Financial services litigation predictions
2018 Litigation Forecast
The scope of financial services regulation is wide, and the turf is policed by a number of different regulators, including the Serious Fraud Office (SFO), the Financial Markets Authority (FMA), NZX, The Department of International Affairs (DIA) and the Reserve Bank of New Zealand. It is an area which has seen significant activity in 2017 by a number of regulators. These have included investigations, prosecutions, civil proceedings and other enforcement tools. We foresee this continuing into 2018. The more significant areas of activity are discussed below.
Ponzi schemes, bribery and corruption, and international sanctions
Ponzi schemes of a more modest scale than those in the 2012 Ross Asset Management case have continued to be a target of the SFO in 2017. Those that were prosecuted include:
- Shane Scott, total offending worth $5.4m, with no direct evidence of any legitimate investments. The offending involved a mixture of some short term and some longer term investors, including some friends and associates who had invested for over a decade. Mr Scott ultimately pleaded guilty and was sentenced to 4 years’, 8 months’ prison in October 2017.
- Paul Hibbs, an unregistered financial services adviser (who ran Cameron Gladstone Investments and then Hansa Limited). The total offending was worth $17.5m from 16 investors and their families, many of whom he had known for years. Mr Hibbs, pleaded guilty in October 2017 and was remanded in custody until February 2018 for sentencing.
The continued focus on Ponzi schemes is consistent with the SFO’s strategic objective of investigating where there is potentially a significant impact on public confidence in New Zealand as a safe place to invest. We expect to see Ponzi schemes remain targets in 2018, with any enforcement action being well-publicised.
Bribery and corruption
Corruption cases continue to be targets for the SFO, even when payments are relatively low-level given the risk to New Zealand’s trading reputation. Expect that to continue in 2018: bribery and corruption remain “priority cases” for the SFO, as confirmed by SFO Director Julie Read, and General Counsel Paul O’Neil, when they spoke at the firm in mid-2017.
- A 2017 example is the prosecution of Simon Hall, a former employee of Fisher & Paykel Healthcare, for receiving $213,000 in secret commissions from Middle Eastern clients of FPH and for deceiving his employer. Mr Hall was sentenced to 8 months’ home detention. Notwithstanding the comparatively small amount involved, the SFO noted that his actions potentially tarnished the reputation of how New Zealand entities do business overseas, and said that “the SFO will continue to act in cases like this to maintain that [corruption free] reputation”.
Also expect enforcement agencies to go after the proceeds of crime following corruption convictions, as they have following the high profile 2016 Auckland roading contractors’ case – in September 2017 the High Court issued a without notice order freezing Mr Borlase’s assets worth approximately $8.6m under the Criminal Proceeds (Recovery) Act. In November, the Court of Appeal confirmed both the conviction and sentence of Mr Borlase, stating that the offending over 7 years reflected “generic and systemic corruption with a tendency to undermine confidence in the administration of public affairs”. Following the Court of Appeal’s rejection of Borlase’s appeal, it is expected that the Commissioner of Police will move to have those assets forfeited.
New Zealand is known for corruption free business practices and the SFO will continue to act in cases like this to maintain that reputation.
Too easily overlooked by local businesses, international sanctions bite in New Zealand too – as was brought home this year by the Pacific Aerospace Limited New Zealand aircraft manufacturer case, with the company pleading guilty in October to breaches of UN Sanctions and the New Zealand Customs and Excise Act for the indirect export of aircraft parts to North Korea (via China).
New Zealand companies need to remember that, given the current international climate, not only have UN Sanctions been significantly strengthened against North Korea, they are being actively monitored by both the international community and New Zealand.
For example, the Pacific Aerospace case was part of a UN Security Council Panel of Experts Report on sanctions against North Korea in February 2017. The detail of the report included excerpts from emails between a Chinese counterpart and Pacific Aerospace showing knowledge by Pacific Aerospace of use by North Korea, and plans to provide training and parts.
The sharing of information and co-ordination of law enforcement action across borders by regulators and enforcement agencies also continues. For example, the International Anti-Corruption Coordination Centre launched in the UK in July 2017, with New Zealand, Australia, Canada, Singapore, the UK, and the USA as members. This collaborative international approach is a trend we expect to continue, consistent also with a “no safe harbours” hard-line on multi-jurisdictional criminal activity.
The sharing of information and co-ordination of law enforcement action across borders by regulators and enforcement agencies also continues.
Market manipulation, insider trading and disciplinary proceedings before the NZMDT
Market manipulation and Insider trading
Last year was an active year for the FMA in litigation matters. Two significant “firsts” were:
- The civil proceedings in Financial Markets Authority v Warminger, making the first extensive judicial analysis of market manipulation in New Zealand. Although the trades involved were relatively modest, the High Court described the conduct as coming from “a very experienced market trader in an attempt to take advantage of parties on the other side of the transaction” and during the subsequent penalty hearing said it was “likely to materially damage the integrity or reputation of New Zealand’s securities markets”. Mr Warminger was ordered to pay a pecuniary penalty of $400,000 and is subject to an automatic 5 year management ban.
- The first successful criminal prosecution of insider trading in New Zealand, involving a former employee at EROAD, Jeffery Honey. Mr Honey, an analytics manager, was convicted in relation to advice given to an associate to sell shares in EROAD on the basis of inside information that trading performance in the United States was worse than expected. He was sentenced to 6 months’ home detention.
The FMA’s areas of strategic interest for enforcement in 2018 includes continued scrutiny of secondary markets trading conduct.
- We are already seeing the FMA educating market participants as to how it interprets and will apply the Warminger decision in the future. Continuing the theme of protecting the integrity and New Zealand markets will be an FMA priority going forward.
We expect to see a hard line taken when further misconduct is identified as the FMA seeks to bed in the gains made.
A tough approach can also be expected on any identified instances of insider trading. The FMA has recently filed criminal charges in the Auckland District Court relating to insider trading in VMob Group Limited shares (now trading as Plexure Group Limited).
The FMA’s expected approach is also reflected in Chief Executive, Rob Everett’s comments following the outcome in Warminger: “Maintaining and promoting the integrity of New Zealand’s financial markets is a core part of our mandate and we will continue to respond vigorously where we see misconduct”, and those of General Counsel, Nick Kynoch following sentencing in the EROAD case: “Insider trading erodes confidence and harms the integrity of our markets. Where we find examples of this kind of misconduct we will take action and use our enforcement powers to uphold the law.”
Another area of interest for the FMA’s enforcement team is promoting compliance with the Code of Professional Conduct for Authorised Financial Advisors. Emphasising the need for vigilance in this area, the recent decision before the FADC in Financial Markets Authority v XYZ shows that the FMA is willing to bring cases despite no apparent client harm or complaints. The decision also shows that even technical breaches of the Code can result in serious consequences.
Also on the FMA’s horizon in 2018 are:
- A major criminal prosecution under the Crimes Act against Auckland-based Steven Robertson. Mr Robertson was charged with 47 theft and fraud offences in the Auckland District Court relating to funds received from clients of PTT Ltd and related entities. It is alleged the clients understood the funds would be traded on their behalves or used for the purchase of shares in Mr Robertson’s companies when they were not.
- The re-trial in the last of the criminal prosecutions arising out of the failed finance companies, R v Bublitz, after the High Court aborted the first trial in May 2017 – almost eight months after it commenced. The trial Judge had earlier dismissed large numbers of charges for reasons of case management and to try and keep the case within manageable bounds.
Increased referrals by NZX to the New Zealand Markets Disciplinary Tribunal
Outside of the courts, we anticipate increased willingness on the part of NZX to refer market participants for disciplinary proceedings before its internal New Zealand Markets Disciplinary Tribunal (NZMDT).
In its 2017 NZX Obligations Report, the FMA said that although generally satisfied appropriate levels of enquiry and professional scepticism were being applied in enforcement matters, there were some instances where NZX fell short of its expectations. Infringement notices, the FMA said, should be reserved for “clear and minor breaches of the rules” and NZX was encouraged to make greater use of the NZMDT where there is “reasonable evidence” of “more than a minor breach of the rules”.
There has been a recent drive toward increased penalties before the NZMDT and, compared to the infringement notice regime, the potential consequences are much more significant (the penalty bands are up to $20,000 for minor breaches, up to $200,000 for moderate breaches and up to $500,000 for serious breaches, whereas the four infringement fees during the FMA’s review period ranged from $3,000 to $5,000). The emphasis toward taking market participants before the NZMDT for other than clear and minor misconduct highlights the need for management and boards to be vigilant with their companies’ obligations under the listing rules.
The emphasis toward taking market participants before the NZMDT for other than clear and minor misconduct highlights the need for management and boards to be vigilant with their companies’ obligations under the listing rules.
AML/CFT: No more excuses
The Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act) has now been in force for over four years. Up until now, there has been some leniency to allow time for entities to acclimatise to the new AML/CFT regime. However, the attitude of the DIA, which is responsible for enforcing part of the AML/CFT regime, is that there are no more excuses for non-compliance. The DIA has already had a successful prosecution under the AML/CFT Act in the Ping An case in which the Court ordered payment of a pecuniary penalty of $5.3 million. Our view is that 2018 will mark the beginning of a more litigious period against non-compliant reporting entities.
In a signal of what is to come in 2018, on 13 December 2017, the DIA filed its third civil proceedings under the AML/CFT Act in the Auckland High Court against a money remitter, Jin Yuan Finance Limited (Jin Yuan). Proceedings have been brought not because there is any evidence of money-laundering or the financing of terrorism, but because the DIA alleges that Jin Yuan failed to meet AML/CFT Act requirements such as customer due diligence, account monitoring, record keeping and reporting suspicious transactions. This prosecution follows on from a formal warning to Jin Yuan issued by the DIA in July 2015. This shows that the DIA will closely monitor entities who have been warned and will prosecute if remedial action is not taken. This is a case to watch for 2018.
The FMA and the Reserve Bank also have responsibility for enforcing the AML/CFT Act in relation to certain sectors and are actively monitoring the sectors they are responsible for under the AML/CFT Act. These regulators are considering a range of regulatory responses, from litigation to formal warnings against reporting entities who are still non-compliant. For instance, on 24 November 2017, the FMA issued a formal warning to Fullerton Markets Limited (Fullerton). An inspection of Fullerton’s AML/CFT compliance by the FMA staff showed that the company did not have adequate risk assessment or AML/CFT compliance programmes. The warning required Fullerton to undertake a series of remedial actions to comply with the law. The FMA signalled that if Fullerton failed to take these remedial steps, the FMA would consider further regulatory responses including civil action which can result in penalties of up to $2 million per offence.
In the Annual Report for 2017, the FMA referred to the following problematic issues in AML/CFT. We consider these may be a focus for enforcement action in the future:
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