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The FMA's court victory over Innovative Securities shows what NZ regulators are up against with the FSPR, and why they need to cooperate with their overseas counterparts

The FMA's court victory over Innovative Securities shows what NZ regulators are up against with the FSPR, and why they need to cooperate with their overseas counterparts

By Gareth Vaughan

Information obtained and released by the Green Party shows the Government's belated move to tighten the rules around the international embarrassment of New Zealand foreign trusts appears to be paying off, with a major cull of such trusts. But a High Court judgment released last week highlights once again that another arena that's also damaging NZ's international reputation still requires major surgery.

I'm talking here about NZ's problematic Financial Service Providers Register (FSPR).

The judgment from Justice Simon Moore dismisses Innovative Securities Ltd's attempt to overturn the Financial Markets Authority's decision to have the company deregistered from the FSPR. 

Moore notes that although Innovative Securities has three staff in Auckland, all its 21,000 clients are located overseas and none of the tasks undertaken by the Auckland office involves the provision of financial advice to clients anywhere. The five key countries in which Innovative Securities' customers are found are the Russian Federation, Kazakhstan, Ukraine, Bulgaria and Uzbekistan. Accounts with ASB and BNZ were closed by the banks due to money laundering concerns, Justice Moore says.

Two paragraphs in Justice Moore's judgment highlight some of the key challenges our regulators face when dealing with NZ registered but offshore operating companies. These challenges apply to cross jurisdictional regulatory arbitrage issues. But more on those below. First a little background.

A NZ registered company since November 28, 2008, Innovative Securities has a NZ director, Peter Meads, as it's required to by law. The other two directors are Hungarian residents Darin Simeonov and Andrej Sztojanov. The shareholder is Innovative International Group Ltd of the UK. According to accounts filed with the UK's Companies House, the ultimate controlling party in Innovative International Group is Stoyan Konstantinov Stoyanov, a Bulgarian national with a Budapest address.

Justice Moore says that, according to Innovative Securities, the company was established in NZ for commercial reasons. The stated purpose was to establish a base in NZ with the intention of eventually offering services to clients in Australia, NZ and Asia.

Innovative Securities was registered on NZ's FSPR on December 3, 2012. It was registered to provide the following financial services; b Innovative Securities was deregistered from the FSPR on June 8 following the court judgment, but remains a NZ registered company.

The FSPR, what is it?

Since December 2010 the FSPR has required anyone providing a financial service, such as insurers, banks, lenders and financial advisers, to be registered on the FSPR, operated by the Ministry of Business, Innovation & Employment's Companies Office. In a similar manner to a telephone directory, the FSPR records the name, address and financial dispute resolution service membership of the provider, along with the services it's registered to provide and any licences it may have. 

Currently a firm can register on the FSPR if it has a place of business in NZ, regardless of where in the world its financial services are pitched or provided. This means entities can, and do, set up superficial operations in NZ by leasing an office or getting a virtual office, and perhaps employing someone to provide back-office services. There's no pre-vetting by a NZ regulator, and they may not offer financial services within NZ. These entities can, however, use their NZ registration overseas to give a false impression that they are regulated in NZ and trade off this country's good name. 

As MBIE has put it, "Registration on the FSPR allows these firms to misrepresent to overseas customers that they are licensed or actively regulated in New Zealand, and enables them to enjoy a lesser degree of scrutiny overseas than might otherwise be the case. The public often interprets 'registration' on the FSPR to mean that an entity is actively regulated in New Zealand." Since 2014, the FMA has had the power to direct the Companies Registrar, now Ross van der Schyff, to deregister companies from the FSPR and it has done so in some instances where they fail to provide a financial service to New Zealanders, or where the FMA believes their only objective is to give the impression that they are regulated in NZ when they aren't. 

Three from three

The Innovative Securities case is the third time an FMA directed FSPR deregistration has been challenged in court and the third time the FMA's decision has been upheld. Albeit in one of the cases, with Vivier and Company, the FMA had to go to the Court of Appeal to have its decision confirmed.

In the Innovative Securities case Justice Moore concluded that; "The FMA was correct to determine that the registration of ISL [Innovative Securities Ltd] is or is likely to create a false or misleading appearance that it is an FSP [financial service provider] in New Zealand, its financial services are provided from New Zealand and that the provision of services from New Zealand to overseas clients are regulated by New Zealand law when this is clearly not the case."

"Thus the FMA was correct to consider that registration in such circumstances will have or is likely to have the effect of damaging the integrity and reputation of New Zealand's financial markets and New Zealand's law and regulatory arrangements for regulating those markets," Justice Moore said.

He also notes there's "a paucity of evidence" the business has expanded in the way Innovative Securities said it intended.

"As I understand the evidence, the New Zealand office remains modest in size and little or no steps have been taken to develop new markets in New Zealand, Australia or Asia," writes Justice Moore.

DIMS & a dodgy AML audit

However, Innovative Securities may not have given up just yet. Asked whether the company may appeal the judgment, Meads told, "We have read through the judgement and we are reviewing our options at this stage. We have a DIMS [Discretionary Investment Management Services licence] application currently being processed [by the FMA] and we expect registration to the Financial Service Providers Register will occur as part of this process."

The High Court judgment notes that Innovative Securities submitted an application for a DIMS licence in September 2015. Included in supporting material with the application was an anti-money laundering audit report purported to have been prepared by Aub Chapman and Michael McDonald. Concerned the report didn't look legitimate, the FMA independently contacted Chapman and McDonald.

Chapman replied saying he had initially declined to participate in the audit due to existing commitments but had informally revised a draft of the final report but only in respect of its structure, format and coverage, Justice Moore writes. 

"He said that at no time did he enter into any formal contractual arrangements and had no involvement in the actual conduct of the audit. He said he did not seek nor was he provided with any documentation regarding any analysis or testing undertaken as part of the audit," the judgment says.

"Mr McDonald's position was more abbreviated. He said he had no connection with ISL, had never heard of them and had not conducted any anti-money laundering audit or anything else for ISL."

The FMA wrote to ISL in December 2015 detailing its concerns in a "minded to decline" letter followed by oral advice. Innovative Securities wrote back saying it had accidentally submitted the wrong document and supplied a new version. However, the company withdrew its DIMS licence application in January 2016 after being advised it had failed to meet any of the minimum standards for registration. Justice Moore notes it has not reapplied.

A series of diverse jurisdictions

From a bigger picture perspective, the two paragraphs that really caught my eye in Justice Moore's judgment are below.

"ISL has provided very limited information as to how it and its related offshore entities are regulated overseas. Furthermore, what explanations it has provided are confusing. For example, ISL advised that its parent company, Innovative International Group Ltd, registered in the United Kingdom, has its headquarters in Hungary and an AML [anti-money laundering] programme in Belize. However, the document attached to the submission is described as ISL's AML/CFT Policy (Belize). It refers only to New Zealand's AML legislation. It makes no reference to AML regulations in Belize. Furthermore, despite apparently having no clients in Belize, ISL is registered and licensed there for international asset protection and management, money transmission services and payment processing services. Why this is necessary if ISL has no clients in Belize is left unexplained," Justice Moore writes.

"ISL owns 100% of Innovative Securities Europe ZRT. Innovative Securities Europe ZRT holds an operating licence from the Hungarian Central Bank. This company is permitted to conduct business and serve clients in all European Union countries. Other related companies include Innovative Securities Asset Management LLC, which is registered in the United States of America as a financial advisor and manages funds in the United States solely for professional clients and third party accounts (brokers and banks). Innovative Securities NBFI is another related company which is registered in the former State of Yugoslavia and serves European clients in non-European countries. It has offices in Bulgaria, Russia, Kazakhstan, Ukraine and Estonia. Another related company, Innovative Securities Profit Max Fund NV, is registered and listed in The Netherlands. Innovative Securities Ltd is registered and licensed in Central America," says Justice Moore.

The Judge also notes that although Innovative Securities Europe ZRT has an operating licence from the Hungarian Central Bank to perform portfolio management investment services, no information has been provided as to how Innovative Securities is subject to regulatory oversight in Hungary or the other European Union jurisdictions where it provides financial services.

Clearly Innovative Securities has woven quite a web across a series of diverse jurisdictions. This demonstrates the importance of NZ's regulators, including the FMA and the Companies Office when it receives applications from foreigners wanting to register NZ companies and be those companies' directors and shareholders, working with their counterparts in other jurisdictions. This is because cross jurisdictional regulatory arbitrage is like rust. Those pursuing such opportunities never sleep. To try and keep up regulators must work with their counterparts in other jurisdictions.

An AML loophole

The Innovative Securities case also highlights a hole in NZ's Anti-Money Laundering and Countering Financing of Terrorism Act (AML/CFT Act), something first wrote about in 2013. This is guidance that says; "An entity incorporated or formed in New Zealand, which carries on financial activities wholly outside New Zealand [like Innovative Securities], will not be a 'reporting entity' under the AML/CFT Act."

Justice Moore's judgment notes the FMA highlighted that Innovative Securities' registration as a financial service provider in NZ was likely to create the misleading appearance that the company is subject to NZ anti-money laundering regulation when it is not.

In terms of international co-operation, the FMA is a signatory to the International Organization of Securities Commissions' (IOSCO) Multilateral Memorandum of Understanding. An FMA spokesman says although this is a useful arrangement, there's an important difference between licensed entities and registered firms and the scope of the information it's able to seek.

"When firms apply for licences we require directors and senior managers to authorise us to complete checks with overseas authorities, and we have done so where we have cause. We’ve received information requests about financial service provider registered companies that have been suspected of carrying out unauthorised activity overseas, but also some concerning NZ registered companies. This information can inform our assessment of whether firms should be considered for deregistration. We have also sought information from overseas regulators under the IOSCO Multilateral Memorandum of Understanding to assist our inquiries into registered firms, especially where we believe that firms have provided us with false information," the FMA spokesman said.

What the Companies Office does to try and combat cross jurisdictional regulatory arbitrage

Asked about working with its counterparts in other countries, a Companies Office spokeswoman said the Registrar of Companies has a Memorandum of Understanding with the Australian Securities and Investments Committee on the exchange of information and mutual assistance. The Companies Office is also a charter member of the Corporate Registers Forum,  an association of international corporate registries.

"Through the Corporate Registers Forum and its other international activities, the Companies Office has strong relationships with its equivalents in many overseas countries. Where appropriate, requests are made of those offices for information relevant to compliance and enforcement activities in New Zealand, including where there is a concern that an overseas person is not qualified to be a director of a NZ company," the spokeswoman said.

"Where an application to register a company or add directors meets certain criteria, which may include that directors of the company reside overseas, the Companies Office may require additional evidence regarding the proposed directors and/or shareholders prior to processing.  Additional evidence includes; Certified copy of director's consent form signed by every person named as a director of the proposed company, certified copy of shareholder’s consent form signed by every person named as a shareholder of the proposed company, proof of residency for every person named as a director of the proposed company such as power, gas or phone or local municipal rates demand, and proof of identity such as certified copy of that person's passport," the spokeswoman added.

The track record of who has slipped through the Companies Office cracks shows these steps are far from water tight. In just one example there's Lord Taylor of Warwick who was a Vivier director. He was a member of Britain's House of Lords, who was jailed in 2011 for false expense claims, and disbarred in 2012 for "conduct discreditable to a barrister." There are also ongoing problems with company agents. And then there's the issue of companies deemed too dodgy to be on the FSPR that are allowed to remain as NZ registered companies. This is madness, in my view.

Govt aims to introduce Bill attempting to clean up the FSPR before September's election

Meanwhile, back to the FSPR. The Government is currently in the middle of its third attempt to clean up the FSPR following an MBIE review. The details of the Government's clean up plans are here. They include the suggestion that companies on the FSPR will need to name who their supervisor is under the AML/CFT Act. This would be either the Reserve Bank, FMA or Department of Internal Affairs. If no supervisor is named, it would be clear said company isn't overseen by any NZ regulator for AML/CFT Act compliance.

The government FSPR review comes as part of a broad review of the Financial Advisers Act 2008 and the Financial Service Providers (Registration and Dispute Resolution) Act 2008. A spokesman for Commerce and Consumer Affairs Minister Jacqui Dean says submissions received on the draft of the Financial Services Legislation Amendment Bill are being analysed.

"Once drafting of the Bill is complete, it will be introduced to Parliament and the normal Parliamentary process for the passage of legislation will begin. This will include a select committee process which will provide a further opportunity for public submissions on the Bill. In terms of timing the aim is to introduce the Bill to Parliament before the [September 23] election. Members will also be appointed to the Code Working Group, which will develop the new code of conduct for financial advice. We expect the Code Working Group will begin developing the code by August 2017," Dean's spokesman said.

On the FSPR also see this article on the 83 countries where the FSPR has been wrecking our reputation, and my view, that the Government should simply abolish the FSPR because NZ doesn't even need it.

*A version of this article was first published in our email for paying subscribers early on Wednesday morning. See here for more details and how to subscribe.

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Our regulators continue to tell us regulatory power is the way forward. But that only keeps them in jobs. A lot of this wild west stuff can't be controlled by registers and disclosure standards and all the rest. It's an illusion.
What needs to happen is that we cut out some of these activities entirely. Like we refuse to register trusts with any foreign component at all. Like local trustees have to be real and carry full liability, not just be fronts.