Major revamp after ASX's 'under-arm bowling'

By Frank Chan

Friday 16th November 2001

Frank Chan

The new Securities Markets and Institutions Bill represents a remarkable and timely policy shift for the government, the Securities Commission and the New Zealand securities market.

Remarkable, because it is the first major revamp of securities market regulation since insider-trading and substantial securityholder rules were introduced in late 1988. Timely, because our exchange is in the midst of restructuring and the bill follows last month's Australian Stock Exchange (ASX) announcement of plans to jettison foreign-exempt listings, including New Zealand issuers on the ASX, from the middle of next year.

Somewhat controversially, the exchange will effectively be subject to directions from the commission. Until now, the exchange and the commission have co-operated informally. This will now be formally recognised. The exchange's rules are to be approved by the commission. More importantly, the Securities Commission has been given enforcement powers. However, the missing piece of regulation, market manipulation rules, has yet to emerge, although it has been promised by the government.

Two of the reforms that will significantly change the landscape for public issuers are the changes to insider trading regulation, and the introduction of statutory continuous disclosure in tandem with a "disclose-as-you-trade" rule for directors and officers.

For a number of years, market participants, commentators and not least the Securities Commission itself, have called for changes to New Zealand's laws on insider trading.

Due to its limited powers and funding, the commission's insider trading enforcement role is in no-man's land. It plays a minor role by observing and having a limited gatekeeper function. The principal right of action rests with the public issuer to recover the benefit received by, gains made or losses avoided by, and up to triple damages from an alleged insider.

Enforcement is available, and in practice has been left to shareholders or former shareholders to apply to the court for leave to bring the company's action against an insider. The commission merely approves applications by shareholders to require the issuer in question to obtain an opinion on whether or not the company has a cause of action.

This private enforcement of insider trading rules in New Zealand has been long considered ineffective and cumb-
ersome by both public issuers and shareholder plaintiffs. A great deal of time and money have been spent without a successful action. A shareholder bringing the action is insulated from costs because they are borne by the issuer.

The practical effect of this has been quite the opposite of what was intended. Private claimants have settled out of court, more often than not for considerations of cost. The reported cases are more about procedure than allegations of insider trading.

Rather than to start afresh and reject the insider-trading enforcement regime that in many people's eyes has clearly failed, the existing regime has been modified. The commission is given standing to take action by exercising the public issuer's rights against an insider.

The requirement for an opinion on whether there is a cause of action with the commission's approval has gone. The commission can bring its own action or take over an existing action if it is in the public interest. The commission has been given teeth, but whether or not and in what situations it will bite remains to be seen.

In this instalment, the government has not made insider trading a criminal offence. It has promised to look at criminal penalties in the near future.

The second significant change proposed is that public issuers will face what is likely to be a tougher and more costly continuous disclosure regime. This is a clear attempt to come into line with our CER partner.

Foreign-exempt issuers on the ASX are currently not required to comply with the equivalent Australian regime. There has been some speculation that the ASX's recent proposal to toughen its stance on foreign exempt listed issuers stemmed from the absence of continuous disclosure in New Zealand.

Directors and officers will also have to publicly disclose trades when they occur (over and above substantial securityholder disclosure).

Right now, relevant information disclosure is governed by the listing rules of the New Zealand Stock Exchange. Under the proposed law, material information must be disclosed immediately after an issuer becomes aware of it, or ought reasonably to be aware of it. Material information that a director or officer is or ought reasonably to be aware of is deemed to be material information that the public issuer is or ought to be aware of.

The new law in essence means information that was of greater value to the issuer that would previously have remained confidential, will no longer remain undisclosed for that reason alone. Material information is information about the public issuer that a reasonable person would expect, if it were generally available to the market, to influence persons who commonly invest in deciding whether or not to buy the securities.

By comparison, the ASX listing rules are aligned with the statutory liability for breach. The ASX monitors compliance and the ASIC is responsible for enforcement.

The ASX Listing Rules require disclosure if a reasonable person would expect that information to have a material effect on the price or value of the securities. This is deemed where the information would or would be likely to influence persons who commonly invest in securities deciding whether or not to subscribe for, buy or sell the securities. In short, this is no different from the proposal.

Under the ASX listing rules, disclosure is not required where a reasonable person would not expect disclosure, that is confidential to those not able to trade and it is in one of the restricted categories.

What is clear from Australian experience is New Zealand issuers will face higher compliance costs. For example, the ASX considers minimum best practice is a website containing information. Agreements that were not disclosed because of confidentiality provisions will likely be required to be disclosed. Issuers will need to be both pro-active and reactive to market information.

Frank Chan is a partner of law firm Hesketh Henry specialising in securities law

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