Gaynor: Swain's law opens up the market

By BRIAN GAYNOR

The winds of change are blowing strongly through the New Zealand sharemarket and they will intensify this year.

The Takeovers Code came into force on July 1, and in the next 12 months the New Zealand Stock Exchange will be demutualised and the Securities Markets and Institutions Bill should become law.

The bill will have a dramatic impact in several areas:

* The Securities Commission will have far more teeth to enable it to oversee securities markets effectively.

* A continuous disclosure regime will require listed companies to disclose immediately all material information to the market. The Securities Commission rather than the Stock Exchange will enforce this.

* Directors and senior executives will be required to report all share transactions to the Stock Exchange within five trading days.

* The insider trading rules will be tightened and the Securities Commission given enforcement powers in this area.

* Penalties for breaches of securities regulations will be substantially increased.

Commerce Minister Paul Swain, the principal promoter of the bill, is showing a remarkable ability to push through important securities regulation reform when previous ministers failed miserably.

The Ministry of Economic Development has released two public discussion documents relating to matters in the bill.

The first, in September 2000, on insider trading, raised several issues related to continuous disclosure, directors' duties and the role of the Securities Commission.

The second, in May 2001, looked at the functions of the commission and Takeovers Panel.

Submissions on these documents form the basis of the bill that had its first reading just before Christmas. The bill, which has priority classification, is with the finance and expenditure committee and public submissions will be accepted until February 8.

The committee is due to report back to Parliament in June, and Mr Swain will be making a big effort to have the bill passed into law before Parliament goes into recess in late August or early September for the election.

The bill establishes the Securities Commission as the statutory regulator with a mandate to oversee securities markets.

This was one of the principal recommendations of the 1989 Committee of Inquiry into the Sharemarket (the Russell Report) and it has taken more than a decade for it to be turned into legislation.

The bill signals a fundamental shift in the commission's functions, from a general monitoring agency with limited powers to an investigatory and enforcement body with greatly enhanced authority. The change will align the commission more closely with the Australian Securities and Investment Commission and other equivalent regulators.

The commission will have several additional powers:

* It will be the public enforcement agency for insider trading and continuous disclosure by listed companies.

* All Stock Exchanges operating in New Zealand will have a statutory obligation to provide information on breaches of securities law to the commission.

* It will have the power to issue directions to a securities exchange, including the ability to order an exchange to suspend a company from trading.

* The commission will advise the minister on any proposed changes to Stock Exchange rules, and the Governor-General, through the minister, will have power to disallow changes to these rules.

This is a significant change as the New Zealand Stock Exchange until now has been a totally independent body that has made its own rules after only limited consultation with outside parties.

The big question is whether the commission will have enough money to carry out its new role. In the June 2001 year it had total revenue of $2.9 million, of which $2.3 million, or 79 per cent, came from the Government. In the same period the Australian Securities and Investment Commission had total income of $A144.2 million ($177 million) of which $A131.6 million ($162 million) or 91 per cent was Government sourced.

Jane Diplock, the commission's new executive chairwoman, is highly regarded but she will need far more Government money if her organisation is to do justice to its new role.

The continuous disclosure regime has been modelled on Australian law and is consistent with the goal of closer coordination between New Zealand and Australian business law. This is reflected in the Memorandum of Understanding on Business Law Coordination signed by the New Zealand and Australian Governments in August 2000.

The essential principle of continuous disclosure is that all price-sensitive information is released to a wide audience as soon as possible.

The bill will outlaw the practice where new companies specifically state they will not update prospectus forecasts and where established companies release selective information to analysts who generally have a positive view of them.

The continuous disclosure rules would have applied to the recent profit announcement by Wakefield Hospital.

On November 16, Wakefield announced a dreadful interim result and indicated that earnings for the full year would be about 50 per cent below the August prospectus forecasts.

The Market Surveillance Panel determined that the company had been aware that the prospectus forecast would not be achieved at least two weeks before the announcement, but no penalty has been applied to Wakefield or its directors.

Under the new Securities Markets and Institutions Act, Wakefield directors could be personally liable to investors who had bought shares at inflated prices before the November 16 announcement.

The continuous disclosure requirement aims to reduce insider trading, as does the requirement for directors, managers and company secretaries to disclose all securities transactions within five working days.

The release of this information to the Stock Exchange will be watched with interest as insiders' share transactions are closely monitored on most overseas markets.

The requirement to report a transaction immediately might have made Fletcher Challenge chairman Kerry Hoggard think twice before he bought a large number of the company's shares just before an important announcement in December 1999.

The biggest change to the insider trading laws is that the Securities Commission will be able to take an action against an alleged insider. Up to now only the listed company or aggrieved shareholder had this right.

This will strengthen the insider trading statute as listed companies have been reluctant to take action against their own directors and the exercise is too costly for individual shareholders.

Finally, penalties for breaches of the regulations increase dramatically, although they still seem remarkably low, particularly for the larger organisations.

For example, the maximum fine for mis-statements in advertisements or a registered prospectus will go from $25,000 to $300,000, with a further fine of $10,000 for every day the offence continues. This is relatively small, particularly for a company raising more than $200 million from the public.

The Australian Securities and Investment Commission has regularly complained that it cannot fine companies directly and has to take them to court for breaches of continuous disclosure requirements. This is costly and breaches of these rules can be difficult to prove in court.

By comparison, Britain's Financial Services Authority has considerable powers to levy financial penalties.

Under Mr Swain's bill, the commission cannot fine companies or their directors and will have to take them to court. This is time-consuming and costly and will create enormous frustrations for the commission.

The legislation is long overdue and is generally in the right direction. In theory, it brings New Zealand's securities regulations more into line with the rest of the world, although it will not fulfil its full objective until the Securities Commission is realistically financed.

* bgaynor@xtra.co.nz