On 4 July 2023 the High Court delivered a judgment rejecting an appeal by Validus to prevent the Financial Markets Authority (‘FMA’) from issuing a permanent stop order in respect of its ‘products’ and related advertisements. 

In this Financial Law Insight we look at arguments raised in the High Court and take a look at the FMA’s stop and direction order powers.

Too good to be true

Validus offered a mix of educational packages and assorted rewards common in the murky area where pyramid schemes and multi-level marketing schemes blur. 

But wait, there’s more! There’s always more. The money used to purchase the educational pack was ‘invested’ on behalf of members in the ‘Validus pool’ which purported to trade in stocks, crypto, NFTs and the like. The ‘too good to be true’ returns were said to be 2% to 3% per week. After 60 weeks members were told they would get 350% of their money back. As always, there were additional rewards for recruiting new members.

A strange timeline

Rather than unpack the ins and outs of the Validus proposition, and whether it was genuine, this article focuses on the FMA’s response and use of its various powers. So, what did the regulator make of all this? Well, things unfolded in a curious manner.

Initial warning

The FMA jumped into action, issuing a warning about Validus on 15 September 2022. However, that warning was the usual generic one with the FMA stating it was (emphasis added):

"concerned that Validus is operating in breach of the New Zealand financial markets legislation, in particular, Validus is providing financial services in New Zealand without registration as a financial service provider as required by the Financial Service Providers (Registration and Dispute Resolution) Act 2008. We strongly recommend that investors do not trade or invest with entities that are not registered and/or licensed in New Zealand."

This initial warning seemed to suggest that Validus simply needed to be registered to comply. The inference being that the services and products provided were legitimate, aside from the failure to register locally as a financial service provider (which, in practice, is actually quite difficult for offshore providers – but that’s another story).

Interim stop order

By 15 February 2023, the FMA ramped things up by releasing an interim stop order against Validus International LLC and all associated persons of Validus. The order was made on the basis it was ‘in the public interest’ to prevent Validus from doing much of anything – making offers, providing services, accepting applications, or distributing communications – until the FMA could make a more considered decision. The FMA was of the preliminary view that Validus was distributing ‘restricted communications’ (including advertisements) that were false, misleading, confusing, or otherwise non compliant. 

Meanwhile, in Australia 

The FMA’s counterpart, the Australian Securities and Investment Commission (‘ASIC’), had by this stage already issued a clear alert to investors (dated 15 November 2022) stating Validus was ‘offering a suspicious investment opportunity’ and warning: ‘do not deal with, or transfer money to this entity’. ASIC also noted that Validus had all the signs of a classic pyramid scheme. 

ComCom also on the case

The Commerce Commission was also in on the act, kicking off a ‘secret’ investigation of the Validus ‘scheme’ on 6 December 2022. The Commerce Commission was of course looking at Validus from a Fair Trading Act perspective which meant a certain level of overlap with the FMA’s ongoing actions. 

Another warning 

Strangely, on 20 March 2023, the FMA decided to issue another warning (or at least an update) about Validus. Using the same wording as the initial warning, the FMA reiterated that it was ‘concerned that Validus is operating in breach of the New Zealand financial markets legislation. In particular, Validus is providing financial services in New Zealand without registration as a financial service provider’. Again, the focus of the warning was on registration (or lack thereof) – compared to the far clearer (and helpful) ASIC alert.

Permanent stop order

On 2 May 2023, the FMA made a permanent stop order against Validus. That order, which remains in force, prevents Validus International LLC, Validus FZCO, and associated persons of the Validus entities from making offers of financial products in New Zealand, distributing communications in relation to those products, and accepting further contributions.

Appeal by Validus

Although the FMA had made the stop order permanent in early May, it was not made public at the time because Validus appealed to the High Court. That appeal sought to prevent the order being made on the basis it was ‘ultra vires, irrational and unreasonable’. The FMA agreed not to publish the order while the appeal was determined.

Validus FZCO v FMA

In Validus FZCO v FMA [2023] NZHC 1701, Jagose J found in favour of the FMA. In the judgment, Jagose J describes the Validus pool as being inexplicably promoted as ‘educational packages’. An illustrative example of the promised returns had NZ$250 compounding to NZ$10,000 at 29 weeks, NZ$20,000 at 45 weeks, and up to NZ$35,000 at 60 weeks. 

Was there an offer of financial products?

The FMA’s stop orders contend that the Validus pool, and interests in the ‘pool’, were managed investment products. That is, the ‘pool’ was a scheme where members contribute money and have the right to participate in, or receive, financial benefits produced principally by the efforts of other persons. And those ‘members’ have no day-to-day control over the operation of the scheme. 

Validus countered that the ‘pool’ referred solely to its own investments, using its own funds, and that it did not pool any funds from members. In doing so Validus undermined its own seminars and advertising guff allowing the FMA to pounce. Essentially Validus had confirmed that the adverts were false, misleading, or at least confusing. What a mess.

One can see where Validus was going with the arguments raised – that since Validus was not offering financial products, either now or in the future, the FMA did not have the jurisdiction to issue a stop order (instead, the Commerce Commission should be the primary enforcement agency by default).

Intended offers included

In rebuttal, Jagose J reframed the Validus pool ‘claims’ as a debt security, being a right to be repaid money or paid interest on money deposited with, lent to, or otherwise owing. That definition, along with the FMA’s stop order power extending to ‘intended offers’, meant that financial products need not be in existence before the FMA can use its enforcement powers.

‘Outright scams’ not excluded

Importantly, Jagose J also points out that ‘the construction contended by Validus would be to exclude outright scams … from the FMA’s enforcement function’. The Judge, in shooting down Validus’ arguments, stated that ‘nothing in the statutory purposes justifies such exclusion’. The promotion of confident and informed participation and fair, efficient, and transparent financial markets means scams, potential scams, and suspicious investment opportunities are ‘in scope’ for FMA action.

FMA rather than ComCom

The Validus FZCO v FMA decision confirms three scenarios where the FMA can use stop orders:

• past contravention;
• likely future contravention; or
• imminent danger of substantial damage by any contravention.

This bolsters the FMA’s ability to readily step into the scam space.

On too many occasions scams and other suspicious investment offers have fallen through the regulatory cracks, with neither the FMA nor Commerce Commission prepared to take decisive action. The FMA already has statutory priority with regard to conduct in relation to financial products or services (confirmed in the 2014 Memorandum of Understanding between FMA and the Commerce Commission). Following Jagose J’s judgment, that priority should be readily reconfirmed to include potential scams masquerading as financial products and services.

Rare use of powers

To date the FMA has only used its stop and direction order powers on a few occasions. For example, an offer and related adverts by The One Management GP Limited were stopped on the basis they were likely to mislead or confuse. The returns payable, at 50% fixed over three years, didn’t stack up. Rockfort Markets Limited (now RockGlobal) was directed to remove or amend misleading advertisements that suggested derivatives were ‘safe’.

Simplicity NZ Limited (‘Simplicity’) was also, via direction order, told to remove certain statements relating to potential KiwiSaver returns and write to members to explain the error of its ways. Simplicity had suggested its members would retire with up to 20% more than the average KiwiSaver plan. The claim was based on Simplicity’s lower than average fees.

In contrast, when NZ Funds boasted of a 107% annual return, rather than reaching for a stop order, the FMA engaged in a sort of public warning process via media. Time will tell as to whether the FMA’s recent restructure leads to a more consistent approach being adopted.

What tool to use?

Ultimately, the use of a stop or direction order, and choosing which one to use, should be fairly straightforward. Stop orders, as the name suggests, can immediately prevent bad stuff happening – they can be issued on an interim or urgent basis where the need arises. Illegitimate offers and confusing or misleading adverts and disclosure documents are perfect fodder. 

Direction orders are suitable for those contraventions that can be corrected to some extent or at least explained, i.e. the FMA has an idea about what the contravening party needs to do to further avoid or mitigate matters. 

The Validus FZCO v FMA decision provides the FMA with additional leverage and support to use these enforcement tools. Expect to see the FMA issuing stop and direction orders more regularly.

Conclusion

The good news from the Validus mess is that the FMA now has a clear mandate to reach into the darker recesses of what it calls the ‘perimeter’. Fee and levy payers should rightly applaud the FMA’s efforts to clean up the fringes. The FMA, however, also needs to take a close look at the way it issues warnings and the content of those warnings. Warnings which focus on registration are not necessarily fit for purpose. 

Concerns regarding the effectiveness of the FMA’s warnings aside, the Validus decision is useful in confirming the FMA’s power to take decisive action when the need arises.