Jane Diplock: On track for right balance of regulation

Jane Diplock

With the spate of finance company failures over the past two years, many small investors have lost much of their life savings. Investor confidence has taken a big hit. Not surprisingly, fingers have been pointed - at directors, trustees, advisers and regulators.

Investors have a right to be angry. The light-handed regulatory regime let them down. It is clear that this sector was under-regulated. There were gaps in the regulatory regime in relation to certain aspects of prudential oversight and competence frameworks for some of the players. These regulatory gaps are now filled or being filled.

At the time of the failures the Securities Commission had limited disclosure-based oversight. It could not regulate finance companies, trustees or advisers.

However, we cannot ignore the fact that investments come with risk and no regulatory framework can or should prevent failures. The question today is: What is the right balance of regulation?

The need for reform was highlighted in 2002 by the findings of a review of the financial sector by the International Monetary Fund and World Bank. The commission has been active in promoting reforms with the Government but they take time. Last year significant new laws were passed.

The Reserve Bank was made the prudential regulator of finance companies and other non-bank deposit takers. An aspect of this, is that finance companies will have to be rated by independent ratings agencies.

The Financial Advisers Act provides for the commission to authorise and supervise financial advisers. When the law is in force financial advisers will be more accountable and investors will have greater confidence in their professionalism and integrity.

In addition, in 2007 the commission recommended urgent changes to regulations to strengthen reporting by trustees and give them extra powers to obtain information to carry out their job properly.

These reforms fit in with the proven 'twin peaks' model which involves two distinct roles: a prudential regulator (the Reserve Bank) and a regulator of market conduct (the commission). This model is being emulated in other parts of the world in response to the financial crisis.

The Registrar of Companies' recent report to Parliament highlighted shortcomings in the trustee framework.

The Minister of Commerce has initiated a review of the role of trustees and is considering fast-tracking the supervision of trustees by the commission. This is part of a broader review of the Securities Act by the Ministry of Economic Development.

As the conduct regulator, the commission has powers to take action regarding offer or disclosure documents. This puts the onus on directors and issuers offering investments to provide full and accurate information to enable investors to make properly informed decisions.

It is, after all, only the directors who can be fully aware of the state of their company. They are responsible for signing off the offer documents and must be held responsible for the failure of companies where they have neglected their duty of care.

This is why the commission continues to stress the importance of good corporate governance and provides guidelines for directors. Where the commission finds that a prospectus may contain false or misleading statements we can take action.

We can only intervene if a company does not provide the required information for investors to make a decision on whether to invest. Like any enforcement agency we need reasonable cause to investigate. Often this arises only once the company has failed.

We have taken action in a number of cases. We prohibited advertisements and suspended prospectuses where we could be satisfied that they were misleading and several prosecutions are under way.

The commission also undertook a review of reporting and disclosure by finance companies. We have time and again emphasised the need for this sector to improve its disclosure standards.

As early as September 2004 the commission warned investors about risks associated with investing in finance companies and that investors must recognise the high level of associated risks. In November 2007 we began a campaign, including advertising in the business pages, giving basic information about making investment decisions, with a particular focus on risk.

These messages were at a time when the New Zealand economy was booming and a downturn in the property or share market was far from people's minds. It was easy for investors to ignore these messages.

Discussions on the right balance of regulation had begun well before the finance company failures had reached their height and they will continue. It is an important debate for the future strength of our securities market.

Jane Diplock is the chairwoman of the Securities Commission.