New Securities Law

for: Investment Advisers

and: Market Participants

Investors to get more information under new securities law

New Zealand Investor, February 2007

Investors will benefit from long awaited changes to the law that require investment advisers to give them more information. The new requirements will come into force around the middle of 2007.

Advisers will have to give investors a written "disclosure statement" that provides information about themselves and their qualifications, the range of investment products they advise on, and how they are paid.

This disclosure must be made up-front by an investment adviser before they give advice to a member of the public. Investment brokers must also give investors a disclosure statement before they receive investment money or investment property from members of the public.

The disclosure is mandatory and must be provided without the client having to ask for it.

Investment advisers disclosure must include:

their experience and qualifications;
criminal convictions;
the nature and level of fees charged;
other interests and relationships; and
types of securities the adviser advises on.

The new rules require more information about fees, commissions and other benefits that the adviser will receive, whether from the client or another source. It includes "soft" commissions and indirect benefits relevant to the advice being given to the client. Advisers will also have to disclose their relationships with the providers of investment products.

Investment brokers disclosure must include:

criminal convictions; and
procedures for dealing with investment money and investment property.

Disclosure statements and advertising must not deceive, mislead or confuse investors and must be kept up-to-date.

An adviser or broker must not recommend an illegal offer of securities or receive investment money for an illegal offer of securities. A breach of this requirement is a criminal offence if the adviser or broker knew or ought to have known that the offer was illegal.

The Commission has powers to enforce these new rules. It can require advisers to withdraw or correct disclosure, suspend people from acting as investment advisers, and apply to the Court to ban people from giving investment advice.

Failure to comply with the disclosure obligations is an offence with fines of up to $300,000. Civil penalties of up to $1,000,000 can be imposed by the Court.

The Securities Commission first recommended tighter rules for investment advisers in May 2002 after submissions on a 2001 discussion paper were considered.

The Commission reiterated the need for new rules in its May 2001 report Investment Advisers: A Case Study - Gideon Investments Pty Limited and Morison Guildford Associates Limited.

This followed investigation of a fraudulent scheme promoted by Gideon Investments and its managing director Michael Bastion. Morison and Guildford, investment advisers in the Wairarapa, recommended the scheme to investors who subsequently lost their money. The Commission's report said that the advisers were "... incompetent and irresponsible. They appear to have taken a key role in obtaining investment money from New Zealanders for Gideon. They did not question the lack of offer documents. Their formal evaluation and monitoring of Gideon was close to non-existent and certainly fell short of what might reasonably be expected of a firm offering investment advisory and broking services to the general public."

The increased disclosure required by advisers and brokers results from the Securities Legislation Bill passed in October 2006. Regulations are being prepared and when they are passed the law will come into effect, probably about the middle of 2007.

The Bill revoked the Investment Advisers (Disclosure) Act which previously determined the rules for investment advice, and amended the Securities Markets Act 1988 to incorporate the new rules for investment advisers.

Substantial Security Holder Disclosure

Investors who have large shareholdings will also be affected by new law.

At present a person who holds 5% or more of voting securities in a listed issuer must disclose any changes of 1% or more to their holding. They must also disclose if they cease to be a substantial security holder in the company.

The aim of substantial security holder disclosure is an informed market. This will deter insider trading, market manipulation, and secret dealing in potential takeover bids, by ensuring that all market participants have information about trading by persons who control or influence significant voting rights in a public issuer.

Changes under the new law include:

a person becomes a substantial security holder by having a relevant interest in 5% of the listed securities in any class (rather than 5% of the total number of voting securities of an issuer); and
disclosure applies to listed voting securities only, not to unlisted securities; but
the Securities Commission can require any person to disclose the nature and extent of any relevant interests in securities of a public issuer, including in unlisted and non-voting securities.

Failure to comply with substantial security holder obligations will be a criminal offence, with a fine of up to $30,000. Civil penalties of up to $1 million can be imposed by the Court, which can also make a range of orders relating to any holding of securities, including orders to forfeit or dispose of securities.

Insider trading

The new regime toughens the law on insider trading. Liability for insider trading is no longer limited to those who are connected or related to the issuer. A person becomes an insider by possessing inside information, rather than by connection to the company to which the inside information relates.

An information insider is someone who has material information about a public issuer that is not generally available to the market, and the person knows or should know that the information is material and is not generally available.

Material information is information that would be expected to materially affect the issuer's share price if it were generally known.

Information insiders must not trade in securities, disclose the information to others to trade on, or advise or encourage others to trade or hold securities.

Breaches of the new insider trading law will incur civil penalties. The maximum penalty in any case will be the greater of:

the consideration paid for the shares;
3 times any profit made or loss avoided; or
$1 million.

Knowingly breaching this law will be a criminal offence with penalties of up to 5 years in prison or a fine of up to $300,000 for an individual and $1 million for a body corporate.

There will be a number of exceptions and defences to liability to encourage legitimate trading activity. These include:

independent research or analysis;
where both parties to a transaction have equal information;
trading in accordance with a fixed trading plan;
where trading or disclosure is required by law;
underwriting agreements;
knowledge of a person's own intentions or activities;
agents and advisers acting on instructions;
certain takeovers-related activity;
trading where information is protected by Chinese Walls.

New laws on market manipulation and general dealing misconduct

Market manipulation is behaviour or practices likely to give a false or misleading impression about the supply, demand, price or value of securities traded on a stock exchange. This new law prohibits:

making false or misleading statements or spreading information which is likely to induce a person to trade or which might affect the price of the securities;
creating a false or misleading appearance of securities trading.

Any trade that does not result in a change of beneficial ownership will be presumed to give a misleading appearance of trading activity, unless the person can show a legitimate reason for the trade. Placing matching buy and sell orders for a security will also be considered misleading.

Penalties for breaching the market manipulation laws will be similar to those for insider trading, and include criminal offence provisions.

Conduct relating to dealing in securities that is likely to mislead or deceive is prohibited. A person who engages in misleading or deceptive conduct can be subject to prohibition or corrective orders made by the Securities Commission, and can be liable to compensate anyone who suffers loss as a result of the conduct.

Timing

The exact timing for the introduction of the new law is not yet known. However, it is expected that the content of regulations will be known early in 2007, and the new rules will come into force around the middle of the year.

Further information

The Securities Commission is preparing a handbook on the new law. Ring 04 472 9830 or email seccom@sec-com.govt.nz to order a copy.

ends

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