by higher-level, principles-based legislation which sets out clearly and more succinctly the key principles, objectives and coverage of New Zealand’s securities market regulation.

The Securities Commission currently lacks the teeth to give full effect to the legislation and regulations. It must be given more extensive powers, including the power to issue rulings, stronger investigative and enforcement powers throughout the life cycle of a security, the ability to monitor the conduct of financial intermediaries such as trustees, asset managers and auditors, a closer supervisory role over directors’ activities and responsibility for monitoring the overall effectiveness of the system for regulating market conduct.

There are too many agencies involved in the supervision of securities market conduct, including investigation and enforcement. The same problem exists in the area of public education in financial literacy. Roles and responsibilities need to be consolidated and rationalised. Where this is not possible, boundaries should be clarified and coordination improved.

2.3 Governance arrangements

The Securities Commission processes a high volume of complex work efficiently and well. Its governance arrangements and management structure meet current good practice standards for Crown entities and seem generally well suited to its purposes. We recommend however that the time has come to make the position of Chair non-executive and to appoint a Chief Executive Officer responsible for the day-to-day management of the agency. We also offer some suggestions concerning the role of the Commission.

2.4 Capability issues

The March 2009 baseline funding review initiated by the Ministry of Economic Development covered the Commission’s resourcing requirements in detail. The KPMG report found that the agency was generally performing its tasks to a high professional standard. We agree with this but see some scope for a more risk-based approach in some areas.

If our recommendations on legislative reform and the future role of the Commission are accepted, consideration will need to be given to the level of funding required for the Commission in the coming years. In our view, it needs to be better resourced to play its full part in market regulation, including the establishment of an office in Auckland, investment in IT systems and the funding of its projected operating deficit. Some additional funding should become available from elsewhere in the system as existing regulatory arrangements are consolidated and streamlined. Moreover a review is underway of the fees levied for the Commission’s work in such areas as exemptions and authorisations. It seems inevitable

however that the government will also need to raise its present level of funding: there is only minimal scope for a shifting of focus within the Commission.

2.5 Stakeholder relationships and communication

The Commission should give high priority to the resourcing and implementation of its new communication strategy in order to get its messages across more clearly to both the market and the public. We offer some suggestions as to how the Commission might improve its engagement with business and the media. The establishment of an office in Auckland and making more extensive use of Commission members in support of the Chair’s public outreach activities will help.

2.6 International comparisons

Although no precise comparisons are possible, we have drawn on our desk studies of selected overseas jurisdictions both for general benchmarking purposes and to suggest some alternative approaches to current New Zealand practice. Perhaps the most important findings in this section are that: New Zealand’s regulatory system is now generally in line with international best practice and IOSCO standards: all jurisdictions face ongoing problems in dealing with fraud and abuse in their financial markets: the global recession is compounding the difficulties facing market regulators around the world; and, even allowing for the small size of New Zealand’s market, resourcing levels here are very light by comparison with overseas countries.

3 List of recommendations and suggestions

Recommendations:

1. That the review of New Zealand’s securities law be aimed at moving legislation to a higher level, principles-based model which sets out clearly and succinctly the key objectives, principles and coverage of market regulation.

2. That in framing this new legislation, careful attention be paid to New Zealand’s close economic ties with Australia and the importance of maintaining and strengthening regulatory alignment within the trans-Tasman relationship.

3. That the review of New Zealand’s securities law give the Securities Commission more extensive powers, including: the power to issue rulings (binding in law but subject to appeal to the Courts); stronger investigative and enforcement powers throughout the life cycle of a security; the ability to supervise trustees, asset managers and auditors; and a closer monitoring role over directors’ activities.

4. That, as its powers expand, the Commission establish mechanisms to ensure appropriate separation between its supervisory and investigation/enforcement roles.

5. That the Commission be given statutory responsibility for monitoring, and advising government on, the overall effectiveness of the regulatory system as it pertains to market conduct and the state of New Zealand’s capital market. This “future watch” role will require the establishment of a small market intelligence unit working to the Commission.

6. That the roles of the various conduct regulatory bodies be reviewed with a view to consolidating functions. This covers supervision, investigation and enforcement. Where consolidation and streamlining is not possible, roles and responsibilities should be clarified and coordination strengthened.

7. That consideration be given to ways of speeding up the judicial process as it applies to criminal actions in the securities market, including the possibility of establishing a separate Court to deal specifically with these matters.

8. That the governance and management functions of the Commission be separated by the re-designation of the Chair position as non-executive and the appointment of a Chief Executive Officer with day-to-day responsibility for management of the agency.

9. That an inter-agency task force (involving inter alia the Ministry of Economic Development, the Treasury and the Securities Commission) be established with some urgency to assess and report on the Commission’s funding and staffing requirements for the coming two or three years.

10. That priority be given to the establishment of an Auckland office of the Securities Commission with a broader representational role as well as functional responsibility for the implementation of the Financial Advisers Act.

Suggestions:

1. That the Commission consider how it can play a more proactive role in keeping the media, the markets and the public informed about investigations and other actions taken against market abuse, taking into account the need to balance desired regulatory and market outcomes against the principles of natural justice and due process.

2. That the Commission take a more proactive approach in deeming whether particular offers are within its remit and be prepared to test the boundaries of legislation in cases of doubt.

3. That the Securities Commission and NZX continue their efforts to develop a more constructive and positive working relationship under the co-regulatory regime.

4. That the Commission work towards securing real time access to full trading data.

5. That consideration be given to filling the currently vacant position on the Commission and when selecting new members particular emphasis be placed on recent or current commercial and technical securities market experience in such areas as capital raising and the issuing of securities.

6. That, if the recommendation to give the Commission a formal monitoring and “future watch” role over the securities market is accepted, consideration be given to the establishment of a small market intelligence unit to support the Commission and to cross membership between the Commission and the Reserve Bank Board.

7. That the Commission consider appointing a suitably-qualified independent person to its Audit and Risk Review Committee.

8. That consideration be given to changing the Commission’s designation to emphasise the importance of its role in protecting investors and to mark the changes envisaged in its role and mandate.

9. That a dedicated working group be established to work with the relevant Division on planning and preparations for the structural and other changes facing the Commission in the next 18 months to 2 years. This could include consideration of how the current financial management system might best be adapted to the Commission’s new role and responsibilities.

10. That the Commission be given the power of pre-vetting offer documents in order to assess whether risks are appropriately disclosed. We note that this power would need to be exercised carefully and that any findings would need to be communicated in such a way as to avoid moral hazard. The staff concerned would need to have commercial experience and knowledge to discharge this function, either through bringing in staff

with recent securities market experience and/or arranging training attachments for existing staff in key sectors of the securities market.

11. That the Commission’s operating procedures and instructions be brought together in a consolidated manual.

12. That the Commission’s communication section be equipped to take responsibility, under the relevant Division, for implementing the Commission’s communication strategy and monitoring progress in the strengthening of the Commission’s relationships with businesses, investors, the media and other important stakeholders.

13. That priority be given to putting the Commission’s relationships with the news media on a better footing and to making more use of press briefings, if necessary on an off- the-record basis, on matters before the Commission which are of concern to investors when this would serve the public interest.

14. That, where an activity is judged to be inappropriate but is beyond the Commission’s powers to act, press releases go beyond a matter of fact interpretation of the law to state an opinion. It is also important that press releases should be worded in such a way as to have the desired impact on target audiences.

15. That all staff be reminded of the importance of maintaining a strong client focus and observing a high standard of communication with the business world and other stakeholders, with senior managers to be responsible for enforcing this requirement. This would include responding as helpfully as possible to requests for guidance on the interpretation of securities law, timely acknowledgement of complaints or requests, keeping an eye on the tone of correspondence and keeping people regularly informed of progress.

16. That a programme of public speaking and attendance at relevant meetings by Commission members and senior staff members be developed to support the outreach work being done by the Chair. This would both help make the Commission and its work better known to investors, businesses and the media and give Commission members and senior staff opportunities to listen to the market.

17. That the section in earlier Securities Commission annual reports describing the securities market, including recent trends and developments, be reinstated.

18. That formal responsibility for coordinating financial literacy education by publicly funded bodies be vested in one agency, with the Securities Commission continuing to have a major input in order to ensure that full use is made of its actions and activities to support public education goals. A close relationship should be encouraged with other privately funded groups involved in financial literacy education.

19. That the Commission be given a greater measure of independence in making the case for legislative or regulatory improvements and, once changes are in prospect, be responsible for formulating and making public a defined law reform process that includes appropriate consultation with market participants.

4 Background

The Securities Commission is established under the Securities Act 1978 and now has the following functions and powers under the Securities Act 1978, the Securities Regulations 1983, the Securities Markets Act 1988 and the Financial Advisers Act 2008:

• Market surveillance (including financial reporting)

^{• Enforcement (including investigation and prosecution)}

^{• Oversight of the New Zealand stock exchange (NZX)}

• Supervision (including powers arising under Financial Advisers Act 2008, not yet implemented)

• Exemptions and authorisation

^{• Law reform}

^{• International cooperation and recognition}

^{• Public understanding}

These functions and powers have evolved over the time since the Commission’s establishment in 1978. It started as a small, independent agency monitoring compliance with securities legislation and commenting on securities markets practices. Since then, through a number of regulatory and legislative changes, the Commission has become a broad financial markets regulator with extensive powers of investigation and prosecution. As new functions have progressively been loaded on to the Commission, additional staff members have been recruited and infrastructure developed or adapted to support the new activity. However, the organisation and its powers had never been comprehensively reviewed until this year.

The Commission currently expresses its intended outcomes in the exercise of these powers as:

• High standards of conduct are expected in the markets and the law is complied with

^{• The regulatory environment is relevant and effective}

^{• Securities law regimes are tailored to the needs of the market}

^{• New Zealand’s markets and regulatory environment are respected internationally}

^{• People understand the law and practice relating to securities}

In late 2003 an independent review of New Zealand’s securities regulation was carried out, against IOSCO standards, as part of a broader review of New Zealand’s financial system by the International Monetary Fund. This review identified a number of deficiencies in the Commission’s powers, in particular those relating to securities exchanges, the regulation of market intermediaries and the enforcement of securities law. These deficiencies have now largely been addressed by a range of amendments to securities legislation and regulations.

The following table summarises the responsibilities of other regulatory agencies.

_{Table 1 – summary of regulatory or investor protection bodies}

Source: review team research

Enforcement and prosecution responsibilities are spread around the Securities Commission, the Serious Fraud Office, the Commerce Commission, the Ministry of Justice (and the judicial system more generally), the New Zealand Police, Crown Law and the Registrar of Companies.

Responsibility for raising New Zealanders’ level of financial literacy (i.e. investor education) is shared among the Securities Commission, the Retirement Commission, the Ministry of Education and the New Zealand Qualifications Authority. A number of non-governmental bodies such as Young Enterprise Trust, Grey Power and the Shareholders Association do valuable work in this field.

5 Effectiveness of securities regulation in New Zealand

5.1 Legislation

A comprehensive overhaul of securities law is currently underway within government. This is timely, as inadequacies in the present legislation are putting a significant brake on regulatory effectiveness. Legislation relevant to the Securities Commission’s role includes the Securities Act 1978, Securities Regulations 1983, the Securities Markets Act 1988, the Companies Act

1993, the Financial Reporting Act 1993 and the Financial Advisers Act 2008. An anti-money laundering Bill is currently before Parliament. These Acts cover the powers of the Commission as well as the roles and powers of other agencies where the Securities Commission acts as referral agency. A more detailed description of this legislation is contained in Annex D.

Most jurisdictions accept the need for prudential supervision of financial intermediaries of all kinds as well as market supervision addressing the conduct of, and relationships among, market participants. In some cases the two kinds of supervision are housed in one body, in others they are conducted by separate agencies. New Zealand has traditionally favoured the “twin peaks” system whereby prudential supervision is the responsibility of the Reserve Bank and market supervision is the remit of the Securities Commission.

Securities regulation in New Zealand is based on the disclosure of information relevant to an investment decision, either through an offer of securities to the public or through secondary markets. An offer of securities has to meet “black letter” (i.e. highly prescriptive) requirements concerning the prospectus or investment statement. Secondary markets are governed by detailed rules requiring continuous disclosure and prohibiting insider trading and market manipulation.

The review of legislation should consider a move to a high-level, principles-based framework which would give the regulator the power to issue rules in quick response to developments in the market. This was the virtually unanimous view of all stakeholders with whom we met. This would also mean that the legislation would not date so quickly: a frequent criticism of the present legislation was that it is way behind the times. The “reasonable person” test should replace prescription in areas such as the definition of a security or offer, material information and timely disclosure. The regulator should be given the power to vet offers and issues on this basis, subject to appeal to the courts. Issuers should be required to make information relevant to an investment decision (under the “reasonable person” principle) on a continuous basis, in the manner that listed issuers already have to do. This would involve far less – but far better - information than is contained in today’s prospectuses and investment statements. An approach along these lines has recently been enacted, although it is not yet in force, in at least one Canadian jurisdiction.

In today’s world the present requirements for prospectuses and investment statements are both cumbersome and anachronistic. We live in the age of real-time information and yet insist on an expensive process that produces vast quantities of information much of which is out of date and of limited relevance to the current market - let alone to an investor’s informed decision about the offer. In May 2009 Morningstar published a report on mutual fund investor experience in

16 jurisdictions. New Zealand was ranked last with an overall rating of “D-”. It scored particularly badly for the transparency of prospectuses and shareholder reports. A number of

people we interviewed gave high priority to dismantling this “gravy train for law firms” which, in their words, produced documents that are “not worth the paper they are written on” and tell an investor “everything yet nothing”. In the words of one person we met, prospectuses need to be “shorter, crisper and clearer”. There may be other areas where compliance costs and processes can be similarly reduced: we received a number of complaints of “creeping regulation”. The Capital Market Development Taskforce has also made a number of suggestions in this area.

Further, some high risk investment schemes have managed to bypass securities regulation through being cleverly designed not to meet the black letter definition of a security. (We recommend below that the Securities Commission be empowered to decide whether or not a new product or offer is a security). The types of information that would be required to be clear and prominent include: all significant aspects of the underlying investment; any significant risks to the issuer and investor; track record information about directors, officers and promoters (including any previous company failures and/or fraud convictions); current and planned business with related parties, and most recent audited financial statements (which would need to be reasonably recent). Again, the “reasonable person” approach to interpretation is preferable to black letter prescription.

As a footnote, many people underlined the importance of staying aligned with Australia’s approach to market regulation when revising legislation and regulations. The trans-Tasman links between New Zealand’s and Australia’s banking systems and capital markets are significant. While it is necessary to develop approaches which are appropriate to New Zealand’s situation and needs, it is also important to maintain alignment within the trans- Tasman regulatory framework wherever possible.

Recommendations:

• That the review of New Zealand’s securities law be aimed at moving legislation to a higher level, principles-based model which sets out clearly and succinctly the key objectives, principles and coverage of market regulation.

• That in framing this new legislation, careful attention be paid to New Zealand’s close economic ties with Australia and the importance of maintaining and strengthening regulatory alignment within the trans-Tasman relationship.

5.2 Commission’s powers

5.2.1 The Commission’s powers throughout the lifecycle of a security

The Commission’s powers in relation to primary markets are concentrated in the period during which an offer is open. While the offer is open the Commission has the power to require offer documents to be amended or withdrawn and to ban advertising if disclosures are not adequate in terms of legal requirements or financial reporting standards. In practice, these powers are usually exercised following a complaint, as the Commission does not routinely review new offers. Down the track (and well after the allotment of securities) the issuer may suffer financial loss leading to losses to investors. In such cases the Commission has the power to investigate

the adequacy of disclosures made during the offer period and, if appropriate, prosecute issuers and directors. These powers apply to all types of securities.

The Commission’s powers post-allotment are stronger in relation to listed securities than to other types. Issuers of listed equities are subject to the Commission’s surveillance functions and its powers of investigation, enforcement and prosecution in relation to continuous disclosure, market manipulation and insider trading. It also has powers over redemptions or additional issues of equity securities to help ensure all shareholders are impacted fairly. By comparison, the Commission has relatively weak powers in relation to unlisted debt securities. Once the securities have been allotted the investors’ interests are the responsibility of the trustee, and the trustees’ powers can be relatively weak – essentially to monitor whether the issuer remains in compliance with its trust deed (and there are minimal regulatory requirements about what a trust deed should contain).

Some issuers of unlisted debt securities are continuous issuers (typically non bank deposit takers, including finance companies). Therefore the Commission has continuous powers in relation to legally required disclosures, including powers of investigation. During the period leading up to the collapse of numerous finance companies the Commission exercised these powers a number of times (refer Annex G). During this period non bank deposit takers were not however subject to prudential supervision. This is now a function of the Reserve Bank of New Zealand. A significant remaining gap in the investor protection framework is that the only legal recourse in relation to directors’ conduct is via a complaint from an individual shareholder, which is inadequate in the case of a privately controlled issuer of debt securities to the public. We recommend below that this loophole be closed.

5.2.2 Commission’s interpretation of its existing powers

In talking with stakeholders we heard a number of comments to the effect that the

Commission’s approach to the exercise of its present powers is too conservative and risk-averse

– for example, it does not normally release information about cases under investigation. The Commission takes seriously the requirements of natural justice and due process. Many stakeholders believe however that this emphasis is overdone to the detriment of the Commission’s credibility and effectiveness. There is a general interest in seeing the Commission interpret its powers less conservatively and start commenting more bluntly about specific cases or trends in the marketplace – “if the police can give details of cases under criminal investigation, why can’t the Securities Commission?” We have some sympathy for this concern and have recommended elsewhere in this report that the Commission consider taking a more aggressive approach to the exercise of its deeming powers including, as appropriate, testing the boundaries of securities law – while still retaining an appropriate commitment to natural justice and due process. We understand that the ISA in Israel – whose powers are not dissimilar to New Zealand’s Securities Commission’s - regards one of its most effective enforcement tools to be “reprimand firms and individuals through public statements”. A related issue has to do with the way in which signals are given and warnings issued: in some quarters the Commission’s press releases and other public pronouncements are seen as too bland and legalistic to have the desired impact among potential investors.

Many interviewees saw the recent expansion of the Commission’s powers in respect of civil and criminal prosecutions as a major improvement but were concerned at the seemingly long delays

involved in securing action against abuse and fraud. (Some of the delays of course are attributable to Court backlogs.) We were told that the publicity given to high-profile handcuffed suspects in the USA had considerable deterrent effect.

To some observers it appears odd that the Commission can devote significant effort to determining whether a specific product meets the legal definition of a security, only to conclude that a potentially risky investment is not legally a security. Most people would like the Commission to be able to apply the “if it barks it’s probably a dog” principle and determine what products should be covered by the provisions of securities legislation - even if this means testing legal boundaries on occasions.

Another complaint we heard from interviewees was that the Commission is reluctant to offer opinions or advice, in particular during the period leading up to an offer and in relation to possible breaches. Some issuers claimed that the message given to them and their advisers was along the lines of "do it, and if it’s wrong we will take action". On the other hand, a number of people we met with went out of their way to praise individual staff members for their readiness to provide informal advice and guidance on questions of interpretation of the regulations. Our conclusion after meeting with stakeholders and discussing this matter with staff members is that the reluctance to offer a definitive view stems mainly from a concern not to give false comfort. Investors are able to take action in Court that could lead to the voiding of allotments and judicial deference would not necessarily be given to an opinion from the Securities Commission.

Suggestions:

• That the Commission consider how it can play a more proactive role in keeping the media, the markets and the public informed about investigations and other actions taken against market abuse, taking into account the need to balance desired regulatory and market outcomes against the principles of natural justice and due process.

• That the Commission take a more proactive approach in deeming whether particular offers are within its remit and be prepared to test the boundaries of legislation in cases of doubt.

5.2.3 Improvements to the Commission’s current powers

A number of options exist with regard to the functions and powers of an independent securities commission. It seems to the panel that the present situation in New Zealand calls for significant improvement, bearing in mind developments internationally. The European experience is of interest in this area, as the EU has recently engaged in a process to harmonise its 27 systems.

First, as mentioned above the legislation should define clear objectives and principles along the lines of those developed by IOSCO. This would provide a basis to justify intervention by the Commission even when detailed rules do not explicitly cover a specific situation. Second, the definition of the persons (either legal or natural), operations and products subject to regulation and supervision must be comprehensive so that the system does not provide opportunities to escape supervision - which is detrimental from the point of view of both fair competition and the protection of investors. Third, there must be a clear definition of the powers and responsibilities of the Commission.

In the panel’s opinion, the Commission should be empowered to:

• Issue a “rulebook” defining the Commission’s approach to applying the legislation and regulations, including a process wherein market participants are able to give their views. This ruling capacity is beneficial from the point of view of flexibility and adaptation to the evolution of the market. From a constitutional point of view, this power may need to be accompanied by a right of appeal to the Courts.

• Issue, on an ongoing basis, individual decisions on such matters as offer documentation (prior to registration), registration of entities and licensing of individuals for specific activities. This power would need to be supported by an IT bulletin board system containing comprehensive information about issuers, intermediaries, offers and individuals.

• Conduct investigations and apply controls through reporting by market players, surveillance of market activities and participants, and on site visits.

• Impose administrative or disciplinary sanctions (subject, again, to the right of appeal to the

Courts).

The Commission needs more comprehensive powers in order to give effect to a policy based on up to date and shared information on entities, operations and products. Concerning issuers, the Commission should be in charge of the whole chain of financial information - periodic reporting, approval of offer documentation and continuous disclosure. For example, in relation to debt securities and collective investment schemes, the Commission should have powers of supervision over trustees and asset managers. This would include clarifying the expectations of trustees and the ability to place minimum requirements on the provisions of trust deeds. Auditors, who are not currently subject to regulatory supervision, should be supervised by a public interest body, possibly the Securities Commission. The Commission should also be given powers of supervision and enforcement over the activities and conduct of directors, including the power to ban directors who are deemed not to be fit and proper persons.

The Commission currently has some enforcement capacities, although it does not have a sanctioning power of its own. It can investigate, or ask other bodies to investigate on its behalf. It has the capacity to settle and to trigger penal or disciplinary procedures which are dealt with by other organisations. The way these functions are organised requires better clarity in order to establish a clear division of remits.

The Commission should have a capacity of ruling. This would reverse the present situation, where an important part of the Commission’s activity is to deliver exemptions. Ever increasing numbers of exemptions may in fact be detrimental to a widespread understanding of the regulatory regime. Many securities regulators today have this capacity of ruling, which provides a good opportunity to bridge the gap with market participants, and build confidence through technical debate and responsiveness to the market. The question of the areas in which rulings may be issued will however require careful thought: it will be important to avoid a situation whereby binding rulings are automatically sought before each and every transaction.

We believe consideration should be given to strengthening the enforcement role of the

Commission in two respects. First, the Commission should have full capacity to control or

investigate the relevant activities of the entities submitted to its monitoring, not just those related to the initial offering of securities. Second, the Commission should have the ability to impose fines and disciplinary sanctions (obviously subject to an appeal procedure open to the parties) in cases of both market abuse (misleading information, market manipulation, insider trading) and professional wrongdoings. If such a power is given to the Commission, it should be organised properly so that investigation, prosecution and judgement are appropriately separated in accordance with the principles of an impartial tribunal.

This would increase the Commission’s credibility and improve efficiency, as administrative decisions are more speedily taken than judicial ones. It is somewhat paradoxical that the Commission has a capacity to settle (which is an excellent thing) and no capacity to sanction. We believe the ideal situation is to have both capacities, as is the case in the US and in the UK.

Concerning intermediaries, the Commission should have full capacity to license entities according to a clear set of requirements (fitness and propriety of the managers, organisational requirements for operational resilience, capacity to deal with the issues raised by the business model, checking that directors are “fit and proper persons” to avoid the situation described to us whereby “known crooks” are still appointed as directors, conduct of business rules, etc). It should also have the capacity to authorise the commercialisation of financial instruments.

In terms of broader market supervision, more than one person told us that there are future vulnerabilities around some specific areas and that the Commission should be more on the front foot in these potential emerging issues. Two examples given were proportionate property ownership schemes and brokers’ custodian services. We note that, in a recent quarterly bulletin, the Commission expressed clearly its concerns about specific risks to investors in relation to the first of these two matters. In this connection, it seems to the panel that it would make sense for the Commission to be given a formal oversight and reporting role over the effectiveness of the overall regulatory system and the functioning of capital market more generally. This is particularly important given the current fragmented state of New Zealand’s regulatory architecture and the number of sophisticated products entering the market.

Recommendations:

• That the review of New Zealand’s securities law give the Securities Commission more extensive powers, including: the power to issue rulings (binding in law but subject to appeal to the Courts); stronger investigative and enforcement powers throughout the life cycle of a security; the ability to supervise trustees, asset managers and auditors; and a closer monitoring role over directors’ activities.

• That, as its powers expand, the Commission establish mechanisms to ensure appropriate separation between its supervisory and investigation/enforcement roles.

• That the Commission be given statutory responsibility for monitoring, and advising government on, the overall effectiveness of the regulatory system as it pertains to market conduct and the state of New Zealand’s capital market. This “future watch” role will require the establishment of a small market intelligence unit working to the Commission.

^{• That consideration be given to ways of speeding up the judicial process as it applies to}

criminal actions in the securities market, including the possibility of establishing a

separate Court to deal specifically with these matters.

5.3 Fragmented regulatory framework

There are many regulatory bodies involved in the regulation of New Zealand’s securities market. The situation has variously been described as “a mishmash” and “a whole panoply of regulators”. Certainly it appears to owe more to history than to logic or functionality. The major regulatory bodies are listed in Table 1 on page 12.

Interviewees criticised the current structure as excessively fragmented, inconsistent, containing overlaps, opening loopholes, causing confusion and imposing additional and unjustified costs. They saw this fragmentation as having an adverse effect on the work of the Commission. The main examples of overlap or confusion raised with us were:

• The Registrar of Companies should retain a legal role of formal registration but its supervisory function would be better located in the Securities Commission

• That in spite of the potential synergies between the Securities Commission and the Takeovers Panel, these two bodies are organised and run quite separately. (This question provoked split views, with some market participants arguing strongly for a continuation of the current arrangement on the grounds that the Takeovers Panel was a specialised body performing its role efficiently and well.)

• Listing authority is split between the Commission and NZX

• The supervision of financial disclosure is split between the Registrar of Companies, the

Commission and the NZX

• The role of auditors is not clear and their relationship with the Commission is seen as

"asymmetric" and ambiguous (this kind of difficulty is not specific to New Zealand)

• The supervision of the asset management industry is inadequate

• Not all intermediaries have to be registered

• The role of trustees and the use of trust deeds as a regulatory mechanism are weaknesses in the system (the Commission can neither rely on them nor control them)

• The division of remits between the Commission and NZX is not clear and gives rise to possible inconsistencies (the licensing of options and futures broker-dealers was mentioned). Also, the Financial Advisers Act gives the Commission supervisory responsibilities for a sector that has overlaps with brokers, who are subject to supervision by NZX.

From the panel’s discussions the architecture of the financial supervision system in New Zealand requires consolidation and clarification. New Zealand is of course not unique in this regard. The financial crisis that has been destabilising the world economy for two years has triggered, in many countries, lively discussions on the restructuring of the framework of financial regulation. The present circumstances in New Zealand provide a unique opportunity to address these issues.

The fragmentation of responsibility for public education is dealt with in section 8.6 below.

Recommendation:

• That the roles of the various conduct regulatory bodies be reviewed with a view to consolidating functions. This covers supervision, investigation and enforcement. Where consolidation and streamlining is not possible, roles and responsibilities should be clarified and coordination strengthened.

5.4 NZX relationship

Secondary markets are regulated under a co-regulatory model whereby NZX is responsible for regulating the conduct of its member broker firms (with oversight from the Commission), has co-regulatory responsibility with the Commission for continuous disclosure and is subject to the Commission’s oversight as an exchange operator. The Commission has regulatory responsibility for insider trading and market manipulation and relies on effective communication of potential issues from NZX, which holds the underlying trading data. A relationship such as this carries inherent tensions and we understand that in the past it has not been particularly harmonious. From our discussions however it appears that at working level the relationship is becoming more constructive and both parties are investing considerable effort in it.

NZX cooperates with the Commission’s wide ranging requests for information under its annual review programme, and we understand there is timely transfer of information from the NZX about trading data that may require follow up by the Commission’s surveillance team. Real time access to full trading data is not however available at present, and this is a weakness in the system that is being worked on at present.

A number of people see the current co-regulatory model as inherently flawed, pointing to the potential conflict of interests in having a profit-seeking company which participates in the market also carrying out a supervisory role. On the other hand, no recent cases were drawn to our attention where the NZX had failed in its regulatory duties, and a number of people commented that the NZX was both well in tune with the market and good to deal with. We do note however that in other markets competition between exchanges has compromised regulatory effectiveness and that this situation can develop rapidly. A discussion paper issued by NZX in late August in the context of the Capital Market Development Taskforce review raises a number of possibilities for changes in the division of responsibility between the co-regulators.

Suggestions:

• That the Securities Commission and NZX continue their efforts to develop a more constructive and positive working relationship under the co-regulatory regime.

• That the Commission work towards securing real time access to full trading data.

5.5 International involvement

We are told that just a few years ago New Zealand was seen as badly out of step with international market regulators because of a failure to observe generally accepted and IOSCO standards. Reports of the IMF and the Financial Action Task Force slated New Zealand for its poor performance. This was damaging to New Zealand’s general reputation as well as to investor confidence in its securities market. The Securities Commission – and in particular the current Chair – are to be congratulated for the improvement in New Zealand’s performance and standing that has been brought about in this area in the past few years.

Not only have the reforms to the regulatory regime since 2000 brought New Zealand into line with international practice, but the Chair and the Commission have played a strong leadership role in IOSCO (with the Chair having been re-elected Chair of the Executive Committee in

2008 for an unprecedented third term) and in the Financial Crisis Advisory Group set up by the International Accounting Standards Advisory Board and the United States Financial Accounting Standards Board. IOSCO represents some 95% of global securities markets and is the acknowledged international standard setter for market regulation. It is also the primary forum for facilitating cross-border cooperation to combat international fraud under the mechanism of its Multilateral Memorandum of Understanding. The Commission contributes to IOSCO’s work – and benefits from it – at both a regional and an international level.

The Commission has made extensive use of its position and contacts in IOSCO to promote New Zealand to a wide and influential international audience. It works closely with New Zealand Trade and Enterprise and the Ministry of Foreign Affairs and Trade to identify opportunities to raise awareness of New Zealand’s strengthening securities regulation among international investors. NZTE has seconded an officer to work with the Chair of the Commission in this area. This activity seems to the review team to be of particular importance at a time of turbulence in the global economy – and of the systemic failure of New Zealand’s non-banking financial institutions - when New Zealand needs to maintain its international visibility and reputation as a reliable business partner and worthwhile investment destination.

The Commission is also playing an important role in the development of closer economic relations with Australia. The two governments have an agreement to remove unnecessary regulation and costs for securities offered in both markets. A regime for the mutual recognition of securities offerings is now in force. This enables issuers of securities to use one prospectus on both sides of the Tasman Sea, subject to certain conditions. The Commission keeps in close touch with its Australian counterpart, the Australian Securities and Investments Commission (ASIC).

While many of the people we met regarded the Commission’s international work as important to New Zealand - and were very positive about the role being played by the current Chair - some were critical of the time being spent on overseas linkages at a time when the New Zealand capital market was coming under real pressure and the regulatory system was undergoing significant change. The view was put to us that the effort made by the Commission over the past few years to lift New Zealand’s game internationally and promote a better understanding of the regulatory framework had largely achieved its objectives and could now be phased down. The review team considers that the Commission has done an outstanding job in restoring and strengthening New Zealand’s image and reputation internationally and that the Chair’s leadership role in IOSCO has been beneficial to the New Zealand economy in a variety of ways. This view was clearly shared by Parliament’s Commerce Committee when it reviewed the Commission’s performance for the 2007/08 year. With the Chair’s third term as Chair of IOSCO’s Executive Committee due to end next year however there will inevitably be a phasing down of the Commission’s international work. Apart from noting the importance of the Commission’s maintaining an appropriate profile and continuing to pay attention to trans- Tasman, wider Asia/Pacific and international interests in the period following the end of the Chair’s IOSCO assignment, we do not consider it necessary to make any specific suggestions on this aspect of the Commission’s work.

6 Governance arrangements

6.1 Introduction

Our terms of reference required us to evaluate the Commission’s governance structures and practices.

The review team had access to a comprehensive report prepared by KPMG earlier this year on the Commission’s baseline funding requirements for the three years from July 2009 to June

2012. In addition we:

• reviewed a number of papers and documents

^{• solicited the views of a wide range of stakeholders}

^{• interviewed members of the Commission and senior Commission staff}

^{• attended two Commission meetings as observers}

6.2 Governance arrangements

A useful definition of governance is “the processes by which organisations are directed, controlled and held to account”. A generally accepted aim of public sector governance is to ensure that an organisation achieves its overall outcomes in such a way as to enhance public and stakeholder confidence in the organisation. The two key measures of good governance are the effectiveness with which the organisation delivers its services (performance) and the extent to which it meets the requirements of its legislation and the public’s expectations of probity and accountability (conformance).

6.2.1 Current situation

The Securities Commission consists of nine Commission members under an Executive Chair. This is one below the maximum number of Commission members provided for in the Securities Act.

The Commission has two main roles: to give effect to the provisions of the Securities Act and other relevant legislation and regulations; and to provide a governance framework for the agency.

Commission members are appointed by the Governor General on the recommendation of the Minister of Commerce. The nomination process is handled by the Ministry of Economic Development, which advertises widely when vacancies occur. Members hold office for an initial term of five years and may be reappointed. Their roles and responsibilities are defined by the Securities Act. They are selected for their knowledge of, or experience in, industry, commerce, economics, law, accountancy, public administration or securities. The current membership is drawn primarily from the legal and accounting professions but includes three members with current or recent market experience.

The Commission meets in full at approximately monthly intervals. It held 11 such meetings in the 2008/09 year. Most specific issues are dealt with by Divisions - smaller groups of members chosen for their particular experience and availability (and taking into account any potential conflict of interests). Divisions have delegated to them the full powers of the Commission. 75

Division meetings were held in 2008/09.

The Commission’s meetings are serviced by the 40-person agency. Senior agency managers are responsible for the preparation of papers and formulation of recommendations. They attend all Commission and Division meetings apart from “Commission only” sessions.

6.3 Observations

The review team was impressed by the calibre of Commission members and the way in which they approached their duties. Comments we heard from stakeholders confirm that they are respected for their integrity and independence. They are well qualified in terms of the experience and knowledge they bring to the table in their respective fields. They are obviously highly motivated and convey a strong sense of professionalism.

We found the Commission meetings to be well prepared and efficiently run. The Chair provides a high standard of leadership. The papers were of a high standard. Discussion was robust and open. Conflicts of interest were dealt with systematically and well. The atmosphere was positive and members showed respect for one another as well as a good sense of teamwork. Interaction with staff attending the meetings was excellent.

We were told that an annual planning session is held at which the Commission steps back from day-to-day work in order to conduct an environmental scan, assess its performance against its strategic plan and determine its objectives and priorities for the coming period. The prioritisation of effort is thereafter kept under constant review in terms of desired regulatory outcomes. Members are involved in the preparation of the Commission’s three-year Strategic Plan and Statement of Intent as well as Annual Reports. The Commission conducts an annual self-evaluation based inter alia on the Institute of Directors’ template. It also includes in its Annual Report an assessment of its performance in the year under review against key governance principles.

The Commission has a four-person Audit and Risk Review Committee chaired by a member who is a chartered accountant. It is charged with assisting the Commission to ensure the soundness and integrity of the financial statements and with overseeing the relationship with external auditors. It is also responsible for monitoring the Commission’s risk management and legislative compliance frameworks. In the 2008/09 year the Committee met five times.

At each meeting Commission members receive a compilation of papers and reports of both general and particular interest. Regular financial reports are tabled before the Commission, normally through the Audit and Risk Review Committee. The Commission’s views are periodically sought on the performance of the agency and its senior managers. The Commission is to be commended for having commissioned an independent review of its overall effectiveness earlier this year. The review team was particularly struck by the interest shown by members at the two meetings we observed in identifying “lessons learned” from the Commission’s recent decisions and actions.

From time to time individual members of the Commission participate in conferences or workshops relevant to their work. The Chair normally acts as spokesperson for the Commission, although press statements are issued in the name of the full Commission. The Commission’s formal stakeholder policy is set out on its website. The potential for Commission members to play a greater role in stakeholder relationship management is dealt with more fully below.

We were told that the Commission’s workload is carefully monitored and that it is currently manageable. Some members indicated that they would be prepared to spend more time on Commission business than is the case at present.

The Commission has its own Code of Ethics (available on its website) which sets out its values and specifies the procedures to be followed in dealing with such matters as conflicts of interest. It adheres to the relevant provisions of the Crown Entities Act and the State Services Commission’s Code of Conduct.

Commission members’ remuneration is set by the Remuneration Authority and disclosed in its

Annual Report.

Recommendations and Suggestions

As indicated above, the Commission seems to us to perform its governance functions efficiently and well. We do however have one major recommendation and some minor suggestions to make concerning current governance arrangements.

6.4 Chair of the Commission

A feature of the present governance structure is that the Commission is headed by an Executive Chair - who effectively doubles as the Chair of the Commission and Chief Executive Officer of the agency. While this arrangement may have been appropriate at the time the position was established in 2002 – when the agency had just 22 staff – it seems to the review team that there is now a strong case for separating the two roles.

The main factor is that staff numbers currently stand at 40 and are likely to rise by a further 30 or so full-time staff as a result of the passing into law of the Financial Advisers Act 2008. Our understanding is that just half-a-dozen of the 84 statutory Crown Entities use the executive chair governance model – and four of those are corporations sole. Thus the separation of the governance role of the Chair from the management role of the Chief Executive Officer would bring the Securities Commission into line with what is now the standard arrangement for all but the smallest of Crown Entities. It is also of course the model usually recommended for corporate New Zealand.

In advancing this suggestion, we acknowledge that the Securities Commission has many unique features and that practice varies widely among counterpart bodies in other jurisdictions. Nevertheless, a large volume of research suggests that the basic principles of corporate governance – including a split of governance and management functions - are likely to be of benefit to all organisations. Our conclusion is that the split model would best meet the needs of

today’s Commission - particularly as it positions itself to take on the additional responsibilities now envisaged for it.

The review team also sees advantages in separating the two roles in terms of the checks and balances that accompany a split between governance and management. The Chief Executive Officer would be responsible for the day-to-day functioning of the agency and for technical preparations for Commission meetings, while the Chair would manage the decision-making process. The next year or two will be a demanding time for the Commission, and it is likely that, even with a Chief Executive Officer in place, the Chair will remain a full-time position. It should in our view however be possible for the Commission to delegate a range of powers and decisions to the agency once its management structure has been strengthened by the appointment of a full-time Chief Executive Officer. (At the present time no delegations exist except in the management area).

If this recommendation is adopted, it will be important to select a Chief Executive Officer who not only has the right technical and managerial skills and experience but will approach his or her role in a spirit of positive partnership with the Chair and Commission. Care will need to be taken over the formulation of a job description and candidate profile. Thought will also need to be given to the likely “knock-on” effects to current second tier positions in the agency. As has often been said, one of the most important responsibilities of any Board is to select the right person as Chief Executive officer - and thereafter perform a careful “assess and assist” role. The Chair and the Chief Executive Officer must form a team dedicated to the efficiency and quality of the agency’s work. The Crown Entities Act and a Crown Entities Manual currently under preparation by the State Services Commission provide guidance on the procedures to be followed in selecting, appointing and working with a Chief Executive Officer. Responsibility for appointing the Chief Executive Officer would rest with the Commission.

As a footnote, the timing of the appointment of a Chief Executive Officer will need to be given careful consideration. It may be that this should be deferred until the future role and responsibilities of the Commission are determined.

Recommendation:

• That the governance and management functions of the Commission be separated by the re-designation of the Chair position as non-executive and the appointment of a Chief Executive Officer with day-to-day responsibility for management of the agency.

6.5 Skill sets

The Commission is, we believe, extremely fortunate in the calibre of its members at present. Their qualifications and experience are appropriate to the role the Commission is expected to play. In the eyes of a number of stakeholders however the Commission does not have quite the level of recent current commercial or securities market experience it needs. This is not a question of veering away from the range of qualifications currently represented at the table. But as vacancies occur on the Commission it might be worth looking for new members with current or recent commercial and technical securities market experience in such areas as capital raising and issuing, notwithstanding that this will inevitably raise conflict of interest questions from time to time. We note that the maximum number of Commission members under the Act is

eleven and there are ten currently appointed. An additional Commission member would enable this broadening of skills and experience as well as assist in the management of conflicts of interest.

Suggestion:

• That consideration be given to filling the currently vacant position on the Commission and when selecting new members particular emphasis be placed on recent or current commercial and technical securities market experience in such areas as capital raising and the issuing of securities.

6.6 “Future Watch” role

As indicated above, the Commission already spends a significant amount of time on planning its work and looking ahead to identify emerging issues and changing priorities. If our recommendations on broadening its mandate and powers are adopted, this role will become even more important and require further time and effort to be devoted to the gathering and analysis of market intelligence and the provision of high-level advice to the government. It seems to us important that the main regulator of the securities market should be in a position to spot emerging problems, maintain a watching brief on new products coming on to the market and furnish appropriate advice, warnings and recommendations to both the public and the government. This might require the inclusion of new skill sets (e.g. economics, mathematics) around the Commission table. It might also lead to cross-membership of the Commission (as the regulator of market conduct) and the Reserve Bank Board (as prudential regulator). The establishment of a small market intelligence unit would support this function. It would also help in the Commission’s performance of its supervisory work generally, including the inclusion in the Annual Report of a section on trends, developments and issues in New Zealand’s securities market.

Suggestion:

• That, if the recommendation to give the Commission a formal monitoring and “future watch” role over the securities market is accepted, consideration be given to the establishment of a small market intelligence unit to support the Commission and to cross membership between the Commission and the Reserve Bank board.

6.7 Audit and Risk Review Committee

As indicated above, the Commission’s Audit and Risk Review Committee is a well-set up body which plays an important role in the Commission’s governance arrangements. A review of papers covering some of the Committee’s recent meetings and external audit reports confirms that it takes its responsibilities seriously and performs them well. Its mandate seems entirely appropriate.

The Auditor-General’s good practice guide on audit committees in the public sector suggests four main principles that should guide the work of such bodies. They are that: members should be independent; they should have relevant expertise and experience; the committee should have

a clearly defined purpose; and the committee should encourage open and transparent communication with staff and stakeholders.

The Commission’s committee scores well on most of these counts. The one area where action could usefully be taken relates to the first principle - the independence of members. While some state sector agencies have established audit committees consisting of mainly independent members, a number have kept to a pattern of mixed or fully internal membership. There is not necessarily a right or wrong way to set up these committees – it is a matter for judgement as to what pattern of membership best suits the circumstances of each agency. In this case we believe that the present composition of the committee covers all the key bases. It could however be advantageous to appoint a suitably-qualified independent person to the committee in order to ensure the objectivity of advice from the committee and provide an extra degree of assurance to the Commission.

Suggestion:

• That the Commission consider appointing a suitably-qualified independent person to its Audit and Risk Review Committee.

6.8 Designation of the Securities Commission

While hesitant to add to the number of changes already in train in this sector, the review team was struck by the fact that the Commission’s current designation means very little to most members of the public and does not highlight the important role to be played in investor protection. Moreover, if the wide ranging changes to the architecture of market regulation recommended in this report are accepted, a new designation for the Commission may be seen as appropriate given the significantly expanded role and mandate envisaged for it. While conscious of the risk of being accused of slavishly following Australian practice, the best suggestion we can put forward is “Investments and Securities Commission”. There may be other, better options – for example, “Financial Markets Authority” is a designation now used in a number of overseas jurisdictions.

Suggestion:

• That consideration be given to changing the Commission’s designation to emphasise the importance of its role in protecting investors and to mark the changes envisaged in its role and mandate.

7 Capability issues

7.1 Introduction

The KPMG February 2009 baseline funding report on the Securities Commission gives a comprehensive account of the agency’s management structure and processes and we will not duplicate it here. Annex F of this report contains an organisation chart of the Commission as at July 2009.

The Commission has grown significantly since it was first established in 1978. Its mandate has been progressively broadened and its powers significantly strengthened, most noticeably in the past few years. From 22 staff members in 2002, its Wellington office has expanded to an establishment of 40 full-time employees. The new responsibilities given to it under the Financial Advisers Act 2008 are likely to add a further 30 positions to its establishment. A further expansion is likely when the Anti-Money Laundering and Countering Financing of Terrorism Bill is enacted into law and closer scrutiny required over trustee supervisory responsibilities and collective investment schemes.

The KPMG report assessed the Commission to be operating efficiently and well. It observed that resources were being managed effectively and could not point to any significant ways of redeploying resources to better effect. Staff remuneration policies were seen as appropriate and the staff turnover rate was satisfactory. The Securities Commission topped the small workplaces category in the Unlimited/JRA Best Places to Work in New Zealand Survey 2006 (as well as being a top 10 finalist in the previous two years) and continues to rate highly in this survey. The Commission may take satisfaction from these ratings.

Office accommodation was deemed to be of a good standard – with some potential for expansion if Wellington-based staff numbers grow. Corporate support functions rated well in terms of both efficiency and effectiveness.

Recent management reports from Audit New Zealand confirm that this is a well-run agency. Audit New Zealand describes it as having appropriate policies, systems and controls in place and as running them effectively. The 2007 report notes that the Commission’s objectives are clearly defined, with appropriate performance standards and measures in place. Financial information systems and controls are described as “good”. The agency is commended for the quality of its risk management and legislative compliance frameworks.

7.2 Observations

There are some significant capability issues requiring to be addressed. One of the major factors militating against better regulation of New Zealand’s markets is the chronic under-resourcing of the Commission. We regard it as important that the team being established to implement the Financial Advisers Act be based in Auckland – where some two thirds of the action takes place. A significant investment is required in the Commission’s IT systems. Staff training has had to be put on a back burner in recent years. And one of the factors contributing to the negative perceptions currently evident among stakeholders has been the inability of the agency - often for

straight work pressure reasons – to put more time and thought into its engagement with market participants and its communications.

7.2.1 Suggestions

We offer two major recommendations and four minor suggestions for addressing this set of management and resourcing issues.

7.3 Resourcing

It is clear from the review team’s surveys and research that under-resourcing is at the heart of many of the Commission’s current problems. Partial relief has been given for the current year but as matters stand the Commission will be running an operational deficit for the foreseeable future – and that without any additional pressures such as are envisaged to flow from the Anti- Money Laundering Bill and other regulatory changes currently under consideration.

International comparisons of resource levels are not easy because of variations in the size and nature of securities markets and the very different approaches taken to market regulation in different jurisdictions. Chapter 9 below summarises the results of our research into six other administrations. The one point that emerges very clearly is that, even allowing for the comparative smallness of New Zealand’s market, as a country New Zealand puts considerably less funding into market regulation than any other comparable country. The Morningstar report referred to above gave New Zealand a “D-” rating for investor protection. A key factor in this low score was that it was deemed (alone among the 16 jurisdictions reviewed) to be “not sufficiently staffed”.

The KPMG report referred to above concluded that the Commission had never been adequately funded for the services expected of it and that additional operational funding of the order of $4 million was needed for the 2009/10 financial year. In the event the latest budget round produced a modest increase in operational funding for the current year. The report also found that additional operational funding of some $10 million would be needed in the 2010/11 and

2011/12 years. The Commission’s reserves as at 1 July 2009 stood at $2.4 million. The KPMG review team identified a shortfall of the order of $1.5 million to $2.2 million in the Commission’s capital funding for the next two years - primarily for the upgrading of IT systems.

The report acknowledges that there is some looseness around some of these figures and that more precise estimates will need to await further decisions relating to the Commission’s new responsibilities. Moreover, any decisions arising from the recommendations in this report will need to be taken into account in framing firm estimates for the next couple of years. Regardless of the outcome of this report, however, the Commission faces a period of significant change and expansion in the next two or three years. It is manifestly not currently resourced to implement these changes. Yet it is important that it at least maintain its current levels of effectiveness as it beds in these changes - and many stakeholders are of course looking for a marked improvement in the way the New Zealand market is regulated.

It may be that the recommended consolidation and rationalisation of the current market regulation architecture will free up some funding from agencies other than the Commission. Consideration will also need to be given to the extent to which fees and levies should fund the Commission’s operations. At the same time, there appears to be no escaping the need for additional Crown funding if the overall effectiveness of New Zealand’s market regulation is to be brought up to standard.

Recommendation:

• That an inter-agency task force (involving inter alia the Ministry of Economic Development, the Treasury and the Securities Commission) be established with some urgency to assess and report on the Commission’s funding and staffing requirements for the coming two or three years.

7.4 Auckland office

The Financial Advisers Act (FAA) 2008 makes the Commission the financial advisory industry’s main regulator, bringing New Zealand into line with overseas standards. It requires financial advisers to attain specified levels of competence, professional standards and disclosure. An 18-month programme is now in train to put in place the systems and training needed for the Act to be fully operational by the end of 2010. An announcement was made in July concerning the membership of the Code Committee which is to draft the Code of Professional Conduct for financial advisers. A Commission member has been appointed Commissioner for Financial advisers to oversee the operation. A summary of the approach being taken to the implementation of the FAA requirements is contained in the KPMG baseline funding review referred to above.

Final funding levels and phasing for the FAA team have yet to be established, as do the staffing numbers. The sum of $800,000 was allocated specifically for this purpose in the 2009/10 year. A provisional baseline increase of $1.4 million was also apparently agreed for each of the succeeding two years. We were told that the intention is for the industry to pick up much of the funding responsibility thereafter.

The KPMG report examined the funding requirements for the FAA operation, including additional enforcement activity, in considerable detail. The only point we would make on top of the KPMG recommendations is that the FAA office should be located in Auckland – since that is where over two thirds of financial advisory work occurs. And given that the head of the FAA operation is required to be a member of the Securities Commission, it would seem to us to make sense to use the Auckland office for broader Commission purposes. It would facilitate the transaction of the Commission’s business in New Zealand’s commercial capital. On-the-spot Securities Commission representation, headed by a member of the commission, would be seen as a positive move by the issuer community in Auckland and should do much to improve the Commission’s engagement and relationships with stakeholders there.

7.5 Staffing issues

As indicated above, no pressing issues were drawn to our attention in such areas as morale, remuneration and general working conditions. The Commission clearly manages such matters efficiently and well. The specific issues of communication and stakeholder relationship management are dealt with in Chapter 8 below.

The Commission currently operates a centrally-controlled financial management system. This seems to work well insofar as it allows highly-qualified senior managers to focus on their specialist tasks and not spend time complying with the increasingly demanding requirements of the public sector financial reporting system. It also carries benefits in terms of the need for the Commission to be constantly reassessing its work priorities and redeploying staff to where the need is greatest.

The panel had the opportunity to talk to all heads of department and to watch their participation in meetings of the Commission. They are obviously competent and dedicated people and we rate the technical capability of its staff as a strength of the Commission.

There are some major questions around staffing numbers. These are explored in detail in the KPMG report and do not require elaboration here. Sufficient to say that a longstanding legacy of staffing shortages continues to handicap the Commission in its work and that a close eye needs to be kept on the implications for the Commission of the numerous decisions being taken, or about to be taken, about the way market regulation in New Zealand should be handled in the future.

We would add that the Commission faces an 18 month to 2 year period of major structural change and adaptation. If its effectiveness and the efficacy of the overall market regulatory system are not to suffer, the Commission will need to contract in additional resources to cope with this intensive period of change management. As new functions such as the implementation of the FAA are acquired, the Commission should consider how its current financial management system should be adapted to meet those requirements.

Suggestion:

• That a dedicated working group be established to work with the relevant Division on planning and preparations for the structural and other changes facing the Commission in the next 18 months to 2 years. This could include consideration of how the current financial management system might best be adapted to the Commission’s new role and responsibilities.

The final point we would make in relation to the agency’s staffing is that a common criticism from market participants was that the agency has a high level of technical capability in such areas as accountancy and law but lacks people with current or recent market experience. There are dimensions to the work of regulating securities markets that go beyond law and accounting. There is a need to assess the commercial substance and risks of an offer and determine whether these are communicated effectively in the offer documents. This stands to be all the more important if the Commission broadens its scope as we have suggested in section 5.2. It is obviously no easy matter to recruit suitably qualified and experienced people from the market for work in a regulatory agency. Remuneration levels and career discontinuity are two

problems that are frequently cited. Secondments can help, but they are notoriously difficult to arrange. Nevertheless, we assess that there is some validity in the criticism and consider that the Commission would greatly benefit from a “leavening” of this kind if it can recruit the right kind of people with market experience. This might be assisted by the current state of the labour market. Training of staff – for example by short-term observation attachments in selected sectors of the market – can also help here, although this will require better resourcing levels.

Suggestion:

• That the Commission be given the power of pre-vetting offer documents in order to assess whether risks are appropriately disclosed. We note that this power would need to be exercised carefully and that any findings would need to be communicated in such a way as to avoid moral hazard. The staff concerned would need to have commercial experience and knowledge to discharge this function, either through bringing in staff with recent securities market experience and/or arranging training attachments for existing staff in key sectors of the securities market

7.6 Operating procedures

At present guidelines on the Commission’s operating procedures and standards are spread around a number of circulars and papers. With its expansion - and against the likelihood of a branch office being set up in Auckland - it would be appropriate to bring all the guidelines and instructions together in a consolidated manual. This might or might not include a Charter for the Commission itself. There are several examples of such manuals around the Crown entity world.

Suggestion:

• That the Commission’s operating procedures and instructions be brought together in a consolidated manual.

8 Stakeholder relationships and communication

8.1 Introduction

Our terms of reference required us to evaluate the state of the Securities Commission’s relationships with its key stakeholders. This was done mainly through our meetings with a representative range of business leaders, commercial firms, securities market participants, regulatory agencies, investor groupings and media commentators. Most of the meetings were in person, a few were by video or teleconference.

8.2 General

The first point we would make is that we encountered an enormously wide range of views on the attitude and the performance of the Commission. At one end of the spectrum we heard trenchant criticism of the Commission, while at the other end stakeholders spoke highly of its achievements and performance. There were of course a number of people holding mixed views in the middle of the range, where credit was given for what the Commission has achieved despite its legislative and resource constraints but a number of suggestions were made as to how its performance - and the effectiveness of the overall regulatory regime - could and should be improved. At the risk of oversimplification, the harshest criticism tended to come from market participants (e.g. directors, issuers and financial advisers), media commentators and investor groups, while the more positive assessments came from law and accounting firms, other agencies involved in market regulation and small business representatives. We understand this to be very much in line with patterns found in other jurisdictions.

A second point is that we found it difficult to separate the most commonly-held criticisms of the Commission from perceptions that the regulatory system more generally had failed to do its job. Many of the issues raised with us seem to have more to do with the inadequacies of the current legislation, New Zealand’s highly dispersed and fragmented regulatory architecture and the Commission’s lack of powers than with any failings on the part of Commission or staff members. Not all the people we spoke with were aware of the extent to which responsibilities are currently dispersed around other parts of the regulatory system, neither is it generally appreciated just how constrained the Commission is by a tight resource situation and how much work comes to it under its various remits.

It has to be recognised too that the role of a regulator necessarily implies a degree of distance from the market and that regulators’ decisions will not always find favour with market participants. Regulatory decisions can impact heavily on business through compliance demands and enforcement actions alike. A survey conducted earlier this year of stakeholders of Australia’s regulatory counterpart, the Australian Securities and Investments Commission (ASIC) found that many of the concerns and complaints that our team encountered featured equally prominently in the feedback from Australian business firms. It also found that ASIC is not without its critics: for example, only 45% of the business representatives polled considered ASIC to be performing well overall; only 42% gave it a satisfactory rating in terms of its contribution to the efficiency of the economy; and only 41% thought it was doing a reasonable job in identifying and dealing with emerging issues.

8.3 The negative....

To begin with the criticisms of the Securities Commission, some of the people we met spoke negatively about what they saw as the Commission’s lack of understanding of, and engagement with, the market. It was variously described to us as “aloof”, “bureaucratic” and even “antagonistic”. The location of the Commission in Wellington rather than Auckland was seen by some as a fundamental problem. The peremptory tone of some of its communications was criticised, as was its perceived reluctance to tackle major cases of fraud and abuse. The effort currently put into IOSCO work was questioned by some. Most critics wanted to see the Commission move from an “ambulance at the bottom of the cliff” stance to a more proactive approach. The regulatory system overall was seen by many to be pushing up compliance costs for no real benefits to the way capital market functioned. There was a sense that Commission staff, while technically competent, were not “market savvy” enough or sufficiently focused on the needs of market participants. Investor groups wanted better protection against fraud while issuers wanted greater clarity and certainty. On the enforcement front, there was a universal desire to see action taken more quickly and decisively against those who transgress the rules. Tighter regulation of financial advisers and more public education were also on many people’s wish lists.

8.4 And the positive

On the positive side, a number of stakeholders felt that the Commission deserved high marks for its achievements in recent years. There was a high level of respect for the independence and integrity of Commission members and for the professional skills and calibre of Commission staff. Many were impressed with the quality of the Commission’s work and expressed the view that individual Commission members and staff were helpful and forthcoming when advice was sought. The Commission’s contribution in the international arena, and particularly the Chair’s work with IOSCO, were seen as notable achievements which carry real benefits for New Zealand. The Commission was seen to be playing a valuable leadership role among other regulatory and enforcement agencies and is clearly regarded by those agencies as cooperative and good to deal with. There was recognition of the Commission’s recent efforts to lift its game in the fields of public education and market engagement, including the Chair’s articles and public presentations. Many judged the Commission to have found the right point of balance in its weighing of the principles of natural justice and due process against the need to take action – and to be seen to be taking action – against alleged abuses of the market.

As indicated above, there was a strong body of opinion among many with whom we met that the Commission was seriously handicapped in its work by the inadequacies of the current securities market legislation and chronic under-funding. The fragmentation of responsibility for the supervision of market conduct and enforcement was seen as adding to the overheads of market supervision and generally causing confusion - “....too many referees for a comparatively small playing field” was one person’s observation. And, as indicated above, the Commission’s lack of “teeth” to make rulings, investigate right across the spectrum of a security’s life and impose sanctions was viewed as a major constraint on its ability to do its job.

8.5 Conclusions and suggestions

We have dealt elsewhere in this report with the constraints on the Commission’s effectiveness that lie outside the direct control of the Commission. This section focuses on actions that are within the Commission’s power to take and which would, we believe, improve both its relations with stakeholders and its operational effectiveness.

8.6 Public education

A number of steps have been taken in recent years to inform and warn the public of the risks involved in investing in certain types of offerings. We were for example impressed by the range of information pamphlets and booklets that have been issued as well as the speeches made by the Chair. The Commission has worked hard to get organisations such as the New Zealand Qualifications Authority to help in its public education work. It liaises closely with the Retirement Commission and other bodies working in this area. At the same time, we are conscious of the comments made by a number of stakeholders along the lines that press releases, speeches and even brochures have only limited impact nowadays and that well-publicised enforcement action is the most effective way of getting messages across. Strong views were expressed about the low levels of economic literacy and gullibility of the New Zealand public: “regulators have to provide fighter cover for those idiots who persist in buying rubbish” was one comment.

It is our view, after considering the stakeholder feedback and reviewing the role of the various parties in public education, that overall coordinating responsibility for publicly funded activities in this area should be vested in one agency. While the Securities Commission has done a lot to improve investors’ literacy (and will always be a major player in this area), it should not in our view be the coordinating agency for public education. We consider that the best contribution that the Securities Commission can make, given its limited resources, is to supervise the conduct of the market, issue clear investor warnings about scams and fraudulent behaviour and take prompt action against fraud and abuse. In addition it is well placed to synthesise periodically information on the New Zealand market and regulation, perhaps in its Annual Report.

8.7 Collapse of finance companies

The strongest criticism of the Commission we encountered related to its perceived failure to regulate finance companies before their collapse over the last couple of years. A number of critics put this down to a reluctance on the part of the Commission to go beyond an overly narrow and legalistic interpretation of its remit. Commentators criticised the Commission for being “to all intents and purposes invisible” and “missing in action” in the period leading up to the failures. It is however difficult to say, even with the advantage of hindsight, just what more the Commission – or indeed other parts of the regulatory system - could or should have done under the existing legislation when the alarm bells started to ring. A discussion document put out by the Commission as long ago as 2004 raised serious concerns about the non-disclosure of risk by finance companies. This was followed in April 2005 by a report Disclosure by Finance Companies. Between April and August 2006 a special review was conducted of finance companies’ disclosure documents, as a result of which 12 companies were ordered to amend offer documents, advertisements or financial statements. An explicit warning about the risks

involved in investing in finance companies was published in August 2006. A series of actions was taken against individual finance companies in 2006 and 2007. From 2006 the Commission was involved in developing proposals to tighten regulatory controls over finance companies. These culminated in the passing of the Financial Advisers Act in September 2008.

As we have already noted, there was no body with prudential regulatory responsibilities over non bank deposit takers during this period. This responsibility has since been given to the Reserve Bank.

A detailed list of the Commission’s actions in relation to finance companies is provided in

Annex G.

8.8 Members’ role in stakeholder engagement

Although Commission members from time to time attend and “front” workshops and make presentations to business organisations (as well as, on occasions, represent the Commission at overseas meetings), we believe that it would be good public relations – and help remove any perception that the Commission is out of touch with today’s market realities - to have members engage more often and more directly with the business community. This would best be done as part of the public relations strategy discussed in section 8.9 below.

Perceptions are an important element in effectiveness, and effective communication is an important function of leadership. New Zealanders by and large do not like to be told what to do by faceless people. The Chair does a valuable and highly commendable job in terms of speeches, articles and participation in meetings and gatherings in New Zealand. In our view however it will be important in the period ahead for other Commission members to get out and about and make themselves known to the market. Done well, such outreach can do much for stakeholder confidence in, and respect for, the organisation. It can add value to consultations and other contacts that already occur between the commission and its stakeholders. Stakeholder relationship management is a key element in any public organisation’s risk management. Stakeholders have a legitimate interest in being properly informed and appropriately consulted on both policy development and service delivery. There is clearly an appetite out in the market to see more of the Commission members.

8.9 A communication strategy

There is a clear need for the Commission to put in place a more proactive public relations and communication strategy. While it is understandable – and in many ways commendable – that the Commission should have put this work on a back burner in recent years in order to concentrate its limited resources on its substantive tasks, its communication with key audiences clearly needs to be paid more attention. Among the comments we heard were that the Commission “lacks good antennae” and often fails to get its message across to target audiences. We were encouraged to find that, conscious of this problem, the Commission devoted a meeting late last year to putting in place a new, overarching communication strategy. The strategy, which is to be overseen by a special five-member Division of the Commission, is based on an agreed set of objectives. It includes a calendar of activities which is to be reviewed at six-

monthly intervals and a research programme. The review team was impressed with both the coverage and the content of the strategy.

The challenge will be to maintain this high level of attention and secure adequate resourcing for the implementation of the strategy on an ongoing basis. Currently the Communications Manager has just one staff member working with him, yet his duties include overseeing the production of all Commission reports and publications, media relations, dealing with public enquiries, maintaining the Commission’s website and database, producing the quarterly bulletins, liaising with a range of external groups and organisations, managing the Commission’s public education activities, assisting with the Chair’s public speaking programme and advising the Commission on public relations and communications issues. Clearly, this level of resourcing is not sufficient.

The review team endorses the approach encapsulated in this strategy and urges that it be given early attention. We repeat here our encouragement in section 5.2.2 that the Commission adopt a less risk averse approach to its communication about matters it has under review and in the way it reports publicly on its findings. We also see it as a high priority task to get the Commission’s relationships with the news media on a better footing. The media are well placed to help the Commission get its messages across to both the market and the public. We consider it would be helpful if regular briefings were held with key journalists, if necessary on an “off the record” basis, on matters being dealt with by the Commission.

As a footnote, engagement is a two-way street and requires effort on both sides. We see scope for a more positive and constructive attitude on the part of some market participants as well as the Commission.

We have one recommendation and a number of suggestions on stakeholder relationships and communication:

Recommendation:

• That priority be given to the establishment of an Auckland office of the Securities Commission with a broader representational role as well as functional responsibility for the implementation of the Financial Advisers Act.

Suggestions:

• That the Commission’s communication section be equipped to take responsibility, under the relevant Division, for implementing the Commission’s communication strategy and monitoring progress in the strengthening of the Commission’s relationships with businesses, investors, the media and other important stakeholders.

• That priority be given to putting the Commission’s relationships with the news media on a better footing and to making more use of press briefings, if necessary on an off- the-record basis, on matters before the Commission which are of concern to investors when this would serve the public interest.

^{• That, where an activity is judged inappropriate but is beyond the Commission’s}

powers to act, press releases go beyond a matter of fact interpretation of the law to

state an opinion. It is also important that press releases be worded in such a way as to have the desired impact on the target audience.

• That all staff be reminded of the importance of maintaining a strong client focus and observing a high standard of communication with the business world and other stakeholders, with senior managers to be responsible for enforcing this requirement. This would include responding as helpfully as possible to requests for guidance on the interpretation of securities law, timely acknowledgement of complaints or requests, keeping an eye on the tone of correspondence and keeping people regularly informed of progress.

• That a programme of public speaking and attendance at relevant meetings by Commission members and senior staff members be developed to support the outreach work being done by the Chair. This would both help make the Commission and its work better known to investors, businesses and the media and give Commission members and senior staff opportunities to listen to the market.

• That the section in earlier Securities Commission annual reports describing the securities market, including recent trends and developments, be reinstated.

• That formal responsibility for coordinating financial literacy education by publicly funded bodies be vested in one agency, with the Securities Commission continuing to have a major input in order to ensure that full use is made of its actions and activities to support public education goals. A close relationship should be encouraged with other privately funded groups involved in financial literacy education.

9 International comparisons

9.1 Introduction

Elsewhere in this report we have referred to regulatory practices followed in other jurisdictions based on a survey of published information about the scope of other countries’ activities and approaches

We selected Australia, Singapore, Netherlands, Israel and Canada as the jurisdictions which provided the best basis for comparison with New Zealand based on a combination of cultural and historical factors and securities markets that operate relatively well in the IOSCO context. All of these countries’ regulators work within a “twin peaks” framework except Singapore’s financial services regulator (MAS).

Our comparison of New Zealand with other jurisdictions took into account the following considerations:

• whether the regulator exercises any rule making powers under principles-based legislation or is primarily administering “black letter” law

• whether the framework is mainly disclosure based, or whether there are also merit based powers

• the powers of the regulator to impose administrative sanctions or whether it only has power to take action through the courts

• the nature of functional segregation between supervision, enforcement, and decision making

• the regulator’s operating style in the way it deals with stakeholders and approaches its work

• the level of staffing and other resources

Comparisons of some of the key regulatory dimensions are set out in Annex H. Taking each of these matters in turn:

9.2 Rule making powers

New Zealand’s framework is based on black letter legislation, which is the case in the other jurisdictions we reviewed. Within the limits of black letter law, the Commission has taken some opportunities to operate in a principles-based manner through the issuing and periodic review of a number of class exemptions. It has also notified interpretations, such as deeming offers to be a certain type of security (with the resulting regulatory compliance requirements). This compares favourably with other regulators, which either do not attempt rule making at all or do not go as far. ASIC has released a number of “Regulatory Guidance” notices, but these contain a disclaimer that they do not constitute legal advice – which does not provide a lot of certainty to market participants.

We identified one area in which the Commission could adopt practice from overseas. There is an opportunity to follow the example of some other jurisdictions whereby the law reform (both legislation and regulations) process is defined publicly and includes target timeframes, the groups that should be consulted and the points in the process during which the consultation should occur. This approach would help to address the concerns expressed to us by some market participants about stakeholder engagement as well as ensure all amendments to regulations are able to be effectively implemented by the market. We consider too that it would be advantageous for the Commission to be able to advocate changes in the legislation and regulations as an independent and expert regulatory body.

While primary responsibility for policy advice rests with the Ministry of Economic Development, the Securities Commission has an important role to play in securities market law reform. As indicated above, the review team would like to see this role strengthened.

Suggestion:

• That the Commission be given a greater measure of independence in making the case for legislative or regulatory improvements and, once changes are in prospect, be responsible for formulating and making public a defined law reform process that includes appropriate consultation with market participants.

9.3 Disclosure or merit based regulation

New Zealand’s disclosure based framework is typical of the comparison group. ASIC in Australia is an exception in that it has the power to prohibit or limit offerings based on assessment of merit, not just disclosure. This is unusual: EU rules prohibit this kind of involvement from the regulator on the grounds of moral hazard risk and the “caveat emptor” principle. The disclosure based regulators all have law reform functions and defined processes to move things through the policy pipeline towards updated regulations or legislation, but this can never be a nimble process.

While most other regulators focus on disclosure issues, we have noted a number of public statements by the Commission emphasising the particular risks inherent to certain investment types, which investors need to understand. These statements are not-so-subtle hints to investors about the investment’s merits – and go about as far as could be expected from a regulator with only disclosure based powers. This approach is at least as proactive as any we have noted in the comparison group. The commentary included in these statements describes in a straightforward way how the investments work and how the risks arise. (We have however suggested elsewhere in this report that the Commission look at ways of sharpening up its warning to investors.)

9.4 Powers of administrative sanction

New Zealand’s Securities Commission, along with ASIC in Australia, does not have powers of administrative sanction. All actions must be through the courts. By comparison, Singapore, Netherlands, Canada and Israel do have powers of administrative sanction. In our view, the power to impose fines or prohibit individuals provides for timely and efficient regulation and is preferable to using courts in the first instance. The courts exist as an appeal forum and remain

the first point of action for criminal proceedings. We have not researched in detail the level of administrative sanction available to each regulator – we understand that the main jurisprudence hurdle relates to the appropriateness of a non-judicial body’s imposing administrative sanctions rather than the level of those sanctions.

9.5 Separation of functions

Other regulators have addressed the need for a separation of functions in different ways. One natural division is between supervision and enforcement (both typically “agency” functions) and decision making (typically a “commission” function). A second is the requirement to segregate supervisory and investigative actions from enforcement decisions. On a matter related to governance, we noted that New Zealand’s Securities Commission is relatively independent of government compared to some of the other regulators. We consider this to be a strength, even acknowledging that the Commission is to some extent constrained from taking a public position on its law reform proposals.

The approach taken to separation of functions in our comparison group is as follows:

Table 2 – how different countries are achieving separation of functions

Source: review team research

9.6 Operating style of the regulator

New Zealand’s Securities Commission appears to some critics to be primarily about administering legislation in a technically “accurate” way, giving lower priority to timeliness and up-front helpfulness. Our review of publications suggest that a similar approach is taken by most regulators. In relation to timely communication, ASIC in Australia and BCSC in British Columbia, Canada, have well publicised targets about processing times and keeping people informed. However the results of recent customer satisfaction surveys do not suggest that a “client oriented” culture has yet permeated these organisations. Our recommendation to the Commission to develop a stronger client focus will, if successfully implemented, put it ahead of most other regulators. Binding rulings and no action letters, which are not currently used by the Commission, do not appear to be in widespread use in the review group. In certain jurisdictions however considerable use is made of consultative panels representing the interests of retail investors and other categories of market participants.

Many stakeholders see the Commission as mainly reactive – dealing with complaints rather than preventing problems from occurring in the first place. This does not fairly describe the secondary markets supervision function and is only partly true in relation to primary markets – the Commission has a track record of publishing its concerns about certain sectors and of requesting meetings with issuers if it has concerns. The extent of publications by the Commission that could be considered “proactive” compares favourably with the overseas regulators we reviewed. As far as we are able to tell, prosecutions arise from complaints rather than surveillance in most jurisdictions.

Lastly, our report raises the question of whether the Commission could be better at prioritising its work and taking more of a risk based approach. Based on our review of other jurisdictions, there seems to be a measure of support for this view. Some other regulators have established targets about focusing effort towards riskier areas and targeting outcomes. It would however be difficult to argue that these regulators have achieved better outcomes than New Zealand in recent times. ASIC has this as a specific goal, and we have suggested that the Commission

consider moving more in this direction. We do not however wish to minimise the difficulties inherent in making judgement calls under a risk-based approach.

9.7 Level of staffing and other resources

Direct comparison between Securities Commission and its overseas counterparts is difficult. Most of the other organisations have different functions (MAS in Singapore is an integrated regulator) and larger capital markets. Further, we understand there is reluctance by the regulators to publish details of their staffing establishments because they see a regulatory benefit in “mystery”. Nevertheless, a comparison of operating budgets shows that New Zealand’s regulator operates on a fraction of the resources available to its counterparts. All of the other regulators are fully or significantly industry funded, with New Zealand having the greatest dependence on government funding.

_{Table 3 – staffing and funding levels of regulators in a range of countries}

Source: websites and/or annual reports of each body, converted at exchange rate 31 July 2009

A Annex A – terms of reference

The review panel agreed the following terms of reference with the members of the Commission: The review will assess the effectiveness of the Securities Commission, in particular how

well the Commission is achieving the outcomes it seeks. The review will cover the effectiveness of:

1. The conduct of securities regulatory work in the Commission, the allocation of work, decision making, and organisation of resources

2. The governance of the Commission, including its governance practices and its governance structure

3. The Commission’s relationship with its primary stakeholders, including its reputation

4. Such other matters as the review team considers relevant

The review will build on the work contained in KPMG’s report to the Ministry of Economic Development dated February 2009, “Baseline funding review of the Securities Commission”.

The review will generally follow the approach as developed by members of the review panel

Timing and reporting

The review will take place during the 2 month period, June and July 2009. The reviewers expect completing their final report by Monday, 31 August 2009.

B Annex B – list of stakeholders interviewed

External Stakeholders

PricewaterhouseCoopers (Bruce Hassall, Partner, and Leo Foliaki, Partner) Chapman Tripp (Roger Wallis, Partner)

NZX Limited (Andrew Harmos, Chair)

Serious Fraud Office (Grant Liddell, Director and Chief Executive) Minister of Commerce (Hon. Simon Power, MP)

Opposition Spokesperson on Commerce (Hon. Lianne Dalziel, MP) Ministry of Economic Development (David King, Director)

Ministry of Economic Development (Andrew Jackson, Deputy Secretary) NZX Limited (Mark Weldon, Chief Executive)

Companies Office (Liz Thomson)

New Zealand Institute of Chartered Accountants (Bruce Bennett, General Manager Admissions/Standards & Quality Assurance, and Steven Bailey, Director Government Relations)

Trustee Corporations Association (David Brown Douglas, Chief Executive) Trustees Executors (Yogesh Mody, Regional Manager)

Cameron Partners (Murdo Beattie, Principal)

Crown Law Office (Maria Deligannis, Crown Counsel)

Crown Law Office (Una Jagose, Crown Counsel Team Leader)

Investment Savings and Insurance Association (Vance Arkinstall, Chief Executive) Kensington Swan (Gerald Fitzgerald, Partner, and David Ireland, Partner)

KPMG (Godfrey Boyce, Partner) Terry Hall, commentator

Russell McVeagh (Derek Johnston, Partner) Crengle, Sheves Ratner (Peter Ratner, Partner) Grey Power (Peter Rutledge, Director)

Ministry of Foreign Affairs and Trade (Simon Murdoch, Secretary) NZX Limited (Chris Moller, Director)

Minter Ellison (Lloyd Kavanagh, Partner)

Society of Independent Financial Advisers (Murray Weatherston, Chair) NZ Shareholders Association (Bruce Shepherd, Chair)

AMP Services (NZ) Limited (Jack Regan, Managing Director) Takeovers Panel (David Jones, Chair, and Colin Giffney, Deputy Chair)

First New Zealand Capital (Scott St John, Chief Executive)

ANZ National Bank of New Zealand, (David Green, Managing Director Institutional) Fran O’Sullivan, commentator

Rob Stock, commentator

Westpac New Zealand (Peter Wilson, Chair)

Tower (Sam Stubbs, Chief Executive Investments) Securities Industry Association (Rob Dowler)

Business New Zealand (Phil O’Reilly, Chief Executive, and Steve Summers, Economist) Brian Gaynor, commentator

John Milne, company director

Reserve Bank of New Zealand (Toby Fiennes, Head of Prudential Supervision) INFINZ (Paul Hocking, Executive Director, and Bruce McKay, Board member) Commission members

Jane Diplock (Chair) David Jackson

John Holland Colin Beyer Keitha Dunstan Annabel Cotton Cathy Quinn Mai Chen Neville Todd

Elizabeth Hickey

Staff members

Alastair Boult (Chief Accountant)

Kathryn Rogers (Director, Primary Markets)

Nick Arathimos (Director, Chairman’s Office & International) Liam Mason (General Counsel)

John Mulry (Director, Market Supervision) Angus Dale-Jones (Director, Supervision) Roger Marwick (Communications Manager) Sanjiv Jetly (Chief Operating Officer)

C Annex C – list of key documents

Annual Reports 2001 - 2008, Securities Commission “Strategic Plan 2009 – 2012”, Securities Commission “Statement of Intent 2009 – 2012”, Securities Commission

“Ministry of Economic Development, Baseline Funding Review of the Securities Commission

2009 – 2012”, KPMG

“2007/08 Financial review of the Securities Commission, Report of the Commerce Committee”, House of Representatives

“Company and Securities Law in New Zealand”, John Farrar et al, 2008, Brookers Limited

“When no Law is better than a Good Law”, Address to INFINZ, Auckland, 1 July 2009, Prof

Utpal Bhattacharya, Cornell University

“Securities Act 1978” (reprint as at 12 March 2009) “Securities Regulations 1983” (reprint as at 10 April 2008) “Securities Markets Act 1988” (reprint as at 2 May 2008) “Financial Advisers Act 2008” (reprint as at 5 December 2008)

“Anti-money Laundering and Countering the Financing of Terrorism Bill”

“2007/08 Financial review of the Ministry of Economic Development”, Report of the

Commerce Committee, House of Representatives

“Annual Report 2008/2009”, Monetary Authority of Singapore

“ASIC: a guide to how we work”, Australian Securities and Investments Commission

“ASIC Stakeholder Survey”, The Allen Consulting Group, April 2008

“Public Sector Governance: Better Practice Guide”, Australian National Audit Office, 2003 “Crown Entities Legislation”, presentation by Minter Ellison Rudd Watts, 2005

“Distributed Public Governance”, OECD paper, 2002 “Report of Ministerial Enquiry into the Sharemarket”, 1989

Securities Commission meeting papers, 2009

Securities Commission Audit and Risk Review Committee papers, 2009

Audit New Zealand management reports on Securities Commission, 2007 and 2008

IMF Financial System Stability Assessment, 2004

Financial Action Task Force report on money laundering, 2003

MOU between Securities Commission and NZX, 2009

IMF Country Report no. 04/417, 2004

Selected press clippings January – August 2009

Morningstar Global Investor Report, May 2009

D Annex D – overview of the market

Introduction

This section briefly describes the securities market in which the Commission performs its work. In commencing this review, we found no comprehensive document which would provide a clear presentation of both the “economics” of the market – volumes, trends, major events, number

and nature of market participants etc - and of the architecture and substance of the regulatory framework. This information is important for an understanding of the context for our review of the Commission’s effectiveness so we have obtained the latest statistics available from a range of sources. These include the Reserve Bank of New Zealand (RBNZ), NZX Limited, and the Spicers Household Savings Indicators compiled jointly by Morningstar and the New Zealand Institute for Economic Research.

We have recommended that, as principal regulator of New Zealand’s securities market, the Commission re-commence regular reporting of the dimensions of the securities markets along these lines. Information in this format was reported in the Commission’s Annual Report up to and including 2001.

New Zealanders’ financial assets

The main types of financial assets held by households in New Zealand are debt securities (bank deposits, and other debt securities with non-bank deposit takers), equity securities (both direct New Zealand and overseas equities), and mutual funds (superannuation, life insurance). The total of New Zealand households’ financial assets was $193.7 billion as at December 2008. The distribution of these assets is represented in the following figure.

_{Figure 1 - New Zealand households’ main financial investments as at May 2009}

_{New Zealand Equity}

_{Overseas Equity}

Superannuation

Life Insurance

_{Other Managed Funds}

Dec-08

Dec-07

_{Deposits with registered banks}

_{Other Debt Securities}

_{0 20 40 60 80 100}

Source: RBNZ

Debt securities

Financial institutions include registered banks as well as non-bank deposit takers. All registered banks, and since 2008 non-bank deposit takers, are subject to the prudential supervision of the RBNZ. They are also subject to the advertising provisions of the Securities Act 1978 and

Securities Regulations 1983. The majority are subject to and abide by the rulings of the

Banking Ombudsman.

As at 29 May 2009 there were 18 registered banks, of which 8 were incorporated in New Zealand. Non-bank deposit takers (companies that are not banks, but which issue debt securities to the public and are engaged in the business of borrowing and lending money, or providing financial services) include around 50 small credit unions, 11 building societies, PSIS, and

around 70 finance companies.

The New Zealand household sector's aggregate investment in debt securities issued by both bank and non-bank financial institutions (M3) stood at $121.8 billion as at December 2008. Included in this amount are debt securities traded on the Debt exchange market (NZDX) provided by NZX Limited. As at May 2009 the market capitalisation of the NZDX was valued at $14.5 billion. Issuers listed on the NZDX include the government, banks and corporates.

Equity securities

NZX is a listed for-profit company that is New Zealand’s principal stock exchange operator. It runs two markets for equity securities, the NZ stock exchange (NZSX) and the NZ Alternatives exchange (NZAX). The NZAX is designed for small to medium sized companies which are

fast-growing or looking for additional sources of capital to fuel growth. The NZSX is the market designed for mature corporations.

The total market capitalisation of the NZX in May 2009 was $48.3 billion, with the NZSX

being $47.8 billion of this total.

The New Zealand Super Fund, which has assets of $13.1 billion, holds 6% of its assets ($823 million) in equity securities listed on the NZSX.

_{Managed funds}

Managed funds are investment funds managed professionally by an expert fund manager who invests in a variety of investments. With managed funds, invested money is pooled together with that of other investors to create a single strong fund to provide investor benefits.

Managed funds totalled $54.5 billion as at December 2008. These are predominantly made up of Superannuation funds ($$18.9 billion), Unit Trusts & Group Investment Funds ($12.1 billion), and Life Insurance ($7.6 billion). Other managed funds make up the remainder.

Of the $12.1 billion in superannuation funds $2.1 billion has been invested into the KiwiSaver scheme introduced by Government in 2007. The KiwiSaver schemes available range from conservative risk to growth funds, with a large percentage of contributors opting for the lower risk conservative schemes. This may reflect a general propensity to invest in safer, interest bearing investments implied by the distribution of New Zealanders’ financial assets presented in figure 1 above.

Financial literacy and its impact on sections of the market

There is general agreement among commentators that financial literacy levels in New Zealand are low. This is the case in most advanced economies, with analysis on this very point having been made public in both the UK and France. The majority of household wealth in New Zealand is invested in the family home and non financial assets (such as residential investment property, land, etc) which do not come within the scope of securities regulation. The distribution of households’ financial assets set out in figure 1 above implies that the majority of investors mainly use products they understand. This leaves a share of the market invested in financial assets that is relatively small by overseas standards. Many people consider that the low level of financial literacy, coupled with the tendency for investors to stick with what they

understand, explains the limited amount of capital available for long term business expansion in

New Zealand.

On the other hand, it seems there has traditionally been a significant minority segment of the public who are prepared to invest in financial assets they do not understand and who do not appreciate the drivers of risk and return on their investments. Such investors are susceptible to products that promise returns greater than is available from products they do understand. This segment of the market has tended to suffer a large proportion of unexpected losses by investors over the years. A view was expressed to us that this pattern has not changed, although the vehicles in which these investors lose their money do change over time to keep ahead of regulation. Examples of such vehicles given to us include contributory mortgage schemes and, more recently, finance companies with high concentrations of risk.

The collapse of a whole investment sector, in addition to causing loss of confidence, contributes little to making capital available for long term business expansion. For example, the collapse of risky finance companies led to a loss of confidence, and drying up of deposits, for much of the entire finance company sector. Finance companies were previously a significant source of finance for smaller expanding businesses.

Another factor in this equation is that it has been possible to offer services as a “financial adviser” without any qualifications or even any knowledge of investments. The payment of commissions to such advisers is considered by some to be a significant driver for investors with low financial literacy to invest in risky financial products. Indeed, there has been little incentive for financial advisers to advise clients to invest in low risk, low return products. The Financial Advisers Act 2008 is an attempt to improve the standard of advice provided to investors and

will provide for classes of financial advisers with levels of registration dependent upon demonstrated competence, though the vast majority of financial advisers will still be remunerated via commission rather than fees for advice.

Legislation and regulation

In common with many other countries, New Zealand’s is a disclosure based regime.

The following table sets out the main legislation and regulations affecting securities. In each case, significant amendments have been made to the original legislation and the comments reflect the current state as at the date of this report.

_{Table 4 – summary of the major securities legislation and regulations}

Source: Review team review of printed legislation

E Annex E – Commission member profiles

Jane Diplock AO BA (Hons), LL B, DipEd (Sydney), Dip Int Law (ANU), FIPAA, FNZIM

Chairman of the Commission since September 2001.

Barrister and Solicitor of the ACT Supreme Court and High Court of Australia, Barrister of the New South Wales Supreme Court; Fellow of the Institute of Public Administration of Australia; Chevening Fellow at London School of Economics; Chairman of the Executive Committee of

IOSCO; Fellow the New Zealand Institute of Management.

Colin Beyer LL B, DistFlnstD.

Consultant to Simpson Grierson, Wellington.

Solicitor, Wellington

Mai Chen LL B (Hons) (Otago), LL M (Harvard), FNZIM

Partner of Chen Palmer, Wellington, Barristers and Solicitors, Public Law Specialists. Specialist in government regulation of business, administrative and constitutional law, public policy and legislation. Member of the New Zealand Trade and Industry Beach Heads Advisory Board and the Asia New Zealand Foundation. Formerly on the Advisory Board of AMP Life Limited (NZ) and Senior Law Lecturer at Victoria University of Wellington. Fellow of the New Zealand Institute of Management.

Annabel Cotton BMS (Accounting and Finance), ACA, CSAP

Business Consultant, Hamilton

Consultant to companies listed in New Zealand and overseas.

Director of Genesis Power Limited, Kingfish Limited, Barramundi Limited, Marlin Global

Limited and a number of private companies.

Keitha Dunstan PhD (QLD), M Bus (QUT), Grad Dip Mgt (UCQ), B Com (QLD), CA Research Professor, School of Accounting Commercial Law, Victoria University of Wellington. Head of School, School of Accounting and Commercial Law at Victoria University of Wellington.

Elizabeth Hickey M Com (Hons), FCA, MInstD

Chartered Accountant, Auckland.

Board member New Zealand Institute of Chartered Accountants, Adjunct Professor, Dept of

Accounting and Finance, University of Auckland.

John Holland B Com, LL B.

Solicitor, Christchurch

Partner and Board member of Chapman Tripp specialising in securities and competition law and mergers and acquisitions.

David Jackson M Com (Hons), FCA. Company Director, Auckland Chartered Accountant

Director of Fonterra Co-operative Group Limited, Nuplex Industries Limited, Pumpkin Patch

Limited, and the New Zealand Refining Company Limited.

Cathy Quinn LL B.

Solicitor, Auckland

Partner of Minter Ellison Rudd Watts specialising in corporate and securities law.

Neville Todd B Com (Otago).

Company director, Wellington

Managing Director of Kinloch Funds Management Limited

Director of Kinloch Funds Management Limited and its subsidiaries.

_{F Annex F – overview of current Commission and agency functions and structure}

_{Executive Chairman}

Commissioner for

_{Financial Advisers}

Members

Director, Supervision

^{∗ Financial}

^Advisers

^{∗ Liaison with}

^{relevant agencies}

e.g. Companies

Office

Chief Operating Officer
^{∗ Strategy and planning
∗ Change Leadership &}

^{Programme Office}

^{∗ Secretary to the}

^Commission

_{∗ Financial Management}

General Counsel
^{∗ Regulatory Policy}

^{& Reform}

^{∗ Legal Compliance
∗ Corporate}

^Governance

_{∗ Exemptions &}

Director, Primary
Markets
^{∗ IPOs
∗ Offer Documents
∗ Illegal Offers
∗ Financial Adviser}

_Disclosure

Director, Market
Supervision
^{∗ Insider Trading
∗ NZX
∗ Market}

^Manipulation

_{∗ Secondary Market}

Chief Accountant
^{∗ Financial}

Surveillance
^{∗ Financial}

Statements of

Issuers

^{∗ Auditor Oversight}
_∗

Director, Chairman’s Office and International

∗ Risk Management HR Management

^{∗ IT Management}

^{∗ Communications &}

^{Public Understanding}

Authorisations
^{∗ Official}

^{Information
∗ Statutory}

^Management
_{∗ Barrister role}

Intermediaries

^{∗ Liaison with}

^{relevant agencies}

eg Serious Fraud

Office

Liaison with
relevant agencies e.g. Institute of
Chartered
Accountants

_{Source: Securities Commission}

55

7. Annex G – history of Commission’s actions regarding finance companies

The following information is taken from the 2007/08 Financial review of the Securities

Commission report to the Commerce Committee of the House of Representatives (Appendix B).

September 2004 Commission publishes release expressing concern about adequacy of disclosure by finance companies, particularly about the risks of investment, and invites comment on proposals for improved disclosure.

April 2005 Report, Disclosure by Finance Companies, published. Commission says finance companies need to improve disclosure; sets out expectations for disclosure and signals intended approach to enforcement.

April–August 2006 Commission undertakes further review of finance company disclosure documents. Twelve companies ordered to amend offer documents, advertising, or financial statements.

August 2006 Commission publishes warning about finance company risk. Says that finance company loans carry a “significantly higher risk” than bank loans, and that this poses added risk to finance company investors. The warning:

^{• says investments carrying 50 percent higher return than banks represent at least 50 percent}

more risk; expresses concern that investors are not discerning the additional risk represented

by a few extra percentage points of interest

^{• stresses importance of governance in finance companies}

^{• urges investors to read disclosure documents and seek advice, and to be clear who the}

finance company is lending money to, so that risks can be assessed

^{• warns finance companies of the need to update offer documents if financial situation}

changes for the worse

^{• explained that the commission has no remit as a prudential regulator of finance companies,}

and can take action only where disclosure documents are shown to be misleading.

September 2006 Ministry of Economic Development discussion document proposes new role

for Securities Commission in supervision of performance by corporate trustees, including power to remove and replace trustees. Document notes that current model provides no mechanism for accountability of trustees for their performance, no official oversight of trustees, and no public remedies against trustees.

March 2007 Commission bans finance company prospectus for failing to disclose adverse information about the competence and honesty of director.

June 2007 Commission suspends prospectus of Bridgecorp Limited, three days prior to the company being placed in receivership, after being alerted of a failure to meet a repayment on debentures.

August 2007 Commission seeks formal statements from directors of 67 finance companies regarding compliance with disclosure obligations. Warns two companies that offer documents may be banned; both withdraw offer documents and close offers.

September 2007 Commission recommends urgent changes to regulations to strengthen reporting to trustees by finance companies and giving extra powers to trustees to gather information. Changes include:

^{• six-monthly audit of accounts for all finance companies}

^{• monthly reports to trustee on liquidity, reinvestment rates, asset quality (including arrears}

reports, and impaired debt), and any breaches of third party financial covenants

^{• quarterly certification by finance companies of compliance with disclosure and trust deed}

obligations

^{• management accounts}

^{• power for trustees to appoint separate auditor}

^{• power for trustee to call in independent expert to provide report on financial position of}

finance company.

November 2007 Launched “Look Learn Invest” advertising campaign, website, and brochures to give investors basic information about making investment decisions, with particular focus on risk.

May 2008 Secured consent of Minister of Commerce to use litigation fund to take criminal prosecutions under Securities Act against finance company directors.

September 2008 Reserve Bank Amendment Act provides prudential oversight role for Reserve Bank in respect of finance companies and other non-bank deposit takers; provides liability for trustees regarding performance of duties.

September 2008 Financial Advisers Act 2008 passed, providing for authorisation and supervision of financial advisers by Securities Commission.

October 2008 Government Deposit Guarantee Scheme announced.

December 2008 Following two-year investigation, Commission lays criminal charges against all directors of Bridgecorp and Nathans Finance.

.

H Annex H – comparison table with overseas regulators

The following table sets out a comparison of some of the broad dimensions of the regulators referred to in this report.

_{Table 5 – comparison of the regulators in the review group}

Source: each organisation’s website