Report on cycle seven of the Securities Commission's review of financial reports

The Securities Commission has completed the seventh cycle of its financial reporting surveillance programme. Although the Commission was generally pleased with the level of compliance by the issuers it reviewed, the Commission has highlighted a number of areas with room for improvement. These include the disclosure of related party transactions, substantial security holders, directors' interests and directors' share dealings. The Commission also highlighted issues surrounding the disclosure of key management in its latest review.

In Cycle 7, the Commission reviewed financial reports of 44 issuers with balance dates from 31 December 2006 to 30 September 2007. This represents the conclusion of the Commission's first round of its financial reporting surveillance programme which began in 2005, with all NZX listed issuers having now been reviewed (except for some dual or overseas listed entities). The next cycle will begin the second round of reviews where listed issuers will be selected again for review.

The level of compliance in Cycle 7 was generally good, but the Commission found that 17 issuers had matters that needed to be addressed. In respect of those 17 issuers, satisfactory agreement was reached on 83 percent of the matters raised following the initial letter from the Commission.

Related Party matters

In its report, the Securities Commission drew attention to inadequate or possible non-disclosure of related party information by issuers. This, they noted, was particularly unsatisfactory given the current climate and the effect related party relationships can have on an entity's financial performance and financial position.

The Commission identified the following disclosure items as instances where inadequate disclosure or possible non-disclosure of related party information occurred:

• the identity of the ultimate holding company of the issuer;
• the nature of the relationship between related companies;
• key management personnel information;
• the identity of related entities;
• the types of transactions between related parties;
• related party transactions; and
• the terms of settlement of outstanding balances.

Key management personnel

In relation to issuers that have no staff or key management personnel, the Commission drew attention to the fact that the term "key management personnel" is not limited to a person directly employed by the reporting entity. This means that reporting entities are also required to disclose key management personnel information:

• where a related party compensates key management personnel on behalf of the reporting entity;

• where the reporting entity contracts out its key management functions or has those functions performed on its behalf by another entity; and

• where the reporting entity's key management personnel compensation is paid, in substance, on its behalf (whether or not the reporting entity pays management fees to the other entity). For example, where these services are rendered on the reporting entity's behalf by the directors and officers of another entity.

Substantial security holder disclosure

In its report, the Commission again reminds issuers to take their obligations under the Securities Markets Act regarding substantial security holders disclosure seriously, notwithstanding that the primary obligation for such disclosures is on the substantial security holders.

Issuers should ensure their annual disclosures are accurate and comply with the Securities Markets Act. Following the amendments to the Securities Markets Act, which came into force on 29 February 2008, the failure to comply with substantial security holder obligations is now a criminal offence, subject to a fine of up to $30,000. Civil penalties of up to $1 million can be imposed by the court, which can also make a range of orders relating to any holding of securities, including orders to forfeit or dispose of securities. The Commission notes that it intends to review substantial security holder disclosures more closely in future and take action where appropriate.

In Cycle 7 some of the areas of concern identified by the Commission related to:

• the number of substantial security holdings disclosed in the annual report being inconsistent with those in the notice filed with NZX;

• no substantial security holder information being disclosed in the annual report in respect of some substantial security holders;

• no substantial security holder notice being filed with NZX; and

• non-disclosure in the annual report of the date of the substantial security information and the total number of voting securities in the issuer.

Directors' interests and share dealings

In this cycle the Commission identified five issuers in relation to the non-disclosure or inadequate disclosure of directors' interests and share dealings in their annual reports as required by the Companies Act, the Securities Markets Act and NZX Listing Rule 10.5.3(c).

The matters highlighted by the Commission in its report includes:

• the non-disclosure of directors' share dealings in the annual report;

• the inconsistent disclosure of total share holdings between the current and previous annual reports without any disclosure of share transactions having taken place during the year;

• the non-disclosure of shares issued and date of issue to directors in lieu of directors' fees in the annual report;

• the non-disclosure of consideration paid or received for directors' share dealings;

• the inconsistent disclosure of the total number of shares held by a director between the annual report and the notice filed with the NZX; and

• the non-filing of NZX notices for changes in the holdings of persons associated with the directors.

The review also identified issues relating to non-disclosure of waivers in annual reports.

To a view a copy of the report visit the Securities Commission website at www.seccom.govt.nz

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.