'Second board' a no-man's land

The light regulation of the unlisted market offers advantages to companies but dangers to investors. ELLEN READ and SIMON HENDERY report.

Caveat emptor: It's certainly a case of let the buyer beware for investors on the New Zealand Stock Exchange's unlisted market.

Often called the "second board" or the "grey market", the unlisted market is facilitated by the exchange, but is not regulated by it.

In fact, the exchange is quick to disavow any responsibility for the market, and hates seeing it referred to as the second board, since that might appear to imply some link with the "real", listed market.

The whole point of the unlisted market is that the companies whose shares trade there are not subject to the restrictions of Stock Exchange rules; their behaviour is governed only by the law and by each company's constitution or trust deed.

This means some things are regulated by the Securities Commission, some by the Companies Office, some by the Commerce Commission, and so on. What that means in practice is that there is no single accountable person or authority who takes responsibility when things go wrong.

Even the task of ringing around to get information on the unlisted market results in an investor - or a reporter - being ping-ponged among the parties involved. No one is willing to make generalised comments on the market.

The Stock Exchange's lack of responsibility for what it describes as the Unlisted Securities Facility, or USF - is spelled out on its website: "Investors in the USF should be aware that the NZSE is not responsible for the dissemination of market announcements in respect of these unlisted issuers, it does not undertake any market-surveillance activities nor does it distribute any price data. The protection that the NZSE offers investors in a Listed Issuer does not exist for an issuer traded on the USF."

Or, in the words of NZSE managing director Bill Foster, "it's a market we facilitate but they're not listed companies".

He describes the market as a place where companies can learn about corporate governance and disclosure before stepping up to a full listing on the main board.

Securities Commission chairwoman Jane Diplock says many of the companies on the unlisted market do not want the work of complying with a full listing, and asks whether further regulating the unlisted board would deter them.

"In most areas there is an unlisted market. I mean people are free to trade in shares of companies that are not listed companies and when a company decides to list, as well as having the obvious liquidity advantages, it takes on a level of responsibility and some companies are not comfortable with that," says Diplock.

Asked whether there is enough regulation of these companies, she says, "It's certainly adequate in some aspects, and then difficult cases might show it to be wanting."

The commission has no plans to revamp regulation of the unlisted market, but Diplock says it does keep an eye on it and looks closely at those companies which come to its attention.

The Ministry of Economic Development, through the Companies Office, also monitors the unlisted market.

John McPherson, the ministry's manager of securities and company compliance, says the unlisted market does not generate much work for them.

"The reality is that we are a relatively lightly regulated market," he says when asked if regulation is adequate.

"Typically, the New Zealand investor is very uneducated about where they're putting their money".

Part of the problem with market control, says McPherson, is that even where things are prohibited by various acts, there is no punishment clause.

In 1994, the NZSE created an electronic "Bulletin Board" within its trading system that allowed member firms to advertise their interest in dealing in the securities of unlisted issuers.

This was replaced in 1995 when the exchange allowed the securities of unlisted issuers to be posted for quotation via the electronic screen-based trading system.

Securities are made available for trading through the exchange's Unlisted Securities Facility only at the request of an NZSE Member Firm.

Unlike listed issuers, which have a formal listing agreement with the exchange, unlisted issuers make no such agreement.

As a result, the exchange cannot enforce compliance in areas such as:

The release of price-sensitive information, including the timing of any dividends.

Governance principles.

Specified release of financial information.

Rules relating to directors.

Transactions with directors and associated parties.

Limits on unequal treatment of shareholders.

Minimum ownership rules.

And unlike the listed market, where the exchange issues frequent updates of share prices and trading activity, it does not provide any public information on activity in the unlisted market.

There are more than 60 companies on the unlisted market, and wine firms and biotech operations are particularly well represented.

One unlisted company whose lack of accountability has been a frequent source of frustration to shareholders is Wilson Neill Corporation.

Though the company has on a number of occasions been late to file annual returns and details of new share issues, it has not suffered the embarrassment of having its shares suspended, as can happen on the main board.

The company's tardiness has, however, resulted in directors being fined for breaching the Companies Act in relation to the late filing of share transaction certificates.

The Ministry of Economic Development is investigating the late filing of the company's latest accounts - due at the end of December but not sent to the Companies Office until February 20 - and directors could again find themselves being prosecuted.

One Wilson Neill shareholder, Ian Andrews, has fought a long campaign to make the company more accountable and says he has been constantly frustrated by its failure to answer his questions.

Andrews says he accepts that less-demanding rules should apply to unlisted board companies, but he would like to see a self-policing "right to be believed" standard adopted, similar to that used by Inland Revenue.

Under such a system, companies would be subject to random audits, follow-ups on information posted, and severe penalties if major breaches were discovered.

If Wilson Neill illustrates the perils of investing on the unlisted market, Wellington retailer Kirkcaldie & Stains is held up by market participants as an exemplary unlisted company, and one which made a successful transition to the main board last year.

Kirkcaldie's finance manager, Nicholas Bartle, says last May's transition was easier because since 1995 the company has had a policy of voluntarily complying with the exchange's listing rules when possible.

Its listing profile compiled at a cost of about $60,000 lists some of the benefits of making the move to the main board, including heightened awareness of the business and greater ability to raise capital.

"Historically, probably more than 80 per cent of our [1650] shareholders have been in and around Wellington," says Bartle.

"But the fact that we are listed is raising the company profile and we are noticing a gradual shift to shareholders further afield."

In December, Kirkcaldie announced a rights issue to help find the $29 million needed to buy the Harbour City Centre, on Lambton Quay, Wellington.

Bartle says the rights issue would have been possible if the company had remained on the secondary board, but was easier on the main board.

"The whole set-up is geared for that sort of thing."