New Zealand Law Society - Is the FMCA a watershed for offer due diligence?

Is the FMCA a watershed for offer due diligence?

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Fund managers, and other continuous issuers are now currently in the process of transitioning to the new Financial Markets Conduct Act 2013 (FMCA) regime, which they must all do before 1 December 2016. This regulatory change provides a catalyst to consider whether due diligence processes for the PDS (product disclosure statement) and Disclose Register entry under the FMCA, should be the same as for prospectuses and investment statements under the old regime.

As was the case in relation to prospectuses and investment statements under the Securities Act 1978, under the FMCA directors have a duty to ensure that the new PDS and Disclose Register entry do not contain any false or misleading statements or omit any material matters. However, the FMCA provides a fresh opportunity for directors to develop new approaches to due diligence which are tailored to fit their organisation and the particular issue to be offered.

This is reflective of the government’s intent behind the FMCA which was to allow a regime which is:

“flexible enough to allow a director to delegate the process for development of disclosure and verifying its completeness and accuracy to others, if it is reasonable to do so in the circumstances.”

Generally, criminal liability only arises for directors of offerors that have issued defective disclosure in a PDS or Register entry, if the offer or continuing of the offer takes place with the director’s authority, permission or consent and the director knows that, or is reckless as to whether, there is defective disclosure. This contrasts with the Securities Act approach of strict liability with defences.

In relation to civil liability, the FMCA provides for strict liability with a broader range of due diligence defences than the Securities Act for defective disclosure in a PDS or Disclose Register entry. In particular, the FMCA provides a new defence to directors who are deemed civilly liable for an issuer’s defective disclosure if they can prove that they took all reasonable and proper steps to ensure that the issuer complied with the relevant disclosure obligations.

Approaches to due diligence under the FMCA

Under the reformed civil liability regime, the FMCA gives effect to the government intent by allowing at least two approaches to offer due diligence:

  • The traditional, Securities Act style of due diligence where directors are heavily involved in the due diligence and verification process itself and personally review the contents of the offer documents. Under the Securities Act a series of decisions involving finance companies established that directors had the ultimate non-delegable duty to ensure that disclosure was accurate and adequate.
  • The new FMCA infrastructure-based approach which involves directors designing and overseeing the due diligence and verification process, rather than their personal performance of it. Under this approach, directors must be able to show they have taken all reasonable and proper steps to ensure that the PDS and Disclose Register entry do not contain defective disclosure.

The traditional style will likely continue to be appropriate for strategically important issues, for example an initial public offering or the raising of capital in a subordinated bond issue, where heavy personal involvement by the board would be expected, in any event, in accordance with good governance practice.

However, for business as usual offerings by continuous issuers, the infrastructure-based approach may be a better fit with the legislation, and with the governance expectations as to the division between director and management responsibility. It is unlikely that the FMCA contemplates no director involvement in the due diligence and verification process at all. However, provided that directors continue to “exercise intelligent oversight of the company’s affairs” it may be possible to delegate the actual verification of the contents of the PDS and Disclose Register entry to others. That being said, the infrastructure-based approach is not due diligence-lite. It may actually be more demanding because of the requirement for a systematic approach and for smaller issuers the traditional process may be more straightforward. What remains important in all cases is that due diligence is designed to ensure investors receive the information they need to make investment decisions and that that information is reliable.

It is important to emphasise that the two approaches outlined are not exhaustive of the ways directors and issuers may seek to comply with the FMCA. Ultimately, the appropriate level of director involvement in the process will depend on the particular circumstances of the offer and of the issuer. In practice some issuers will likely adopt a hybrid approach.

Infrastructure-based approach

An infrastructure-based approach is a new concept to offer due diligence in New Zealand. It has, however, been endorsed by courts as helping to establish a similar “reasonable and proper steps” defence to that in the FMCA in Australia under the Corporations Act 2001 (Cth) in Clarke (as trustee of the Clarke Family Trust) v Great Southern Finance Pty Ltd (Receivers and Managers Appointed) (in liq) [2014] VSC 516 and in New Zealand, in the context of financial reporting in Ministry of Economic Development v Feeney (2010) NZCLC 264,715 (DC).

While the Financial Markets Authority has not yet issued any guidance on what an infrastructure-based approach may look like under the FMCA, issuers may look to other compliance frameworks such as Standard NZS/AS 3806 Compliance programmes. AS 3806 was originally created in 1998 following a request from the Australian Competition and Consumer Commission (ACCC) to assist with competition law compliance. In 2006, it was revised and adopted in New Zealand and Australia in its current form. The NZS/AS 3806 standard is well respected and is referenced by numerous regulators including the FMA in relation to Qualifying Financial Entities Advisers, the Australian Securities and Investments Commission (ASIC) and the ACCC. Subsequently, NZ/AS3806 has been a model for the development of ISO 19600 Compliance management systems issued in 2014.

Broadly, the NZS/AS 3806 approach is based on four key aspects of compliance being: commitment; implementation; monitoring and measuring; and continual improvement. Applying this to FMCA offer verification, this will likely to involve the board of directors at an oversight level:

  • developing and implementing an effective due diligence planning memorandum that is appropriate for the issuer’s business and for the specific offer;
  • taking reasonable precautions in the selection of the members of the due diligence committee – the roles of each member of the committee must be clearly articulated and the committee must have access to the board, all levels of the organisation and expert advice;
  • laying down an effective system of supervision of the due diligence process to ensure it is working as expected – this is to ensure that problems are identified and reported to the board (if necessary) and remedied;
  • receiving and being satisfied with compliance reports from the due diligence committee setting out whether there are any issues with the final disclosure materials and whether in their view, it should be approved; and
  • post-process review of the operation of the process (including the outcomes) to identify areas for improvement for future offerings.

The issuer’s due diligence infrastructure will also need to be designed to ensure that the new Disclose Register is kept accurate and up to date. Under the FMCA, the Disclose Register will be the ultimate repository of all “material information” and continuous updating is expected not only during the initial offering, but for so long as financial products are outstanding.

Directors must be careful not to take a formulaic approach to due diligence and verification. The compliance framework needs to be adapted to suit their particular organisation and circumstances. What is crucial is that the board must be satisfied that the processes which they have designed can reasonably be expected to ensure that there are no omissions or false or misleading statements in the PDS and Register entry. In other words, directors must be satisfied that the right people from their organisation are involved in the process so that all material information will be drawn out, verified and disclosed in a clear, concise and effective manner.


In deciding what type of process to adopt and design, directors need to have the mindset that the primary purpose of due diligence is to ensure that investors have all material matters, accurately and effectively disclosed, to allow them to decide whether or not to invest in the particular offer. While a well designed and correctly implemented process will help directors and issuers establish a defence where there is defective disclosure, the best defence is getting it right in the first place.

The authors’ analysis of the relevant law will be set out in greater length in an article to be published in the upcoming issue of New Zealand Business Law Quarterly (NZBLQ Volume 21 Number 3).

Key considerations

The FMCA provides an opportunity for boards of directors to consider what the transition to the FMCA regime means in terms of their offer due diligence processes. Directors need to think carefully about their appropriate level of involvement in offer due diligence and verification under the FMCA. Some questions they need to ask themselves include:

  • Is the offer a strategic, one-off event, or is it business as usual?
  • Who in the business has material information about the offer and how will they be involved in the due diligence process?
  • How do they exercise intelligent oversight over the process and ensure that it has been implemented correctly?
  • How will the effectiveness of their process be tested and reported back to them?
  • Will the process ensure that investors receive the information they need and that the information is reliable?

Ultimately, directors must have a robust answer to the question “how do you know that the PDS and Disclose Register entry comply with the FMCA and FMC Regulations, and that they will continue to do so while the offer remains open?”

Lloyd Kavanagh is a partner at Minter Ellison Rudd Watts and leads the financial services practice. Samantha Youjia Zhang is a solicitor in the banking and financial services team at Minter Ellison Rudd Watts.

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