Disclosure requirements: some anomalous laws

Parliamentary sovereignty is a key feature of our political and governance system. But sometimes parliaments end up producing rather anomalous results when we look from one piece of legislation to another.

Twenty years ago, the Reserve Bank moved to a system of prudential regulation of banks that was designed to rely heavily on public disclosure of key information on a regular basis. Disclosure was never envisaged as the only element of the regulatory regime. Basle 1 basic regulatory capital requirements were also in place, and were left in place as much at the request of the banks (who wanted to be seen as operating in an internationally-recognisable regime) as because of any conviction by the Reserve Bank that capital requirements were worthwhile. And the Bank and the Minister of Finance retained significant powers to intervene if a bank was getting into trouble, and was (or appeared to be approaching) insolvency.

But the proposition underpinning the disclosure framework was that investors (depositors, bond-holders) and others transacting with a bank should have all the information that the Reserve Bank had about a regulated bank. That seemed only fair and reasonable – after all, it was investors’ money that was at stake, not the Reserve Bank’s.  And if the Reserve Bank had private information that was not disclosed to depositors/investors that could, in the event of a subsequent failure, open the Reserve Bank up to charges (political and rhetorical, even if not legal) that it should have acted earlier, and thus prevented the losses investors/depositors subsequently experienced.  Private information might have supported the argument for government bailouts if things went wrong.

A lot of effort went in to devising the disclosure regime. In some areas it may have gone a little too far.  One example might have been requirements on banks to have Key Information Summary documents immediately available in every branch.  I suspect the number of these documents that were ever actually read was extremely small. The regime went to somewhat absurd lengths: someone who worked in the economics department of one local bank told me that their bank interpreted the regulations to mean that Key Information Summaries had to be available for perusal in the economics department (“branch”)  itself – a part of a bank not typically visited by the public.

Because so much weight was put on disclosure requirements, the law was written in a way that exposed those responsible for bank disclosure documents to significant penalties (including potential imprisonment) for breaches of the requirements. Don Brash has many stories to tell of the reaction of outraged directors (and puzzled ones in other jurisdictions). There had, perhaps, been a tendency for bank boards to be made up of people with gilded reputations, rather than much ability or willingness to ask hard questions about the conduct of the Bank. The prospect of such steep penalties certainly altered incentives, and behaviour.   Banks may, or may not, be safer, but directors have certainly gone to considerable lengths to minimise their own risks

In the last decade, the Reserve Bank has backed away from heavy reliance on the public disclosure aspect of the regulatory regime for banks. The disclosure requirements have themselves been watered down, and there are proposals for further reductions in the requirements in a recent Bank consultative document. This tendency seems unfortunate – despite inevitable complaints from banks about compliance costs. If anything, the focus globally in recent decades has been on more and more disclosure. Perhaps more concerning is the explicit shift the Reserve Bank has made to collecting private information about banks’ day-to-day activities and risks, information which is not available to investors and depositors.  The  Reserve Bank has been keen to promote the idea of its OBR tool being used in the event of a bank failure, so it remains the case that the regime is designed to be about depositors/investors being primarily at risk of losing money, not the Crown. And yet the Crown uses statutory powers to acquire information about these regulated institutions which depositors do not typically have access to.

But notwithstanding the diminished emphasis on disclosure, the Reserve Bank is still keen to remind people of the stiff penalties for breaches of disclosure requirements. In a speech only a couple of years ago, the head of the banking supervision department noted

Self-discipline is closely linked with sound governance. We have a strong tradition of director attestations, coupled with heavy penalties for non-compliance. For example, bank directors who fail to comply with disclosure obligations face fines of up to $200,000 or 18 months in prison.

Those are very stiff penalties for individuals, even if the scale of potential fines on the institutions themselves seems lighter (a maximum fine of $2 million –  banks typically have rather more than 10 times the equity of a typical director).

But, of course, banks are only one element of the financial system, and only one of the areas in which people are exposed to financial risk.  Another, in which people are typically quite risk averse, is superannuation schemes.   There is no prudential supervisory regime for superannuation schemes –  no government regulator actively scrutinises the business of schemes to minimise the risk of failure.  To a large extent, members of superannuation schemes are on their own.

However, there is a Superannuation Schemes Act, which is designed to provide some basic regulatory parameters and protections for members.  One key component of that regime is disclosure.  And that makes sense, how can members make good decisions, and help ensure that their money is safe, if they do not have access to information.

One of the key requirements is regarding scheme annual reports.  For members of superannuation schemes, the material in the Annual Report is akin to a disclosure statement for bank depositors.  But an important difference is that there is a quite a lot of public information available about banks, even if disclosure statements didn’t exist (credit rating information for example), whereas there is almost none about superannuation schemes.  The disclosures in the Annual Report are absolutely imperative.

There is an entire schedule to the Act which sets out minimum information that must be included in the Annual Reports.  That includes audited financial statements, disclosure of related party exposures, affirmations that contributions and payments have been made in accord with the rules of the relevant scheme.  And scheme trustees must also advise members of any amendments to the relevant trust deed since the previous Annual Report.  All of those seem pretty foundational.  You wouldn’t want to be in a scheme where the rules could be changed without you being aware of it.

Recall that breaches of disclosure requirements on banks could be met with both civil and criminal sanctions, with the latter including up to 18 months in prison.

And in the Superannuation Schemes Act?  Well, there, Parliament seemed to take a rather different approach.  Breaches of disclosure requirements are subject to a fine of up to $500.  No, there are no missing zeroes there, the maximum penalty is five hundred dollars.  I’m a trustee of a superannuation fund, and I was surprised to learn how light the potential criminal penalties are [1].  And yet people who are members of longstanding defined benefit pension schemes typically have far more money tied up in those schemes than most will have in any bank or other regulated financial institution.

I’m not quite sure why Parliament in 1989 had such a different approach to the importance of full  and honest legally-required disclosures than it had only a few years later when it came to consider the case of banks.

I’m not usually a fan of increased regulation, but if there is a good case for such disclosure laws at all, as there probably is with very long-lived commitments such as superannuation schemes, which often involve people in their declining years, then such slight penalties almost make a joke of the requirements.  Trustees might, for example, come to treat apparent breaches of such requirements as a matter of little account, even if the consequences for members of such breaches could have been serious.

I hesitate to encourage them, but this looks an issue for MBIE, in its policy role, and the FMA to take up.

[1] And apparently, and equally remarkably, there is apparently a two year statute of limitations on prosecuting such offences

One thought on “Disclosure requirements: some anomalous laws

  1. Piffle fines compared with the million dollars and five years in jail for a businessman whose employee may get killed.

    On a scale the financial fines should be a lot higher.


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