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Presentation by Sean Hughes to NZICA Forensic Conference 2011


17 May 2011

Thank you for inviting me to speak today.

It's a great pleasure to be here with you all as Chief Executive of New Zealand's new Financial Markets Authority.

I've been in my role all of two and a bit weeks, but even though we're very new, we've had an extremely busy time, with two very recent outcomes involving Mr Whimp last week, and a great deal of media interest in both our establishment and in ongoing issues to do with Mr Whimp and Mr Hotchin.

Our establishment legislation, the Financial Markets Authority Act 2011, has set up FMA as a new financial sector 'umbrella regulator'.

Our main objective is to promote and facilitate fair, efficient and transparent markets. We have enhanced powers of regulation and enforcement, including important changes to the governance of KiwiSaver schemes. We oversee registered securities exchanges and we're responsible for the regulation of financial advisers and financial service providers. We will add trustees and statutory supervisors to that list on 1 October, and auditors from 1 July next year.

Over the past 20 years, while working in financial markets risk management, enforcement, and litigation, most recently for ASIC, the Australian securities regulator, I've heard of lots of analogies for the role of regulators. They've been likened to an ambulance at the top of the cliff - and an ambulance at the bottom of the cliff! They've also been likened to an air traffic controller and to a sheriff…

But I like to think of us as sports coach and referee. We help the players understand the rules so they know how to play the game safely, and we check to see they're playing by the rules. When there is foul play, we put up the red flag and send the player off the field. If their conduct is so out-of-line, we'll advocate for a season ban. We're constantly analysing the play, and we advise the national body on how the rules might be changed in order to improve the way the game is played.

At FMA, we are focused on ensuring there is a level playing field and that the risks are obvious to all who enter the arena.

The reality is that capital markets are risky. And not everyone is careful. Companies do fail and investors do get hurt. Creditors are left unpaid. Employees are exposed and vulnerable. That's the nature of capital markets. Through good market regulation and oversight, we might be able to reduce the chances of this happening, but we cannot prevent it nor will we. That is not the role of a regulator in a developed market economy and nor should it be. It is not our job to provide a capital guarantee for failed investment outcomes or flawed investor decisions.

I reject any assertion that regulators are there to guarantee survival. There will always be an element of risk in securities market participation and this will never change despite all the regulation, close supervision, powers and resources in the world. Risk-taking, in the right circumstances and with the right resources and controls, is appropriate and I encourage it as an enabler of capital growth.

I am not, however, an advocate of the efficient markets theory of minimalist regulator. When a company hits the wall because its directors and management have been asleep at the wheel - or worse, because they've bailed out the door and let their investors take the impact - then we will look to see what action FMA can take. We will and are taking action.

In recent years, as you all will know, confidence in the financial sector has been sorely tested by the Global Financial Crisis and further damaged in New Zealand by a number of serious corporate collapses.

In particular, around 60 finance industry companies have gone under or arranged moratoria in the last five years, putting at risk $8.5 billion of investors' money. In the wake of these events, investigations into allegations of false and misleading statements are ongoing, and charges have been laid against a number of directors of finance companies.

Jane Diplock, the outgoing chairman of the Securities Commission, is on record as saying these finance company collapses occurred in a 'regulatory desert'. Given the extent of its legislation, the Commission's role was limited to ensuring risks were properly disclosed in prospectuses, investment statements and so on, allowing investors to make their own judgments as to whether the returns being offered were worth those risks.

Clearly they were not, and the Government heeded the call for a much more integrated approach to regulating the financial sector - hence the establishment of FMA, a significantly increased budget, and the arsenal of new powers that we enjoy today.

I am also pleased that New Zealand has implemented a 'twin peaks' regulatory model similar to the Australian ASIC / APRA design, which proved itself during the GFC. In Australia's case, it led to a reaffirmation of the twin peaks approach and a tightening of information sharing and communication through the Council of Financial Regulators representing the Reserve Bank, APRA, ASIC and the Treasury.

Under New Zealand's twin peaks model, FMA sits alongside the Reserve Bank. The Reserve Bank has had its prudential supervisory powers over the banking sector extended to cover the likes of finance companies, building societies and credit unions, as well as the insurance industry. The Reserve Bank and we are determined to ensure the success of this new model.

Can I also point out that FMA's establishment is not the beginning or end of the Government's reform agenda. The Government is currently working on a wider review of New Zealand's securities laws, which will overhaul the 'conduct' side of our regulatory regime. The securities law review is an important piece of work that is being fast-tracked, so please keep an eye out for the first consultation document, which is expected in August.

The Government's key focus now is to restore investor confidence in New Zealand's capital markets. Where has that confidence gone?

In 1987, just before the share market crash, 26 percent of household assets were directly invested in New Zealand's equity markets. As at the end of 2010, this share had plummeted to 7 percent.

The latest ASB Investor Confidence Survey reported over the weekend showed that investor confidence had dropped still further in the wake of the February earthquake in Christchurch, with investors continuing to focus their investment activities on Auckland rental property and term deposits.

Let's stop the decay now. Let this moment mark the baseline from which New Zealand's flight from the capital markets halts, and begins a long, steady, permanent and sustainable improvement. Investor confidence, and understanding of the importance of asset class diversity, is absolutely critical if New Zealand is to develop the kinds of vibrant capital markets needed to attract investment in our productive industries and, in turn, to lift our economic performance.

Market participants need to be subject to clear rules so that investors can be confident that those rules will be actively and consistently enforced. Investors also need to be able to easily access relevant information about investing wisely and well.

So FMA faces some very significant challenges and I do not underestimate the scale of the task ahead. Only in March, a Morningstar global study of investor experience in 22 countries rated New Zealand last with a D-minus. The report said New Zealand scored worst because of its low rating in disclosure as well as regulation and taxation.

Morningstar acknowledged New Zealand was moving to improve its performance with the creation of FMA and the securities law review. What this demonstrates is that the eyes and expectations of the global investment community are on New Zealand and FMA's work. And we not only have the major task of restoring investor confidence among New Zealand investors but internationally as well!

Believe me, we are very mindful of the high expectations held both by Government and of the market for our success going forward. But I welcome that challenge, and I'm eager to get things underway.

Nevertheless, FMA is still little more than two weeks old, the new FMA Board formally met for the first time only yesterday, my appointment as CE was only then ratified, and our Statement of Intent remains in draft form. But I thought I would spend a bit of time now focusing on the surveillance and enforcement area of our work, which is of greatest interest to you.

The Board has yet to set its law enforcement strategy, and to get advice and recommendations from the executive team. We hope to finalise that and be in a position to publish it in the next few months. In the meantime, what I can share with you are some principles that we're being guided by in our early days.

The first point to make is that for the first time New Zealand has a fully-fledged financial services law enforcement body operating in the capital markets. This means no disrespect to our predecessor bodies at the Ministry of Economic Development or more especially the Securities Commission, which started off life as a policy-making and exemptions-type organization with limited enforcement and investigatory powers. Added to that, we've been given some very powerful new tools of which the most significant and controversial is s34.

So this is new for everybody, not least for FMA staff.

First, FMA will focus its energy not across every act of misbehaviour or insignificant breach but primarily on those areas of misconduct where the failings or beaches are deliberate or reckless and where the perpetrator set out to deliberately mislead or deceive innocent investors or third parties.

Our enforcement approach must be guided by our overriding mandate to promote fair, efficient and transparent capital markets, and to grow New Zealand's capital base.

So, conduct that would attract our attention is conduct that would undermine any of those objectives. This is why we decided to take early action against Mr Whimp.

Second, FMA has inherited a number of finance company cases and investigations from the Securities Commission and our MED predecessors. We will deal with those matters on our books by taking a holistic approach.

Obviously, cases already before the courts must be pursued and we will meet court deadlines, and prosecute those matters to the best of our ability. Where possible, we will add additional resources so as to enhance our prospects of success.

For matters not before the courts but that are under investigation and inherited from the Commission, we will undertake a detailed forensic analysis - but quickly - to assess whether those matters meet our new strategic priorities including those in our statutory objective.

Among the questions we will ask are: What is the current state of the investigation? How many people are affected and to what degree? What additional evidence needs to be gathered in order to bring those matters to trial? Are there any alternative remedies including new civil remedies we previously did not have? Are there other agencies that have an interest in the case and who might also pursue matters to achieve similar or even better outcomes? Is it in the public interest to pursue this case, and what chance is there of recovering a sizeable or significant proportion of lost funds?

So each matter that we have inherited from the Securities Commission that is not already before the courts will be put through this process, one we are calling a triage process.

Inevitably, this means that some matters will be progressed more aggressively, more quickly and in a more targeted fashion than perhaps in the past. And that's a good thing.

There will be some matters that will not be progressed at all either because there are other avenues of redress for those who have lost funds, or where other regulators or agencies have an interest or, importantly, where the impact or significance does not meet our strategic objective.

We cannot run every case, nor pursue every breach or mishap, otherwise we will imperil and strangle any prospect we have of achieving our forward-looking agenda.

In addition, we need to be responsible in our use of public resources, and we will not pursue matters where there would be a disproportionate cost versus the likely outcome.

I'd also like to say at this point, however, that we will retain our discretion to step outside our own guidelines on the odd occasion. There will be times when it is important for us to take a stand, to test the law, and to use particular cases to check that our analysis or interpretation of the law is correct.

It is our intention to be bold and intrepid in our approach. There must always be cases we are prepared to lose, provided there is a cogent reason and lesson to be extracted which benefits the whole market.

Any litigation is by its nature risky, and we cannot predict the outcome of matters that will be determined appropriately by an independent judicial body. This means that where it's possible for us to resolve matters without redress to court, or perhaps with court as an alternative, we will apply commercial common-sense in seeking effective, tailored remedies that match the severity of the misconduct.

Some have said that we've had an easy start by inheriting a large number of existing cases and investigations from Securities Commission. I disagree.

What we have inherited is a large number of matters that relate to events that occurred some years ago and are yet to be resolved. That's an unfortunate byproduct of the number of finance companies that collapsed. It would be far better to have fewer of those matters and therefore to have more time, energy and resources to devote to new investigations that better fit our strategic objective.

Our targets for surveillance will follow a similar path. We will focus our compliance monitoring on both newly licensed entities, and on existing regulated entities to ensure they are meeting their obligations and that investors are receiving the services and disclosure they are entitled to receive.

Newly regulated entities such as financial advisers can expect that we will pursue a measured approach to surveillance. This will give them an opportunity to understand, and reach full compliance with, their obligations before we take a tougher enforcement approach.

For entities that have been under regulatory supervision for some time, we will be much less lenient.

Most importantly, we will never be soft on conduct that is deliberate or reckless or that is intended to deceive or defraud innocent third parties of their funds.

An important new aspect of our work is the establishment of a strategic market intelligence function. We must build this from scratch. Our aim is to bring together a range of different information sources from across the market, and from within FMA and other government agencies, to start to build a picture of where the most risky behaviours are occurring.

It's critical that we develop strong information-sharing arrangements with the Serious Fraud Office, the Police, and other investigatory bodies. In part, this will allow us to identify which is the most appropriate agency to lead an investigation. Other important sources of intelligence about fraud and illegal activity are our fellow regulators overseas, especially ASIC in Australia.

We aim to have the framework for a market intelligence function in place by mid to late June, be recruiting staff towards the end of that period and have it fully operative by the end of winter.

This does not mean though that we won't be gathering information and assessing it at the same time. In this work, we're reliant on you - all of you in this audience today - to help us, and to point us in the right direction. FMA is not an island. We cannot be everywhere in the market. We need your input to help us best target our activities.

Naturally, we hope that through the early use of our powers, and by sending clear signals to the market about unacceptable behaviour, we will be able to improve behaviour generally, head off unnecessary litigation, and facilitate positive commercial outcomes from those who do come to our attention.

This does not mean that we will abandon criminal prosecutions for the most serious wrongdoing, far from it. We will also follow with interest and contribute actively to the Government's review of securities legislation, in particular, its review of the current liability regime so as to ensure that we have a proper, tiered approach to any conduct that is a breach of those laws.

It's true that of the staff we have inherited from the Securities Commission and MED, only a handful has forensic accountancy or investigation expertise. This is a priority area for us to build, both in terms of lifting internal capability and recruiting directly from outside FMA. It will also be important that we work in a collegial way with other regulators on shared investigations and other exercises, and with external service providers, such as law firms and forensic accountancy firms.

Other agencies and private firms should interact with us frequently and wherever they believe they are in a position to add value.

Obviously, we must be mindful of conflicts of interest, and there will be occasions when it is inappropriate for a private firm or other agency to be carrying out work or undertaking exercises on behalf of FMA.

However, we will take a balanced approach to the utilization of our resources, and where it is appropriate for us to bring in specialist expertise we will do so - but that needs to be on rates that reflect our position as a public sector agency.

So what can you do to contribute to FMA's work in promoting market integrity?

I encourage you to be ethical leaders. Do the right thing. Take no action that might damage or tarnish your professional integrity, or the integrity of your profession. Be brave. Take your responsibilities seriously. Keep the market appropriately informed. In other words, do your jobs well.

As both gatekeepers and participants in the regulatory model, you have a potentially critical part to play in the rebuilding of confidence in New Zealand's investment environment.

And what can you expect from us? You can expect more guidance and more communication. When our market intelligence function is up and running, be assured that we will be quicker to act - we will not hesitate to take enforcement action where it's needed. We will test our new powers.

Over the coming months, I encourage you to reach out and interact directly with FMA's Board and my chairman Simon Allen, with me, and with my strategic leadership team to deepen existing relationships, create new opportunities for sharing ideas and intelligence, and to build the trust that we each need to do our jobs well. This will be a partnership we can all be proud of.

We are all in this together. For those of you in the investigative, forensic and broader corporate governance areas, this is a wonderful time to be in New Zealand.

You have an active engaged regulator, a committed government, an impatient and exasperated populace, and a new set of laws that we are keen to use.

It's a great moment in history for those in this audience to be part of the journey to lifting the standard in our market, and encouraging investors to come back in.