Law change to allow peer-to-peer lending

The Government has confirmed that online peer-to-peer will be made possible in New Zealand as part of the long-awaited overhaul of securities laws. A recently released Cabinet paper says:

Peer-to-peer lenders are effectively precluded from operating in New Zealand given the regulatory regime. Licensing is intended to introduce a regulatory regime proportionate to the risks that they pose. The licensing criteria will look at the character and background of the key individuals involved, and also a limited assessment of organisational processes.

This is welcome news for what could be a niche fledgling market in New Zealand. However, as tends to be the nature with securities law, the devil may lie in the yet-to-be-determined detail.

Review of securities law

The Government has released a discussion document on the “biggest shake-up of fundamental securities law in a generation”. The main act governing securities, the Securities Act, was passed in 1978 and has been in dire need of a review for some time. One proposed change of interest to the IT industry (and others) is to relax the rules on offering shares to employees. Employee share plans are often a desirable strategy for many startups. As the document notes, employee share plans:

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.

Tech law update 9 June 2010

Software patents and venture capital

An argument often made in support of software patents is that attracting investment will be harder without them. Clearly this isn’t always the case. US venture capitalist Brad Feld has written an open letter against software patents:

In more recent years, patents on software have been granted – hundreds of thousands of patents. These patents cover essential techniques in computer programming, and their existence is having a chilling effect on the startup companies that I work with… Venture capitalist like me, who work with new innovative start-ups can testify that software patents have a chilling effect on the market.

He joins a number of other venture capitalists who have expressed similar sentiments. Now, this is not an either/or situation. There is no doubt that many investors have been, and will continue to be, attracted by a potentially lucrative software patent. But comments such as Feld’s highlight the potential “chilling effects” of software patents, as seen by some investors, and also (further) dispel the myth that software patents are necessary for investment – as reflected by the fact that a huge amount of IT investment has always occurred in situations without software patents.

See also: Protecting IP in a post-software patent environment

Waiting for Bilski

Feld’s letter also highlights the long-awaited Bilksi decision. The case has attracted attention for the potentially major implications on the US patent system – of relevance to all patent-holders including in New Zealand – as well as the long wait for judgment.

Defamation by hyperlink

A US court ruling that “forwarding a link to defamatory material can be considered defamation” has caused some consternation, showing again that, thanks largely to constitutionally protected free speech, US defamation laws are rather less stringent than in New Zealand. Under New Zealand / English common law, such actions have long been capable of being defamatory. For example, in the old case of Hird v Wood (1894) 38 SJ 234, a Court found that a man sitting in a chair and pointing at another person’s defamatory sign contributed to the defamation. If linking is “innocent”, however, the publisher has a defence.

Tech law news 20 April 2010

ACTA deal and 3-strikes disconnection

ACTA negotiators have issued a statement that the agreement will not require participant countries to implement 3-strike internet disconnection laws. As it happens, the Government’s revised s92A bill (currently before parliament) still provides for disconnection in limited circumstances, but only as a Court-sanctioned remedy.

ICT finance regulation

Computerworld has an article on the upcoming financial services reform and its possible impact on ICT finance providers:

It is not clear which financial providers in the IT industry will be affected. The MED says that, in general, if an organisation is providing credit under a credit contract, then they are offering a financial service and the registration requirement will apply, meaning they have to join a dispute resolution service.

Consumer finance customers (i.e. those obtaining finance for personal or domestic purposes) already receive a good measure of protection under the Credit Contracts and Consumer Finance Act 2003. The new reforms are still being refined; the extent to which they will affect finance operators remains to be seen.

Government indemnities

The Government recently amended clause 4 of the Public Finance (Departmental Guarantees and Indemnities) Regulations 2007 to permit Government departments to agree to:

any guarantee or indemnity contained in the standard terms and conditions for the purchase, licence, or use by the Crown of—

(i) an Internet site;
(ii) software;
(iii) information technology tools, products, or services.

Many websites include indemnities in their standard terms (for example, by even reading the New Zealand Herald you agree to an indemnity). This change makes it more practicable for the Government to use common online and software applications, without having to obtain internal sign-offs.

The “Immortal Soul” clause

On the subject of website terms, a website recently added an “immortal soul” clause to its terms and conditions:

By placing an order via this Web site on the first day of the fourth month of the year 2010 Anno Domini, you agree to grant Us a non transferable option to claim, for now and for ever more, your immortal soul.

While this was an April Fool’s Day prank, it’s purpose was to highlight the fact that very few people actually read website terms. In any case, something tells me this would not be an enforceable website term!

Clearing the path for employee ownership

Discussions at Foo Camp are under the Chatham House Rule (not to mention FriendDA), so generally what happens at Foo Camp stays at Foo Camp. However, it’s okay to share your own thoughts on a session you ran. So here are my points from a session I co-presented at this year’s Kiwi Foo Camp, “Clearing the path for Employee Ownership”:

  • 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.