Stephen Layburn

Introduction

In the UK, sporting organisations seeking public funding for sport and physical activity must meet new gold standards of governance considered to be among the most advanced in the world.

A new Code for Sports Governance sets out the levels of transparency, accountability and financial integrity that will be required from those who ask for Government and National Lottery funding from April 2017.

The Code has three tiers and will apply to any organisation seeking funding from Sport England or UK Sport, regardless of size and sector, including national governing bodies of sport, clubs, charities and local authorities.

The Code is proportionate, expecting the highest standards of good governance from organisations requesting the largest public investments, including:

 

• Increased skills and diversity in decision making, with a target of at least 30 per cent gender diversity on boards;

 

• Greater transparency, for example publishing more information on the structure, strategy and financial position of the organisation; and

 

• Constitutional arrangements that give boards the prime role in decision making.

 

It will be interesting to see whether our Government grant funding agencies make use of this resource and seek to follow this development for sporting bodies and other not-for-profits seeking grant and development funding.

 

Principles of good governance

 

The UK Code has, at its heart, five principles of good governance.  Whilst there are stated to be principles (and not mandatory) they are expressed in rather emphatic language, namely:

 

1. Structure: Organisations shall have a clear and appropriate governance structure, led by a Board which is collectively responsible for the long-term success of the organisation and exclusively vested with the power to lead it.  The Board shall be properly constituted, and shall operate effectively.

 

This is important because the right governance structure with decisions made at the right level enables the best decisions to be made to drive the success of the organisation.

 

Having an appropriate governance structure demonstrates to all stakeholders that the organisation is well managed.  This is key to winning the confidence of staff, suppliers and potential investors and also provides a framework for organisational growth and development.

 

2. People: Organisations shall recruit and engage people with appropriate diversity, independence, skills, experience and knowledge to take effective decisions that further the organisation’s goals.

 

This is important because diverse, skilled and experienced decision-making bodies which contain independent voice and engage in constructive, open debate enable good decision-making.

 

3. Communication: Organisations shall be transparent and accountable, engaging effectively with stakeholders and nurturing internal democracy.

 

This is important because being responsive to stakeholders, understanding their interests and hearing their voice helps shape the organisation’s governance and strategy.  Transparency about why the organisation exists, what it is trying to do, how it is doing it and with what results empowers stakeholders by giving them the information about the organisation that they need to know.

 

4. Standards and Conduct: Organisations shall uphold high standards of integrity, and engage in regular and effective evaluation to drive continuous improvement.

 

This is important because having the right values embedded in the culture of the organisation helps protect public investment and also enhances the reputation of the organisation, earning stakeholder trust.  Constantly seeking to improve makes an organisation swift to respond to new challenges and opportunities.

 

5. Policies and Processes: Organisations shall comply with all applicable laws and regulations, undertake responsible financial strategic planning, and have appropriate controls and risk management procedures.

 

This is this important because understanding the legal environment and having in place appropriate financial and other controls help mitigate risk and enhance stakeholder trust.

 

The three tiers

 

Organisations in receipt of less than £250,000 will need only to comply with the basic standards in Tier 1 whilst organisations in receipt of over £1m and where funding is granted over a period of years on a continuing basis, will need to comply with Tier 1 standards and the far more stringent standards in Tier 3.

 

Tier 2 is a broad sector which falls between the two and organisations within this category will be required to meet all Tier 1 standards and some Tier 3 standards.

 

Tier 1 standards are mandatory for all organisations seeking public funding.  They are broad and not overly prescriptive; thereby giving sports organisations discretion while offering guidance on best practice.  For example all organisations are required to have a governing committee that meets regularly.  How often this should take place is an internal matter but the Code suggests a minimum of four times annually.

 

Significantly higher and more prescriptive governance standards are required for organisations in Tier 3.

 

Concluding comments

 

The drafters of the Code have condensed a great deal of material into a publication that is well-written and populated with examples fleshing out why the elements of the Code are important.

 

Even if funding agencies in New Zealand take some time to review this material and consider whether some of the material can be right-sized for a New Zealand audience, it is worth reviewing.  Many of the key elements have been adopted by our largest sporting organisations through a combination of environmental and other factors – including assistance from Sport NZ.

 

 

Introduction

Across the Tasman, a number of commentators have been pointing to the significance of a decision arising out of ASIC’s legal battle in the aftermath of the failure of Storm Financial – one of the high profile collapses of the GFC. The central issues flow from the so-called ‘mass harm’ to a large number of clients as a result of being encouraged by a network of financial planners to adopt aggressively-geared financial models.

In the latest round (#8) the Federal Court has found that the directors of Storm Financial breached their directors’ duties, by breaching their duty of care and diligence, under the equivalent of section 137 of the Companies Act 1993. They were found to have done so by permitting / failing to prevent the Storm Financial model being applied “indiscriminately” to a wide range of clients. The key (worst) examples being clients who were retired or near retired with limited income and few assets – with the Storm model involving clients borrowing against their homes and obtaining margin loans to invest in index funds.

Specifically, the Court found that a reasonable director would have realised that there was a strong likelihood that it would be inappropriate for retired or near-retired clients to use their homes as security for such an investment. As a result, the directors were found to have contravened their duty of care and diligence under the Corporations Act 2001 (Australia) by exercising their powers in a way which caused or “permitted” (by omission to prevent) inappropriate advice to be given to the relevant clients.

The judge found that a reasonable director with the responsibilities of the directors of Storm would have known that the Storm model was being applied to clients within the retired / nearly retired class and that its application was likely to lead to inappropriate advice. The consequences of that inappropriate advice would be catastrophic for Storm (the entity to whom the directors owed their duties). It would have been simple to take precautionary measures to attempt to avoid the application of the Storm model to this class of persons.

The decision involved an exploration of a number of concepts arising in respect of the directors’ duty of care and diligence. In particular, the decision is regarded as noteworthy because it confirms that, in exercising care and diligence, directors must think beyond the financial consequences of a particular action or approach and consider all of the possible harmful effects that may arise – including reputational harm and potentially, the failure of the company’s business (in this case by the loss of a financial services licence) arising from the failure by the company to comply with the law.

Also of note is the discussion about whether a breach of this duty gives rise to both a private and public wrong.

Is company misconduct a necessary stepping stone to a directors breach?

ASIC’s case relied on an actual breach by the company as a “stepping stone” for a finding that the directors breached their duty of care and diligence. Although an actual breach was found to have occurred – the judge queried whether the prosecution had set itself an (unnecessarily) high bar, and that there must be some doubt as to whether a contravention by the company was a necessary stepping stone in order to find breach by a director. (If so, a director might escape liability for an acts or omissions which were highly likely to involve a serious breach of the law, if (by chance) no actual breach occurred).

Accessory liability – by the back door?

Accessory liability or “aiding and abetting” is a key issue in matters such as breaches of consumer protection legislation but is only starting to be explored in the context of Companies Act matters – including under the heading of criminalisation of certain breaches of directors’ duties.

In the Storm case, the judge rejected the idea that the directors’ duty of care and diligence can be used to create liability for directors simply because the company had breached another provision of the Corporations Act (labelled “back door accessory liability”). In doing so, he rejected ASIC’s submission that directors were under a general duty to ensure that the company met its statutory obligations.

This part of the judgment seems quite orthodox – but the judge went on to add that contraventions or the risk of contraventions by the company are circumstances to be taken into account in assessing whether a director exercised care and diligence. However, they are not the only circumstances, and they are not conditions of liability.

The Court also considered the concept that any breach of the directors’ duty of care and diligence must be “founded on jeopardy to the interests of the corporation”. This was described as shorthand for the idea that, if the interests of the company are not threatened (or foreseeably harmed), there cannot be any breach. Where, as in the Storm case, the issue is a breach of law by the company, the relevant jeopardy is the (reasonably foreseeable) threat of damage to the interests of the company – such as fines and penalties. That is, the risk of exposure to liability for fines and penalties must be clear to the directors.

Is the directors’ duty of care and diligence limited to financial harm?

In order to discharge their duty of care and diligence, directors need to balance the (foreseeable) risk of harm against the potential benefits. Because business itself is all about balancing risks and potential rewards, it does not follow that just because a course of action involves a foreseeable risk (of harm to the interests of the company) does not mean that a director has failed in their duty (to exercise care and diligence).

However, the judge noted that harm is not limited to financial harm. It covers harm to any of the interests of the company, including its reputation and interests which relate to compliance with the law (e.g. the potential loss [in Storm’s case] of a financial services licence).

The judgment also notes that the balancing exercise to be undertaken in determining whether the duty has been breached is not simply an exercise of examining costs and benefits – so that a finding of a breach of duty could not be avoided by showing that the likely financial cost (fines and penalties) of a breach of the law was exceeded by the potential profit from the breach.

Is a breach of directors’ duties a public wrong?

Another aspect of the Storm judgment that has attracted the attention of commentators is its exploration of a question as to whether a breach of the directors’ duty to exercise care and diligence is both a private and a public wrong.

For the Storm directors it was argued that the duty is “private” owed only to the company – with any “public” element being ASIC’s ability to pursue fines and penalties. (It was also argued that, in the case of a solvent company, the only stakeholders of the company are its shareholders.)

By contrast, ASIC argued that the directors’ duty of care and skill creates an independent public duty requiring consideration of a “general norm of conduct” which is not limited to the interests of the company – and also requires the public interest to be taken into account.

Whilst the judge concluded that he did not need, in the context of the case, to resolve this issue, he did explore the possibility that the wording of the relevant provision in the Corporations Act and other contextual matters might indicate that a public duty is owed.

Concluding comments

Some commentators have suggested that current trends, including the approach indicated by regulators use of such buzz phrases as “setting the tone from the top” and “culture is the new black” and even statements by the new British PM about rebuilding trust in business and making boards more accountable, hint at the possibility of a broader public duty. This raises the possibility that directors might be at risk, regardless of the impact on shareholders, for the failures of the company and its employees.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

The Court of Appeal gave judgment earlier this month in Steel & Tube Holdings Limited v Lewis Holdings Limited [2016] NZCA 366, on appeal from the High Court. It will be recalled that the case concerned a parent company that had placed one of its wholly-owned subsidiaries into liquidation. The liquidators of the subsidiary disclaimed a lease under section 269 (Power to disclaim onerous property) of the Companies Act. The landlord sought damages as well as an order that the parent company should be liable for those damages under section 271 (Pooling of assets of related companies) of the Companies Act. Section 272 sets out the matters the Court is required to consider under section 271, including the extent to which the related company took part in the management of the company in liquidation and the extent to which the businesses of the companies were combined.

The High Court held that it was just and equitable, as section 271 requires, for liability to be imposed on the parent. The Court of Appeal upheld this decision. This is an important decision, because there are few cases on section 271 – and insolvency practitioners have suggested that there are more instances where the pooling provisions in the Companies Act should be applied. The High Court decision contains more analysis than that the of the Court of Appeal – provides a clear message that the separate legal personality of group companies will be respected where each company is conducted and governed as a separate entity. To disregard the separate legal status of the companies will be to run the risk of liability being imposed under section 271 even where, as in Steel & Tube, the subsidiary’s constitution permitted directors of the subsidiary to prefer the interests of the parent. Indeed, as the High Court judgement observes, provisions of this kind do not mean that the interests of both companies can be conflated or the subsidiary’s interests ignored.

Convertible preference shares are a popular financing tool – especially for start-ups. They have priority over ordinary shares, but not creditors. Distributions are treated as dividends (not interest). They provide considerable flexibility in relation to distributions to decide if and when they are made.

Preference shares allow investors to maintain some form of priority while still benefiting from the equity upside of owning shares. This also means that the company is not required to expend cash until it is able to covert. In economic terms this results in convertible shares being classified as a debt instrument (a bond) coupled with an option to convert to equity.

A recent case Cadre Investments Ltd v Activedocs Ltd [2016] NZHC 1489 provides some sharp lessons about the need to address problems (such as the inability to pay dividends) when they arise.

Background

In 2002, Activedocs Limited (a software developer) was in desperate need of more working capital and offered Preference Shares to existing shareholders. A group of existing shareholders subscribed. Subsequently, the company was not able to pay dividends on the Preference Shares – and then, several years later, a dispute arose between Activedocs and the subscribers over the extent of the subscribers’ entitlement to preferential dividends and whether the Preference Shares have been validly converted to ordinary shares.

Under the terms of issue, the Preference Shares were issued, a preferential dividend of 15% pa was payable when the shares were converted to ordinary shares. Conversion was to occur 2 years from the date of issue unless Activedocs was unable to pay the dividends that had accrued at that date. If that happened, conversion was to be postponed until either the accrued dividends were paid or a preferential shareholder required shares to be converted.

As it happened, Activedocs could not pay any dividend on the nominated conversion date. It treated the preferential dividends as continuing to accrue and made provision for the accrued dividend entitlement in its financial statements each year. In 2007 and 2008 it made dividend payments in respect of the 2003 and 2004 years’ entitlements. No other dividends were authorised. In 2013, Activedocs changed its position; it determined that the Preference shareholders had no entitlement to any further dividend and purported to convert the Preference Shares to ordinary shares.

The subscribers claimed that as at the nominated conversion date in 2004, dividends had accrued in respect of 2003 and 2004 and Activedocs inability to pay them meant that conversion was postponed. As a result, dividends continued to accrue until conversion of the shares, which has not yet occurred. (They also claimed that Activedocs purported conversion of the Preference Shares in 2013 was invalid).

By contrast, Activedocs maintained that dividends cannot accrue until they have been authorised, and because no dividends were authorised prior to 2004 – there were no accrued dividends as at that date so the Preference Shares converted automatically. Alternatively, only two years’ worth of dividends were ever payable and had been paid by 2008 so that the Preference Shares either converted automatically in 2008 or were validly converted in 2013.

Terms of issue

The terms of issue of the Preference Shares provided for:

• The right to be paid a preferential dividend of 15%pa in priority to the payment of dividends on the ordinary shares – payable at the time of conversion into ordinary shares.
• The right on the liquidation of Activedocs to be paid $1.00 per share plus any accrued but unpaid preferential dividend in priority to the ordinary shares but ranking behind creditors of Activedocs.
• Subject to the exceptions specified below, automatic conversion into 4 ordinary shares – 2 years from the date of issue. The exceptions being:
o Activedocs may accelerate conversion by written notice to the holder if at any earlier time an offer is made for 50% or more of its ordinary shares or there is a change in ownership of 50% or more of the ordinary shares through one or more linked or related transactions or there is a sale of all or substantially all of Activedocs’ business or assets.
o Conversion will be postponed in the event that Activedocs is unable to pay dividends accrued as at the conversion date until either Activedocs makes payment of all accrued dividends or a holder of Preference Shares by notice in writing to Activedocs requires that the Preference Shares held by that person are converted.
• In all other respects the Preference Shares ranked equally with the ordinary shares (and, in particular, carried the same voting rights).

The Preference Shares were issued on 8 November 2002, making the Conversion Date 8 November 2004.

Were there accrued dividends at the 2-year date (i.e. cumulative or non-cumulative)?

The judge decided that there were settled canons of construction relating to the nature of dividend entitlement. Where (as here) the terms of issue are silent as to whether the Preference Shares are cumulative or non-cumulative as to dividend they are presumed to be cumulative, though that presumption can be rebutted by language showing that the dividend is to be paid only from the profits of the particular year.

In doing so, the judge rejected Activedocs’ argument that:

• the lack of modern authorities and the recent changes to New Zealand company law, as well as modern principles of contractual interpretation, made the dividend entitlement a question of interpretation rather than presumption; and
• the fact that, under the Companies Act 1993, directors are precluded from authorising any dividend unless the company can satisfy the solvency test (and so the parties must have contracted on the basis of the statutory constraint – the issue could not have contemplated that any dividend entitlement would accrue in years when no dividend could legally be authorised).

Did the terms of issue displace the (cumulative) presumption?

Activedocs argued that, since it was known to all parties that the directors could not authorise a dividend unless the solvency test was met, the phrase “accrued dividends” in the second exception is properly interpreted as meaning dividends that have been authorised. Since the Company’s financial position did not allow a dividend to be authorised on or before the (2-year) conversion date there were no “accrued” dividends for the purposes of the second exception. Therefore the shares automatically converted on 8 November 2004 (the 2-year date). This argument was based on general principles of contractual interpretation but, given the judge’s conclusion that the Preference Shares are presumed to be cumulative, the judge approached it as an argument that the wording of the second exception operates to displace the presumption that the Preference Shares were cumulative.

On Activedoc’s argument the right to be paid a preferential dividend would arise only if a dividend had been declared prior to November 2004.

The judge agreed with authority cited by the holders – that the word “accrue” connotes the ability to calculate a precise amount of money. And the word “due” connotes that it is payable whether or not the time for payment has arrived. As a result, judge stated that the second exception is concerned with dividend entitlement in the future, not whether dividends are currently payable. In that context there is no basis for interpreting “accrued” as being limited to dividends that have actually been declared so as to rebut the presumption that the shares are cumulative. The natural and ordinary meaning of the word describes a right to be paid at a future date, not the existence of a debt actually payable.

Did the terms of issue displace the (cumulative) presumption? – other aspects

The judge found that there were three other aspects of the wording of the terms of issue that make it clear that the Preference Shares were cumulative so that the presumption is not rebutted:

• First, providing for conversion to be postponed is consistent with the Preference Shares being cumulative – because no dividend can be declared once the shares have been converted, postponing conversion preserves the holders’ rights to have their dividend entitlement carried through to later years. By contrast, where Preference Shares are non-cumulative the right to a dividend in relation to a particular year is lost at the expiry of that year if no dividend is declared; whether conversion occurs immediately or is postponed makes no difference to the entitlement of non-cumulative preferential shareholders. In particular, postponing conversion would not address the concern that the company cannot pay a dividend that has already been authorised. Once a dividend is authorised it becomes payable as a debt whether or not the shares have been converted.
• Secondly, the law is clear that when a cumulative dividend of an amount that reflects prior short or non-payment is paid, it is treated as a single dividend for the year in which it is paid, not as a dividend in respect of any previous year. Therefore, the dividend entitlement under a cumulative preference share cannot depend on a dividend being declared in a particular year; otherwise there would be no possibility of a dividend being declared in later year in respect of that earlier year, which is the defining feature of a cumulative preference share.

In the present case, the fact that two years’ dividends were expected to be declared at once, and that it was explicitly provided that payment of dividends could be delayed if necessary through the postponement of conversion, points to the Preference Shares being cumulative. If they were not cumulative the dividend entitlement would be lost at the end of each year and postponing conversion would not prevent that.

• Finally, the provisions of the winding up clause do not detract from the interpretation of the second exception. This clause confers the right to payment of “any accrued but unpaid preferential dividend” in priority to any payment to the holders of ordinary shares. Since dividends only become payable if declared, then arrears (even of cumulative dividends) are prima facie not payable on a winding up unless previously declared. Activedocs relied on Mosgiel (1995) as clear authority that there would have been no “accrued but unpaid preferential dividend” unless such dividends had already been declared. The judge added that this must be right. However, it is the additional words “but unpaid” that make it clear that a declaration of the dividend was required because those words carry the implication that the dividends had become payable.

Was the right to the preferential dividend limited to 2 years?

Activedocs also argued (as an alternative) that the preferential dividend was payable only for 2 years and that, since 2 years’ worth of dividend was subsequently declared and paid, nothing further was owing. This argument was based on the wording of the authorising Board resolution for issue of the Preference Shares stating that the Preference Shares will automatically convert to ordinary shares – 2 years from the date of issue (subject to the delay in conversion until the dividend is paid in full).

The judge rejected this argument, based on:

• interpretation of the relevant resolution (and a subsequent Board resolution); and
• its inconsistency with the circumstances in which the Preference Shares were issued – when all parties knew that Activedocs’ situation was precarious.

The judge also rejected a commercial absurdity defence (the effect of accumulating preferential dividends at $193,000 pa produced an accumulated dividend slightly over $1.9m in the context of a business with a total operating revenue of slightly over $1.6m and total liabilities (excluding dividends) of slightly over $1.3m). Such a level of liability would not only deter potential investors but also mean that the Company was insolvent.

But, as the judge noted, even if this meant that, no dividends can be declared and, in the event of liquidation, the holders will not recover any of the claimed dividends because no dividend will have been authorised. However, there is no obligation on the directors to authorise a dividend – and the company is not insolvent merely by reason of making provision for accrued dividends. Therefore, whilst the result was not anticipated (though it could have been by the Board at the time of issue) and is disadvantageous to Activedocs – it is not commercially absurd.

Impact of accrual in financial statements

For 10 years, Activedocs treated the dividend entitlement as accruing and made provision for it in its financial statements. For reasons that I find less than compelling the judge concluded that the financial statements are not a reliable indicator of the company’s intentions. The judge focused on the fact that the directors who determined that the financial statements would show preferential dividends continuing to accrue after 2004 were not the same directors as those who finalised the terms on which the preferential shares were issued.

As a result, the fact that their identity differed in the relevant periods means that the acts of Activedocs in subsequent years is not necessarily a reliable objective indicator of its previous intention.

A decade is a rather long time to continuing accruing dividends on the basis that conversion had not occurred. From where I sit, the prospect that the holders would have relied on this, to their detriment, seems not to have bene given sufficient weight.

Were the Preference Shares validly converted to ordinary shares?

The judge concluded that the second exception was triggered in November 2004 as a result of Activedocs being unable to pay the accrued dividends. Consequently, conversion did not occur then but was postponed until all the accrued dividends were paid.

As a result, the holders’ dividend entitlement continued beyond November 2004 until conversion of the Preference Shares. Conversion would only occur upon payment of the accrued dividends. The dividend payments made in 2007 and 2008 represented only 2 years’ worth of dividends and therefore did not constitute payment of all the accrued dividends. Consequently, conversion of the Preference Shares did not occur in 2008.

Since entitlements to the preferential dividend continued to accrue each year and dividends of the accrued amount have never been authorised the shares could not have been validly converted. The purported conversion of the shares in 2013 was therefore invalid – and the Preference Shares remained in existence.

Takeaways

I find most of the judgement unsurprising and, as a result, I am left wondering how the matter came before a Court. If there is a lesson here, it is to underline the need to dive on problems quickly. In my view, the board should have had discussions about conversion to equity as soon as it became apparent (in 2004) that the company as not able to pay the accumulated dividends – and certainly any decision in 2007/8 to pay a dividend should have been predicated on removal of the overhang created by the Preference Shares.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

The advent of the resident director requirement, which came into effect on 1 May 2015, has meant that it is an essential requirement for New Zealand companies that they have at least one director who:

• lives in New Zealand; or
• lives in Australia and is the director of an Australian-registered company.

The term “live in New Zealand”’ is not defined in the Companies Act. As a result, the Registrar of Companies has decided to interpret this on the basis that a director lives in New Zealand if he or she is personally present in New Zealand for more than 183 days in total in a 12-month period. The Registrar did not conjure this interpretation up out of thin air – it is in line with income tax residency requirements.

In a test case, the Registrar determined that, in the case of a Mr Carr who did not meet the 183-day threshold, the string of companies of which he was sole director were non-compliant and could have been liable to removal from the register.

On appeal from the Registrar’s determination , the High Court held that Mr Carr has wrongly been held not to “live in New Zealand” for the purposes of the Companies Act – and allowed the appeal. The judge found that:

“When one factors in all the other matters to which I have just referred, it is apparent that he lives in New Zealand in the ordinary meaning of the word.”

A few facts

Mr Carr has extensive business interests in New Zealand and elsewhere and the details he provided of the days when he had been physically present in New Zealand indicated that had spent less than 183 days in the country over a 7-year period (just 69 days in 2015).

However, Mr Carr had New Zealander residency, who owns two residences here. His partner lives most of the year in one of them (rather than travel extensively with him). He has several New
Zealand companies which employ staff and which require his supervision. He also owns several parcels of land here and otherwise enjoys or possesses many of the trappings of a New Zealand resident – driver’s licence, firearms licence, Tax Agent status, on the voting roll, New Zealand bank accounts and credit cards, membership of organisations, and long-term telephone term telephone
term telephone numbers. He even has a New Zealand GP as his primary care physician.

Consequently, he submitted that the Registrar’s focus on the number of days when he is physically present in New Zealand is not required by the Companies Act, and is too narrow.

Decision

The Court found, that by contrast to the meaning of the term “ordinarily resident” for income tax purposes, the paramount driver for the resident director requirement was the capacity to enforce obligations (against directors). For this reason, the judge considered greater weight should be placed on the ties Mr Carr has to New Zealand and the regularity with which he spends
spends significant periods of time here.

The judge was helped in this conclusion by the fact that living in New Zealand is one alternative. That requirement may also be satisfied by a company having an Australian resident director who is also a director of an Australian-registered company.

It was also noted that the Registrar’s adoption of 183 days was an initial threshold – providing a criterion through which directors can automatically meet the statutory test (i.e. it definitively includes, but does not automatically exclude). As a result, he found that it is open to directors to meet the test by other means. (And the judge indicated that this arbitrary black line would lead to inquiry as to the director’s circumstances when, for example, they fell one day short of automatic acceptance).

Therefore, without laying down any definitive set of criteria, the judge found that matters that will be relevant, given the emphasis on enforcement, are:

• the amount of time the person spends here;
• their connection to New Zealand;
• the ties they have to New Zealand; and
• the manner of their living when here.

In finding that Mr Carr presents an example of the type of arrangement that can satisfy the test without living here for 183 days – the judge noted that no one factor is critical or determinative but together he considered they mean Mr Carr can properly be said to live in New Zealand.

Concluding comments

This decision will come as some relief in underlining the point that long periods of absence will not necessarily be fatal where, as in this test case, there are other factors connecting the director to New Zealand, noting the enforcement object of the resident director requirements.

In some regards, this might be seen to be an unusual test case given the accumulation of other factors relevant to Mr Carr’s connection to New Zealand. It appears that the Registrar has a number of other cases under examination and it may take further decisions affecting persons who do not meet the 183-day threshold test before we have a clearer set of criteria.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

In an update to my February note on the FMA’s prosecution of the directors of Apple Fields under the Financial Reporting Act 1993 for failing to deliver financial statements and an auditor’s report to the Registrar of Companies for the financial years ending 2011, 2012 and 2013 – leave to appeal has been granted by the Court of Appeal.

The issues on appeal were those of whether the directors took “all reasonable and proper steps” to ensure compliance with section 18 of the Financial reporting Act 1993 – which requires the directors to both:

• take all practical steps to ensure compliance (such as the efforts to appoint auditors and to obtain the [Noble] accounts); and

 

• to seek comprehensive legal and/or accounting advice as to the range of options available to them when those practical steps did not bear fruit.

The judge at first instance in the District Court reasoned, with reference to section 138 of the Companies Act, that directors might sometimes rely on professional advice.  But in this case she found that:

• the directors did not take further accounting advice because they did not want to file financial statements that excluded the potential profits from Noble, without which Apple Fields might not be a going concern; and

 

• the directors ought to have taken legal advice on whether they could compel Noble to deliver the necessary financial information.

 

Did the appellants act reasonably by not seeking a second opinion about the need for consolidation?

 

The judge at 1st instance found that the directors honestly relied on their accountant’s advice, which they were right to take seriously, and made diligent efforts to obtain information from Noble with a view to consolidation.  That being so, the Court of Appeal judgement states that they must be taken to have acted reasonably, unless a second opinion ought to have been sought in the circumstances and there is reason to suppose that it might have resulted in advice that consolidation was not required.

 

Pleasingly, the Court of Appeal appears to reject the FMA’s stance, that a second opinion might be needed even if the original advice was correct (from a top-tier firm, because de-registration is a serious matter) as preferring process to substance.

 

The court noted its opinion that it matters not how many professional opinions were taken in this case, so long as the directors prove that the advice was correct.  Of course this is not to deny that a second opinion may be needed where the first one is or may be wrong and there is reason to suppose that the directors ought not to have relied upon it without further inquiry.  Nor is it to suggest that directors can hide behind professional advice about things they ought to know for themselves.

 

On the facts, the Court of Appeal did not accept that the appellants chose to rely on their advice because they wanted to avoid a qualified audit.  That assumes they may have doubted its veracity or accuracy and chose not to get a second opinion, a conclusion that is irreconcilable with the findings of the judge at 1st instance that they honestly relied on the professional advice, properly considered it should be taken seriously, and diligently went about trying to follow it.

 

Nor, was there good reason to suppose that a second opinion would have differed from the first.  The Court of Appeal declined the FMA’s invitation to infer that the advice was wrong because NZ IAS 27 was the applicable standard at the time and, based on previous years’ financial statements, financial statements that did not consolidate Noble would nonetheless have been GAAP-compliant.  Its reasons were:

 

• First, one might think it unsurprising, as a matter of common sense, that an auditor would insist on consolidation; after all, Apple Fields was not a going concern without returns from Noble.

 

• Secondly, the only evidence that non-consolidated statements would have complied with the existing standard was displaced by the balance of evidence confirming that consolidation was necessary and that Noble was a “deemed subsidiary” and ought to have been consolidated.

 

• Third, there is no evidence that the directors’ adviser was wrong in his opinion that, once aware of the proposed new standard an auditor might properly insist on taking it into account, making it still more likely that consolidation would be unavoidable if the financial statements were to be certified at all.

 

As a result, the Court of Appeal concluded, differing in this respect from the Courts below, that the directors acted reasonably by pursuing consolidation, rather than separate but qualified financial statements, in reliance on their adviser’s opinion.

 

Did the appellants act reasonably by not seeking legal advice about whether Noble could be required to deliver financial information?

 

The judge at 1^st instance did not find that the directors ought to have inquired into whether Apple Fields could compel Noble to deliver its financial information.  No legal advice was taken.

 

The judge in the 1st tier appeal held that the directors ought to have taken such advice, and having failed to do so they could not claim to have taken all reasonable and proper steps.

 

The Court of Appeal took a different view.  On the evidence, they said that there is no reason to suppose that Apple Fields could compel Noble to comply.  It does not control Noble in any orthodox sense.  The FMA was not able to identify any basis on which production might have been compelled.  The most its counsel could do was to suggest that the documentary record is incomplete and, that being so, there is a possibility that some right exists in the contracts between Apple Fields and Noble such that the directors have not discharged the burden of proof.

 

The Court of Appeal’s response is that in its opinion the evidence, such as it is, is that legal advice would have made no difference. That being so, it cannot be said that reasonable and proper steps required that legal advice be taken.

 

Outcome

 

Leave to appeal was granted.  A full (appeal) hearing is awaited – but the Court of Appeal appears to have nailed its colours to the mast on the reasonable reliance issue.

 

Further information

 

If you would like more information about any of the matters discussed in this note, please contact me.

The recent Supreme Court decision in Ririnui has triggered some debate about the efficacy of the earlier principle that the informal unanimous assent of shareholders binds the company.

There are a number of difficulties with citing the decision as authority on the matters that lie at the heart of this article – because the broad thread of the decision hinges on administrative law issues on which the Supreme Court, by a majority, allowed an appeal in part only. And, of the majority, only O’Regan J. addressed the company law issue in any detail. Nonetheless, at least one commentator has suggested that the comments by O’Regan J. provide a useful steer on an important (but controversial) company law issue.

Briefly, the principle of informal unanimous assent (the Duomatic principle) after a 1969 English decision was that where shareholders who have a right to vote at a general meeting of the company assent to a matter which a general meeting of the company could carry into effect, that assent is as binding as a formal resolution.

In Ririnui the applicant sought the judicial review to overturn a decision by Landcorp to sell one of its farms. One of threads of argument pursued by the applicant was that Landcorp’s shareholding Ministers could (relying on the Duomatic principle) have intervened in the sale process and, in effect, instructed the directors not to proceed with the sale. This is a sort of reverse application – because the Duomatic principle is usually seen as allowing informal (shareholder) ratification where the correct formalities have not been observed. Often the effect of that ratification is to excuse directors from breaches of duty.

Application of the principle in New Zealand

In a New Zealand context, Duomatic was extended by the 1994 Court of Appeal in Kensington and has been thought as being summarised by the comments of Lord Hoffman, in the 1995 Privy Council decision of Meridian Global Funds Management that:

“…the unanimous decision of all shareholders in a solvent company about anything which the company under its memorandum of association has power to do shall be the decision of the company.”

This extension is not without its difficulties, particularly since the Companies Act 1993 came into force. In particularly, section 128 of the 1993 Act delegates the management of the company to the board. As a result, when shareholders do not agree with management of the company’s business, it is generally thought that their remedy is to remove the board.

Ririnui

In the High Court, Williams J relied on Duomatic as authority to support his finding that the shareholding Ministers of Landcorp could have stepped in to stop the sale of a farm which was potentially subject to a Treaty claim. By contrast, the Court of Appeal held that Duomatic is not authority for the proposition that a company’s shareholders have the power to make management or operational decisions normally reserved to shareholders. Instead, the Court of Appeal accepted that the purpose of the Duomatic principle was to permit corrections of technical non-compliance.
In the Supreme Court, the only judge to address Duomatic was O’Regan J. And, besides indicating that he did not believe that the Duomatic principle did not apply to SOEs (because he considered that any resolution to amend the constitution to reallocate a management power from the board to the shareholding Ministers would not be consistent with the SOE Act, which legislatively allocates powers between the board and shareholders in a carefully calibrated way), he noted his doubts that Duomatic had survived the passing of the Companies Act 1993.

This is a matter that is currently the subject of some debate in academic circles – with Professor Peter Watts suggesting that Duomatic does survive (and that it would be highly inconvenient if it did not). By contrast, Professor Susan Watson and, in a very recent article, Auckland barrister John Land cast serious doubt on its survival.

While O’Regan did not reach a final landing on the issue, his judgment points to three reasons why the enactment of the 1993 Act brought about the demise of Duomatic:

• Law Commission: The Law Commission reports that led to the enactment of the 1993 Act can be taken as indicating a rejection of the Duomatic principle. Report No. 9 discusses whether to include a provision allowing shareholders acting by unanimous resolution to exercise powers of the company and decided against it. Instead it proposed the allocation of powers reflected in what is now section 128 of the 1993 Act (see below) and that, subject to the constitution would not leave shareholders with a residual power to decide on management matters – which were the domain of directors.

Interestingly, the Law Commission also proposed that unanimous shareholder approval to ratify a breach of directors’ duties not be allowed – but the section 177(4) of the 1993 Act preserved the existing law – allowing the ratification or approval by the shareholders or any other person of any act or omission of a director or the board.

• Section 107: Section 107 of the 1993 Act expressly provides for the unanimous assent of shareholders to certain specified actions, which can be taken as an indication of a legislative intent that the Duomatic principle is now limited to those specified actions – subject to certain conditions being met (including that the assent be in writing and (in all but two cases) the solvency test met). Therefore, it would be quite odd to provide a finite list of matters that can be achieved by means of a section 107 entitled persons’ assent – and at the same time keep alive a much wider (and more informal) power for shareholders to undertake certain management functions.

• Section 128: The allocation of management powers to the Board under section 128 of the 1993 Act also suggests that, in the absence of a reallocation of such powers to shareholders by the constitution, shareholder approval of such actions would be ineffective.

The commentary by Professors Watts and Watson, respectively, pre-dated the Supreme Court decision in Ririnui. The John Land article concludes that O’Regan J.’s comments, whilst not an essential part of the Supreme Court decision (in which the majority allowed Landcorp’s appeal, in part, on other grounds), should be followed and that the earlier decision in Kensington, which predated the 1993 Act, and contemplated some sort of default setting that shareholder resolutions on management issues was no longer relevant.

Takeaways

The primary takeaways from the Supreme Court decision in Ririnui and recent commentary appear to be that:

• Unless the constitution specifically allows – shareholders cannot exercise management decisions. (Note also that section 109(3) of the 1993 Act does provide scope for the constitution to expressly permit shareholders to pass binding resolutions on management issues. I have yet to encounter a constitution which does so).

• Otherwise, the scope for shareholders to deal with management matters is specifically limited to:

o the matters covered by the unanimous asset procedure under section 107; and
o the power to ratify the acts or omissions of directors or the board that is preserved by section 177(3).

Failing that, the remedy of shareholders who disagree with management decisions taken by the board is to remove the directors.

Shareholders’ Agreements

One permutation on these issues which does not appear to have (yet) come before the Courts is the interaction between the constitution and a Shareholders’ Agreement (if there is one in place).

In my experience, it is an increasingly common drafting practice (where there is a Shareholders’ Agreement in place) to state, in the constitution, that the directors’ powers of management are subject to the restrictions contained in the Shareholders’ Agreement.

Most Shareholders’ Agreements will contain negative assurance or veto powers – stating that certain types of decisions (many of which affect matters that might otherwise be regarded as management decisions) may not be made without certain thresholds being met in the form of shareholder approvals.

Increasingly, those provisions in the Shareholders’ Agreement are also being reflected by constitutional provisions which address:

• The nature of the Shareholders’ Agreement: Noting that there is, in addition to the constitution, a Shareholders’ Agreement in place which is binding as between each shareholder in accordance with its terms.

• Primacy: By providing that the constitution shall be applied having regard to the terms of the Shareholders’ Agreement – and to the extent of any inconsistency between the terms of the constitution and the Shareholders’ Agreement, the provisions of the Shareholders’ Agreement shall prevail.

• Limits on the Board’s management powers: Some constitutions now go so far as to provide that the Board’s powers of management (being those delegated to the Board under section 128 of the 1993 Act) are limited by any specific provisions in the constitution or the Shareholders’ Agreement.

Ultimately, the question of the relationship between the constitution and the 1993 Act and Shareholders’ Agreements must come before the Courts. Whether the constitutional provisions referred to above can be said to incorporate key elements of the Shareholders Agreement into the constitution (and thereby limit directors’ management powers by reference) by reference and thereby effectively rely on the limitation contemplated by section 128 is an interesting question. Possibly, the issue is more problematic where a subset of the shareholders (say – only the majority shareholders) is a party to the Shareholders’ Agreement.

Finally, in the context of what has in some quarters become the new weapon of choice as a vehicle for commercial transactions, namely the limited partnership – there is scope for further permutations. Amongst the practices that have developed are different structures in which the limited partners do or don’t also hold shares in the general partner. In some cases, there is appearing Shareholders’ Agreements (sometimes labelled ‘General Partner Agreements’) governing the actions of the general partner. Just what a Court would make of such an agreement – where it purported to give the shareholders of the general partner (who may or may not be different to the limited partners) veto rights or something stronger affecting management decisions by the general partner is a topic for another day.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

Having helped write a submission on the first round of consultation by NZX on its corporate governance reporting requirements, I was interested in the next round – being the responses received from interested parties in response to proposed changes.

NZX has published the on-confidential submissions received from 40+ responders, grouped into the category of responder, namely:

• Accounting and auditing
• Gender Diversity/Diversity
• Governance groups
• Health & Safety
• Investors
• Listed issuers
• Law firms
• Sustainability groups
• and a report on the views of 15 smaller to medium sized listed issuers

In the time available to me, it is difficult to get an accurate weighting on any sort of consensus on the specific areas that NZX raised for responders attention. As a result, I will await the next round of material from NZX (a consultation document with proposed rule changes) due by mid-year.

Equally difficult to determine has been the level of support for NZX preference for a tiered approach to reporting requirements and expectations (i.e. principles, recommendations (or guidelines) and commentary). Under this approach, the principles outline the overarching concept for each topic and are supplemented by recommendations which outline in more detail the particular matters which are expected of issuers in relation to the principle discussed. These recommendations would be more prescriptive (with a requirement that they be met on a “comply or explain” basis). The final layer would comprise commentary in relation to application of the relevant recommendations and additional best practice commentary in areas where issuers may choose, but are not required, to report against.

Smaller-to-medium-sized issuers

I found the responses to the survey smaller-to-medium-sized issuers conducted by TNS easier to access.

The key messages derived by the TNZ survey included:

• The overall response to the initiative is positive as there is a desire for an up-to-date single source set of governance reporting guidelines and a positive reaction to the tiered approach, incorporating a ‘comply or explain’ requirement.
• The notion of incorporating ‘best practice’ commentary is polarising; as while for some it will provide good guidance in developing governance protocols, others fear their non-compliance with the best practice may suggest their apparent sub-standard practice in the eyes of investors.

TNS also managed to band the level of support for reporting requirements per se into:

• Advocates – identify and co-opt into the engagement process with aim of their informing and persuading of others.

• Potentials – drive up awareness of initiative, develop engage activities and communications and highlight key benefits of the initiative.

• Functionals – focus on communicating the key mid-and long-term benefits to the business of good governance, good reporting regimes and the resultant increase of the company’s value and attractiveness to investors.

• Antagonists – develop arguments to close down and challenge their anti-governance/bureaucracy stance.

Other interesting findings were:

• Ethical standards: Most companies spoken to have codes of conduct/ethics already in place that expanded beyond the board/executives, so the extension of the current NZX code is acceptable, including dealing with whistle blowing. For all the presence of a code/policy and its disclosure are thought to be sufficient and this could be made readily available on the company website. Unless for exceptional circumstances additional reporting around this is not considered necessary by any respondents.

• Board composition and performance: The principles of independence, mix of skill sets and diversity are all taken as positive and largely agreed with. But then discussion moves onto the realities of the New Zealand market and its relatively small talent pool. Appointing the ‘right person for job’ is the over-riding desire with all spoken with and causes a resistance to the notion of fixed quotas on gender, race, and disability. This is added to by the smallest issuers spoken with in relation to the realities of board make up with companies with small boards of 3-5 directors and their likely personal involvement in companies in the early stages of their development. (Overall there is a desire for less prescription and more guideline in this area in order to increase the chances of compliance across all issuers).

• Board committees: The overall stance for most is that the current set of recommendations of committee composition and the requirement for charters worked well and benefitted from the ‘unless constrained by size’ exception. So there is a resistance to further prescriptive recommendation on the number and make up of committees. Flexibility for small companies – in terms of numbers of committees, committee role sharing – is a strong requirement. All acknowledge the importance of remuneration committees and acknowledged the need for the requirement to continue, but again wanted flexibility around committee composition.

• Reporting and disclosure: Continuous disclosure is accepted as a fundamental requirement for listed companies seeking investment, so the writing and publishing of the company’s policy is thought to be acceptable for the sake of clarity. The current mandatory requirements are thought to cover this adequately. There is discussion on the nature of ‘publishing’ with a call for a lot of policy and disclosure information to be located on company websites rather than the in annual reports for efficiency and cost reasons. There is a resistance to the wholesale introduction of recommendations for non-financial reporting, including ESG disclosure, as it is thought to be an area of relative importance –critical to some seeking investment, peripheral to others –so the freedom to choose the level of disclosure should stay with the company.

• Remuneration: Interestingly, given the diversity of the sample base, no one feels there is a need for further more detailed disclosure of executive remuneration. This is partly driven by concerns of the competitive commercial sensitivity of the information and partly by the concerns of the small talent pool in New Zealand and the desire to get the best people available from that small pool. Policy setting is fine, it is the specific details of the remuneration packages themselves that are sensitive…in short, the dollar amounts. Remuneration consultants are not widely used by companies among the sample base.

• Risk management: There is widespread acceptance of the need for boosting the NZX policy and reporting requirement of issuers around general risk management:

o Key risks
o Risk auditing
o Staff share dealing

However, there is variability of response on the requirement of ESG reporting based on the nature of the companies’ business. There is an acceptance by some that investors would be extremely interested in ESG information; and for others the fear that they may have onerous reporting requirements made on them for metrics that are irrelevant for their investors.

• Auditors: There is consensus around the current level of regulation of the auditing process and support for the external auditor attending the AGM and auditor fees being reported. Whilst not a strongly held view, issuers think the five year rotation is a sound one and long enough to allow auditing firms to develop a sound understanding of the business, to allow partner succession.

• Shareholder relations: All respondents accept the importance of having sound shareholder relations programmes, but because of the variability in the size and make-up of the firms’ shareholder base there was a concern among the smaller companies of prescriptive requirements adding complexity and work load to their reporting/shareholder management. For those dual-listed companies this is not a concern as they already have additional requirements which they handle. Should the guidelines be developed the smaller companies feel more comfortable with best practice commentaries being involved, rather than recommendations.

• Stakeholder interests: Most respondents admit that this is a vague area and the relevant stakeholder map is largely idiosyncratic to each company. It is an area thought to be more relevant to public bodies and NGOs, rather than commercial organisations whose primary reporting responsibility is towards shareholders. In addition, a number believe the issues touched on are covered by the ethical standards requirements of the firm. The exception to this is those organisations whose licence to operate requires government and community acceptance. In which policy and reporting requirements are considered important.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

Earlier this month, the FMA released its auditor regulation and oversight plan for 2016. The FMA’s plan sets out the new style of audit report issued by the XRB, intended to provide better information to investors.

The new auditor’s report includes new standards for listed entities – an auditor will be required to communicate key audit matters, and their report will include the name of the engagement partner. The auditor will report on significant matters in the audit of the financial statements, explaining why the matter was significant and how the matter was addressed by their audit work. This, the FMA says, is expected to improve the information available for investors.

The new auditor’s report also gives auditors the opportunity to explain their work and to provide additional information, and the FMA expects reporting that reflects the uniqueness of each business.

FMA’s workplan

The oversight plan notes that, over the next three years (to 30 June 2019), the FMA will focus on three main areas:

• Improving audit quality: The FMA states that it aim to perform audit quality reviews of registered audit firms once every three years. This is designed to ensure that key stakeholders, including audit firms, are informed about developments in audit quality, and any potential areas of improvement. (It also stated that its areas of focus for the reviews have not significantly changed compared to previous years and are aligned with what audit regulators are doing internationally).

• Monitoring changes in the new standards for auditor reporting: A new standard for auditors’ reports, including more comprehensive information, will be required for all New Zealand listed issuers with a reporting period ending on or after 15 December 2016, and can be used earlier. For other FMC reporting entities considered to have a higher level of public accountability, the effective date will be periods ending on or after 31 December 2018.

• Monitoring how it performs audit quality reviews: These were previously done by ICANZ on behalf of the FMA, but will be performed by the FMA (using FMA staff and independent contractors) from 1 July 2016 to align with international practice.

Improving audit quality – areas of focus

Under the new standard, the auditor will be required to communicate ‘key audit matters’ (those that, in the auditor’s professional judgement, were most significant in the audit of the financial statements for the current period.) The auditor will be required to report why each matter was considered to be significant, and how the matter was addressed in the audit. The FMA notes that this will provide users of financial statements with previously unavailable information.

During its audit quality reviews, audit firms’ internal quality control and the quality of individual audit files will also be assessed. The FMA has also signalled that it has selected the following focus areas based on issues identified by international audit regulators and its own findings from its most recent reviews:

• Auditor independence – particularly in the case of firms that provide significant non-audit services to FMC reporting entities.

• Audit quality control systems and supervision – especially where the FMA’s review picks up matters not detected in the firm’s own quality review procedures.

• Professional scepticism – particular emphasis will be placed on documenting:

o significant judgements on accounting estimates and fair value calculations;
o reliability of data provided by management or directors;
o management and directors’ representations;
o impairment calculations and recoverability of assets; and
o changes in accounting treatments / use of unusual treatments.

• Audit evidence – concentrating on ensuring audit firms obtain sufficient evidence in the following areas:

o going concern;
o revenue recognition; and
o the completeness and accuracy of related-party transactions.

• Understanding the issuer and its environment – demonstrating an understanding of the FMC reporting entity’s business model to cover all key risk areas in the audit strategy.

• The auditor’s responsibilities relating to fraud – the auditor must identify and assess the risks of material misstatement of the financial statements due to fraud. The FMA review the auditors’ assessment of this risk, and whether they adequately performed the procedures used to address this risk (including an increased focus on the review of journal entries and other specific fraud procedures).

• Use of experts – requiring the auditor to assess the competence and objectivity of any experts relied on.

• Audit fees and audit performance – the FMA says it will focus on those audits that have a very low audit fee or where audit fees do not reflect the complexity of the business, to assess whether sufficient work has been completed.

Comments

In recent years the auditing of financial statements has undergone a major sea change, requiring auditors of FMC reporting entities to be registered and individual auditors licensed by the FMA.

The changes heralded by the XRB’s new standard and the focus on ‘key audit matters’ (requiring the auditor to report why each matter was considered to be significant and how the matter was addressed in the audit) are expected to raise a number of complex issues. In the first instance, the audit profession and users of financial statements will likely be guided by the FMA, as frontline regulator. However, a quick glance at developments overseas would also indicate that there will be adjustment period by both FMC reporting entities and the audience for the financial statements.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

Earlier this week the FMA announced that it had finally approved a series of class exemptions for overseas issuers which allow issuers making offers to New Zealand investors to rely on the disclosure, governance, financial reporting and audit requirements of their overseas jurisdiction where their regulatory standards are equivalent to New Zealand’s.

The basis for these class exemptions is that an overseas issuer which is subject to regulation in their home jurisdiction that is at least equivalent to that of New Zealand, the costs of requiring them to comply with the full weight of the disclosure regime under the FMC Act may outweigh the benefits to the New Zealand investor audience.

Once implemented, these class exemptions will replace a number of earlier class exemptions granted under the Securities Act 1978 that applied to overseas issuers.

Coverage

The new class exemptions will exempt compliance from a number of requirements under the FMC Act under the following headings:

• Offers by overseas issuers: Exemptions will be available to overseas issuers making two types of offers:

o For offers made to existing holders of securities with a primary listing on an overseas exchange in a recognised jurisdiction with a high quality regulatory regime – issuers will receive complete exemptions from the disclosure, governance and financial reporting requirements of the FMC Act. This will continue the relief available under an existing class exemption (the Overseas Companies Exemption) – although details of the relevant jurisdictions have not been finalised.

o For offers made on recognised high quality exchanges under the laws of an overseas jurisdiction and then extended in to New Zealand – the overseas issuers making these offers will primarily be able to rely on the requirements of their home jurisdiction. However they will also need to prepare a warning statement, appoint an agent for service in New Zealand, and lodge certain documents with the Companies Office. Again, this will continue the relief available under an existing class exemption (the Overseas Listed Issuers Exemption) but will be limited to overseas issuers with a primary listing on either main board of the NYSE, the NASDAQ or the London Stock Exchange.

• Financial reporting and audit

Exemptions will allow overseas issuers with a primary listing on a market in a high quality jurisdiction to use their overseas financial statements and auditors as an alternative to the financial statement and audit requirements in Part 3 (PDS disclosure) and Part 7 (ongoing financial reporting) of the FMC Act.

Again, details of the relevant jurisdictions have not been finalised.

The exemptions only apply when:

o the financial statements of the overseas issuer are prepared in accordance with accounting standards that are broadly comparable to New Zealand GAAP; and
o the auditor is subject to audit standards that are broadly comparable to those that apply in New Zealand, including independent auditor oversight.

• Securities already issued

As a result of the transitional regime applying to the transition from the Securities Act to the FMC Act, without an exemption – overseas issuers will be subject to the full rigour of the FMC Act for securities that have already been issued in reliance on an exemption from the Securities Act.

The FMA has recognised that these issuers should be able to rely on the requirements of their home jurisdiction. As a result, these issuers will receive:

o exemptions from the ongoing disclosure, governance and financial reporting and audit requirements of the FMC Act; and

o an exemption from having to notify all security holders that the requirements of the FMC Act will apply after the effective date for the securities.

The FMA notes that it considers that relief is warranted where the overseas issuer made an offer into New Zealand relying on one or more of a finite list of the Securities Act exemptions (which will include both existing class and specific exemptions) and has not made any other type of offer into New Zealand.

• Additional exemptions

The FMA has also approved two class exemptions that recognise audit and assurance standards in recognised overseas jurisdictions as an appropriate substitute for the requirements of the FMC Act:

o Exemptions for overseas custodians from the requirement under the FMC Regulations 2014 to obtain an assurance engagement from a New Zealand qualified auditor. Where the custodians already conduct a robust assurance engagement in the country in which they are based, the FMA has accepted that the costs of engaging a New Zealand auditor may potentially be disproportionate to the benefits to investors.

o Exemptions to remedy technical issues preventing certain overseas registered banks and licensed insurers from relying on the Financial Markets Conduct (Overseas Registered Banks and Licensed Insurers) Exemption Notice 2015 – allowing overseas registered banks and licensed insurers to engage Australian auditors to audit their New Zealand business and financial statements and remove the New Zealand specific requirements when they are not aligned with the home jurisdiction.

Comments

The bulk of the new exemptions are an overdue resolution of some uncertainties affecting overseas issuers who have previously offered financial products in New Zealand under a class exemption from the Securities Act disclosure regime – about life after the final transition date to the FMC Act after 30 November 2016.

Timing

The short answer is that we are not there yet – and the FMA’s announcement stated that it intends to finalise the exemption notices and publish them by the end of July.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.