Exploring additional avenues for investment disclosure

Last month “The Supervisor” scrutinised a key disclosure document of New Zealand’s managed investment scheme (MIS) regulatory regime, the Statement of Investment Policy and Objectives (SIPO).  SIPOs were identified as being among the most important documents that most retail investors have never read and the unsung heroes of financial product disclosure.  In this month’s article we consider yet another such worthy item that far too often languishes in the shade of underappreciated obscurity: Other Material Information (OMI).  Unlike a SIPO, which is a standalone document separately constructed under its own prescriptive set of rules in law and regulation, an OMI is derivative of and referential to a Product Disclosure Statement (PDS) to which it relates.

The investor-centric purpose of PDSs is succinctly set out in section 49 of the Financial Markets Conduct Act 2013 (FMCA):

The purpose of a PDS is to provide certain information that is likely to assist a prudent but non-expert person to decide whether or not to acquire the financial products.

As a document supplementary to the PDS, the OMI by logical extension should share the same purpose even though this is not legislated.  PDSs are additionally subject to the FMCA section 61 requirement to provide information that is “worded and presented in a clear, concise, and effective manner”.  Although OMIs are not captured by this FMCA section, as a matter of best practice and good conduct on the part of financial product offerors they should be written to meet the same “plain English” standard.  To understand where OMIs fit within regulated product disclosure and what they are supposed to do for the benefit of retail investors, it helps first to grasp the constraints placed on PDSs.  Basically, OMIs start out from the informational point where PDSs end.

Tight rules constrain documents

Akin to SIPOS, PDSs have a prescriptive set of rules for their form and content that is embedded within the FMCA and the Financial Markets Conduct Regulations 2014 (FMCR).  If anything, PDSs are more highly specified than SIPOs, which is consistent with the role that PDSs serve as the primary mode of retail investor disclosure.  SIPOS are required only for managed investment products, whereas PDSs are specified in the FMCR for public offers of financial products under the  categories of debt, equity, managed investment products, and derivatives (regulations 22-25).  

Imposing uniformity across PDSs brings with it the substantial benefit of making it easier for investors and their financial advisers to compare apples with apples and spot the oranges.  For one matter, depending on the type of financial product involved, PDSs are restricted in total length by two alternative standards, as per the table below:

Within the PDS, a key information summary (KIS) is required that is subject to its own alternative length specifications in FMCR regulation 29:

In 2018, the Financial Markets Authority issued an exemption notice for dual-language PDSs that are published in both English and Māori which permitted variations in word count for the Māori text but required the English text maximum limits to stand.  It is evident that tight rules imposed on the length of PDSs is intended to compress their content into matters most relevant to the investing public, especially in the case of managed fund PDSs.  This intention is emphasized by specification of the categories of information that must be included. For example in Part 1, Schedule 4 of the FMCR concerning managed funds, the ten sections legally permitted in the PDS are listed in regulation 9, with further detailed requirements for the contents of each specified in the following regulations 10 through 50. 

In September 2019, the FMA issued an FAQ that further underscored the rigid restrictions on form, content and length for PDSs, and therefore it is clear that this type of disclosure is kept on a short leash by the regulator as per requirements in law.  The PDS is surely one of the most legislatively micromanaged of financial product disclosure documents in New Zealand.

The meaning of “material”

The PDS is a standalone document intended to provide sufficient information for investors to make informed decisions.  In many cases, however, offerors of financial products may wish to provide potential investors with more information than the PDS straitjacket permits.  This is where the OMI comes in as an optional supplement to the PDS.  However, the OMI itself is not an open slather opportunity to smuggle through the back door just about anything that cannot be squeezed into a PDS.  This much is apparent when the terms in the OMI’s own name are analysed. 

“Other” indicates that the information provided is different from and additional to information already contained in the PDS.  “Information” is minimally defined under the FMCA Interpretation section as including documents.  However the word “material” makes all the difference in this instance – “material information” is explicitly defined at some length in section 59 of Part 3, subpart 2 of the FMCA:

Meaning of material information in this Part

(1)

In this Part, material information, in relation to a regulated offer, means information that—

(a) a reasonable person would expect to, or to be likely to, influence persons who commonly invest in financial products in deciding whether to acquire the financial products on offer; and

(b) relates to the particular financial products on offer or the particular issuer, rather than to financial products generally or issuers generally.

(2) However, material information does not include—

(a) information about the specific terms of a financial product that have been customised for a particular investor; or

(b) information about an identifiable investor.

Section 59 contains a wide definition that leaves substantial latitude for what information can be classed as material, albeit somewhat constrained negatively in terms of what does not belong to the class.  On material information criteria, OMIs represent a non-PDS disclosure option for issuers of regulated offers to communicate with investors in a manner that permits considerable discretion as to what may be disclosed.

Checking out the disclosure market

An online survey of fund manager disclosure documentation for KiwiSaver and retail funds reveals three sorts of approaches to publication of OMIs:

1. No OMI is published, meaning that the PDS alone is relied upon for disclosure by the issuer;
2. An OMI is published to supplement the PDS with extra information, but does not include any legislative or regulatory reference to either the FMCA or the FMCR as the basis for its disclosure;
3. An OMI is published that specifically states bases for disclosure in both the FMCA and the FMCR.

In the third case, the OMIs concerned uniformly refer to FMCA subsection 57(1)(b)(ii), which states, “contains all material information relating to the regulated offer that is not contained in the PDS”.  Additionally, the same OMIs refer to FMCR, Schedule 4, clause 52.  The latter clause deals with four matters of disclosure concerning (i) material contracts, (ii) market indices, (iii) conflicts of interest and (iv) best estimates (if any) of annual fund charge amounts used in the PDS.  The range of matters covered in the OMIs surveyed often extends beyond those specified in clause 52, but whatever is included must still meet the test of being material information as defined in FMCA section 59.  In practice OMIs seem to be given longer rein than PDSs so far as form, content and length are concerned. 

Getting best value out of OMIs

If an OMI is provided by an issuer in respect of an investment, then it is prudent for a potential investor to read it alongside the PDS in order to gain a more complete picture of the proposition on offer.  Certainly, a professional financial adviser considering recommending this investment to a client should regard it as mandatory first to have closely read both the PDS and the OMI.  There can be no excuse for a professional adviser to stop at having read the PDS and leaving the OMI out of account.

Of particular importance regarding OMIs is that they can go into greater detail concerning risks attached to investing in the financial products they describe than can length-constrained PDSs.  Under FMCR regulation 9, the fourth itemized section required to be addressed in a PDS is, “What are the risks of investing?”.   As crucial as this topic is for investors and their financial advisers to understand properly, it still jostles for PDS space with the other nine mandatory sections.  In the OMI, investment risks can be treated more expansively.  It would be imprudent, if not hazardous, for investors and financial advisers not to follow up on the risk section of a PDS by failing to read any corresponding information provided within a related OMI.

From a licensed Supervisor’s perspective, an OMI should meet certain basic standards that at minimum should include:

1. Compliance with FMCA section 59 and subsection 57(1)(b)(ii) in respect of material information;
2. Compliance (if applicable) with FMCR, Schedule 4, clause 52;
3. Relevancy of OMI content to information provided in the related PDS;
4. Inclusion of any other material matters that meet the FMCA section 49 purpose test for the PDS (e.g., policies or procedures relating to the financial products that could influence investment decisions if known about);
5. No inclusion of content that does not properly belong within the definition of material information under FMCA Part 3 subpart 2 section 59;
6. Adherence as a matter of best practice and good conduct to the same “plain English” requirements as are specified for PDSs in FMCA section 61;
7. Close review and update (if applicable) of the OMI whenever the related PDS is changed or replaced, or any investment risks attached to the financial product concerned have altered in any manner;
8. Commitment to provide material information that is evidently in the best interests of potential investors in the financial product concerned.

Conclusion

“OMIs shouldn’t be relegated to playing poor cousins of PDSs,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.

“These additional disclosure documents don’t get their fair share of credit due for the invaluable role they play in the creation of effective financial product disclosure, informed investors, and efficient markets.”

“OMIs are of course optional for financial product issuers, who might otherwise prefer to rely on PDSs alone to disclose to potential investors.”

“Nonetheless, OMIs should be given serious consideration by issuers where providing them is genuinely in the best interests of investors, particularly concerning helping the public to make better-informed decisions about where to place its money.”

“An OMI judiciously written could make all the difference needed to assist investors to make the right decisions for themselves.”

“Where OMIs are published, investors and their financial advisers should read them thoroughly alongside their companion PDSs.”

“From the Supervisor’s perspective, we pay as close attention to OMIs as we do to PDSs and think that investors and their advisers should follow suit.”

For comment or more information, please contact Matt at [email protected].