Thank you for inviting me here to speak today at the New Zealand Shareholders Association National Conference. Thanks to Chairman John Hawkins for organising such a quality line-up of speakers.
The Shareholders Association has a very important role to play in New Zealand's capital markets both as an advocate for shareholders and as a watchdog of Boards. Your presence at company meetings is critical, and the questions you ask on behalf of your members and all investors are important. AGMs are, after all, where Boards present and report on their achievements as well as the challenges they face. AGMs are where shareholders have their say.
FMA's purpose is to "promote and facilitate the development of fair, efficient and transparent markets" and I believe the Shareholders Association's activities assist us in achieving just that. Can I also applaud the Association and its leadership for the constructive and open dialogue it has promoted with FMA since our inception in May 2011. We regard the Association not only as one of our most important stakeholders, but integral to our success in engaging with the investor market.
I see the title of my speech today is, "How the advent of FMA has created a sea change in the New Zealand regulatory environment."
That's a big statement for an organisation that has only been in existence for 15 months. We are ambitious though, and have set ourselves challenging targets for the first two years. We are well advanced to achieve them. When we review our progress to date and our heavy workload going forward, I think you'll agree that FMA is on the right track to achieve its key strategic outcome of "increasing confidence and participation in New Zealand's financial markets."
In fact we've just tested the effectiveness of our work in a soon to be released Colmar Brunton stakeholder survey. More than two thirds of respondents said FMA has performed well, and the large majority said their awareness of both FMA and its actions has increased in the past year.
There are a number of themes I would like to talk to today. They are:
• Lessons learnt from the finance company court cases;
• How we grow our pool of talented Directors;
• The Mixed Ownership Model programme and what it means for investors;
• Remedies for shareholders;
• How we ensure that within more diverse Boards, directors have sufficient financial knowledge to carry out their duties.
Directors' responsibilities have been the focus of continued court action - the most recent being National Finance and the guilty verdict of a director, Carol Braithwaite. Notably, Ms Braithwaite is the first director to be tried by a jury. She was found guilty by a majority of 11 to one.
This judgment, and the many others, should not concern diligent directors. In fact many directors, both privately and publicly welcomed these outcomes. Importantly, the judgments have provided valuable reference points for what is reasonably expected of directors in their governance role and duty of care. This case and those which preceded it in 2011 and 2012 have clearly established that finger-pointing and blaming each other is a flawed defence.
In July 2011, directors of Nathans Finance were convicted and sentenced to periods of imprisonment for making untrue statements in a prospectus. This case reinforced the responsibility that every director of an issuer has to provide truthful and complete information to investors.
In March this year, the four Lombard directors received non-custodial sentences for issuing misleading prospectuses and investment statements. The High Court found the documents failed to express the severity and imminence of the liquidity squeeze confronting the company. While external advice on documents was sought the case highlighted that director's obligations in regard to the accuracy of offer documents cannot be delegated. We now await the outcome of appeals in this case to be heard in early 2013.
In the Bridgecorp case, the Crown prosecutor told the High Court that directors Mr Rod Petricevic and Mr Rob Roest "manufactured a smokescreen of scenarios" to support their claim they knew nothing of Bridgecorp's deteriorating cash flows. These directors were charged on breaches of the Crimes Act, the Companies Act, and the Securities Act. While these directors were probably outliers in their offending, the prison sentences received reflect the seriousness of their offences in making false statements.
The Centro case across the Tasman is another example where directors were found to have breached their statutory duty to ensure financial information was accurate by the omission of significant liabilities, which were readily apparent to the Board.
In all these cases, questions were asked about the advice upon which directors relied. In short, the findings suggest directors are able to rely upon advice, but not unquestioningly. Directors have a duty to question assumptions, forecasts, and the quality of information presented to ensure it is true and correct. It's important that management understand that it is the directors who are primarily accountable to investors for the company's performance - hence the necessity for Board to test management's assurances.
While Boards will comprise of directors from a variety of backgrounds with expertise in different areas, they must all be sufficiently financially literate to adequately monitor the company's business and financial performance. It is clear that individual directors cannot hide behind the concept of collective decision-making - the collective whole of the Board does not provide immunity from individual obligations.
The failed finance companies raise questions about whether those companies had achieved adequate standards of corporate governance. Many of the directors of these companies, and others involved in the operations, weren't doing their jobs properly to the standard required by the law in relation to disclosure. I think it's also fair to say that the Chairman of many of the failed companies did not ensure they had an adequate level of skill and experience around the boardroom.
Another lesson highlighted is the serious mismatch of the risks that investors were prepared to take on and the returns they accepted for doing so. No matter how high the advertised return, many investors assumed that their capital and the promised return was guaranteed in perpetuity. This is not just a case of financial illiteracy, it's more than that and goes to the heart of the culture of New Zealand investors.
It could also be argued that, in part, there has been a failure of regulatory policy. Under a regulatory regime which would have required more rigorous standards of disclosure, would investors have been better-placed to be able to assess the risk / return equation?
The bottom line for directors is that if something is material it must be disclosed to investors if it might influence an investor's decision, including the timing at which an investor might acquire, hold or sell.
New Zealanders will only feel confident investing in if they believe companies are well managed, well governed, transparent and fair, and that they are receiving relevant and accurate information on a timely basis, devoid of window-dressing, or endorsements by celebrities.
For aspiring directors, the long roll-call of failed finance companies and the images of directors being sent to prison may cause them to think again before taking on the liability that comes with the job.
And while it's true that we can't afford to have bad directors making poor decisions, it is also true that we need sound directors prepared to take sensible commercial risks if corporations are to succeed and our capital markets grow. This should be at the forefront of shareholders' minds. It is directors after all who you entrust to set the strategy and grow the business.
New Zealand has around 5500 directors working for NZX-listed companies, not-for-profit entities and in the public sector.
In our recently issued guidance on Effective Disclosure, FMA addressed a number of areas relating to directors. Specifically:
• That directors cannot cede responsibility for what they include in their prospectuses to other people - they need to look holistically at the documents and ensure a balanced disclosure is made of risks and benefits (material matters to be disclosed would include related party transactions and other potential conflicts).
• The guidance also covers what we consider might be material information about the directors themselves - including independence- such as any shareholding in companies where they might have a beneficial interest (in a family trust or other) so we are definitely asking directors to think very carefully about matters of independence and what might be material to disclose in this respect to investors.
• We also have a section on related parties and transactions- and include examples of information that might be material and should be disclosed in this context, including disclosing how any conflicts of interest have been handled.
Then there is the Financial Markets Conduct Bill. Currently before the Commerce Select Committee, it is the outcome of a comprehensive review of New Zealand's 35 year old securities laws. It proposes some significant reforms, which include:
• Changes to disclosure - replacing the prospectus and investment statement regime with a single product disclosure statement tailored to retail investors;
• A modified liability framework for securities law breaches including criminal penalties for the first time for reckless and intentional breaches of directors' duties, as well as civil penalties for misleading information in disclosure documents and advertisements;
• Notably the draft Bill also amends the thresholds for civil and criminal liability for directors. It states that only the most serious, deliberate, intentional misconduct will attract criminal liability, while in less serious cases it prescribes civil action to recover compensation; and
• The Bill expands civil liability options.
The FMC Bill is expected to pass this year and come into effect in 2013. Regulations prescribing further detail will follow. Once enacted FMA looks forward to seeking compliance with and, where necessary, enforcing it.
So that is what FMA and Parliament is doing, but what about industry?
Good directors need not fear the current climate or the one that will emerge once the Financial Markets Conduct Bill is passed.
We need a high level of professionalism amongst directors, senior management and their advisers. Participants who operate with integrity and who act consistently in the best interests of their investors are an essential element for restored investor confidence.
In essence what we are seeking to bring about requires a culture change. If we are to lift our game, then it requires all market participants to take the new rules and responsibilities of conduct, governance and integrity seriously. What I can also say is that a bare minimum-standards approach (ie tick the box mentality) is unlikely to be enough. Competition between markets players will drive weak compliance-performers out of the market.
For FMA, the MOM sales programme is important in that it exposes New Zealanders to the workings of capital markets. Even if they choose not to invest, the amount of coverage in the media means people will be more financially literate as a result. For example, the glossary of terms feeding its way into the public is encouraging. They include:
• What are shares?
• What is a stock exchange?
• How many New Zealanders own shares?
• What are dividends?
• What makes share prices go up and down?
• Why invest in shares?
• Are shares guaranteed?
• Where do I get professional advice on investing in Share Offers?
• What is a stockbroker?
The role of FMA in the MOM sales programme is no different to the role it plays in other publically listed companies. FMA's job therefore is to ensure the Crown, and each of the MOM companies, comply with the Securities Act as an issuer of the shares.
FMA accepts that some limited information about the MOM Companies must be available in order to give a full and balanced description of the MOM Programme, so it has given an exemption notice allowing the Crown and MOM companies to provide information of a general educational nature about investment in securities. It is also the role of FMA to review each investment statement including details of the share offer.
Our message to potential investors is that they should look at the Offer Document/ Investment Statement and consider seeking professional advice. There are 2000 AFAs or authorised financial advisers who we now licence. They must be listed on the Financial Service Providers Register, so you can check for yourselves before appointing an adviser.
It goes without saying that as a result of the MOM sales programme, there will be more New Zealand shareholders. And while it's not the role of FMA to remove risk or stifle innovation, we do have a role to play in delivering tailored oversight of the markets.
FMA has increased powers of surveillance, regulation and enforcement. Our focus is on conduct that harms or presents the greatest likelihood of harm to the function of open, transparent and efficient capital markets. FMA has the powers to bring both civil and criminal action for misconduct by financial market participants. We will ensure criminal sanctions are used appropriately and do not create undue disincentives to participate in the market for businesses or individuals such as directors.
As you will know all of the failed finance company cases which FMA has been running over the last 15 months were criminal prosecutions. However, these were inherited from other agencies and we are determined to use the law appropriately as the facts of each case differ. That's why we commenced a civil action against the Hanover Finance entities, which includes a claim for compensation for investors.
Alongside our power to initiate civil and criminal proceedings (or to take "top of the cliff" enforcement or administrative action) is the power to initiate, take over and control civil actions against financial markets participants where FMA considers it is in the public interest to do so. This is known as our s34 power and it allows FMA to pursue civil proceedings against directors for breaches of their duties such as:
• The duty to act in the best interests of a company
• The duty to exercise care, diligence and skill
Until now, only the company, receivers, liquidators or shareholders could pursue such action. Now, FMA has the power to do this on behalf of shareholders, provided we meet a suitably onerous public interest test.
In saying that, the Act does not permit FMA to take a case merely because parties cannot or will not bear the cost of private litigation. The threshold for FMA taking a case is set high.
There are three principle considerations FMA will look at when deciding whether to use its s34 powers. They are:
1. Promote the fairness, efficiency and transparency of New Zealand's financial markets; and
2. Clearly advance FMA's regulatory objectives; and
3. Use FMA's resources effectively.
Many commentators and submitters sought to panic the directors and other market participants that FMA would use this power excessively resulting in an abuse of regulatory power. We are currently giving serious consideration to a number of possible investigations where we could bring such an action, but to date we have not commenced any such action, despite the dire predictions of the pessimists.
I want to come back to the recent case of National Finance director Carol Braithwaite who was found guilty of making untrue statements in a prospectus. During her trial Ms Braithwaite told the jury that she had become a director at the request of her de facto husband. She told the jury, and I quote, "I thought that's what wives did, they just became a director of their husband's company."
You won't be surprised to hear, and you may have read, some rather scathing personal views shared online about Ms Braithwaite's lack of experience. Some seemed to question whether women should even be allowed to sit at the boardroom table. I am here to tell you, categorically, that yes they should.
In fact we need more women in the boardroom. NZX knows this, and so it's going to introduce a Diversity Listing Rule which will be applied to annual reports for all NZX Main Board listed issuers. It will require them to:
• Provide a breakdown of the gender composition of their Directors and Officers; and
• If they have a formal diversity policy, give an evaluation of their performance with respect to that policy.
But as Boards move with the times to improve gender composition, they must also ensure the right support and training is provided to all its members, men and women.
All directors need to be financially literate and need to take responsibility to ensure that they and their fellow board members are sufficiently financially literate. Those who are more financially literate should take some responsibility for pointing the less financially literate in the right direction in terms of further training and those less financially literate need to actively seek out how to become more financially literate. It is a shared and individual responsibility among directors to ensure that they are up to the task. The Chairperson should ensure an appropriate skills and experience mix on the Board.
But might I also say that investors / shareholders have a role to play here too. It is for them to ask the right questions and read the right documents before they invest. It is for them to understand risk, and to decide whether given that risk, it is still worth investing their money. And it is up to them to seek advice.
Remember, all financial advisers in New Zealand are now required to be licensed or registered. We have licensed almost 2000 AFAs, and we're carrying out surveillance on a population of nearly 6000 RFAs. We're also supervising 62 QFEs who in turn are responsible for the compliance of an estimated 25-thousand QFE advisers. Expert help is out there. So use it. Regulators such as FMA are not here to sit in the boardroom to guide directors to make the right decision for investors and creditors. Nor are we equipped to look over the shoulders of investors and save them from making foolish investment choices. We set the rules, we monitor performance but we cannot penalise every breach nor anticipate every failure.
In summary, the role of the FMA is to create boundaries within which our regulated population takes responsibility for their own decisions. Management's core role is to make good judgments for which shareholders and FMA should hold them to account.
The right judgments depend not only on good governance but also a strong culture - one focussed on delivering the right long-term obligations to society. This requires a strong ethical foundation as well as the right people who make principles-based decisions, not ones driven by short-term commercial considerations. For FMA, that means that bare minimum (ie strict legal) compliance will never be enough, no matter how much the entity's lawyers tell them that it is. Directors, not their lawyers, need to decide what level of compliance risk the company should take. Markets need to evolve increasingly improving standards of behaviour, not remain static.
History tells us that good governance, the right culture and principled individuals are still not the complete answer, and FMA needs to have a credible enforcement capability and tool-box to bolster market integrity.
While some regulators talk about - at one extreme - a relationship with their regulated population of fear and - at the other -one of a partnership - I envisage a relationship between FMA and participants of constructive tension, yet mutual respect.
Such a relationship needs the following ingredients to be successful: recognition that the majority of participants are decent and honest (even if unwittingly ignorant) and recognition that good regulatory and business judgments should be aligned.
The end point should be both markets and entities that we can trust and which act in the best interests of their consumers / users.
And if we have that, then New Zealand's capital markets will be all the better for it.