On 7 March the Commerce Commission released its report into the failed Credit SaILS investment product, and has published details on its website.
Readers may remember that a settlement was reached between the Commission and Forsyth Barr, Credit Agricole, and related entities responsible for structuring and promoting Credit SaILS in December, and that a $60m settlement was paid to avoid any action being taken by the Commission under the Fair Trading Act.
The Commission has now published its findings in the form of an "Investigation Closure Report" – essentially setting out the case it would have made had the matter proceeded to the courts. As such it represents a summary of evidence that the Commission had gathered, but that has not been tested in the courts.
Forsyth Barr and Credit Agricole have denied any breaches of the Fair Trading Act and criticised aspects of the Commission's report – their responses can be accessed from the link above. Naturally, this has attracted considerable press attention, but it's worth probing behind the headlines to see what lessons might be learnt.
In addition to its media release, the Commission's summary of the investigation contains a helpful "Q and A" describing the settlement and implications for investors. It's a useful refresher of an unfortunate period for the individuals involved. The publication of the report has given the Commission an opportunity to describe the evidence it received, outline its view of whether breaches of the Fair Trading Act had occurred, and explain its regulatory stance – in this case its reasons for seeking a settlement rather than commencing litigation. Much of this information could have been deduced from the publication of the settlement document in December, but the further information provided in the report fleshes out the details.
Very briefly, Credit SaILS (an abbreviation for "Credit Saleable Index Linked Securities") were debt securities that were issued by Credit Sail Limited and listed on NZX. Credit SaILS were relatively complex debt securities involving an investment in other securities called Momentum Notes, which carried credit exposure with a range of entities. Had all gone well, investors would have received a redemption premium on repayment of the Credit SaILS, as well as quarterly interest payments. Unfortunately all did not go well, and during the worst of the GFC in 2009 interest payments were suspended, and investors were informed that the Credit SaILS would have no redemption value.
The Commission's investigation was concerned with the manner in which the Credit SaILS had been promoted, both through the offering documents prepared under the Securities Act and subsequent marketing activity. The Commission's conclusions (which, we reiterate, were not tested in the courts and have been disputed by Forsyth Barr and Credit Agricole) were that:
- Credit SaILS were marketed in a manner that was misleading and deceptive
- Credit SaILS were marketed to retail investors despite being unsuitable for such persons
- The promoters knew or ought to have known that Credit SaILS were unsuitable for the average retail investor.
Lessons for market participants?
The Commission has taken the opportunity to provide guidance on how it considers offering documents should be drafted to avoid falling foul of the Fair Trading Act. The Commission notes the work that the Financial Markets Authority has done in this area, and many of its pointers will be familiar to market participants given the extensive consultation the FMA did with its guidance in 2012. Some of the pointers should be fairly obvious – "all information conveyed to investors must be accurate" and "all key terms must be disclosed up front" - and should not come as a surprise to any interested persons. The full list of the Commission's pointers can be accessed from its media release via the link above.
Particularly relevant points in the present case, in our view, include the following:
- Claims of capital protection and capital guarantee should be avoided unless they are perfectly true and
- Creators and promoters of investment products may have liability even where they are not named as an "issuer" or "promoter".
With the last point, it should be noted that while only a limited number of parties might be caught by liability under the Securities Act, liability under the Fair Trading Act can potentially cast its net wider (we go on to discuss the relationship between the statutes and the agencies responsible for investigating alleged breaches below).
As always it's a reminder of the tension between the use of offering documents as a marketing tool, and their status as disclosure documents with stringent legal requirements. In the case of complex and relatively novel products (as the Credit SaILS were at the time), however, these are likely to be subject to a greater degree of scrutiny. Warning signs were disregarded (for example, concerns expressed by the Companies Office when the prospectus was being finalised), and a number of brokers and financial advisory firms had declined to participate in the Credit SaILS offer, on the grounds that they did not consider the products suitable for retail investors. While the Commission decided not to proceed against those brokers who had promoted the offer, it is a reminder that brokers and financial advisers do still potentially face responsibility for their conduct in marketing and promoting financial products.
As might be expected, the press reports following the publication of the report focused on "the sizzle" – that was, in fact, one of the expressions used in an internal Forsyth Barr email, expressing concern that proposed changes to the offer document would "in my view detract from the "sizzle" of the offer". Other comments that the Commission included, and the media reported on, included:
- "Remember we catch more flies with honey than vinegar!" (again, expressing concern with deletions that external legal advisers had proposed to the offering documents)
- "We're not selling bloody cigarettes!" (in relation to how concerns expressed by the Companies Office should be reflected in marketing materials).
There's a saying among lawyers that you shouldn't state anything in a letter or email that you wouldn't be willing to have read out in a courtroom. We'd suggest for market participants a similar rule might apply – you shouldn't state anything in a letter or email that might be subject to a regulator's information gathering powers and subsequently published. The media will tend to look for colourful quotes, and these may develop a life of their own. Having the report published three months after the settlement was reached meant the issues involved were given new life – but the internal emails from the parties involved gave further "sizzle".
Who investigates, and who will investigate in future?
A point to note for the future is that the responsibility for investigations and enforcement matters will change in the financial services space. At present both the Commission (acting under the Fair Trading Act) and the FMA (acting under the Securities Act, or other pieces of financial markets legislation such as the Financial Advisers Act) may investigate and take action where investments are alleged to have been promoted in a misleading manner. In this particular case the Commission met with the FMA's predecessor, the Securities Commission, to discuss which agency should lead the investigation.
Under the new regime that will come into effect under the Financial Markets Conduct Bill (which is expected to be operational in May 2014), the FMA will have sole jurisdiction for fair dealing issues in respect of financial products and financial services. The Bill contains fair dealing provisions that are drafted to apply to dealings in financial products and services, and follow a similar form to the Fair Trading Act provisions. The Bill also contains an amendment to the Fair Trading Act that will remove the Commission's jurisdiction in respect of these matters. Under the new regime the FMA would be expressly empowered to accept an undertaking to pay compensation in consideration for not taking enforcement action, and the FMA has publicly indicated that it considers such payments an appropriate outcome, so a similar outcome could well be reached in a future Credit SaILS type scenario. The FMA may also, it should be noted, exercise its powers under section 34 of the Financial Markets Authority Act to exercise an investor's right of action in certain circumstances.
At this stage it is too early to tell how the FMA might exercise its powers, but during the course of 2013 we expect the market regulator to give some indications of how it might use the toolkit it will have under the new legislation.