are … used as a partial substitute for cash remuneration (especially in young, rapidly growing companies that are “cash poor”), and to foster a sense of ownership among employees and participation in the company’s management and direction.

Unfortunately, New Zealand’s existing law makes them more complex to implement than they should be, in particular for small businesses (see my post Clearing the path for employee ownership). The review will hopefully change that:

The Ministry proposes to [allow] offerings of equity and equity options to employees of all companies (listed and unlisted), up to 15% of assets or 15% of the outstanding value of securities of the same class. An additional restriction that we are considering is to require that employee share schemes are offered as part of an employment contract, and would form a single, discrete offering not integrated with any other offers. This would focus the scheme on the employment relationship and its role in remuneration rather than allowing offers to all employees for fundraising purposes.

This would be a big improvement on the current regime. In my view, the restrictions on employee share schemes should be minimal. The idea of linking share schemes to employment contracts, while potentially slightly more onerous for employers, is a sensible way of providing protection for employees. Generally, people working for a company will have a better impression of its prospects and whether or not it is “dodgy” than the public. If they are offered the opportunity, and make an informed decision to invest, the law should avoid putting roadblocks in their way.

Peer-to-peer lending

The review will also look at peer-to-peer lending. The discussion document outlines the problem:

The Ministry is told that [peer-to-peer lending] services are not practical in New Zealand because the borrower is an “issuer” for the purposes of the Securities Act and Financial Reporting Act. The Securities Act states that for a debt security the issuer is “the person on whose behalf any money paid in consideration of the allotment of the security is received”. The borrower, usually a private individual receiving a relatively small sum of money, would have to register a prospectus, produce an investment statement, and file annual audited financial reports.

Peer-to-peer lending, driven by the internet, is experiencing rapid growth in other countries. It would be very unfortunate if New Zealand does not use the rare opportunity of this review to remove undesirable barriers to this new form of finance. This is especially important given the long-term tightening of credit availability since the global financial crisis, and the possibility that peer-to-peer lending and other forms of micro-finance could provide a critical source of capital for small Kiwi businesses.

The discussion document suggests that the service provider, rather than the individual lenders, could be regulated. That would provide a large piece of the solution, but still has the potential to impose an unrealistic or uneconomic burden on the service provider. To make peer-to-peer lending really feasible, the new securities law must not lump such services (and the people who will use them) in the same class as retail finance operations. Imagine, for example, if every casual Trade Me seller, or even Trade Me itself, was required to be licensed under the Secondhand Dealers and Pawnbrokers Act. A clear exemption should be made for “casual lenders” to participate in peer-to-peer finance, and service providers should be recognised as such – intermediaries, not active participants in any financing.

• New Zealand companies want to be able to offer employee share ownership. Employee share schemes are an established part of industries (including the IT sector) in other countries. They are recognised as having a number of benefits, such as encouraging employee retention with minimal (if any) cash-flow cost to the firm.
• However, in New Zealand they are not common. New Zealand law does not encourage employee share ownership. In fact, New Zealand law puts a number of obstacles in the way of a small business trying to set up a scheme.
• The law that makes it difficult (or tries to make it difficult) for dodgy finance companies to rip off “mum & dad” investors, the Securities Act 1978, is unfortunately the same law that makes it difficult for small companies to set up employee share schemes.
• The Securities Act 1978 is outdated, complicated, and has been heavily amended over the years into its current messy state. Also, much of the detail is not found in the Act itself, but in myriad regulations with obscure names. This makes it hard for the average business person to do their own research and understand the various rules.
• There is no “safe harbour” provision, with bright-line tests and plain-English requirements, to enable companies to efficiently implement employee share schemes. In fact the opposite is the case.
• There are a number of tax disincentives and complications, for businesses and employee shareholders. Other countries have introduced tax advantages for employee share schemes.
• It would be a simple change for the Government to fix these problems and create an environment where employee share schemes are encouraged. There is a review underway as part of the Capital Markets Taskforce which may result in a new Securities Act being developed, but the review had not looked at incentivising employee share schemes. Furthermore, while the report discusses introducing clearer, broader exemptions in certain areas, given the great recession and the finance company collapses, it is possible there will be a tightening, rather than a loosening, of the overall regulation currently in the Act. What effect this will have on employee share schemes waits to be seen.
• This again reflects the problem of having employee share schemes governed by the same protective, prescriptive rules as actual offers of securities to the public, which are in reality very different.
• A simple solution would be to clearly separate the rules for offers of securities to the public from the rules for employee share schemes, with the latter being significantly streamlined.This could possibly be done in a separate act from any new Securities Act.