Opinion: Memo to the Govt: Please allow the FMA to take retrospective action on investors' behalf and pass the Class Actions Bill too

By Gareth Vaughan

Our politicians have a couple of key decisions to make in coming weeks, or months, that could improve the landscape for New Zealand's beleaguered retail - or ma and pa - investors.

Firstly, Parliament's Commerce Select Committee is due to report back on the Financial Markets (Regulators and KiwiSaver) Bill by February 28. Among other things this bill covers the establishment of a new financial regulator to be known as the Financial Markets Authority (FMA), which will replace the Securities Commission and take on some regulatory functions from the Ministry of Economic Development, including the Government Actuary, and NZX.

And secondly legislation that would allow class action law suits to be taken in New Zealand, which has been languishing with the Ministry of Justice and its minister Simon Power for about two years, may finally be about to see the light of day.

First to the bill that will see the FMA created, hopefully by May this year.

One of the things the bill does is propose a new power, similar to what the Australian Securities and Investments Commission (ASIC) already has at its disposal, enabling the FMA to exercise a person's civil right of action.

Basically what this would mean is that If, after an FMA investigation or inquiry, the new regulator believes it's in the public interest to do so, it could exercise the right of action of a person (investor) by launching and controlling civil proceedings against "financial markets participants" or individuals including company directors, auditors or trustees. It could also take over proceedings that have already been launched.

The FMA would be able to seek money or "other relief" for fraud, negligence, default, breach of duty, or other misconduct.See clause 34 in the bill here for full details.

Retrospective power

A fascinating aspect of this proposed new power, which was specifically requested by the Simon Botherway chaired FMA Establishment Board, is that the FMA could take retrospective action dating back up to six years. Therefore the FMA could have a crack at any directors, auditors or trustees from any of the 63 finance companies and other entities that have fallen over since 2006 putting NZ$8.59 billion of investors' money, held in more than 205,000 deposits, on the line. See our Deep Freeze list for full details of the failed entities.

This new power could mean, for example, the FMA following a similar route to that taken by ASIC in a recent successful case against auditor KPMG and directors of failed property finance group Westpoint. ASIC has recouped up to A$67.5 million for Westpoint investors.

Compare this with what the Securities Commission here was, or wasn't able, to do to Ernst & Young for its role in auditing collapsed carpet maker Feltex. After reviewing Feltex's demise, the Securities Commission concluded work done by Ernst & Young and its responsible partner Gordon Fulton, in a review of Feltex's December 31, 2005 half-year accounts, didn't meet required standards and failed in professional responsibility. The Commission was merely able to refer the matter to the New Zealand Institute of Chartered Accountants, which it did in November 2007.

Almost three years later, October last year, the accounting industry body found Fulton guilty of accounting breaches and ordered him to pay NZ$150,000 in costs, none of which found its way to Feltex's largely retail shareholders who lost the shirts off their backs when the company fell over.

The big boys don't like it

The big end of town isn't thrilled about the idea of the FMA being given this new power. Submissions from the Business Roundtable, major law firms, the New Zealand Bankers' Association, and the Trustee Corporations Association raise various concerns.

Some are legitimate such as Chapman Tripp's point that the FMA would be able to take over an action on a person's behalf without their consent and yet the court could order that person to continue to pay the case's costs. A fear here could be that the investor might want to settle the case, perhaps receiving some compensation, but the FMA might be prepared to fight on through the courts for several years.

That said, the Business Roundtable's argument that giving the FMA power to take over private cases infringes property rights, probably wouldn't be taken too seriously by a Bridgecorp or Capital + Merchant investor who lost their hard earned savings, life savings in some cases, when those companies collapsed.

The New Zealand capital markets need the new regulator to have this power, albeit slightly tweaked from what's currently proposed. With the 1987 share market crash still fresh in many investors' minds, the finance company melt down has left many retail investors with renewed fear of putting their money anywhere other than in the bank or property market.

Share market in a perilous state

If you're not clear on just what a perilous state the local share market is in, take a look at this Double Shot interview with JBWere strategist Bernard Doyle.As Doyle notes, the New Zealand share market  is ceasing to be relevant to the economy with its market capitalisation as a percentage of Gross Domestic Product (GDP) at just 29%. That has New Zealand, sandwiched between Ireland at 28% and Greece at 30% and way down on Australia's 114%.

But it hasn't always been this way. In 1997 our market capitalisation to GDP ratio was 52% compared with Australia’s 65%, Doyle points out.

And despite NZX's protestations in its submission on the FMA establishment bill that "there has been no regulatory failure in our public markets," regulatory failures have stretched into the share market helping undermine retail investors' confidence in it.

There was the ugly 2006 demise of Feltex, just 27 months after its NZ$1.70-a-share, NZ$254 million initial public offering amid allegations it traded in breach of NZX continuous disclosure rules from August 23, 2005 till June 30, 2006, the woeful tale of Plus SMS which once had a market capitalisation of about NZ$250 million and was finally kicked off NZX after repeatedly breaking the rules, demise of Access Brokerage, and losses from an array of finance companies including Strategic Finance, Dominion Finance, Lombard Finance and South Canterbury Finance who had debt or equity listed.

'Restoring confidence'

The FMA, as Commerce Minister Simon Power puts it, is being established to "restore the confidence of mum and dad investors in our financial markets."

So giving the FMA this new power is not about big business. It's not about company directors. It's not about lawyers. It's not about auditors. It's not about trustees. It's not about NZX. It's about trying to provide some confidence and encouragement to ma and pa investors. Encouraging them that if they invest in the local securities markets and the proverbial hits the fan, they have a watchdog behind them with the teeth and inclination to fight to get their money.

It's telling that the Shareholders' Association, as a voice for the small investor, "strongly supports" this plan to allow the FMA to take over civil actions, considering it "essential for effective regulation and discipline in the securities markets."

So to Lianne Dalziel, who claims to have experienced "many sleepless nights" as the finance company dominos fell when she was Commerce Minister, her fellow members of the Commerce Select Committee, and the rest of our MPs, please pass the Financial Markets (Regulators and KiwiSaver) Bill will the clauses giving the FMA the ability to take civil action on behalf of investors intact.

Give us class action suits too

Something else the politicians and bureaucrats are sitting on, literally in this case, is legislation and amendments to allow New Zealanders to take class action lawsuits. A Class Action Bill has been on the agenda for some time, as these minutes from a March 2009 meeting attended by Chief Justice Sian Elias show.

Currently we have no legislative mechanism to enable class action law suits. So, for example, a disgruntled group of investors' in a failed finance company could go down the much more difficult path of a representative action.

Through this method the disgruntled have to sign up individually with a law firm or litigation funder. And if someone doesn't know the action is being taken and that there was a cut off date by which they had to sign up, they would miss out. In contrast, under the proposed class action legislation, a litigant merely requires seven people’s support to bring proceedings. Then the court controls the litigation and it becomes a class action in the sense that anyone who believes they have suffered a loss and meets the criteria, becomes eligible to share the spoils if the litigation succeeds.

Bank suit thwarted

This lack of ability to launch a class action suit is thwarting Christchurch law firm Wakefield Associates' attempt to piggy back on an Australian class action suit against the big banks for allegedly overcharging customers' with penalty and late fees.

Asked this month whether there had been any progress with the class action legislation, a spokeswoman for Power told interest.co.nz there hadn't been but "feel free to get in contact with us again in a month or two and we might be able to update you then."

Well, here's hoping Power & Co do push this legislation through.

Because as the previously mentioned memo points out, the purpose of the class action legislation is to facilitate social justice claims. And finance company investors could use a bit of that with a "classic" class action situation enabling hundreds of plaintiffs, each with small, individually uneconomic claims, to team up and obtain enough scale to take on those they deem to be responsible for losing their hard earned savings, or failing to do their professional duty to prevent the loss of their hard earned savings.