After some delay the Securities Legislation Bill was passed on 12 October 2006 as four separate Acts. Most of the Securities Act and Takeovers Act changes came into effect after their assent on 24 October but some, such as the new insider trading and market manipulation provisions, will not come into force until regulations relating to the new provisions have been finalised. Here we provide an update on the events leading to the passing of the securities legislation and outline of the key changes under each of the amendment Acts.
The Securities Legislation Bill took nearly two years to make its way through the system and has been the subject of much controversy. One might have expected more media coverage following its passage into law but there has been little to date. This is no doubt in part due to the fact that we are still waiting on regulations to come through before some of the key provisions can take effect. It is however a major new suite of legislation and is likely to have wide implications for market participants. The legislation was passed as:
The Securities Legislation Bill was stalled to allow the Ministry of Economic Development (MED) to address some outstanding gaps identified by market participants after the Bill emerged from the select committee process. The gaps were addressed in the form of a Supplementary Order Paper (SOP No.59) which was released in September. A further Supplementary Order Paper (SOP No. 58) divided the omnibus Securities Legislation Bill into four separate bills.
One of the key changes requested by market participants was related to concerns that advisers acting in a professional capacity could find themselves inadvertently in breach of the new insider trading provisions. This would have had serious consequences for a number of normal commercial transactions especially in the context of intending bidders acting on advice from corporate advisers and/or officers or executives of the bidder.
The Government had indicated that this was not intentional and through the SOP has added provisions to the Securities Markets Amendment Act to clarify that an adviser acting in a professional capacity will not be in breach of the "no dealing", "no disclosure", and "no advice or encouragement rules" in the new insider trading provisions (namely, sections 8D and 8E of the Securities Markets Act).
The other substantive changes arising from SOP (No 59) include:
The passing of the new securities legislation amendments represents the completion of part three of the Government's four part securities and financial market reform programme.
The Government began its shift in direction on securities law in 2000 with the introduction of the Takeovers Code in 2001. This was followed in 2002 with the reform of the stock exchange and the regulation of listed issuers. The fourth and final part of the securities reform programme is currently under way as part of the Government's Review of Financial Products and Providers. This addresses issues relating to securities offerings under the Securities Act 1978.1
The key components of the latest legislation includes:
There are also substantive changes to the way these laws can be enforced through wider powers given to the Securities Commission and the Takeovers Panel and harsher penalties for those found in breach of the law.
A brief outline of the key amendments in each Act are set out below.
The Securities Act 1978 establishes the Securities Commission and regulates offers of securities "to the public" in New Zealand. As noted above, changes to the provisions relating to securities offerings under the Act are to be dealt with in part four of the Government's securities reform programme. However in this round of changes, the Securities Act has been amended to strengthen the Securities Commission's enforcement options under the public offering provisions of the Act. The amendments to the Securities Act include:
The SMA (under the Securities Markets Amendment Act 2006) has been subject to substantial amendments in this round of reforms. However, none of the amendments will take effect until an Order in Council is made on the promulgation of regulations currently being drafted. The MED website indicates that this is not likely to be before the middle of 2007. The amendments to the SMA include:
The key provisions for the amendments in Part 1, the disclosure regimes and the new Part 5 of the SMA are outlined below.
The insider trading reforms reflect a new rationale for the prohibition of insider trading and are based on the Australian insider trading provisions. The philosophy behind the new philosophical approach is to treat insider trading as involving harm to the integrity and efficiency of the market as a whole. Consistent with that philosophy, a person's status as an "insider" no longer depends on their connection with the public issuer itself. Formerly, a person was only an "insider" if they received the information directly or indirectly through their relationship with the public issuer.
Under the new legislation, the insider trading prohibition applies to any person described as an "information insider" who "has material information" that is "not generally available to the market" and who "knows or ought reasonably to know" that this is the case. Information is "material information" where "a reasonable person would expect it to have a material effect on the price of the relevant securities if generally available to the market".
As under the present law, the proposed new laws prohibit an information insider from trading, disclosing information or encouraging or procuring another person to trade (tipping).
The new feature of these prohibitions is the introduction of liability where the disclosure of information, or the advice or encouragement, results in a person deciding to hold securities. This feature is not present in the Australian legislation. It also introduces a necessary asymmetry into the prohibitions because there is no prohibition on an information insider itself deciding to hold securities where the person has inside information (for obvious reasons).
Given the breadth of the prohibitions, the defences are especially critical to the operation of the legislation.
There is an extended range of defences to the new insider trading liability provisions. Briefly these include:
There are also new affirmative defences where:
In addition, the existing Chinese Wall defence is retained.
There is however a significant gap in the defences with the removal of the Approved Procedure for Company Officers2 which permits company directors and executives to trade during designated window periods provided they comply with the procedure approved under the existing regime.
The Government's view is that these procedures cannot be justified under a law that is based on market efficiency or fairness. Under the new model, directors and executive trading is required to take place at the times when the market is clearly informed about the company and when the directors/executives in question are not in possession of inside information.
In practice this will mean that directors/executives will always have to go through a process to determine whether they have "material" information classed as inside information before trading in shares. 3
A further possible avenue for exclusion from insider trading provisions is through the power under the Act to make regulations for the purposes of exempting conduct from being insider conduct. This is to ensure that market efficient conduct will not be caught under the new regime. The Government has also stated that its aim is to provide certainty for market participants where there may be a risk that a particular behaviour will be caught by the legislation. At this stage it is envisaged that such regulation will be made only in respect of passive investment instruments such as index funds and exchange-traded funds.
The insider trading reforms will not take effect until these regulations have been finalised.
As under the previous legislation, civil liability arises for anyone who contravenes the insider conduct prohibitions. This includes pecuniary penalties and management banning orders. The new legislation retains those civil penalties and goes further by imposing criminal liability if the defendant had actual knowledge of certain elements of the offence.
The sanctions prescribed by the new legislation are substantial. Individuals face a maximum penalty of five years' imprisonment and a $300,000 fine. Bodies corporate face a $1,000,000 maximum fine. The imposition of criminal liability is especially grave given that the ordinary criminal standard of guilt beyond reasonable doubt is not required.
For further commentary on the new insider trading regime, please refer to the article by Bell Gully Partner, Roger Partridge, "Insider Trading Reform".
Another key area of change under the new regime is the introduction of dedicated provisions prohibiting forms of market manipulation (or market rigging).
Insider trading and market manipulation issues are closely linked. They both involve a person having some prior knowledge of the likely effect of the information they have acquired and using this information to gain some transactional advantage.
The Government saw the lack of any dedicated laws against market manipulation as one of the most obvious gaps in New Zealand's securities markets regulation when compared with other countries.
The legislation creates three new offences for manipulating or interfering with the operation of a securities market. The rules are intended to prohibit practices that are considered to impermissibly affect the price of listed securities and distort the operation of the market in listed securities.
The three offences are set out in sections 11, 11B, 11C and section 13 of the SMA.
Under section 11, it is an offence to make a statement or disseminate information if a material aspect of that statement or information is, and the person knows that it is, materially misleading. In addition, under section 11B a person must not do or omit to do anything that will have the effect of creating or causing the creation of a false or misleading appearance with respect to the trading of securities or the supply of, demand for, price or value of those securities.
There is a rebuttable presumption under section 11C that a defendant has breached section 11B in two situations:
The presumption under section 11C will not apply if the defendant establishes on the balance of probabilities that the trading in securities occurred for a legitimate reason, that the defendant was acting on behalf of another person, or that the defendant neither knew nor ought reasonably to have known that no change in beneficial ownership would result.
Finally a new section 13 introduces a general catch-all prohibition against misleading or deceptive conduct, in relation to any dealings in securities, similar to that which currently exists under the Fair Trading Act 1986.
There are four exceptions to the market manipulation offences:
The MED has acknowledged that the breadth of the prohibitions may require regulations exempting certain forms of efficient and desirable market conduct from the operation of the rules. There are three such exemptions presently under consideration:
As for the insider trading provisions, the market manipulation provisions will not come into force until the regulations have been finalised.
The continuous disclosure and directors' and officers' disclosure regimes under the SMA remain substantially unchanged. Mostly the amendments are in the form of consequential changes to the penalty and remedy provisions.
However as noted above, a last minute change in the SOP now includes in the SMA a provision to protect a person from liability for contravention of an issuer's continuous disclosure obligations if the person has taken reasonable steps to comply with the obligation.
The review of the substantial security holders' disclosure regime indicated that on the whole the existing system works well. The amendments do however attempt to simplify the previous regime by requiring disclosure of relevant interests by class of securities in respect of listed voting securities only (although this is to include classes of listed securities that are convertible into voting securities). The intention is that these changes will clarify the situations in which disclosure is required and reduce compliance costs over the medium to long term.
A new power is also given to the Securities Commission. In addition to the four existing mandatory "event" disclosure obligations the Commission now may require persons to disclose all relevant interests that the person has in the securities of a public issuer and all powers that the person has to acquire a relevant interest in the securities in the public issuer. The Securities Commission may require disclosure of any relevant interests in securities whether they are voting interests or not, listed or unlisted, or issued or yet to be issued. The Government has indicated that the Commission would exercise such an order upon being satisfied that the person is, or may be in the future be, entitled to control or influence significant voting rights in the issuer.
The 1997 regulations relating to the disclosure regime will require amendment to give effect to the new substantial obligations and are being considered by the Government at present.
One of the major changes in the new legislation is the complete overhaul and improvement in the enforcement powers and remedies available for breaches of securities trading law. These have been collected into a new Part 5 of the SMA and include:
The Commission orders include:
The Act provides that it is a criminal offence for a person to breach a Commission order. The courts' enforcement powers include injunctions and interim injunctions, corrective orders and disclosure orders, as well as the civil remedy provisions and criminal sanctions. These remedies exist in addition to automatic or discretionary management banning orders.
The Takeovers Act and the Takeovers Code have been altered by the Takeovers Amendment Act in four significant areas:
Apart from the new market manipulation provisions (dealing with misleading and deceptive conduct) in sections 44B, 44C and 44DAA of the Takeovers Act and in the new Part 8 of the Takeovers Code, all of the Takeovers Amendment Act provisions came into effect on 25 October. The market manipulation provisions will come into effect once the regulations for the new SMA provisions have been finalised. At that time, the Fair Trading Act will no longer apply to misleading and deceptive conduct that is regulated by the Code and the Takeovers Act.
For further details on these amendments visit the Takeovers Panel's website for their latest issue of their newsletter "Code Word" at http://www.takeovers.govt.nz/.
The amendments to the Fair Trading Act 1986 follow on from the changes made to the Securities Act, SMA and the Takeovers Act. Under the Fair Trading Amendment Act 2006 two new sections have been inserted to:
A further section authorises the Commerce Commission to share information with the Securities Commission and the Takeovers Panel. As noted already, similar provisions have been added in the other legislation to allow the Securities Commission and Takeovers Panel to do the same.
The MED released a discussion document on the Securities Legislation Bill regulations in March.
As noted above, the four areas in the new legislation that require regulations to be passed to bring into effect substantial obligations in the Securities Markets Amendment Act and the Takeovers Amendment Act are:
investment advisers and brokers disclosure obligations;
substantial securities holders disclosure;
insider trading exemptions; and
market manipulation exemptions.
Submissions on the discussion document closed in May 2006 and the MED website indicates that policy proposals for the regulations will be sent to Cabinet before the end of 2006 followed by draft regulations to Cabinet in April 2007.
Most of the Securities Act amendments and Takeovers Act amendments (aside from the market manipulation provisions in the Takeovers Act and Code) came into effect after their assent on 24 October 2006.
However, the Takeovers Act amendments relating to market manipulation, and all of the amendments to the Securities Markets Act require regulations to be promulgated before the amendments can come into force. This is not likely to be before the middle of 2007.
To view more background information on this topic visit the Ministry of Economic Development's website at http://www.med.govt.nz/.
The introduction of the new insider trading regime and market manipulation provisions combined with the removal of the Approved Procedure for Company Officers means that all listed companies (if they have not already done so) should revisit their securities trading policies for their directors and employees as soon as possible. Bell Gully will be contacting listed company clients on this aspect as part of assisting clients prepare for the new provisions coming into effect.
Clear guidelines and procedures should be provided to cover situations where directors and/or employees are in possession of price sensitive information which has not been made public. It may also be advisable to extend these policies to apply to any other person (such as advisers and consultants) who may possess inside information from time to time.
It will be important in formulating the new guidelines to clarify the scope of what constitutes inside information. In particular, it should be made clear to directors and employees that it is no longer possible to focus just on information received from or through the director's or employee's relationship with the company. As noted, under the new regime all information that is potentially relevant to the price of the company's securities is important.
Preventing any appearance of insider trading can be equally as important as preventing an actual breach. Some of the steps that can be taken to minimise this risk include:
It is important to remember that under the new insider trading regime, if trading windows are used these time periods will not operate as a defence to the legal prohibitions. Trading during the specified periods should be always made subject to compliance with the insider trading provisions and separate approval requirements. From now on, trading windows can only be used as a management tool in relation to risk.
Trading under a fixed trading plan or under options with a fixed exercise price is now an affirmative defence under the insider trading regime. The defence is however very narrow in its application.
A fixed trading plan is one that does not give the investor any right to withdraw before the end of a specified period nor must it be subject to any influence by the investor as to trading decisions after the plan has begun.
Directors and other affected employees will therefore need to review existing share trading and option incentive plans to check if they comply with the defence. If they do not, it may be worth considering amending the scheme to allow directors and employees to participate in a scheme without risking being in breach of the new insider trading regime.
A further area that may need to be reviewed by professional service firms, in particular, is the practice of using "stop lists" to prohibit members of the firm from trading securities where the firm has inside information. This arises from the addition of a new prohibition to the insider trading regime which provides for liability where the disclosure of information, or the advice or encouragement, results in person deciding to hold securities. Arguably, this new prohibition may put firms using "stop" lists at risk of liability for tipping members of the firm to "hold" their shares.
1 For details on this review see the Recent Developments section in this issue of Commercial Quarterly.
2 Insider Trading (Approved Procedure for Company Officers) Notice 1996 and Schedule
3 Please refer to the Practical Implication section of this article for Bell Gully's recommendations on how listed issuers should address the removal of this defence.
For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.