Corporate Advisory

04 Dec 2008

Increased Clarity as to Habitual Investors

Last week Dan McEwan was convicted of offences under the Securities Act 1978 (Act). In delivering its judgment, the court clarified who qualifies as an "habitual investor" under the Act. 

This is an important judgment, as it is the first time a court has attempted to define who may be considered an "habitual investor", not requiring the protections afforded by the Act. However, the decision of the District Court (Ministry of Economic Development v Stakeholder Finance Limited, Agnes Water Acquisitions Limited and Robert Daniel McEwan, District Court, Auckland CRI 2007-004-028150, 9 December 2008, Cunningham J) is expected to be appealed to the High Court. 

Background - Offers to the Public

The Act (and Securities Regulations) provide the framework for any offer of securities (such as shares or bonds) made to the public. Any of these offerings must comply with the Act - the principal requirement being that the offer cannot be made without a registered prospectus and investment statement, which comply with the Act. The prospectus and investment statement documentation requirements are generally considered rigorous. They can add substantial cost and burden to any person who wishes to issue securities. 

If securities are offered and allotted to a member of the public without complying with the Act, the allotment can be voided and the issuer required to repay subscription monies, with interest. As we have seen from the McEwan case, there is also a risk of personal liability (both criminal and civil) for the directors of the issuer and promoters of the offer.

Framework Exclusions

There are categories of persons to whom offers may be made where the Act will not apply. This is because such persons are "presumed by the legislature to be a category of persons able to protect themselves, because of their expertise. They are treated by the Act as not being a part of the public who need protection and excluded accordingly" (Lawrence v Registrar of Companies [2004] 3 NZLR 37). 

One of these categories often relied upon is that of "habitual investors" - persons whose principal business is the investment of money or who, in the course of and for the purpose of their business, habitually invest money.

This and other exclusions provide companies with the ability to raise funds without the costs and burdens of full documentation compliant with the Act, where offerees are sufficiently knowledgeable in relation to the business (and attendant risks) and do not need the protection of the Act.

Habitual Investors - Who Qualifies

The McEwan case sets out factors which may be considered in determining whether an investor qualifies as an habitual investor.

The class of habitual investors can be broken down into two limbs:

1. persons whose principal business is the investment of money; and
2. persons who, in the course of and   for the purposes of their business, habitually invest money.

The first limb will not apply unless the investments are the offeree's "principal" business. This has not been generally considered by the courts and was not considered in any detail in the McEwan case. However, "principal" is likely to have its ordinary natural meaning - first in order of importance; main.

The second limb was examined in more detail in the case. Cunningham J suggested the following considerations should be taken into account in determining whether a person, in the course of and for the purposes of their business, habitually invests money.

First, the question must be assessed against the background of the purpose of the Act: investor protection. To qualify as an habitual investor, the investor must be able to protect themselves as a result of their expertise.

Secondly, the person must constantly or continually invest money; this is the nature of an habitual investor.

Thirdly, in judging whether investment is "in the course of and for the purposes of their business", the following factors may be considered:

1. the number of investments an investor has made;
2. the period of time over which those investments have been made;
3. the nature of the investments and transactions;
4. the amounts of money involved; and
5. the success or otherwise of those investments.

In the McEwan case, Cunningham J stated summarily "[i]n order to describe someone as an habitual investor, the nature and quality of their investment history must come into the mix when one reflects on the fact that an exception is being made to the statutory requirements [to] fully inform members of the public about what is proposed". 

The court found that the investments the investors had made in the case did not qualify them as habitual investors. The investors had made seven investments over four years, six of which were in rental properties and one $10,000 investment in shares. 

One issue remains unclear, and that is whether a person can be considered an habitual investor for one class of investments only, e.g. property investments. In this case the investor had largely only invested in rental properties. Conceivably, even had the investor qualified as habitual in respect of investments of that nature, the investor would still require the legislative protection in respect of non-property related investments, although no judicial opinion on this has been forthcoming.

Habitual Investor Determination - An Issuer Matter

The court made it clear that the determination of whether an investor is an "habitual investor" is a matter for the directors of the issuer (and any promoter(s)), and not one which can be delegated to advisers. It is the responsibility of the directors to be satisfied that the potential investors have a sufficient understanding of the investment such that they can be within the habitual investor exclusion.  

Authors

Kevin Jaffe

Partner - Corporate & Commercial

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Shelley Cave

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Peter Hinton

Partner - Corporate & Commercial

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Don Holborow

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Michael Pollard

Partner - Corporate & Commercial

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Alex Campbell

Senior Associate - Corporate & Commercial

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