Brian Gaynor: Unlisted, unregulated: buyer beware

Widespread enthusiasm has greeted the announcement that M-co, former stock exchange chief executive Bill Foster and other investors are establishing Unlisted, a new unregistered share-trading platform.

The beauty of the new market is that it will be almost totally unregulated. Directors and management won't be burdened by corporate governance requirements, insider trading laws or continuous disclosure rules.

They won't have to waste time obtaining shareholder approval for related-party transactions or seeking waivers from listing rules because there will be no listing rules. There will be no requirement to make applications to a surveillance panel because there will be no surveillance panel.

The new market should rekindle the entrepreneurial spirit of the 1980s. That was a period when directors and management could focus exclusively on making money for themselves and their shareholders. They didn't have to waste time on regulatory or corporate governance issues. The era produced some extraordinarily high growth companies, including Chase, Equiticorp, Robt. Jones Investments, Capital Markets and Judge Corporation.

The 1980s was a landmark period for New Zealand business. Stockbrokers made a tonne of money and it was unfortunate that a totally unrelated current account problem in the United States in October 1987 took the steam out of our supercharged companies.

The promoters of the new share-trading facility believe that listed companies are subject to too much high-cost regulation. They believe that Unlisted's low-cost, low-regulation platform offers a viable alternative, even though the New Zealand Stock Exchange became becalmed when Bill Foster implemented this policy in the 1990s.

The unlisted market will have two types of listings: one for companies that do not want to follow any rules in excess of their statutory regulations, and the other for blue-ribbon companies, those that comply with a set of governance rules that have yet to be determined.

There won't be much incentive to comply with these governance rules because if a company does, and receives the blue-ribbon status, its listing fee will increase from $5000 to $12,000 a year.

Unlisted's promotional material highlights the benefits of the new market as far as companies and stockbrokers are concerned but there is little mention of investors.

The press release from M-co makes no reference to investors and it sums up the new market with the following comment: "Unlisted is intended to provide a marketplace and greater liquidity for the benefit of small- to medium-sized businesses".

Additional promotional material outlines the benefits of the new market to stockbrokers. This includes no joining fees, a nominal trading charge (no fees will be charged until next January 1) and the low-cost nature of the internet trading facility.

The new facility seems to be based on the traditional New Zealand view that equity markets should be run for the benefit of companies and stockbrokers and it is buyer beware as far as investors are concerned.

Unlisted is being set up in opposition to the stock exchange's new AX (Alternative Market) market, which is due to open before the end of the year. AX is being established to attract companies from the existing unlisted facility run by brokers on the NZX's computer system.

The NZX believed that the unlisted market was not achieving its full potential as investor interest was limited due to the unregulated nature of the market. The AX is seen as a stepping stone to bigger things because as soon as AX companies achieve a market value of $15 million, they will migrate to the main board.

The big advantage of the AX market is that listing fees are slightly lower than the main board. Regulatory requirements are less onerous but investors will still have a far higher level of protection than on the Unlisted facility.

How can we have two equity trading facilities in direct competition with each other yet one complies with statutory requirements and the other doesn't?

The simple answer is good old Kiwi ingenuity - it appears that M-co and its fellow investors have found a loophole in the law.

At the end of last year new requirements regarding the registration, conduct and control of securities exchanges were enacted under Part 2b of the Securities Markets Act. This statute was supposed to ensure that all public share-trading facilities would be regulated but it was poorly drafted and is easily circumvented.

Effectively, the act says that no organisation can use the words "stock exchange" or "securities exchange" without registering under the act, and no organisation can operate a securities market without registering. Registration means that a facility has to be fully compliant with securities regulations.

The proposed Unlisted facility, being promoted by M-co, is not being called either a market or an exchange in an attempt to evade registration under the Securities Markets Act (Unlisted calls itself an unregistered trading platform).

The NZX is extremely annoyed that Unlisted can avoid all statutory regulation when it is putting a huge effort into lifting disclosure, governance and regulatory standards in New Zealand.

The use of a legal loophole is surprising given the background of some of the people involved in Unlisted. Bill Foster headed the stock exchange, Rob Cameron and Brian Kreft were members of the old mutual stock exchange and M-co chief executive Chris Russell has had a disturbing experience with the lightly regulated New Zealand sharemarket.

On November 13, 1990, Russell and his brother, Tim, bought a 49.3 per cent stake in Euro-National (now called CDL Hotels) for $18.2 million. Most of the purchase price was financed through a stockbroker based in Penang, Malaysia.

Three days later, the Euro-National board decided to invest $21.1 million in an option to subscribe to a planned new listing on the Indonesian Stock Exchange. This transaction would now be captured by stock exchange listing rules but there would be no requirement for shareholder approval under Unlisted.

To cut a long story short, the money was taken to Kuala Lumpur and nearly disappeared into a bogus investment promoted by Malaysian interests. The money was saved by Mark Chennells, an Euro-National executive, who smelled a rat, but a few months later the Russells were forced to sell to Hong Kong interests and the new controlling shareholder invested the company's money in Eurobonds at 30 per cent above the market price.

Not only did Chris Russell have an unfortunate exposure to our relatively unregulated market but he is also the son of the late Sir Spencer Russell, chairman of the 1989 committee of inquiry into the sharemarket.

The committee recommended that New Zealand should have strong and enforceable securities laws consistent with international standards because there had been a major loss in the rule-making structure, in ethical standards and in the general integrity of the sharemarket.

None of Sir Spencer's recommendations was implemented.

The backbone to the new Unlisted platform is expected to be Skyline Enterprises, the Queenstown gondola, restaurant and luge operator that has an unlisted market value of $180 million. Barry Thomas, the driving force behind Skyline, is one of Unlisted's investors.

But how many other firms will sign up? How many investors want to return to the pre-1987 era when there was no continuous disclosure, Takeovers Code, restrictions on related-party deals, corporate governance standards, substantial security notices or insider trading rules?

Unlisted will be running by mid-October and NZAX shortly after. The relative popularity of the two will give a strong indication of the business sector's desire to turn back the clock to the free-spirited days of the mid-1980s.

* Email Brian Gaynor