Financial Services Law Reform – the final pieces in the puzzle?

David Craig, Partner | Tuesday 15 June 2010

The last six months or so have been a frustrating time for both client and legal adviser. On the one hand, significant law reform is impending – in the form of the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (the FSP Act) and the Financial Advisers Act 2008 (the FA Act). On the other hand, critical decisions surrounding the scope of that law reform have either not yet been made or have been revisited.

With the Commerce Committee last week reporting back on the Financial Service Providers (Pre-Implementation Adjustments) Bill (the FSP Bill), we should now, hopefully, have all the pieces in the puzzle. The FSP Bill is unlikely to change materially prior to its enactment. And there simply will not be time, or space in the legislative calendar, to implement further changes prior to the new regime taking effect as from 1 December 2010 (or 1 July 2011 for certain parts of the FA Act).

So, what are these final pieces in the puzzle?

Wholesale client exemption

This is the big one. In this regard, the legislators have come full circle – moving from the current (retail-only) regime embodied in the Securities Markets Act 1988, to the initially-proposed (wholesale and retail) regime embodied in the FA Act, to the now-proposed (retail-only) regime embodied in the FSP Bill. Nonetheless, despite this circuitous route, the change is a welcome one.

The two key questions are, first, 'who is a wholesale client?' and, secondly, 'what is the extent of the exemption?'.

Who is a wholesale client?

A "wholesale client" for the purposes of the FA Act includes, among others:

• a person who is in the business of providing another financial service and who receives the services of the financial adviser or broker in the course of that business;

• a habitual investor, in terms of the test in the Securities Act 1978;

• an entity that, at the end of each of the last two accounting periods had net assets or turnover exceeding NZ$1 million (and any related body corporate of such an entity);

• a local authority, a Crown entity, a State enterprise, the Reserve Bank and the National Provident Fund;

• certain investors in the context of a private offer of securities; and

• "eligible investors". These are individuals or entities who provide certain written certifications that are, in turn, accepted in writing by the financial adviser, broker or qualifying financial entity (QFE).

This definition is broader than what was initially proposed for the FSP Bill, and considerably broader than the concept proposed in the draft Code of Professional Conduct. Furthermore, the exemption extends to any controlling owner, director, employee or agent of the underlying wholesale client.

A modified version of this FA Act "wholesale client" definition will be inserted into the FSP Act for the purposes of determining whether a financial service provider needs to belong to an approved dispute resolution scheme. In other words, the "retail client" concept that flows from the definition of "wholesale client" will replace the more nebulous concept of "the public", which currently exists in the FSP Act.

What is the extent of the exemption?

Financial advisers or brokers servicing wholesale clients exclusively will be exempt from all of the more onerous provisions of the FA Act. Their residual obligations are largely confined to compliance with certain statutory conduct obligations – such as the obligation to act with due care, skill and diligence.

Scope of financial adviser services

In response to submissions about the uncertainty of the current definitions of "financial advice" and "financial adviser services" in the FA Act, and the unintended consequences due to the breadth of those definitions, certain changes have been recommended, including:

• removing the word "guidance" from the definition of "financial advice", in order to draw a more clear cut distinction between mere information and advice; and

• exempting financial adviser services provided only as an incidental part of a non-financial service, in order to avoid catching, for example, retail assistants discussing hire purchase arrangements with clients.

Class and personalised services

Currently, the FA Act does not distinguish between personalised services (that is, services given to named or readily identifiable clients who would reasonably expect the adviser to take into account their particular circumstances) and class services (that is, services that are not personalised services, such as generic newsletters or brochures). The FSP Bill now draws that distinction. In very broad terms, the position is as follows:

• the FSP Bill recognises three scenarios in which financial adviser services may be provided:

  • personalised services to retail clients;

  • class services to retail clients; and

  • any services (personalised or class) to wholesale clients;

• as expected, the highest degree of regulation applies to the first scenario – personalised services to retail clients. These services may only be provided by individuals, not entities. Moreover, in the context of the more-complex category 1 products, these services may only be provided by authorised financial advisers or, if a member of a QFE group is the product provider or promoter, a QFE adviser; and

• in respect of the second and third scenarios, the services may be provided by a broader range of persons, including those who are merely registered under the FSP Act (and not also authorised under the FA Act). These services may also be provided by entities as well as individuals.

QFEs and corporate groups

Currently, the FA Act's rules for QFEs do not allow all members of a corporate group to operate under the umbrella of a single QFE. Instead, multiple QFEs would be required. The Select Committee now proposes that a single QFE could oversee compliance on behalf of an entire corporate group.

Territorial scope

FSP Act

Unfortunately, this aspect of the legislation continues to confuse and disappoint. Specifically, in response to submissions that requiring offshore advisers to register under the FSP Act would result in them withdrawing from the market (and so stifle competition), the Select Committee recommended that the FSP Act only apply to those "based in New Zealand". However, this concession has not filtered through to the FSP Bill itself. The FSP Bill will amend the FSP Act so that the latter will apply to an overseas-incorporated entity that carries on business in New Zealand. While a one-off service provided to a New Zealand client by an offshore adviser will not cross that threshold, repeated services with multiple clients may well do so. Put another way, despite the Select Committee's recommendation, merely being offshore-based will not be enough to exempt a financial service provider from the need to register under the FSP Act. But perhaps order can be restored by a last-minute supplementary order paper.

FA Act

By contrast, the FA Act clearly applies to offshore-based persons who provide financial adviser services to New Zealand clients. The shift in the focus in the FA Act's territorial scope provision from the place of performance of the service to the place of receipt of the service removes any doubt that such activity is caught.