Investor Protection in the Asia Pacific

Transcription

1 Investor Protection in the Asia Pacific Asia-Pacific Regional Committee meeting in Seoul IOSCO Annual General Conference Oct 2003 Prepared by the Monetary Authority of Singapore

2 Background 1.1 At the February 2001 APRC Meeting in Bali, the Monetary Authority of Singapore proposed a project on studying investor protection practices in APRC countries. This project was discussed and endorsed at the same meeting. 1.2 Following further discussions, MAS circulated a draft questionnaire ( APRC Survey on Investor Protection from Market Misconduct, False and Misleading Statements, and Recommendations Without Reasonable Basis ), and a final version was sent out in September MAS received 14 replies to date At the January 2003 APRC Meeting in Colombo, MAS presented an Interim Report on Investor Protection in the Asia-Pacific, which highlighted some of the trends observed and gave a preliminary analysis of the survey results available then. Since then, MAS has received several additional responses. 1.4 This report aims to present an analysis of investor protection practices among the Asia- Pacific jurisdictions, based on the survey results, and makes several suggestions for improvements. 1 From Dec 2002 to Sep 2003, the Monetary Authority of Singapore has received replies from the following agencies: Australian Securities and Investments Commission, Australia Securities and Exchange Commission, Bangladesh China Securities Regulatory Commission, China Securities and Futures Commission, Chinese Taipei Securities and Exchange Board of India, India Bapepam, Indonesia Japanese Financial Services Agency, Japan Securities Commission, Malaysia Securities Commission, New Zealand Securities and Exchange Commission, Philippines Monetary Authority of Singapore, Singapore Securities and Exchange Commission, Sri Lanka Securities and Exchange Commission, Thailand State Securities Commission, Vietnam Page 2 of 20

3 The Importance of Investor Protection 2.1 One fundamental purpose served by capital markets is the provision of an avenue for companies to raise capital directly from investors. The secondary market in turn provides a price-discovery mechanism and allows investors to transact directly with each other in a fair, efficient and transparent manner. 2.2 The fact that members of the public have the opportunity to participate in the capital markets places a responsibility on regulators to ensure that investors 2 are adequately protected from various forms of dishonest behaviour. Indeed, IOSCO included investor protection as one of three key objectives of securities regulation, as outlined in the September 1998 report on Objectives and Principles of Securities Regulation, which has been adopted by many jurisdictions. 2.4 With demographic changes throughout Asia, growing retail participation in the stock market (either directly, or through pension plans) and a recent spate of high-profile scandals in the US and elsewhere, there is no doubt that investor protection is an important priority which can directly impact public welfare. An appropriate level of investor protection will also boost investor confidence by reassuring investors (both retail and institutional) that their rights are being safeguarded. This is crucial to the development of capital markets, as well as increasing shareholder value and decreasing the cost of capital. 2.5 Another impetus for facilitating comparable investor protection standards across jurisdictions lies in the increasing volume of cross-border securities transactions. An investor who engages in cross-border transactions will find it comforting that he enjoys comparable levels of protection. This also makes it important to ensure transparency of investor protection measures. Indeed, in terms of the types of investor protection covered in the study, we have found that all of the jurisdictions surveyed do have safeguards in place for dealing with common forms of misconduct. 2 In this regard, investor includes consumers of financial services. Page 3 of 20

4 2.7 The aim of this study is to enable APRC members better understand the different investor protection practices available to investors in the region and identify some useful measures put in place by other jurisdictions for consideration or possible adoption. Page 4 of 20

5 What is Investor Protection? 3.1 The term investor protection covers a wide range of topics. For the current study, we have chosen to limit ourselves to three main areas. These are: a) market misconduct b) false and misleading statements or omissions (in offer documents); and c) recommendations without reasonable basis. While investor protection may broadly be interpreted to include corporate governance issues relating to shareholder rights, transparency, disclosure or take-over issues, these have been excluded from the scope of the current project. The General Framework For Investor Protection 3.2 Investor protection framework is established by way of statutory instruments, or through delegated or self-regulation. In general, most survey respondents have enacted securities and company legislation. There is also reliance on stock exchange rules to supplement statutory provisions. Additionally, certain jurisdictions rely on criminal law, as well as common law actions in tort, negligence or misrepresentation, as legal sources of investor protection. 3.3 Several countries also have more general consumer protection laws, which may be applied to violations of securities law. For example, New Zealand has enacted the Fair Trading Act 1986 and the Consumer Guarantees Act 1993 while India has a Consumer Protection Act. Retail investors have recourse to such consumer protection laws in addition to protection that is afforded under securities legislation. Singapore has taken a different approach financial services will be carved out of the draft Consumer Protection Fair Trading Bill to be passed later this year. 3 3 The decision to exclude financial services from the application of consumer protection legislation is premised on the fact that reliance will be placed on the industry to put in place measures such as consumer codes and dispute resolution schemes to afford protection to consumers. This exclusion will be reviewed two years after the law comes into effect. Page 5 of 20

6 A Holistic Approach To Investor Protection 3.4 The regulatory framework only provides a foundation - it is still necessary to consider how the process of investor protection actually occurs. Generally, investors can be shielded from fraudulent practices through a combination of three complementary approaches: on-going supervision and regulation, enforcement and remedial action, and investor education. a) On-going supervision The first level of investor protection is the proper approval/licensing and supervision of markets and intermediaries framework to ensure that prudential and conduct standards are met. This should be complemented by a regulatory framework that clearly sets out the nature of offences under the relevant laws. b) Enforcement and remedial actions As is the case with any effective regulatory and legal framework, the second limb of investor protection is appropriate mechanisms to conduct swift and effective enforcement against perpetrators of misconduct, and to enable investors recover their losses from offenders. This right of action could either be spelt out in securities regulation or covered in general law (such as contract, tort or consumer protection laws). Securities regulators should have appropriate enforcement powers. Enforcement action could include civil penalties, as is the case in some jurisdictions. c) Investor education The third layer of investor protection involves raising the basic level of financial literacy and increasing awareness of securities laws and investors rights. This will empower investors to know how to make use of disclosed information so that they may look after their own interests and minimise the risk of fraud. A regulatory system that is able to address public complaints and act on them reinforces this, raising public confidence in capital markets. 3.5 There is no one regulatory regime that is suitable for every jurisdiction. The effectiveness of a regime largely depends on the level of market development, level of investor sophistication, the legal system of respective jurisdictions and the resources availed to the regulator. This is recognised by IOSCO in the Objectives and Principles of Securities Page 6 of 20

7 Regulation. However, despite the differing circumstances in each jurisdiction, the survey results highlight some interesting observations on investor protection practices in the region. Investor Education 3.6 Though the survey circulated did not cover investor education, several respondents specifically mentioned it as an important function of the regulator as well as a keystone in investor protection efforts. Thus, this report will briefly touch on the role of investor education here. Investor education (and financial literacy) is seen in many jurisdictions as an important part of their investor protection efforts. Securities regulators are increasingly involved in these efforts to complement their other regulatory activities. Jurisdictions such as Australia, China, India and Singapore have actively taken steps to improve the level of investor awareness. For example, the Australian Securities and Investments Commission ( ASIC ) has a dedicated consumer protection website fido, and plays a prominent role in consumer and investor education, such as issuing discussion papers on such matters. 3.7 Investor education can be done through several channels, depending on the target audience - the mass media, the Internet or grass-roots organizations. Investor education is typically slanted towards pension and retirement planning issues as these are particularly relevant and provide a wider coverage for investor education initiatives. Special care should be given to the elderly and the less-educated segment of the population as they are likely to be more susceptible to being victims of opportunistic behaviour. 3.8 At the very least, consumers need to be aware of the importance to deal only with licensed entities, their rights, and the general rules that are in place. They should also have some fundamental knowledge of how the stock market works. In particular, the public needs to be aware of the market and other risks involved in common investment instruments, and to be wary of unrealistic and fraudulent claims. 3.9 Another aspect of investor education is to equip members of the public with the knowledge and ability to seek recourse in the event of misconduct. They must be aware of the existence of complaints channels in order for it to be effective. The responsibility for the Page 7 of 20

8 existence of such channels (and hence public awareness) is often shared between different agencies, such as the securities regulator, industry associations, criminal law enforcement agencies, the securities exchange or even consumer tribunals. Page 8 of 20

9 Market Misconduct 4.1 Market misconduct refers to opportunistic behaviour that interferes with the operation of fair, efficient and transparent markets. They comprise of various types of behaviors. While not exhaustive, the following list shows the types of behaviour generally considered market misconduct: a) Market manipulation b) False trading or market rigging c) Dissemination of information about illegal transactions d) False or misleading information e) Fraudulently inducing persons to deal f) Dishonest or deceptive conduct g) Insider trading h) Bucketing i) Failure to comply with continuous disclosure requirements j) Dealing on behalf of customers without permission Most jurisdictions consider market misconduct as serious offences and would subject them to criminal and/or other penalties, including imprisonment. How is Market Misconduct Uncovered? 4.2 Typically, the statutory regulator is given responsibility for detecting and enforcing market misconduct. This responsibility is also typically delegated to the securities exchanges, as front-line regulators. Most securities exchanges therefore conduct surveillance and memberdealer supervision. (Sometimes, as in the case of Japan s Securities and Exchange Surveillance Commission, a separate regulatory agency may be formed to perform such a role.) 4.3 Where SROs (ie the surveillance units of the exchanges) or industry groups (such as dealer associations) uncover suspicious trading activity or receive feedback from investors, they may raise this to the attention of the lead regulator. The lead regulator may then, by itself or in Page 9 of 20

10 co-operation with law enforcement agencies (such as the police) investigate the alleged misconduct. 4.4 Many of the survey respondents have also stated that they actively handle public complaints (about market misconduct) received via telephone or written communications, as well as electronic media (through or the Internet). In fact, Australia and China have indicated that they have specialised units whose function is to deal with complaints from members of the public. This provides another avenue for market misconduct contraventions to be brought to the attention of the relevant authoritires. Regulatory Actions 4.5 Apart from criminal sanctions, some regulators are also empowered to impose administrative sanctions such as written warnings, suspension or revocation of licences. This can be an effective deterrent as the reputational risk to licensed entities of such an administrative action can be severe. 4.6 Regulators in Malaysia, Singapore and Sri Lanka also have the power to compound offences. Composition refers to the process by which the regulator imposes a monetary fine for certain offences in lieu of criminal prosecutions, and can usually only be done with the consent of the public prosecutor (or its equivalent). Aside from these actions, regulators generally do not impose monetary fines or other punitive measures on their own authority. Only the Bangladesh SEC has specifically indicated that it has the power to impose financial penalties. 4.7 In Australia, ASIC has the power to accept enforceable undertakings. These undertakings are similar to a court order, and their purpose is to ensure compliance with securities law by requiring that an entity refrains from (or perform, where appropriate) a certain action. Enforceable undertakings are used in lieu of more severe regulatory action, where they may be more appropriate in protecting the interests of investors. 4.8 In Singapore, the Monetary Authority of Singapore may initiate civil penalty actions in Court against offenders for more serious forms of market misconduct. The maximum penalty Page 10 of 20

11 payable by the defendant is 3 times the profit gained or loss avoided by the offender as a result of his misconduct. 4.9 Another common power given to securities regulators is the power to put in place trading suspensions. Such suspensions may apply to only a particular security, but may also be used to halt the entire securities market in extreme cases. Generally, the use of such powers may be curtailed by a list of conditions. As an example, the Malaysia Securities Commission has the power to prohibit trading in particular securities (or classes of securities) where it is satisfied that the prohibition is in the public interest, or it is appropriate to do so for the protection of investors. When this power is invoked, a written report is submitted to the Minister setting out the reasons for the action. This is to ensure that this power is only exercised judiciously, as such a trading suspension could adversely affect investor confidence. Powers To Seek Injunctions or Court Orders 4.10 Regulators and law enforcement agencies may often have to go to court to seek injunctions or court orders. The aim of such orders may be to facilitate investigations through the seizure of property or records. Other injunctions may be filed with the intention of freezing the assets of the defendant to prevent the ill-gotten gains from being moved to a third-party or even offshore The provisions for the power to seek such injunctions may be found in securities law, or in common law. As such powers are an essential part of the regulatory toolkit, and it may be prudent to explicitly spell out such powers in securities law and to develop clear operating procedures which can be followed when there is a need to apply injunctive relief. Page 11 of 20

12 False or Misleading Statements and Omissions 5.1 It is a widely accepted principle of company and securities legislation of most jurisdictions that any offer of securities made to the public must be accompanied by a prospectus. The prospectus is meant to set out the material financial and other information relating to the issuer, as well as risk warnings and other facts that are relevant to an investment decision. The prospectus plays an important role as it is a document, and oftentimes the only one, that investors can rely upon to make their investment decisions. The prospectus must therefore be accurate and not contain any false or misleading statements, or omit material information. 5.2 The survey shows that the process by which contents of prospectuses are checked for false or misleading statements varies among jurisdictions. In some jurisdictions (such as Bangladesh, China, Indonesia, Malaysia, Chinese Taipei, Thailand and Vietnam), the securities regulator has lead responsibility, and pre-vets or reviews prospectuses. In Japan and New Zealand, other government agencies vet prospectuses. In Sri Lanka, vetting is done by the exchange (who may refer infractions to the SEC). 5.3 In Australia, India and Singapore, a slightly different approach is adopted. Neither the regulator nor SROs vet the contents of prospectuses. Instead, prospectuses are put on a website and exposed to the public for comments, which are taken into account when deciding if the offer is allowed to continue. 5.4 Because of the critical role played by the prospectus, it is important to identify who are accountable for the content of an offer document. While most jurisdictions recognize the liability of the issuer (such as the directors of the company), others also place a burden on the underwriters (or other entities party to the due diligence process, such as auditors.) If the breach is deemed to be serious enough to apply sanctions, then these parties will all be liable to some degree. Some regulators also retain the power to bar persons found guilty of such offences from company directorships or from taking any part in public offerings. Page 12 of 20

13 5.5 In general, false or misleading statements or omissions in offer documents are criminal offences punishable by both fines and imprisonment terms (typically, of up to 5 years). We also note that certain jurisdictions treat such an offence as market misconduct. Regulatory Actions 5.6 Once a material defect is detected in an offer document (through public comments, or during the vetting process), most jurisdictions would halt the offering. One common tool is for the regulator to issue a stop order, which has the effect of freezing the offering and preventing further collection of funds from the public. The regulator can then ask for an amended prospectus to be prepared by the issuer. If the stop order is not lifted, all funds collected will have to be returned to investors. 5.7 ASIC also has the power to take remedial action against wrongdoers, including the issuance of orders in relation to a defective product disclosure statement. The order provides offerors with a choice of repaying monies to applicants, as above or providing a supplementary product disclosure statement but to give applicants one month to return the financial product and be repaid. 5.8 In general, the types of regulatory actions that can be undertaken for market misconduct in terms of applying for injunctions or court orders are also available for false or misleading statements in prospectuses. Certain regulators may also impose fines for such offences. (For example, the Malaysia Securities Commission has indicated that it can impose fines not exceeding RM500,000.) Page 13 of 20

14 Recommendations without Reasonable Bases 6.1 With the increasing growth of distribution of financial products to retail clients, the giving of investment advice has become an important regulatory concern in many jurisdictions. Different jurisdictions have different issues confronting them, such as the scope of financial advisory regulation, the definition of what forms a reasonable basis of a recommendation, and the need to address conflicts of interest, whether through adequate disclosure or otherwise. 6.2 Investment advice is a regulated activity in most jurisdictions. However, the form of the regulation differs. In many jurisdictions, investment advisory is a separately licensable activity while in others, such advice will fall under the securities law and will apply to brokers and securities firms. Nevertheless, most jurisdictions set out statutory obligations on the quality of investment advice that can be offered, as well as relevant disclosures about the professional fitness of the adviser (i.e. whether the adviser has previously committed fraud or has a criminal record). 6.3 What constitutes a recommendation, and when is an adviser liable?. Generally, an adviser is only liable for a recommendation without reasonable basis if an investor can reasonably be expected rely on the recommendation to make a decision, and suffered a loss as a result. 6.4 We must also consider the meaning of reasonable basis. This typically consists of three elements: First, is the recommendation factually accurate and did the adviser take reasonable care to ensure that the recommendation was accurate? Second, did the adviser disclose relevant facts such as possible conflicts of interest 4? Third, did the recommendation take into account the individual needs and circumstances of the recipient? While each jurisdiction may apply its own test as to what constitutes a recommendation without reasonable basis, the three criteria above are commonly used, both in legislation as well as defenses in Court. 4 These conflicts of interests typically refer to the shareholdings of the adviser as well as existing business relationships between the adviser and the issuer of the securities. Page 14 of 20

15 6.5 New Zealand has adopted a slightly different approach by relying on provisions in its Fair Trading Act and Consumer Guarantees Act to provide guidance as to what constitutes a recommendation without reasonable basis. Under the Consumer Guarantees Act, all services (including investment advisory) must be carried out with reasonable care and skill. Other provisions may be interpreted to suggest that investment advisers should not recommend investments which are unsuitable for a client. Codes of Conduct 6.6 In some jurisdictions efforts are being made to improve standards of investment advice through the use of industry Codes of Conduct, either in place of or to complement statutory provisions. For example, Thailand has a Code of Conduct for investment analysts. One issue to be addressed for such Codes is whether or not they should be enforced by the regulator or industry association (through SROs, for example). 6.7 Such non-statutory Codes may be useful instruments when the financial advisory industry is still in its state of infancy. This allows the market to develop its own standards. However, even in developed markets, non-statutory Codes are still useful as a self-regulatory tool. Thus, we see the development of such guidelines as part of the overall regulatory framework. Treatment of Mass Media 6.8 A distinction is sometimes made for investment advice made through media channels. For example, jurisdictions including Australia, Malaysia, Singapore and Thailand exempt investment advice provided through newspapers or periodicals, as long as they are generally available to the public and the provision of advice is incidental to the main purpose of the media. Japan also exempts the Law on Investment Advisory to newspapers, magazines or books. 6.9 Despite this special treatment of mass media, we note that the exemption only applies in respect of investment advice and not in terms of market misconduct in general. Thus, if a newspaper were to publish an article which contains misleading statements about securities, they Page 15 of 20

16 would still be liable for an offence under market misconduct, in spite of the fact they are not a regulated entity. In this respect, the mass media is no different from any other person. Regulatory Actions 6.10 The kind of administrative actions that regulators can undertake for offences relating to recommendations without reasonable basis is largely similar to those for the other two categories. However, the Chinese Securities Regulatory Commission has indicated that it has the power to impose fines on entities which make recommendations without a reasonable basis in violation of its securities law. Page 16 of 20

17 Investor Recourse to Remedies 7.1 An important aspect of investor protection is the recourse availed to investors to recover any losses caused by fraud, misconduct or other breaches of fiduciary or regulatory obligations. This fosters market discipline, which in turn, deters misconduct. In most jurisdictions, aggrieved investors may initiate civil action in courts to obtain compensation for misconduct. This can be difficult to accomplish. Indeed, several jurisdictions have indicated that despite these action being available under their laws, no such cases involving securities fraud have ever gone to the courts in their jurisdiction. 7.2 Civil action on the basis of a successful criminal prosecution by a regulatory authority is one approach that has been accepted to help reduce the barriers to successful lawsuits by independent investors (who have less resources).asic as well as the Malaysia Securities Commission are empowered to institute civil proceedings on behalf of investors to recover losses if it feels that it is in the public interest to do so. In Singapore, the aggrieved investors may latch on to a successful criminal conviction or civil penalty action and file his claim in court for damages, without having to re-prove the incidence of misconduct. 7.3 Besides relying on securities law and common law principles relating to tort, negligence or failure in fiduciary responsibilities, investors in jurisdictions such as India and New Zealand may also rely on consumer protection laws. These laws will allow investors to pursue their cases in court if they feel that their rights as consumers have been violated, even if no clear contravention of securities law has occurred. 7.4 The amount of money that can be recovered in court is subject to limits. Generally the amount recoverable is limited to the loss suffered by the investor. For offences relating to prospectus inaccuracies or material omission, an offeror may be required to refund all monies invested even after secondary trading has commenced. Australia allows for the extreme case where even if the offeror (who is a corporation) is winding up, its directors will still be liable to refund all investors if they can prove that the prospectus was deficient. Alternative Dispute Resolution Mechanisms Page 17 of 20

18 7.5 Another route involves setting up alternative dispute resolution mechanisms. For example, in Australia all regulated entities are subject to a compensation scheme authorised to offer settlements (up to a fixed limit sufficient to protect most retail investors). However, such dispute resolution mechanisms may be difficult to set up and enforce, and it is not clear if their rulings are subject to legal recourse. Investor Compensation Funds 7.6 Another common practice is to set up investor compensation funds. These would usually be funded by a levy on exchange turnover, and protect investors from intermediaries that are unable to meet their obligations to investors. The exact use of the fund differs. Most jurisdictions use the fund to protect investors from the collapse of a broker, or to compensate investors where a broker is unable to meet its obligations. Other funds may be used to compensate investors for fraud by intermediary. 7.7 The key reason behind such funds is to allow retail investors who may not have the means to seek legal recourse or properly establish their claims as creditors on an insolvent intermediary to recover their losses in a relatively quicker and more efficient manner. The compensation funds themselves (or the authority administering them, whether the regulator, exchange or an independent agency) can later try and recover whatever assets it can from the defaulting intermediary. 7.8 In order to ensure that the greatest number of retail investors can be covered, the payouts from such funds are usually capped, both on an individual basis and sometimes on a per-event basis. This will ensure that the fund remains sufficient to handle any crisis that might occur. 7.9 Lastly, we note that investor compensation funds serve to protect individuals by pooling together obligations from the entire industry. While the creation of compensation funds can increase investor confidence, their applicability, funding and governance should be carefully studied to avoid moral hazard on the part of investors and intermediaries. Such funds are meant to be a protection of last resort. In fact, several jurisdictions such as Bangladesh, Singapore Page 18 of 20

19 and Sri Lanka indicated that their compensation funds have never been utilised. Countries which do not have such funds may be interested in experience in other jurisdictions as part of studying the desirability of implementing such a scheme Malaysia has pointed out that the statutory deposits collected from regulated intermediaries can also be used to compensate investors who have suffered a loss from a breach of fiduciary duties. This is a common practice in many jurisdictions. 5 China and Thailand are currently considering setting up investor compensation funds. Page 19 of 20

20 Conclusion 8.1 In general, the survey results indicate that a certain baseline level of investor rights exists among the responding jurisdictions, if not the entire Asia Pacific region. Market misconduct, inaccuracies in prospectuses and recommendations without reasonable basis are generally criminal offences and systems have been put into place to detect contraventions. There are also mechanisms in place to allow aggrieved investors to seek compensation in court, or in certain cases, from investor compensation schemes or third-party arbitration tribunals. 8.2 However, there are some points which jurisdictions may wish to consider to enhance the level of investor protection. a) Investor education Several jurisdictions have embarked on investor education as an important pre-condition for fostering efficient markets and protecting retail investors. It may be useful for more jurisdictions to consider this. b) Investor recourse to remedies While the legal framework may theoretically allow for investors to sue in court to recover their losses, this is difficult to achieve in practice. Jurisdictions should review how they can make it easier for retail investors to do so. One way is to allow for class actions, or similar joint action suits where investors can pool their resources when contemplating legal action. c) Alternative dispute resolution schemes The industry should be encouraged to set up alternative dispute resolution schemes. Such schemes may prevent costly and drawn-out litigation, and expedite investor compensation for minor contraventions. d) Administrative powers The administrative powers of regulators are largely limited to suspending or revoking licences, and does not cover the imposition of administrative fines. It may be useful for the regulators to consider adopting enforceable undertaking - type of administrative powers to enhance their ability to deal with situations where criminal prosecution is not appropriate, yet some form of substantive sanction and remedial action may be needed. Page 20 of 20