The Financial Markets Conduct Act 2013, which came into force on April 1, should have a significant impact on financial markets.
The latest edition of The Script, the New Zealand Shareholders’ Association’s excellent newsletter, describes the legislation with the phrase “The sheriff has a new gun”.
The association believes this is the first time investors have had a significant input into new securities legislation.
It writes: “Politicians have largely managed to keep their noses out of developments. This has resulted in very little political interference, something which often seems to derail decent outcomes.”
“The new law may not be perfect and undoubtedly a few unintended consequences will require minor changes, but that should not detract from the cooperative efforts of all involved.”
The new regulations will not please everyone, particularly investors who want to hold directors of failed companies to account.
For example a large number of failed finance company directors, including Sir Douglas Graham, would not be prosecuted under the new regulations because the Financial Markets Authority (FMA) now has to prove that directors deliberately misled investors rather than just being aware that investors were being misled.
The flip side to this is that issuers, rather than directors, will now be liable under civil action.
In other words directors are safer under the Finance Markets Conduct Act (FMC Act) but companies are now more susceptible to civil charges which, if successful, would force them to draw on their insurance policies to compensate investors.
However, the ultimate objective of the new FMC Act is to avoid the finance company and Ross Asset Management debacles that have afflicted our financial markets in recent years. Two of the main features of the FMC Act are capital raisings and disclosure requirements.
Roger Wallis and Ross Pennington of Chapman Tripp have described New Zealand’s traditional disclosure regime as a combination of flat roads interspersed with occasional mountains that are extremely difficult to traverse. By this they mean that investors receive limited information on a day to day basis but they receive a mountain of detail, sometimes incomprehensible, through offer documents when capital is being raised.
The objective of the new regulations is to flatten out this road with far more information on a day-to-day basis, through continuous disclosure requirements, and smaller and easier to understand offer documents.
The massive IPO documents issued by Mighty River Power and Meridian Energy were examples of this. The Mighty River Power and Meridian Energy combined prospectus/investment statements were 276 pages and 244 pages respectively while the Genesis Energy investment statement, which is heavily influenced by the new regulation, is only 75 pages and much easier to understand.
It was totally ridiculous that finance companies issued substantial prospectuses once a year, with most of the important information buried in fine print at the back, and released almost no information to investors in between these prospectuses.
There is a huge amount of support for continuous disclosure and smaller offer documents but will these changes be enforced?
Will the Shareholders’ Association’s “sheriff has a new gun” turn out to be “sheriff’s new gun stays in holster”?
Enforcement has always been a major issue in New Zealand.
The Government commissioned Roche Report in the early 1990s, named after chairman Brian Roche who is now NZ Post CEO, concluded that the country’s securities laws were adequate but enforcement was poor. Enforcement continued to be a problem under the Securities Commission, which was replaced by the FMA in 2011.
Unfortunately the backdoor listing of Kim Dotcom’s Mega through TRS Investments indicates that enforcement may continue to be a problem under the FMC Act.
As this column highlighted two weeks ago TRS Investments told the NZX on March 25 that it would acquired 100 per cent of Mega Limited for $210 million through the issue of TRS shares. No other information was disclosed.
The announcement was made before the introduction of the FMC Act but that legislation is now operative yet no further details of this transaction have been revealed.
This column is not against backdoor listing but TRS Investments’ disclosure has been woeful and totally inconsistent with the continuous disclosure requirements of the FMC Act.
The FMA should take action in relation to the TRS/Mega transaction under Section 34 of the Securities Market Act, which empowers the regulator to require persons to disclose and attach documents in relation to the acquisition of a substantial shareholding. At the very least TRS should be required to release a copy of its contract with Mega.
This will give investors more information, particularly in terms of any escrow agreements on the proposed new shares and how the $210 million purchase price was determined.
Retail investors will welcome the move to less complicated offer documents because under the old regime individual investors were often excluded from attractive capital raisings.
The most obvious examples of this were share placements by listed companies.
Before April 1 companies could issue new shares to sophisticated or wholesale investors without publishing an offer document but a prospectus was required if the offer was extended to retail investors.
This usually meant that retail investors were excluded from these capital raisings because companies didn’t want to incur the expense of preparing and issuing offer documents. Under this scenario individual investors could only participate in Share Purchase Plans (SPP) which are capped at a maximum of $15,000 per investor.
This clearly disadvantaged individual investors as the Shareholders’ Association has consistently noted.
Under the Financial Markets Conduct Act companies will be able to issue an additional number of existing securities without a long and complicated prospectus.
In most cases they will only have to produce a “cleansing statement” – which confirms that the continuous disclosure requirements are up to date – and a simple explanation of the offer. This is consistent with Chapman Tripp’s analogy that the road will be much flatter in the years ahead because we won’t need huge offer documents as continuous disclosure requirements will keep investors fairly fully informed on a day to day basis.
However, one of the most important features of the new FMC ACT is Part 2 – Fair trading.
Under this section a person may not engage in conduct that is likely to mislead investors and the FMA can take steps to correct any misleading statements or behaviour. This is a significant development because the Securities Commission argued that it could only take action after a statement was clearly proved to be misleading whereas the FMA can now take action when the first sign of misleading conduct becomes evident.
In other words the ambulance has been moved from the bottom to the top of the cliff.
The London Pacific and finance company debacles are good examples of this.
In the late 1980s Malaysian interests acquired a controlling stake in NZX listed London Pacific and more than $50 million was transferred overseas to acquire timber cutting rights in Malaysia. Numerous submissions were made to the Securities Commission to reverse this transaction because the value of the timber rights was clearly misleading.
The commission refused to do anything because it argued it had to wait until the valuation was proven to be misleading. London Pacific was placed in receivership and none of the $50 million-plus was ever recovered.
A large number of finance companies issued misleading statements but the Securities Commission took no action regarding these statements.
The FMA has been given far more preventative powers under the FMC Act and investors will be hoping that the sheriff uses his new gun and on the right people. The TRS Investments/Mega backdoor listing transaction would be an excellent place for the FMA to start.